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ADO Update 2005 Press Conference with ADB Chief Economist Ifzal Ali
A. Quon: My name is Ann Quon and I'm the Director of the Department of External Relations. I'd like to welcome you here to ADB headquarters and the launch of the Asian Development Outlook Update 2005 which I hope you all have copies of. As many of you know, the Update reviews our macroeconomic trends, policy developments, and short-term forecasts that were contained in the Asian Development Outlook released in April. At the time, we expected the region's economies to perform well, and now, six months later, with higher oil prices a major feature of the economic landscape, what impact is that having on our forecasts and on regional economies? To answer that and other questions, - I'd like to introduce our Chief Economist, Dr. Ifzal Ali.
Dr. Ali: Thank you Ann, and good morning to all of you. Since we launched our Asian Development Outlook in April, there have been a lot of changes globally as well as regionally. It is in this context that this update takes on added importance. Compared to the Outlook proper, in the Update, as far as the country chapters are concerned, instead of having 42 countries, we just focused on nine of them in terms of country chapters. This has been based on two considerations: We have focused on our borrowing countries, and number two, we have focused on countries where significant new data became available which should warrant individual chapters. With this background, let me get into my presentation.
Developing Asia's healthy growth is likely to continue. We expect 6.6 percent to be maintained in both 2005 as well as 2006. However, this strong outlook masks significant diversity in performance within countries. In this regard, the People's Republic of China and India emerge as major stabilizers in the Asian growth process. However, since our Outlook in April, there is considerable uncertainty both globally as well as regionally and the downside risks are gathering pace. Of the downside risks, this rapid rise in oil prices is one of the most worrisome, and this is what Asia will have to adjust to very quickly. We are confident that this adjustment will be carried out because the strong fundamentals in developing Asia enable reforms to continue. The projections that are reported to you are carried out on baseline assumptions that are stable. The external environment is generally benign. Industrial country growth rates, though lower than 2004, will be healthy at 2.5 percent in 2005 and 2006. This compares to an average of about 2.4 percent in the last five years. The US, the Euro zone and Japan will drop from 2004 and 2005, but are expected, particularly the Euro zone and Japan, to pick up in 2006. The world trade volume will be at about trend rate in 2005 and 2006, while the federal funds rate in the US is expected to go up sharply in 2005 and 2006. The external financing and conditions for developing Asia continue to be bright and spreads are at an all-time low presently. The picture that is very important is what is happening to the price of oil. In the first seven months of this year, the price of oil has gone up to $53. It's almost a 70 percent increase, and this increase is likely to stay.
This chart describes to you our Outlook for our five major subregions. Central Asia, East Asia, South Asia, Southeast Asia and the Pacific. Regarding East Asia, growth is likely to remain robust, and it is the PRC's growth which will pull up the subregions in 2005. In the PRC, we have raised the growth projection to 9.2 percent in 2005 and to 8.8 percent in 2006. However, in the other economies of East Asia - Korea, Hong Kong, Taipei,China - there will be a slowing down in these economies.
In South Asia, we have raised our growth projections. Basically, Pakistan, in 2005, has done much better than we had anticipated earlier. At 8.4 percent, it has shown the highest growth rate in the last 20 years. India's momentum continues. In particular, in 2006, we have sharply raised our growth rate for India from 6.1 to 6.8 percent. Basically, the structural reforms that have been ongoing in India are beginning to bear fruit; Efficiency improvements are occurring, productivity improvements are occurring, business and consumer confidence is high, a huge infrastructure program is about to be launched. So for all these reasons, South Asia is looking up.
In contrast, Southeast Asia is showing multiple strains. Of course, there is the problem associated with higher oil prices, but the downturn in the electronic cycle has hurt Malaysia and the Philippines. We've witnessed that Thailand and the Philippines have suffered from drought in the earlier part of this year, and Thailand has also suffered from the insurgency that is going on in the southern part of the country.
In Central Asia, all the countries with the exception of Turkmenistan and Kyrgyz, are reaping the windfall of the high oil prices.
In the Pacific, while PNG and Timor Leste are benefiting from the high oil prices, the other countries are particularly vulnerable to these high oil prices because we have seen balance of payments strains, difficulties in financing these strains and the likelihood of infusions from outside to help overcome these countries.
Turning to current account surpluses, across the region, we expect the current account surpluses to narrow, with the exception of the PRC. This year, we are expecting that the trade surplus in the PRC will surge. Exports have grown at about 32 percent in the first half of the year. Imports are sharply down. The trade surplus is up by $40 billion in the first half of the year.
For oil-dependent South Asia, we are witnessing trade deficit widening across all the countries. Southeast Asia which has historically had had very high current account surpluses, we are already seeing signs that these are beginning to narrow and we have lowered our forecasts for current account surpluses in Southeast Asia.
Central Asia is moving from current account deficits to surpluses largely because of the oil price boom. Overall the external balances of non-oil exporting DMCs with the exception of PRC are likely to suffer in our forecast period as maybe expected inflationary pressures are surfacing with the oil dollars providing a boost to aggregate demand prices are rising there in South East Asia and South Asia prices are rising because of cost push factors.
In East Asia, while inflationary pressures are easing, this is primarily due to a sharp deceleration in prices in China. They have had a very good harvest this year so far, excess capacity is emerging in some sectors and we are seeing prices softening in these. It is for this reason that overall for East Asia our inflation forecast show that the pressure is easy.
In the Pacific we are seeing that prices are increasing but modestly.
Coming to policy developments so far in 2005, across the board we see that monetary accommodation is lessening. Nominal interest rates are edging up from a low base but in real terms interest rates are very low in Asia today. As far as the fiscal picture is concerned it is mixed, with subsidies straining fiscal balances in many countries and the most acute cases are in Indonesia, Bangladesh and India. One major change that we witnessed in the first half of this year was the new exchange rate regime put in place by the PRC and also followed by Malaysia. While the currency appreciations have been very modest, so far the efficiency gains that are likely to occur as a result of a more flexible exchange rate policy are likely to be considerable. That's one aspect. The other aspect is with greater flexibility shown by PRC it is likely the central banks in other parts of Asia will also allow much greater flexibility which would lead to overall improvements and efficiency over time. As far as responses to high oil prices are concerned let me just show you this graph which indicates the red line shows the crude oil price; the green line shows the price that is paid in the United States where efficiency of refining is high, where there is a small taxation on gasoline about 10 percent. The yellow line is the Luxembourg price, a typical European price both for diesel as well as gasoline. The chart shows that developing Asia some countries do not even charge their crude price at the gas pump there are others who charge a price which is comparable to what prevails in the United States but as far as the Luxembourg price with the exception of Hong Kong and Korea no other country comes even close to it. What this chart shows is that there is a considerable amount of subsidy in the sector and there's considerable room for taxation in this sector. This chart is taken from a box in Part 3 of the document where it is described in greater detail.
Let's turn to the challenge of high oil prices. The price of crude as I had mentioned at the outset has risen by nearly 75 percent since the beginning of 2005. You can see that in this chart. Asia is a major importer of oil. We produce about 11 percent of the world's supply and consume over 20 percent of oil in the world. Secondly, we are oil intensive and we are comparatively energy inefficient in this region. For example, countries here, their oil efficiency is significantly lower than that of Japan or the United States. Japan is five times more efficient than us on the average and US three times more efficient. There's considerable room for efficiency gains. The point that is made throughout the ADO Update is these high prices we are witnessing today is a structural shift and this structural shift makes it imperative that we adjust to higher oil prices in a serious manner we have to come out of our mindset that price increases are temporary so we can find temporary solutions to cushion consumers and producers from oil price increases.
We are already witnessing major strains in many of our developing countries. We are seeing huge increases in oil import bills. Some of them are beginning to feel pressure on the external balance payments. Fiscal strains in India, Indonesia and Bangladesh are particularly acute. For example in Indonesia, almost one third of the budget will be eaten up by fuel subsidies. In India, fuel subsidies are increasing very rapidly which are likely to undermine the budget deficit program that the government has in place. These subsidies lead to a very perverse situation where we find that there are supply shortages in the country and the refined oil from the country is being exported. We see this happening in China. We are seeing early signs happening in Taipei,China. And we are also seeing it in other countries like Viet Nam.
As I have mentioned earlier, we are also witnessing the emergence of inflationary pressures. This is something fairly new for this part of the world after the 1997 financial crisis. One of the most acute cases of inflationary pressures is being witnessed in Pakistan, where inflation is running at above 8 percent. Against this backdrop, overall growth in this region is at risk unless we adjust to these oil prices with appropriate policy responses.
Now, the ADO Update focuses on three major responses. One is the pricing of energy products and particularly focusing on subsidies. What we found is that subsidies created open-ended fiscal liabilities which have huge cost because they crowd out other high-priority expenditures. While it is important that the poorest are insulated, the targeting programs that we have in place now are simply not working and some alternatives have got to be found. In terms of macro responses, having learned from earlier oil price increases it is important that monetary policy be used to keep inflation under check and fiscal discipline is maintained. We cannot over-emphasize the importance of maintaining macro economic stability to allow countries to ensure both growth as well as equity. In the long term, as I had indicated in the chart earlier, there is considerable room for having taxes on oil products which would be a source of revenue and promote efficient energy mix as well as protect the environment. As far as long term development is concerned, we are convinced that quick fix administrative controls are going to be counterproductive. It is better to work through incentives particularly through price incentives for long term efficiency in the use of energy.
Since our last Outlook, the risks have not changed but they have become far more acute. We are already witnessing a slowdown and tightening of monetary policy rate that will be considerably higher end of this year than end of last year. And in this regard while Hurricane Katrina's effects are likely to be small in the short run, we do not know what this would do to the US in general. Almost 30 percent of the oil imports into the United States come through the Gulf ports. As a result there are going to be some shocks to the supply chain in the United States. What that will result in is still a matter of conjecture. However, we are seeing that while crude prices have dropped in the last 3 days from about 70 to 65, at the retail level we are not witnessing this because of shortages in refining capacity. And there is a close relationship over the medium term between prices at the retail level and crude prices. So there is a possibility that oil prices could again go higher.
The balance of payments imbalances that we had referred to in the Outlook in April, nothing much has changed. But given the increased uncertainty there is a risk of a disorderly unraveling of the payments imbalances which could impart significant volatility in currency markets. Associated with these imbalances are some of the trade disputes we are witnessing now. And there is a danger that trade protectionism could increase. Within the region there is a risk of a hard landing in the People's Republic of China. Its growth is on a very narrow base essentially investment driven if there was a softening in its export market if there was a softening in profits in PRC we could see investment rate coming down which could significantly lower overall growth rate in that country. And as always, Asia is very vulnerable to natural disasters. In this case the risk of an avian flu pandemic always lurks on the horizon. So basically we are living in a very uncertain world where the risks are highlighting the imperative for policy reforms at the macro and micro level which would impart resilience to their economies. With this I close my presentation.
A. Quon: Thank you very much Dr. Ali for that very comprehensive overview of the region. I'd now like to open it up to questions.
Shirley Flores, Nikkei: You mentioned a slowdown in the US. Do you expect it to continue, which would explain the flat growth forecast for developing Asia, 6.6 percent?
Dr. Ali: 6.6 percent might appear flat but it is probably the highest in the world for a region of this size. As far as these risks are concerned, one or more of them could eventuate. We always should be prepared for that. What is different from before is the external balances of our countries are much stronger than we had in 1973, 1979, 1991. There is much greater credibility of monetary policy in terms of fighting inflation so inflationary expectations are likely to be subdued. In many countries, fiscal balances do provide some cushion, but not in all. And finally what we find is economies have undertaken structural adjustments over the last few years which provided some flexibility. In this regard, Asia is much better prepared to take on these risks individually or collectively.
Burd Wang, Guangming Daily: Dr. Ali, You mentioned in your presentation there is a hard landing risk in China, would you explain this?
Dr. Ali: The high growth in China has been primarily based on a narrow base and high rates of export, 32 percent in the first half of this year, and very high levels of investment, higher than 25 percent. But if demand for exports falls, we could see profit rates coming down excess capacity emerging in many sectors of the economy and as a result there could be a pull back in investments which would of course lead to a much lower level of growth in China than what we have been witnessing in the last 3 years, so that is what I mean by hard lending.
Naoko Sato, Daily Manila Shimbun: Is there any outstanding issue about the Philippines?
Dr. Ali: In the Philippines, we have trimmed our growth forecast for all three years, for the first two years it's been lowered to 5.7 percent, then it goes up. There are certain elements which call for fragility in the Philippines, the oil shock being one of them. We saw that it is witnessing a sharp slow down in electronics export in 2005, there were problems in the agriculture sector in the first half but some of these things are exogenously given, what happens to weather we don't know. But as far as the electronics cycle is concerned, we feel that the electronics cycle has reached its bottom, and in 2006 it will pick up. So the sharp slow down in exports that we witnessed this year is likely to be reversed next year.
Cecil Morella, Agence France Presse: The report advocates the removal of fuel subsidies and the potential for increasing excise taxes on oil products. How will large countries like Indonesia and China deal with the potential for political disruptions caused by the removal of subsidies and taxes of oil? And will these remedies not be worst than what they intend to cure?
Dr. Ali: We are very cognizant of the point you have raised about the political sensitivity of reducing subsidies and here. Thailand presents a good example. It has abolished fuel subsidies and as a result it has absorbed local short-term pain, but this will eventually lead to medium and long term gains. Having said that, one has to be very conscious as to what happens to the most vulnerable sections of society. In this regard, some of the savings that would come from reducing or eliminating subsidies, some of these resources could be used to provide income support to the really needy. What we are focusing on here is that there is a need to minimize leakages such that the targeted beneficiaries actually do benefit from highly targeted programs and with that I think much of the pain associated with removing these subsidies could be addressed for the neediest. Further, for the neediest it is very important that countries remain on a high growth trajectory because it is only through growth that we have seen in Asia that poverty reduction can really take place. Short term pain versus medium to long term gain and I think because oil prices are going to remain high for the foreseeable future it is time we started focusing on the medium to long term.
Cecil Morella, Agence France Presse: For the Philippines, would you advocate that the government impose the value added tax on oil and energy products and not reduce the excise taxes to compensate for it?
Dr. Ali: I think one of the overriding challenges in the Philippines is to address the issue of fiscal imbalances. Unless this issue is addressed effectively the crowding out effects are very, very big. So I would say that even in the Philippines the general prescription that we've advocated to this Outlook applies.
Fan Yuelong, Xinhua News Agency: You suggestion that high oil prices specially in the near term will not come down, what is your suggestion for China's oil consuming industries to survive the high oil crisis?
Dr. Ali: There is considerable room for improvement in the use of energy in many of our countries, including China. The technology is already there, the question is applying the technology in-house. With state-owned enterprises, I think there has to be a concerted effort in improving the use of energy, particularly increasing energy efficiency, number one. Second point, maybe diversification in the generation of electricity but most importantly it is how well we deal with the issue of this explosive increase in vehicular traffic and number of vehicles in the country, how that is addressed. That is really going to make the difference between success and failure. As you all know the highest consumption of oil is in cars and trucks in all our countries and unless that issue is dealt with I don't think there is going to be significant improvement in efficiency of energy use in China.
Caesar Vallejos, Net 25: You mentioned that the US and Japan have higher energy efficiency levels, can you cite specific recommendations on certain policies on how the Philippines can increase its energy efficiency level.
Dr. Ali: There is a two-pronged approach to this: one is, over time, one has to seriously consider the use of energy tax to increase energy efficiency in this country and secondly, the issue of the appropriate technologies to use both in electricity generation as well as waters used by industry, basically adopting technologies that are already available.
Burd Wang, Guangming Daily: Do you expect the Chinese Yuan to appreciate within the next 12 months? If so, by how much?
Dr. Ali: I don't think anybody would even dare to suggest a number but the change in policy has led to a small appreciation of the Yuan but more importantly, I think this is a step that will, over time, lead to significant improvements in terms of efficiency. Further, it will also allow room for flexibility by other Central Banks across the region. I think this is a small step but a very important one in the right direction not only for China but for the region as a whole.
Beverly Verches, RPN 9: How do you think the current political crisis will impact on the Philippine economy?
Dr. Ali: We have deliberately shied away from political considerations, so I will take a pass on your question.
Douglas Bakshian, Voice of America: You mentioned subsidized oil and adding taxes, you get efficiency, and you could deal with the rising oil prices. What is the political likelihood that these economies could take such action?
Dr. Ali: I am optimistic that the strains that are beginning to emerge in many of our countries are triggering responses by governments. We saw a major change in India, we have witnessed a change in Pakistan, the markets hammered the Indonesians because of the vagueness of their policy statements and it is likely that sooner, rather than later, we are going to see something more concrete put in place. There is no choice, while politically this may be very painful, given the world that we live in today, there will be no choice but to address these issues squarely, otherwise you will have major fiscal imbalances, resulting macroeconomic imbalances and the cost of borrowing in capital markets would go up, foreign direct investment would stay away. For all these reasons, it is in their self interest for these countries to recognize this and will deal with it.
Ditas Lopez, Dow Jones: You mentioned that the external environment is generally benign, what's the probability that that could change over the near term?
Dr. Ali: We are living as I said in very uncertain times, and some of the strains and pressures we are facing, particularly the ones in the global imbalances would require global responses and basically we will swim or we will sink together. In this regard, global imbalances which could unravel very quickly, I think there is a recognition that the US is to get its fiscal deficits in order, the Euro zone and Japan have to increase its aggregate demand, boost their growth rates and Asia would need to adjust by increasing investment in all Asian countries and consumption in China as well as greater flexibility in their exchange rates so that greater consumption and investment in Asia would also trigger additional imports from the US and other countries. Unless this happens, there is considerable risk that all of them could occur together and the prospect of that is frightening but it is remote in my view.
Glenn Omanio, Kyodo News: Can we expect oil prices to reach the historic high of $83 per barrel by year's end and if so, which countries are most vulnerable to price shocks?
Dr. Ali: We have already seen a softening of oil prices in the last two days and having said that, the spare capacity among the OPEC countries today is 2.2 million barrels per day, which is very, very narrow and if you take some of the high risk countries like Iraq, Nigeria and Venezuela out of this, it drops to 1.2 million. What the Update highlights is that, while demand factors contributed significantly in the run up to high prices in 2005, supply constraints are emerging. This is seen in the 1.2 million excess capacity that we have today. As a result of this very slim excess capacity, any untoward event in terms of sudden spike in demand from a certain country or a supply disruption caused by terrorist or natural activity would have a very highly magnified impact on oil prices. It is for this reason it is extremely difficult to speculate if oil prices could go higher because some of these events that could occur simply cannot be predicted but it is true that we are very, very vulnerable now to sudden increases in oil prices because the supply constraints are beginning to become binding.
Mich Cruz, GMA 7: The threat of an oil crisis has been quite politicized here in the Philippines and there have been criticisms that it's being used as a diversionary tactic, but in your opinion how big a threat is this problem in oil, high prices of oil?
Dr. Ali: This is a clear and present danger to all of developing Asia and I think this is an issue which should not be politicized but has to be addressed with clinical objectivity taking into account the need to address the requirements of the very needy but keeping in mind what are the medium and long term policy changes that are needed to keep our economies on track.
Cecille Lardizabal, ABS-CBN: Will you revise your projections for growth of 6.6 for 2005-2006 in Asia because of high oil prices?
Dr. Ali: No, the 6.6 percent that is projected for Asia already factors in oil prices that prevailed in the first seven months of the year and which are likely to rise over time. The reason that we have not changed our projections from April is that while the price increase in oil has been very significant, this has been counter-balanced by some of the factors which were highly positive, particularly in the larger countries like India and China. India and China provide about 50 percent of the GDP of Developing Asia. And because growth rates were raised for PRC as well as for India in 2006, Pakistan came in much higher for 2005. This is what has allowed our overall growth projections to be maintained at levels that were provided six months ago. But if you look at what is happening within countries, particularly in Southeast Asia, you will find that we have revised them downwards very drastically.
Maricel Halili, IBC 13: Sir, will you articulate the reason that the Asian Development Outlook trimmed the Philippine growth forecast for 2005 and 2006?
Dr. Ali: There are three main reasons: Number one, export growth has dropped very sharply in the Philippines basically because of the downturn in the electronic sector. Second, drought in the first quarter of the year trimmed agricultural growth. Third, higher oil prices have had an effect. And finally, we have seen investment slowing down very rapidly. And because of the fiscal constraints, it has not been possible to have counter-cyclical measures in terms of higher public investments. These are the main reasons why we have trimmed the growth rates in the Philippines.
John Grafilo, Deutsche Press Agentur: When you skirted discussing the political crisis in the Philippines, do we take you to mean that this crisis has no significant impact on the Philippine economy?
Dr. Ali: I never discussed anything about the Philippine crisis at any time in my presentation. But generally, this is a generic statement, when you have political uncertainty, this definitely has an impact on consumer and investor confidence. And you can draw your conclusions from that.
Roderick dela Cruz, Manila Standard Today: Sir, do you see India and China growing by above 6 percent annually over the next decade? And what do you think would be its impact on oil prices and the global supply of crude oil?
Dr. Ali: We are confident that while China's growth rate is likely to come down in the medium term, it will still maintain very, very high rates of growth. And I think an 8 percent rate of growth over the next decade per annum is doable.
In the context of India, what we are seeing is the opening up of the economy, the improvement in the investment climate triggering private investments in a very significant manner, and an increase in consumer confidence, a financial sector which is efficient and healthy - all these together will make possible growth rates of 7 to 8 percent per annum over the next ten years feasible.
Regarding what this will do to world oil prices, I'll just take you back to 1990 to 2003 when 40 percent of the increase in global world demand came from India and China. This rose to nearly 50 percent in 2004. So these are countries that are very, very energy hungry, and will keep increasing their demand.
The issue that we have highlighted in this Outlook is that energy demand has to be met from alternative sources apart from oil. And it is in this regard that some of the long-term issues, the long-term policy challenges that are mentioned, will be extremely important in terms of slowing down the energy demand from these countries. At the same time, improved efficiency would enable these countries to remain on a high-growth path.
Douglas Backshian, Voice of America: What are some of the alternative energy sources that are available?
Dr. Ali: With alternative sources, I think hydro would have to be tapped much more aggressively than has been in the past. And I think the time has come that even nuclear energy would have to be considered far more carefully than what we have seen in the last few decades.
A. Quon: Our time is running out, but if I can just briefly recap what Dr. Ali has been saying: Developing Asia is expected to perform well with a growth of 6.6 percent for 2005 and 2006. And we expect growth to remain strong in countries such as the PRC and India, but there are downside risks, as he mentioned, oil prices are expected to remain high and we expect that there could be considerable volatility.
Here in the Philippines, we have trimmed our forecasts slightly due to the global electronics downturn, the drought in the earlier part of the year, and weak foreign and domestic investment.
Let me just end by thanking Dr. Ali and his team for putting the Asian Development Outlook Update together.