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Asian Development Outlook 2006 Update : 1. Developing Asia and the world
Prospects for developing Asia, 2006 and 2007Growth
The forecast for growth in 2007 is predicated on generally favorable external conditions, but it factors in tighter global liquidity and softer growth in the industrial countries. The forecast also anticipates oil prices staying high. The impacts on commerce of the recent heightened security alert on international air travel are expected to be short-lived. However, if elevated threats persist over a prolonged period and disrupt international travel this would clearly be a negative factor, especially for those countries, such as the Maldives (and to a lesser extent Thailand), which are highly dependent on tourism. In the first half of 2006, East Asia grew at a fast tempo. Growth of 8.2% is now expected for the full year (Figure 1.2.2), up from the estimate of 7.7% made in April’s ADO 2006. The upward revision reflects a faster expansion in the PRC on greater than expected strength of fixed investment and exports. Brisk 11.3% year-on-year growth in the second-quarter of 2006 in the PRC was the fastest since 1994, bringing first-half growth to 10.9%. Even with an interest rate increase in mid-August, adding to earlier monetary and administrative tightening measures, second-half cooling will likely be modest. Growth for full-year 2006 is now estimated at 10.4%. 
Fast growth in the PRC helped lift the performance of Hong Kong, China, and with strengthening in domestic demand, projected growth there has been raised from ADO 2006’s forecast by 1 percentage point to 6.5%. In the Republic of Korea (hereafter Korea), a softening in consumer spending and in construction activity prevail; nevertheless, growth is still expected to come in at just over 5%. In Taipei,China, consumer spending and private investment are weak, but exports are keeping the economy more or less on track, and it should grow by 4.3%, marginally adjusted down from April’s forecast. Mongolia is now expected to grow by 6.8%; the upward revision reflects stronger exports of copper and gold, driven by higher global prices and by increased foreign direct investment (FDI) in mining.
Other notable developments in South Asia include an improvement in prospects for Nepal with the restoration of Parliament and a broadened political process that has resulted in the cessation of insurgent hostilities. The growth forecast has been nudged up to 2.3%. Still, Nepal will likely need some time to regain the economic momentum that it saw in the mid-1990s. Elsewhere, Sri Lanka enjoyed broad-based, good growth in the first half of 2006, despite rising violence that threatens the maintenance of the cease-fire agreement. Favorable developments in major crops and rapid expansion in the large services sector (including tourism) provide the basis for lifting the full-year GDP growth forecast from 5.3% to 6.1%. 
Southeast Asia has had a mixed year so far. The Update slightly downgrades the 2006 estimate for subregional growth to 5.4%, from the earlier 5.5% forecast (Figure 1.2.4). Political uncertainty and the postponement of large infrastructure projects in Thailand are now registering in slower expansion, and so the estimate for 2006 has been revised down by a half percentage point to 4.2%. In Malaysia, a bounce in investment expenditure has supported growth, but domestic consumption has slowed. The economy is now expected to post slightly slower (than earlier projected) growth of 5.2% in 2006. More positively elsewhere in Southeast Asia, favorable weather conditions and progress with fiscal consolidation have helped lift confidence and performance in the Philippines, and higher expansion of 5.4% is now expected for 2006. In Singapore, the growth forecast has been lifted to 6.6% for 2006, reflecting buoyant electronics and pharmaceuticals activity. In Indonesia, high inflation and last year’s increase in interest rates have, as expected, crimped first half growth, but domestic demand should pick up in the second half as liquidity eases, and so the growth forecast of 5.4% has been maintained. Viet Nam continues to attract significant inflows of FDI and is set to achieve the 7.8% growth forecast for 2006, the fastest rate in the subregion. There is no change in the 2006 growth forecasts for Cambodia and the Lao People’s Democratic Republic. In Central Asia, the Update lifts projections for the oil-producing countries of Azerbaijan and Kazakhstan, reflecting their strengthened oil sectors, and for Armenia, mainly because of continued very strong construction activity. These revisions push up the Central Asian aggregate to 11.3%, about 1 percentage point higher than the average pace of the last 5 years. 
Faster growth in the Pacific subregion, now put at 3.3% for 2006, reflects upward revisions for the two largest economies of Papua New Guinea (benefiting from high oil prices) and the Fiji Islands. Looking ahead, developing Asia’s growth in 2007 is now expected to be 7.1%, up a notch from the 7.0% forecast in ADO 2006 in April. This minor revision balances a less optimistic outlook for Southeast Asia with a positive reassessment of East Asia’s prospects. In Southeast Asia, growth in Thailand and Malaysia could be prone to weakness next year. Thailand’s growth forecast has been reset at 4.0% from 5.5% while Malaysia’s is adjusted to 5.0% from 5.8%. In Thailand, since political uncertainty is clouding the near term, investors are likely to defer projects until the direction ahead is clearer. Public sector investment programs may also take a back seat until the new government resolves vexed political issues. If heightened security concerns were to impact on travel and tourism, this would be another negative element for the country. 
In Malaysia, an expected softening in global information technology demand and in domestic consumption is likely to hold growth in check. No changes have been made to other countries’ forecasts. Viet Nam’s anticipated entry into WTO should help support growth at 8.0%. Taken together, these country considerations are expected to deduct about a half percentage point from April’s projections from growth in Southeast Asia in 2007, which is now set at 5.3% (Figure 1.2.5). In East Asia, the Update raises projected growth to 7.5% (from 7.1%) on the assumption that both the PRC and Hong Kong, China may grow more quickly than previously anticipated. Growth in the PRC seems unlikely to decelerate significantly ahead of the 2008 Olympics in Beijing, and the Government’s own target of 8.0% may well be overshot. However, it is expected that growth in Korea may now be closer to 4.6% than the 4.9% predicted in ADO 2006. The revised estimate for Korea reflects both the impact of the won’s appreciation on net exports, and the effect of increases in interest rates on domestic investment and consumption demand. 
South Asian growth is expected to consolidate at 7.5% in 2007, an unchanged aggregate from 2006 that masks some revisions at country level. In particular, the outlook for Nepal has been upgraded to 4.0%, on the basis of a more stable political environment and an improvement in security. Sri Lanka’s forecast, too, is revised up, to 5.8%. Despite underlying inflationary pressures and fiscal difficulties, it is anticipated that momentum in industry and services will be underpinned by an expansive fiscal policy and tsunami-related reconstruction. This outlook is contingent on no further escalation in the conflict between the Government and the Liberation Tigers of Tamil Eelam. In Pakistan, growth is expected to accelerate in 2007 to 7.0% as agriculture picks up. Fiscal policy is also seen remaining supportive of growth, with further increases in development expenditure. The subregional averages for Central Asia and the Pacific are heavily influenced by the outlook for oil prices, and the baseline forecast assumes a higher level in 2007 than was predicted in ADO 2006. For Central Asia, the Update revises growth for 2007 up to 10.3% from 9.8% in April, in reflection of an improved outlook for the two major oil producers. In the Pacific, most economies are totally reliant on fuel imports, but Papua New Guinea, with about two fifths of the subregion’s GDP, and Timor-Leste are net oil exporters. Upward revisions to their growth projections have lifted the aggregate Pacific outlook. 
InflationA modest headline inflation average disguises a wide variation in outcomes. Average price inflation in developing Asia is expected to increase to 3.8% in 2006 from 3.4% in 2005 (Figure 1.2.6). In some countries, inflation is high but pressures are ebbing; in others, inflation is low but inflationary expectations are rising. Monetary authorities continue to show vigilance and generally lean toward tightening. Policy rates have tracked up in many countries (Figure 1.2.7). 
Despite fast growth, the PRC faces few signs of price pressures (with the exception of property assets) and is expected to record inflation of 1.6% in 2006. This reflects the supply-side nature of the current boom and burgeoning growth of capacity, which has helped keep goods prices in check. Inflation has also been helped by a good harvest that has kept food prices low. Inflation rates in most countries in South Asia are high and trending up, despite fairly common heavy subsidization to limit domestic fuel price increases (Figure 1.2.8). It is estimated that inflation will average 6.0% in 2006, up from 5.2% in 2005. In Pakistan, inflation climbed steeply in 2005 and, though falling, remained high in 2006. This presents a significant challenge for the authorities. In addition to raising policy interest rates in 2005 and again in July 2006, the central bank has taken several steps to rein in liquidity and credit growth. In India, too, inflation data for the first 6 months of 2006 have shown an uptick, in part reflecting higher food prices and a fuel price increase in June. The authorities lifted key policy rates in late July, the fifth rise since October 2005, as well as provisioning requirements for personal credit and mortgages. In Bangladesh, a depreciation of the taka and high prices for commodity imports have contributed to inflation. Monetary growth has breached official targets, with borrowing by the public sector, particularly the Bangladesh Petroleum Company, helping feed rapid credit growth. 
Southeast Asia’s aggregate inflation outcome is lifted by Indonesia (Figure 1.2.9). In 2006, Indonesian inflation is expected to average 14.0%, having been stoked by large rises in retail fuel prices in 2005. To limit knock-on effects, Bank Indonesia aggressively raised its policy rate. This tightening has made itself felt and monthly inflation figures are now heading back toward single digits, which has enabled the central bank to lower its repurchase rate. In the Philippines, too, inflationary pressures are beginning to recede—full-year 2006 inflation is put at 6.7%—and the policy rate has held steady. In Central Asia, the windfall from high oil prices has spilled over into demand and this has added to inflationary pressures. Monetary authorities have attempted to strengthen policies, but underdeveloped policy tools and cost-push pressures hamper their efforts. It is expected that inflation will pick up to average 8.5% in 2006. The outlook for 2007 is for inflation in developing Asia to ease to 3.3%. Slower demand growth in the world economy, some respite in commodity price rises, higher interest rates and tighter liquidity domestically, and downward supply pressures on prices of manufactured goods should keep the lid firmly on inflation. If regional currencies were to appreciate this would also help check inflation. Despite robust growth, inflation in the PRC is expected to remain tame at 1.8%, revised down from ADO 2006’s April estimate of 3.0%. Rising food production as well as productivity gains and competitive pressures on manufactured goods prices will help contain inflation. Other countries have seen only few and comparatively minor revisions to the earlier forecast. In South Asia, Pakistan is now expected to make better progress in reducing inflation in 2007, as is the Philippines in Southeast Asia. 
External payments balancesPartly as a consequence of high oil prices, current account surpluses have narrowed in many countries and in some have now moved into deficit. Nevertheless, for the broader region, the current account surplus is expected to widen (Figure 1.2.10) and a strong balance-of-payments position is confirmed by developments in foreign exchange reserves through June 2006 (Box 1.2.1). Driven by fast export growth, the PRC’s current account surplus is still widening, with July’s figures setting new monthly records. For the year, the PRC’s surplus is estimated at $187 billion, or 7.0% of GDP. Developing Asia for 2006 is expected to run a current account surplus equivalent to 4.2% of GDP (Figure 1.2.11). Taking the PRC out of the aggregate cuts the surplus for developing Asia to 2.6% of GDP. 
Southeast Asia generally remains a surplus region, with Malaysia and Singapore’s surpluses running into double digits. Indonesia is also expected to remain in surplus. Strong inward remittances from overseas workers more than outweigh a deficit on the trade account in the Philippines. Thailand is expected to stay in deficit in 2006, but with slower growth of domestic demand now anticipated, the estimated deficit has been revised down to just 0.5% of GDP, from 2.5% in April’s forecast. In South Asia, the current account deficit for 2006 is estimated at 2.1% of GDP. As a net importer of oil, South Asia has had to shoulder the costs of high prices. However, the estimated deficit is lower that the ADO 2006 estimate, largely reflecting a smaller projected deficit for India at 2.1% of GDP, down from the earlier forecast of 3.0%. Faster export growth built on solid growth of the country’s export-oriented manufacturing sector is the basis for the revision. Conversely, Pakistan’s current account deficit is widening as a consequence of rapid growth in domestic demand and an escalation in the oil import bill. Although the deficit has been easily financed, about one third of the financing comes either from privatization inflows, which are likely to dwindle, or from equity inflows, which are volatile. However, to the extent that investment demand is priming imports, future deficits may come down. Only Bangladesh and Nepal are expected to run a surplus on the current account. The small surplus for Bangladesh reflects strength in exports and workers’ remittances as well as credit restraint limiting non-oil imports. Substantial workers’ remittances also contribute to Nepal’s surplus, but so does weak domestic demand associated with the insurgency.
As a net oil-exporting subregion, high oil prices are expected to improve the current account surplus in 2006 for Central Asia. But net oil importers—Armenia, Tajikistan, and Kyrgyz Republic—will post sizable deficits. A similar pattern of surpluses and deficits is evident in the Pacific. Papua New Guinea’s current account surplus is more than offset by deficits in other countries. Although the outlook for 2007 is still for a small reduction in developing Asia’s overall current account surplus to 4.0% (from 4.2% in 2006), the estimated surplus has been revised up since April. The main factor in the upgrade is the jump in the PRC’s expected surplus from 5.7% to 6.8% of GDP. Developments to date have also led to revisions in the outlook for several other large economies in developing Asia: a reduction in the projected deficit for India and Thailand, an increase in the surplus for Malaysia and the Philippines, and an increase in the deficit for Pakistan. Viet Nam may move into a current account surplus in 2007 for the first time since 2001, its strengthening external position bolstered by high oil export prices and remittance inflows.
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Developing Asia is expected to grow by 7.7% in 2006, easing to 7.1% in 2007 (Figure 1.2.1 and Table 1.2.1). Fast growth at a regional level is supported by strong performances by the PRC and India, since together these two economies account for over 50% of regional GDP. The remaining economies of developing Asia are expected to grow by more modest averages: 5.5% in 2006 and 5.1% in 2007. 
South Asia continues to make strong headway. Growth of 7.5% is now estimated for 2006, slightly higher than April’s 7.3% forecast (Figure 1.2.3). Annual income growth in the subregion has averaged 7.7% since 2002, outpacing Southeast Asia by about 2 percentage points and almost matching that of East Asia. Recent data provide a basis for modestly upgrading forecasts for Bangladesh, India, and Pakistan as well as for the smaller economies. As noted in the country chapters in Part 2 of ADO 2006, manufacturing industries are increasingly vibrant in the three larger economies, pushing export growth to high levels. However, services are still the main driver of growth. On the demand side, investment rates have begun to show a healthy and sustained rise—as has consumer demand, aided to varying degrees by greater availability of consumer and housing credit and by increased inflows of workers’ remittances. 
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