Catalog

Developing Asia and the Pacific:
Performance and prospects

Performance in 2006

Developing Asia grew at its fastest pace in 11 years in 2006 (Figure 1.1.1). Steady global expansion of output and trade, moderate inflation with low real interest rates, as well as the impact of earlier reforms on productivity, were all conducive to growth. In many countries, circumstances proved unusually benign, and risks failed to materialize.

Asia's giants-the People's Republic of China (PRC) and India-alone accounted for just under 70% of the region's expansion. In 2005, the PRC accounted for 41% of regional output compared to just 35% in 2000. India's share in regional output increased by half a percentage point (Figure 1.1.2).

In both countries, fast growth coexists with stresses and imbalances. In the PRC, booming exports and fixed asset investment again propelled growth. The authorities-concerned about the pace and quality of fixed asset investment, fast credit growth in the banking sector, and rising asset prices-raised interest rates, increased reserve requirements for banks, and introduced a raft of administrative controls intended to discourage or defer new capital projects. As a consequence, the growth of fixed asset investment slowed in 2006, though it still advanced at double digits. Export growth showed no letup, and the current account surplus widened again. By December 2006, the PRC had amassed international reserves of close to $1.1 trillion. To stem the leeching of reserves into domestic liquidity, the People's Bank of China sold additional sterilization bonds.

In India, agricultural productivity continued to languish, largely reflecting neglected infrastructure and poor rural extension services. Rising food prices contributed significantly to inflation. Tensions also surfaced as rapidly expanding industry and services activities encroached on agricultural land. Gaps continued to widen between the more prosperous coastal states and those in the interior of India-where population growth is fastest and the record on job creation weakest.

Many other countries also enjoyed vigorous growth. Azerbaijan and Kazakhstan again saw benefits from high oil prices. Favorable commodity prices helped expansion in Mongolia. Armenia's construction boom continued, and the services sector grew by 20% as rising wages and remittances bolstered private consumption. Cambodia saw double-digit rates of expansion for the third straight year: textiles, tourism, and agriculture all performed well. Robust growth has become almost routine in Viet Nam, and 2006 was no different, with both exports and domestic demand making strong contributions. Growth in the Lao People's Democratic Republic (Lao PDR) accelerated, as large hydropower and mining projects progressed. The Maldives bounced back from the destruction of the tragic 2004 tsunami, growing at 18.2%. Although Pakistan could not repeat its record-breaking performance of 2005, growth in 2006 was above its recent pattern. Bangladesh, too, continued to see its trend up. Despite civil conflict, Sri Lanka grew at its quickest pace since 1979, buoyed by strong private sector activity and expansionary public spending. (Figure 1.1.3 gives a profile of growth in developing Asia.)

However, performance was patchy in the larger economies of Southeast Asia. High interest rates-aimed at bringing down the inflationary surge caused by the reduction of gasoline and diesel subsidies late in 2005-curtailed growth in Indonesia. Consumption and investment demand growth was insipid. In the Philippines, growth edged up from 2005, underpinned by a strong recovery in agriculture. But investment spending stayed weak. In Thailand, net exports lifted growth, but gathering political uncertainty dented domestic demand, and business and consumer confidence ebbed. Growth accelerated in Malaysia, largely primed by another year of robust consumption demand and greater public investment spending.

Growth in the Pacific countries followed a familiar sawtooth pattern, with growth accelerating in some countries but slowing in others. Growth accelerated in Fiji Islands and Papua New Guinea and, as these are the largest economies, lifted overall performance. The former benefited from a pickup in sugar production and in construction, and latter from favorable export prices.

Weak performance was seen in isolated cases. In Nepal, politics continued to dominate and growth was slow. Growth in the Kyrgyz Republic moved into positive territory, but recovery was hampered by weak gold production and by lingering political difficulties. Civil disorder in Timor-Leste caused its non-oil economy to shrink, but oil extraction activity (which is accounted for separately) was unaffected. Economic activity also contracted in the Federated States of Micronesia. Growth in the Cook Islands, Kiribati, and Tonga trailed in at less than 2%.

Despite exceptionally fast growth and rising oil prices, consumer price inflation did not, in general, accelerate in 2006. The outcome of 3.4% was less than the 4.0% projection made in Asian Development Outlook 2006. But this aggregate pattern disguises wide variations at the country and subregional level (Figure 1.1.4). In some countries, inflationary pressures rose as the year progressed. In India, wholesale price inflation accelerated, despite tightening measures by the Reserve Bank of India, which raised interest rates on four occasions in 2006, lifting the key policy rate from 6.25% to 7.25%. The central bank also imposed tighter reserve requirements on commercial banks and stricter conditions for lending to the property sector. In Bangladesh too, annual inflation accelerated. Fast credit growth, pass-through of earlier oil price rises, and rising prices of other commodities all contributed to inflation. Although inflation fell in Pakistan, it remained high and above the State Bank of Pakistan's target. In Sri Lanka, inflation accelerated over the course of the year to average 9.6%. Strong domestic demand in Central Asia, fed by high oil prices, lifted inflation to 8.0%.

In the PRC, food prices climbed toward the end of the year, and although monthly inflation picked up, the annual average remained low. Highly competitive supply conditions in industry helped restrain consumer price inflation, as did falling oil prices in the later months of the year. But overheating manifested itself in other ways. In particular, bank credit remained a concern, and equity and property prices soared. In response, the central bank lifted the key policy interest rate by 54 basis points in 2006, and increased reserve requirements on commercial banks on three occasions. It subsequently raised interest rates by another 27 basis points in March 2007.

In Indonesia, Malaysia, and Thailand, annual average inflation rates rose. In large part, this reflected the effects of increases in oil prices and of reduced retail subsidies on gasoline and diesel. However, in the second half of the year monthly inflation rates began to slow, responding to tighter monetary conditions (Figure 1.1.5). Modest exchange rate appreciation also played a part. In the Philippines, where the pass-through of high oil prices was quick, annual headline inflation fell in 2006. In view of falling monthly inflation rates, a number of countries lowered policy interest rates-most notably Indonesia, where the central bank lowered its main policy rate by 300 basis points in seven steps during the year (Figure 1.1.6).

Fiscal risks were to the fore in some countries of Central Asia, as well as in Sri Lanka. Tajikistan's external debt position leaves little room for maneuver and the Kyrgyz Republic's debt indicators make it eligible for relief under the Heavily Indebted Poor Countries initiative. In Sri Lanka, rising public spending widened the deficit and was partly financed through domestic credit expansion. Pakistan also ran a sizable fiscal deficit in 2006, to support development programs and earthquake rehabilitation and reconstruction activities.

Elsewhere, deficits were generally modest, and were financed with comparative ease. Strong growth buoyed fiscal revenues. Various countries continued their efforts to bring down levels of public debt. In the Philippines, a legislative impasse in the approval for the 2006 budget led to nominal expenditures being frozen at 2005 levels. As a consequence, expenditures as a proportion of GDP fell. At the same time, revenues accrued from the newly expanded value-added tax. Reduced outlays and rising revenues cut the central Government's deficit to just 1% of GDP. In Indonesia and Malaysia too, deficits were modest in 2006 as governments sought to consolidate or reduce debt. Thailand's planned disbursements for infrastructure projects were delayed by political uncertainties.

In India, the Fiscal Responsibility Act is a centerpiece of the Government's economic stabilization and reform program. It calls for a reduction in the federal budget deficit by at least 0.3% of GDP a year, taking it to 3.0% of GDP by FY2008 (ending March 2009). In 2006, the federal budget deficit as a proportion of GDP again fell, despite rising expenditures on social programs and on rural infrastructure. Fast growth has done much to buoy revenues. Improved collection at the state level has also helped the overall fiscal position.

Developing Asia's trade surplus widened in 2006. Both the value of exports and imports grew quickly in United States (US) dollar terms, but as exports grew from a larger base, the trade surplus expanded. In some countries, export growth was extraordinary. In Azerbaijan, for example, it ballooned by 61% as new sources of oil and gas came on stream. Torrid growth of exports from Mongolia and Papua New Guinea reflected both higher volumes and better prices for their primary resources.

The PRC's merchandise exports again grew rapidly in 2006, barely down on 2005's expansion. Imports also grew briskly, but continued to trail export growth such that the PRC's trade surplus jumped to nearly $200 billion dollars, or 7.4% of GDP. This pattern of strong import growth but even stronger export growth was repeated in a number of other countries. Thailand moved from a trade deficit to a trade surplus and surpluses widened in Indonesia and Singapore. In the Republic of Korea (hereafter Korea) and Malaysia, trade surpluses narrowed. In South Asia, trade deficits were again the norm, and in all countries but Bangladesh and Bhutan they widened (Figure 1.1.7). Nevertheless, they remain manageable.

Broadly, current account payments positions moved in step with trade balances. For the region as a whole, the current account surplus in 2006 was 5.3% of GDP in 2006, the largest on record. Central Asia, East Asia, and Southeast Asia all posted hefty surpluses, but South Asia's deficit stepped up to over 2% of its GDP. Pakistan's deficit is large and was partly financed through privatization receipts. Buoyant remittances provided a valuable source of foreign exchange for a range of countries in 2006. In Central Asia, remittance income climbed in the Kyrgyz Republic and Tajikistan. It is also important to many small Pacific islands. In Bangladesh, Nepal, and Philippines, inward remittances reversed trade deficits and generated current account surpluses. Remittances significantly helped the payments positions of Pakistan and Sri Lanka.

Large current account surpluses made a significant contribution to reserve accumulation (Box 1.1.1). Developing Asia's stock of foreign exchange reserves at end-2006 reached about $2.3 trillion, up $418 billion in a year. Although the region attracted gross capital inflows in 2006, it also invested significantly overseas, which helped stem the buildup of reserves. Of the increase in total reserves, just less than 80% was attributable to current account transactions.