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Asian Development Outlook 2006 Update : 1. Developing Asia and the world : Subregional summaries
South AsiaTrends in 2006 and 2007
Projections for inflation in this Update are generally consistent with those made in April. Inflation is still put at a high 6.0% in 2006, slightly trimmed from the earlier forecast of 6.1%, since anticipated large price increases in Bangladesh and Pakistan have been somewhat less than expected. To control inflation, monetary authorities across the subregion are lifting policy interest rates, with notable progress in limiting the extent of price increases expected by next year. The forecast for subregional inflation in 2007 remains at 5.4%, with each country likely to experience lower inflation than in 2006. The aggregate current account deficit for 2006 is now projected to be considerably smaller than previously forecast, at 2.1% of GDP, about a percentage point less. This is attributable to stronger than originally projected current account positions for Bangladesh, India, and Pakistan. These developments on balance further translate into a more favorable outlook for 2007, when the subregional current account deficit is now expected to remain at 2006’s level as a share of GDP. India
A sharp rise in inflation to 5.5% is projected in FY2006, as surging demand for credit boosts the money supply and as food and fuel prices exert pressures from the supply side. Prices of “primary articles,” for example, particularly vegetables, pulses, and wheat, have been rising substantially, not due to poor harvests in FY2005 but rather due to bumps in the process of liberalizing the agroprocessing sector. Rising inflation has already been recorded and it reached 5.4% in the latter half of June. The Reserve Bank of India has responded by raising key shortterm interest rates twice, first in early June and then in late July. Higher international oil prices and their limited pass-through to domestic fuel prices are contributing to inflationary expectations, even if high quasi- fiscal fuel subsidies are keeping inflation in check in the short term. India’s inflation should moderate to 5.0% in FY2007, with expected improved stock management by food security agencies and slowing international commodity price inflation. Current developments suggest an improving industrial export position for India, forming the basis for substantial reductions in ADO 2006’s current account deficit projection. The Update reduces the current account deficit projection for FY2006 to only 2.1% of GDP (from 3.0%). For FY2007, it lowers it to 1.9% of GDP (from 3.3%), primarily because of stabilizing international oil prices and rising domestic fuel prices, which should damp domestic demand and slow the growth of oil imports. PakistanThe economy is estimated to have expanded by 6.6% in FY2006, slightly in excess of the projection. Growth is still strong, though at its slowest rate in 3 years due to significantly lower output expansion in agriculture and some deceleration in industry. Services, however, registered recordhigh growth of 8.8% as financial services, telecommunications, and wholesale and retail trade expanded rapidly. Projected growth for FY2007 has been lowered to 7.0%, though this still represents significant acceleration relative to FY2006. Increased investment and imports of capital goods and machinery are expected to push growth rates in both agriculture and industry higher in FY2007, while privatization of the Pakistan Telecommunication Company, along with continuing benefits flowing from other reforms, will help maintain robust services sector growth. Inflation in Pakistan is still among the highest in the subregion at 8.0% in FY2006 (Figure 1.4.8). However, this rate was a half percentage point lower than expected, and shows significant improvement from the 9.3% recorded in FY2005. The State Bank of Pakistan implemented monetary tightening to combat inflation, reducing growth in the money supply to less than that of nominal GDP. Forecast inflation for FY2007 is revised downward to 6.5%, reflecting the State Bank’s tighter monetary stance adopted in late July when it increased its policy rate to 9.5% and raised banks’ reserve and liquidity requirement ratios. The current account deficit ballooned to 4.4% of GDP in FY2006, partly due to a sharply rising oil import bill but mainly due to the very rapid expansion in domestic demand that boosted non-oil imports. Worryingly, about a third of this deficit was financed through nonrecurrent privatization proceeds and foreign investment inflows into equities. Although the deficit recorded in FY2006 was lower than the projected level of 4.9%, prospects for the current account position in FY2007 have not improved, and a further deterioration in the deficit to 5.5% of GDP is expected. Bangladesh
International commodity price increases—compounded by a depreciating currency—and a rapid rise in the money supply pushed inflation to 7.2% in FY2006. In spite of the tighter monetary policy stance adopted by Bangladesh Bank, which featured policy interest rate hikes and an increased cash-reserve requirement and statutory liquidity ratios, the growth of broad money maintained its rapid pace. Domestic credit also expanded considerably due to high public sector borrowing. Inflation for FY2007 is forecast at 7.0%, as monetary tightening is only expected modestly to offset inflationary pressures from the reduction in fuel subsidies and continued depreciation of the taka. Instead of the projected deficit of 0.8% of GDP, a current account surplus of 0.9% was actually recorded in FY2006, primarily because of impressive export earnings and a reduction in import growth to a more sustainable rate (Figure 1.4.9). Workers’ remittances also played a part in this. Sustained growth of exports and rising remittances should again translate into a small current account surplus in FY2007, projected at around 0.3% of GDP. Other South Asian economiesGrowth forecasts for Sri Lanka have been marked up substantially. Based on its high first-quarter growth performance—due mainly to major crops and the services sector—and on indications that growth momentum is being sustained, the economy is now projected to expand by 6.1% in 2006. With prospects of continued robust growth in industry and a return of services growth to trend, the forecast for 2007 at 5.8% is also significantly higher than in ADO 2006. However, further escalation of the conflict between the Government and the Liberation Tigers of Tamil Eelam will likely damage prospects for any sustained rapid economic expansion. In Nepal, growth in FY2006 is estimated at only 2.3%, reflecting the adverse effects of the conflict and political problems, particularly for manufacturing, transport, and communications. However, this estimate is slightly higher than projected in April, and stems from the restoration of Parliament and prospects of some political progress to break the current logjam. For similar reasons, GDP growth in FY2007 has been upgraded from 3.4% to 4.0%. Self-evidently, progress in the peace process remains the key factor in realizing growth forecasts. In Afghanistan, economic expansion in FY2006 is likely to slow to 12.0% from the FY2005 rate because of the drought affecting large portions of the country. Reconstruction efforts and overall political stability have also been adversely affected by renewed problems regarding security, and growth is expected to decline further to 10.6% in FY2007. The economy of Bhutan is estimated to have expanded by a robust 10.0% in FY2006, and this should accelerate to about 12.0% in FY2007 as the Tala hydropower project reaches full production. Finally, the Maldives is projected to register high GDP growth of 18.7% in 2006, due essentially to the very strong post-tsunami recovery in tourism seen in 2006. The outlook for 2007 is for growth to moderate to a steady and more sustainable rate of 6.0%.
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Aggregate output in South Asia is expected to expand by 7.5% in 2006,
marking a continuation of recent impressive economic performance
(Figure 1.4.7). This outcome is slightly better than the forecast given
in ADO 2006, and rests on upward revisions of estimated or projected
GDP growth in 2006 for all countries, except Bhutan. Growth is
generally driven by services, though industry’s contribution to total
output is becoming more significant. Strong domestic demand is buoyed
by vigorous private consumption and rising investment. South Asia
is projected to post 7.5% growth in 2007, due primarily to sustained
expansion of the Indian economy and acceleration in Pakistan.
Forecast growth for South Asia’s largest economy remains buoyant with
successive annual expansions of 7.8% projected for FY2006 and FY2007.
If these projections bear out, India will have achieved rapid growth of at
least 7.5% annually for 5 consecutive years by FY2007—a most un-Hindu
rate of growth. Services continue to drive growth, as the dominant and
most rapidly expanding sector, but industrial production has also been
accelerating in recent years, directed toward both domestic and foreign
markets. This implies the development of a stronger industrial base to complement the consistent expansion of services, further improving
prospects for long-term growth in output and trade. Against this, fiscal
pressures are mounting.
Growth exceeded expectations in FY2006, with GDP increasing by
6.7%, the highest rate in the past 10 years. Industry was the primary
driver, though the manufacturing subsector still underperformed due to
recurrent power disruptions. Recovery in agriculture also helped boost
growth. Strong private consumption, aided by workers’ remittance inflows
and rising private investment, were the main demand contributors to
growth. Growth is projected to slow to 6.0% in FY2007, reflecting some
sluggishness in agriculture.
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