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Asian Development Outlook 2006 : I. Developing Asia and the World : Developing Asia and the Pacific: Performance and Prospects
Outlook for 2006 and 2007
The outlook for developing Asia in 2006 and 2007 will clearly depend on global economic prospects (Table 1.1.1). As explained in Prospects for the World Economy in 2006—2007, below, these are seen as remaining broadly favorable and supportive of growth in the region. Collectively, the major industrial economies are forecast to grow close to their potential, and global trade is expected to expand at about its recent historical average. The upswing in the global electronics cycle, which began in 2005, should continue through most of 2006, supporting growth in a number of regional economies, in East Asia and Southeast Asia especially. Fast growth is again expected in the PRC and India. Risks to the regional outlook would, however, be mitigated if domestic demand were to play a more supportive role going forward. The baseline assumptions on which the country projections rest are set out in each of the country chapters (see Part 2). Although it is difficult to generalize across such an expansive and diverse region, it seems reasonable to expect that macroeconomic policy settings will remain broadly neutral in terms of their impact on demand. In a number of countries, interest rates are likely to continue to climb in a context where global interest rates are also likely to rise. The room for fiscal maneuver is limited in many countries of developing Asia. Indeed, in a number of countries, it is expected that governments will take measures to rein in deficits. In those countries where fuel subsidies are directly or indirectly adding to fiscal burdens, subsidies are likely to be gradually rolled back and retail prices brought more closely into line with border prices. Hidden subsidies to other energy prices, such as electricity, may also be gradually removed as the cost of fuel inputs rises. Against a backdrop of favorable global conditions, of marginally less accommodative macroeconomic policy settings, and of continued adjustments to high oil prices, aggregate growth in 2006 is expected to soften a little to 7.2%, and by some more in 2007 to 7.0%. By historical standards, these growth rates in developing Asia are robust (Figure 1.1.7). In the PRC, growth is set to ease in 2006. In its recently announced 11th Five-Year Program (2006—2010), the Government has set its sights on a lower growth trajectory for the economy. The Government now intends to pay more attention to some of the social and environmental stresses that have emerged as a consequence of the prolonged rapid growth that has largely been concentrated in urban and coastal areas. However, given the existence of gaps in market institutions and signaling processes, and the difficulties in changing incentives and reining in spending at the local level, it is unlikely that the momentum of growth can be slowed quickly. Growth of about 9.5% is forecast for 2006, softening to about 8.8% in 2007. In Korea, growth in 2006 is expected to accelerate to 5.1%, supported by a continued recovery in consumption demand, and strong investment demand by large-scale enterprises. A combination of slower growth in the PRC and an acceleration of growth in Korea should just about cancel each other out, leaving the average for East Asia at about 7.7%, matching 2005's performance. 
India has ambitions to lift its growth rate to over 9% in the medium term. This is likely to require that it increase the ratio of its investment to GDP and that it raise capital productivity. Both will need determined reform efforts. However, it is unlikely that growth in 2006 can match 2005's strong performance. The base effect that lifted agricultural growth in 2005 will be removed, the Reserve Bank of India is likely to continue to nudge interest rates up over the next 12 months, and the program of fiscal consolidation that is now under way is set to continue. As part of this program, the economy will likely have to adjust to the effects of higher global oil prices so that subsidies can be reduced. In Pakistan too, growth is expected to soften as agricultural conditions revert to normal. Outside agriculture, particularly in the large-scale industrial sector and in services, Pakistan's economy should continue to perform strongly. Softer growth in India and Pakistan will clip the average for South Asia, which is put at about 7.3% in 2006, but with some upside potential in 2007 as investment expands to relieve infrastructure bottlenecks. The performance of Southeast Asia in 2006 and 2007 is likely to change little from recent economic performance, with growth projected at 5.5% in 2006 and rising marginally to 5.7% in 2007. Until there are clear signals that inflationary threats have abated, domestic demand in Indonesia will probably be contained by high interest rates. Thereafter, possibly in the second half of 2006, growth should begin to pick up. Medium-term prospects will hinge on an improvement in the business investment climate, and on an easing of infrastructure bottlenecks. In Malaysia and Thailand, it is expected that public sector investment programs will address critical bottlenecks and support growth. Both economies may also benefit from the current upswing in the electronics cycle. Over the near term, growth in the Philippines is expected to stay largely unchanged. The Philippines faces a difficult reform agenda, which has upfront costs but which should deliver durable benefits over the longer term. As a net oil exporter, Central Asia will continue to benefit from high oil prices. Robust growth in Kazakhstan should continue. Azerbaijan in 2005 became one of the fastest-growing economies in the world, with momentum set to build further as new investments in oil and gas fields and export pipelines come into full operation. An important challenge in Azerbaijan and in other oil-exporting countries is to manage windfall gains in a way that provides a basis for balanced and sustainable growth over the long term. Uzbekistan has enjoyed strong growth in the past 2 years and this momentum will likely be carried forward, aided by greater FDI. Growth in the Kyrgyz Republic, which is a net oil importer, should bounce back after 2005's difficulties. In both 2006 and 2007, growth in Central Asia is expected to remain close to 10%. In the Pacific, high oil prices will help sustain subregional growth in 2006 as both Papua New Guinea and Timor-Leste are comparatively large economies and net oil exporters. Timor-Leste will see growth boosted by higher public investment financed by petroleum revenues. In contrast, Papua New Guinea's growth prospects remain hobbled by a difficult law-and-order situation. The small economies, which are entirely dependent on fuel imports, will continue to face pressures, but Solomon Islands is expected to consolidate its recovery. In the Fiji Islands, growth of tourism and opportunities in some niche sectors will help offset difficulties created through the loss of clothing quotas and reductions in sugar subsidies by the EU. Growth in the Pacific is predicted to remain at about 3.0% in 2006 and 2007.
Developing Asia is expected to continue to run a substantial current account surplus over the next 2 years (Figure 1.1.9). As a proportion of GDP, though, it is likely that the current account surplus will begin to edge down (Figure 1.1.10). In the PRC, measures to support domestic demand and greater exchange rate flexibility should start to narrow its trade and current account surpluses. Korea's current account surplus may also close as domestic demand plays a stronger role in supporting growth. In South Asia, deficits are likely to persist or may even widen as large infrastructure projects get under way. Thailand, which ran a current account deficit in 2005 for the first time since 1997, is expected to maintain deficits in 2006 and 2007 as domestic investment picks up further. 
A narrowing current account surplus suggests that, on average, domestic demand will play a more important role in supporting growth in developing Asia in 2006 and 2007. In some countries, the growth of consumption spending is set to pick up and, in others, there is greater optimism about investment. Public investment programs will be ramped up in some countries to address deficits in areas such as roads, ports, power, and the environment. Ongoing efforts to improve the business climate for private investment, and improved corporate balance sheets, should also contribute to capital spending. The moves toward greater currency flexibility against the US dollar taken by the PRC and Malaysia in 2005 have so far resulted in only small appreciations of the dollar value of their currencies. In recent months, the Korean won and the Singapore dollar have appreciated by more. The likelihood of continued current account surpluses, robust FDI inflows, and—-possibly—sustained portfolio interest in developing Asia is likely to keep exerting pressures for an appreciation of many regional currencies through 2006. Additional exchange rate flexibility of key currencies would help adjustments and could give a fillip to domestic demand.
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The inflation outlook for developing Asia in 2006 and 2007 is generally favorable (Figure 1.1.8). In most countries, authorities are expected to respond adroitly to inflationary threats. Slowing price inflation—or even declining prices—for commodities, a mild appreciation of regional currencies, and stiff competition in the market for manufactured goods are all likely to help keep price rises in check. However, a gradual pass-through of earlier oil price rises seems set to continue in 2006 and will seep into inflation numbers. Food prices may also rise if agricultural conditions turn out to be less favorable than in the recent past. For these reasons, inflation is expected to edge up in some countries, but should pose little threat to overall prospects. As the impact of earlier oil price rises should have largely faded by 2007, and higher interest rates will have had more time to work on demand, it is envisaged that inflationary pressures will subsequently recede. Further sharp rises in oil prices would, of course, pose a risk to the outlook for inflation.
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