Developing Asia 2004-2005: Is the Boom Sustainable ?

1. Developing Asia 2004-2005: Is the Boom Sustainable ? Ifzal Ali Chief Economist Asian Development Bank Economic Congress Casa Asia, Barcelona, Spain 22 November 2004

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

3. 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?

4. Developing Asia Booming in 2004-2005 • GDP Growth much stronger than expected in 1H 2004 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

5. Developing Asia… • Regional current account surplus narrowing but still 2.9% GDPCA/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

6. East Asia: Upward Growth Trend Continues since 2000… • PRC Economy at near full throttle in 2004 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 demandHong Kong Taipei,China • Korea lagging as consumption still depressed and low growth continuing 2005 Korea • PRC micro soft landing in 2005 CA/GDP:East Asia

7. GDP Growth, East Asia back to East AsiaCA/GDP: East Asia

8. 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 • Contribution of consumer expenditure remaining robust Philippines

9. 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

10. GDP Growth, Southeast Asia CA/GDP:SEAsia

11. 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

12. GDP Growth, South Asia CA/GDP:South Asia

13. 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

14. 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

15. 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)

16. … 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

17. …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?

18. Risks to Developing Asia… Regional Risks • Hard landing in PRC still a possibility 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)

19. ...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

20. 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.)

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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

28. Baseline Assumptions on External Conditions back to Global Context

29. GDP Growth: Developing Asia, 2003-2005 back to Developing Asiaback to East Asia * as of Nov 10, 2004

30. Inflation: Developing Asia, 2003-2005 back to Developing Asia

31. CA/GDP: Developing Asia, 2003-2005 back to Developing Asia

32. CA/GDP, East Asia go to East Asiago to GDP:East Asia

33. CA/GDP, Southeast Asia go to SEAsiago to GDP:SEAsia

34. CA/GDP, South Asia go to SAsiago to GDP:SAsia

35. Contribution to Growth, Hong Kong, China (% points) back to East AsiaTaipei,China

36. Contribution to Growth, Taipei,China (% points) back to East Asia

37. Contribution to Growth, Korea (% points) back to East Asia

38. Contribution to Growth, Indonesia (% points) back to Southeast Asia Malaysia

39. Contribution to Growth, Malaysia (% points) Philippinesback to Southeast Asia

40. Contribution to Growth, Philippines (% points) back to Southeast AsiaSingapore

41. Contribution to Growth, Singapore (% points) back to Southeast Asia Thailand

42. Contribution to Growth, Thailand (% points) back to Southeast Asia

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

44. Impact in 2005 of Sustained Increase*: Scenario I vs. Scenario II next * Until end of 2005; from a baseline of $35/bbl; brent crude

45. Impact of a Sustained Increase…cont. back to global risks

46. 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.

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

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

49. China Industrial Countries Rest of E&SE Asia The regional production chain is dependent on final demand from industrial countries

50. 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