Developing Asia : Is the Boom Sustainable ? Ifzal Ali Chief Economist Asian Development Bank Economic Congress Casa Asia, Barcelona, Spain 22 November 2004

The Global Context for – and a glimpse beyond Synchronized robust growth in main industrial countries in 2004, leveling off moderately in 2005 baseline assumptions baseline assumptions Oil prices to stay high baseline assumptions baseline assumptions But inflation rising moderately Monetary policies returning progressively to neutral stance/some tightening

The Global Context … 2004 Growth built on large imbalances (US fiscal and current account deficits, fiscal situation in Japan and Euro zone) Imbalances could start to weigh on outlook end of 2005 and onwards: –Increases in dollar interest rates –Volatility in exchange rates –Steep decline in US aggregate demand and inputs Will the specter of stagflation return?

Developing Asia Booming in GDP Growth much stronger than expected in 1H 2004 GDP growth: Developing Asia GDP growth: Developing Asia Expansion broad based Return of strong investment adds to export rebound and sustained consumer spending Inflation remains generally low despite high oil prices Inflation: Developing Asia Inflation: Developing Asia

Developing Asia… Regional current account surplus narrowing but still 2.9% GDP CA/GDP: Developing Asia CA/GDP: Developing Asia GDP Growth to climb to 7.2% in 2004; still strong 6.2% in 2005, 0.5 percentage points below ADO 2004 forecast GDP Growth:Developing Asia GDP Growth:Developing Asia

East Asia: Upward Growth Trend Continues since 2000… PRC Economy at near full throttle in 2004 GDP table GDP table Hong Kong, China and Taipei,China recovering strongly in 2004 and remaining on track in 2005 due to buoyant exports and recovering domestic demand Hong Kong Taipei,China Hong Kong Taipei,China Korea lagging as consumption still depressed and low growth continuing 2005 Korea Korea PRC micro soft landing in 2005 CA/GDP:East Asia CA/GDP:East Asia

GDP Growth, East Asia back to East AsiaCA/GDP: East Asia back to East AsiaCA/GDP: East Asia back to East AsiaCA/GDP: East Asia GDP Growth (%) East Asia PRC PRC Hong Kong, China Hong Kong, China Korea, Rep. of Korea, Rep. of Taipei,China Taipei,China

Southeast Asia: at long last awaited revival in business investment… Strong growth momentum, now broad-based In a first since Asian crisis, business investment doing well Welcome response of exports to buoyant world economy But imports surging also:contribution of net exports to GDP growth down Malaysia Malaysia Contribution of consumer expenditure remaining robust Philippines Philippines

Southeast Asia… Growth in 2004 revised upward to 6.2% and 5.6% in 2005 Outlook improving for Indonesia and the Philippines, but deteriorating for Cambodia

GDP Growth, Southeast Asia CA/GDP:SEAsia CA/GDP:SEAsia GDP Growth (%) Southeast Asia Cambodia Cambodia Indonesia Indonesia Lao PDR Lao PDR Malaysia Malaysia Philippines Philippines Singapore Singapore Thailand Thailand Viet Nam Viet Nam

South Asia: Gathering strength despite uncertainties… Weather dampens growth in India and Bangladesh Growth momentum remains strong but policy choices are crucial Trade continues to grow at double digit rates End of MFA quotas – India and Pakistan better prepared than Bangladesh Insurgency in Nepal continues to stifle growth

GDP Growth, South Asia CA/GDP:South Asia CA/GDP:South Asia CA/GDP:South Asia GDP Growth (%) South Asia Bangladesh Bangladesh Bhutan Bhutan India India Maldives Maldives Nepal Nepal Pakistan Pakistan Sri Lanka Sri Lanka

Central Asia: Bright horizon for energy exporters… Oil/gas investments and higher prices boost oil-exporting economies Higher commodity prices benefiting non-oil export-led economies Economic diversification urgently needed, especially to boost employment, but structural reforms and finding an effective strategy difficult

Pacific: Doing better than expected… 2003 turned out better than expected at 4.3% Second largest economy Fiji continuing on recovery road Fiscal governance issues remaining major problem

Risks to Developing Asia: Clouds gathering beyond the clear skies … Global Risks Surging oil prices could create havoc for world economy –Aggravate existing global imbalances Effects of Oil Price Inc –Duration of oil price increase more important than the level of increase Oil price simulation –Higher oil price environment calls for medium to long-term structural adjustments (e.g., improving energy efficiency)

… Global Risks Japan and EU highly vulnerable to a downturn in US Widening US fiscal and current account deficits exacerbating vulnerability of world economy No leeway left for macroeconomic policy support in industrial countries

…Global Risks Uncertain sustainability of growth momentum in major industrial countries, rising inflation, rising interest rates and persistent slide in dollar. The specter of stagflation beyond 2005?

Risks to Developing Asia… Regional Risks Hard landing in PRC still a possibility PRC Slowdown PRC Slowdown With exports a main driver of growth, region vulnerable to world economic slowdown beyond 2005 Weakness in financial sector regulation and supervision could hurt domestic demand (e.g., Korea)

...Regional Risks Employment generation still lagging in spite of strong growth:risk to social stability Epidemics and security threats:real danger in the region Developing Asia must be resilient in the face of turbulence resulting from global and regional risks

Making Developing Asia’s robust growth sustainable over the medium term? Consolidate fiscal situations to allow for future anti-cyclical policies Implement policies to bolster domestic demand:deepen financial sector reforms and supervision(consumer credit, long- term mortgage lending, etc.)

Making Developing Asia… Address investment climate problems (from infrastructure to governance to legal systems) Review labor market policies to share benefits of growth Adopt more flexible exchange rate policies and ensure the productive use of foreign exchange reserves Growing importance of domestic demand and increased competitiveness will ensure resilience in the face of turbulence

Making Developing Asia’s robust growth sustainable over the long term? Developing Asia is in catch-up mode and there is still a large scope for efficiency improvement through reforms and adoption of new technology, leading to a potential increase in productivity Demographic outlook is positive, dependency ratio will come down in most economies, savings rate will stay high or increase leading to higher investment rate

Making Developing Asia… Over the long term 7-8% growth rate of GDP is feasible:a tri-polar Asia could emerge by 2020 Challenge: stay competitive in Asia and the world Buoyant domestic demand will trigger imports while increased competitiveness will spur exports

Making Developing Asia… Increased complementarities within Asia will strengthen trade and investment integration thereby providing a buffer to global turbulence With the increased importance of Asia in global GDP, strengthened linkages with US and EU will lead to win-win outcomes

Key Messages: medium term Developing Asia growing at fastest rate in 2004 since 2000 Growth more broad based:investments and exports picking up; consumption demand remaining sustained Moderate growth slowdown in 2005 mainly due to easing of aggregate demand Risks linked to imbalances in world economy increasing Accelerate macro and micro policy reforms to make growth sustainable

Key Messages: long term Strengthened inclusiveness and improved investment climate will boost aggregate demand Aggregate supply must be made more efficient through strengthening the microfoundations of growth thereby improving competitiveness Complementarities between South Asia, East Asia, and ASEAN need to be fostered to boost intraregional trade

Key Messages:… Complementarities between Asia, US, and EU need to be strengthened to augment inter-regional trade Open market-oriented competitive economies will be the key to resilience and sustained growth

Baseline Assumptions on External Conditions back to Global Context back to Global Context back to Global Context ADOUpdateADOUpdate GDP Growth (%) Industrial Countries United States Euro Zone Japan Memorandum Items US Federal Funds Rate (%) Brent Crude Oil ($/bbl) Global Trade Volume (% change)

GDP Growth: Developing Asia, back to Developing Asia back to East Asia back to Developing Asiaback to East Asia back to Developing Asiaback to East Asia GDP Growth (%) ADOUpdate*ADOUpdate* Developing Asia East Asia East Asia Southeast Asia Southeast Asia South Asia South Asia Central Asia Central Asia The Pacific The Pacific * as of Nov 10, 2004

Inflation: Developing Asia, back to Developing Asia back to Developing Asia back to Developing Asia Inflation (%) ADOUpdate*ADOUpdate* Developing Asia East Asia East Asia Southeast Asia Southeast Asia South Asia South Asia Central Asia Central Asia The Pacific The Pacific

CA/GDP: Developing Asia, back to Developing Asia back to Developing Asia back to Developing Asia Current Account Balance/GDP ADOUpdate*ADOUpdate* Developing Asia East Asia East Asia Southeast Asia Southeast Asia South Asia South Asia Central Asia Central Asia The Pacific The Pacific

CA/GDP, East Asia go to East Asia go to GDP:East Asia go to East Asiago to GDP:East Asia go to East Asiago to GDP:East Asia Current Account Balance/GDP East Asia PRC PRC Hong Kong, China Hong Kong, China Korea, Rep. of Korea, Rep. of Taipei,China Taipei,China

CA/GDP, Southeast Asia go to SEAsia go to GDP:SEAsia go to SEAsia go to GDP:SEAsia go to SEAsia go to GDP:SEAsia Current Account Balance/GDP Southeast Asia Cambodia Cambodia Indonesia Indonesia Lao PDR Lao PDR Malaysia Malaysia Philippines Philippines Singapore Singapore Thailand Thailand Viet Nam Viet Nam

CA/GDP, South Asia go to SAsia go to GDP:SAsia go to SAsiago to GDP:SAsia go to SAsiago to GDP:SAsia Current Account Balance/GDP South Asia Bangladesh Bangladesh Bhutan Bhutan India India Maldives Maldives Nepal Nepal Pakistan Pakistan Sri Lanka Sri Lanka

Contribution to Growth, Hong Kong, China (% points) back to East Asia Taipei,China back to East AsiaTaipei,China back to East AsiaTaipei,China Q1Q2Q3Q4Q1Q2 GDP Consumption Investment Net Exports

Contribution to Growth, Taipei,China (% points) back to East Asia back to East Asia back to East Asia Q1Q2Q3Q4Q1Q2 GDP Consumption Investment Net Exports

Contribution to Growth, Korea (% points) back to East Asia back to East Asia back to East Asia Q1Q2Q3Q4Q1Q2 GDP Consumption Investment Net Exports

Contribution to Growth, Indonesia (% points) back to Southeast Asia Malaysia back to Southeast Asia Malaysia back to Southeast Asia Malaysia Q1Q2Q3Q4Q1Q2 GDP Consumption Investment Net Exports

Contribution to Growth, Malaysia (% points) Philippinesback to Southeast Asia Philippinesback to Southeast Asia Philippinesback to Southeast Asia Q1Q2Q3Q4Q1Q2 GDP Consumption Investment Net Exports

Contribution to Growth, Philippines (% points) back to Southeast AsiaSingapore back to Southeast AsiaSingapore back to Southeast AsiaSingapore Q1Q2Q3Q4Q1Q2 GDP Consumption Investment Net Exports

Contribution to Growth, Singapore (% points) back to Southeast Asia Thailand back to Southeast Asia Thailand back to Southeast Asia Thailand Q1Q2Q3Q4Q1Q2 GDP Consumption Investment Net Exports

Contribution to Growth, Thailand (% points) back to Southeast Asia back to Southeast Asia back to Southeast Asia Q1Q2Q3Q4Q1Q2 GDP Consumption Investment Net Exports

Sustained high oil price Inflationary pressures Interest rate hikes Reversal of Savings and Consumption Behavior Rise in HH Credit Default Rates Investment Setback Reduction of attractiveness of Asian financial Markets SLOWDOWN OF ECONOMIC ACTIVITY IN ASIA back to Global Risks

Impact in 2005 of Sustained Increase*: Scenario I vs. Scenario II next next Scenario I ($10/bbl increase)Scenario II ($20/bbl increase) GDPTrade Balance (% of GDP) Consumer Prices GDPTrade Balance (% of GDP) Consumer Prices Asia incl. Japan Asia excl. Japan Japan PRC Hong Kong, China Korea * Until end of 2005; from a baseline of $35/bbl; brent crude

Impact of a Sustained Increase…cont. back to global risks back to global risks back to global risks Scenario I ($10/bbl increase)Scenario II ($20/bbl increase) GDPTrade Balance (% of GDP) Consumer Prices GDPTrade Balance (% of GDP) Consumer Prices Indonesia Malaysia Philippines Singapore Thailand India

Key stylized facts The slowdown in PRC is mainly investment- induced; Despite rapid growth, PRC remains a relatively small trading partner of most Asia developing economies, compared to the US, Japan and EU; A large part of Asia's exports to the PRC involves intermediate goods that are processed and reexported.

Weakening fixed investment in some selected sectors is the main component of the slowdown of PRC

Regional Distribution of Trade in Developing Asia, 2003 (%)

The regional production chain is dependent on final demand from industrial countries

Effects of a PRC Slowdown The simulations using a global CGE model show that PRC’s slowdown would have a moderate impact on Asian economies A two % pts reduction in PRC’s growth would slow GDP growth by 0.5 ppts for NIEs, 0.24 ppts for ASEAN and 0.1 ppts for South Asia

Effects on GDP Growth in Selected Regions (2 % pts reduction in PRC’s GDP growth, 2005) US-0.11 Japan-0.24 EU-0.12 NIEs-0.50 ASEAN-0.24 South Asia-0.09 The World-0.24

Sectoral Impacts In Japan, the textile sector is most hit due to strong dependence on PRC market. NIEs are expected to experience some production losses in their chemicals, metals, services, and textiles sectors. In ASEAN, electronics and chemical industry would be major losers from PRC’s back to Regional Risks. back to Regional Risks