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Asian Development Outlook 2005 : I. Developing Asia and the world : Overview of economic highlights and prospects
Developing Asia: Subregional trends and prospectsIn the aftermath of the tsunami disaster that struck some parts of developing Asia on 26 December 2004, the new year began on a somber note. While the human dimensions of the disaster were tragic, recovery is expected to be rapid, with minimal downside effects at the macroeconomic level (Box 1.1). East AsiaThe economies of East Asia performed strongly in 2004, recording aggregate growth of 7.8%, about a percentage point higher than in the previous 2 years (Figure 1.13). As conditions improved during the year, expectations for growth were ratcheted up, and actual aggregate growth surpassed the forecast in ADO 2004 by nearly a percentage point. The five East Asian economies benefited from strong external demand for their mainly manufactured products. Investment was robust in most of them, joining with generally buoyant consumption spending to lift domestic demand. Growth in the PRC was expected to decline as the Government introduced a range of controls starting in September 2003 to limit excessive investment in some industries. As it turned out, though, GDP growth edged up to 9.5% in 2004, the highest level in 7 years. Fixed asset investment grew more slowly, but still rose by a steep 25.8%. Actual net foreign direct investment (FDI) reached a huge $60.6 billion (up by 50% in 4 years) as global companies continued to relocate labor-intensive and export-oriented industries to the PRC. FDI in services has also surged since the country joined WTO in 2001 and opened more services to foreign competition. Consumption, driven by rising incomes, grew faster and merchandise trade--both exports and imports--soared by about 36%. Adding to the strong year, the growth rate of agriculture more than doubled.
Growth in Taipei,China and Hong Kong, China rose sharply, the former by 2.4 percentage points to 5.7% and the latter by nearly 5 percentage points to 8.1%. The recovery of the information technology industry was of particular benefit to Taipei,China. As production and export shipments rose, so did the need for further investment in this important industry. Domestic demand, mainly private consumption and investment, was the driver of growth. Services such as tourism and retail trading had been hit hard in 2003 by the outbreak of SARS in Taipei,China; PRC; and Hong Kong, China, so that a services sector rebound in 2004 contributed to growth in these three economies. Hong Kong, China had suffered 3 years of weak growth until 2004, so its bounce was particularly marked. The economy's property market recovered from a prolonged slump, helping drive consumption and investment. 
In Korea, a surge in global demand for electronic products and motor vehicles pushed up manufacturing output and exports, and helped lift investment slightly. However, private consumption fell for a second year in a row because of high household debt levels, acting as a drag on GDP growth. For the year, GDP growth picked up by 1.5 percentage points to 4.6%, which was the lowest rate of increase in the subregion. In contrast, Mongolia, from a much lower level of economic development than elsewhere in East Asia, recorded growth of 10.6%, nearly double the 2003 pace and the strongest since the country began its economic transition in 1991. Mongolia's economy got a lift from the expansion of mining and a milder winter, which allowed the livestock industry to expand rapidly. Several East Asian economies have battled deflation in recent years. That was not a problem in 2004. A combination of stronger economic growth, together with much higher prices for imported fuel and raw materials plus price increases in domestically produced food in the PRC and Mongolia, revived inflation. Consumer price inflation averaged 3.3% for the subregion, up by 2.0 percentage points from 2003. In the PRC, inflation rose to above 5% in the third quarter, prompting the first increase in interest rates since 1995. Inflation moderated later in the year to leave the PRC's full-year average rate at 3.9%. In Mongolia, inflation hit 10.6% for the year. Korea's inflation rate was unchanged from 2003 at 3.6%. Taipei,China recorded 1.6% inflation after almost 3 years of deflation. In Hong Kong, China the CPI recorded year-on-year increases from July, which still left the price index down by 0.4% on average for the year. East Asia's growth will slow in 2005, but economic activity will remain robust in most economies. Aggregate growth for the subregion in 2005 is forecast to decline by about 1 percentage point from 2004's high rate, to 6.7%, before rising to 7.0-7.2% in the following 2 years. All of the subregional economies are expected to see easing growth rates in 2005. One reason is an expected halving of the expansion in subregional merchandise exports, from 2004's unsustainably rapid rate of 28.0%. Demand for high-tech products started to soften in late 2004, though the cyclical downturn is expected to be mild and relatively brief. In the PRC, growth is projected to decline to 8.5% in 2005, but this would still put the economy on a higher growth track than other subregional economies. Mongolia is projected to grow by 7.0% in 2005, and the other three economies in the 4-6% range. A key to this scenario is a soft landing of the PRC economy. The authorities have used administrative, fiscal, and monetary controls to cool investment in industries considered overheated, including cement, steel, and real estate. They are expected to rely more on market-oriented pricing measures from this year. But there are risks on both sides: substantial investment under way will not be stopped and large pools of funds are still seeking new investment outlets. Any relaxation of the investment controls could spark another round of overheating, which eventually could end in a very hard landing. At the same time, there are reasons to think that economic growth could slow more sharply than expected in the medium term. Administrative controls have had some unintended adverse effects, mainly on SMEs, which are struggling to secure working capital loans. That could hurt employment creation. Rapid increases in farmers' incomes may be unsustainable if prices of agricultural products fall, which would reduce consumption spending. Additionally, the PRC financial sector faces a big challenge over the next 2 years when it is opened to foreign banks as the country meets its WTO commitments. A heavy flow of funds out of the state-owned commercial banks to competitors would further strain these major lenders. On expectations that the country will make a soft landing, fixed asset investment growth in 2005 for the PRC is projected to be near 20%, with exports growing at this same high rate, and consumption likely maintaining double-digit growth rates. As imports will outpace exports, economic growth will depend on consumption and investment. In Taipei,China, private consumption is forecast to keep rising. Growth in private investment will slow from 2004's high levels, but government spending on infrastructure will support overall investment. Hong Kong, China's more moderate growth rate, too, will be driven by consumption and investment, rather than net exports, with a revival of construction bolstering investment. Mongolia is set to continue to benefit from the PRC's demand for minerals and expansion of the livestock industry (depending heavily of course on weather conditions). In Korea, the prolonged slump in consumption appears to be ending as household debt and credit card delinquency rates stabilize. Expansionary macroeconomic policies and stronger corporate balance sheets provide a favorable backdrop for investment. However, these factors will take some time to lift Korea's growth rate. The expected sharp fall in the growth rate of subregional merchandise exports will be matched by a drop in merchandise import growth rates as GDP expansion slows. Moreover, growth of both exports and imports is projected to slow further through 2006-2007. Trade surpluses run by the PRC and by Taipei,China are forecast to fall significantly over the next 3 years, and Korea's surplus will be little changed. The subregional current account surplus will slide to 1.7% of GDP by 2007, from 4.2% in 2004, mainly because the PRC's small current account surplus will move to a deficit over 3 years. International reserves are high and rising in the major subregional economies. Although most East Asian economies are major importers of oil and other commodities that shot up in price last year, consumer inflation rates are expected to be moderate in 2005. Indeed, average inflation for the year will slow in some economies and hardly move in others. For the subregion as a whole, annual consumer inflation is likely to be about 3.0% over the next 3 years. In the PRC, smaller price rises for grains and overcapacity in many industries will offset much of the upward impact of imported inflation, to put inflation in the 3.2-3.6% range in the forecast period. Higher exchange rates in Korea and Taipei,China will help counterbalance imported inflation in those economies. Hong Kong, China will record inflation of 1.5% in 2005, its first full year of price rises since 1998. Even Mongolia, which is susceptible to bouts of double-digit inflation, is expected to keep price increases to around 5.0%. With subregional economies generally growing at a reasonable pace, fiscal policy is being tightened in the PRC and Hong Kong, China. The PRC, as part of its effort to cut investment in overheated industries, is sharply reducing issuance of long-term bonds that are used to finance fixed assets. Taipei,China aims to narrow its fiscal deficit over the medium term by broadening the tax base, raising some tax rates, and selling stakes in government-owned companies. However, resistance to these revenue-raising measures within Parliament, labor unions, and some companies has so far frustrated that goal. Mongolia has reduced its fiscal deficit over the past 2 years, although the gap will widen a bit in 2005. Korea, though, still is operating a budgetary policy that aims to stimulate sluggish economic growth. Monetary policy, too, is being tightened in most of East Asia. Historically low interest rates were no longer considered appropriate as 2004 progressed; inflationary pressures built up, economic activity was robust, and US rates were raised. The People's Bank of China increased rates in October and indicated that it will use them to help control inflation and investment. The Bank of Mongolia sharply raised rates on its benchmark bills to damp inflationary pressures. Taipei,China moved up its official discount rate three times between September 2004 and March 2005, the first increases since mid-2000. In March 2005, banks in Hong Kong, China lifted rates. The banks had been able to keep rates steady in the second half of 2004, despite the currency's link to the US dollar that usually requires parallel rate moves, because of flush liquidity in the domestic banking system. Again, Korea went against the trend because of its below-potential economic performance. The Bank of Korea cut its policy rate in August and October and this accommodative stance is expected to be maintained while the financial position of households and small businesses remains weak. Major challenges for East Asia in the medium term include the PRC guiding its economy to a more sustainable growth path, and its neighbors standing ready to handle any disruptions that may occur if the PRC's efforts overshoot. The economic links between the PRC and other East Asian economies have become much more extensive in recent years. Another challenge is to strengthen financial systems. The PRC has injected huge amounts into state-owned commercial banks to repair their balance sheets, has plans to sell stakes in some banks to investors, and is shaking up the management of banks, but action on all these fronts needs to be accelerated, since the PRC's banks will face greater competition in the next few years as the country opens the sector to meet its WTO commitments. Taipei,China is pushing consolidation and privatization in the banking industry to build some bigger, stronger institutions. Finally, Korea needs to complete work started on restructuring its troubled credit card companies and to improve risk management in the financial sector. Southeast AsiaThe economies of Southeast Asia expanded on aggregate by 6.3% in 2004, with Malaysia, Singapore, and Viet Nam the fastest growing (Figure 1.14). In spite of some improvement, Indonesia, the third most populous country in Asia, continued to perform well below potential, a matter of concern. Based on their level of per capita income, the economies of Cambodia and the Lao PDR fell further behind relative to the rest of Southeast Asia. The economic performance of the Southeast Asian economies in 2004 rested on three pillars: robust consumption growth, a strong revival of business investment, and an unusually favorable external environment. Private consumption expenditures continued to contribute significantly to overall growth. With inflation relatively subdued for most of the year, macroeconomic policies, both monetary and fiscal, remained generally supportive. The most remarkable feature of the 2004 performance was the upsurge in investment in many subregional economies and its large contribution to overall growth. In all countries except Cambodia, investment-to-GDP ratios increased in 2004. ADO 2004 projected a revival of business investment in most of the subregion, but the outcome turned out much stronger than expected. A combination of factors contributed to the surge in investment: reduced political uncertainties following peaceful elections in Indonesia, Malaysia, and Philippines; reform measures in several countries to improve investment climates and reduce the cost of doing business (e.g., Singapore); much reduced excess capacity; and continued improvement in FDI flows to the subregion. On the external front, the subregion experienced its best environment in many years, as major industrial countries grew rapidly and the rest of Asia, in particular the PRC and India, also experienced solid economic growth. The result was that exports shot up in 2004 by an average of 20.2%, compared with a 12.8% rise in 2003. The outcome was well above the expectations of early 2004.
Given high income growth in the subregion over the past few years, imports also rose very fast in 2004, on aggregate by 23.6%, up from 12.1% growth in 2003. With the exception of the Philippines and Singapore, net exports subtracted from growth. Developments in the external sector also helped lower the aggregate current account surplus, to 7.1% of GDP in 2004 from 7.8% in 2003. Finally, a notable feature of the 2004 outcome is that in spite of a robust economic performance and high oil prices throughout the year, inflation remained relatively subdued in most countries, with the exception of the Lao PDR and Viet Nam. Inflation averaged 4.2% for the subregion, up from 3.3% in 2003. In some countries, appreciation in exchange rates helped keep inflation under control, notably in the Lao PDR and Thailand. As the year advanced however, inflationary pressures increased in several countries, prompting Thailand's monetary authorities, for instance, to start raising interest rates. Inflationary pressures will be an important variable to watch over the forecast period. GDP growth in Southeast Asia is forecast to remain robust in 2005-2007, albeit at a slower pace than in 2004. Average GDP growth is forecast at 5.4-5.9% over the medium term. In a welcome development, and in spite of the negative impact of the Indian ocean tsunami, somewhat faster expansion is projected for Indonesia, mainly in 2006 and 2007 when GDP could expand at an average of 6.2%. In Cambodia, however, a less favorable external environment due to the termination of the Multifibre Arrangement (MFA) in January 2005 is expected to lead to a significant slowdown. In the Philippines, a weak fiscal situation and hesitant investment could lead to growth below potential, at rates of around 5.0%. The outlook remains optimistic both with regard to private consumption expenditures as well as investment, which are projected to be the main contributors to GDP growth over the forecast period. However, the forecast depends critically on inflation remaining moderate. This would mean that monetary policies could remain generally supportive, with low interest rates, although some monetary tightening is expected in most countries. In some countries, fiscal support to private consumption can be expected to abate because the economies are on a firmer footing. This is the case in Singapore and to a lesser extent Thailand, as well as in the Philippines where fiscal consolidation will be a policy priority. In Singapore, Thailand, and Viet Nam, and to a somewhat lesser degree, Indonesia and Malaysia, robust investment, both public and private, will be the most dynamic variable in the economy. While in Viet Nam, strong investment spurred by FDI inflows will remain part of the economy's transition and its catching-up process, in Singapore and Thailand, higher investment will be focused on restructuring of the economies to raise productivity and maintain their competitiveness in the regional and global context. In Singapore over the past few years, government policies, including tax policy, have been strongly oriented toward making the economy more competitive by reducing business operating costs and attracting new forms of FDI. In Thailand, the Government intends to pursue active policies over the next few years to spur investment in small and medium enterprises. It has also announced a major infrastructure development plan, which focuses on large-scale investments in transport and energy, which could push up GDP by 0.2 percentage point annually. In Indonesia, the Government is struggling to make the legal and regulatory environment for investment more transparent and to open new sectors to foreign investors. Subject to satisfactory progress in the reforms, the country's natural resources and its large domestic market are expected to spur domestic and foreign investment over the forecast period. In a similar manner, policy reform measures to improve the investment climate and reduce the cost of doing business are being enacted in Malaysia. Public investment, though, is expected to be scaled back in a drive for fiscal consolidation. In the Philippines, there is a need to significantly raise the investment-to-GDP ratio, a major challenge if economic growth is to improve in the medium term. Some positive developments are expected, but a tight fiscal situation will limit the scope of public policy. Reviving private sector investment will be the main challenge over the next 3 years. In the external sector, while global prospects remain relatively bullish, the exceptional performance of exports in 2004 cannot be sustained in 2005 and beyond, as already presaged in many countries over the last quarter of 2004. Export growth is projected at around 7.9-9.1% over the next 3 years, down from 20.2% in 2004 and 12.8% in 2003. The downturn in the electronics sector evident at the end of 2004 is projected to be relatively mild and short lived. While exports to industrial countries are likely to expand more slowly in 2005, before leveling off in 2006-2007, intraregional trade should remain dynamic as only a mild slowdown is projected in the PRC, while India's economy is expected to continue its solid expansion. Both developments should boost trade opportunities for the economies of Southeast Asia, which are in between the two regional growth poles. The PRC absorbs 6% of Southeast Asian exports, and these exports to the PRC have been growing at rates of about 37% over the past 2 years. Exports to India have been growing at rates of about 26% over the same period, accounting for about 2% of Southeast Asia's exports. Over the forecast period, South Asia is likely to emerge as a growing and dynamic market for Southeast Asia. Already several countries, such as Indonesia, Malaysia, Thailand, and Singapore, are negotiating preferential trade arrangements with India and other South Asian countries. A moderation in growth will damp import growth, which is forecast to be 10.6% in 2005, less than half the rate of 2004, and about 10% in the following 2 years. Southeast Asia will continue to exhibit a sizable--albeit reduced--current account surplus of about 6.2% of GDP in 2005 and about 5% on average in 2006-2007. The need for fiscal consolidation in most subregional economies has been noted in recent ADOs. Budgets, at least for 2005, show mixed outcomes. In the Philippines, where fiscal problems are most acute, a progressive reduction in budget deficits is projected over the forecast period as new revenue measures are introduced and as expenditures are curtailed. In Malaysia, too, the Government has indicated its intention to rein in the fiscal deficit by selectively cutting expenditures and improving revenue collection. Gasoline subsidies are being phased out, and changes in the tax structure and the introduction of a goods and services tax in January 2007 are expected to narrow the deficit by half by 2007. In Indonesia, the fiscal deficit is expected to be brought down further over the next 3 years, to below 1% of GDP. In Singapore, tax reforms will continue to support the restructuring process but the need for large fiscal stimulus packages will no longer exist. Significant surpluses of around 3% of GDP are projected. Thailand, which posted a surplus in 2003-2004, expects a balanced budget in 2005. In Viet Nam, the budget deficit will widen to around 5% of GDP as expansionary fiscal policy continues to support implementation of economic reforms and development of infrastructure. Planned cuts in import tariffs will also affect revenues. In Cambodia and to a lesser extent the Lao PDR, fiscal deficits are projected to remain substantial, threatening macroeconomic stability. While the forecast remains optimistic for the economies of Southeast Asia, the high global and regional risks in the outlook could affect this group of countries more severely than others. First, what happens to inflation globally and in the subregion, and as a consequence, to interest rates, will be of paramount importance. In this context, the subregion is highly sensitive to further increases in oil prices, particularly as there is a need to further rein in rising subsidies (Box 1.2). While damping consumer demand, a sharp rise in interest rates also could derail the recovery in investment that is needed to support high long-term growth. In addition, some countries such as Indonesia, the Philippines, and possibly Thailand, where public or household debt stocks are larger, could be significantly affected by high interest rates. As they are extremely open, a second main concern in subregional economies is what happens to the value of the US dollar. Should it fall precipitously, the upward pressure on the subregion's currencies would increase substantially. While this would contain inflation somewhat, it would damage the important export sectors and exacerbate competition from the PRC. Obviously, if a further weakening of the US dollar and higher world interest rates led to a major slowdown in the world economy, the impact on Southeast Asia would be very severe. Hence the importance of sound macroeconomic policies, in particular fiscal restraint. At the same time these policies need to be complemented by microeconomic reforms to continuously enhance the competitiveness of the economies of the subregion. In part, this means keeping investment rates high. Finally, the subregion remains particularly vulnerable to the impact of epidemics. The continued resurgence of avian flu should not be underestimated. Governments and the international community need to significantly enhance collaborative efforts to ensure that risks of transmission of the virus are kept to the absolute minimum and prepare contingency plans in case it becomes transmissible among humans. South AsiaSouth Asia's aggregate GDP is estimated to have expanded by 6.4% in 2004, substantially slower than in 2003 (7.8%), and below the 7.0% expansion projected for the subregion in ADO 2004 (Figure 1.15). The divergence in performance stems from developments in India, which accounts for nearly 80% of the subregion's output, as all countries except Afghanistan and Sri Lanka grew more rapidly in 2004 than in 2003. Indian GDP growth is estimated at 6.5%, 2 percentage points below 2003, with the marked change in outcome mainly due to the vagaries of the monsoon that sharply depressed agriculture sector growth from its normal rate in 2004 while a recovery from an earlier poor monsoon inflated it in the previous year. Developments in the industry and services sectors remained buoyant on the grounds of strong consumer and investment demand. The 26 December tsunami, which affected the coastline of some mainland southern states as well as the Andaman and Nicobar Islands, led to heavy loss of life and great destruction; however, the impact was localized and has not significantly affected national economic activity. Pakistan saw GDP growth accelerate to 6.4%, the highest rate in 7 years. Investment in key large-scale sectors picked up and consumer demand was energetic, even as the fiscal position strengthened, the balance of payments remained in surplus, and foreign exchange reserves touched new highs. Growth in Bangladesh, at 5.5%, was only slightly higher than a year earlier, as a strengthening in export-oriented manufacturing was in part offset by weakness in crop production. Though larger imports outweighed larger exports and increased the trade deficit, further gains in large workers' remittance inflows, which markedly boosted domestic incomes, kept the current account at a small surplus.
After 2 years of double-digit GDP growth, estimates for Afghanistan indicate that recovery of its war-racked economy slowed to 7.5% in 2004 as another drought lowered cereal production by 25%. The year, however, was marked by considerable progress in that the first ever presidential election was held and economic structural reforms continued to advance at a good pace, especially with respect to budget implementation. Rapid growth of the opium economy, however, has emerged as a major issue in development. Sri Lanka saw its GDP growth moderate slightly to 5.5%, which remained driven by domestic consumption and fast-growing exports, with performance underpinned by the continuing cease-fire. With two elections--for parliament in April that resulted in a change in government and for provincial councils in July--most progress on the previous government's structural reform policies stalled and awaits determination of a new direction. The year ended in tragedy with the tsunami. 
In the Maldives, tourist arrivals and hotel capacity utilization expanded at a strong pace to reach record levels, where the economy grew by 8.8% in 2004. While loss of life from the tsunami was less than in most other affected countries, the damage to the economy was substantial. Economic growth may fall to as low as 1.0% in 2005 as the high tourist season was lost, and there will be a substantial widening of the fiscal and balance-of-payments deficits. However, most resorts were unaffected and 2006 should see a marked economic rebound. In 2004, the economy in Nepal continued to recover from the downturn of 2 years earlier. Improved performance in agriculture and services marginally raised GDP growth to 3.3%. The economy has performed weakly since the second half of 2001 as a result of a worsening insurgency and political instability, while the royal proclamation of emergency rule in February 2005 has increased political and economic uncertainties. Bhutan's economy continued its steady growth at 7.0% during the year, reflecting sound economic management and further development of its hydropower resources. South Asian growth is projected to move up to 6.7% in 2005, dip to 6.2% in 2006, and then recover to 6.9% by 2007. While Afghanistan, Bhutan, India, and Pakistan are projected to have somewhat stronger growth in 2005, the rest of South Asia is likely to experience slower growth--Bangladesh because of serious flooding, Maldives and Sri Lanka due to the tsunami and its aftermath, and Nepal as a result of weaker paddy production. The subregional slowdown in 2006 reflects a slowing in India's growth, which will rebound in 2007. Although Afghanistan's growth is expected to slow marginally after 2005, other subregional countries are expected to match or exceed the 2005 growth performance in the 2 subsequent years. The South Asia forecasts assume continued cooperative efforts between India and Pakistan and no deterioration in the security situation in Afghanistan, Nepal, and Sri Lanka. India's growth outlook is buoyant--6.9% in 2005, 6.1% in 2006, and 7.0% in 2007. Agriculture is projected to recover in 2005, and expand at normal rates subsequently, though expansion in the industry and services sectors will slow. The industry slowdown in 2005 is attributable to cost-smoothing behavior of firms to tide themselves over an anticipated cost escalation. In 2006, GDP is projected to decline on account of a further deceleration in growth of the industry and services sectors, but these sectors should experience a revival in 2007. In Pakistan, with sound macroeconomic fundamentals achieved and key sectors strengthened by reforms of recent years, the projection is for stronger growth of 7.0% in 2005 and 2006, nudging up to 7.5% in 2007. Notably, private investment is on the rise and fiscal consolidation and structural reforms have made space for increased social and infrastructure expenditures that underpin this upbeat outlook. Growth in Bangladesh is projected to slow only slightly to 5.3% in 2005 despite widespread and destructive flooding, as activity is to be sustained by donor-supported reconstruction efforts and continued expansion in export-oriented production and greater workers' remittances. Growth may reach 6.0% in the following 2 years; however, it is necessary that strong economic reform efforts be continued and that downside pressures associated with a loss of MFA quotas and current confrontational domestic politics be kept to a minimum. Afghanistan's economic prospects are good, with growth expected to recover to 11.3% in 2005, on the assumption of better rainfall, and then moderating slightly in 2006-2007. This outlook assumes continued support by the international community in economic assistance and in security efforts, as well as continued strong efforts in structural reform. Sri Lanka's growth is expected to tail off only a little to 5.2% in 2005, as the tsunami did not damage areas of major economic activity, though there was great loss of life. Assuming that reconstruction plans are implemented smoothly, growth should pick up to just under 6.0% in the following 2 years. The major risk to the outlook, as in the past, is uncertainty in the peace process. Also, it will be important for the new Government to define its plans for economic and structural reforms needed to achieve a high, sustainable growth path. Economic growth in the Maldives is expected to drop sharply in 2005 to 1.0% due to extensive damage to the fishing fleet, hotel closures, and the loss of tourism during the high season. A recovery in tourist arrivals could bring GDP growth to 9.0% in 2006 and 8.0% in 2007. Growth in Nepal is projected to fall to 3.0% in 2005 due to weather-related weaker performance in agriculture and a deterioration in other activities, especially those connected to tourism, due to the insurgency. Growth is expected to slowly strengthen to 3.7% and 4.3% in the subsequent 2 years, on the basis of no further deterioration in the security situation. However, the outlook is highly uncertain and depends crucially on how parties respond to developments in the period of emergency rule. Bhutan's economy is projected to grow by 8.0% over 2005-2007, reflecting the steady expansion in the power sector and the country's new economic strategy for poverty reduction. Exports in 2004 surged by 20.8% in South Asia, on top of the strong 18.3% gain in 2003, with almost all countries bettering their earlier performances. At the same time, imports shot up by 33.5% due in the main to continued strong growth in domestic demand and in part to the steep increase in global oil prices and the subregion's import dependence. The subregion's current account balance moved to a deficit of 0.7% of GDP in 2004 from the solid 1.9% surplus recorded in 2003. The main player in this swing was India, which recorded a deficit of 1.0% of GDP during the year, the first since 2000, in marked contrast to a 1.8% surplus recorded in 2003. For 2005, South Asia's current account deficit is expected to widen further to 1.2% of GDP, with every country but Nepal recording a deficit and India maintaining a deficit of 1.0% of GDP. These deficits are moderate and are readily financed. Exchange rates against the dollar appreciated modestly in 2004 in most countries in the subregion and all countries but Sri Lanka recorded gains in gross international reserves. Average inflation for South Asia rose to 5.9% in 2004, up from 5.1% a year earlier, reflecting increases in all countries except Afghanistan, Bhutan, and Nepal. In response to growing price pressures, monetary polices were tightened during the year in Bangladesh, India, Pakistan, and Sri Lanka. Moreover, many countries took measures to delay and not fully pass through the cost of global oil price rises. Central AsiaEconomic growth in the six Central Asian republics (CARs) as a group is estimated at 10.4% in 2004, higher than the 8.1% projection made in ADO 2004, and representing a continuation of the very strong performance of recent years (Figure 1.16). Nearly all of the countries in the subregion performed better than expected. A notable and welcome feature was unexpected strength in the Kyrgyz Republic, Tajikistan, and Uzbekistan, countries that have the lowest per capita incomes in the CARs and that had seen various economic difficulties in recent years. Higher than expected commodity prices for the region's main exports, not only oil and gas but also for gold, cotton, and aluminum, were the principal stimulus underlying the strong gains made during the year. Indeed, exports surged by about 38.9% for the subregion as a whole in 2004, up from 25.0% growth in 2003, at country rates that varied from 9% to 54% in dollar terms. Kazakhstan, where substantial FDI has developed the oil and gas sector in recent years, recorded the highest export gain of 53.7%, with expanded oil volume boosting the steep rise in export prices. Kazakhstan now accounts for about 60% of aggregate CAR exports. An upturn in domestic consumption demand as well as continued investment boosted the CARs' imports at essentially a matching pace of 38.1%, again well above the 2003 expansion (19.0%). Consequently, as a group, the CARs' current account deficit at 1.9% of GDP was only slightly improved from a year earlier. Kazakhstan and Uzbekistan recorded a surplus on the current account. Deficits were fully financed by FDI and other capital flows to allow all countries to post moderate increases in official reserves. Both Azerbaijan and Kazakhstan, which saw particularly heavy FDI inflows in 2004, are experiencing upward pressure on their exchange rates. The medium-term outlook for the CARS is quite favorable, pointing to a moderate slowing in growth for the subregion as a whole to 8.7% in 2005 but then a mild advance to 8.8% and 9.2% in the following 2 years. Even though the oil and gas sector will continue to drive growth for the region, some change is foreseen in the country pattern. In Azerbaijan, growth is expected to accelerate sharply to 14.5% in 2005 and to 19.0% and 22.0% in 2006 and 2007, respectively. This impressive outlook reflects the phasing in of production from investments in oil and gas fields and pipeline facilities. Conversely, growth in Kazakhstan is projected to moderate to 8.5% in 2005 and 8.0% in the following 2 years as additional petroleum sector production in this period builds on a larger base. Since Kazakhstan is the bigger economy, the differing outlooks in the two countries are largely offsetting for aggregate CAR growth. 
In Turkmenistan, a large producer of natural gas, the outlook is underpinned by long-term export contracts with the Russian Federation and Ukraine. GDP growth is projected to be strong at 10.0% in 2005, but then to slow to 6.3% in 2007. Any assessment of the country outlook is difficult, however, because of the limited information available. The outlook for Kyrgyz Republic, Tajikistan, and Uzbekistan is for a slight easing in growth in 2005 as circumstances are expected to be generally less propitious. In the Kyrgyz Republic, GDP growth is expected to decelerate to 5.0% in 2005, reflecting depleting reserves and consequent declining production at the Kumtor gold mine, though growth may be lifted to 5.5% in subsequent years as deposits elsewhere are developed. The March 2005 uprising and apparent change of government appear related mainly to governance issues rather than to economic policy. However, it will take some time to assess the full impact of these events on the economic outlook. In Tajikistan, growth is expected to slow to 8.0% in 2005 and then to 5.9% by 2007 because of capacity limits on expansion in aluminum and cotton production, the two main economic activities. With cotton and gold prices less favorable in 2005, a moderate deceleration in Uzbekistan's growth to 5.0% is expected; however, growth is projected to pick up to 6.0% and 6.5% in the following 2 years, on the assumption that policy reforms are adopted, which would boost agricultural, manufacturing, and trade activity. Inflation is not a central policy issue in the CARs. However, in Turkmenistan and Uzbekistan subsidies and controls keep official inflation rates lower that what would be determined by the operation of fully free market forces. Implementation of more effective monetary polices sharply reduced Tajikistan's average inflation to 6.8% in 2004 from 17.1% a year earlier. Azerbaijan and Kazakhstan experienced some price pressure during the year and as a result tightened monetary policy. Average inflation in the subregion in 2004 was 6.0% with little country variation. This rate is likely to be maintained in 2005 and is projected to moderate slightly to about 5.0% by 2007. As countries in transition to market economies, the CARs have made varying degrees of progress in their reform efforts. Kazakhstan (per capita GNP of $1,780) and Azerbaijan (per capita GNP of $810) have attracted by far the bulk of FDI made in the subregion and have built substantial oil and gas sectors that have buttressed very rapid rates of growth. Both countries, however, are struggling to deepen economic diversification to expand employment opportunities that have grown only slowly because of the capital-intensive nature of their resource-based growth. To this end, Kazakhstan adopted its Innovative-Industrial Development Strategy while Azerbaijan has drawn on its State Program on Poverty Reduction and Economic Development. Whether the two countries can avoid "Dutch disease," which could stymie broad-based rapid growth, is a major concern. Among the other countries, the Kyrgyz Republic (per capita GNP of $330) and Tajikistan (per capita GNP of $190) have developed medium-term poverty reduction and growth strategies supported by International Monetary Fund economic programs and development assistance. Heavy external debt burdens and a limited resource base make rapid growth an arduous process, despite very substantial macroeconomic and structural reforms that the countries are undertaking. Recently, Uzbekistan (per capita GNP of $420) has tightened economic policies and maintained current account convertibility, and is in the process of developing a wide-ranging framework to accelerate broad-based growth. Its longer-term outlook depends on whether it adopts a substantially reinvigorated structural reform program or continues with its present policies. Turkmenistan is relatively wealthy (per capita GNP of $1,120) based on energy production and exports that will underpin reasonable rates of growth in the medium term. Central planning and management of the economy persist and a substantial change in policies would be required to move from growth that relies primarily on exploitation of natural resources to broader-based growth that would reduce exposure to volatility in the energy markets. The PacificAggregate GDP growth of the Pacific DMCs was unchanged at an estimated 2.6% in 2004 (Figure 1.17). Increases in GDP ranged from 1.5% (Timor-Leste) to 4.6% (Solomon Islands). The Federated States of Micronesia, Republic of the Marshall Islands, and Tuvalu registered contractions because of reductions in public sector activity. The maintenance of high international prices for primary commodity exports benefited those economies with relatively large natural resource endowments. Solomon Islands' second year of relatively rapid growth was led by agriculture, forestry and fisheries, though this entailed harvesting of the natural forest at an unsustainable rate. Primary production also led a mild acceleration of growth in Vanuatu and contributed to a pickup in growth in the Fiji Islands, the second-largest economy. The agriculture and mining sectors of the largest economy, Papua New Guinea, expanded at around 3.0%, but the oil and gas subsector contracted significantly because of the depletion of oil reserves. As a result, growth decelerated slightly to 2.6%, from 2.8% in 2003. Tourism continued to grow across the subregion, partly because of lower airfares that resulted from increased competition in airline services to several destinations. Consequent stimulation of the services and construction sectors was important to the economies of Cook Islands, Fiji Islands, Samoa, and Vanuatu. In contrast,
Economic growth at modest rates generated an increase in employment levels across the subregion, but growth in labor supply continued to outpace labor demand. Inflation decelerated to an average 3.6% in the subregion, largely because of a sharp drop in inflation in Papua New Guinea. Inflation fell in the majority of other Pacific DMCs, the notable exceptions being Samoa and Tonga, which both registered double-digit rates. Fiscal outcomes improved in most Pacific DMCs plus Palau during 2004. In Papua New Guinea, the budget balance moved from deficit in 2003 to surplus in 2004 as total revenues and grants exceeded budget projections and fiscal management improved with assistance under an Enhanced Cooperation Program with Australia. The fiscal deficit exceeded the budget estimate in the Fiji Islands because of unanticipated expenditures, but was lower than the 2003 deficit. Public financial management in Solomon Islands demonstrably improved with the continued assistance of the Australian budget stabilization team. Budget outcomes worsened significantly in the Federated States of Micronesia and the Republic of the Marshall Islands as "bump-up" funding under the previous Compact of Free Association with the US ended; and Palau continued to fund a large budget deficit by drawdowns from its Compact trust fund. External accounts generally improved in 2004 as export growth accelerated faster than import growth and tourism earnings strengthened. Political uncertainty continued to be a concern in a number of Pacific DMCs, most conspicuously in Vanuatu; and corruption and poor governance remained as major obstacles to improving development outcomes in the subregion. On the positive side, Nauruan voters rejected the leadership that had mismanaged the economy for years and elected a reformist government. Some progress was made in 2004 in formulating and implementing economic and public sector reform strategies aimed at improving public service delivery and the enabling environment for private sector development. However, reforms needed to be extended and consolidated. For most Pacific DMCs, physical infrastructure development and creation of an effective legal and regulatory environment for business (including property rights) remained major challenges. Relatively large civil services still needed rightsizing and refocusing on performance, and the importance of public enterprise reform was underlined by the bankruptcy of Royal Tongan Airlines. At the regional level, Pacific Island Forum leaders decided in 2004 to create a Pacific Plan for Strengthening Regional Cooperation and Integration. This will potentially strengthen the contribution of regional institutions to achievement of sustainable development, good governance, and regional security. In the context of a weaker international economic environment, economic growth in the subregion is forecast to slow slightly to around 2.0% in 2005-2007, while inflation is expected to be in the 3.4-4.0% range. Papua New Guinea is forecast to grow at an average annual rate of 2.4% as depletion of mineral reserves continues and logging is curtailed. A major growth slowdown is forecast in the Fiji Islands, as the garment industry loses concessionary access to export markets and the sugar industry confronts structural adjustment. Modest growth is expected in most other Pacific DMCs. This aggregate growth outcome will mean that a substantial proportion of the annual net increase in labor market entrants will continue to flow into the pool of the under- and unemployed, increasing hardship in both rural and urban areas. The main downside risk to the growth forecasts is that governments will fail to implement the structural reforms necessary to stimulate private sector development.
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The disaster has displaced at least 475,000 people, and by taking into account other indirect effects, the number of poor people is estimated to have increased by more than 1 million, adding 0.5 percentage point to the national head count ratio (HCR)--the ratio of the number of poor people to the total population.
The pickup in exports was particularly robust in Cambodia, Malaysia, Singapore, Thailand, and Viet Nam. Increased demand for electronic products as investment spending strengthened in major industrial countries benefited many subregional countries. But the strong performance of exports was broad based. Cambodia's merchandise exports were boosted by garments and rubber, while petrochemicals and pharmaceuticals contributed significantly to the growth of Singapore's exports. At the same time, buoyant world prices for oil and agricultural products boosted Viet Nam's export revenues by 30.3%. 
tourism contracted in the Federated States of Micronesia where the lack of sustained competition in airline services provision left airfares at a high level compared with other subregional destinations. The recovery in international capital markets improved returns for the long-established Kiribati and Tuvalu trust funds and for the newly established trust funds in the Federated States of Micronesia and the Republic of the Marshall Islands. 
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