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Highlights
Recent Economic Performance•Economic growth in emerging East Asia remained strong in
the second half of 2007, in many cases performing better-than-expected—supported by healthy growth in consumption,investment,andcontinuedsolidexports.
•Inflationarypressureshavebeenincreasingacrosstheregionoverthepastseveralmonths,withheadlineinflationreachingmulti-yearhighsinseveraleconomiesonhigherfoodandenergyprices.
•Current account surpluses continued to grow, and with capitalinflows remaining strong through the first 9months of 2007,balanceofpaymentspositionsstrengthenedacrossmuchoftheregion.
•Currencyappreciationagainst theUSdollar gainedmomentumthroughoutmuchof2007,withexchangeratesupnearly5%onaveragesincethebeginningoftheyear.
•Monetarypoliciesacrosstheregionhavebecomemorecautioussince the July global financial turbulence—given the increasedvolatilityoftheregion’sfinancialmarkets,inflationarypressures,andtheuncertainoutlookformajorindustrializedeconomies.
•Despite limited spillover into emerging East Asia from the USsubprimeturmoil,thereareseveralsignsoffinancialvulnerabilityrelatedtosharpgainsinequityandrealestateprices.
Outlook, Risks, and Policy Issues•The external environment for emerging East Asian economiesisexpected toweakensomewhat in2008,aseconomicgrowthin industrial countries moderates, oil and commodity pricesremainelevated,andglobalfinancialmarketscontinuetoexhibitheightenedvolatility.
•With the external environmentweakening somewhat—and thePRC,theregion’slargesteconomy,expectedtosoftennextyear—aggregateGDPgrowthinemergingEastAsiaisforecasttoslowto8.0%in2008fromalikely8.5%thisyear.
•The region’s economic outlook is subject to greater downsiderisksnowthanjustafewmonthsago—includingthepossibilityofaUShardlanding,furthertighteningofglobalcredit,anabruptadjustment in exchange rates, and a continued rise in oil andcommodityprices.
Continued overleaf
The Asia Economic Monitor (AEM) is asemiannual review of emerging EastAsia’s growth, financial vulnerability,and emerging policy issues. It coversthe 10members of the Association ofSoutheastAsianNations;People’sRepublicofChina;HongKong,China;RepublicofKorea;andTaipei,China.
Asia Economic Monitor 2007 December 2007 aric.adb.org
Asian Development Bank Office of Regional Economic Integration
6ADBAvenue,MandaluyongCity1550MetroManila,Philippines
Telephone+6326326265+6326324444
Facsimile+6326362183
How to reach us
ContentsRecentEconomicPerformance 3
GDPGrowth 3Inflation 6BalanceofPayments 7FinancialMarketsandExchangeRates 10MonetaryandFiscalPolicy 12
AssessmentofFinancialVulnerability 15
EconomicOutlookfor2008,Risks,andPolicyIssues 21
ExternalEconomicEnvironment21RegionalEconomicOutlookfor2008 27RiskstotheOutlook 30PolicyIssues 34
Special Section
CanEmergingEastAsiaWeatherGlobalFinancialInstability? 42
Boxes
1.FedRateCutsandPolicyDilemmas 35
2.MeasuringMonetaryIndependenceinEmergingEastAsia 37
3.AssetMarketsandtheRealEconomy 51
4.IsEmergingEastAsiaDecouplingfromtheUS? 55
ADB AsianDevelopmentBankAEM AsiaEconomicMonitorASEAN AssociationofSoutheastAsian
NationsASEAN-4 Indonesia,Malaysia,Philippines,
ThailandBIS BankforInternational
SettlementsCLI compositeleadingindicatorCPI consumerpriceindexECB EuropeanCentralBankEU EuropeanUnionFDI foreigndirectinvestmentFed FederalReserveG3 GroupofThreeGDP grossdomesticproductH1 firsthalfH2 secondhalfHKMA HongKongMonetaryAuthorityIMF InternationalMonetaryFundIT informationtechnologyJCI JakartaCompositeIndexKLCI KualaLumpurCompositeIndexKOSPI KoreanStockPriceIndexLaoPDR LaoPeople’sDemocraticRepublicM2 broadmoneyMSCI MorganStanleyCapital
InternationalInc.m-o-m monthonmonthNEER nominaleffectiveexchangerateNIE newlyindustrializedeconomyNPL nonperformingloanOECD OrganisationforEconomicCo-
operationandDevelopmentOREI OfficeofRegionalEconomic
IntegrationPCOMP PhilippineCompositeIndexPRC People’sRepublicofChinaQ1 firstquarterQ2 secondquarterq-o-q quarteronquarterRMB renminbiROA returnonassetsROE returnonequityROPOA realandotherpropertiesowned
andacquiredROW restofworldS&P Standard&Poor’sSET StockExchangeofThailandSTI StraitsTimesIndexTWSE TaiwanStockExchangeIndexUK UnitedKingdomUS UnitedStatesy-o-y yearonyearWTO WorldTradeOrganization
Acronyms, Abbreviations, and Notes
TheAsia Economic Monitor December2007was prepared by theOffice of RegionalEconomic Integration of the AsianDevelopment Bank and does notnecessarily reflect the views of ADB’sBoardofGovernorsorthecountriestheyrepresent.
Note:“$”denotesUSdollarsunlessotherwise
specified.
•Givenspecificdomesticconditionsfacingtheregion’seconomies,monetary authorities will need great care in designing policyresponsestothechangingexternalenvironment:
—ineconomiesthatusegreaterexchangeratecontrol,increasingcurrencyflexibilitycouldaddusefulmonetaryleverage;and
—East Asian economies may wish to explore ways to bettermaintainstabilityamongintraregionalexchangerates.
•Otherpolicyprioritiesmayfocuson(i)managingtheconsequencesofrapidlyincreasingcapitalinflows,(ii)improvingtheinvestmentclimatetostrengthendomesticdemand,(iii)continuingtodevelopefficientanddeeperfinancialmarkets,and(iv)promotingenergyefficiencyandconservation.
Can Emerging East Asia Weather Global Financial Instability?Despitestrongresiliencetotheweakeningexternalenvironment,vulnerabilities in the region’s financial systems should not beunderestimated,asresurgentcapitalinflowsandexcessliquiditymaycomplicateatrueassessmentofrisk.
Theregion’slargelybank-dominatedfinancialsystems—withweaksystemicsupportforeffectiveriskmanagement—leavedoorsopento potential spillovers if conditions in global financialmarketsworsenorinvestorsentimentshifts.
Recenttrendsintheglobalfinancialsystem—notablythegrowing
presenceofnonbankfinancialinstitutionsandproliferationofnew
instrumentsforrisktransfer—willalsobecomeincreasinglyrelevant
intheregionalcontext.
Greaterfinanciallinkageswithglobalmarketsincreasestheregion’sexposuretorisksarisingfromglobalfinancialinstability.
Similarly,strongtradetiestomajorindustrializedcountriessuggestthat the risk to the regionmightbegreater ifgrowth in thoseeconomiesslowssharply.
Monetarypolicyanchoredoninflationtargeting,aprudentfiscalapproach, and greater exchange rate flexibility could limit anyspilloverofcontinuedglobalfinancialinstability.
Policymakers will need to concentrate on enhancing riskmanagement systems, strengthening disclosure requirements,andupgradingsupervisoryframeworkstobetterassesspotentialvulnerabilities.
Economieswith less-developed financial systemsmay not faceimmediatefinancialtransmissionfromthesubprimeturmoil,butnonethelesscouldfocusonlonger-termdevelopmentissuessuchasinstitutionbuilding,financialsectorreforms,andcapitalmarketdevelopment.
•
•
•
•
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•
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•
�
Emerging East Asia—A Regional EconomicUpdateRecentEconomicPerformance
GDP Growth
Economic growth in emerging East Asia remained strong in the second half of 2007, in many cases performing better-than-expected—supported by healthy growth in consumption, investment, and continued solid exports.
EconomicgrowthinemergingEastAsiainthesecondhalfof2007
likelysustainedthemomentumofthebriskfirsthalf.Combined
gross domestic product (GDP) of the nine largest economies
inemergingEastAsia1grew8.9%(year-on-year) inthethird
quarter of 2007—or 6.1% excluding the People’s Republic of
China (PRC)—the highest in recent years (Figure 1). In the
PRC,GDPgrew11.5%inthethirdquarter,thesameasinthe
firsthalf.Thefourmiddle-incomecountriesoftheAssociationof
SoutheastAsianNations(ASEAN-4)grew6.2%,higherthanthe
5.7%recordedinthefirsthalf.GDPgrowthinthefournewly-
industrializedeconomies(NIEs)—HongKong,China;Republicof
Korea(Korea);Singapore;andTaipei,China—acceleratedto6.0%
inthethirdquarterfrom5.0%inthefirsthalf.
Excluding the PRC, robust growth was supported by strong
consumptiondemandandsolidexports(Figure 2).Theexternal
sectorcontributedstronglytotheoverallexpansiondespitethe
slowdownintheUnitedStates(US)economy,drivenbyrelatively
healthygrowthintheeurozoneandongoingrecoveryinJapan.
Privateconsumptionintheregionalsostrengthenedmarkedly
over the past 3 quarters of 2007. Private consumption grew
5.2%inthethirdquarter,upfrom4.6%inthepreviousquarter
(Figure �).
1TheninelargestemergingEastAsianeconomiesarePeople’sRepublicofChina(PRC); Hong Kong, China; Indonesia; Republic of Korea (Korea); Malaysia;Philippines;Singapore;Taipei,China;andThailand.
7.1
5.7
4.14.24.7
4.03.44.0
4.64.9
2.9
4.7
0
1
2
3
4
5
6
7
8
2004Q1 2004Q3 2005Q1 2005Q3 2006Q1 2006Q3 2007Q1 2007Q3
ASEAN-4Emerging East Asiaex. PRC
NIEs
6.2
5.2
Figure3: Consumption Growth (y-o-y,%)
Source:OREIstaffcalculationsbasedonCEICdata.
China, People’s Rep. of
7.3
8.5 8.9
11.5
11.911.5
9.1
6.05.0
6.26.7
6.2
8.1
6.6
3.2
0
2
4
6
8
10
12
2004Q1 2004Q3 2005Q1 2005Q3 2006Q1 2006Q3 2007Q1 2007Q3
Emerging East Asia2
ASEAN-4
NIEs
Figure1:GDP1 Growth—Emerging East Asia2
1Weightedbygrossnationalincome(atlasmethod,current$).2IncludesASEAN-4,NIEs,andPeople’sRepublicofChina(PRC).Aggregates do not include Brunei Darussalam, Cambodia,LaoPDR,Myanmar,andVietNamforwhichquarterlyGDPdataarenotavailable.Source:OREIstaffcalculationsbasedonnationalsources.
2.6 2.1 2.3 3.1 2.3
1.4
1.7
1.6
1.31.0
2.9
-0.5
0.91.6
2.1
1.53.3
-0.4
0.35.7
4.9
6.35.4
4.8
7.4
6.5
-1
0
1
2
3
4
5
6
7
8
2004Q1 2004Q3 2005Q1 2005Q3 2006Q1 2006Q3 2007Q1 2007Q3
Statistical discrepancyNet exportsInvestmentConsumptionGDP
6.1
1.8
0.9
3.3
Figure2:Contributions to GDP Growth—Emerging East Asia ex. PRC (y-o-y,%)
Source:OREIstaffcalculationsbasedonCEICdata.
R E G I O N A L U P D A T E
�
Earlyindicatorssuggeststronggrowthintheregionwill likely
continue in the fourthquarter,althoughata somewhatmore
moderatepace.Industrialproductionremainedgenerallyhealthy
acrosstheregion,exceptinthePhilippines,whereitcontinued
tocontract(Figure �a, �b).Butindustrialproductiongrowth
mayhavepeakedinseveraleconomies,includingthePRC,Korea,
andSingapore,andremainedmodestinIndonesiaandMalaysia.
Retail salesalsopoint toa relatively strongsecondhalf,with
growth in thePRC;HongKong,China;Korea;andSingapore
generallyhigherinthethirdquarterthaninthefirst6months
oftheyear(Figure 5).
InthePRC,stronginvestment,solidconsumption,andresilient
exports supported high GDP growth. The investment boom
regainedstrengthin2007aftereasingsomewhatinthesecond
halfof2006,withfixed-assetinvestmentedgingupto25.7%
(year-on-year)inthethirdquarter,from24%in2006(Figure 6).
Consumerspendinggrewsteadily,withretailsalesgrowthonan
upwardtrend—reachingarecord18.1%inOctober.Theexternal
sectoralsoremainedstronginthePRC,despitemeasurestocool
exportgrowth,suchasadownwardadjustmenttotheexporttax
rebatesystem,andevenamidconcernaboutproductqualityand
safety.Exportswereup27.1%inthefirst3quartersoftheyear,
justunderthe27.2%growthrateforallof2006.
Astrongrecovery indomesticdemandboostedgrowth in the
ASEAN-4economies(Figure 7).ButThailandwasanexception
as lingering political uncertainty ahead of the 23 December
electionsaffectedprivateconsumptionandinvestmentdemand.
Consumption growthwas the weakest in 6 years and fixed
investmentfellby0.7%inthefirsthalf.Butprivateconsumption
generally increasedintheotherASEAN-4countries,fueledby
publicsectorsalaryhikes,healthylabormarkets,andstronger
overseasremittances,whichproppeduphouseholdincomeand
spending.FixedinvestmentalsopickedupstronglyintheASEAN-4
countries,contributingabout1.7percentagepointstototalGDP
growthof6.2%inthethirdquarter(Figure 8).Election-related
government spending in the Philippines and infrastructure
programdisbursementsintheotherASEAN-4economiesprovided
anadditionalboosttoconsumptionandinvestment.Meanwhile,
intheASEAN-4countries,thecontributionofnetexportstoGDP
growthfell to0.6percentagepoint inthethirdquarter,down
from3.4percentagepointsinthesecondquarter(Figure 9).
Themainfactorsincludetheweakeningexternalenvironmentand
Singapore
Korea, Rep. of
Hong Kong, China
China, People's Rep. of
15.8
28.6
18.115.5
3.6
-4.3-2.8
6.5
-3.6 -5.0-10
-5
0
5
10
15
20
25
30
Jan-05
Apr-05
Jul-05
Oct-05
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Figure5:Retail Sales Growth (y-o-y,%)
Source:CEIC.
Figure4a:Industrial Production Growth1 (y-o-y,%)
13-monthmovingaverage.Source:OREIstaffcalculationsbasedonCEICdata.
Philippines
Thailand
Malaysia
Indonesia
2.0
-9.3
-4.8
-14.2
-2.6
12.6 12.5
17.6
9.012.4
-3.5
11.1
4.4
-20
-15
-10
-5
0
5
10
15
20
Jan-04
Jun-04
Nov-04
Apr-05
Sep-05
Feb-06
Jul-06
Dec-06
May-07
Oct-07
Singapore
Korea, Rep. of
Taipei,China
9.6
18.1
3.5
-5
0
5
10
15
20
25
Jan-04
Jun-04
Nov-04
Apr-05
Sep-05
Feb-06
Jul-06
Dec-06
May-07
Oct-07
China, People's Rep. of
11.5
Figure4b:Industrial Production Growth1(y-o-y,%)
13-monthmovingaverage.Source:OREIstaffcalculationsbasedonCEICdata.
R E G I O N A L U P D A T E
5
strengtheningcurrencies,butstrengtheningdomesticdemand
hasalsobeguntohelpnarrowtradesurpluses.InthePhilippines,
forexample,theappreciationofthepesoinrealterms—mainly
duetostrongcapitalinflowscombinedwithasurgeinoverseas
workerremittances—hashurttheexportcompetitivenessofthe
manufacturing sector and seen exports slowing. Remittances
havebolsteredprivateconsumption,however,andtheservices
sectorhasbecomethemaindriverofstronggrowththisyearin
thePhilippines,contributing3.6percentagepointstothe6.6%
third-quarterexpansion.
PrivateconsumptionalsostrengthenedintheNIEs(seeFigure3).
InHongKong,China,privateconsumptionpickedupasincome
andwealthincreasedamidstrongemploymentandhealthygains
intheequitymarkets.InKorea,theon-and-offrecoveryfrom
2003’s household debt-related contraction has steadied, with
supportfromatighterlabormarketandboomingequitymarkets.
And in Singapore and Taipei,China, private consumption was
boostedbytightlaborandstrongerpropertymarkets.Investment
intheNIEseconomiesalsoremainsbuoyant,althoughiteased
inthethirdquarterfromstronggrowthinthepreviousquarter:
itscontributiondeclinedto0.6percentagepoints,from2.5in
thesecondquarter(Figure 10).Fixedinvestment,specificallyin
plantandfacilities,pickedupinTaipei,Chinaoncapitalexpansion
in the semiconductor sector. Private investment remained
stronginSingaporeandHongKong,China,supportedbyrapid
constructionsectorgrowth.Korea’sfixedinvestmentheldupas
well, despite slowing construction demand. Non-construction
business investment, in particular,made a strong showing in
recentquartersonthebackofrecoveryindomesticdemand.
InVietNam,third-quarterGDPgrowthof8.7%wasthehighestin
adecade,aidedbycontinuedexpansioninindustry,construction,
and services. GDP in Brunei Darussalam contracted 1.7% in
thefirsthalfof2007,afterstronggrowthin2006,largelyona
dropinoilproduction.InCambodia,agradualdecelerationin
GDPgrowthcontinuedasexternaldemandsoftenedandprivate
consumptioneased,although thepace likely remainedstrong
atanestimated9.2%thisyear.IntheLaoPeople’sDemocratic
Republic (LaoPDR),GDP likelygrew6.8%in2007as foreign
investment drove robust expansion of the industrial sector,
especially in mining and energy. In Myanmar, independent
projectionsputGDPgrowthinarangeofabout3–6%forthe
2007fiscalyear.
10.5
9.9
5.64.9
6.45.4
6.7
4.53.9
3.8
-2
0
2
4
6
8
10
12
2004Q1 2004Q3 2005Q1 2005Q3 2006Q1 2006Q3 2007Q1 2007Q3
Fixed investmentPrivate consumptionDomestic demand
8.1
6.1
6.4
Figure7:ASEAN-� Domestic Demand Growth (y-o-y,%)
Source:OREIstaffcalculationsbasedonCEICdata.
2.0 2.3
0.51.2
0.8
-1.7
0.3
-1.4-1.6
2.2
-1.1-0.2
3.1
0.3
-3
-2
-1
0
1
2
3
4
2004Q1 2004Q3 2005Q1 2005Q3 2006Q1 2006Q3 2007Q1
Fixed assetsChanges in inventoryTotal domestic investment
1.7
1.6
-0.1
2007Q3
Figure8:Investment Contributions to GDP Growth: ASEAN-�(y-o-y,%)
Source:OREIstaffcalculationsbasedonCEICdata.
10.5
5.62.6
11.6
3.4
8.7
3.5
11.2
7.7
1.2
5.7
43.0
29.8
25.7
0
2
4
6
8
10
12
14
2004Q1 2004Q3 2005Q1 2005Q3 2006Q1 2006Q3 2007Q1 2007Q305101520253035404550
ASEAN-4
Emerging East Asia,ex. PRC
NIEs
China, People's Rep. of
China, People's Rep. of1
Others
5.0
8.1
Figure6:Fixed Assets Growth(y-o-y,%)
1PRC figures are based on nominal fixed-asset investmentgrowth(year-to-date).Source:OREIstaffcalculationsbasedonCEICdata.
-1.4
3.4
0.60.4
-1.7
2.43.1
0.61.2
1.62.2
1.7 1.51.00.5
1.6
-3
-2
-1
0
1
2
3
4
5
6
2004Q1 2004Q3 2005Q1 2005Q3 2006Q1 2006Q3 2007Q1 2007Q3
ASEAN-4 net exportsNIEs net exportsEmerging East Asia ex. PRC net exports
1.8
0.6
Figure9:Contributions of Net Exports to GDP Growth (y-o-y,%)
Source:OREIstaffcalculationsbasedonCEICdata.
R E G I O N A L U P D A T E
6
Inflation
Inflationary pressures have been increasing across the region over the past several months, with headline inflation reaching multi-year highs in several economies on higher food and energy prices.
WhileheadlineinflationstartedtoriseintheASEAN-4economies,
it reached a 16-year high in Singapore, 12-year highs in the
PRCandTaipei,China,anda9-yearhighinHongKong,China.
Inrecentmonths,itwasalsoatitshighestsince2005inKorea
andinVietNam.Onaverage,theregion’sinflationwasup5.2%
inOctober2007; fromarecent lowof1.9%inOctober2006
(Figure 11).Theriseinheadlineinflationismainlyattributedto
rapidandpersistentincreasesinfoodandenergypricesresulting
fromrealcapacityconstraints—notsimplyone-offeventssuchas
poorweather.Coreinflationisalsoincreasinginsomeeconomies
(Figure 12). Persistent high growth inmonetary aggregates
may have also contributed to rising inflationary pressures
(Figure 1�).
InthePRC,theconsumerpriceindexhita12-yearhighof6.5%
inAugustandagaininOctober—fromalowof1%inJuly2006—
puttingpressureonthecentralbanktofurthertightenmonetary
policy.Surgingfoodprices(up17.6%overtheyeartoOctober)
havedrivenheadlineinflationinrecentmonths.Theunderlying
factor,however,isampleliquidityintheeconomyasaresultof
persistently largecapital inflowsandstrongmoneygrowth in
recentyearsdueto incompletesterilization.Rapidassetprice
inflationhasalreadybeenasignificantmacroeconomicproblem
inthePRC.Andnow,headlineinflationalsoexceedsreturnson
bankdeposits,encouragingmorehouseholdstoputtheirmoney
inthealreadyoverheatingstockmarkets—whichtheauthorities
havebeentryingtocool.
InflationinASEANcountrieshasincreasedinrecentmonthsas
stronggrowthcontinuestoclosetheoutputgapandenergyand
foodpricesrise.InIndonesia,exemplifyingtheASEAN-4trend,
inflationwasbackupto6.7%inNovember,afterfallingto5.8%
inJune2007.Inthepast6months,inflationalsodriftedhigher
inMalaysia(fromabout1.5%tocloseto2%),thePhilippines
(fromaround2.3%to2.7%),andinThailand(frombelow2%to
3.0%) (Figure 1�).Andwiththepossibleremovalofremaining
fuelsubsidiesintheretailmarket,inflationmayhaverisenstill
Fixed assetsChanges in inventoryTotal domestic investment
1.6
0.81.4
0.81
-0.2-0.2-0.8
0.80.7
-0.2
0.6
2.3
2.52.4
1.5
0.6
-4
-3
-2
-1
1
2
3
4
2004Q1 2004Q3 2005Q1 2005Q3 2006Q1 2006Q3 2007Q1 2007Q3
Figure10:Investment Contributions to GDP Growth: NIEs(y-o-y,%)
Source:OREIstaffcalculationsbasedonCEICdata.
China, People’s Rep. of
NIEs
Emerging East Asia
6.55.3
3.9
6.2
10.7
4.24.8
3.63.4
5.2
2.8
-1
1
3
5
7
9
11
Jan-04
Jun-04
Nov-04
Apr-05
Sep-05
Feb-06
Jul-06
Dec-06
May-07
Oct-07
ASEAN-4
Figure11:Regional Inflation—Headline Rates (y-o-y,%)
Source:OREIstaffcalculationsbasedonCEICdata.
Philippines
Korea, Rep. of
Thailand
Malaysia
Singapore
Indonesia
2.4
5.0
7.1
0.7 1.5
2.9
-1.4
3.9
-0.1 1.0
6.3
10.2
-2-10123456789
1011
Jan-04
Jun-04
Nov-04
Apr-05
Sep-05
Feb-06
Jul-06
Dec-06
May-07
Nov-07
Figure12:Core Inflation Rates (y-o-y,%)
Note:Officialfigures,exceptMalaysia(ex.food,fuel,utilities)andSingapore(ex.food,privatetransport).Sources:OREIstaffcalculationsbasedonCEICdata.
Philippines
Malaysia
Thailand
18.5
26.0
11.3
32.3
12.2
3.6
6.2
2.76.9
10.3
0
5
10
15
20
25
30
35
Jan-04
Jun-04
Nov-04
Apr-05
Sep-05
Feb-06
Jul-06
Dec-06
May-07
Oct-07
China, People's Rep. of
Korea, Rep. of
Figure13:Money Growth1 (y-o-y,%)
1M2.Source:CEIC.
R E G I O N A L U P D A T E
7
furtherinMalaysiaduringthecourseoftheyear.Astrongpeso
inthePhilippinesandweakerdemandinThailandshouldhelp
ease inflation in both countries.Meanwhile, fast growth also
contributedtoinflationinsmallercountries:Novemberconsumer
pricesinVietNamwereup10.0%overayearearlier,thehighest
innearly3years.
TheNIEshaveseeninflationrisingquicklyinrecentmonths—most
significantlyinTaipei,China(5.3%inOctober),andinSingapore
(3.6%inOctober),whereinflationwasbelow1%inthefirsthalf
of2007.Whilehigheroil pricespushedupheadline inflation,
abouthalfoftheincreaseinSingaporewasduetothehikeinthe
goodsandservicetaxes.Higherfood,oil,andothercommodity
prices,alongsiderisingwagesduetorelativelytightlabormarkets
andthepass-throughofincreasingbusinesscosts,havefueled
inflationarypressuresintheNIEs.
Balance of Payments
Current account surpluses continued to grow, and with capital inflows remaining strong through the first 9 months of 2007, balance of payments positions strengthened across much of the region.
Third-quarterexportgrowth(invalueterms)inemergingEast
Asia softened, although it was still robust. However, import
growthslowedmoreandthecombinedtradesurpluswidened
asa result, comparedwith thesameperiod in2006.Exports
slowed largely because of a cyclical downswing in the global
information technology industry,while importseasedbecause
ofrelatedinventoryadjustmentsintheindustryoverthepast
fewquarters.Despitestrengtheningdomesticdemand,current
accountsurplusesacrosstheregionweresustainedgoinginto
thesecondhalfof2007.Capitalinflowsalsoremainedstrongin
thefirst9months,contributingtoasignificantlystrongerbalance
ofpayments.Internationalreservescontinuedtobuildascentral
banksintervenedinforeignexchangemarketstocurbtherapid
paceofcurrencyappreciation.
InthePRC,exportsgrewablistering26.2%inthethirdquarter
of2007,thoughmarginallyslowerthanthe27.6%ofthefirst
half. Import growth accelerated to 21% in the same period,
abovethe18%ofthefirsthalf.Thetradesurplusreachedmore
Indonesia
Philippines
Viet Nam
Malaysia
Thailand 2.7
7.6
4.5
6.7
18.4
14.5
8.810.0
9.110.3
1.93.02.8
5.3
02468
101214161820
Jan-04
Jun-04
Nov-04
Apr-05
Sep-05
Feb-06
Jul-06
Dec-06
May-07
Nov-07
Figure14:Inflation in Selected ASEAN Economies—Headline Rates (y-o-y,%)
Sources: OREI staff calculations based on data from CEICandInternational Financial Statistics,InternationalMonetaryFund.
R E G I O N A L U P D A T E
8
than$212billioninthefirst10monthsoftheyear,already20%
abovetheentire2006total.That ispartiallyduetoarushto
movegoodsbeforecertainexport taxrebateswereabolished
orreducedon1July.Thebiggertradesurplusmayalsoderive
fromacceleratedexport receipts or delayed import payments
astheprivatesectorisexpectingafurtherappreciationofthe
renminbi(Table 1a).
TheaggregateASEAN-4tradesurplusremainedhighinthefirst
halfof2007,despiteaslowdown inexports(Table 1b).The
currentaccountbalanceimproveddramaticallyby79%year-on-
yearduetoastrongtradesurplus,maintainingahealthyoverall
balanceofpaymentspositionwithanadditionalsmallsurpluson
thefinancialaccount.AstrongcurrentaccountsurplusinThailand
wasfueledbyrapidexportgrowthinelectronics,vehicles,and
ironproducts.ExportgrowtheasedsomewhatinMalaysia,but
remainedrobustinrecentmonthsinIndonesia.ThePhilippines
hasbeenrunningtradedeficits,butithaspostedcurrentaccount
Table1b:Balance of Payments—ASEAN-�(%ofGDP)
2004H1 2004H2 2005H1 2005H2 2006H1 2006H2 2007H1
CurrentAccount 2.2 4.5 1.2 2.9 3.9 6.3 5.9
NetGoodsBalance 7.4 9.5 5.2 7.9 7.7 9.7 7.3
NetServices -2.6 -2.8 -2.5 -3.2 -2.5 -2.4 -0.7
NetIncome -3.9 -3.6 -3.5 -4.1 -3.3 -3.0 -2.6
NetTransfers 1.4 1.4 1.9 2.3 2.0 2.0 2.0
CapitalAccount 0.0 0.0 0.0 0.1 0.1 0.1 0.0
FinancialAccount 0.4 1.7 3.2 -2.5 1.2 -2.5 1.1
NetDirectInvestment 0.9 1.3 2.9 1.9 2.1 1.5 0.7
NetPortfolioInvestment 1.9 3.0 2.3 0.5 1.9 1.8 4.3
NetOtherInvestment -2.4 -2.7 -1.9 -4.9 -2.8 -5.8 -4.0
NetErrors&Omissions 0.7 -1.3 -1.6 -0.7 0.1 -0.6 -0.6
OverallBalance 3.3 4.8 2.8 -0.3 5.3 3.2 6.4
Sources:International Financial Statistics Online,InternationalMonetaryFund;andCEIC.
Table1a:Balance of Payments—PRC(%ofGDP)
2004H1 2004H2 2005H1 2005H2 2006H1 2006H2 2007H1
CurrentAccount 1.1 7.3 7.0 12.7 8.0 16.7 11.8
NetGoodsBalance 0.8 6.3 5.6 10.6 7.0 14.6 9.8
NetServices -0.8 -1.0 -0.4 -0.7 -0.5 -0.6 -0.2
NetIncome -0.3 -0.4 0.5 0.8 0.3 0.8 0.9
NetTransfers 1.4 2.4 1.3 2.0 1.2 2.0 1.3
CapitalAccount 0.0 0.0 0.2 0.3 0.2 0.3 0.1
FinancialAccount 9.4 11.8 3.7 4.7 3.2 0.4 6.4
NetDirectInvestment 4.3 5.7 2.3 5.4 2.7 4.0 3.7
NetPortfolioInvestment 3.9 2.1 -0.1 -0.4 -2.6 -4.5 -0.3
NetOtherInvestment 1.2 4.0 1.5 -0.3 3.1 0.9 3.1
NetErrors&Omissions -1.0 2.9 -0.5 -1.3 -0.7 -0.9 0.9
OverallBalance 9.4 22.0 10.4 16.4 10.7 16.6 19.2
Sources:International Financial Statistics Online,InternationalMonetaryFund;andCEIC.
R E G I O N A L U P D A T E
9
surpluses because of the strong inflow of remittances from
overseasFilipinoworkers—amountingtoabout10%ofGDPinthe
firsthalfof2007.Inaggregate,theASEAN-4financialaccount
showedasmallsurplusinthefirsthalfof2007—incontrasttoa
largedeficitinthesecondhalfoflastyear—resultinginanoverall
balanceofpaymentssurplusofabout$30billion.Foreigndirect
investment remained robust, but it was portfolio investment
flowswhich rose sharply to about $20billion in thefirst half
fromthe$15billionin2006.Partlyduetodebtrepayments,the
“otherinvestment”accounthasbeenpersistentlydeepindeficit
inrecentyears.
ThethreesmallerNIEshadlargecurrentaccountsurplusesin
thefirsthalf,butKorearanasmalldeficit.ThereversalinKorea
waslargelyduetoahugedeficit in itsservicestrade,caused
bypersistentgrowthinoutboundtourism.HongKong,China’s
strongservicestradeandincomereceiptsonitsassetsabroadled
toahealthycurrentaccount,inspiteofadeficitingoodstrade.
Inthethirdquarter,exportgrowthremainedgenerallyrobust
intheNIEs,withamodestdropinimportgrowth,pointingtoa
continuedsurplus intheaggregatecurrentaccount.TheNIEs
financialaccountperformancewasquitevaried(Table 1c).In
thefirsthalf,whilecapitalflowedintoKorea(mainlyintheform
ofotherinvestmentstohelphedgingactivitiesofitsshipbuilding
industry),itflowedoutofTaipei,China(mainlyportfoliooutflows),
andoutofSingaporeandHongKong,China(intheformofother
investmentoutflows).InKorea,netinflowsinotherinvestments
werealmostthreetimesnetoutflowsinportfolioinvestments.
Thishasbeenthetrendoverthepastyearorso,reflectingthe
sharpriseinhedgingbyKoreanshipbuildersforsurgingexport
orders.Butrecently,domesticbanks’on-shorelendingactivities
Table1c:Balance of Payments—NIEs(%ofGDP)
2004H1 2004H2 2005H1 2005H2 2006H1 2006H2 2007H1
CurrentAccount 5.8 7.2 5.2 5.9 4.5 6.5 5.8
NetGoodsBalance 5.6 6.4 4.9 6.1 4.6 5.9 4.9
NetServices 0.7 0.5 0.3 0.6 0.4 0.9 0.3
NetIncome 0.3 1.0 0.7 -0.2 0.3 0.4 1.3
NetTransfers -0.8 -0.7 -0.7 -0.7 -0.8 -0.7 -0.7
CapitalAccount -0.2 -0.2 -0.3 -0.2 -0.2 -0.2 -0.2
FinancialAccount 1.7 -3.1 0.3 -4.4 -1.9 -2.9 -3.5
NetDirectInvestment -0.3 0.2 1.8 0.2 1.1 0.4 0.9
NetPortfolioInvestment -6.7 -0.2 -5.0 -1.3 -5.5 -5.8 -4.0
NetOtherInvestment 8.7 -3.2 3.5 -3.3 2.5 2.4 -0.4
NetErrors&Omissions 0.5 1.0 0.6 0.6 0.8 -0.1 0.2
OverallBalance 7.8 4.9 5.8 1.8 3.2 3.3 2.3
Sources:International Financial Statistics Online,InternationalMonetaryFund;andCEIC.
R E G I O N A L U P D A T E
10
inforeigncurrencyhavebecomestronger,someofwhichwere
madeinyen,suggestingthatborrowingfromforeignbanksmight
havebeenincreasingpartlytotakeadvantageofwideningyield
differentialsbetweendomesticandforeigncurrencies.
Financial Markets and Exchange Rates
Financial markets across the region quickly recovered from the expansive wave of US subprime turmoil in July and August—many reaching record highs fueled by large portfolio inflows—raising concern among policy makers about the risk of an equity market bubble.
Afterasharpsell-offinlate-Julyandearly-Augustamidconcerns
aboutUSsubprimemortgagesandtheimplicationsforUSgrowth,
mostequitymarkets inemergingEastAsia recoveredquickly
(Figures 15a, 15b).BoomingequitymarketsinthePRCwere
barelyaffectedbytheglobalfinancialturmoil,althoughtheyhave
beenlosingsteaminrecentmonths.Therestofregionalequity
markets also retreated somewhat inNovember amid concern
aboutafurtherslowdownintheglobaleconomy.Currenciesin
theregionfellbrieflyattheheightoftheturbulenceascapitalfled
andpushedtheUSdollarhigher.ButsincelateAugust,currencies
intheregionhaveappreciatedsignificantlyagainstthedollaron
furtherevidenceofaslowingUSeconomyandthreesubsequent
USFederalReservepolicyratecuts,totaling100basispoints.
(Figures 16a, 16b).
ExcludingthePRC,gainsinequitypricesovertheyear—through
theendofNovember—rangedfrom10%inTaipei,Chinato49%
inIndonesia.InthePRC,equitypriceshavebeenrisingeven
faster,withthestockpriceindexinShanghaigaining130%by
mid-Octoberfortheyear,ontopofa148%risein2006.Since
then(throughend-November),however,theShanghaiComposite
Indexhasfallenbyalmost20%astheauthoritiescontinuedto
tightenmonetarypolicy.
Nowpolicymakersinsomeeconomiesarebecomingincreasingly
anxious about the risk of an equitymarket bubble driven by
strong capital inflows and ample liquidity. Across the region,
equitymarketshavebeenonaquickrise,puttingauthoritiesin
abindbecauseraisingpolicyratesmayattractfurtherportfolio
Philippines
Thailand
Malaysia
Indonesia 230
133
157
204
153154
132123 118
105
87
171162
80
100
120
140
160
180
200
220
240
2-Jan-06
30-Mar-06
25-Jun-06
20-Sep-06
16-Dec-06
13-Mar-07
8-Jun-07
3-Sep-07
29-Nov-07
Figure15a:Composite Stock Price Indexes1—ASEAN-� (lastpricedaily,2January2006=100,localindex)
1DailystockpriceindexesofJCI(Indonesia),KLCI(Malaysia),PCOMP(Philippines),andSET(Thailand)Source:OREIstaffcalculationsbasedonBloombergdata.
Singapore
Korea, Rep. of
China, People's Rep. of
Taipei,China94118
99
137120
485
155
277
399
85
115
145
175
205
235
265
295
2-Jan-06
30-Mar-06
25-Jun-06
20-Sep-06
16-Dec-06
13-Mar-07
8-Jun-07
3-Sep-07
29-Nov-07
60120180240300360420480540600
Hong Kong, China
China, People's Rep.ofOthers
191
148135
Figure15b:Composite Stock Price Indexes1—NIEs and PRC(lastpricedaily,2January2006=100,localindex)
1DailystockpriceindexesofHangSeng(HongKong,China),KOSPI (Korea), STI (Singapore), TWSE (Taipei,China), andcombinedShanghaiandShenzhenComposite(PRC),weightedbytheirrespectivemarketcapitalization.Source:OREIstaffcalculationsbasedonBloombergdata.
R E G I O N A L U P D A T E
11
inflows, which are already strong.Meanwhile, an unwinding
ofcarrytradesontheyen(andotherlow-yieldingcurrencies)
remainsaworrygivenheightenedfinancialuncertainty.Apartial
unwindingoccurredbrieflyduringtherecentmarketturmoilasa
partofre-pricingofrisks.Ifinvestors,whopreviouslyborrowed
low-yieldingcurrenciestoinvestinhigh-yieldingemergingmarket
assetsandcurrencies,choosetoclosetheirpositions,itcould
significantlyexacerbatevolatilityinfinancialmarkets.
Currency appreciation against the US dollar gained momentum throughout much of 2007, with exchange rates up nearly 5% on average since the beginning of the year.
Strongbalanceofpaymentspositionsfromcurrentandcapital
account surpluses continued toputupwardpressureonmost
currencies in the region. In the first 11months of 2007, the
region’scurrenciesappreciated4.8%againsttheUSdollaron
average,andby4.1%sincemid-August.Centralbankscontinued
tointerveneinforeignexchangemarketstocurbtheappreciation
(particularlysinceAugust),asindicatedbyrisingforeignexchange
reserves.Intheyeartodate,thePhilippinepesoandtheThai
baht (both up 15%) outperformed other currencies, largely
supportedbygrowingcurrentaccountsurpluses.TheMalaysian
ringgit,Singaporedollar,andthePRCrenminbihaveappreciated
by5–6%sofarin2007,withothercurrenciesintheregionfairly
steady,thoughvolatileinrecentmonths.ThePeople’sBankof
Chinaallowedtherenminbitoappreciate0.5%inthelastweek
ofOctober,thebiggestweeklyrisesinceitmovedtoamanaged
floatinJuly2005.Thissuggestsitmayhavedecidedtoaccelerate
thepaceofappreciation.
Sovereign bond spreads over US Treasuries widened in July
and August as the financial turmoil intensified, particularly
in Indonesia and the Philippines. After narrowing somewhat
during September and October, these spreads widened even
furtherinNovember,asthespecterofasharperUSslowdown
increasedandinvestors’riskappetitedecreased(Figure 17).
Andbyend-August,yieldcurveshadshiftedupinmostemerging
Asian economies compared with the second quarter—again,
particularlyinIndonesiaandthePhilippines.InthePRC;Korea;
and Taipei,China; the upward shift may also have been the
outcomeofcontinuedmonetarytighteningintheseeconomies
inthethirdquarter.InterestratesinthePRCwereontherise
Singapore
Korea, Rep. of
China, People's Rep. of
109
102
115
109
110109
Taipei,China95
100
105
110
115
120
125
130
135
140
02-Jan-06
30-Mar-06
25-Jun-06
20-Sep-06
16-Dec-06
13-Mar-07
08-Jun-07
03-Sep-07
29-Nov-07
99
Figure16b:Exchange Rate Indexes—NIEs1 and PRC (2Jan2006=100)
1Rep.ofKorea;Singapore;andTaipei,China.Source:Bloomberg.
Philippines
Thailand
Malaysia
Indonesia
105103
113
124
110
118
99
123
100
105
110
115
120
125
130
135
140
145
9502-Jan-
0630-Mar-
0625-Jun-
0620-Sep-
0616-Dec-
0613-Mar-
0708-Jun-
0703-Sep-
0729-Nov-
07
133128
117
142
112111
Figure16a:Exchange Rate Indexes—ASEAN-� (2Jan2006=100)
Source:OREIstaffcalculationsbasedonBloombergdata.
Philippines
Malaysia
China, People's Rep. of
280
237
Indonesia
Viet Nam121
262
198
180
309
286
116
246
134
0
40
80
120
160
200
240
280
320
3-Jan-06
31-Mar-06
26-Jun-06
21-Sep-06
17-Dec-06
14-Mar-07
9-Jun-07
4-Sep-07
3-Dec-07
204
Figure17:JP Morgan EMBI Sovereign Stripped Spreads (basispoints)
Source:Bloomberg.
R E G I O N A L U P D A T E
12
in2007,comparedwithend-2006,asauthoritiestriedtocool
anoverheatingeconomy.Yieldcurvesinmosteconomiesalso
steepened thisyear,mirroring the trend inworldmarkets. In
Indonesia,Philippines,andThailand,curvessteepenedasloose
monetarypolicypusheddownyieldsonshortermaturities,while
rising inflationpushed theyieldshigheronbondswith longer
maturities(Figures 18a, 18b, 18c).
Monetary and Fiscal Policy
Monetary policies across the region have become more cautious since the July global financial turbulence—given the increased volatility of the region’s financial markets, inflationary pressures, and the uncertain outlook for major industrialized economies.
EastAsia’smonetaryauthoritieshavebeencautioussinceJuly
2007,witheconomiesbuoyant,inflationontherise,yetwithan
uncertainoutlookfortheexternalenvironmentandforfinancial
volatility.ThailandhaskeptpolicyratesunchangedsinceJuly,
whenitloweredrates.Malaysiahasnotchangeditspolicyrate
sinceApril2006—thelasttimeitraisedtherate.Koreatightened
policyinJulyandinAugustbuthaskepttheratesteadysince
then.ButthePRCandTaipei,Chinacontinuedtotightenduring
September.Amongtheregion’sbiggereconomies,onlyIndonesia
andthePhilippineshaveloweredpolicyrates(Figure 19).
Sofarthisyear,thePRCcentralbankhasraiseditsbenchmark
rate five times (1.17 percentage points) and the reserve
requirementratio10times(5.5percentagepoints)initseffortto
containanincreasinglyoverheatingeconomyandsurgingstock
markets.Themostrecentincreaseofthereserverequirement
ratioof1percentagepointwilltakeeffecton25December.Real
interestratesremainverylow,however,andthereisgrowing
concernthatthisisfuelingresurgentinvestmentandasset-price
inflation. The authorities have also restricted loans for stock
purchases and raised the stamp duty on share trading. The
centralbankwidenedtherenminbitradingbandagainsttheUS
dollarfrom0.3%to0.5%inMay.Moneysupply(M2)inrecent
months, however, has continued to grow above 18%, higher
thanthecentralbank’stargetof16%.Giventhattheinvestment
surgecontinuesunabatedandthestockindexesremainonthe
Figure18b:Indonesia Benchmark Yields (%perannum)
Source:Bloomberg.
8.95
9.33
10.29
8.45
9.62
9.88
10.43
7.5
8.0
8.5
9.0
9.5
10.0
10.5
11.0
2 4 6 8 10 12 14 16 18 20
12-Nov-200729-Aug-200728-May-200729-Dec-2006
15
Year of Maturity
4.15
4.58
3.79
4.43
2.89
3.36
2.68
3.22
2.0
2.5
3.0
3.5
4.0
4.5
5.0
2 3 4 5 6 7 8 9 10
12-Nov-200729-Aug-200729-May-200729-Dec-2006
Year of Maturity
Figure18a:PRC Benchmark Yields (%perannum)
Source:Bloomberg.
5.5
6.6
7.4
9.6
6.1
8.8
8.3
6.0
6.5
7.0
7.5
8.0
8.5
9.0
9.5
10.0
2 4 6 8 10 12 14 16 18 20 22 24
12-Nov-200729-Aug-200728-May-200729-Dec-2006
157 25
Year of Maturity
9.5
Figure18c:Philippines Benchmark Yields (%perannum)
Source:Bloomberg.
R E G I O N A L U P D A T E
1�
rise,furthermonetarytighteningiswidelyexpectedbeforethe
endoftheyear.
IndonesiapauseditseasingcyclefromJulythrough6December,
whenitlowereditspolicyrateto8.0%.InitsDecemberstatement,
BankIndonesiasaiditremainsconfidentthatinflationisonalong-
termdecliningtrenddespiteloominginflationarypressures.The
PhilippinesalsocutpolicyratessinceJuly,loweringitsdiscount
rate three timesandbringing it to5.5%byNovember. Itdid
so, however, in tandem with liquidity management measures
tocontainhighmoneygrowthinthefirsthalfoftheyear.The
BankofThailandmaintaineditspolicyinterestrateat3.25%in
October,afterinflationrosetoa9-monthhighof2.5%inthe
samemonth—duetorisingfuelcosts.Malaysiahaskeptitspolicy
unchangedsinceApril2006.
AmongtheNIEs,therehasbeensomeconvergenceinmonetary
policydirection.Citingrobustgrowthandincreasinginflation,the
BankofKorearaiseditspolicyrateinJulyandAugust(byatotal
of50basispoints).ButitpausedfromSeptembertoNovember,
pointingtostablegrowthandpricesamidampleandincreasing
liquidity,evenasoilpricesroseandfinancialmarketsweathered
highervolatility.Taipei,Chinahascontinuedtohikeitspolicyrate,
whichreacheda6-yearhighof3.25%inSeptember,bringingits
monetarystancetoamoreneutrallevel.Taipei,China’sinterest
ratesare lower than inotheremergingmarkets,encouraging
capitaloutflowsputtingdownwardpressureonitscurrency.Due
to rising inflation, the SingaporeMonetary Authority slightly
increasedtheslopeofitsnominaleffectiveexchangeratepolicy
bandinOctoberinordertocapinflationarypressuresandensure
pricestabilityoverthemediumterm.
Governments in the region have maintained fiscal prudence, but budgetary trends diverged slightly as varied economic and social situations warranted different fiscal strategies.
On fiscal policy,most governments in the region have been
prudent, although trends have varied (Table 2). The PRC’s
fiscal position remains healthywith amodest deficit due to
strongrevenuegrowth,butauthoritiesseeaneedfor further
improvementinthestandardsoffiscalmanagementandpractices.
Thegovernmentcontinuestoadjusttheemphasisandstructure
ofexpenditures,addressingweaklinksineconomicandsocial
Philippines
Malaysia
Thailand2China, People's Rep. of
8.00
12.75
5.003.503.503.00
5.50
7.507.50
2.752.25 3.253.25
7.29
0
2
4
6
8
10
12
14
01-Jul-04
27-Dec-04
24-Jun-05
20-Dec-05
17-Jun-06
13-Dec-06
10-Jun-07
06-Dec-07
Indonesia
Korea, Rep. of
Taipei,China
Figure19:Policy Rates1 (%perannum)
Notes:1BankIndonesiarate,(Indonesia);overnightcallrate(Korea);overnight policy rate (Malaysia); reverse repurchase rate(Philippines); official discount rate (Taipei,China); 1-yearlendingrate(PRC).2BankofThailandswitcheditsbenchmarkfromthe14-dayto1-dayreverserepurchaserateon17January2007.Source:Bloomberg.
R E G I O N A L U P D A T E
1�
Table2: Fiscal Balance of Central Government(%ofGDP)
2003 2004 2005 2006 20071 20081
Cambodia -6.0 -4.7 -3.4 -1.5 -4.1 -3.2
China,People’sRep.of -2.2 -1.3 -1.2 -0.5 -0.9 -1.2
HongKong,China -3.3 1.7 1.0 1.6 1.9 2.3
Indonesia -1.7 -1.0 -0.5 -1.0 -1.5 -1.7
Korea,Rep.of 0.1 -0.5 -1.0 -1.3 -1.5 -1.2
Malaysia -5.3 -4.3 -3.8 -3.3 -3.2 -3.1
Philippines -4.6 -3.8 -2.7 -1.1 -0.1 0.1
Singapore2 4.1 5.5 8.3 6.6 4.4 …
Taipei,China2 -3.0 -2.1 -1.7 -0.7 -1.9 …
Thailand2 0.6 0.3 0.2 0.1 -1.7 …
VietNam -1.2 0.9 -1.2 -5.0 … …
…=notavailable1Budget.2Fiscalyear.Sources:Nationalsources;Asian Development Outlook 2007,AsianDevelopmentBank;EconomistIntelligenceUnit;andWorldBank.
developmentandimprovingruralpublicservices,whichwillhelp
promotebalancedgrowthbetweenruralandurbanareas.
TheNIEshaverelativelystrongfiscalpositions.Singaporeand
HongKong,Chinawereinsurplusin2006,whichlikelycontinued
into2007.AlthoughKoreahasrunaprimaryfiscalsurplus,its
adjustedfiscalbalance—whichexcludessocialsecurityfundsand
iscloselymonitoredbythegovernment—wasindeficit.Whileits
fiscalpositionremainsgenerallysound,thegrowingcostsofsocial
securityandwelfareprogramscontinuetoconstrainbudgetary
room.Taipei,Chinahasreduceditsbudgetdeficitoverthepast
fewyears,thoughithasbudgetedabiggerdeficitin2007than
in2006.Overall,theNIEsaremovingtowardfiscalconsolidation,
with ongoing efforts to improve revenue collection, broaden
taxbases,rationalize incentives,andmanageexpendituresto
efficientlyaddresskeypublicconcerns.Revenuesareexpected
torisewitheconomicgrowth,whileexpendituresandreforms
arefocusedonmovingtowardamoreequitablesystem.Amajor
concernistheadequacyofsocialsafetynets,inparticularfor
anageingworkforce.TheNIEsalsoneedtoresolvestructural
issues tomaintain their competitiveedge in the regional and
globalmarkets.
InIndonesia,thefiscaldeficithasbeenkeptatgenerallymodest
levels following the successful consolidation of recent years.
The challenge remains in keeping the deficit around 1.0%of
GDPandreducinggovernmentdebt to30%ofGDPby2009,
whilepromotingabetterinvestmentclimateandinfrastructure
development.Malaysia’sfiscalpositionhas improvedrecently,
R E G I O N A L U P D A T E
15
possibly due to stronger-than-expected oil-related revenues.
Butfurtherspendingisexpectedinrelationtonewinvestment
projects and development programsplannedunder theNinth
MalaysianPlan.InThailand,lingeringpoliticaluncertaintyand
tightenedgovernanceruleshavedelayeddisbursementofthe
plannedfiscalexpenditures,whichlimiteditseffortstoaccelerate
infrastructurespendinginkeyutilitiesandservices.ThePhilippine
government,meanwhile,targetedadeficitofP63billionin2007
fromP64.8billion (1.1%ofGDP) in2006and is expected to
surpassitsgoalduetostrongrevenuesandlargeprivatization
receipts. To ensure a balanced budget by 2008, stronger tax
administration and continued restraint in expenditures are
needed.PublicsectordebtintheASEAN-4economieshasdeclined
since2003.
AssessmentofFinancialVulnerability
Despite limited spillover into emerging East Asia from the US subprime turmoil, there are several signs of financial vulnerability related to sharp gains in equity and real estate prices.
Recentturbulenceininternationalfinancialmarketshassofar
hadonlylimitedeffectontheregion’sfinancialmarkets.Following
sharpdeclinesinthethirdquarter,regionalequitymarketshave
generally advanced—albeit amid higher volatility—and there
hasbeen sufficient liquidity in the region’s short-termmoney
markets.Theresiliencehasbeentheresultofthestrengthening
ofmacroeconomic and financial fundamentals in the region
togetherwith limiteddirectexposuretosubprimeandrelated
financialproducts.Thepotentialforspilloverremains,however,
assegmentsofthemajorinternationalfinancialmarketshave
notyetreturnedtonormalcy,additionallossesfromsubprime
relatedproductscontinuetoappear,andawiderre-pricingof
creditriskcannotberuledout.Inaddition,elevatedequityand
realestatepricesinanumberofregionaleconomiesareatrisk
of correction in the event of further international turbulence.
Reported large capital positions in regional banking systems,
generallylowernonperformingloan(NPL)ratios,andimproved
cushionsagainstmarketriskaregroundsforguardedoptimism,
butnotcomplacency.
R E G I O N A L U P D A T E
16
Prudential Indicators
Prudential indicators for regional banking systems generally remain strong, with a sizable build up of capital cushions.
Favorableeconomicandfinancialconditionsinrecentyearshave
playedakeyroleinhelpingregionalbankingsystemsbuildup
largecapitalcushionsandreturntoprofitability.Supported in
manycasesbyofficialassetmanagementcompanies,manybanks
havealsosubstantiallyreducedtheirNPLratiosandstrengthened
assetquality.Reductionsinpublicandexternaldebtburdensto
relativelylowlevels(Table �)andupgradesinsovereignrisk
ratingshavealsoplayedakeycontributingrole(Figures 20a,
20b, 20c, 20d).Exposure toglobalmarket risk,however, is
higherthaninthepastandanyfurtherworseningininternational
financialmarket conditions could prove challenging. Banking
systems in the region entered the current period of financial
turbulencewithconsiderablestrength.Mostnotably,NPLratios
havegenerallyremainedloworhavefallenfurther(Table �a).
In addition, regulatory capital cushions have generally been
sustained at high levels (Table �b). Profitability in regional
bankingsystemscontinuedtobestrongthroughthemiddleof
theyearasreflectedinhighratesofreturnonassetsandequity
(Tables �c, �d).Thehighlevelsofprofitabilityhavereflected
notonly improvements incore lendingactivities,butalsothe
recentfavorablefinancialconditionsthathaveboostedreturns
onbanks’securitiesholdings.
Activity Indicators
Recent improvements in banking sector strength and soundness, sustained by strong macroeconomic fundamentals, reflect the improved risk profiles of regional banking systems, but they are now more closely linked to financial market conditions and thus more sensitive to movements in asset prices and returns.
Subduedlendingtothebusinesssectorhasmadedebtandequity
investmentsanincreasingshareofbankassets,whilebanksalso
havemovedaggressivelyintonewareassuchashouseholdand
realestatelending.Althoughbanks’newbusinessoperationshave
helpedprofitability,theyhavealsolefttheriskprofilesofbanking
Malaysia
Thailand
Philippines
Indonesia
Viet Nam
B-BB+
BB-
CCCCCC+
BB
BBB-BB+
AA-
BBB+BBB
2-Jan-03
30-Dec-03
27-Dec-04
21-Dec-05
15-Dec-06
27-Nov-07
Figure20a:S&P Sovereign Ratings (Long-termforeigncurrency)
Source:Bloomberg.
Singapore
Korea, Rep. of
Hong Kong, China
China, People's Rep. ofBBB+
A-
A
A+
BBB-
BBB
AA-
AA+
AA
AAA
2-Jan-03
30-Dec-03
27-Dec-04
21-Dec-05
15-Dec-06
27-Nov-07
Taipei,China
Figure20b:S&P Sovereign Ratings (Long-termforeigncurrency)
Source:Bloomberg.
B2B1
Ba3Ba2
Caa1B3
Ba1
Baa2Baa3
A2A3
Baa1
Malaysia
Thailand
Philippines
Indonesia
Viet Nam
2-Jan-03
30-Dec-03
27-Dec-04
21-Dec-05
15-Dec-06
27-Nov-07
Figure20c:Moody’s Sovereign Ratings (Long-termforeigncurrency)
Source:Bloomberg.
Baa1A3
A2
A1
Baa3-
Baa2
Aa3
Aa1-
Aa2
AaaSingapore
Korea, Rep. of
Hong Kong, China
China, People's Rep. of
2-Jan-03
30-Dec-03
27-Dec-04
21-Dec-05
15-Dec-06
27-Nov-07
Taipei,China
Figure20d:Moody’s Sovereign Ratings (Long-termforeigncurrency)
Source:Bloomberg.
R E G I O N A L U P D A T E
17
Table3: Public and External Debt(%ofGDP)
200� 200� 2005 2006 2007
Public Sector Debt
China,People’sRep.of 19.2 18.5 17.9 17.3p …
Indonesia1 58.3 55.2 45.6 38.6 35.7p
Korea,Rep.of1 22.0 25.2 29.5 32.2 33.3p
Malaysia 68.8 66.7 62.5 56.5p 55.6p
Philippines2 100.8 95.4 86.3e 77.4p 72.7p
Thailand 50.7 49.5 47.4 42.3p 39.2p
VietNam 40.8 42.7 43.7 45.5p …
External Debt
China,People’sRep.of 12.7 12.8 12.6 12.7p …
Indonesia 57.7 53.5 46.6 36.6 31.2p
Korea,Rep.of 25.9 25.3 23.7 29.7 35.8p
Malaysia 47.3 44.6 39.6e 35.2p 33.5p
Philippines 78.8 70.5 62.6e 51.5p 46.7p
Thailand 36.2 31.7 29.5 27.5p 25.8p
VietNam 33.8 33.9 32.5p 32.6p …
p=projection,e=estimate,…=notavailable.1Centralgovernmentdebt.2Nonfinancialpublicsectordebt.Source:ArticleIVConsultations,InternationalMonetaryFund.
Table4a: Nonperforming Loans (%ofcommercialbankloans)
2001 2002 200� 200� 2005 2006 20071
China,People’sRep.of … 21.6 17.8 13.2 8.6 7.1 6.2
HongKong,China2 6.5 5.0 3.9 2.3 1.4 1.1 1.0
Indonesia 12.1 8.1 8.2 5.7 8.3 7.0 5.8
Korea,Rep.of 2.9 1.9 2.2 1.7 1.1 0.8 0.7
Malaysia2 10.5 9.3 8.3 6.8 5.6 4.8 3.5
Philippines2 17.3 15.0 14.1 12.7 8.2 6.0 5.3
Singapore … … 5.4 4.0 3.0 2.43 …
Taipei,China 7.5 6.1 4.3 2.8 2.2 2.1 2.3
Thailand 10.5 15.7 12.8 10.9 8.3 4.2 4.4
Memoitems:compromisedassetsratio(Indonesia)andnonperformingassetsratio(Philippines)
Indonesia 31.9 24.0 19.4 14.2 15.6 16.03 …
Philippines 27.7 26.5 26.1 24.7 19.7 18.64 ……=notavailable1DataforHongKong,ChinaasofMar2007;KoreaandTaipei,ChinaasofJun2007;PhilippinesasofAug2007;Indonesia,Malaysia,PRC,andThailandasofSep2007.2Reportednonperformingloansaregrossclassifiedloanratioofretailbanks.3AsofSep2006.4AsofJun2006.Notes:1.Thetableexcludesnonperformingloanstransferredfrombankbalancesheetstoassetmanagementcompanies.2.ThemeasurementofNPLsfollowsofficialdefinitionsanddiffersacrosseconomiesdependingonloanclassification(forexample,whethera3–monthor6–monthruleisused),thetreatmentofaccruedinterest,andwhetherspecificprovisioningisdeductedfromtheNPLmeasure.3.ForMalaysiaandthePhilippines,reportedNPLsarenetofspecificprovisioning.4.CompromisedassetsratioincludesreportedNPLs,restructuredloans,andforeclosedassetsforthe16largestbanksinIndonesia;distressedassetratioreferstotheratioofNPL+realandotherpropertiesownedandacquired(ROPOA)+restructuredloans,currenttototalloanportfolio,gross+ROPOA.Sources:Nationalsources;CEIC;andGlobal Financial Stability Report,InternationalMonetaryFund.
R E G I O N A L U P D A T E
18
Table4d: Rate of Return on Commercial Bank Equity(%perannum,endofperiod)
200� 200� 2005 2006 2007H1
China,People’sRep.of … 13.7 12.4 14.1 …
HongKong,China 16.9 18.7 18.4 18.9 …
Indonesia1 25.3 37.1 32.3 33.2 35.52
Korea,Rep.of 3.4 15.2 18.4 14.6 …
Malaysia 15.3 16.0 16.5 16.1 …
Philippines 9.3 7.6 9.5 11.5 9.9
Singapore 10.3 11.8 11.1 12.43 …
Taipei,China 6.5 8.8 4.4 -7.3 5.1
Thailand 15.7 15.7 14.2 8.5 5.7
…=notavailable.12005figureonadomesticconsolidationbasis;notstrictlycomparablewithpreviousyears.2AsofMar2007.3AsofSep2006.Sources:CEIC,nationalsources,andIMFGlobal Financial Stability Report, InternationalMonetaryFund(PRCandIndonesia).
Table4c: Rate of Return on Commercial Bank Assets (%perannum)
200� 200� 2005 2006 2007H1
China,People’sRep.of … 0.8 0.8 0.9 …
HongKong,China 1.4 1.5 1.6 1.5 1.72
Indonesia 2.6 3.5 2.6 2.6 2.9
Korea,Rep.of 0.2 0.9 1.3 1.1 …
Malaysia 1.3 1.4 1.3 1.3 …
Philippines 1.2 1.0 1.1 1.3 1.1
Singapore 1.1 1.3 1.2 1.31 …
Taipei,China 0.5 0.6 0.3 -0.4 0.3
Thailand 0.7 1.3 1.4 0.8 0.3
…=notavailable.1AsofSep2006.2AsofMar2007.Sources:CEIC,nationalsources,andGlobal Financial Stability Report, InternationalMonetaryFund(PRCandIndonesia).
Table4b: Risk-Weighted Capital Adequacy Ratios (%ofrisk-weightedassets)
200� 200� 2005 2006 20071
HongKong,China 15.3 15.4 14.8 14.9 13.63
Indonesia 19.4 19.4 19.5 20.5 21.3
Korea,Rep.of 11.2 12.1 13.0 12.8 12.9
Malaysia 14.0 14.3 13.6 13.1 12.6
Philippines 17.4 18.7 17.7 18.5 …
Singapore 16.0 16.2 15.8 15.42 …
Taipei,China 10.1 10.7 10.3 10.1 9.5
Thailand 14.0 13.0 14.2 14.5 15.4
…=notavailable.Note:Basedonofficiallyreportedrisk-adjustedcapitaladequacyratiosunderBaselIandappliedto commercialbanks (exceptRepublicofKorea,wheredata includesnationwide commercialbanks, regionalbanks,andspecializedbanks).Data for thePhilippines isonaconsolidated,notsolo,basis.1DataforHongKong,ChinaasofMar2007;KoreaandTaipei,ChinaasofJun2007;Indonesia,Malaysia,andThailandasofSep2007.2DataforSingaporeasofSep2006.3BasedonBaselIIcalculations.Thepreviousyears’calculationswerebasedonBaselI.Source:Nationalsources.
R E G I O N A L U P D A T E
19
systems more susceptible to movements in bond and equity
prices,realestateprices,andconsumercredit-worthiness.
AspartofthepreparationfortheadoptionofBaselII,banksinthe
regionhaveincreasinglybeenrequiredtoholdmoreregulatory
capital in relation tomarket risk,which should help increase
resilience to adversemarket developments. Debt and equity
securitiescurrentlyrepresentasignificantshareofbankassets
intheregion,withthesharesinIndonesiaandthePhilippines,for
example,reachingaboutonethirdoftotalbankassets (Table 5).
Holdingsofofficialdebtsecuritiesgenerallyimplylowlevelsof
creditrisk,butthesesecuritiesarestillsubjecttomarketrisk,
asareprivatedebtandequitysecurities.
Awareoftheserisks,supervisoryandregulatorybodiesinthe
regionhavebeenincreasinglyusingstressteststoassessthe
robustnessofbankingsystemstoworseningmarketconditions
and to determine appropriate cushions. Both secured and
unsecuredhouseholdlendingarebecomingincreasinglyimportant
tobankactivitiesintheregion(Tables 6a, 6b, 6c).Household
indebtednessinrelationtoGDPisover40%inseveraleconomies,
but remains low in Indonesia and the Philippines. Generally,
householdindebtednesshasnotrisentothelevelsthatwould
warrantconcern.However,givenrecentrapidgrowth,thelack
oflong-establishedcreditregistriesinseveralcountriesand,in
somecases,alackofinformationaboutthedistributionofcredit
acrosshouseholds, thesituationneedsclosemonitoring.Real
estate loans(asclassifiedbynationalauthorities)account for
anincreasingshareofoverallfinancialsectorlendinginseveral
Table5: Securities Investment to Total Bank Assets of Commercial Banks (%)
200� 200� 2005 2006 20071
HongKong,China 19.0 19.2 19.6 20.2 17.3
Indonesia 19.2 20.2 18.0 24.8 29.6
Korea,Rep.of 21.3 20.8 22.1 20.2 20.2
Malaysia 14.1 10.6 9.6 9.3 13.2
Philippines 28.6 31.6 32.0 30.0 35.9
Singapore 17.7 17.1 16.5 15.9 16.8
Taipei,China 15.2 14.2 12.1 12.0 11.5
Thailand 17.8 16.0 16.0 15.8 16.4
…=notavailable.Note:ForPRCandIndonesia,claimsratherthansecuritiesdataareused.1DataforHongKong,China;Singapore;Malaysia;andTaipei,ChinaasofSep2007;IndonesiaandThailanddataareasofAug2007;PhilippinesasofJul2007;andRepublicofKoreaasofJun2007.Sources: CEIC, Hong Kong Monetary Authority, Bank Indonesia, and Bangko Sentral ngPilipinas.
R E G I O N A L U P D A T E
20
Table6a: Household Indebtedness (%ofGDP)
2002 200� 200� 2005 2006 2007Q�1
Indonesia 5.4 6.7 8.2 9.1 8.5 8.3
HongKong,China 62.0 60.9 58.2 55.5 52.1 54.0
Korea,Rep.of 32.5 34.9 35.3 37.6 40.8 41.0
Malaysia2 47.2 49.2 50.0 52.5 53.1 53.7
Philippines 5.3 4.8 5.2 4.7 4.2 4.2
Singapore3 … … 51.0 49.4 46.4 47.4
Taipei,China 43.2 47.2 53.0 58.3 56.7 56.8
Thailand … … 24.5 24.7 23.7 23.5
Table6b: Household Non-mortgage Indebtedness (%ofGDP)
2002 200� 200� 2005 2006 2007Q�1
Indonesia 4.2 5.2 6.4 7.1 6.3 6.1
HongKong,China 10.3 10.3 10.9 11.0 11.7 13.2
Korea,Rep.of 13.2 13.8 13.6 14.2 15.2 15.5
Malaysia2 21.0 21.3 21.9 23.7 24.8 24.9
Philippines 4.5 4.1 4.5 4.1 3.6 3.6
Singapore3 … … 18.0 16.7 15.4 15.2
Taipei,China 16.3 18.4 21.5 23.5 19.5 18.3
Thailand … … 8.4 7.6 6.5 6.1
Table6c: Household Mortgage Indebtedness (%ofGDP)
2002 200� 200� 2005 2006 2007Q�1
PRC 6.9 8.7 10.6 10.0 10.7 11.6
Indonesia 1.2 1.5 1.8 2.0 2.2 2.2
HongKong,China 50.3 49.9 47.3 44.4 40.3 40.8
Korea,Rep.of 19.3 21.1 21.8 23.4 25.6 25.5
Malaysia2 26.2 27.8 28.0 28.7 28.4 28.8
Philippines 0.8 0.7 0.7 0.6 0.6 0.6
Singapore3 29.3 32.9 33.0 32.7 31.0 32.2
Taipei,China 26.9 28.9 31.5 34.8 37.2 38.5
Thailand 13.9 14.6 16.1 17.1 17.2 17.4
…=notavailable.1Asof30Jun2007forIndonesiaandKorea;31Mar2007forthePhilippines.2Sumofloansforpersonaluse,creditcards,purchaseofconsumerdurablegoods,andpurchaseofpassengercarsforcommercialbanks,merchantbanks,andfinancecompanies.2006and2007datafromcommercialbanksandmerchantbanksonly.3Referstoconsumerloansfromcommercialbanksandfinancecompanies.Sources:CEIC;Monthly Statistical Bulletin,BankNegaraMalaysia;Monthly Statistical Bulletin,MonetaryAuthorityofSingapore;People’sBankofChinaandHongKongMonetaryAuthority.
regional economies (Figure 21). As a result, the financial
system’s exposure to real estate has increased, as have the
possibleadverseeffectsofanycorrectioninrealestateprices.
National authorities in several countries—including the PRC,
Korea, andVietNam—have recently taken steps tohelp cool
thesemarkets.
0 10 20 30 40 50
Hong Kong, China
Indonesia
Korea, Rep. of
Malaysia
Philippines
Singapore
Taipei,China
Thailand
Dec-04Dec-05Dec-06Sep-071
China, People's Rep. of 15
20
15
8
36
46
38
19
18
11
47
1236
16
9
17
40
20
Figure21:Real Estate Loans (%oftotalloans)
Sources:People’sBankofChina,Bank Indonesia, FinancialSupervisoryService(Korea),BankNegaraMalaysia,BangkoSentralngPilipinas(Philippines),BankofThailand,HongKongMonetaryAuthority,andCEIC.1KoreaasofJun2007.
R E G I O N A L U P D A T E
21
Market Indicators
While the share prices of listed financial corporations in the region have largely avoided the sharp downward corrections of their US and European counterparts, they have generally underperformed the stock market indexes on which they are listed.
Regional banking systems have avoided the sharp downward
adjustments in share prices evident inmany of themature
financialmarkets during the recent turbulence. For themost
part, this has reflected relatively low direct exposure to the
creditandliquidityproblemsintheUSsubprimemarket,along
withlessconcernonthepartofinvestorsaboutthepossibility
of unreported off-balance sheet losses. To date, several
economies in the region—including PRC; Hong Kong, China;
Korea; Singapore; and Taipei,China—have reported exposure
totheUSsubprimemarket,butthesehavegenerallybeenvery
small,andprovisioningchargeshavehadonlyalimitedimpact
onprofitability.Acontinuedbenignoutcomeisnotnecessarily
guaranteed, however, in the event that international financial
turbulenceresumesand there isamoregeneral re-pricingof
creditrisk.
EconomicOutlookfor2008,Risks,andPolicyIssues
External Economic Environment
The moderation in economic growth among the world’s major industrial economies that started this year is likely to continue in 2008.
LedbyaslowdownintheUSeconomy,economicgrowthinthe
OrganisationforEconomicCo-operationandDevelopment(OECD)
is projected tomoderate further to 2.3% in 2008, following
estimatedgrowthof2.7%in2007.Butgrowthdecelerationin
thenon-USOECDeconomiesisexpectedtoremainreasonably
modestin2007–08,withdomesticdemandintheeurozoneand
Japanmakingagradualrecovery.Andwhilefinancialturbulence
inrecentmonthshasyettohaveanymajorimpactonthereal
R E G I O N A L U P D A T E
22
economy, stockmarkets around theworld continue to show
significant volatility. Tighter credit conditions persist in some
segmentsofmoneyandlendingmarkets,andmoresignificant
economicrepercussionscannotberuledout.
US economic growth—down from 2.9% last year to a likely 2.2% this year—is expected to slow further in 2008, driven by the housing market correction and related financial market volatility.
Third-quarterUSGDPgrowthcameinstrongat4.9%,unexpectedly
acceleratingoverthesecondquarter’s3.8%(quarter-on-quarter,
seasonally adjusted annualized rate) (Figure 22). Although
consumerswilllikelyfeelthedowndraftfromthesubprimeturmoil
inthemonthsahead,recentconsumptionandemploymentdata
showmuchresilience.Relativelyrobustconsumerspending is
supportedbyahealthyjobmarket.InAugustthroughOctober,
non-farm payrolls were up an average of nearly 120,000.
Average hourly earnings are also edging up and an increase
in real disposable personal income has supported consumer
spending.Butthepersistenthousingslumpposesasignificant
threattogrowth.Homesalesarestillfallingand,withtheglut
of home supply, house prices are expected to drop further
(Figure 2�).Theeffectonconstructionfromthehousingmarket
correctionisalsolikelytocontinuetoconstraingrowthinto2008.
Meanwhile,thehousingmarketdownturnhasspilledoverintothe
manufacturingandserviceindustries.Retailsaleshaveslowed
inrecentmonths,hitbyasharpdeclineinconsumerconfidence.
RecentsurveysofbusinessactivityfromtheInstituteforSupply
Managementalsoshowalossofmomentumamidsluggishnew
ordersandrisinginventories(Figure 2�).Inresponsetothe
downside risks to economic growth, the US Federal Reserve
(Fed) cut its official rate again on 11December by 25basis
points(bp),addingtothe31October25bpcutandthe50bpcut
on18September.Whileslowingeconomicactivityhashelped
keeppricepressuresatbay,resurgentglobaloilandcommodity
pricesarereignitinginflationconcerns.Headlineinflationdrifted
higherto3.5%(y-o-y) inOctober, fromthefirst-halfaverage
of2.5%,althoughcoreinflationremainsstablewithintheFed’s
comfortzone.TherecentdeclineintheUSdollarisalsoraising
concerns,althoughitishelpingimproveexportperformance.The
UScurrentaccountdeficitispersistentlylarge,butaweakerUS
dollarwillallowforanothermoderateimprovementinthetrade
balancein2008.
Figure22:Contributions to Growth—US (seasonallyadjusted,annualized,q-o-q,%change)
Source:USBureauofEconomicAnalysis.
2.1
0.6
2.7 33.5 3.6
2.5
3.1
2.8
4.5
1.2
7.5
3.5
1.2
4.8
1.1
2.4
4.93.8
-4
-2
0
2
4
6
8
10
2003Q1
2003Q3
2004Q1
2004Q3
2005Q1
2005Q3
2006Q1
2006Q3
2007Q1
2007Q3
Personal consumptionGovernment consumptionPrivate domestic investmentNet exportsGDP
Real GDP growth
4.97
6.927.12
255.5
184.3
215
4
5
6
7
8
Jan-01
Oct-01
Jul-02
Apr-03
Jan-04
Oct-04
Jul-05
Apr-06
Jan-07
Oct-07
150
200
250
300
Sales (million units)
Prices(Mean, $ '000)
Prices
Sales
Figure23:Existing Home Sales1 and Prices—US
1Seasonallyadjusted;annualized.Source:CEIC.
5249 51
65
56
61
65
43464952555861646770
Jan-04
Jun-04
Nov-04
Apr-05
Sep-05
Feb-06
Jul-06
Dec-06
May-07
Oct-07
Non-manufacturing
Manufacturing
Figure24:US Business Activity Survey Indexes1
1Data survey from the Institute for Supply Management.Theindexesareasummarymeasureshowingtheprevailingdirectionandscopeofchange.Anindexabove50%indicatesthat the manufacturing or non-manufacturing economy isgenerallyexpanding;below50%indicatesthatitisgenerallydeclining.Source:Bloomberg.
R E G I O N A L U P D A T E
2�
Growth momentum in the euro zone is likely to slow from an estimated 2.6% this year to 2.1% in 2008 amid heightened financial volatility and a substantial appreciation of the euro.
In2007,theeurozoneeconomyheldfirmonthebackofrobust
investmentandGermanindustrialstrength(Figure 25).However,
thatpaceisunlikelytocontinueasaslowingUSeconomyand
astrongereurostarttocrimpexportgrowthandtightercredit
damps investment. Euro zone financialmarketswere visibly
shakenbytheUSsubprimeturmoil.Indeed,severalEuropean
bankswithdirectexposuretoUSsubprimemortgagesandrelated
mortgagederivativeswerecaughtinthemeltdown.Notably,IKB
DeutscheIndustriebankreportedlargelossesandBNPParibas
made headlines by suspending withdrawals from $2.2billion
worth of funds invested in asset-backed securities.Worries
aboutthefinancialturbulenceinturnunderminedconsumerand
investorsentiment(Figure 26).Astrongeuro—whichsurgedto
recordhighsagainsttheUSdollar—andtherecentriseinmoney-
market interestratesabovetheEuropeanCentralBank(ECB)
reference rate suggest thatmonetary conditions arede facto
tightening,whichmightallowtheECBtorelaxitstighteningbias
forthetimebeing.Nonetheless,inflationarypressuresarerising,
witheurozoneinflationpickingupto3.0%inNovemberdueto
risingenergyandfoodprices.Tightenedproductioncapacityand
labormarketconditionsarealsotranslatingintohigherpricesand
wages.Onabrighternote,externalperformancesofarexhibits
relativebuoyancydespitethestrongeuro.Remarkableresilience
in emergingmarket economies coupled with their currency
strengthagainsttheUSdollar’sslidehashelpedsustainexport
growth,especiallyinGermany.Theeurozonecurrentaccountis
expectedtobeinbalancein2008.
In Japan, GDP likely grew 1.9% this year but the momentum has weakened visibly, with GDP growth projected to slow to 1.7% in 2008.
Third-quarter growth rebounded to an annualized 1.5% from
a1.8%declineinthesecondquarteronstrongexportsanda
pickupininvestment(Figure 27).ButaslowingUSeconomyand
recentstrengtheningintheyencastashadowoverexport-driven
growthnextyear.Arecoveryinprivateconsumptionalsostilllags,
reflectingsluggishgrowthinhouseholdincomedespiteagradual
tighteninginthelabormarket.However,theinvestmentoutlook
95.4
112.1
104.8100.8
85
90
95
100
105
110
115
Jan-04
Oct-04
Jul-05
Apr-06
Jan-06
Nov-07
Figure26:Economic Sentiment Indicator1
—euro zone
1The economic sentiment indicator is a composite indexof business and consumer confidence indicators based onsurveysofoveralleconomicassessmentandexpectationsintheeurozone.Source:Bloomberg.
4.35.9
4.3
8.4
0.80
2
4
6
8
10
Jan-04
Jun-04
Nov-04
Apr-05
Sep-05
Feb-06
Jul-06
Dec-06
May-07
Oct-07
Figure25:German Industrial Production (y-o-y,seasonallyadjusted)
Source:Bloomberg.
2.6
4.6
1.4
3.1
1.8
-1.8
1.5
3.2
1.2
-0.4-1.7
2.1
3.0 4.4
6.6
-0.8 -0.3
3.3
5.3
-4
-2
0
2
4
6
8
2003Q1
2003Q3
2004Q1
2004Q3
2005Q1
2005Q3
2006Q1
2006Q3
2007Q1
2007Q3
Private consumptionGovernment consumptionInvestmentNet exportsStatistical discrepancyGDP Growth
Real GDP growth
Figure27:Contributions to Growth—Japan(seasonallyadjusted,annualized,q-o-q,%change)
Source:CabinetOffice,GovernmentofJapan.
R E G I O N A L U P D A T E
2�
remainsgenerallypositivegivenhealthycorporateprofits,tight
capacitylevels,andstillbenignfundingconditions.Butconcernis
rifethattherecentfinancialturmoilmaydepressconsumerand
investorsentimentfurther,particularlyiftheUSeconomyslows
moresignificantly.Headlineinflationhasagainbeenbelowzero
formostoftheyear,whilecoreinflation—whichexcludesfood
andenergyprices—hasbeenfurtherdippingintothenegative
(Figure 28). TheBankof Japanhaskept rates steadysince
February, reflecting amore cautious stance in light of softer
economicactivityandtherecentfinancialmarketvolatility.
Continued strong growth in most emerging market economies is likely to partially compensate for the easing demand in developed countries; yet growth in world trade volume is projected to slow to 7.6%, after growing about 9% this year.
Worldtradevolumegrowtheasedin2007asdemandfrommajor
industrial countries slackened. But brisk demand elsewhere,
particularlyinthedevelopingworld,ishelpingsustainrelatively
healthymomentum. After someweakness aroundmidyear,
industrial production in key industrial countries is slowly
recovering, but not to previous levels. And while unable to
compensate fully for the moderation in demand from OECD
economies,healthymomentuminmanufacturingoutputamong
developingcountriesisexpectedtoprovidesupportforcontinued
robust world trade in 2008, albeit at amoderated pace. In
emerging East Asia, for example, industrial production grew
morethan13%inthesecondquarterof2007.2ThePRCleads
thegroup,withindustrialproductionup18.1%.Butsolidgains
havebeenachievedacrosstheregion.
Anotherfactorinexpectationsformoremoderatebutstillhealthy
world trade growth is the recovery in the global information
technology(IT)industry.Earlysignsindicatethatglobaldemand
for IT products—amajor source of export earnings formany
emergingEastAsianeconomies—is likelytoreboundin2008.
Therewasacyclical ITdownturnthroughmostof2007,with
weakeningequipment investment in theUSearly in theyear,
fallingchipprices,andsluggishinventoryadjustments.However,
itnowappearsthatarecoverymaybeunderway,whichmayhelp
theregion’s industrialproductionandtradefurther into2008.
Thedecelerationinnewordersisslowingandthesemiconductor
2ExcludingBruneiDarussalam,Cambodia,LaoPDR,andVietNam.
0.3
-1.0
0.3
0.8 0.9
-0.3
-0.2
-1.5
-1.0
-0.5
0.0
0.5
1.0
Jan-04
Apr-04
Jul-04
Oct-04
Jan-05
Apr-05
Jul-05
Oct-05
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Headline inflation
Core inflation
Figure28:Inflation—Japan (y-o-y)
Source:OREIstaffcalculationsbasedonCEICdata.
R E G I O N A L U P D A T E
25
book-to-billratio,whichslidto0.79inSeptember,isalsoheading
upward(Table 7).
High energy and commodity prices are expected to continue into 2008 due to a combination of strong demand—especially from emerging markets—and consistent worries over supply conditions.
InNovember,crudeoilpricessetanewrecordhighnear$100a
barrel.Globaldemandisstrongdespitesofteninggrowth,while
supply conditions remain precarious. Persistent geopolitical
tensionsandsupplyconcernscoupledwithlimitedsparecapacity
giverisetosignificantpricevolatility.Foodpricesandsomemetals
pricesalsocontinuedtogainsignificantlyin2007(Figure 29).
Althoughamoderation in theupward trend is expected, it is
likelythatenergyandseveralcommoditypriceswillremainat
historicallyhighlevelsinto2008.
Recent shifts in monetary stances of major central banks suggest global monetary conditions may remain accommodative a bit longer.
In response to ade facto tightening inmajormoneymarket
conditionsduringthesubprimeturmoil,theUSFederalReserve
decisivelylowereditsovernightrate,whileothermajorcentral
bankshavepausedintheirtighteningcycles.Flighttoqualityand
liquidityduringtheAugust2007marketsell-offpushedyields
on 10-year US, United Kingdom (UK), and euro government
bondslower(Figure �0).Andageneralre-pricingofcreditrisks
haswidenedcreditspreads forcorporatebonds(Figure �1).
Emergingmarket sovereign bond spreads also widened as
Table7: Semiconductor Shipments, Bookings, and Book-to-Bill Ratio
Date Shipments Bookings Book-To-Bill
y-o-y, % m-o-m, % y-o-y, % m-o-m, % Value y-o-y, % m-o-m, %
31-Jan-07 14.98 -2.31 17.94 -3.43 1.00 3.09 -0.99
28-Feb-07 10.89 -1.73 8.11 -3.30 0.98 -2.97 -2.00
31-Mar-07 7.30 0.94 2.48 1.54 0.99 -3.88 1.02
30-Apr-07 10.64 11.02 -2.30 10.42 0.98 -11.71 -1.01
31-May-07 14.98 4.73 1.41 4.75 0.98 -11.71 0.00
30-Jun-07 13.53 5.86 -9.80 -2.09 0.91 -20.18 -7.14
31-Jul-07 2.92 -4.65 -18.93 -12.52 0.83 -21.70 -8.79
31-Aug-07 -3.47 -0.21 -20.73 -2.50 0.82 -17.17 -1.20
30-Sep-07 -6.90 -7.42 -24.66 -9.93 0.79 -19.39 -3.66
31-Oct-07 -4.79 -4.45 -16.14 -0.28 0.83 -11.70 5.06
Source:OREIstaffcalculationsbasedonBloombergdata.
All PrimaryCommodities
Metals2
Food & Beverage3
AgricultureMaterials4
50
100
150
200
250
300
Jan-04
Jun-04
Nov-04
Apr-05
Sep-05
Feb-06
Jul-06
Dec-06
May-07
Oct-07
222
163165
141
107
287
251
134
Energy1
230
Figure29:Primary Commodity Price Indexes (Jan2004=100)
1Crudeoil,naturalgas,coal.2Copper,aluminum,ironore,tin,nickel,zinc,lead,uranium.3 Cereal, vegetable oils, meat, seafood, sugar, bananas,oranges,coffee,tea,cocoa.4Timber,cotton,wool,rubber,hides.Source:OREIstaffcalculationsbasedondatafromtheIMF Primary Commodity Prices,InternationalMonetaryFund.
1.94
3.95
5.19
4.44
5.55
4.594.67
4.04
3.69
1.0
1.5
2.0
2.5
3.0
3.5
4.0
2-Jan-06
20-Mar-06
5-Jun-06
21-Aug-06
6-Nov-06
22-Jan-07
9-Apr-07
25-Jun-07
10-Sep-07
26-Nov-07
3.0
3.5
4.0
4.5
5.0
5.5
6.0
Japan
euro zone
UKUS
euro zone, UK, USJapan
Figure30:10-year Government Bond Yields (%perannum)
Note:Theshadedareaindicatestheperiod15Julto20Sept2007.Source:Bloomberg.
R E G I O N A L U P D A T E
26
investors fled risky assets. There is now concern that tighter
global creditmayaffectoveralleconomicactivityby reducing
loanstobusinessesandhouseholds.Thereisalsoevidencethat
lending standards are already becoming more strict in some
maturecreditmarkets.
Despite significant injections of liquidity into the financial system by the world’s major central banks, financial volatility in global markets remains high, with heightened investor sensitivity to risk likely to persist into 2008.
StockmarketsralliedaftertheFed’sratecutsinSeptemberand
October.TheworldMorganStanleyCapitalInternational(MSCI)
BarraIndexisnowhigherthanbeforethemarketcorrectionin
AugustandSeptember(Figure �2).3Butglobalequitymarkets
remain sensitive to new data releases on the US economy,
reflectingheightenedriskperception.There-pricingofcreditrisks
hasalsobeenorderlyinmostcreditmarkets.Butsomesegments
ofthemoneymarketsarestillstrainedbyalackofliquidityand
increasedcounterpartyrisk.Despitegenerallytightercreditand
heightened financial volatility, however, external funding for
emergingEastAsianeconomiesremainsadequate.
In sum, the external environment for emerging East Asian economies is expected to weaken somewhat in 2008, as economic growth in industrial countries moderates, oil and commodity prices remain elevated, and global financial markets continue to exhibit heightened volatility.
Althoughrecentfinancialinstabilityhashadonlylimitedimpacton
theglobaleconomy,furthersignificantspillovercannotberuled
out.WorldGDPgrowthisexpectedtoslow,althoughwiththe
globalITmarketslowlyrecoveringfromitsrecentslump,external
demandforregionalproductsmayremaingenerallysupportive
nextyear.Andinflationarypressuresareresurfacingasglobaloil
andcommoditypricessurge,complicatingmonetarydecisions
into2008.AfterabriefretreatinAugustandSeptember,capital
flowstoemergingmarketeconomieshaveresumed,againadding
topressureonassetpricesandcurrenciesinthesemarkets.Amid
increasedvolatilityinpriceandvolume,financialconditionswill
warrantclosemonitoring.
3 TheMSCIBarraindexesarewidelyusedasperformancebenchmarksbyassetmanagers.TheMSCIAllCountryWorldIndexcovers23developedand26emergingequitymarkets.Sources:WallStreetJournalandMSCIBarra.
Japan
US
euro zone
142131
32
72
195
150
124
105 100
676458
370
25
50
75
100
125
150
175
200
02-Jan-06
30-Mar-06
25-Jun-06
20-Sep-06
16-Dec-06
13-Mar-07
08-Jun-07
03-Sep-07
29-Nov-07
basis points
Figure31:Corporate Bond Spreads1
Note: The shaded area indicates the period 15 Jul to 20Sep2007.1 Refers to the difference between yields of 5-year bondsissuedbyBBB-ratedfinancecompaniesandyieldsofsovereignbenchmarkbondsofthesametenor.Source:Bloomberg.
130
120115
174
197190
214
162
80
100
120
140
160
180
200
220
02-Jan-06
20-Mar-06
05-Jun-06
21-Aug-06
06-Nov-06
22-Jan-07
09-Apr-07
25-Jun-07
10-Sep-07
26-Nov-07
Emerging Latin America
Emerging Europe
Emerging Asia
World
Figure32:MSCI Indexes(2Jan2006=100)
Note:Shadedareaindicatestheperiod15Julto20Sep2007.Source:MorganStanleyCapitalInternational(MSCI)Barra.
R E G I O N A L U P D A T E
27
Regional Economic Outlook for 2008
With the external environment weakening somewhat—and the PRC, the region’s largest economy, expected to soften next year—aggregate GDP growth in emerging East Asia is forecast to slow to 8.0% in 2008 from a likely 8.5% this year.
While much of the region will be affected by the expected
slowdownineconomicexpansionin industrialcountries,there
remain several mitigating factors that will allow emerging
EastAsianeconomies tosustain lowerbutstill robustgrowth
(Table 8). Despite attempts to cool its economy, the PRC is
likelytocontinueitsdouble-digitexpansion.Atthesametime,
growthintherestoftheregionhasbecomemorebroad-based,
withstronggainsinsomelargereconomies—includingIndonesia
and thePhilippines—andsmall economiescontinuing to catch
up.GDPgrowthintheNIEsisexpectedtoeaseonlymodestlyin
2008,whileGDPgrowthinASEAN-4islikelytobe,ifanything,
higher. Also, despite softer external demand and the cyclical
downswingintheglobalITindustry,exportsperformedstrongly
andmosteconomiesintheregionpostedsolidcurrentaccount
surplusesin2007(Figure ��).Asrobustgrowthpersistsinthe
regionandtheglobalITindustryisexpectedtorecoveroverthe
courseof2008,exportgrowthisexpectedtorecover.Butrapid
economicgrowthandstrengtheningdomesticdemandarelikely
tocompresscurrentaccountsurplusesacrosstheregion.
The PRC economy is expected to continue double-digit growth in 2008, but the pace may soften—off its current peak—if measures to cool the economy begin to take hold.
Growthinthefirst3quartershitarecord11.5%,andisprojected
tosustaindouble-digitlevelsfortheremainderofthisyearand
next,althoughthepace isexpectedtomoderateto10.5%in
2008.Aseriesoftighteningmeasureshasbeenintroducedto
curb rapid investment growth and asset-price inflation since
mid-2006,butthefulleffecthasyettobeseen.Strongexports
continuetobolsterinvestment,especiallyinmanufacturingand
mining.Increasingly,privateconsumptiongrowthiscontributing
toeconomicstrength.Risingincomesandimprovementstothe
social security system underpin rapid consumption growth. A
planned increase in fiscal spending should also supportmore
2.6
16.711.8
2.7
31.0
8.0
7.4
27.9
14.0
1.4
18.5
4.2
13.9
14.7
12.0
-0.3
-5 0 5 10 15 20 25 30 35
2007H12006H22006H1China, People's Rep. of
Hong Kong, China
Indonesia
Korea, Rep. of
Malaysia
Philippines
Singapore
Thailand
Taipei,China
5.5
7.87.5
4.55.4
Figure33:Current Account Balance (%ofGDP)
Source:International Financial Statistics,InternationalMonetaryFund.
R E G I O N A L U P D A T E
28
broad-basedexpansion in2008,withmorepublic investment
slatedforeducation,healthcare,andruraldevelopment.
GDP growth in the NIEs is forecast to average 5.1% next year, just slightly below an estimated 5.3% in 2007.
InKorea,growth isgatheringpaceasstrongexportearnings
andcorporatesectorbalancesheetssupportreasonablyhealthy
investmentgrowth.Inaddition,asteadytighteninginthelabor
marketisdrivingagradualrecoveryinconsumption.InSingapore,
despitebuoyantindustrialactivity—drivenbythemanufacturing
Table8: Annual GDP Growth Rates (%)
Average ADB Forecasts
1996–2006 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Emerging East Asia 1,2 6.5 6.7 7.7 �.6 7.0 6.9 8.0 7.8 8.� 8.5 8.0
ASEAN 1,2 �.2 �.� 6.7 1.9 �.9 5.� 6.� 5.6 6.0 6.� 6.1
BruneiDarussalam 2.0 3.1 2.9 2.7 3.9 2.9 0.5 0.4 5.1 1.9 2.3
Cambodia 8.6 12.6 8.4 7.7 6.9 8.5 10.0 13.5 10.8 9.2 8.0
Indonesia3 3.1 0.8 4.9 3.6 4.5 4.8 5.0 5.7 5.5 6.2 6.4
LaoPDR 6.3 7.3 5.8 5.8 5.9 5.8 6.9 7.2 7.3 6.8 7.9
Malaysia4 4.9 6.1 8.9 0.5 5.4 5.8 6.8 5.0 5.9 5.9 5.9
Myanmar5 10.7 10.9 13.7 11.3 12.0 13.8 13.6 13.2 ... ... ...
Philippines6 4.3 3.4 6.0 1.8 4.4 4.9 6.4 4.9 5.4 7.0 6.4
Thailand 3.1 4.4 4.8 2.2 5.3 7.1 6.3 4.5 5.0 4.3 4.8
VietNam 7.3 4.8 6.8 6.9 7.1 7.3 7.8 8.4 8.2 8.3 8.5
Newly Industrialized Economies1 �.5 6.9 7.7 1.0 5.� �.2 6.0 �.8 5.5 5.� 5.1
HongKong,China 3.8 2.6 8.0 0.5 1.8 3.0 8.5 7.1 6.8 6.1 5.4
Korea,Rep.of 4.6 9.5 8.5 3.8 7.0 3.1 4.7 4.2 5.0 4.8 5.0
Singapore 5.5 7.2 10.1 -2.4 4.2 3.1 8.8 6.6 7.9 8.1 6.3
Taipei,China 4.6 5.7 5.8 -2.2 4.6 3.5 6.2 4.2 4.9 5.0 4.8
China,People’sRep.of 9.3 7.6 8.4 8.3 9.1 10.0 10.1 10.4 11.1 11.4 10.5
Japan 1.2 -0.1 2.9 0.2 0.3 1.4 2.7 1.9 2.2 1.9 1.7
US 3.2 4.5 3.7 0.8 1.6 2.5 3.6 3.1 2.9 2.2 1.9
Eurozone 2.1 3.0 3.8 1.9 0.9 0.8 2.0 1.5 2.8 2.6 2.1
...=notavailable1Aggregatesareweightedaccordingtogrossnationalincomelevels(atlasmethod,currentUS$)fromWorld Development Indicators(WorldBank).2ExcludesBruneiDarussalamandMyanmarforallyearsasweightsareunavailable.3GDPgrowthratesfrom1999–2000arebasedon1993prices,whilegrowthratesfrom2001onwardarebasedon2000prices.4Growthratesfrom1999–2000arebasedon1987prices,whilegrowthratesfrom2001onwardarebasedon2000prices.5ForfiscalyearApril–March.6Figuresfor2004–2006arenotlinkedtotheGDPfigures2003backwardsduetoNationalStatisticsOfficerevisionsofsectoralestimates.Sources:ADB;governmentestimates(BruneiDarussalam);Eurostatwebsite(eurozone)EconomicandSocialResearchInstitute(Japan);BureauofEconomicAnalysis(US).
R E G I O N A L U P D A T E
29
andconstructionsectors—moderationisexpectedduetoaslowing
infinancialservices.TheoutlookforHongKong,China,whichis
heavilyinfluencedbythePRC,remainssolid.However,therapidly
closingoutputgapandmoresubduedfinancialmarketconditions
implysomeeasingofgrowthin2008.
The four largest ASEAN economies—currently in the upswing phase of their business cycles—are forecast to maintain strong growth in 2008, with Indonesia and Thailand accelerating, Malaysia maintaining this year’s pace, and the Philippines slowing somewhat from a strong 2007.
Strong domestic demand and resilient exports are likely to
keepthefourmiddle-incomeASEANcountriesingoodstead.In
Indonesia,GDPgrowthcontinuestoaccelerate,afterexceeding
6%in2007forthefirsttimesincethe1997/98Asianfinancial
crisis.Buoyantconsumptionandstronginvestmentonthebackof
easiermonetarypolicyunderpintherobustoutlook.InMalaysia,
improvingelectronicsexportswillsupportrelativelystronggrowth
whiletheimpactoffiscalstimulusondomesticdemandgradually
fades.InthePhilippines,GDPgrowthwillremainhighatabout
6.4% in 2008—although off the post-crisis peak reached this
year—onstronggainsinnetexports,privateconsumption,and
governmentspending.Thailand’seconomycontinuestostruggle
amid ongoing political and policy uncertainties. But there is
substantial scope for expansionary policies—which can boost
GDPgrowthin2008—oncetheDecembernationalelectionshave
reducedpoliticaluncertainty.
The smaller ASEAN economies—Cambodia, Lao People's
Democratic Republic (Lao PDR), and Viet Nam—continue to
post impressiveeconomicgrowth,althoughGDP inCambodia
isexpectedtoslowabitin2008.Thepaceofeconomicgrowth
in2008isexpectedtoquickenfurtherinVietNam,drivenby
vigorousindustrialactivityandstronginvestmentfollowingits
January2007accessiontotheWorldTradeOrganization(WTO).
Cambodia is working to consolidate output performance by
promotingamorebalancedexpansionamongkeyindustries—
includingagriculture,construction,garments,andtourism.But
GDPgrowthremainsnarrowlybasedongarmentsandtourism.
Intheshortterm,increasinglyuncertainprospectforgarments
ishamperingtheeconomy.TheLaoPDRisbenefitingfromlofty
globalenergyandcommodityprices,asstronginvestmentand
R E G I O N A L U P D A T E
�0
growthinminingandhydropowersectorssupporttheexpansion.
GDPisforecasttogrowsignificantlyat7.9%in2008from6.8%
in2007.
Even as growth slows somewhat, inflation is generally picking up in many emerging East Asian economies, largely due to resurgent oil and other commodity prices.
InthePRC,inflationwasbackupto6.5%inOctober2007,with
particularlyacuteinflationriskridingthebackofrapiddemand
growthandwageincreases(see Figure 11).Plannedpricing
reforms of state-controlled sectors—an increase in the prices
of public utilities, including power and water, for example—if
implemented,mayadd toexisting inflationarypressuresnext
year. In general, for the rest of the region, robust growth,
relatively tight labormarkets, and higher energy prices are
expectedtogenerallyincreaseinflationarypressuresin2008.
Currentaccountsareexpectedtocontinuetoshowlargesurpluses
inthePRC;HongKong,China;Malaysia;andSingapore,butwill
likelybeclosetobalanceinIndonesia,Korea,andThailand.After
abriefwithdrawalofforeigncapitalduringtherecentfinancial
turbulence,capitalinflowstotheregionhaveresumedtheupward
trendwithavengeance.Persistentcurrentaccountsurplusesand
netcapitalinflowswillcontinuetoplaceappreciationpressures
onregionalcurrenciesin2008.Andasauthoritiesintervenein
foreignexchangemarketstocurbthepace, foreignexchange
reserveswillriseacrosstheregion(Table 9).Withheightened
volatilitythreateningfinancialstability,authoritiesshouldclosely
monitorfinancialmarketdevelopmentsandremainvigilantfor
anymis-pricingofrisk.
Risks to the Outlook
The region’s economic outlook is subject to greater downside risks now than just a few months ago—including the possibility of a US recession, further tightening of global credit, an abrupt adjustment in exchange rates, and a continued rise in oil and commodity prices.
ThepossibilityofaUSrecessionremainsariskgivenunderlying
housingmarketweaknessandgrowingconcernaboutaspillover
R E G I O N A L U P D A T E
�1
onto consumer spending and business activity in general.
The persistent housing slump already dragged down private
residentialinvestmentfortheseventhconsecutivequarterduring
July–September2007.Businessandinvestmentactivityarealso
slowingastheoutlookbecomescloudierandfinancialmarket
uncertainty dampens business confidence. Consumersmay
also comeunder significantpressure if deterioratingbusiness
sentiment affects the labor market. Consumer confidence
droppedforathirdconsecutivemonthinOctober,toitslowest
level in a year, as housingmarketwoes andwidening credit
concernscompoundedworriesabouttheeconomyandfuturejob
prospects.EmergingEastAsia’stradelinkswithG3economies4
remainsubstantial,althoughingradualdecline(Figure ��).If
theUSeconomyslowssharply,itseffectonglobaltradewould
be significant—it remains an important source of demand for
manyEastAsianexporters,andforthePRCinparticular(21%
of totalexports in2006,andhigher if factoring in third-party
economies’ re-exports). The US subprime turmoil could also
spawnareassessmentofhousingpricesglobally.Othercountries
withsignificanthouse-priceinflationinthepastfewyears,such
assomeEuropeancountries—particularlytheUK—andAustralia,
alsoremainvulnerabletoahouse-pricebust.IftheUSeconomy
entersarecessionandtheglobaleconomysubstantiallyslows
4G3includestheeurozone,Japan,andUS.
Table9: Foreign Exchange Reserves (excludinggold)
Country/Region$ billion % change (y-o-y)
Dec-05 Dec-06 Mar-07 Jun-07 Sep-071 Dec-05 Dec-06 Jun-07 Sep-071
BruneiDarussalam 0.5 0.5 0.5 0.5 0.5 -2.2 5.9 2.6 3.1
Cambodia 1.0 1.2 1.2 1.4 1.4 1.0 21.4 36.4 32.4
China,People’sRep.of 821.5 1,068.5 1,204.0 1,334.6 1,435.6 33.7 30.1 41.4 44.9
HongKong,China 124.2 133.2 135.3 136.3 140.8 0.6 7.2 7.6 8.1
Indonesia 33.1 41.1 45.7 49.4 51.2 -5.2 24.0 28.4 25.3
Korea,Rep.of 210.3 238.9 243.8 250.6 257.2 5.7 13.6 11.1 12.7
LaoPDR 0.2 0.3 0.4 0.5 0.5 4.9 39.5 80.8 63.9
Malaysia 69.9 82.1 88.2 98.1 97.9 6.0 17.6 25.0 23.6
Myanmar 0.8 1.2 1.7 1.8 1.8 14.7 60.3 87.8 62.0
Philippines 15.9 20.0 21.7 23.5 27.9 21.4 25.7 28.7 47.9
Singapore 116.2 136.3 137.7 144.1 152.4 3.2 17.3 12.3 18.2
Taipei,China 253.3 266.1 267.5 266.1 262.9 4.8 5.1 2.2 0.5
Thailand 50.7 65.3 69.1 71.3 78.7 4.2 28.8 26.3 31.2
VietNam 9.1 13.4 18.3 20.3 20.3 28.5 47.9 79.5 70.2
EmergingEastAsia 1,706.6 2,068.1 2,235.3 2,398.2 2,529.1 16.6 21.2 26.9 29.5
1Ifdataisunavailableforreferencemonth,datareferstomostrecentmonthwheredataisavailable.Source:International Financial Statistics, InternationalMonetaryFund.
Figure34:Trade links (shareofG3inemergingEastAsian1exports)
1BruneiDarussalam;Cambodia;People’sRepublicofChina;HongKong,China; Indonesia;RepublicofKorea;LaoPDR;Malaysia; Myanmar; Philippines; Singapore; Thailand;Taipei,China;andVietNam.Source:Direction of Trade Statistics,InternationalMonetaryFund.
Japan
22.2 20.7 20.9 18.9 21.4 21.1 20.0 17.6 16.7
14.1 15.4 15.214.815.7
15.1 14.016.6 15.4
11.213.2 10.6 12.314.6
12.7 12.510.2
8.836.4 36.0
42.741.9
0
8
16
24
32
40
48
56
1990 1992 1994 1996 1998 2000 2002 2004 2006
EU
US
Intra-regional trade
R E G I O N A L U P D A T E
�2
intandem,theimpactonemergingEastAsianeconomieswill
bepotent.
EveniftheUSavoidsarecession,globalfinancialmarketsseem
tobeenteringaperiodofincreasedvolatility,andtheresulting
marketadjustmentscouldinstigatefurtherboutsofturbulence.
Somemarketadjustmentsthatcorrectmis-pricingandreassess
riskexposuresoffinancial institutionsshouldbewelcome—as
theextendedperiodofeconomicandfinancialstabilityinstilled
asenseofcomplacencyanddeterioratedmarketdiscipline.But
initiallybenigncorrectionscouldrapidlyturndisruptive.Credit
risk re-pricingandretrenchment fromhigh-riskassets—taken
in the context of the complexity and illiquidity embedded
in new investment vehicles—have causedmajor clogging in
money/interbanklendingmarkets.Continuedstrainsinmoney
markets—andinsomecreditmarkets—willlikelytightengeneral
creditconditionsbyincreasingthecostandreducingtheamount
offunding.Inmajorindustrialcountries,suchastheUSandthe
eurozone,lendingstandardshavebeentightenedandthereare
signsthattheoverallcreditsupplytobusinessesandhouseholds
isbeingreduced.AfullblowncreditcrunchcouldslowGDPgrowth
substantiallyinG3economiesandhavemajorimplicationsfor
externaldemandforemergingEastAsianproducts.
Sudden swings in capital flows and abrupt adjustments in
exchange rates due to the large global payments imbalances
and a potential reversal in investors’ risk appetite is another
concernfortheregion’seconomies.Attheheightoftherecent
financialturbulence,globalinvestorsretreatedfromriskyassets,
includingthoseinemergingEastAsia.Mostregionalcurrencies
havealreadyappreciatedsubstantially(see Figures 16a, 16b),
buttheyremainvulnerabletogreatervolatilityintermsoffuture
directionsandmagnitudeofcapitalflows.Perceivedexchange-
ratemisalignmentsinemergingEastAsianeconomiescontinue
todrawcapital inflows,particularly in the formof short-term
portfolioinvestments,whichaddappreciationpressureandfuel
asset-priceinflationinmanyoftheseeconomies.Inparticular,
somecountriesintheregion—includingIndonesia,Korea,and
Philippines—have seen rapid increases in capital inflows for
portfolioinvestmentsoverthepastfewyearscoupledwithhigher
ratesofcreditgrowth.Foreignportfolioandotherinvestments
nowexceeddirectinvestmentsinemergingEastAsia(Figure �5)
andthispatternofincreasingshort-termcapitalflowsmakesthe
regionvulnerabletofinancialvolatilityandanunexpectedreversal
Direct investment inflows
Portfolio investment inflowsOther investment inflows
Total gross investment inflows
4.2
1.93.4
7.02.9
4.1
3.4 3.9 4.3
2.41.91.7
13.011.5 12.2 11.8
-113579111315
2004H1 2004H2 2005H1 2005H2 2006H1 2006H2 2007H12
10.1
7.09.2
Figure35:Emerging East Asia1 Financial Accounts (%ofGDP)
1IncludesPRC,ASEAN-4,andNIEs,LaoPDR,Myanmar,andVietNam.22007H1figuresdonotincludeMalaysia(dataunavailable).Sources: International Financial Statistics, InternationalMonetaryFundandcountrysources.
R E G I O N A L U P D A T E
��
ofglobalfinancialflows.Recentswingsinglobalfinancialflows
andheightenedvolatilitycanbeexacerbatedbyvulnerabilities
stemmingfromthepersistentlylargeglobalpaymentsimbalances.
Somesignsofmoderationhaveemerged.TheUScurrentaccount
deficit this year is expected at 5.6% of GDP, down sharply
from6.2%lastyear.5Still,resultingglobalimbalancesremain
extremely large. To theextent that theongoing correction in
globalfinancialmarketsmayreflectthedynamicsofunderlying
marketforcestoreducethescaleofglobalimbalances—which
entails aUSdollar depreciation,USeconomic slowdown, and
reductionofUSdollarassetreturns—evenagradualandthus
protractedunwindingprocesswouldhavesignificantimpacton
emergingEastAsianmarkets.Atthesametime,slowerUSgrowth
couldreviveprotectionistsentiment.Takentogether,adisorderly
adjustmentinglobalpaymentsimbalancescoupledwithasharp
contractioninUSaggregatedemandandafreefalloftheUS
dollar,althoughveryunlikely,cannotberuledout.Thiswould
haveapotentiallyseriousimpactontheregion.
Freshboutsofinflationarypressuresduetosustainedincreases
in food and energy prices pose a threat to maintaining
macroeconomicstabilityinsomeemergingEastAsianeconomies,
withtherisksmorepronouncedinsomethanothers.Inparticular,
inthePRCandHongKong,China,inflationisbeingfuelledby
risingfoodprices,rapidlygrowingdomesticdemand,tightening
labormarkets,andstrongforeignexchangeinflows—exacerbated
byrigidexchangerateregimes.Intherestoftheregion,although
stillmanageable,inflationarypressuresarequicklyresurfacing
aswellduetonarrowingoutputgapsandrisinginputprices.The
sustainedriseinglobaloilpricesisamajorconcern(Figure �6),
asmarketsremaintightand,withlittlesparecapacity,anysupply
disruptionorheightenedgeopoliticalconcerncouldleadtoeven
higherprices.GiventalkofrecessionamongtheG3economies
andcurrentinflationarypressuresintheregion,anothermajoroil
priceshockcouldcontributetoaperiodofstagflation.Ifinflation—
especiallycoreinflation—headshigher,monetaryauthoritiesin
theregionwillhavelessflexibilitytodealwithpotentiallyslower
economicactivityarisingfromweakerexternaldemand.
5WiththeweakeningintheUSdollar,exportspickedupstronglyby16.2%(q-o-q,seasonallyadjusted,annualizedrate)inthethirdquarterof2007—from7.5%inthepreviousquarter—whileimportgrowthremainsmoderateduetoaslowingeconomy.Ifexportandimportgrowthcontinuesatthecurrentpace,allelseequal,theUScurrentaccountdeficitwillstabilizeatabout3%ofGDPby2011.
64.1
54.6
77.273.987.2
92.6
70.3
0102030405060708090100
May-05
Nov-05
May-06
Nov-06
May-07
Nov-07
May-08
Nov-08
Spot
Future prices (as of 19 Nov 2007)
Future prices (as of 14 Aug 2007)
Figure36:Brent Spot and Future Prices1 ($perbarrel)
1Historicalpricesaremonthlyaveragesofdailyspotprices.Source:Bloomberg.
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Policy Issues
Slower economic growth coupled with a buildup of inflationary pressures—despite appreciating currencies—poses major challenges in macroeconomic management for emerging East Asian economies.
The region’s resilience to recent financial turmoil was in no
small part due to strongmarket confidence derived from a
robustgrowthoutlook,soundmacroeconomicindicators,current
accountsurpluses,andhealthyexternalpositions.Theremarkable
improvementsmadeinthedecadesincetheAsianfinancialcrisis
reflectstrongmacroeconomicprudence in termsofcontinued
fiscalconsolidationandmeasuredinflationrates.However,given
the uncertain global outlook, heightened financial volatility,
andsustainedhighoilandcommodityprices,macroeconomic
managementremainsamajorchallenge.Policydilemmasmay
be particularly acute in countries where rapid credit growth
andasset-priceinflation—associatedwithstrongforeigncapital
inflows—limit the scope formonetary responses to external
adversity(Box 1).
Given the specific domestic conditions among the region’s
economies,monetaryauthoritieswillneedgreatcareindesigning
policyresponsestothechangingexternalenvironment.Slowing
externaldemandandtheuncertaingrowthoutlook—butrising
inflationarypressures—raisetheriskofpolicymistakesinthose
economieswheremonetary policy needs to be fine-tuned to
meetbothgrowthandinflationobjectives. Becausetheworld’s
majorcentralbanks’keypolicyratesareexpectedtofallfurther
orleveloffamidbelow-potentialgrowthexpectations,monetary
authoritiesintheregionmayfeelpressuretokeepratesonhold
orevenlowertheminlinewiththeglobaltrend.
However, to the extent that some decoupling of the region’s
growthoutlook fromthatof theglobaleconomy isunderway,
monetarypolicies in the regionshouldalsodecouple.Despite
weakening growth in key industrial countries, the region’s
prospectsremainstrong,evenifslowingsomewhat—thePRC,
forexample,stillfacesoverheating.Incountrieswheredomestic
demandisstrongandinflationisrising—particularlythePRCand
VietNam—theremaybemeritincontinuingmonetarytightening.
Inmuchoftheregion,however,inflationremainslargelyincheck,
suggesting room forpolicydiscretion if thedownside risks to
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The potential for a stronger-than-expected slowingof theUSeconomypresentspolicychallengesforauthoritiesthroughoutemergingEastAsia.Butforthe fast-growing economies of thePeople’sRepublic ofChina (PRC)andHongKong,China—whichmaintainlimitedflexibilityorahardpegtothe US dollar—it creates seriouspolicydilemmas,amidsignsthatinflation isbecomingproblematicandassetpricesmorefrothy.
Rigid exchange rate regimesin both economies create policydilemmas because US monetarypolicyhasbeguneasing.AweakerUSeconomy—thedestination forabout 20% of PRC exports andabout16%ofHongKong,Chinaexports—and the correspondingUSFederalReserveratecuts,maypromptauthoritiestocutinterestrates to maintain exchange rateregimes and accelerate policiesthat could steer demand towarddomestic sources. Yet, in bothcases, r is ing asset prices—exacerbated by large inflows offoreigncapital—callforpoliciesthatinsteadreinindomesticdemand.
TheissuesareparticularlyacuteinthePRC,whereauthoritiesarestruggling to conduct policy thatwillsteeranoverheatingeconomyto a more sustainable growthpath.Macroeconomicstabilizationpolicy is further complicated bygrowthimbalancesacrossdifferentsectorsandprovinces,astill-fragilefinancialsystemawashinliquidity(largelyduetopersistentlyswellingtrade surpluses), and a currencysubject to strong appreciationpressures.Thedilemmaarises inpart from the fact that policiesto boost domestic sectors to balancegrowthcould feed fast-rising inflation(Figure B1.1). A persistent risein headline inflation could in turnweakenprivateconsumption,insteadofshiftingthegrowthbalancetodomesticsources.
Conversely,atightermonetarypolicyalso carries risks for the economy.1Asset price appreciation has beenveryrapidinthepastfewyears,withmarked increases in price-earningsratiosinlocalstockindexes.Aparticular
concern is the increasingly largenumberofhouseholdinvestorsplayingthestockmarket,somewithborrowed
1Withinflationhigh,realinterestratesarestillverylow.The1-yearbenchmarklendingrate,adjustedfor inflationof6.5%,is just0.79%,whicharguablymakesforthecasethat the currentmonetarypolicy stance isstillexpansionary.
money.Correctionsmaybesharpandswift, with adverse repercussions forits fragile banking system and thebroader economy. More importantly,newhikes in interest rates combinedwithunabatedanticipationofcurrency
appreciation will attract capitalflows further, aggravating theliquidity overhang and fuelingassetpricerises.
Faced with this dilemma,authoritieshaveuseddirectinstru-ments, including administrative“windowandcreditpolicyguidance”controls to rein in the speedof credit growth. Under these,banksmaybesanctionedthroughliquiditypenaltiesorevenpersonnelchargesifexcessivelendingisnotcurtailed.Giventhelimitedpolicyoptions, such targetedmeasuresmight be more effective than amonetarytightening,whichcouldhaveaneconomy-wideeffect.Thedilemmanowfacingpolicymakersalso strengthens the case forgreater exchange rate flexibility.Astrongercurrencyshouldcontainthe excessive trade surplus,moderate investment in tradablesectors,andmitigate inflation.Itwouldalsohelptightenmonetaryand credit conditions withoutinterestrateincreases.Thatsaid,thegovernment’spolicyofgradualappreciationcontinuestoblunttheeffectiveness of monetary policyand entices capital inflows inanticipationofhigherreturnsfromthe yuan’s revaluations, addingfueltoassetmarkets.LikewiseinHongKong,China,
theimportanceoftheUSmarketpresentspolicychallengesbecauseofthehardcurrencypeg.Cutsto
theUSfederalfundsratearematchedlocally through the Linked ExchangeRateSystemthatpegstheHongKongdollartotheUSdollar(Figure B1.2).Yet, given the strong economy andrecentinflationat9-yearhighs,lowerinterestratesarenotcalledfor.
Box1: Fed Rate Cuts and Policy Dilemmas
Nominal Effective Exchange Rate (increase = appreciation)
Nominal Interest Rate
Inflation Rate
104.9
95.4
5.5
6.8 6.3
3.8
0.4
3.2
92
95
98
101
104
107
Jan-05
May-05
Sep-05
Jan-06
May-06
Sep-06
Jan-07
May-07
Sep-07
-1.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
%NEER Index
Interest rateInflation rate
1Baserate.2Jan2005=100.Sources:BankforInternationalSettlementsandHongKongMonetaryAuthority.
FigureB1.2:Nominal Interest Rate,1 CPI Inflation, and Nominal Effective Exchange Rate (NEER)2—Hong Kong, China
FigureB1.1:Nominal Interest Rate,1 CPI Inflation, and Nominal Effective Exchange Rate (NEER)2—PRC
1Benchmark1-yearlendingrate.2Jan2005=100.Sources:BankforInternationalSettlements,CEIC,andNationalBureauofStatisticsofChina.
103.7
106.7
107.05.6
7.3
6.5
3.3
0.998
100
102
104
106
108
110
Jan-05
May-05
Sep-05
Jan-06
May-06
Sep-06
Jan-07
May-07
Sep-07
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
%NEER IndexNominal Effective Exchange Rate (increase = appreciation)
Nominal Interest Rate
Inflation Rate
Interest rateInflation rate
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Domesticdemandgetssupportfromrising incomes, strong employment,the buoyant stockmarket, renewedbusiness confidence, and a recoveryinconstruction.Andinthenearterm,thedomesticeconomyshouldbeableto shoulder some export weakness.But,theparallelratecutsbuiltintothepegcomewithundesirablechallenges,particularlyincontaininginflation,whichinOctober hit 9-year highs at 3.2%.Inflationarypressuresarehighduetorobustdomesticdemandandsustainedhighoilandfoodprices.Butwithapeg,aweakerUSdollarandtheFed’seasingpolicy are readily transmitted to thelocalcurrencyandinterestrates,fuelinginflationconcerns.
Excess liquiditycouldalsocauseabubbleinlocalstockmarketsandfuelarealestateboom.TheHangSengIndexhas been hitting new record highs,
althoughprice-earningsratiosarenotyetexorbitant.Andthelistingofseveralpopular mainland Chinese companieson the localmarket has also led toa surge in capital inflows. Combinedwithcurrentaccountsurpluses,thesehave boosted domestic liquidity andcredit growth. Asset prices may risefurtherasdepositholdersswitchfromlower returns earned on savings intothe higher-yielding asset markets.Propertypricesarerisingaswell:thedomesticpropertypriceindexinJunebroke a level last achieved in 1999,andallothersegmentsofthepropertymarkethavebeenbullish,reachingorsurpassing peaks attained before the1997/98Asiancrisis.Whiletheseareallingredientsforrisinginflationandassetbubbles,thelackofshort-termcountermeasuresduetothepegraiseconcernsaboutsustainabilityofmacroeconomic
andpricestability.Thelackofmonetarypolicyoptions
means the onus for maintainingeconomic stability falls on fiscalpolicyandotherstructuralpolicies.Inparticular,iftheexchangeratecannotadjust to external shocks, domesticwages and prices will have to. Thismeansthatlaborandproductmarketswill have to be even more flexible.However,anymeasurestomakethemso,mostlystructuralinnature,canonlybearfruitinthemediumtolongterm.Inthetradablesector,theseeconomies’competitiveness iscommendable,butmuch room for improvement is leftin the domestic sector. In the labormarket, an aging population andshortageofskilledlaborpresentlonger-termchallengestopolicymakers.
growthmaterialize.Nevertheless,inflationaryconcernslingerin
severalcountries—includingIndonesia,Korea,andPhilippines—
wheretheoutputgapisclosingonrobustgrowthwhilerising
global oil and commodity prices threaten to push input costs
higher.Clearly,thereisno“one-size-fits-all”solutionforthese
countries,but thesituation requiresheightenedvigilanceand
carefulmonitoringofinflationarydevelopments.
Ineconomiesthatusegreaterexchangeratecontrol,increasing
currency flexibility could add useful monetary leverage
domesticallyinanenvironmentofheightenedexternaluncertainty
(Box 2).Continuedlargecurrentaccountsurplusesandforeign
capital inflows remain destabilizingmacroeconomic forces in
many parts of the region. Associated with this, rapid credit
growthandasset-priceinflationgenerallynarrowthescopefor
monetaryeasingagainstasharpeconomicslowdown.Acurrency
appreciationcanbolstermonetarydiscretionby tighteningde
factomonetaryconditions.However,despiteincreasingcurrency
flexibility over the past few years,many regional economies
continuetointerveneinforeignexchangemarkets.Theseefforts
tomaintaincurrencystabilityareoftenineffectivebeyondthe
shortterm,wheneconomicfundamentalscontinuetoputupward
pressureonthecurrency.Ineffectivesterilizationalsocontributes
toexcessliquiditygrowthandasset-pricebooms,whilefuelling
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In an environment where capitalmovesfreely,simultaneouslytargetingan exchange rate and maintainingan independent monetary policyis impossible. This is the so called“impossibletrinity”.1Twoofthesethreeobjectivescanbeachievedatthesametime,butnotallthree.Ifacountrypegsits currency to another’s, the UnitedStates(US)dollar,say,itcannotdeviatesignificantlyfromthe ‘host’monetarypolicy.Ifbusinesscyclesarein tandem, then that maycreate no problems—theUSFederalReserve’spolicymaybeappropriateforthepeggingeconomy.Butifcyclesdiverge,what’sgoodfortheUSmaynotbegoodfortheother.
Some countries, especially small,open ones with underdevelopedfinancialsystems,electtohavedollarpegs. They are willing to sacrificemonetary independence in order topromotetradeandeconomicgrowthbyminimizingexchangeratefluctuations.That said, an oft-cited cause of theAsianfinancialcrisiswasthede factopegging of the region’s currencies totheUSdollar.Afewyearsbeforethecrisis, those currencies strengthenedalongsidetheUSdollar,leavingexportsless competitive and causing rapiddeterioration of current accounts.AfterThailandmovedtofloatthebaht,concernaboutthesituationturnedtofear and massive amounts of capitaltookflight,triggeringachainofeventsthataffectedmuchoftheregion.
Sincethen,thelessonsofthecrisishaveledmanyeconomiesintheregiontoadoptflexibleexchangerates.Thislikely also allowedmore independentmonetary policies in the region, assuggestedinKimandLee(2004)2and
1A formal model for this hypothesis wasdeveloped by Robert Mundell and MarcusFleminginthe1960s.2Kim,C.J., and J.W.Lee,2004.ExchangeRateRegimeandMonetaryIndependenceinthePost-CrisisEastAsia:AnApplicationofRegime Switching Model with EndogenousExplanatoryVariables.Economics Department Working Paper,KoreaUniversity.
Kawai(2007).3This box examines empirically
whether the economies of emergingEast Asia have indeed pursued moreindependent monetary policies sincethe financial crisis. In the spirit ofFrankel,SchmulkerandServen(2002)4andShambaugh(2004),5thefollowingerror-correction formulation can beused to examine monetary policyindependence:
where ∆ denotes first difference, forexample,∆rt
lc=rtlc-r lc
;rlcthelocalcurrencyinterestrate;r*theforeigncurrencyinterestrate;ut the error term, α1p and α2p thecoefficients of short-run dynamics oflagged domestic interest rates andforeigninterestraterespectively;δthespeedofadjustmenttothelong-runrelationship;andβ the long-run sensitivity of thedomestic interest rate to the foreigninterestrate.
The error correction model iscommonlyusedtoempiricallyanalyzethe dynamic behavior of time-seriesvariables. Intuitively, the equationtakes a set of variables—here theyarelocalandforeigncurrencyinterestrates—thathasalong-runequilibriumrelationship,andtracestheirdynamicbehaviors to converge towards theequilibrium condition. Given an opencapitalaccount,acountrythatincreasesinterest rateswill attract capital, andthis will cause the exchange rate toappreciate. If a central bank wants
3Kawai, M. 2007. Toward a RegionalExchange Rate Regime in East Asia. ADB Institute Discussion Paper No.68.4Shambaugh,J.C.,2004.TheEffectofFixedExchangeRatesonMonetaryPolicy.Quarterly Journal of Economics 119,301–352.5 Frankel, J.A., S.L. Schmulker, and L.Serven, 2002. Global Transmission ofInterest Rates: Monetary IndependenceandCurrencyRegime.NBER Working Paper Series WP8828.
tofix itscurrencytoahostcountry’scurrency, its domestic interest rateswillhavetoadjustaccordinglytothehost country’s interest rate changes.Thislong-runequilibriumrelationshipiscapturedintheequationbythetermsinthesquarebracket,whereδmeasureshow fast localcurrency interest ratesreturn to equilibrium, and β showshowmuchlocalcurrencyinterestratesshouldmoveinresponsetothechanges
in foreigncurrency interestrates. Ifacountrypegs itsexchangerate,itsmonetarypolicyshouldmirrorthatofthehostcountryinthelong-
run:β will be close to one,while itsspeedofadjustment,δ,willbegreaterthanzero.Incontrast,whenacountryadopts a fully floating exchange rateregime,δwillbeclosetozeroandβbecomesinconsequential.Monthlymoneymarketrates6from
January1990toJuly2007areobtainedfor Indonesia; theRepublicofKorea;Malaysia;thePhilippines;andThailand,aswellastheeffectiveovernightfederalfunds rate for the US. The pre-crisissamplespans1990:1to1997:5,justbeforethefloatingoftheThaibaht.Thepost-crisissamplegoesfrom1998:10onwardssoastoreducetheeffectsofunnecessaryvolatilityassociatedwiththecrisis.7The results generally confirm that
thedomesticmonetarypoliciesoftheregionaleconomieshavegainedgreaterindependence from the Fed’s policysincethecrisis.Figure B2.1showsthatthespeedofadjustments(δs)ofmostcountrieshasvisiblydeclinedsincethecrisis,except forMalaysia,wheretheresult is statistically insignificant forthepre-crisisperiod.Figure B2.2alsoreportsthegenerallyaffirmativeresultsin terms of the long-run sensitivity
6 TakenfromtheInternationalMonetaryFundIFSandcentralbankwebsites.7 For Malaysia, it starts from July 2005aftertheunpeggingoftheringgittotheUSdollar.Theidentifiedcrisisperiod(1997:6to1998:10)isalsolargelyalignedwithKimandLee’s(2004)datingofstructuralbreaksfortheirsimilarsetofcountries.
Box2: Measuring Monetary Independence in Emerging East Asia
ΣΔrtlc = δ β[Δrt
lc -p1p
P
p=1+Σ
P
p=0Δrt
* -p2p
- rtlc -1-
0- rt
* -1 [+ut
t-1
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coefficient,β.Sincethecrisis,β hasfalleningeneral,suggestingthatthelong-runrelationshiphasbecomeweaker.Thatis,thereislessevidenceofaone-to-one relationship between domesticinterestratesandtheUSfederalfundsrateafterthecrisis,exceptinIndonesiaand the Philippines. For Indonesia, itis statistically insignificant to rejectthat there is one-to-one relationship,but β has declined nonetheless. Forthe Philippines, other circumstantialevidence suggests that the larger β after the crisis should be interpretedwithcautionanddoesnotnecessarily
reflectalossofmonetaryindependence.Prior to the establishment of BangkoSentralngPilipinasin1993,whichgavethecentralbankitslegalindependence,thePhilippineswasexperiencingvariousfiscalanddebtproblemsandmonetarypolicywaspreoccupiedwithresolvingthem.Takentogether,theseresultssupport
the idea that a move towards moreflexible exchange ratemanagementafter the financial crisis has allowedgreatermonetarypolicyindependenceinmanyemergingEastAsianeconomies.Inthecontextofrecentfinancialmarket
developments and the likely impactonregionalandglobaleconomies,thelesson from this empirical analysis isclear.Theregion’sbusinesscyclesareheading in a different direction thanthe US, which is directly affected bythefinancialturmoil.Totheextentthatthe region’s business cycles divergefrom that of the US, autonomousmonetarypolicyisalsoneeded.Allowingcurrencies to move more freely mayhelptheregionattaingreatermonetarypolicy lever in the face of increasingeconomicandfinancialuncertainty.
0.24*
0.12*
0.10*
0.07*
0.39**
0.34*
0.17*
0.46*
0.03
0.70*
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8
Indonesia
Korea, Rep. of
Philippines
Thailand
Malaysia Pre-CrisisPost-Crisis
FigureB2.1:Speed of Adjustment Coefficient (δ)
Notes:*and**denotesignificanceatthe1%and5%levelsrespectively.δmeasureshowquicklythelong-runequilibriumbetweendomesticinterestratesandtheUSinterestratesisrestored.
Pre-CrisisPost-Crisis
0.46
0.27*
0.65
0.21*
0.25*
1.34
0.74
1.40
0.95
0.04*
0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6
Indonesia
Korea, Rep. of
Philippines
Thailand
Malaysia
FigureB2.2:Long-run Sensitivity Coefficient (ß)
Notes:*denotessignificanceatthe1%level,meaningtherejectionofthehypothesisß=1.ß measuresthelong-runsensitivityofdomesticinterestratestotheUSinterestrates.
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expectations for futureappreciationand thus attractingmore
capitalinflows.Ineconomieswithrigidexchangerates,itwillbe
increasinglydifficulttomeetbothinternalandexternalobjectives
usingmonetarypolicyalone.
There may be merit in emerging East Asian economies cooperating to maintain relative stability in intraregional exchange rates, considering the increase in intraregional trade and other economic cooperation within the region.
With strong current and capital account surpluses, some
economiesintheregionwithmoreflexibleexchangerateshave
experiencedveryrapidcurrencyappreciation.Theseeconomies
maybetemptedtointroducesomeformofcapitalcontrolsoruse
administrativemeasurestocurbstrongshort-termcapitalinflows
and portfolio investments. Hurried administrative measures,
however, are potentially disruptive and may only temporarily
alleviatethesymptomsofunderlyingstructuralproblems,and
they should be used with caution. When any type of capital
controlshavetobeusedasalastresort,theseshouldbecarefully
definedandpreciselytargetedtominimizecreatingdistortions.
Butthetrendofintraregionaltradeandinvestmentflowsisvisibly
risingandcontinuestosupporttheregion’seconomicgrowth.
Wherepossible,drawingupamorecoordinatedregionalapproach
toexchange ratepolicymightbeabetteralternative to take
advantageofgrowingintraregionaltradedynamicwhilehelping
alleviatetheburdenofsharp,unilateralappreciationpressures.
Even as economies design the right mix of macroeconomic
responses,theywillcontinuetobenefitfromundertakingdeeper
andmorecomprehensive structural reforms.Withheightened
financial volatility and its potential spillover on the global
economy,theregion’sgrowthstrategyshouldreinforceeffortsto
rebalancesourcesofgrowthwhileretainingresiliencetoexternal
shocks.Inthisrespect,areasoffocuscouldincludeimprovement
oftheinvestmentclimateandbusinessenvironment,advancing
post-crisisfinancialsectorreformagendas,developingdeeper
financialmarketsintheregion,andpromotingenergyefficiency
andconservation.
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For several ASEAN economies, a better investment climate could strengthen domestic demand—which could help offset lower external demand—and help ensure that strong capital inflows are put to better use.
The post-crisis recovery in investment remains incomplete in
manyof the region’seconomies,morespecificallyamong the
crisis-affected economies themselves. Key areas ofweakness
are policy uncertainties, governance, the quality of legal and
institutional frameworks, and regulatory capacity. Addressing
these problems will require more comprehensive structural
reforms to improve efficiency and competitiveness through
minimizing unnecessary regulatory barriers for businesses,
encouragingprivateincentivesandmarketdiscipline,creatinga
levelplayingfieldacrossallsectors,andfosteringcompetition
toupgradeinstitutionalcapacity.
Measures to develop efficient and deeper financial markets in the region can help enhance the resilience of the region’s financial systems against heightened global market volatility.
Advancingpost-crisisfinancialsectorreformagendasremainkey
toensuringfinancialstabilityinthecrisis-affectedcountriesinthe
faceoflargeswingsincapitalflows.Financialsectorweakness—
coupledwithalackofprudentialoversight—oftenledtobooming
credit and surging asset prices during past eras of liquidity,
onlytobefollowedbypainfulcorrections.Althoughtheregion’s
bankingandfinancialsectorshavemaderemarkableprogress,
rapidfinancialglobalizationrequiresstepped-upeffortstokeep
upwiththeevolvingfinancialenvironmentandinnovation.These
effortsshouldincludeupgradingriskmanagement,revamping
information disclosure policies and transparency, enhancing
governance,andstrengtheningprudentialoversight.Thesound
managementofprivatecapitalflowsisalsocrucial,possiblyby
deepeningfinancialmarkets,strengtheningmarketinfrastructure,
buildingasoundlegalandregulatoryframework,andheightening
markettransparency.
Regionalpolicymakersarewellawareoftheproblemposedbythe
shallownessoffinancialmarketsintheregionrelativetodeeper
marketsintheUS,eurozone,andevenmoredevelopedregional
peers.Indeed,theAsianBondMarketsInitiativerepresentsa
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cleardesiretodevelopefficientandliquidbondmarketsinthe
regiontodiversifyfundingoptionsandenhancetheefficiencyof
financialresourceallocation.Recentglobalturbulencereinforces
theimportanceofmorediverseandresilientfinancialsystemsin
thefaceofpotentialmarketvolatility.
Finally, measures to promote energy efficiency and conservation remain imperative, given record oil prices and the region’s high dependency on oil imports.
Althoughsignificanteffortshavebeenmadetobringlocalprices
closertogloballevels,manycountriesintheregioncontinueto
subsidizeenergypricesorinfluencedomesticprices.Theincomplete
pass-throughcouldcomplicatemacroeconomicmanagementby
weakening fiscal positions. The agenda for domestic energy
marketreformmayinclude(i)reducingsubsidiesandaligning
thelocalpriceswithglobalprices;(ii)removingupstreamand
downstreampricecontrolsandavoidingadministrativemarket
distortions; (iii) promoting energy conservation and energy
efficiency;and (iv)fostering competitiveenergymarkets that
rewardprivatesectorinnovation.
SPECIALSECTION
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CanEmergingEastAsiaWeatherGlobalFinancialInstability?
Introduction
EmergingEastAsiaexhibitedremarkableresilienceduringrecent
boutsofglobalfinancialturbulence.Theregion’sfinancialmarkets
tumbledinAugust2007amidconcernsoverUnitedStates(US)
subprimemortgages and spreading global credit fears. But a
relativelyquickrecoveryfollowedbymid-September.Emerging
East Asian share prices rebounded to record levels while the
region’s currencies resumed their upward trend against the
weakeningUSdollar.Sovereignbondspreadsinlocalmarkets
remainsignificantlyhighercomparedwiththestartoftheyear—in
linewithglobalmarketdevelopments.Butthisreflectsgeneral
creditriskre-pricingandaratherhealthymarketcorrectionafter
anextendedperiodofheightenedriskappetites.
Severalimportantfactorscanhelpexplainthisresilience.First,
the region’s financial institutions have relatively small direct
exposure to US subprime mortgages and structured credit
products.Second,stronggrowthprospectsandsoundexternal
positionshavecontinuedtosupportinvestors’confidenceinthe
region’seconomies.Andthird,improvedandprudentpoliciesin
mostemergingEastAsianeconomieshelpmitigatetheimpact
ofexternalshocks.
This, however, does not imply that the region will remain
shieldedfromglobalfinancialmarketdevelopments.Theexternal
environmentisincreasinglyuncertainandthecurrentperiodof
financialturbulencewilllikelycontinue.Therearesomeimportant
channels throughwhich further instability can be transmitted
totheregion’sfinancialmarkets—withsignificantimpacttothe
regionaleconomyasawhole.Heightenedriskperceptionand
erodinginvestorconfidenceisone.Aswinginmarketsentiment
and a sudden change in liquidity conditions is another. The
contagioneffectscouldbecomemoreseriousiftighteningcredit
conditions and financial instability dampen broad economic
activitiesbothatglobalandregionallevels.
Thissectionexaminestheregion’sstrengthandvulnerabilitiesin
thecontextofcurrentfinancialmarketsituationstoshedlighton
thechallengesfacedbytheregion’spolicymakers.Afterbriefly
summarizingrecenteventssurroundingtheUSsubprimeturmoil
SPECIALSECTION
��
anditsimplicationstotheregionalbankingandfinancialmarkets,
thesectionexaminesthevariouschannelsofcontagiontothe
region’seconomiesinlightofongoingdevelopmentsinregional
financialmarketsandinstitutions.Implicationsforfuturepolicy
decisionsareevaluated.
How Did Emerging East Asia Survive the Recent Turmoil?
Ridingthehousingpriceboomduring2001–2005,USresidential
mortgage lendingsawrapidgrowth—with increasingamounts
goingtoborrowerswithshakycredithistories.AstheUSFederal
Reserve(Fed)beganraisinginterestratesinJuly2004,these
subprime mortgage holders naturally faced larger interest
payments.Thesubsequentcoolinginthehousingmarketalso
madeitmoredifficulttorefinancemortgagesintoloanswithbetter
terms—orpayoffmortgagesbysellinghomes.Consequently,
delinquencies on subprimemortgages rose significantly from
mid-2005(Figure �7).
Proliferationofstructuredcreditproducts—whichhelpedbundle,
repackage,andsellsubprimemortgagestoabroadspectrumof
globalinvestorgroups—providedthelinkforfinancialcontagion.6
Thesenewcreditrisktransferproductsandmechanismshave
gainedpopularityinmaturemarketsasawayofboostingprofits
inanenvironmentofrelativelylowinterestrates,whilehelping
manageriskexposuresoffinancialinstitutions.Butasdefaults
onUSsubprimemortgagesspilledoverontothebalancesheets
ofhedgefundsandotherinvestmentfunds,anumberofbanks
havebeenaffectedthroughoff-balancesheetfinancial“conduits,”
whichinvestedheavilyinrelatedmortgagederivativesandcredit
products.
Theuncertaintyaboutwhoholdshowmuchofthesemortgage-
related products—and where—generated widespread distrust
amongfinancialinstitutionsworldwide.Addfinancialinnovation
andglobalization,andtherisksbecamedispersedonabroader
basisthroughouttheglobalfinancialsystem.Also,whilefinancial
innovation has increased banks’ ability tomove risk off their
balancesheets,ithasnoteliminatedthepossibilitythatthissame
riskcouldreturnunexpectedly,andsuddenly.Asconcernsabout
6 Foramoredetaileddiscussion,seeAsia Bond Monitor,November2007,athttp://asianbondsonline.adb.org/documents/abm_nov2007.pdf,pg33.
0
2
4
6
8
10
12
14
16
1 11 21 31 41 51 61 71 81
2000200120022003200420052006
2006
Months after origination
Figure37:Nonprime Mortgages Delinquencies (60-DayDelinquenciesbyVintageYear,inpercent)
Source: Update on the Global and Regional Outlook, InternationalMonetaryFundpresentation,29Nov2007.
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creditandcounterpartyrisksspread,banksbecamedefensive
and scrambled for liquidity. Key short-term rates in mature
marketssoaredinearlyAugust(Figure �8),promptingmajor
centralbankstoinjectlargeamountsofliquidityintheinterbank
moneymarket.
Heightenedriskaversionledglobalinvestorstoretreatfromrisky
assetsduringtheAugustsell-off,includingthoseinemergingEast
Asianmarkets.Stockpricesplummetedacrosstheregionand
regionalcurrenciestookatumble.High-yield,high-riskemerging
marketsovereignbondspreadsalsowidenedsharply,asinvestors
begantorequirehighercompensationforassumingrisk.
Because the region’s banks—which continue to dominate emerging East Asian financial systems—were little affected by the US subprime problem, the impact on local financial systems was largely contained.
DisclosedexposuresofemergingEastAsia’sbankinginstitutions
havebeenlimitedthusfarandrelativelysmallagainsttotalbank
assets.7BanksinIndonesiaandMalaysiahavevirtuallynodirect
exposure.AndwhilebanksinthePhilippinesandThailanddeal
withstructuredcreditproducts,theyarelargelydispersedrather
thansystemic,andsmall insize.Somebanks in thePeople’s
RepublicofChina(PRC);HongKong,China;RepublicofKorea
(Korea);Singapore;andTaipei,Chinareportedmoresignificant
exposurestotheUSsubprimemarket—throughstructuredcredit
productssuchascollateralizeddebtobligationsandasset-backed
securities.Buthereagain,theexposureislessthan5%oftotal
assetsformost.Therearesomereportsoflossesfromnonbank
financialinstitutionssuchasinsurancecompaniesinTaipei,China
andbanks’off-balancesheet investment funds inHongKong,
China;butthegeneralpictureremainsbenign.
Still,thespilloverfromthefinancialturmoilemanatingfromG3
financialmarkets could be potentially large. Generally sound
macroeconomicfundamentalsandgrowthprospectshelpedlimit
the initial losses in emergingEastAsianequities, bonds, and
currencies.However,somerecenttrendsintheregion’sfinancial
systemswarrantclosemonitoring.Assetpricesareboomingin
severalemergingEastAsianmarkets,withheightenedrisksof
mis-pricing.Bankingsystemsareextendingnewbusinesslines,
7 The estimates are based on the surveys of Fitch ratings, Moody’s Investors’Service,andStandard&Poor’s.
UK
64.6
83.8
16.1
32.5
88.4
91.3
114.3115.3
0
20
40
60
80
100
120
06-Jul-07
20-Jul-07
03-Aug-07
17-Aug-07
31-Aug-07
14-Sep-07
28-Sep-07
12-Oct-07
26-Oct-07
09-Nov-07
23-Nov-07
07-Dec-07
US
euro zone
Figure38:Key Short-term Money Market Rates (inspreadsoverpolicyrate,basispoints)
Source:Bloomberg.
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bringing new exposure to new territories and types of risk.
Foreigncapitalinflowstotheregioncontinuetorise—insome
casessharply—contributingtorapidgrowthinmoneysupplyand
credit,thusfuellinginflation.Againstthisbackdrop,heightened
uncertaintyoverthedurationandmagnitudeofcapitalinflows
and increased financial volatility pose a significant threat to
macroeconomicandfinancialstability.
Where Are the Lurking Vulnerabilities in Emerging East Asia’s financial systems?
The region’s largely bank-dominated financial systems—with weak systemic support for effective risk management—leave doors open to potential spillovers if conditions in global financial markets worsen or investor sentiment shifts.
In the aftermath of the Asian financial crisis, large-scale
restructuringandreformswereundertakentobringtheregion’s
bank balance sheets back to health—and to revamp highly-
leveraged firms. Prudential regulationswere also reinforced.8
Ongoingeffortstodevelopcapitalmarketshelpbroadensources
forcorporatefinancing,yetbanksstilldominateastheprimary
sourceforeconomicactivity(Table 10).Tosupportcurrencyand
financialstability,macroeconomicmanagementingeneralhas
becomemuchmoreprudent,withinflationtargetingintroduced
inseveraleconomies,fiscalbudgetsconsolidated,andexchange
rateregimesmoreflexible.However,somepocketsofweakness
remainintheregion’sbankingandfinancialsystems,whilenew
challengesareemerging.
On balance sheets, the region’s banks appear healthy, with
virtuallynoexposuretothetypeofexternalcreditrisksthatthe
current turmoil involves.Nonperforming assets have declined
dramatically across the region since the crisis. Risk-weighted
capital adequacy ratios are higher. And banks have reduced
short-termexternalborrowings—whichhadpreviouslyexposed
themtorisksstemmingfromcurrencyandmaturitymismatches.
Meanwhile, bank income sources have been broadened by
diversifyingintohouseholdlending,offeringnewtypesoffinancial
services,andstrengtheningfeestructures.8 Foramoredetaileddiscussion,seeAsia Economic Monitor,July2007,athttp://www.aric.adb.org/pdf/aem/jul07/July%20AEM%20complete%20250707.pdf,page54.
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Thelimitedexposuresoftheregion’sbankingsystemstotheUS
subprimefalloutmaybemoreareflectionoftheregion’srelatively
less-developedfinancialmarketsandinstitutions,whichremain
largelyunsophisticatedintermsofthearrayofproductsoffered.9
Indeed, bank lending generally fell in the post-crisis period
(Figure �9).Conservativelendingpracticesandstrengthened
prudentialregulationsfollowingthe1997crisishavekeptbank
investmentsinrelativelysafeassets,suchaslocalgovernment
securities(Figure �0).
Andrisksmayarisefromthebroadeningscopeofbankingbusiness
andtheirexposurestonewtypesofmarketrisks(Table 11).
Withtherecenthousingboomsacrosstheregion,forexample,
mortgage-related lending has increased sharply. Elevated
levelsofhouseholdindebtednessalsoshowsignsofstress(see
AssessmentofFinancialVulnerability,pages15–21).
Securities holdings have increased as a share of total bank
investments. Alongwith the rise in investment banking-type
activities,thisindicatesexposuretogreatermarketrisks.Regional
banks are participating in securities-related transactions—
underwriting,dealing,andbrokerage,forexample—andinforeign
exchange,leasing,andinsuranceactivities.Bankshavealsobeen
encouragedtotakepartinlocalbondmarketdevelopment—as
issuers, underwriters, investors, and guarantors. This also
exposesbankstonewrisks.
9Banksinthenewlyindustrializedeconomies(NIEs),however,arebeginningtooffermoresophisticatedproducts,rapidlynarrowingthegapwiththeircounterpartsintheG3.
Table10: Sources of Finance in Emerging East Asia (percentageofGDP)
Commercial bank loans1 Domestic debt securities outstanding Stock market capitalization
2001 Sep 20072 1996 2006 2001 Oct 2007
China,People’sRep.of 102.1 111.0 7.2 44.4 40.0 121.7
HongKong,China 168.2 192.0 22.5 34.8 299.4 1021.9
Indonesia 18.7 24.1 3.0 24.0 14.5 49.5
Korea,Rep.of 57.4 88.0 50.8 113.8 41.1 116.5
Malaysia 97.2 109.4 72.5 98.6 131.9 187.3
Philippines 44.7 29.6 33.6 38.4 59.0 124.8
Singapore 106.2 93.7 26.5 65.5 216.5 348.2
Taipei,China 142.3 144.2 34.6 56.5 103.9 195.5
Thailand 83.0 74.6 10.1 54.0 31.3 86.1
1PRCdatareferstototalloans.2PhilippinesasofAug2007.Source:OREIstaffcalculationsbasedondatafromCEIC,Bloomberg,andPeople’sBankofChina.
1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
160
120
80
40
0
160
120
80
40
0
IndonesiaKorea, Rep. of
Malaysia
Philippines
Thailand
Figure39:Bank credit to the private sector before and after banking crises1
Source:Turner,Philip(September2007)Are Banking Systems in East Asia Stronger?BankforInternationalSettlements.
0 5 10 15 20 25 30 35 40
Thailand
Singapore
Malaysia
Korea, Rep. of3
Indonesia2
Hong Kong, ChinaEnd-1994Mid-2005
Figure40:Government securities held by commercial banks (%ofdomesticcredit1)
1Ofcommercialbanks.2Firstbarreferstoend-1996.3Secondbarreferstoend-2004.Source:Mohanty,etal(2006),Banksandaggregatecredit:whatisnew?,BIS Papers No 28,August2006.
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Recent trends in the global financial system—notably the growing presence of nonbank financial institutions and proliferation of new instruments for risk transfer—will also become increasingly relevant in the regional context.
In regionaleconomieswithmoreadvancedfinancial systems,
technologicalprogressandcompetitionarerapidlymodifyingthe
overallriskprofileofbankingandthefinancialindustry.Nonbank
financialinstitutionssuchasinsurancecompanies,pensionand
mutualfunds,andleasing,factoringandventurecapitalfirms,
whilestillunderdeveloped,havegrownrapidlyinrecentyears.
Althoughsmallasashareoftotalfinancialsystemassets,the
sizeofthemanagedassetsisrisingrapidlyat25.4%onaverage10
overthepast5yearsinNIEs.
Despite generally conservative banking activity in the region,
largely unregulated nonbank financial institutions are already
taking on increasingly risky investments for higher returns.
Localinstitutionalinvestorshavealsostartedtoincreasetheir
overseas investments and diversify their holdings into riskier
andmoresophisticatedequity,credit,andcurrencyderivatives.
Overthepastfewyears,sharpincreasesinportfolioinvestment
outflows(mainlydebtsecuritiesfromPRCandKorea)suggestthat
exposuresinsomeemergingEastAsianeconomiestomortgage-
relatedsecurities—althoughthemajorityarelikelytobeprime
ratherthansubprimemortgages—mightbebiggerthancurrently
estimated(Figure �1).
10 TheestimatedgrowthisbasedonthesizeofmanagedassetsofmutualfundsandprivatepensionfundsinNIEsreportedbytheOrganisationforEconomicCo-operationandDevelopmentandtheInvestmentCompanyInstitute.
4.5 5.33.4 4.7
5.19.5
6.5
12.1
-0.4-3.8
10.1
11.1
2.26.8
4.2
19.0
27.9
20.0
5.2
14.6
9.2
-3
2
7
12
17
22
27
2000H1 2001H1 2002H1 2003H1 2004H1 2005H1 2006H1 2007H1
Direct investment outflows
Portfolio investment outflowsOther investment outflows
Total Gross investment outflows
Figure41:Investment Outflows—NIEs(%ofGDP)
Note:Negativevaluesindicatethatproceedsfromredemptionofearlierinvestmentoutflowsexceedinvestmentoutflowsfortheperiod.
Sources: OREI staff calculations based on data from International Financial Statistics,InternationalMonetaryFund,andcountrysources.
Table11: Composition of bank lending1
Housing loans Consumer loans Business credit
199� 1999 200� 199� 1999 200� 199� 1999 200�
HongKong,China 7 15 15 2 3 3 86 76 73
Singapore 14 20 26 13 12 15 60 51 39
Indonesia 5 6 7 18 60 37
Korea,Rep.of 9 33 18 17 69 47
Malaysia 10 18 28 8 16 64 45
Thailand 9 7 10 4 3 6 64 71 68
1Ofcommercialbanks.Aspercentageoftotaldomesticcredit.Source:Mohanty,M.etal(2006),Banksandaggregatecredit:what’snew?”BIS Papers No. 28.
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Atthesametime,abroadeninginvestorbasehasledtoincreasing
demandfornewdebtproductsandservices,whichisspawning
increasinglycomplexnewinstruments.Taketheregion’sbond
markets,forexample.Sincethe1997financialcrisis,developing
localcurrencybondmarketsintheregionhasbecomeapriority—
inparttoofferalternativestobankfinance.Theexpansionof
globalliquidityandincreasingdemandforhigh-yieldingassets
alsoresultedinasharpriseinshort-terminvestmentinflows,
whichpouredintolocalcurrencydebtmarkets.Thesizeoflocal
bondmarketsroseto56.8%ofGDPinthefirsthalfof2007,up
from19.1%in1997.
Furthermore, ongoing development of derivativesmarkets in
some economies—and increasing off-balance sheet financial
transactions in connectionwith rising local fundmanagement
activities—implyfundamentalchanges intheregion’sfinancial
systembalancesheetstructures,inparticular,thetypesofrisks
towhichbanksareexposed,andtheirmagnitude.Thesefinancial
marketdevelopmentsmaycontributetoalackoftransparencyin
bankingoperationsandcompoundtheopacityofriskexposures
withinbroadfinancialsystems.
Thecomplexityofnewfinancialproductsandservicespresent
bothchallengesandopportunitiesintermsofriskmanagement.
Ononehand,theavailabilityofnewfinancialinstrumentsand
marketssuchascredit-risk-transferinstrumentsandderivatives
markets allows banks to broaden the scope of their risk
managementcapabilities.Butasbusinessoperationsgrowmore
complexandsophisticated,keepingriskmanagementsystems
up-to-datewillpresentincreasingchallengestobothbanksand
bankregulators.
Despite the resurgent capital inflows to the region following the August turmoil, a sharp reversal in risk appetite and financial flows remains a possibility in a climate of heightened volatility and uncertainty, due to a re-pricing of risk and the potential unwinding of the so-called “carry trade.”
Effects from growing capital movement—and short-term
investments—associated with increased financial market
integrationandcapitalaccountliberalizationalsoposeasignificant
risktotheregion’seconomiesshouldanexogenousshockoccur.
Thisposesapotentiallygreaterrisktothecountriesthathave
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experiencedrapidgrowthinportfolioinvestmentflowsandasset
priceinflationinrecentyears.
Capital flows to and from the region reached record highs in
recent years (Figure �2). With the volume of cross-border
capitalflowsontherise,sotoohavecross-borderholdingsof
financialassetsincreasedsharply (Figure ��).Grossexternal
assetsandliabilitiesasashareofGDPreached131%in2004,
upfrom51%in1990.11
Moreworryingisthechangingstructureofcapitalinflows,with
short-termcapitalnowaccountingformorethan60%oftotal
inflows.Substantialrisesinthe“otherinvestment”inflowsmay
alsoreflectincreased“carrytrade”activitiesand“hotmoney”—
drivenbyinterestratedifferentials.12Againstthisbackdrop,a
suddenshiftinthedirectionandmagnitudeoffinancialflowsisa
significantconcern.Thesharpincreaseinshort-terminvestments
inthemid-1990shasbeenoftenblamedasamajorreasonfor
the1997Asianfinancial crisis—as these instantly turned into
significantcapitaloutflowsattheonsetofthecrisis.Totheextent
that thisparticularcomponentofshort-termcapital inflows is
extremelyvolatileandhighlyinterest-ratesensitive,theregion’s
financialmarketsaresubjecttothevagaryofforeigninvestor
sentiment. This also places regional authorities in a difficult
positionwhenpursuingautonomousmonetarypolicies.
Large capital inflows, strong credit expansion, and adverse
macroeconomic consequences are not new to emerging East
Asia.Robusteconomicgrowthinrecentyearshasunderpinned
surgingassetpricesbyboostingtheregion’sincomeandfueling
marketexpectationsforhigherfuturereturns.Keyregionalstock
marketindexessoaredandpropertypricesarerisingrapidlyin
manyregionaleconomies.Thejumpinmoneysupplyandfalling
domesticinterestrateshasbeenbehindthesharpriseinasset
prices.Butaprolongedperiodofmacroeconomicstabilityalso
seemstohavebredabiggerriskappetiteandsomecomplacency
amonginvestors.
11 Lane,PRandGMMilesi-Ferretti(2006):TheexternalwealthofnationsmarkII:revisedandextendedestimatesofforeignassetsandliabilities,1970–2004,IMF Working Papers, no 06/69,March.
12 These non-foreign direct investments (FDI) and non-portfolio inflows oftenrepresentshort-termborrowingsoftheregion’sbankingsystemsandtradecredits.Althoughsomecountry-specificfactorscanaccountfortherecentincreases—suchasasharpriseinoverseasborrowingbybanksinKoreatohelplocalshipbuildershedgetheirfutureUSdollarreceipts—thiscannotbethefullregion-wideexplanation.
-2,500
-2,000
-1,500
-1,000
-500
0
500
1,000
1,500
2,000
2,500
1990 1992 1994 1996 1998 2000 2002 2004
Gross financial derivatives Gross portfolio equity Gross debt Net financial assets
Assets
Liabilities
Figure43:Cross border financial assets and liabilities of Emerging East Asia1 ($billion)
1ASEAN+PRC+NIEs.Source:OREIstaffcalculationsbasedondatafromLane,P.andG.Milesi-Ferretti(2006),TheExternalWealthofNationsMarkII:RevisedandExtendedEstimatesofForeignAssetsandLiabilities,1970-2004,IMF Working Paper 06/69.
5.05.0 4.7 4.3
3.3 2.4 2.7 2.9 3.4
2.7 3.9 4.6 4.1
-1.7 -2.1 -2.0-2.6 -0.9
-3.2-6.8
-4.6
-3.2
3.9
-3.8
-5.8-4.4
-2.4
-15.0
-10.0
-5.0
0.0
5.0
10.0
15.0
2003H2
2004H1
2004H2
2005H1
2005H2
2006H1
2006H2
2007H1
Other investmentsPortfolio investmentsDirect investmentsNet flows
Inflows
Outflows
Figure42:Financial account—Emerging East Asia (%ofGDP)1
1FiguresincludeChina,People’sRep.of;HongKong,China;Indonesia;Korea,Rep.of;Malaysia;Philippines;Singapore;Taipei,China;andThailand.22007H1figuresdonotincludeMalaysiabecausedataareunavailable.Source:OREIstaffcalculationsbasedondatasourcedfromtheInternational Financial Statistics,InternationalMonetaryFund,andcountrysources.
2
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50
Theassetpriceboomhasalsobeengenerallybroad—covering
local equity, bond, and property markets. Rapid liquidity
growth,fueledbyhighofficialexchangereserves,hasincreased
demandforvariousassets.Theappearanceofmoreinstitutional
investorsand theirassetmanagementactivities in the region
alsoincreasedtheshareoffinancialassetsinindividualinvestor
portfolios.Growingsizeofassetmarketsvis-à-vistheeconomy
has naturally led to increased exposures of various sectors—
household,corporate,andfinancial—tochangesinassetprices
(Box �).Againstthisbackdrop,ifassetpricesareaffectedas
macroeconomicconditionsworsen,theoveralleconomicimpact
ontheregion’seconomiescouldbesignificant.
Could These Vulnerabilities Combine to Become “the Perfect Storm?”
Uncertaintiesabouttheevolutionoftherecentturmoilpersist,
especiallyonheightenedvolatilityinfinancialmarkets,re-pricing
of risks globally, and the increased odds of a US recession.
EmergingEastAsiaboastsstrongeconomicfundamentalsand,
asofnow, thereare fewsignsoffinancialmarket turbulence
derailingtheregion’srobustgrowth.Butsomeoftherecenttrends
haveincreasedtheregion’svulnerabilitiestoprolongedfinancial
instability and its continuing influence on themacroeconomic
stability.
As equity prices rose sharply, price-earning ratios shot up
(Figure ��).With their new business lines, banks entered
new territories of exposure and risks; exposure to consumer
credit, housing loans, and securities investments could incur
losses should macroeconomic conditions worsen with rising
household indebtedness and falling asset prices. Inadequate
information—andinmanycaseslimitedsupervisorycapacity—on
off-balancesheetexposuressuchasderivativesisalsoaconcern.
Inaddition,theincreasedactivityofnonbankfinancialinstitutions
and growing complexity of available financial products (and
services)contributetotheopacityoffinancialsystemsandtheir
riskexposures.
PhilippinesThailand
China, People's Rep. of
Indonesia
Korea, Rep. of
Taipei,China
12.9
44.7
15.419.8
Singapore
Hong Kong, China
Malaysia
0
5
10
15
20
25
30
35
40
45
50
Jan-05
Apr-05
Jul-05
Oct-05
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Figure44:Price Earnings Ratio
Source:Bloomberg.
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51
Asset markets (equity andproperty) in the nine biggereconomiesinemergingEastAsiahave been booming in recentyears.1Since2001,stockpriceshaverisenover100%onaverage,and property values have alsosoared(FiguresB3.1a,B3.1b,andB3.1c).Policymakersacrosstheregion have expressed concernabout surging asset prices andthepotentialimpactoneconomicactivity of amajor correction inthesemarkets.As asset markets grow in
size, the regional economy isincreasinglyexposedtoswingsinassetprices.Inthepastsixyears,stockmarketcapitalization,asaratio to gross domestic product(GDP),hasdoubledortripled inmostofemergingEastAsia,exceptforMalaysiaandSingapore,whereithasgoneup lesssignificantly.BytheendofOctober,theaveragemarket capitalization for sevenoftheninelargeremergingEastAsian economies—except HongKong, China and Singapore,whosemarket capitalization ismuch higher—was about 126%ofGDP(FigureB3.2),morethandoubletheaverageattheendof2001.Propertypricesare risingfastaswell.Althoughofficialdatasuggestpropertypricesremaininlinewitheconomicgrowth,datalimitations may have resultedin underestimation of propertyprice increases in many of theregion’s economies, particularlythe People’s Republic of China(PRC). Data from the privatesector, such as Jones Lang LaSalle Research, suggest thatpropertypricesare rising fasterin the region than official dataindicate.Thewaveoffinancialdeepeninghas
1 The economies covered in this box areIndonesia,Malaysia,Philippines,andThailand(ASEAN-4), the People’s Republic of China(PRC), and the four newly industrializedeconomies(NIEs):HongKong,China;RepublicofKorea;Singapore;andTaipei,China.
also accompanied the expanded sizeoffinancialassetholdingsofindividualinvestors.Fastrisingstockpricesandincreasingnewissuance—reflectedinthedramaticriseinmarketcapitalization—attracted ever growing participationof individual investors in local stockmarkets. In the PRC, the number of
investor accounts doubledto133millionbyNovember2007,from66millionin2001.Indirectly through mutualfunds, the value of stockmarket investments roseto RMB3.3trillion by end-October fromRMB80billionat the end of 2001. Withgrowing income, housingownership is also rising. Insome large countries in theregion, policymakers havealreadybeenconcernedaboutthe rapid rise in householdmortgagedebt.
Changes in asset pricescouldaffecttherealeconomyby the wealth effect andchangesinthecostofcapital.Higherassetpricesincreasethe wealth of consumers,boostingconsumerconfidenceand encouraging higherspending. Stronger assetvalues would also improvefirms’ and banks’ balancesheetsandthusinducebanksto charge lower premiumsorincreasethesizeofloansby the so-called ‘financialaccelerator’ effect. At thesame time, booming stockmarkets would encouragecorporate investment byloweringthecostoffunding.
Empiricalresearchshowsthat the wealth effect ofassetprices,thoughsmall,issignificant in emergingEastAsia.Kuralbayeva,Karlygash,and N’Diaye (2006) findsthat in Malaysia; HongKong, China; Indonesia;and Korea, a 10% rise inreal stock prices increasesprivateconsumptionbyabout
0.2–0.3%, similar in magnitude toestimatesforindustrializedcountries.2Althoughresultsarenotavailable for
2Kuralbayeva,Karlygash,andPapaN’Diaye,2006,DeterminantsofPrivateConsumptioninASelectedNumberofAsianCountries,IMFWorkingPaper(forthcoming).
Box3: Asset Markets and the Real Economy
78.0
220.5
95.4
125.3
50
70
90
110
130
150
170
190
210
230
Real stock price
Real property price
Real GDP
2001Q1
2001Q4
2002Q3
2003Q2
2004Q1
2004Q4
2005Q3
2006Q2
2007Q1
2007Q3
FigureB3.1b:ASEAN-�: Asset Prices and Real GDP(2003=100)
Source:OREIstaffcalculationsbasedonCEICandBloombergdata.
69.1
332.1
116.9
141.0
50
100
150
200
250
300
350
2001Q1
2001Q4
2002Q3
2003Q2
2004Q1
2004Q4
2005Q3
2006Q2
2007Q1
Real stock price
Real property price
Real GDP
2007Q3
FigureB3.1a:People’s Republic of China: Asset Prices and Real GDP(2003=100)
Source:OREIstaffcalculationsbasedonCEICandBloombergdata.
82.8
214.1
112.5
124.5
70
90
110
130
150
170
190
210
230
Real stock price
Real property price
Real GDP
2001Q1
2001Q4
2002Q3
2003Q2
2004Q1
2004Q4
2005Q3
2006Q2
2007Q1
2007Q3
FigureB3.1c:NIEs: Asset Prices and Real GDP (2003=100)
Source:OREIstaffcalculationsbasedonCEICandBloombergdata.
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52
the region, changes inasset prices have beenfound to have significanteffect on investment aswell in most industrialcountries.3The1997Asianfinancialcrisiswasavividexamplethatsoaringassetprices, pushed by largecapital inflows, increasedtheleverageofborrowersandexpandedinvestmentthrough the f inancialacce lerator channe l ,contributing to financialandeconomicvolatility.4
Withsurgingassetpricesand increasingly sizableassetmarkets,themainchallengeformacroeconomicpolicyinemergingEast
3See,forexample,RobertBarro,TheStockMarketandInvestment,Review of Financial Studies, Vol. 3, No. 1 (1990),pp.115–131,forUSevidence.4 Edison, Hali, Pongsak Luangaram, andMarcusMiller,2000,“AssetBubbles,Leverageand‘Lifeboats’:ElementsoftheEastAsianCrisis,”Economic Journal,Vol.110,No.460,pp.309–34.
Asiaistopreventanyfinancialmarketexcessfromspillingovertogoodsandservices markets, thus threateningmacroeconomicstability.Policymakersshould also aim tominimize the riskof financial instability as a sustainedperiod of asset price inflation oftenunderminesfinancialsectorsoundness,even if those gains initially appearbroadlyjustifiedbyfundamentals.Thisrequiresauthoritiestoremainfocused
on containing inflationarypressuresandexpectations,andstrengtheningfinancialmarket regulation andsupervisiontoaddressrisksassociatedwithassetpricebooms.Prudentialmeasures,such as tightening lendingstandards and criteria,could limit the speculativeparticipationthatmayleadto misalignment of assetpricesand the consequentprice collapse. Tighteningsupervisory policies canalso be helpful, as theycantargetproblemsectorsmoreclosely,whilelimiting
theriskofderailingeconomicgrowthby using monetary policy that canhave long-lasting and much broadermacroeconomicconsequences.
0 30 60 90 120 150 180 210
Taipei,China
Malaysia
Philippines
China, People's Rep. of
Korea, Rep. of
Thailand
Indonesia
Latest *Dec 2001
103.9
59.0
41.1
14.5
195.5
187.3
124.8
121.7
116.5
86.1
49.5
40.0
31.3
131.9
150 300 450 600 750 900 1050 1200
Singapore
Hong Kong, China
216.5348.2
299.41021.9
Hong Kong, ChinaSingapore
Others
FigureB3.2:Stock Market Capitalization (%ofGDP)
*Asatend-Oct2007.Source:CEICdatabase.
Tightening financial linkages increase the region’s exposure to risks arising from global financial instability.
Booming assetmarkets in some regional economies also run
theriskofcorrectionshouldglobalfinancialinstabilityreverse
investmentsentiment.Theregion’sequitymarketstendtomove
intandemwithglobalequitymarkets.Since1997,greatermarket
openness has enticed greater foreign investor participation
directlyintoemergingEastAsia’sequitymarkets.Portfolioinflows
totheregionhavebeenparticularlystrong,especiallyinrecent
years.Sotheregion’sequitymarketsremainhighlysensitiveto
swingsinforeigninvestors’riskappetite.
Intheperiodsince1990,correlationbetweendailychangesin
stockpricesintheregionandthoseintheDowJonesIndustrial
Average ranged from20%to40%,with theexceptionof the
PRC,whichshowedalmostnocorrelation.Inthemorerecent
period from 2006, however, the correlation of emerging East
Asianmarketswith theUSmarket pickedup sharply to over
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90%(Figure �5).Shouldtherebeasell-offinsay,USmarkets,
onecouldexpectasimilarmovewithintheregion.Ingeneral,the
correlationwithintheregionhasalsoincreasedinrecentyears,
reflectingthetighteningfinancialintegrationattheregionallevel
aswell.
Although the environment for external funding remains broadly positive, heightened financial volatility—together with elevated funding costs—are expected to narrow external funding opportunities for emerging East Asian borrowers.
Sovereigncreditspreadshavealreadywidenedinthewakeofthe
USsubprimeturmoilandhavedriftedhigherinrecentmonths.
Creditriskre-pricingtriggeredbytherecentfinancialfermentis
alsoexpectedtobroaden.
EmergingEastAsia’sdebtmarketshavebeengrowingstrongly,
attractingglobalinvestorsinsearchofyield—particularlyagainst
theclimateofgenerally lowinterestrates inmaturemarkets.
Butheightenedmarketvolatilitywill likelyslowgrowth in the
market on both the demand and supply side. On the supply
side,risingcostsoffinancingandelevateduncertaintyoverthe
economicoutlookmayleadcompaniestodelayplansforraising
newcapital.Acrosstheregion,offshore issuanceofcorporate
bondsfellsharplyinthewakeofthesubprimecrisis(Figure �6).
Simultaneously, investors’ heightened sensitivity to risk could
forcetheirretreatfromtheregion,reducingdemandforemerging
marketdebtaswell.
Ifthegrowingriskaversion—accompaniedbyare-pricingofrisk
andasuddenshiftintheglobalinvestmentclimate—leadstoa
creditcrunch,tougherfundingconditionscouldaffecttheregion’s
economicactivitiesmoreseriously.TheUSsubprimeproblemand
relatedglobal creditmarket turbulencehasalreadyadversely
affected credit conditions inmaturemarkets. Recent reports
confirmtighterlendingconditionsintheUSandtheeurozone,
whichisexpectedtoaffectbothhouseholdandcorporatefunding
decisions.13 If this global trend spreads to the region, tighter
credit conditions and increasingly uncertain economic outlook
coulddampeninvestorconfidenceandslowcorporatespending,
particularlyineconomiesthatarelessbusiness-friendly.
13SeeEuropeanCentralBank(2007),theNovemberissueofEUbankingsectorstability.TheFedquarterlyreportsalsoindicatedtighteninglendingcriteriaandrestrictions.
0
1
2
3
4
5
Singapore China, People's Rep. of
Hong Kong, China
Korea, Rep. of
JanFebMarAprMay
JunJulAugSepOct
Figure46:Foreign currency bond issuance (JantoOct2007,$billion)
Source:Bloomberg.
0
50
100
150
200
250
300
350
01-Jan-04
07-Oct-04
14-Jul-05
20-Apr-06
25-Jan-07
01-Nov-07
00.10.20.30.40.50.60.70.80.91
Emerging East Asia
US Dow Jones
Correlation for the period2004-2005 = 0.35
Correlation for the period2006-2007 = 0.93
Figure45:Correlations between US and Emerging East Asia stock markets (1Jan2004=100)
Source:OREIstaffcalculationsbasedonBlooombergdata.
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Strong trade ties to major industrialized countries suggest that the risk to the region might be greater if growth in those economies slows sharply.
The possibility of a slowdown in theUS economy is amajor
concern,withitsannualGDPgrowthprojectedtofallfurtherto
1.9%in2008—downfromthisyear’smoderationtoanestimated
2.2%.TheUSeconomyremainsthesingle largestmarketfor
emergingEastAsia’sexports(Figure �7).Shouldtheworld’s
largest economy stumble into recession, knock-on effects on
theregion’seconomiescouldbeconsiderable.Studiessuggest
thata1%reductioninUSGDPgrowthcouldshavetheregion’s
growthintherangeof0.3–0.5percentagepointthroughdirect
andindirectdemandeffects.14
Thereislittledoubtthatfavorableexternaltradeandfinancial
conditionsprovidedanimportantfoundationforrobustgrowthin
emergingEastAsiaoverthepast5years.Althoughtheregion’s
growthappearssettocontinue,asharpslowdownorrecession
intheUSeconomywouldcertainlyleaveitsmarkontheregion’s
economies(Box �).
First,accountingfornearly30%ofglobalGDP,theUSeconomy
couldtriggerasignificantreductioninworldincomeanddemand
for the region’s exports should it slow much sharper-than-
expected.Second,with theUSasglobalfinancial center,any
majordisturbanceinUSmarketscouldquicklytransmittoother
majorglobalfinancialmarkets,withrepercussionsfeltthroughout
emergingmarketsaswell.Astherecentsubprimemarketturmoil
showed, contagion through financial channels can be potent.
Heightenedfinancialvolatilitywillalsoinfluencecapitalflowsand
investorconfidence.Thereareotherchannelsof transmission
aswell—viacommoditypriceadjustmentsortermsoftrade,for
example.Changes inUSmonetarypolicyandexchangerates
mayalsohavesecond-roundpriceandwealtheffectsontrade
andglobalfinancialassetpositions.
PastepisodesofUSslowdownsandtheirimpactontheregion’s
economiescanprovidesomeroughestimatesofthepotential
effectshouldtheUSeconomyfallintorecession.Duringthefive
US recessionsbetween1974and2001, emergingEastAsia’s
growth fell by about 0.28 percentage points on average for
everypercentagepointdeclineinUSgrowth.Buttheaverage
maskssignificantvarianceintheextentofspilloversdepending
14SeeADB,2007,DevelopingAsiaandtheWorld,Asian Development Outlook.
1990
US 20.4Japan
14.6
EU16.2
ROW 19.4
Emerging East Asia 30.0
2006
Emerging East Asia 39.5
ROW 20.7
EU15.2
US 16.2
Japan8.4
Figure47:Composition ofEmerging East Asia’s Exports (%)
Note:ROW=restofworld.Source:StaffcalculationsbasedondatafromDirection of Trade Statistics,InternationalMonetaryFund.
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TheideathatemergingEastAsianeconomiesinaggregatearedecouplingfrom the US economy has becomea hot topic lately. The region’s GDPgrowth,forexample,hasnotfaltereddespiteavisibleslowinginUSgrowthinrecentquarters(Figure B�.1).Has emerging Asia becomebetterableto insulate itself fromeconomicfluctuationsinindustrialcountries—and, ifso,howandtowhatextent?
Theregion’sresilienteconomicperformance stems from bettereconomicpoliciesandstrengthenedinstitutionalframeworksasaresultof successful reforms in the 10years since the 1997/98 Asianfinancial crisis. Strong growthand economic development haveresumed in most crisis-affectedcountries. And, with increasinglyopen financial markets in theregion—andrelativelylowinterestratesinindustrialcountries—capitalinflowstoemergingEastAsiahavebeenstrongduringthepastseveralyears,boostingeconomicactivity.More efficient financial systemscoupledwithpositiveexpectationsaboutfuturegrowthprospectsandprofitabilityintheregioncontinuestoattractforeigncapital.
Improvedmacroeconomicpolicyframeworksandreformstoestablishefficientfinancialmarketswasanimportantelementofthepost-crisisrecovery. All five crisis-affectedeconomies1 have more flexibleexchangerate regimescomparedwith pre-crisis period. And fourout of the five also opted forinflationtargeting.Whileincreasedcurrency flexibility increased thedegreeofmonetarypolicyfreedom,the adoption of inflation targetinghas helped maintain macroeconomicstabilityagainstcyclicalfluctuationsandenhanced monetary policy credibility.Improved fiscal positions withmore
1 The five crisis-affected countries areIndonesia, Malaysia, Republic of Korea,Philippines,andThailand.
effectivepublicdebtmanagementalsohave allowed increased options forfiscal action when appropriate—withfurtherreformscurrentlyunderwaythatshouldcreatemoreeffectiveautomaticstabilizers.Whilereformshaveyetto
becompletedinsomeareas,significantprogresshasbeenalsomadeinbankingsupervision and regulatory reformin crisis-affected countries. Effortsare continuing to introduce greatermarketdisciplineintheoverallfinancialsystemthroughbettergovernanceandenhancedmarkettransparency.
Another l ikely reason for theregion’s continued economic strengthisthediversificationofemergingEastAsia’s export base—the geographiccompositionofitstradingpartnersalongwiththerapidgrowthin intraregional
trade. Trade is amajor channelthroughwhich economic shocksare transmitted across borders.The region’s export-to-GDPratio—nearly 32.5% of GDP in2006 compared with the worldaverageof24.9%—illustratestheregion’srelativelystrongexternaldependency. But emerging EastAsia’sincreasingtradeopennesshasbeen accompanied by significantprogress in the diversification ofits exportmarkets.Although theUS remains the region’s singlelargestmarket,itabsorbed16.7%of the region’s exports in 2006,downfrom23.2%in1985.Japanand theeurozonenowaccountsfor24.0%ofemergingEastAsia’stotal exportmarket, well abovetheUSmarketshare.Meanwhile,intraregionaltradeasaproportionof total exports also rose from26.2%in1985to42.7%in2006.This increased diversificationof the region’s export marketssuggeststhatanexternaldemandshock arising from idiosyncraticindividualmarketturbulencecouldbe mitigated to some extent bystronger growth in other exportmarkets.Indeed,therelationshipbetween US non-oil imports andemerging East Asian exportsloosened visibly in 2006-07(Figure B�.2).
However, changing demandconditions in the world’smajoreconomies—including the US—
represent still an important factorbehind emerging East Asia’s exportgrowth.Nearly41%oftheregion’stotalexportsaredestinedforG32markets.Althoughlooseningsomewhatinrecentyears, the relationship between US
2G3 includes the euro zone, Japan, andUS.
Box4: Is Emerging East Asia Decoupling from the US?
-2
0
2
4
6
8
10
12
2001 Q1
2001 Q3
2002 Q1
2002 Q3
2003 Q1
2003 Q3
2004 Q1
2004 Q3
2005 Q1
2005 Q3
2006 Q1
2006 Q3
2007 Q1
2007 Q3
-2
0
2
4
6
8
10
12
Emerging East Asia
US
FigureB4.1:GDP Growth in US and Emerging East Asia1(y-o-y,%)
1Weightedbygrossnationalincome(atlasmethod,current$).Aggregates include People’s Republic of China; Hong Kong,China; Indonesia; Republic of Korea; Malaysia; Philippines;Singapore;Taipei,China;andThailand.Source:OREIstaffcalculationsbasedonnationalsources.
0.46
0.63
0.52
-20
-10
0
10
20
30
40
Jan-91
Dec-93
Nov-96
Oct-99
Sep-02
Aug-05
%
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
US non-oil importsEmerging Asian exportsAverage 1991-97 (rs)Average 1998-02 (rs)Average 2002-07 (rs)
Apr-07
FigureB4.2:Correlation between growth rates of US non-oil imports and emerging East Asian exports
Source:OREIstaffcalculationsbasedondatafromDirection of Trade Statistics,InternationalMonetaryFund.
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non-oilimportgrowthandthatoftheregion’s exports also remains tight—theircorrelationover2002–2007was0.52 (see Figure B4.2). Despite thegrowing share of intraregional trade,evidenceindicatesthatasubstantiallylargeportion of emergingEastAsia’sintraregionaltradestillcatersexternaldemand3. Indeed, when taking intoaccount the share of intraregionaltrade ultimately destined for the G3economies, the share of G3marketsin the region’s total exports rises toover60%insteadofthe42%.Totheextentthatintraregionaltradeisdrivenbytradeofintermediategoodsamongtheregionaleconomiesforfinalgoods
3ADB. 2007. Uncoupling Asia: Myth andReality.Asian Development Outlook 2007.
destinedoutsidetheregion,emergingEastAsia’sintraregionaltradedynamicsremains sensitive to the changes inexternaldemandconditions.
Clearly, with its unparalleledpresence inworld tradeandfinancialmarketscenes,theUSeconomyexertsbyfarthemostsignificantleverageontheglobalbusinesscycle.Ofteninthepast,aUSrecessionwasaccompaniedbyslowergrowthelsewheretovaryingdegrees.4 Evidence drawn from pastrecessionsandthedirectandindirecttradelinkagesfortheregion’sexportssuggest that a US slowdown wouldhavesignificantimpactontheregion’s
4 International Monetary Fund. 2007.DecouplingtheTrain?SpilloversandCyclesintheGlobalEconomy.Chapter4inWorld Economic Outlook(April).Washington,DC.
economies.TheimpactwouldbemuchgreatershouldtheUSeconomyenterarecessionwithothermajorindustrialeconomies slowing in tandem. Thereisalsoachancethatongoingmarketcorrectionsandre-pricingofcreditriskscould becomemuchmore disruptive,leadingtoprolongedfinancialinstabilityandasevereglobaleconomicslowdown.Policies will need to remain flexibleand readily accommodating againstradical financialmarketmovements,whilecontinuingtoimproveeconomicresilience through deeper and morecomprehensivereformefforts.
onthenatureoftheUSslowdown—spilloversweregreaterwhen
therecessionwastriggeredbyashockthatwasmoreglobalin
nature.Themostrecentrecessionin2001wastriggeredbythe
burstingofthedot-combubbleandanassociateddownturninthe
globalITindustry.Theregion’smedianquarterlygrowthfellby
1.1percentagepointsinconnectionwitha2.9percentagepoint
declineinUSgrowth.Despitegenerallyrobustmacroeconomic
fundamentals and large accumulated reserves as a cushion,
theregion’seconomiesneedtoplanincaseofsharpswingsin
externaldemandandfinancialconditions.
Where Policy Can Make a Difference
Monetary policy anchored on inflation targeting, a prudent fiscal approach, and greater exchange rate flexibility could limit any spillover of continued global financial instability.
Gains achieved in fiscal consolidation and the application of
prudentialpoliciesshouldbemaintainedtoensureappropriate
insulation.Althoughpost-crisisfiscalreformsandprudentpolicies
haveconsolidatedfiscalandexternaldebtpositionsinmanyofthe
region’seconomies,publicsectordebtratiosremainsubstantial,
ranging froma high of 72.7%ofGDP in the Philippines to a
lowof33.3%inKorea,reflectingthecostoffinancialsystem
restructuring.
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Monetarypolicyshouldcontinuetoreinininflationaryexpectations.
Inflation—gatheringsteamacrosstheregion—hasalreadypushed
thelong-termbondyieldshigherdespitelowershort-termrates,
steepeningtheyieldcurves.Theriseinlong-terminterestrates
couldraisetheburdenofinterestratepaymentsongovernments,
particularlythosewithlargepublicdebtpositions.Withincreased
holdings of long-term government securities by the region’s
banks, this increase in long-termbondyieldscouldalsopose
risksofcapitallossesifbondpricesdropandassetsarevalued
mark-to-market.
As the global financialmarkets enter a period of turbulence,
heightenedvolatilitycanbuildhigherriskpremiumsintoemerging
markets,bringingwithitahighercostoffundingthroughoutthe
system.Ifemergingmarketcreditriskspreadswidenfurtherand
externalfundingconditionsdeterioratesharply—associatedwith
changes in investors’riskperception—relatedhikes infunding
costsandtheshortageofavailablefundingcouldhaveharmful
effects on the economies of emerging East Asia particularly
thosethatstillrelyonexternalfundsforinfrastructureandother
developmentrequirements.
Againstthisbackdrop,it is imperativeformonetaryandfiscal
authoritiestoensuresoundmacroeconomicpoliciesremain in
placewithsufficientflexibilitytoadapttotheevolvingexternal
environment.
Policymakers will need to concentrate on enhancing risk management systems, strengthening disclosure requirements, and upgrading supervisory frameworks to better assess potential vulnerabilities.
Creditriskmanagersinemergingmarketshaveadifficulttime,
asnecessaryinformationoncreditratingsandtradedsecurity
prices,forexample,canbehardtocomeby.Inmanyeconomies
therearevery limiteddataondefaulthistories.Even if there
weredata—variablessuchasdefaultprobabilitiesandlossgiven
defaults—mightnotprovideagoodguidetothetruesituationin
arapidlyevolvingfinancialenvironment.
Thus,enhancedsupervisoryreviewiscriticalinmaintainingsound
riskmanagementandensuringminimumcapitalrequirements
aremet.Arobustsupervisoryreviewprocess,includingefforts
bybankstoassesscapitaladequacycanalsoallowbankersand
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regulatorstoengageindiscussionstobuildariskmanagement
system that is flexible, yet reinforces their risk assessment
capacity.
Enhancedbank transparency canbolstermarket discipline. It
shouldenablemarkets to rewardbanks that take responsible
approachestoriskmanagementandpenalizethosethatdonot.
This isagain theapproach takenby theBaselCommittee—to
encouragemarketdisciplinebyrequiringdisclosuresthatwillallow
marketparticipantstoassesskeypiecesofinformationabouta
bank’srisks.Onewayistofollowa“menuofoptions”approach,
wherebybankswouldberequiredtodiscloseinformationrelevant
totheapproach(es)usedinthemeasuringofcapitalrequirements
andonthebasisofmateriality.
The region’s banking systems have gone through major structural changes since the financial crisis, but further reforms are needed to enhance their flexibility and resiliency against heightened volatility.
Althoughtheregion’sbankingsystemssofarexhibitedresilience,
somenotablechangesintheregion’sbankingbusinessessuch
as increasing household lending and securities transactions
requirespecialattention.Rapidexpansionbyfinancialinstitutions
intounfamiliarareasinevitablyentailsnewtypesofrisks.The
growing involvementofnonbankfinancial institutionsand the
plethoraofnewinstrumentsforrisktransferarechangingthe
regionalfinanciallandscape.Butthevastlydifferentdevelopment
stagesoffinancialmarketsandsystemsacrossborderssuggest
immediate policy challenges and reform needs would differ
greatly,thusrequiringcarefultailoringofthereformeffortsto
countryspecifics.
Some economies in emerging East Asia with more advanced
financialsystemsneedtobettermanagetheirbankingsystem’s
risk exposures in light of the recent turmoil and continue to
guardagainstpotentialspillovers.Theycouldacceleratereform
efforts to keep abreastwith ongoing global financialmarket
trendsanddevelopments,particularlyinbuildingtowardBaselII
compliance—severalof theNIEsareplanning tobegin this in
2008.Strengtheninginformationdisclosurepolicies,upgrading
standards in accounting and auditing, enhancing corporate
governance,andenhancing institutional capacityareareas to
address.
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Economies with less-developed financial systems may not face immediate financial transmission from the subprime turmoil, but nonetheless could focus on longer-term development issues such as institution building, financial sector reforms, and capital market development.
ForemergingEastAsianeconomiesthatareintheprocessof
buildingthebasicsoftheirfinancialsystems,itisusefultopursue
abroadpolicyframeworkthatestablisheslegalandinstitutional
infrastructureforfinance.Thesecanincludeinsolvencyregimes,
creditorrights,andprudentialregulations.Earlyeffortstobuild
information and governance infrastructure—such as credit
information systems, accounting and disclosure rules, and
internalandexternalauditingsystems—arealsoprerequisites.
Strengthening systemic liquidity support through effective
monetaryoperations,efficientpaymentsandsettlementsystems,
andliquidmoneyandcreditmarketswillfollowsuit.Thistype
ofinstitutionalbuildingisanimportantpreconditionforfinancial
liberalizationwithoutunderminingfinancialstability,particularlyas
theseeconomiesmovetowardstructuresthatcantakeadvantage
ofthebenefitsofeconomicandfinancialglobalization.
Conclusion
Despite strong resilience to the weakening external environment, vulnerabilities in the region’s financial systems should not be underestimated, as resurgent capital inflows and excess liquidity may complicate a true assessment of risk.
Against a backdrop of continued uncertainty over the future
growthoutlookandglobalfinancialstability,deeperandmore
comprehensivefinancialsectorandmarketreformsarerequired
toenhanceflexibilityandresiliencyoftheregion’sbankingand
financial systems—whilemaintaining strongmacroeconomic
prudencetounderpineconomicandfinancialsoundness.
Therecentfinancialmarketturmoilhighlightstheimportanceof
transparencyandgovernanceinthefinancialsystems.Globalized
finance alongwith rapid innovation has complicated the task
of effectively regulating and supervising financial institutions.
Strengthening regulatory and supervisory frameworks is
particularly important for emerging East Asianmarkets that
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have relativelyweakfinancialmarket infrastructure for credit
riskassessmentandeffectiveriskmanagement.
Alackofinstitutionalcapacityamongbothfinancialinstitutions
andregulatorsisanotherfactorthatcanhampereffectiverisk
monitoring and control, let alone the onslaught of evolving
financial technology. Although country-specific requirements
varygreatlydependingonareasofimmediatedomesticpolicy
concern,formulatinganappropriatepolicyframeworktoprepare
forpossiblerisksfromcontinuedglobalfinancialinstabilitycan
help insulate emerging East Asia from anymajor deleterious
effects.