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p. 6 of 68 BACK | NEXT I. Developing Asia and the World Overview of Economic Trends and Prospects Overview of Economic Trends in Developing Asia in 2002 Macroeconomic Conditions in 2002 Outlook for Industrial Countries Developing Asia: Subregional Trends and Prospects Developing Asia: Risks and Uncertainties Overview of Fiscal Policy in Developing Asia II. Economic Trends and Prospects in Developing Asia III. Competitiveness in Developing Asia Statistical Appendix

Asian Development Outlook 2003 : I. Developing Asia and the World : Overview of Economic Trends and Prospects

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Developing Asia: Subregional Trends and Prospects

Following an outcome for 2002 which was significantly stronger than expected, growth projections for 2003-2004 show the Asia-Pacific region to continue to expand at a robust rate (Table 1.1). Despite the softness in the world economy expected for the first part of 2003 and uncertainties linked to the conflict in Iraq and the outbreak of the SARS epidemic, aggregate GDP growth of 5.3% for 2003 is only slightly below the projections made in the September 2002 ADO Update. The Asia-Pacific region will thus remain a bright spot on the world economic map. There will be diversity, but continued strong domestic demand, sustained export performance partly linked to greater diversification and to dynamism of intraregional trade, as well as a continuing supportive policy environment, in particular fiscal and monetary policies, will be the main driving forces of Asian economic dynamism over the next 2 years. This partly results from the strong fundamentals of the region as shown by the high level of reserves (Box 1.1) and generally low inflation rates. While international reserves are estimated at about $1 trillion at the end of 2002, the aggregate current account surplus for developing Asia is projected at $99 billion for 2003, further adding to the region's remaining reserves. Average inflation for the region is estimated at 2.5% in 2003, about a percentage point higher than in 2002, but still a fairly low average rate. The positive outlook is also predicated on the continuation and often acceleration of major economic reforms in finance, trade, industry, small and medium enterprises, and economic governance in most countries of the region. Governments are also making determined policy efforts to raise productivity and competitiveness of Asian firms.

East Asia

The East Asian subregion posted a solid performance in 2002, with GDP growth averaging 6.5%, though performance varied considerably among countries. The PRC continued its rapid expansion bolstered by strong exports, surging FDI, buoyant domestic demand, and expansionary macroeconomic policies. Korea's brisk recovery was underpinned by both strong external and domestic demand. While exports in the second half of 2002 moderately lifted economic growth in Hong Kong, China and Taipei,China, both economies continued to face weak domestic demand. After 2 years of stagnation, expansion in industry and services and a mild winter saw growth return to Mongolia.

Despite strong overall growth in the subregion, some economies still had to grapple with deflation and high unemployment. Deflation in the PRC occurred because of cheaper imports following WTO accession, productivity growth, and excess capacity. Rising unemployment, intensified competition, and increased economic integration with the PRC caused deflationary pressure in Hong Kong, China and Taipei,China. Falling prices in Hong Kong, China also reflected the post-financial crisis decline in property prices. Weak domestic demand dampened labor market performance in Hong Kong, China while economic restructuring pushed unemployment higher in the PRC. Strong economic growth has helped Korea's unemployment rate decline each year since 1998. Mongolia's official unemployment rate dropped from 4.6% in 2001 to 3.6% in 2002, though incomplete registration may mask the actual figure.

Robust economic growth is likely in 2003-2004 if the global economic environment strengthens, geopolitical stability prevails, and the recent outbreak of SARS is brought under control quickly. Growth is expected to be lower than in 2002, however, averaging 5.6% in 2003 and 6.2% in 2004 (Figure 1.9). In the PRC, rising unemployment, an expanding fiscal deficit, and lagging development in poor interior provinces are likely to constrain expansion. The 2003 outlook for Korea reflects significantly more moderate growth than in 2002, due primarily to the slowdown in consumer credit expansion and a deterioration in investor sentiment stemming from geopolitical uncertainties, including those on the Korean peninsula. While economic performance will improve in Hong Kong, China and Taipei,China in the second half of 2003 and in 2004, domestic recovery will lag behind due to ongoing structural adjustments. In Mongolia, growth is expected to strengthen as mining and labor-intensive industries expand. In contrast, the agriculture sector is likely to struggle.

Consumption growth will vary among economies in East Asia. Consumption in the PRC will expand on the back of continued enthusiasm in the emerging markets for housing and cars. High unemployment will partly offset this expansion, however. Korea's consumption growth is likely to remain firm because of strong real wage growth and low unemployment, although tighter consumer credit and mortgage terms will restrain growth somewhat. High unemployment in Hong Kong, China and Taipei,China will constrain consumer spending there. Additionally in Hong Kong, China, falling property prices and deteriorating household balance sheets will dampen consumption growth. The recent outbreak of SARS will further delay the pace of economic recovery in the first half of 2003.

Private investment will, however, firm up over the next 2 years. In the PRC it is likely to gather momentum as economic reforms continue, rural incomes grow moderately, and substantial FDI inflows continue. Korea's 200 largest corporations plan to increase investment in 2003 as corporate indebtedness declines, and the successful promotion of broadband Internet usage boosts high value-added technology sectors. Investment spending in Hong Kong, China and Taipei,China is expected to rebound moderately, with renewed acquisition of machinery and equipment to boost productive capacity. However, building and construction may decline again in Hong Kong, China, with few new projects planned and a public housing construction cutback.

Trade has increased within East Asia. In particular, the PRC is emerging as one of the largest export markets for the other economies in the subregion. Strong growth in the PRC should, therefore, help exporters in developing Asia to weather slowdowns in other markets, though East Asian export growth will still be affected by economic performance beyond the region. Strong price competitiveness will support PRC export growth, but growth may not match the 2002 level as only modest demand is expected in its biggest markets, the US and Japan. Hong Kong, China and Taipei,China for their part should experience an export-led recovery, fueled by strong growth in the PRC. This will eventually feed into the domestic economies, although ongoing structural adjustments will continue to curb domestic demand. Growth in tourism (and in the services sector in Hong Kong, China) is likely to slow in the subregion as a result of mounting concerns over the emergence of SARS. The impact of a short epidemic of SARS on Hong Kong, China's economy is estimated at about 0.6% of GDP in 2003.

Fiscal expansion has played an important role in stimulating East Asian growth, though concerns about rising deficits and debt are likely to constrain expansion in 2003-2004. In the PRC, there is a growing need to reduce the fiscal deficit and debt as the Government contemplates another huge bank bailout as well as ways to fund its fledgling pension system. Reining in the deficit is the top priority for the authorities in Hong Kong, China. Although legislation in Taipei,China has cleared the way for fiscal expansion if necessary, the authorities remain cautious about implementing such policies. Concerns are also mounting over Mongolia's short- to medium-term debt sustainability. Although structured as long-term debt, repayments are due to start soon. Korea's healthy fiscal position has given the Government leeway to carry out desired spending.

With the exception of Korea and Mongolia, price pressures are likely to remain subdued in East Asia. Monetary policy in most subregional economies is thus expected to remain expansionary, while interest rates in the US, and so in Hong Kong, China, are likely to remain low for most of 2003.

Tackling unemployment has become a major issue for PRC; Hong Kong, China; and Taipei,China. Unemployment is a particularly pressing problem in the PRC. More workers from state-owned enterprises will be laid off as reforms continue, swelling the ranks of the 8 million new labor-market entrants and rural migrants seeking work each year. These challenges add urgency to the task of fostering the conditions that promote private sector development. Developing an urban social safety net and social security reforms are also needed to ameliorate the social costs of economic reform.

East Asia's growth hinges on global economic recovery and continued robust growth in the PRC. Considerable downside risks are evident in this regard since the global economic recovery remains uncertain. The aftermath of the conflict in Iraq and the potential instability stemming from developments in the Korean peninsula could lead to a significant economic deterioration. All East Asian economies are net oil importers, which makes any significant rise in oil prices harmful to them.

The recent outbreak of SARS has already affected the economy of Hong Kong, China, and, to a lesser extent, those of the PRC and Taipei,China. Any further spread of SARS would pose a serious threat to the subregion's economic outlook. The forecasts are based on the assumption that SARS will be brought under control quickly.

Southeast Asia

The recovery in the economies of Southeast Asia was generally much stronger in 2002 than anticipated earlier in the year. Indeed, GDP growth at 4.1% in 2002 was about 1% above that forecast in ADO 2002. Malaysia, Thailand and, to some extent, the Philippines showed a strong recovery in growth in 2002 while Singapore moved out of recession. The economies of Indonesia, Lao PDR, and Viet Nam improved only marginally from the 2001 levels. In contrast, GDP growth fell from 6.3% in 2001 to 4.5% in Cambodia, one of the poorest countries in Southeast Asia.

The recovery in Southeast Asia was the outcome of a combination of factors. Although business investment remained generally depressed due to overcapacity, domestic demand through the subregion, mainly consumption (both private and public), gained strength during the year. At the same time, the subregion experienced a significant improvement in exports, particularly in the second half of the year. For many countries, high export growth to the PRC appears to have played an important role in this favorable outturn (Box 1.2). With inflation generally low except in Indonesia and the Lao PDR monetary policies remained accommodative while fiscal policies maintained a generally strong expansionary stance.

Given the momentum of strong domestic demand and solid export performance, GDP growth in Southeast Asia is projected at 4.0% in 2003. As the world economy recovers from the uncertainties and weaknesses experienced in 2001-2002, prospects are somewhat better for 2004, with a forecast of 4.8% GDP growth. Still, many countries are expected to grow at a rate well below their potential. This is particularly the case for Indonesia (Figure 1.10).

In most Southeast Asian countries, domestic demand is expected to remain strong in 2003-2004, particularly private and public consumption. In early 2003, consumer expenditure strengthened in several countries, including Singapore, Thailand, and Viet Nam. In Indonesia, Malaysia, and Philippines, consumption growth is, however, expected to decelerate somewhat in 2003 as fiscal policies become less expansionary. With few exceptions, fiscal policy stances will be less expansionary in 2003 because of governments' concerns to varying degrees over increasing fiscal deficits in the past few years and rising public debt burdens. In Cambodia, Lao PDR, Malaysia, Philippines, and Viet Nam, fiscal deficits are a particular concern that will be addressed.

In the outlook for 2003-2004, a progressive strengthening of private investment is indicated as capacity utilization rates improve and financial sector reforms are accelerated. The vigorous pursuit of financial sector reforms will be particularly critical in Indonesia, Philippines, and to some extent Thailand. In the subregional economies in transition of Cambodia, Lao PDR, and Viet Nam, the momentum of market-oriented reforms accelerated in 2002 and is expected to continue in 2003-2004, thereby stimulating private sector investment.

Accommodative monetary policies will continue to support resilience of domestic demand. With the exception of Indonesia and the Philippines, nominal interest rates are projected to remain low and in some cases to be reduced further in 2003, before increasing in 2004. In the Philippines, real interest rates will remain high in 2003, further dampening investment prospects. Inflation is projected to remain relatively low in most countries of Southeast Asia, with the exception of Indonesia and the Lao PDR.

A critical factor in the outlook is the continued strength of exports. Despite a softening of growth in industrial economies expected during the first half of 2003, exports are forecast to keep their momentum in 2003-2004, and data in the first months of 2003 appear to confirm this trend. Greater diversification in export production, restructuring of regional manufacturing production, and increases in trade among subregions linked to continued strong domestic demand in the East and Southeast Asian economies are supporting the forecast for sustained export growth. A driving force for the subregion's exports will be the PRC market, which will absorb a rapidly rising share of the subregion's exports (Box 1.2). The governments in virtually all countries in the subregion have been concerned over the past 2 years about a possible loss of competitiveness of their economies (Part 3) and are implementing measures to address this issue. For instance, Singapore strongly supports the development of biotechnology; Malaysia and Thailand have both initiated national competitiveness programs over the past year; and the Philippines is pursuing a Medium-Term National Action Agenda for Productivity. For the oil exporters of the subregion (Indonesia, Malaysia, and Viet Nam), higher oil prices were a windfall, although countries like Viet Nam, which is a large exporter of rice and tea to Iraq, and countries receiving substantial overseas remittances from workers in the Middle East (the Philippines and Viet Nam) will be adversely affected by the conflict in Iraq.

Imports in Southeast Asia are projected to grow more rapidly in 2003 and 2004 (by 7.8% and 9.6%, respectively), partly due to higher average oil prices in 2003. Overall, as current account surpluses shrink or deficits increase, trade will likely contribute less to GDP in 2003-2004 than in 2002.

In the first few months of 2003, downside risks have significantly increased for many Southeast Asian economies as prospects for industrial countries have weakened for the first half of 2003, thus possibly dampening stronger export prospects. Several of the Southeast Asian economies are vulnerable to volatile oil prices, the loss of export markets in the Middle East, and reduced remittances from overseas workers (see the section Impact of Conflict in Iraq, below). Finally, and more importantly, the outbreak of the SARS epidemic might substantially affect tourism and the other services sectors of the subregion if prolonged. Already, it is estimated that SARS will lower GDP growth in Indonesia and Singapore by about half a percent and that of Malaysia by somewhat less.

South Asia

In recent years, South Asia has experienced relatively low growth in per capita income. Relative to its population, the subregion accounts for a very low share of global GDP (less than 3%) and an even lower share of global exports (about 1%). The economies in the subregion are relatively closed on average, with the subregion's ratios of merchandise exports and imports to GDP lower than any other major subregion in the world. Government revenues tend to be low in relation to GDP while expenditures continue to be higher than revenues, resulting in persistent fiscal deficits.

Savings and investment rates vary widely across countries, with gross domestic savings reaching about 46% of GDP in the Maldives and only about 15% in Pakistan. Similarly, gross domestic investment as a share of GDP ranges from under 14% in Pakistan to 48% in Bangladesh. In India, 2002 savings and investment rates were about 24% of GDP substantial, but less than would contribute to more rapid poverty reduction.

In 2002, South Asia was affected somewhat less than other subregions by global developments due to its relatively low levels of trade and financial integration with the rest of the world. The subregion's export growth rate continued to exceed the import growth rate, further reducing the trade deficit. Domestic factors played a more important role, such as the security situation in Nepal, tensions between India and Pakistan, and progress on peace talks in Sri Lanka. With the relatively high importance of agriculture to GDP and to food security, floods and droughts in different parts of the subregion impacted significantly on economic growth and development.

Growth in GDP for the subregion declined to 4.2% from 5.0% in 2001, instead of increasing as forecast in ADO 2002, primarily as a result of adverse weather conditions in Bangladesh, India, and Nepal. In addition, the economies of Bangladesh and Nepal suffered from extremely weak external demand. In contrast, Bhutan, Maldives, Pakistan, and Sri Lanka experienced stronger growth in 2002 compared with the previous year. Strong construction growth in Bhutan, tourism recovery in Maldives, robust consumption in Pakistan, and services recovery in Sri Lanka contributed to dampen the negative effects of insufficient rainfall in other parts of the subregion.

Inflation remained generally mild at 3.0%, as most economies in the subregion adopted macroeconomic policies that kept prices stable. While Sri Lanka still had double-digit inflation in 2002, it was an improvement from the previous year's 12.1%. Export growth in the subregion picked up to 7.0% in 2002 as India's exports recovered, in spite of weak external demand in some major markets. Import growth also recovered to 2.5% on account of India's strong demand.

The medium-term outlook for South Asia is based on an assumed acceleration in global economic growth, improved political stability and security in the countries of the subregion, and normal weather conditions. In this context, growth is expected to increase to 5.7% in 2003 and to 6.1% in 2004, led by strong expansion in India which accounts for roughly three fourths of the subregion's economy (Figure 1.11). Growth in Pakistan and Sri Lanka is expected to accelerate substantially, benefiting from continued macroeconomic stability and favorable developments on both supply and demand sides. In addition, domestic demand recovery in Bangladesh, plus continued construction expansion in Bhutan, should contribute to the subregion's growth. Per capita income growth of 4.1% and 4.4% in 2003 and 2004, respectively, will contribute to poverty reduction.

With continued economic liberalization and private sector-led growth, gross domestic investment as a share of GDP is expected to increase in most countries, contributing to rising labor productivity and future growth. With the stronger growth and accommodative monetary policy, prices are expected to rise in South Asia, to 4.9% in 2003 and to 5.0% in 2004, though these rises are still moderate.

Agricultural production, a key for poverty reduction in the subregion, is expected to increase moderately over the medium term on the assumption of less inclement weather. Industrial output and services, which already account for the bulk of value added in South Asian economies, are expected to continue expanding more robustly.

With strengthening recovery in major markets outside the subregion, merchandise export growth will accelerate to double-digit levels in 2003-2004 and exceed import growth, contributing to a narrowing of the subregional trade deficit. This is particularly true for Bangladesh and India, where export growth is projected to surpass import growth by over 3 percentage points in 2003. While there are significant variations across countries, the balance-of-payments surplus on the current account is expected to significantly decline for the subregion as a whole to about $620 million in 2003 and about $130 million in 2004, assuming oil prices remain fairly stable. However, as a percentage of GDP, the aggregate current account is projected to remain near zero in the medium term, as the deficits in Bangladesh, Nepal, and Sri Lanka are offset by surpluses in India and Pakistan.

Fiscal consolidation may again make slow progress because of political uncertainties. The revenue-to-GDP ratio in most countries is expected to moderately rise, but restraint of expenditure is expected to continue to be difficult. Consequently, government share in the economy will increase and fiscal deficits are projected to persist. The external debt service ratio is already high in several South Asian countries, and may increase to the extent that the persistent fiscal deficits are financed from external sources.

The medium-term outlook is subject to several risks. Political uncertainty could affect the scope and pace of economic reforms, and volatile oil prices would adversely affect growth. Remittances from overseas workers could decline substantially as a result of the conflict in Iraq. In addition, growth will remain fragile unless governments pursue fiscal consolidation with determination. Prudent exchange rate management will be necessary to take advantage of the revival in global growth, and enhanced foreign reserve management is becoming increasingly important as the subregion's reserves rise.

Central Asia

Economic growth for 2002 in the six Central Asian republics (CARs) as a group is estimated to be 7.7%, somewhat better than the 5.7% rate forecast in ADO 2002. While growth had been expected to moderate from the strong 10.9% expansion in 2001, GDP growth weakened by more than predicted in two countries due to unexpected events in the Kyrgyz Republic an accident that closed the important Kumtor gold mine, and in Turkmenistan an extremely poor cotton harvest. On the other hand, this was more than offset by faster than expected growth in Azerbaijan, Kazakhstan, and Tajikistan at rates of 9-11%. Growth in Azerbaijan and Kazakhstan continued to be driven by large-scale investments in the oil sector, largely funded by FDI, while in Tajikistan it reflected continued strong post-civil war recovery in aluminum, agriculture, and electricity.

Export gains, at rates of 9-13% in dollar terms, boosted growth in Azerbaijan, Kazakhstan, and Turkmenistan (the large oil/gas producers), and in Tajikistan where the gain in part reflected a bounceback from a sharp drop in 2001.

Unemployment and underemployment were little improved in 2002, even in the fast-growing oil/gas-producing economies, due to the capital-intensive nature of oil and gas development.

As countries in transition to market economies, the CARs have faced—and to varying degrees effectively dealt with—a legacy of issues including large structural and pricing distortions, off-budget spending, and incomplete statistics that make macroeconomic assessment and comparison between countries difficult. However, some broad developments in 2002 can be highlighted.

Progress continued on the inflation front. Monetary policy in Azerbaijan, Kazakhstan, and Kyrgyz Republic maintained relative price stability in 2002, while strong adjustment efforts reduced average inflation in Tajikistan to 14.5% from the very high levels associated with the civil war and its aftermath. In Uzbekistan, monetary policy remains largely oriented to meeting the credit needs of state-owned enterprises and inflation has remained high at about 28%. Policy is similar in Turkmenistan where inflation increased to 8.8%. In both Uzbekistan and Turkmenistan, price structures are heavily affected by state provision of commodities and services, and distorted by the multiple exchange rate regime with highly overvalued fixed official rates. Uzbekistan, however, adjusted the official rate over 2002 to reduce the spread between the official and market rates.

Financial policies kept floating exchange rates in Azerbaijan, Kazakhstan, Kyrgyz Republic, and Tajikistan roughly stable, or marginally depreciating, in real terms. In Azerbaijan and Kazakhstan, accumulation of part of the governments' large oil/gas revenues in oil funds (to be used for economic diversification) led to overall government budget surpluses and aided sterilization efforts to prevent excessive appreciation of the exchange rate that would stunt development in the non-oil sector ("Dutch disease").

Regarding structural reforms, significant actions were taken to improve budget management and transparency in Azerbaijan, Kazakhstan, and Kyrgyz Republic; reduce energy subsidies in Azerbaijan, Kyrgyz Republic, and Tajikistan; and improve the tax system while enhancing incentives in Kazakhstan and Kyrgyz Republic. Action to strengthen bank supervision was taken in Kazakhstan and the Kyrgyz Republic. Deposit mobilization from the private sector improved in Kazakhstan and Tajikistan, but there as elsewhere in the CARs the bulk of deposits remained denominated in foreign exchange. The banking system needs to be strengthened and the public's confidence in it lifted if the low levels of savings and financial intermediation in the system are to be raised.

In April 2002, four of the CARs—Azerbaijan, Kyrgyz Republic, Tajikistan, and Uzbekistan—together with three other low-income Commonwealth of Independent States (CIS) countries joined with bilateral donors, and four international financial institutions—ADB, European Bank for Reconstruction and Development (EBRD), International Bank for Reconstruction and Development (IBRD), and International Monetary Fund (IMF)—to create the CIS-7 Initiative. The Initiative seeks to create a collaborative effort to enhance economic growth and poverty reduction. Azerbaijan unveiled its Program on Poverty Reduction and Economic Development for 2003-2005 in October 2002. Moreover, the Kyrgyz Republic and Tajikistan have developed plans in the context of IMF's Poverty Reduction and Growth Facility, implementing macroeconomic stabilization programs during 2002 and continuing in 2003-2004.

The outlook for the CARs is for a moderate slowing in growth for the subregion as whole to an annual 5.8% in 2003-2004 from 7.7% in 2002 (Figure 1.12). This is because growth in the oil/gas producers is expected to be somewhat below recent rates, while present policies indicate that the economy of Uzbekistan can be expected to grow by only 3.5-4%, marginally lower than in recent years. The Kyrgyz economy should recover from its 2002 setback and grow at about 5%, while Tajikistan is likely to slow gradually since the recovery phase is now ending and new investment has been small.

The Pacific

After 2 years of stagnation, the Pacific subregion witnessed a subdued recovery in economic growth in 2002 as GDP grew by about 1.0% (Figure 1.13). The recovery reflected the strengthening of international commodity prices, a rise in tourist arrivals, and generally expansionary fiscal policies accompanied by accommodative monetary policies in most countries. As a result, domestic demand strengthened. The external environment also improved slightly with some strengthening of global trade in 2002 compared with the previous year.

Tourists' perceptions of the Pacific as a safe destination due to global and regional security concerns seem to have benefited tourism in the subregion. However, the Pacific is still suffering from the after-effects of ethnic tension that erupted in mid-2000 in the Fiji Islands and Solomon Islands. Internal problems accompanied by weak macroeconomic management in many countries prevented the Pacific from posting a stronger recovery. With an annual population growth rate of 2.7%, per capita GDP declined in 2002 for the third year in a row. Labor market conditions improved slightly in some countries but unemployment among educated young people remained a concern and continued causing social tensions.

Fiscal outcomes in 2002 were disappointing, particularly among the larger countries. As a result, nearly all the countries are facing fiscal difficulties. In some of them, the situation is approaching crisis proportions. The average inflation rate increased from 6.9% in 2001 to 7.1% in 2002, reflecting a weakening of most Pacific currencies, and higher local food and transport prices in some countries. Despite some rise in most countries, merchandise exports declined by 9.7% for the subregion as a whole, largely reflecting a sharp fall in exports from Papua New Guinea due to declining oil production. Exports also declined in the Cook Islands and Samoa. Imports into the region fell, by 5.8%, reflecting high costs as currencies depreciated in value. The overall current account for the subregion recorded a deficit for the first time since 1997, primarily reflecting a deterioration on the current account in Papua New Guinea. The current account as a share of GDP also worsened in Fiji Islands, Kiribati, and Timor-Leste. The flow of remittances, which is very important for some countries including Samoa and Tonga, remained strong in 2002. In several countries, trust funds suffered capital losses, reflecting weakness in global equity markets.

Medium-term prospects are for a modest rebound in economic performance in the Pacific. Factors contributing to the positive outlook include rising tourist levels, favorable commodity prices, and prospects of a more stable macroeconomy. GDP is forecast to grow at a weighted average rate of 2.4% in 2003, with all countries projected to record growth, except for Timor-Leste where the international presence will continue to wind down. Papua New Guinea and Solomon Islands are expected to emerge from recession and the Fiji Islands is expected to experience much faster growth with a strong boost from tourism. In 2004, the subregion is projected to grow by 2.5%, with all Pacific countries experiencing growth. Inflation is forecast to decline to 6.3% in 2003, largely reflecting lower inflation in Papua New Guinea and modest or no increases in most other countries. Inflation is projected to decline further in 2004, mainly due to yet slower inflation in Papua New Guinea with expected currency stabilization.

The difficult fiscal situation in 2002 caused many countries to present more responsible budgets for 2003, which were mostly accompanied by frameworks for gradual adjustments toward fiscal consolidation. Accordingly, some progress is projected for an improvement in fiscal balances over the medium term.

Risks to these projections arise from the continuing possibility of sociopolitical instability, weakening of commitment to reforms, adverse commodity price movements, natural disasters, and external shocks. The credibility of fiscal measures and complementary policies announced in budgets for 2003 and their likely success also remain to be seen. Further, with the free-trade Pacific Island Countries Trade Agreement (PICTA) expected to come into force soon, PICTA will likely have an adverse impact on tax revenue of countries relying heavily on trade taxes; it will require them to make necessary adjustments, such as greater reliance on value-added-type taxes and excise taxes. Some countries face very demanding fiscal adjustments in both the medium and longer terms. In some cases, there are good signs that comprehensive economic and public sector reform programs will continue to be developed and implemented, but in other cases weak government commitment or slow progress is likely to continue to be a major constraint in achieving higher standards of living.

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