Asian Development Outlook 2007: Growth Amid Change

8/7/2019 Asian Development Outlook 2007: Growth Amid Change

1/387


2/387

Asian Development Bank

All rights reserved. Published .

Printed in Hong Kong, China.

Cataloging-in-Publication Data

ISBN: ----

ISSN: -Publication Stock No.

Asian Development Bank.

Te annual Asian Development Outlook provides a comprehensive economic analysis o economies in

developing Asia and the Pacic.

ISBN ----. Asian Development Bank. . Economics, Finance.

Te views expressed in this book are those o the authors and do not necessarily reect the views and policies o

the Asian Development Bank or its Board o Governors or the governments they represent.

Te Asian Development Bank does not guarantee the accuracy o the data included in this publication and

accepts no responsibility or any consequence o their use.

Use o the term country does not imply any judgment by the authors or the Asian Development Bank as to the

legal or other status o any territorial entity.


3/387

Foreword

Te Asian Development Outlook 2007(ADO 2007) is the 9th edition othe annual comprehensive economic report on the developing membercountries o the Asian Development Bank.

ADO 2007provides an assessment o recent economic perormanceor developing member countries, and projections or majormacroeconomic indicators or 007 and 008. It also provides adiagnosis o macroeconomic challenges and uture growth prospects orthe regions economies.

Te perormance o developing Asia in 00 was exceptional.Aggregate gross domestic product or the region grew at 8.%, theastest since 99. Growth was aided by a highly avorable external

environment, benign domestic circumstances, good economicmanagement, and the ruits o reorm eorts. Remarkable growth inthe Peoples Republic o China and India underpinned this regionalexpansion, with a large number o other countries enjoying vigorousgrowth.

Even with exceptionally ast growth and rising oil prices, consumerprice ination did not, in general, accelerate in 00. But this aggregatepattern disguises wide variation at the country and regional level. Insome countries, evidence o overheating gathered as the year progressed.Authorities answered by raising interest rates, mopping up excessliquidity, and restraining credit growth and public spending.

Te outlook or the international economy remains broadly avorable,

although growth will slow in 007. Despite production cuts by theOrganization o the Petroleum Exporting Countries, crude oil pricesare well o their highs o 00 and are expected to continue stabilizingaround $7 a barrel in 007. Some metals prices, such as copper,have also come down. Lower commodity prices will generally easeinationary pressures and bring terms-o-trade gains, as developing Asiais a net importer.

Against this backdrop, still-robust growth o 7.% and 7.7% ordeveloping Asia is expected in 007 and 008. Tese projectionsimply that growth will move to a more sustainable ooting and thatoverheating pressures that suraced in 00 will gradually ease. Growthin all subregions, except the Pacic, is seen soening in 007. In thePeoples Republic o China in 007 and 008, soer external demand andpolicy curbs are expected to pull growth down gradually. In the shortrun, the Government is likely to restrict investment growth and coolthe economy. In India, steps taken by the central bank to cool inationare expected to slow the pace o investment and consumption spending.In other countries, such as Indonesia, growth is seen picking up in007 as lower interest rates and lower ination give a boost to domesticspending. Falling prices o commodities in international markets, as wellas vigilance rom monetary authorities across the region, will help easeination in 007. Developing Asias current account is expected to be insurplus or 007 and 008.


4/387

iv Asian Development Outlook 2007

As always, events could evolve in surprising and unexpected ways,and derail projections. Risks remain tilted down. Markets have movedto reprice risks, but calm could yet give way to less settled conditions.I asset prices get badly punctured and reversals occur, the chill would

be widely elt. Although average oil prices are expected to be lowerthis year than last and to come down some more in 008, they remainsensitive to supply conditions, surges in demand, and geopolitical events.In trade negotiations, time is running out or an agreement in the DohaRound, and in the developing vacuum, preerential trade agreementsare gathering momentum, and calls or protection are becoming moreaudible. A human u pandemic remains a threat. In many countries,elections are scheduled in the next year. Teir conduct and outcomeswill be important or condence.

Over the next ew decades, developing Asias prospects will dependcritically on its ability to adapt to a constantly changing environment.Te theme or ADO 2007, growth amid change, looks at the evolutions

that have been associated with successul growth experiences. Increasingtechnological sophistication and structura l complexity are importantdimensions o change. Industry and manuacturing have played a pivotalrole, and in most countries, services have been an important providero jobs. A key message is that walking on two legsostering bothindustry and servicesis the only viable development model or manyeconomies.

While prescriptions and priorities need to be country specic, theollowing elements are crucial: high investment rates that over timebuild, expand, and upgrade the range o economic activities; unds orinrastructure services that are vital or economies o scale and otherbenets; relevant and purposeul education; markets that support

labor mobility and exibility, alongside aordable social protection;arrangements that lower risks and uncertainty or businesses, and thatallow new rms to enter and old rms to exit; and removal o at- andbehind-the-border impediments to integration.

HARUHIKO KURODAPresident


5/387

Acknowledgments

Te Asian Development Outlook 2007(ADO 2007) was prepared by thesta o the Asian Development Bank (ADB) rom the Central and WestAsia Department, East Asia Department, Pacic Department, SouthAsia Department, Southeast Asia Department, Economics and ResearchDepartment (ERD), as well as the resident missions o ADB.

Te economists who contributed the country chapters are: LuxmonAttapich (Tailand); Sharad Bhandari and Joven Balbosa (Philippines);Johanna Boestel (Sri Lanka); Philip Chang and Raael Abbasov(Azerbaijan and Kazakhstan); Emma Ferguson (Small Pacic countries);David Green and Hiroki Kasahara (Malaysia); adateru Hayashi (Bhutanand Maldives); Christopher Hnanguie and Rattanatay Luanglatbandith

(Lao Peoples Democratic Republic); Anqian Huang (Fiji Islands);Neeraj Jain and Zaardjon Khotamov (ajikistan); Mandar Jayawantand Luvsanchultem Vanjildorj (Mongolia); Shikha Jha (Armenia);Rezaul Khan and Mohammad Zahid Hossain (Bangladesh); XuelinLiu (urkmenistan); Aashish Mehta (Hong Kong, China); HiranyaMukhopadhyay and Aashish Mehta (India); Cyn-Young Park (Republico Korea); Sadar Parvez and Ghulam Qadir (Pakistan); Michaela Prokop(Islamic Republic o Aghanistan); Purnima Rajapakse and Vanndy Hem(Cambodia); Lyaziza Sabyrova and Gulkayr antieva (Kyrgyz Republic);Omkar Shrestha and Dao Viet Dung (Viet Nam); Paolo Spantigati andShyamal Shrestha (Nepal); Pradeep Srivastava (Myanmar); RameshSubramanian and Hari Purnomo (Indonesia); Kiyoshi aniguchi (Papua

New Guinea, Democratic Republic o imor-Leste, and Small Paciccountries); Hong Wei and Norio Usui (Uzbekistan); Fan Zhai (Singaporeand aipei,China); and Jian Zhuang and Jesus Felipe (Peoples Republic oChina). Bruce Knapman also contributed material on the Pacic.

Te subregional coordinators were Padmini Desikachar and BahodirGaniev or Central and West Asia; Klaus Gerhaeusser and V.B. ulasidharor East Asia; adateru Hayashi or South Asia; Sharad Bhandari orSoutheast Asia; and Kiyoshi aniguchi and Emma Ferguson or thePacic. A team o economists rom ERD, led by Frank Harrigan,Assistant Chie Economist, Macroeconomics and Finance ResearchDivision (ERMF), assisted by Aashish Mehta and Editha Lavia,coordinated the overall production o the publication. Part , DevelopingAsia and the worldwas prepared by Frank Harrigan and Cyn-Young Park.Te chapter en years aer the crisis was prepared by Frank Harrigan.Uncoupling Asia: Myth and reality was written by Cyn-Young Park.William James o Nathan Associates, Inc. prepared the section radeand structural change in East and Southeast Asia. In Part , Jesus Felipeand Frank Harrigan wrote the chapter entitled Growth amid change;and Aashish Mehta and Jesus Felipe prepared the chapter Educationand structural change in our Asian countries. Juthathip Jongwanich alsocontributed to Part .

echnical and research support was provided by Shiela Camingue,Gemma Esther Estrada, Pilipinas Quising, Nedelyn Magtibay-


6/387

vi Asian Development Outlook 2007

Ramos, Lea Sumulong, and Rashiel Velarde. Richard Niebuhr andAnthony Patrick as the economic editors made substantive contributionsto the country chapters, subregional summaries, and other partso the book. Jonathan Aspin did the style and copy editing, and

Elizabeth E. Leuterio was responsible or typesetting and data linking,as well as graphics generation in which she was assisted by Maria Susanorres. Artwork and cover design were rendered by Mike Cortes o/Doubleslash/ Media Inc. Maria Susan orres, assisted by Zenaida Acacio,provided administrative and secretarial support, and Lily Bernal-Sadiadid the prooreading. Te publication would not have been possiblewithout the cooperation o the Printing Unit under the supervision oRaveendranath Rajan.

Ann Quon and Saby Mitra o the Department o External Relationsplanned and coordinated the dissemination oADO 2007.

IFZAL ALIChie EconomistEconomics and Research Department


7/387

Contents

HighlightsADO

Part Developing Asia and the world

Developing Asia and the Pacic: Perormance and prospects Prospects or the world economy in and Subregional summaries en years aer the crisis: Te acts about investment and growth Uncoupling Asia: Myth and reality rade and structural change in East and Southeast Asia: Implications or growth and industrialization

Part Economic trends and prospects in developing Asia

Central Asia

Armenia Azerbaijan Kazakhstan Kyrgyz Republic ajikistan urkmenistan Uzbekistan East Asia Peoples Republic o China Hong Kong, China Republic o Korea Mongolia

aipei,China South Asia Islamic Republic o Aghanistan Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka Southeast Asia Cambodia Indonesia Lao Peoples Democratic Republic Malaysia Myanmar Philippines Singapore Tailand Viet Nam


8/387

Te Pacic Fiji Islands Papua New Guinea Democratic Republic o imor-Leste

Small Pacic countries

Part Growth amid change

Growth amid change Education and structural change in our Asian countries

Statistical notes and tables

Denitions

Te economies discussed in Asian Development Outlook 2007(ADO 2007) are classied by major analytic or

geographic groupings. For purposes oADO 2007, the ollowing apply: Association o Southeast Asian Nations (ASEAN) comprises Brunei Darussalam, Cambodia, Indonesia,

Lao Peoples Democratic Republic, Malaysia, Myanmar, Philippines, Singapore, Tailand, and Viet Nam. Developing Asia reers to developing member countries o the Asian Development Bank discussed in

ADO 2007. Central Asia comprises Armenia, Azerbaijan, Kazakhstan, Kyrgyz Republic, ajikistan, urkmenistan,

and Uzbekistan. East Asia comprises Peoples Republic o China; Hong Kong, China; Republic o Korea; Mongolia; and

aipei,China. South Asia comprises Islamic Republic o Aghanistan, Bangladesh, Bhutan, India, Maldives, Nepal,

Pakistan, and Sri Lanka. Southeast Asia comprises Cambodia, Indonesia, Lao Peoples Democratic Republic, Malaysia, Myanmar,

Philippines, Singapore, Tailand, and Viet Nam. Te Pacifc comprises Cook Islands, Fiji Islands, Kiribati, Republic o the Marshall Islands, Federated

States o Micronesia, Nauru, Papua New Guinea, Republic o Palau, Samoa, Solomon Islands, DemocraticRepublic o imor-Leste, onga, uvalu, and Vanuatu.

Unless otherwise specied, the symbol $ and the word dollar reer to US dollars.Te Statistical Notes give a detailed explanation o how data are derived.ADO 2007is based on data available up to 15 March 2007.

Acronyms and abbreviations

ASEAN Association o Southeast Asian NationsCPI consumer price indexEU European UnionFDI oreign direct investmentFY scal yearGDP gross domestic productIMF International Monetary FundOECD Organisation or Economic Co-operation and DevelopmentPRC Peoples Republic o ChinaUS United StatesVA value-added taxWO World rade Organization


9/387

SynopsisDeveloping Asias expansion gathered speed in 2006. Regional GDP grewat 8.3%, aster than any year since 1995. Growth was aided by a highlyavorable external environment, benign domestic circumstances, goodeconomic management, and the ruits o reorm eorts.

But evidence o imbalances and overheating continued to gather: surging

property and equity markets, ast credit expansion, and rising goods prices,particularly o oodstus. Authorities answered by raising interest rates,mopping up excess liquidity, and restraining credit growth and publicspending. But structural responses have been slower. Widening currentaccount surpluses as well as capital inows contributed to a urther buildupo international reserves. In trade-weighted terms, and adjusted orination, many regional currencies appreciated in 2006, though someremained broadly unchanged. Inequality, job creation, and environmentalpressures are growing concerns.

Although the pace o expansion is expected to ease in 2007 and 2008,growth is still set to remain brisk. Net exports contribution to growth willsoten, but strengthening domestic demand will ll part o the gap.

Another year o strong perormance should see GDP growth o 7.6% in2007, with little change in tempo in 2008. In response to tighteningmeasures and lower oil prices, inationary pressures should start to recede.Current account surpluses will begin to narrow as a share o GDP, butslowly.

Growth in 2006 is the

astest since 1995

Growth in 2006 is the

astest since 1995

Stresses and imbalances

become more visible

Stresses and imbalances

become more visible

Brisk expansion is

expected in 2007 and

2008

Brisk expansion is

expected in 2007 and

2008

HighlightsADO Developing Asias perormance in was exceptional. Strong growth o . looks set or ,and inationary pressures should ebb. Managing macroeconomic stresses, moving ahead with microreorms, and rebalancing economic growth are important challenges. Asia also needs to do betterat creating jobs.


10/387

Asian Development Outlook 2007

Perormance in Prodigious growth in the Peoples Republic o China (PRC) and Indiaunderpinned aggregate regional expansion in 2006. The share o both inregional output continued to increase.

In the PRC, rapid expansion o exports and strong xed asset investmentspurred growth to 10.7% in 2006. To cool the economy, the authoritiesraised interest rates, increased bank reserve requirements, mopped upexcess liquidity in the nancial sector, and applied a rat o administrativecontrols intended to curtail or delay new projects. Fixed asset investmentslowed in the second hal, but export growth continued unabated, andthe current account surplus swelled to 8.6% o GDP. Reserves in the PRCbroke through the $1 trillion mark. Ination rose toward the end o theyear, largely as a result o rising grains prices. Elsewhere, avorablecommodity prices helped lit growth in Mongolia. Korea expanded by arobust 5%. East Asias growth accelerated to 8.7% in 2006.

In India, vibrant industrial growth as well as buoyant services helpedgrowth accelerate to an estimated 9.2%. Manuacturing exports expandedat a ast clip. Employment in manuacturing also picked up. But steadilyrising wholesale price ination, booming property prices, and ballooningcredit growth has prompted the Reserve Bank o India to crank up policyrates and to impose restraints on lending to the property sector. Sluggishagricultural productivity growth remains a concern as the majority oIndias population still depends on agriculture or their livelihoods. Sharprises in ood prices have underlined the need or structural reorms.

Trend growth in Bangladesh and Pakistan again accelerated in 2006, butthe countries perormance on ination was less impressive. In Bangladesh,annual ination picked up in response to ast credit growth, pass-through

to consumers and producers o oil-price rises, and higher commodityprices. In Pakistan, ination came down rom its earlier peak in 2005, butremained well above target. In the Maldives, growth in 2006 bouncedback as it recovered rom the devastation o the tragic tsunami. Despitehostilities, ueled by expansionary spending policies, growth acceleratedin Sri Lanka. Political developments continued to dominate in Nepal, andgrowth remained anemic. A drought dragged down growth in Aghanistan,while Bhutan beneted rom increased hydropower exports to India. ForSouth Asia as a whole, growth o 8.7% was the astest since 1988.

Azerbaijan and Kazakhstans perormance beneted rom high oil prices.Although oil prices drited down in the ourth quarter, average prices in

2006 were still 20% higher than in 2005. A housing boom and heavyinvestments in mineral development sustained Armenias rapid growth.In the Kyrgyz Republic, growth was slow, due to weak gold productionand lingering political difculties. Strong remittances, as well as healthyaluminum output and exports, sustained growth in Tajikistan. Uzbekistankept up its solid growth record, helped by continued arm privatization.Central Asias GDP grew at 12.4%.

Southeast Asias perormance was patchy. Growth in Indonesia was lamedue to weak consumption and xed investment spending. But as monthlyination rates eased, Bank Indonesia lowered policy rates. In the Philippines,growth edged up on a strong recovery in agriculture, but investment

The PRC and Indias

weight in regional

output is getting larger

The PRC and Indias

weight in regional

output is getting larger

The PRC grows at a

blistering 10.7%

The PRC grows at a

blistering 10.7%

India consolidates ast

growth

India consolidates ast

growth

Central Asia booms on

oil price gains

Central Asia booms on

oil price gains

Southeast Asia shows

checkered growth

Southeast Asia shows

checkered growth

Trend growth in

Bangladesh and Pakistan

accelerates


11/387

Highlights

stayed weak. Net exports lited Thailands growth, but domestic demandwas crimped by earlier increases in interest rates and by gathering politicaluncertainty. In Malaysia, strong growth o domestic consumption helpedlit growth; public investment spending accelerated. Viet Nams impressiverun o rapid growth continued: strong domestic demand growth was

supported by gains in oil prices and by vibrant exports. Cambodia and theLao Peoples Democratic Republic both showed healthy expansion.Aggregate growth in Southeast Asia was 6.0% in 2006.

The Pacic islands grew at 3.1%. The two largest economies, Papua NewGuinea and Fiji Islands, both enjoyed aster expansion, liting the average.In Timor-Leste, civil disorder and security problems stymied growth o thenon-oil economy. Elsewhere, perormance was uneven. Overall in thePacic, outcomes remain largely unimpressive and are constrained as muchby economic mismanagement and ineective institutions as by thedisadvantages o small size and remoteness.

International outlookProspects or the international economy remain broadly avorable. Despiteproduction cuts by the Organization o the Petroleum Exporting Countries,crude oil prices are well o their highs o August 2006. Some metalsprices, such as copper, have also come down. Lower commodity priceswill generally ease inationary pressures and bring terms-o-trade gains,as developing Asia is a net importer.

Growth in the major industrial economies is set to slow, but growth in theeuro zone and Japan is close to potential. Inationary pressures seem tobe slowly dissipating in the United States (US). Corrections in the housingmarket there have been sharp, but not disorderly. There is now lessdissonance about the outlook, and the chances o a recession are receding(though not completely), and so ar markets have absorbed risks. Asinvestment spending pulls back, US growth is expected to slow in 2007.In Europe, the outcome in 2006 was the best in 6 years and momentumhas picked up. Germany leads the way, but business and consumercondence is more broadly strong. Growth may moderate a little in 2007.In Japan, domestic demand has come back to lie ater temporarily saggingin the middle o 2006. Employment growth and positive business sentimentshould help support demand, and growth should nearly match 2006sperormance. Although the Bank o Japan raised interest rates in February,tightening is expected to be gradual.

With easing o industrial output growth, global trade volumes will expandless quickly than last year, but at a still-robust pace. However, there areindications that the global electronics cycle could slip a gear, and i capitalspending slows more quickly than anticipated in the US, the downdratwould be elt by Asian producers.

Growth lags in Pacic

islands

Growth lags in Pacic

islands

Commodity prices are

set to soten

Commodity prices are

set to soten

Growth is seen

moderating in G3

Growth is seen

moderating in G3

Growth o trade

volumes will stay robust

Growth o trade

volumes will stay robust


12/387


Prospects or developing AsiaAs output growth gently slows in industrial countries, there will be modestknock-on eects in developing Asia. Lower oil prices should help sootheinationary pressures, as might any appreciation o regional currencies.Domestic tightening measures already taken in 2006 and ollowed up in2007 will help guide down both output growth and ination. For developingAsia, robust growth o 7.6% is projected in 2007 with ination easing to3.0%. With expenditure switching to domestic demand, the regions currentaccount surplus is seen narrowing. Growth is expected to nudge up to7.7% in 2008.

In the PRC, eorts to restrain galloping xed asset demands are expectedto gain more traction in 2007. Recent monthly data are yet to show cleartrends or industrial production and xed asset investment. It may provedifcult or the central Government to make lasting inroads into investmentspending, as this will depend on it changing the strong incentives orexpansion at provincial and local levels. Concerns linger about excess

liquidity in nancial markets; reserve-ratio requirements or commercialbanks, as well as interest rates, were raised early in 2007. Further reservesaccumulation in 2007 is expected, and this will continue to exert pressureson domestic liquidity. Aggregate growth o 10.0% is orecast or 2007.Pressures or spending will ease, allowing growth to moderate to 9.8% in2008.

In India, the key wholesale price index o ination hovered just below 6.5%in early 2007, well above the central banks comort level. The Reserve Banko India has, in act, lited policy rates on our occasions since April 2006,has increased reserve-ratio requirements on commercial banks, and hasimposed limits on bank lending to the property sector. Growth is expectedto trim to about 8% (and inationary pressures abate) in 2007, but accelerate

a little in 2008, provided that restraints do not inadvertently choke oindustrial expansion. The pace o reorm momentum in India is weakeningas elections approach.

Although growth in most other countries will come o the pace set in2006, the regions economic pulse remains strong. In some countriesthough, growth should accelerate. With inationary pressures receding,and with the prospect o urther interest rate reductions, growth in 2007is expected to pick up in Indonesia, which is also showing hopeul signso a recovery in consumption and investment spending. In the KyrgyzRepublic, growth should accelerate as the political situation settles andgold-mining operations expand. There is also some upside potential in

other countries, such as Papua New Guinea, which is expected to benetrom avorable export prices and a recovery in mining.

In a ew countries, prospects are now much more uncertain. Even beorethe coup o December 2006, Fiji Islands aced many challenges and2007 looked as i it would be a difcult year. But now the attrition ocondence and loss o new aid ows triggered by the coup may push thecountry into recession. In Thailand, consumer and business condenceis slipping and growth is expected to slow in 2007. The introduction ocapital controls in December 2006 unsettled markets and ne-tuning isstill going on. Clarity about uture direction is yet to emerge. Bangladeshscaretaker Government will remain in power until elections are held. Early

Developing Asia is

picked to grow at 7.6%in 2007

Developing Asia is

picked to grow at 7.6%in 2007

Gentle deceleration

seen in the PRC

Gentle deceleration

seen in the PRC

Indias growth, too, will

ease in 2007

Indias growth, too, will

ease in 2007

Some countries, like

Indonesia, are expected

to accelerate

Some countries, like

Indonesia, are expected

to accelerate

Some countries ace

downside political

risksothers upside

risks


13/387

Highlights

indications there suggest that conditions or business could improve asreorm momentum is maintained and the anticorruption drive intensies.Nepal is looking orward to elections, which, i they go well, could yielda peace dividend.

ChallengesMacroeconomic stabilization, structural rebalancing, and building marketsand institutions to support uture growth are the biggest challenges acingdeveloping Asia. In some ways they are linked, but stabilization has tomove astest.

Rising ination (or pressures or credit expansion) and rapidly accumulatingoreign exchange reserves suggest that adjustments would be helped bothby an increase in interest rates and by an appreciation o domestic currencies.Smaller exchange rate adjustments would require larger interest rate rises

to douse inationary threats. But any capital inows attracted by higherinterest rates would add to orces or the expansion o domestic liquidity.

In part, macro pressures relect underlying structural impediments.Retarded agricultural development in India has contributed to rapidlyrising ood prices and distributional tensions over land use. Constraints onconsumption spending in the PRC an the investment boom and theballooning external surplus.

Closer regional integration and tighter links to the G3 are connected acetso globalization. They stress the need or strong macroeconomic policycoherence and sound prudential management, as well as or initiatives

that support these aims at a global, regional, and domestic level. Evidenceabout the evolving nature o macroeconomic and trade relationships isexamined in Part 1 (Uncoupling Asia: Myth and realityand Trade and structuralchange in East and Southeast Asia: Implications for growth andindustrialization).

Developing Asia can make better use o its huge international reserves,exceeding $2 trillion at end-2006. By most measures, countries are holdingreserves ar in excess o those they need to cover short-term maturingoreign exchange liabilities, plus any demands that may come rom internalsources. Even on conservative assumptions, redeployment o reservescould yield a substantial scal dividend. For example, i only 50% odeveloping Asias reserves were invested in a globally diversied portolio,

attracting a yield o 500 basis points above the current return, this wouldgenerate a $60 billion scal dividend, equivalent to about 0.9% o regionalGDP. These additional resources could plug inrastructure gaps and increasethe supply o essential public goods. Or they could be used to retire publicdebt, creating larger scal space in the years ahead.

Some countries are already taking a more active posture. The KoreanInvestment Corporation (ormed in 2005) has a mandate to achievesustainable returns on oreign currency assets. In March 2007, the PRCauthorities announced their intention to more actively manage theiroreign exchange reserves. But while the potential rewards are certainly

Stabilization is a key

challenge

Stabilization is a key

challenge

Exchange and interest

rates need to adjust

Exchange and interest

rates need to adjust

Structural imbalances

aggravate macro

stabilization problems

Structural imbalances

aggravate macro

stabilization problems

Asia is integrating more

deeply with itsel and

the world

Asia is integrating more

deeply with itsel and

the world

Countries are looking or

better ways to use their

reserves

Countries are looking or

better ways to use their

reserves

Korea is already moving

in this direction

Korea is already moving

in this direction


14/387


tempting, central banks and governments are rightully wary o risks. Iinvestments go bad, it could undermine condence in government or thecentral bank (or both). Having an appropriately regulated und, actingat arms length, to manage some portion o reserves may have advantages.But setting up such structures and attracting people with the right

expertise to run them will take time.

A more direct approach, recently proposed in Indias budget, is to usereserves to pay or oreign-currency costs o projects or to guaranteeborrowing by special-purpose investment vehicles. The latter approachcould exert pressure toward currency appreciation. Interest rates couldalso rise, as a consequence o sterilization operations. With no sterilization,investment guarantees that attract oreign debt inows would implydomestic credit expansion.

Exchange rate management issues remain to the ore. Although the yuanappreciated against the US dollar by 3.3% in 2006, its trade-weighted valuebarely budged. But other regional currencies, such as the baht and thepeso, moved up in trade-weighted terms.

Thailands controls on capital inows introduced in December triggered amarket rout. The initial rules were widely regarded as too stringent. Inresponse, exemptions have been widened. As oshore investors do notbear the costs o any destabilizing eects o their behavior, a tax on inowscould be benecial.

But theory and practice can be dierent. First, identiying conditions thatwarrant a tax on capital inows is not straightorward. Even i the Thaibaht appreciated sharply in 2006 against the US dollar and reservesaccumulated, it is uncertain that this threatened the economy or export

businesses. In trade-weighted terms, the appreciation was unexceptional.Also, the appreciation did not deter healthy export perormance, and thetrade balance moved rom decit to surplus in 2006.

Even i there is compelling evidence that the pressures directed towardspeculative capital inows need easing, there are questions o how to dothis. Precisely because capital is ungible, designing regulations that arenot porous is extremely difcult. I short-term capital ows threatendestabilization or longer-term structural damage, simpler approaches,perhaps based on at withholding taxes on inows with rebates orapproved transactions, may have attractions.

Fast economic growth can both breed complacency and slow reorm

eorts. But as the Asian crisis painully illustrated, the ailure o institutionsand structural policies to keep pace can derail growth. It is much easier toadjust and make difcult changes in good weather.

The challenge in the PRC is to diversiy growth and spread its benetsmore widely. But there are constraints. In some sense, the availability oresources has run ahead o the capacity to administer and deliver high-quality services. A crucial blockage is the banking and nancial system,which is geared to lending or enterprise investment but not yet or

Some approaches may

put upward pressure on

exchange rates

Some approaches may

put upward pressure on

exchange rates

Exchange rates are

appreciating at dierent

speeds

Exchange rates are

appreciating at dierent

speeds

Taxing capital infows

can make sense

Taxing capital infows

can make sense

The devil is in the detailThe devil is in the detail

Simple taxes are bestSimple taxes are best

Fast growth can breedcomplacencyFast growth can breedcomplacency

In the PRC, bank-

dominated nance is a

bottleneck

In the PRC, bank-

dominated nance is a

bottleneck


15/387

Highlights

household needs, including spending on durables, education, and healthcare. Easing constraints will require a variety o institutional and policyadjustments in the nancial and scal arenas.

Industrialization in India is gathering pace, having had several alse starts

in earlier decades. The country needs a vibrant industry sector to sustaingrowth and create jobs. Maintaining momentum will require attention toglaring inrastructure inadequacies, as well as to labor and other regulationsthat can deter investors.

Investment appears to be struggling in some countries. The ixedinvestment ratio is alling in the Philippines and industrys share in outputis declining. In Pakistan, xed investment is a constraint in pushing growthto the next level and modernizing the economy. In Indonesia, the Asiancrisis and a comparatively slow recovery appear to have badly dentedinvestor condence. In Malaysia and Thailand too, postcrisis investmentrates have remained in the doldrums. Investment rates may have been toohigh beore the crisis, but they are now too low (see Part 1, Ten years afterthe crisis: The facts about investment and growth).

Investment shortalls mask deeper challenges. Business investment climatesurveys point to a wide array o problems that vary in nature and degreeacross countries. Some countries in developing Asia, such as Korea andMalaysia, do well by international standards, but many do not. Heavy andsometimes predatory regulation, corruption, onerous administrativerequirements, and difculties with contract enorcement can quickly turnprots to losses, and assets into liabilities. Central to all this is improvingthe policy, regulatory, and institutional environment in which businessesoperate.

Across developing Asia, complaints about poor inrastructure are heardtime and again. Good inrastructure is needed to connect villages andtowns to each other and to the global economy. In India, poor ruralinrastructure is taking its toll on agricultural productivity growth. In thePhilippines, stark inrastructure gaps have played a role in retardingindustrialization and job creation. High levels o congestion, squalor, andgrime in Asias megacities are a result o years o sorely neglectedinrastructure investment (and maintenance). By adding to costs, poorinrastructure services deter private investment.

Asian Development Outlook 2007 throws the spotlight on a variety ostructural issues. Developing Asias prospects over the next ew decadeswill depend critically on its ability to adapt in a constantly changing

environment.

In Growth amid change, it is shown that those countries that have sustainedast growth have both successully industrialized andexpanded services.Successul industrialization is intimately linked to the kinds o products madeand how they are made. Korea, Malaysia, and Singapore, or example, haveall been successul at moving up the technological ladder. For somecountries, market size and location restrict opportunities or industrialization.These countries will have to incubate approaches tailored to their owncircumstances and potential. For some, outmigration and inward remittancesmay oer opportunities that would otherwise not be available.

India needs to sustainindustrializationIndia needs to sustainindustrialization

Investment is struggling

in some countries

Investment is struggling

in some countries

Policy, regulatory, and

institutional ailures

hinder investment

Policy, regulatory, and

institutional ailures

hinder investment

Inrastructure gapshobble private

investment

Inrastructure gapshobble private

investment

Prospects ultimately

depend on capacity to

change

Prospects ultimately

depend on capacity to

change

What you make, and

how you make it,

matters

What you make, and

how you make it,

matters


16/387


Walking on two legsostering both industry and servicesis the onlyviable development model or most countries. Services, as well as industry,oer signicant potential or productivity gains. And a vibrant industrysector needs efcient services inrastructure. High-productivity tradableservices can make an important contribution, but on their own they are

unlikely to create sufcient jobs. Education constraints may also limit rapidexpansion o high-productivity services.

Approaches need to be country specic, but some orthodox elements arecrucial: high investment rates that over time build, expand, and upgradethe range o economic activities; unds or inrastructure services vital oreconomies o scale and other benets; relevant and purposeul education(discussed in Education and structural change in four Asian countries); marketsthat support labor mobility and exibility, alongside aordable socialprotection; arrangements that lower risks and uncertainty or businesses,allowing them to create wealth; and integration that exposes countries todiversity as well as to new technological and institutional designs.

Yet markets cannot accomplish everything on their own. New economicactivities and the diversity that appears vital or growth may need ahelping hand. But good design principles are key. Winners need to selectthemselves through perormance, not be picked by governments.

RisksAs always, events could evolve in surprising and unexpected ways, andderail projections. Given underlying economic momentum, risks remaintilted down.

Markets have moved to reprice risks in a calm manner so ar this year. Yetthis could still give way to less settled conditionsa turn o eventstriggered by policy mistakes, or geopolitical or other shocks. I asset pricesare badly punctured, and markets decisively reverse, the chill will soonbe elt.

While any slowdown in global growth would adversely aect the volumeo world trade, the ailure o the Doha Round would make things worse.In this growing vacuum, preerential trade agreements would thrive urtherand already-audible protectionist calls would be amplied.

The overall geopolitical and security situation remains a source o

uncertainty. The price o strategic commodities, such as oil, could be hitby negative developments. In the event o a human lu pandemic,developing Asia would bear a disproportionately high cost.

Recent developments have brought country risks to the ore. Securityissues across Asia are unresolved. In some countries, important electionsare scheduled, and their outcomes will be crucial or condence.

Services alone cannot

sustain growth

Services alone cannot

sustain growth

How to shit gear

smoothly

How to shit gear

smoothly

Risks remain tilted downRisks remain tilted down

Asset market reversals

are a threat

Asset market reversals

are a threat

Protectionist calls are

growing

Protectionist calls are

growing

Geopolitical andsecurity risks could harm

prospects

Geopolitical andsecurity risks could harm

prospects

Country risks need to be

watched

Country risks need to be

watched

Design principles are

key


17/387

Part 1Developing Asia and the world


18/387


19/387

Developing Asia and the world

Developing Asia and the Pacic:

Perormance and prospects

Perormance in Developing Asia grew at its astest pace in years in 00 (Figure ..).Steady global expansion o output and trade, moderate ination with lowreal interest rates, as well as the impact o earlier reorms on productivity,were all conducive to growth. In many countries, circumstances provedunusually benign, and risks ailed to materialize.

Asias giantsthe Peoples Republic o China (PRC) and Indiaaloneaccounted or just under 70% o the regions expansion. In 00, thePRC accounted or % o regional output compared to just % in 000.Indias share in regional output increased by hal a percentage point(Figure ..).

In both countries, ast growth coexists with stresses and imbalances.

In the PRC, booming exports and xed asset investment again propelledgrowth. Te authoritiesconcerned about the pace and quality o xedasset investment, ast credit growth in the banking sector, and rising assetpricesraised interest rates, increased reserve requirements or banks,and introduced a ra o administrative controls intended to discourageor deer new capital projects. As a consequence, the growth o xed assetinvestment slowed in 00, though it still advanced at double digits.Export growth showed no letup, and the current account surplus widenedagain. By December 00, the PRC had amassed international reserveso close to $. trillion. o stem the leeching o reserves into domesticliquidity, the Peoples Bank o China sold additional sterilization bonds.

In India, agricultural productivity continued to languish, largelyreecting neglected inrastructure and poor rural extension services.Rising ood prices contributed signicantly to ination. ensionsalso suraced as rapidly expanding industry and services activitiesencroached on agricultural land. Gaps continued to widen between themore prosperous coastal states and those in the interior o Indiawherepopulation growth is astest and the record on job creation weakest.

Many other countries also enjoyed vigorous growth. Azerbaijanand Kazakhstan again saw benets rom high oil prices. Favorablecommodity prices helped expansion in Mongolia. Armenias constructionboom continued, and the services sector grew by 0% as rising wagesand remittances bolstered private consumption. Cambodia saw double-

1.1.1 GDP growth, developing Asia

0

2

4

6

8

10

060402200098961994

%

Source: Asian Development Outlookdatabase.

Click here or fgure data

1.1.2 Shares in regional output

2000

2005

PRC

35.3%Other ADB

developing

member

countries

50.8%

India

13.8%

Other ADB

developing

member

countries

44.7%

India

14.3%

PRC

40.9%


http://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-1.xlshttp://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-2.xlshttp://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-2.xlshttp://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-1.xls


20/387


digit rates o expansion or the third straight year: textiles, tourism,and agriculture all perormed well. Robust growth has become almostroutine in Viet Nam, and 00 was no dierent, with both exports anddomestic demand making strong contributions.Growth in the Lao

Peoples Democratic Republic (Lao PDR) accelerated, as large hydropowerand mining projects progressed. Te Maldives bounced back rom thedestruction o the tragic 00 tsunami, growing at 8.%. AlthoughPakistan could not repeat its record-breaking perormance o 00,growth in 00 was above its recent pattern. Bangladesh, too, continuedto see its trend up. Despite civil conict, Sri Lanka grew at its quickestpace since 979, buoyed by strong private sector activity and expansionarypublic spending. (Figure .. gives a prole o growth in developing Asia.)

However, perormance was patchy in the larger economies oSoutheast Asia. High interest ratesaimed at bringing down theinationary surge caused by the reduction o gasoline and dieselsubsidies late in 00curtailed growth in Indonesia. Consumption

and investment demand growth was insipid. In the Philippines, growthedged up rom 00, underpinned by a strong recovery in agriculture. Butinvestment spending stayed weak. In Tailand, net exports lied growth,but gathering political uncertainty dented domestic demand, and businessand consumer condence ebbed. Growth accelerated in Malaysia, largelyprimed by another year o robust consumption demand and greaterpublic investment spending.

Growth in the Pacic countries ollowed a amiliar sawtooth pattern,with growth accelerating in some countries but slowing in others. Growthaccelerated in Fiji Islands and Papua New Guinea and, as these are thelargest economies, lied overall perormance. Te ormer benetedrom a pickup in sugar production and in construction, and latter rom

avorable export prices.Weak perormance was seen in isolated cases. In Nepal, politics

continued to dominate and growth was slow. Growth in the KyrgyzRepublic moved into positive territory, but recovery was hampered byweak gold production and by lingering political diculties. Civil disorderin imor-Leste caused its non-oil economy to shrink, but oil extractionactivity (which is accounted or separately) was unaected. Economicactivity also contracted in the Federated States o Micronesia. Growth inthe Cook Islands, Kiribati, and onga trailed in at less than %.

Despite exceptionally ast growth and rising oil prices, consumer priceination did not, in general, accelerate in 00. Te outcome o .% wasless than the .0% projection made in Asian Development Outlook 2006.But this aggregate pattern disguises wide variations at the country andsubregional level (Figure ..). In some countries, inationary pressuresrose as the year progressed. In India, wholesale price ination accelerated,despite tightening measures by the Reserve Bank o India, which raisedinterest rates on our occasions in 00, liing the key policy raterom .% to 7.%. Te central bank also imposed tighter reserverequirements on commercial banks and stricter conditions or lending tothe property sector. In Bangladesh too, annual ination accelerated. Fastcredit growth, pass-through o earlier oil price rises, and rising prices oother commodities all contributed to ination. Although ination ell inPakistan, it remained high and above the State Bank o Pakistans target.

1.1.3 Prole o regional growth, 2006

0

3

6

9

12

15

The Pacific

Southeast Asia

South Asia

East Asia

Central Asia

%Average growth for the last 5 years



1.1.4 Regional ination trend, 2006

0

3

6

9

The PacificSoutheast Asia

South AsiaEast Asia

Central Asia

%Average inflation for the last 5 years



1.1.5 Monthly ination rates

4

8

12

16

20

-1

2

5

8

11

Singapore

Malaysia

Viet Nam

Thailand

Philippines

Indonesia

OctJulAprJan

06

OctJulAprJan

05

OctJulAprJan

2004

%, year-on-year%, year-on-year

3

6

9

12

PakistanIndiaBangladesh

OctJulAprJan

06

OctJulAprJan

05

OctJulAprJan

2004

%, year-on- year

-3

0

3

6

Taipei,China

Korea, Rep. of

Hong Kong, China

China, People's Rep. of

OctJulAprJan

06

OctJulAprJan

05

OctJulAprJan

2004

%, year-on-year

Sources: CEIC Data Company Ltd., International MonetaryFund, International Financial Statistics online database,downloaded 10 March 2007.

http://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-3.xlshttp://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-4.xlshttp://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-5.xlshttp://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-5.xlshttp://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-4.xlshttp://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-3.xls


21/387


In Sri Lanka, ination accelerated over the course o the year to average9.%. Strong domestic demand in Central Asia, ed by high oil prices,lied ination to 8.0%.

In the PRC, ood prices climbed toward the end o the year, and

although monthly ination picked up, the annual average remainedlow. Highly competitive supply conditions in industry helped restrainconsumer price ination, as did alling oil prices in the later months othe year. But overheating maniested itsel in other ways. In particular,bank credit remained a concern, and equity and property prices soared.In response, the central bank lied the key policy interest rate by basispoints in 00, and increased reserve requirements on commercialbanks onthree occasions. It subsequently raised interest rates by another7 basis points in March 007.

In Indonesia, Malaysia, and Tailand, annual average ination ratesrose. In large part, this reected the eects o increases in oil pricesand o reduced retail subsidies on gasoline and diesel. However, in the

second hal o the year monthly ination rates began to slow, respondingto tighter monetary conditions (Figure ..). Modest exchange rateappreciation also played a part. In the Philippines, where the pass-through o high oil prices was quick, annual headline ination ell in00. In view o al ling monthly ination rates, a number o countrieslowered policy interest ratesmost notably Indonesia, where the centralbank lowered its main policy rate by 00 basis points in seven stepsduring the year (Figure ..).

Fiscal risks were to the ore in some countries o Central Asia, aswell as in Sri Lanka. ajikistans external debt position leaves littleroom or maneuver and the Kyrgyz Republics debt indicators make iteligible or relie under the Heavily Indebted Poor Countries initiative.

In Sri Lanka, rising public spending widened the decit and was partlynanced through domestic credit expansion. Pakistan also ran a sizablescal decit in 00, to support development programs and earthquakerehabilitation and reconstruction activities.

Elsewhere, decits were generally modest, and were nanced withcomparative ease. Strong growth buoyed scal revenues. Various countriescontinued their eorts to bring down levels o public debt. In thePhilippines, a legislative impasse in the approval or the 00 budget ledto nominal expenditures being rozen at 00 levels. As a consequence,expenditures as a proportion o GDP ell. At the same time, revenuesaccrued rom the newly expanded value-added tax. Reduced outlays andrising revenues cut the central Governments decit to just % o GDP. InIndonesia and Malaysia too, decits were modest in 00 as governmentssought to consolidate or reduce debt. Tailands planned disbursements orinrastructure projects were delayed by political uncertainties.

In India, the Fiscal Responsibility Act is a centerpiece o theGovernments economic stabilization and reorm program. It calls ora reduction in the ederal budget decit by at least 0.% o GDP a year,taking it to .0% o GDP by FY008 (ending March 009). In 00, theederal budget decit as a proportion o GDP again ell, despite risingexpenditures on social programs and on rural inrastructure. Fast growthhas done much to buoy revenues. Improved collection at the state levelhas also helped the overall scal position.

1.1.6 Policy interest rates

2

4

6

8

10

Pakistan repo rate

India repo rate

Bangladesh reverse repo rate: 1-2 days

OctJulAprJan

06

OctJulAprJan

05

OctJulAprJan

2004

%

0

2

4

6

Malaysia overnight policy rate

Viet Nam base interest rate for short-term lending

Thailand discount rate

OctJulAprJan

06

OctJulAprJan

05

OctJulAprJan

2004

%

4

6

8

10

12

14

PRC base lending rate (working capital, 1 year)

Philippines overnight reverse repo rate

Bank Indonesia rate

OctJulAprJan

06

OctJulAprJan

05

OctJulAprJan

2004

%

Sources: CEIC Data Company Ltd.; International MonetaryFund, International Financial Statistics online database;both downloaded 10 March 2007.

http://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-6.xlshttp://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-6.xls


22/387


Developing Asias trade surplus widened in 00. Both the value oexports and imports grew quickly in United States (US) dollar terms, butas exports grew rom a larger base, the trade surplus expanded. In somecountries, export growth was extraordinary. In Azerbaijan, or example,

it ballooned by % as new sources o oil and gas came on stream. orridgrowth o exports rom Mongolia and Papua New Guinea reected bothhigher volumes and better prices or their primary resources.

Te PRCs merchandise exports again grew rapidly in 00, barelydown on 00s expansion. Imports also grew briskly, but continued totrail export growth such that the PRCs trade surplus jumped to nearly$00 billion dollars, or 7.% o GDP. Tis pattern o strong import growthbut even stronger export growth was repeated in a number o othercountries. Tailand moved rom a trade decit to a trade surplus andsurpluses widened in Indonesia and Singapore. In the Republic o Korea(hereaer Korea) and Malaysia, trade surpluses narrowed. In South Asia,trade decits were again the norm, and in all countries but Bangladesh

and Bhutan they widened (Figure ..7). Nevertheless, they remainmanageable.

Broadly, current account payments positions moved in step withtrade balances. For the region as a whole, the current account surplusin 00 was .% o GDP in 00, the largest on record. Central Asia,East Asia, and Southeast Asia all posted hey surpluses, but South Asiasdecit stepped up to over % o its GDP. Pakistans decit is large andwas partly nanced through privatization receipts. Buoyant remittancesprovided a valuable source o oreign exchange or a range o countries in00. In Central Asia, remittance income climbed in the Kyrgyz Republicand ajikistan. It is also important to many small Pacic islands.In Bangladesh, Nepal, and Philippines, inward remittances reversed

trade decits and generated current account surpluses. Remittancessignicantly helped the payments positions o Pakistan and Sri Lanka.

Large current account surpluses made a signicant contributionto reserve accumulation (Box ..). Developing Asias stock o oreignexchange reserves at end-00 reached about $. trillion, up $8 billionin a year. Although the region attracted gross capital inows in 00,it also invested signicantly overseas, which helped stem the buildupo reserves. O the increase in total reserves, just less than 80% wasattributable to current account transactions.

Outlook or and As usual, the outlook or developing Asia in 007 and 008 will hinge onprospects or the global economy. Te idea that, because o its growingimportance in global demand and strengthened intraregional tradelinkages, developing Asia is now less susceptible to the vicissitudes othe international economy is at odds with the acts (see the chapter,Uncoupling Asia: Myth and reality, in Part ).

As explained in the ollowing section, Prospects or the world economyin 2007 and 2008, the outlook is broadly avorable. Although globalgrowth is anticipated to slow, it will also become more balanced withinthe G (US, euro zone, and Japan). Growth is expected to come downin the US in 007 beore picking up in 008, but output growth will

1.1.7 Regional trade balance trend, 2006

-8

0

8

16

24

The Pacific

Southeast Asia

South Asia

East Asia

Central Asia

% of GDP

Average trade balance for the last 5 years


http://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-7.xlshttp://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-7.xls


23/387

Developing Asia and the world 7

Developing Asias oreign exchange reserves rose by . billionduring to . trillion, according to preliminary data (box

table). Te advance was much larger than the . billion seen in and represented a return to the pattern o steadily increasinglarge annual gains made by the region since (Box gure ).

Te rebound in accumulation in was mainly due to recoveryrom anemic increases in by some large reserve holders such asHong Kong, China; India; Korea; and Singapore, as well as solid gainsmade by Kazakhstan, Malaysia, and Tailand. All countries but oneappear to have increased their oreign exchange holdings in .

Te larger increase in reserves o the Peoples Republic o China(PRC) in reected a strengthening in its current account surplusduring the year. At . trillion, the PRC accounted or about

o developing Asias stock ooreign exchange reserves

at end-, up rom at end-, accumulatingabout o the regionsincrease in reserves overthis period (versus in).

Box gure indicatesthat the regions share inthe United States (US)merchandise trade decit,which has been relativelystable since , increasedat a aster pace in .

Te trade decit withdeveloping Asia amountedto . billion, or .o the total trade decit(. billion), up by. percentage points rom.

In East Asia, the PRCaccounted or . billion,or . o the US decit,up by .percentagepoints, while the shareo other countries ell by. percentage points, toproduce a net . percentagepoint increase or East Asia.A deeper US trade decit

with Southeast Asia accounted or the balance o s increase.Te PRCs gain in share o the US decits since reects

both the countrys development as the lowest-cost producer o manygoods, and the growth o specialization and intraregional trade, whicheatures exports o components and supplies to the PRC or assemblyinto goods or export.

1.1.1 Developing Asias oreign exchange reserves and the United States merchandise trade decit

1 Developing Asias oreign exchange

reserves

-150

0

150

300

450

1995 96 98 2000 02 04 06

Annual change, $ billion

-1

0

1

2

3

China, People's Rep. of

Rest of Asia Stock, end of period

Stock, $ trillion

Sources: International Monetary Fund, InternationalFinancial Statistics online database; Central Bank o China,available: http://www.cbc.gov.tw; Bank o Korea, available:

http://www.bok.or.kr; all downloaded 8 March 2007.

2 Share in total US trade decit, 19952006

0

15

30

45

60

0503200199971995

East Asia Southeast AsiaSouth Asia

%

Source: US Census Bureau, available: www.census.gov,downloaded 16 February 2007.

Developing Asias oreign exchange reserves

( billion)

Stockend-

Change over the year

Central Asia . . -.

Armenia . . .

Azerbaijan . . .

Kazakhstan . . -.

Kyrgyz Republic . . .

Tajikistan . . .

East Asia ,. . .

China, People's Rep. o ,. . .

Hong Kong, China . . .

Korea, Rep. o . . .

Mongolia . . .Taipei,China . . .

South Asia . . .

Bangladesh . . -.

Bhutan . . .

India . . .

Maldives . . .

Nepal . . .

Pakistan . . .

Sri Lanka . . .

Southeast Asia . . .

Cambodia . . .

Indonesia . . -.

Lao People's Dem. Rep. . . .

Malaysia . . .

Myanmar . . .

Philippines . . .

Singapore . . .

Thailand . . .

Viet Nam . . .

The Pacic . . -.

Fiji Islands . -. -.

Micronesia, Fed. States o . . .

Papua New Guinea . . .

Samoa . . .

Solomon Islands . . .Tonga . . .

Vanuatu . . .

Developing Asia , . . .

Note: Foreign exchange reserves exclude gold, special drawingrights, and the reserve position in the International MonetaryFund.

Sources: International Monetary Fund, International FinancialStatistics online database; Hong Kong Monetary Authority,available: http://www.ino.gov.hk/hkma/; both downloaded8 March 2007; sta estimates.


24/387


stay close to potential in both the euro zone and Japan. Global trade isexpected to expand at about 7.%, which is close to longer-term averages.Oil and other commodity prices are expected to come down in 007, andagain in 008. But it is also possible that the global electronics cycle could

turn in 007, which would negatively aect export prospects particularlyor East and Southeast Asia.Te baseline assumptions or individual economies are set out in

each country chapter in Part . Monetary conditions are generally set totighten in 007 as a number o countries attempt to tame inationarypressures. Tis is particularly true in South Asia but urther tighteningmay also occur in the PRC i liquidity continues to wash through theeconomy. In Southeast Asia, as the pass-through eects o high oil pricescome to an end, there may be scope or interest rates to come down. Teyhave already been reduced in Indonesia and in Tailand.

Fiscal stances are tipped toward mild expansion but most countriesare mindul o the costs that rising and high public debt brings. In

the Philippines, a stronger scal position may allow some additionalspending on priority programs, including inrastructure. Largerspending on inrastructure is also planned in Indonesia, Malaysia,and Tailand. In India, spending at the state level could threaten thecommitments o the Fiscal Responsibility Act. Fiscal positions are moreproblematic in Pakistan and Sri Lanka, but it is expected that decitswill narrow in 007. Fiscal consolidation is also needed in severalCentral Asian countries. In the PRC, the central Governments decit isexpected to stay below %, but spending or rural development and theenvironment may pick up.

Set against this background, robust growth is again expected in 007and 008. Growth o 7.% is projected in 007, nudging up

to 7.7% in 008. Tese projections imply that growth willmove onto a more sustainable ooting and that overheatingpressures that suraced in 00 will gradually abate.able .. summarizes projections by subregion or growth,consumer price ination, and the current account balance(as a percentage o GDP).

Growth in all subregions, except the Pacic, is expectedto slow in 007. Te biggest deceleration is likely in CentralAsia, as lower oil prices work their way through to demand.Te slowdown there partly reects the removal o the one-time impact o large investment projects. Now that they areon stream, their eects register in a higher level o income,but not in a llip to growth. In 007, the pace o expansionis expected to moderate in Armenia, Azerbaijan, andKazakhstan. A more stable political situation in the KyrgyzRepublic and new mining projects should help li growth.Tere is also room or aster growth in ajikistan.

In 007, South Asia is expected to grow by 7.7%. Stepstaken by the Reserve Bank o India to cool ination areseen slowing Indias pace o investment and consumptionspending in 007, and growth o 8% is orecast or 007.But i ination proves to be stubborn, urther tighteningby the central bank is likely to ollow. In Pakistan growth

.. Selected economic indicators, developing Asia,

Gross domestic product (annual % change)Developing Asia . . . .

Central Asia . . . .East Asia . . . .South Asia . . . .Southeast Asia . . . .The Pacic . . . .

Consumer price index (annual % change)

Developing Asia . . . .Central Asia . . . .

East Asia . . . .South Asia a . . . .Southeast Asia . . . .The Pacic . . . .

Current account balance (% o GDP)

Developing Asia . . . .Central Asia . . . .East Asia . . . .South Asia -. -. -. -.Southeast Asia . . . .The Pacic . -. -. .

a India reports on a wholesale price index basis.

Sources:Asian Development Outlookdatabase; sta estimates.


25/387


is expected to pick up on 00: as stronger perormance by agricultureis expected. Tere is also scope or expansion o the garment sector, butchallenges are just over the horizon with the end o voluntary restraintson the PRCs textile and clothing exports to the US and European

Union in 008. In Bangladesh much will depend on how the interimGovernment perorms economically, as well as on political developments.Growth in Sri Lanka will come o the record pace o 00, but it is stillexpected to consolidate trend perormance. I political conditions becomemore settled, Nepal may reap a modest dividend in 007. Continuingrecovery rom the tsunami should see double-digit growth in theMaldives.

In 007 and 008, soer external demand and policy curbs areexpected to pull growth down gradually in the PRC. But incentives orspending at the local and provincial level will remain strong in the lead-up to the Communist Party Congress later in 007. Industrial expansionis also set to continue apace, as the PRC makes inroads into new markets

and improves productivity. Growth o 0.0% is now orecast in 007,with a urther slowing to 9.8% in 008. Outcomes have previouslyconsistently beaten orecasts or the PRC, but i growth does not begin toslow, the authorities will most likely press harder on the brakes. Failureto moderate growth in the near and medium term would raise risks opainul adjustments later on.

Elsewhere in East Asia, growth is expected to soen in Hong Kong,China and in aipei,China, partly because o their close economic ties tothe PRC, though local actors will also play a part. Korea, too, is expectedto slow as exports cool with the moderate slowdown in the US economy.Mongolia should continue to enjoy ast growth over the next years asagriculture, mining output, and construction continue expanding. For

East Asia as a whole, growth o 8.0% is projected in 007 and 008.Overall, Southeast Asia will show little change in 007 relative to

00. Growth is put at .%, edging up to .9% in 008. But Indonesia,Southeast Asias largest economy, is seen accelerating as lower interestrates and weaker ination give a boost to domestic spending. Eorts toimprove the investment climate may also begin to pay o. In Malaysia,growth is likely to ease a little in 007. Electronics activity will remainsusceptible to global developments and any slowing o durable goodsdemand in the US. Te Philippines is expected to maintain steady growtho around .%. Te investment rate may stabilize and then pick up, andalthough expansion o inrastructure spending would be helpul, thebenets would unlikely be elt beore 008.

Cambodia, Lao PDR, and Viet Nam will again grow quickly in007 and 008. But Cambodia will need to diversiy its export baseand improve productivity i it is to stand up to stiening garmentscompetition. In Tailand, prospects are dominated by political actors.Since the coup o September 00, business and consumer condencehave declined. Shis in policy and uncertainty about uture directionhave kept consumers and investors on the sidelines. Growth o .0% ispenciled in or 007, but has a larger than usual degree o uncertainty.

Growth is expected to accelerate briey in the Pacic in 007 beorereverting to a more lackadaisical pace. Te anticipated leap in growth in007 largely reects the stimulus to demand provided by the deployment


26/387

10 Asian Development Outlook 2007

o a large international orce in imor-Leste or peacekeeping and toassist in the conduct o elections. However, stronger growth in PapuaNew Guinea will also help li the average. With the planned departureo peacekeepers in 008 and slower growth in Papua New Guinea, the

subregional average will drop back. A coup and the withdrawal o new aidhave added to already dicult circumstances in Fiji Islands. Its economymay well contract in 007, with growth remaining anemic in 008.

Ination is expected to ease in 007 (Figure ..8). Falling prices ocommodities in international markets will help, as will vigilance rommonetary authorities across the region. Te largest reduction in inationis expected to be in Southeast Asia: ination will slow in nearly allsubregional countries, but the largest contributor to the decelerationis likely to be Indonesia. Running at double digits in 00 and 00,ination is expected to drop to .% in 007, stabilizing at about that levelin 008. Only in Singapore is ination expected to pick up, and even thennot by much.

In South Asia, alling ination in Indiaprompted by slower creditgrowth and higher interest rateswill lead the headline gure down.Ination in Pakistan is orecast to move closer to the State Bank oPakistans target, and is seen coming down to about 7% in 007 andurther to .% in 008. Despite rapid growth, ination is expected toremain tame in the PRC. Any urther currency appreciation would tendto restrain it. Te main downside risk to ination across developing Asiaremains the possibility o a rebound in oil prices.

Developing Asias current account is expected to remain rmly insurplus in 007 and 008 (Figure ..9). In nominal US dollar terms, thesurplus will widen but should steady as a share o GDP. Although someurther appreciation o regional currencies is expected, both exports

and imports are again likely to grow strongly. On the export side o thetrade balance, productivity gains and lower unit costs wi ll help osetimpacts o any currency appreciation on prices. Remittances will stay animportant source o oreign exchange or some countries. Import demandwill be supported by stronger domestic spending, but lower prices oroil and other commodities will reduce import bills or some economies.Te prole o the surplus is unlikely to change much, with South Asiacontinuing to run a decit, and all other subregions in surplus. SoutheastAsias surplus is expected to close somewhat as expenditure switches moreto domestic demand.

Challenges

Economic management

Macroeconomic stability

In many countries o developing Asia, rst generation reorms, whichocus on macroeconomic stability and opening markets, have progresseda lot. Achievements have contributed to avorable outcomes on inationwithout damaging growth. For example, in Southeast Asia, the authoritieshave been quick to tame the inationary pressures that occurred on theheels o large oil price increases. Te enhanced credibility o monetarypolicy doused inationary expectations and allowed many countries

1.1.8 Regional ination trends

0

2

4

6

8

10

20082007

The Pacific

Southeast Asia

South Asia

East Asia

Central Asia

%

Source: Sta estimates.


1.1.9 Current account, developing Asia

100

200

300

400

500

2

3

4

5

6

Current account/GDPCurrent account

0807060504032002

$ billion %

Forecast

Sources: Asian Development Outlookdatabase; staestimates.

http://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-8.xlshttp://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-9.xlshttp://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-9.xlshttp://www.adb.org/Documents/Books/ADO/2007/figs/f1-1-8.xls


27/387


to absorb high oil prices more easily than would have been possible inthe past. Equally, scal authorities, realizing the scal risks and highopportunity costs posed by rising gasoline, diesel, and kerosene subsidies,were quick to pare them back.

In South Asia, inationary pressures have suraced as a consequenceo the pass-through o high oil prices but also because o acceleratinggrowth. Growth has trended steadily upward in Bangladesh, India,and Pakistan. As sizable subsidies have been retained on oil products,and domestic prices remain well below international prices (ADO 2006Update, Box ..), scal strains have been accentuated. Nevertheless, in allcountries, policy rameworks governing interest rates, exchange rates, andscal regimes are acquiring greater clarity. Te monetary authorities haveset clear goals and have taken concerted measures to ease inationarypressures. Fiscal problems and diculties still lurk, but the overalldirection is one o improvement. In Central Asia, International MonetaryFund programs have helped stabilize macroeconomic balances

But there are some countries where macroeconomic balances aremore ragile. In Sri Lanka, or example, credit nancing o expansionarygovernment spending is directly stoking ination. In Myanmar, thedual exchange rate system and monetization o government decits keepination a perennial problem. In some o the small Pacic countries,an oversized government sector crowds out the space or private sectorinitiative and activity.

Foreign exchange reserves

Since 00, a particularly sharp buildup o oreign exchange reserves hasbeen seen in developing Asia, largely in East and Southeast Asia, but alsoin India. Initially, reserve accumulation was motivated by a strong sel-

insurance motive and was intended to provide a buer against speculativeattacks. I the costs o a nancial crisis in terms o lost GDP are large (asthey appear to be), and the probability o a crisis occurring is signicantlyreduced by sizable reserves, then it may be worth paying a hey insurancepremium to do this (Rodrik 00).

Te need or reserves is inuenced by a variety o actors, includingexposure to short-term external liabilities, the nature o the exchange rateregime, country risk characteristics, and import nancing requirements.A comparison o actual reserves with estimates o a broad measure oneeds shows that actual reserves exceed adequacy levels by 0% ormore (Asia Economic Monitor, December 00). Although these ratiosare by no means exceptional or emerging market economies, it is hardlysurprising that there is now growing interest in how to make better useo international reserves. Asias reserves tend to be invested in short-term,secure assets that earn low yields that may be insucient to compensateor even modest exchange rate appreciation.

Te rewards rom investing more actively are potentially large. Forexample, i just 0% o reserves were invested in a globally diversiedportolio, attracting a yield o 00 basis points above the current return,this would generate a scal dividend o about $0 billion, equivalentto 0.9% o regional GDP. Tese additional resources could pluginrastructure gaps and increase the supply o essential public goods. Or


28/387


they could be used to retire public debt, creating larger scal space in theyears ahead.

Some countries have already moved in the direction o more activereserves management. Capitalized by unds rom the exchange equalization

account, the mandate o the Korean Investment Corporation (ormed in00) is to achieve sustainable returns on oreign currency assets. InMarch 007, the PRC announced that it would take a more active approachto reserves management (Box ..). But while the rewards are certainlytempting, central banks and governments are rightully wary o risks. Iinvestments go bad, this could undermine condence in government and/or the central bank. Having an appropriately regulated und, operatingat arms length, to manage some portion o reserves may have advantages.But setting up such an organization and attracting people with the rightexpertise is likely to take time.

On the back o a surging trade surplus and rising oreigndirect investment, the PRCs oreign exchange reserves,already the worlds largest oreign reserves holding, hit. trillion at the end o , up billion rom theend o . All the (ocial) oreign reserves are nowmanaged by the State Administration o Foreign Exchange(SAFE), an arm o the central bank.

Tey are conservatively invested in US treasury bondsand other government securities, and generally earn smallyields. Standard Chartered Bank in Shanghai has estimatedthe investment return on the PRCs reserves to be ,

compared with, or example, an average annual returnor Singapores emasek Holdings since it was established.In addition, the central bank may even lose rom holdingcurrency reserves in US dollars, including valuation lossesas the yuan appreciates and opportunity costs due tothe dollar depreciating against investment in alternativecurrencies.

In , Central Huijin Investment Company Limitedwas established to be another investment arm o thecentral bank. It has used part o the oreign reserves torecapitalize major state banks and other state-ownednancial institutions. It now holds a large proportiono state-owned nancial assets. However, Central

Huijin seems to be managed much like SAFE, whichconservatively invests in low risk and return securities.

On March , the Government unveiled a plan toestablish a state investment agency, to make better use oits reserves. Te intention is to model operational aspectso the agency along the lines o emasek Holdings and theGovernment Investment Corporation (GIC) o Singapore.Even though the proposal has not yet been nalized, itis likely that the oreign reserves will be divided into twopartsnormal reserves that will continue to be managedby SAFE and others directed by the new investment

agency. Te new agency is expected to manage at least billion o oreign reserves, and to adopt an assetmanagement model in which reserves will be investedin higher-yielding products, such as stocks, corporatebonds, commodities, and technology companies abroad, inorder to spread portolio risks. It is still unclear i CentralHuijin will be merged with the new agency. I it is, thenew agency will be able to manage not only the currencyreserves but also state-owned assetsreecting the GICemasek approach.

emasek, one o the operational models or the new

agency, was set up by the Singapore Government in to manage state-owned assets. emasek owns stakes inmany o Singapores largest companies, including SingaporeAirlines, DBS Bank, and Singapore Power. It also holdsinvestments in iconic Singaporean institutions like RaesHotel and Singapore Zoo. About hal o its managed assetsare held externally. As o March , emasek had billion o assets under management, yielding around or the year.

Te Singapore Government established GIC in as another investment arm to directly manage its oreignreserves. GIC is run as a private investment company,although it is wholly owned by the Singapore Government.

Tis arrangement allows GIC to operate as a global undmanager, while allowing the Government oversight overthe management o the countrys reserves. GIC investsinternationally in equities, xed income instruments,money market paper, and real estate. It is also involvedin some o Asias largest unds, such as the AIG AsianInrastructure Fund, the largest private inrastructure undin Asia.

Sources: Bloomberg 9, 10, 11 March 2007; Financial imes, 9 March2007; www.temasek.com.sg; www.gic.com.sg.

1.1.2 New investment agency or reserves management in the Peoples Republic o China


29/387


An alternative, more direct approach, recently proposed in IndiasFY007 budget, would be to use oreign exchange to pay or the oreigncurrency costs o projects, or to back guarantees that would lower thecosts o borrowing by special purpose investment vehicles.

Both proposals have their attractions. But in either case contingentscal liabilities would be likely to rise. I guarantees are used, theresulting debt inows could exert pressure or an appreciation o theexchange rate. I inows are sterilized, this wi ll push interest rates up;with no sterilization, the inows would add to credit expansion. Decisionson whether and how to put reserves to better use should be taken in thebroader context o scal and monetary policy rameworks.

Exchange rates

Figure ..0 shows the movement o nominal exchange rates againstthe US dollar. Most currencies appreciated, Viet Nams dong being anexception. Te Malaysian ringgit and the PRC yuan, whose dollar pegs

ended in July 00, appreciated modestly in 00. Te appreciation oother currencies, including the Korean won, Philippine peso, and Taibaht, was more pronounced.

Changes in nominal eective (trade-weighted) exchange rates arecompared with unweighted US dollar changes in Figure ... Generally,movements o nominal eective exchange rates were smaller than theirappreciation against the US dollar in 00. Tis is because the currencieso most countries major trading partners also appreciated against theUS dollar. In nominal eective terms, the appreciation o the ringgit hasbeen small. By December 00, the Tai baht had appreciated in nominaleective terms by over 0%, and the Philippine peso by .%.

Following the announcement o a near-record trade surplus in

February 007, the PRC authorities stated in March that they may nowconsider greater exibility o the yuan. Te sensitivity o other countriesnominal eective exchange rates to an appreciation o the yuan wouldbe quite small (Figure ..). Te main impact o its appreciation wouldmost probably be seen in adjustments to market shares outside theregion, not in terms o bilateral trade ows within. About % o thePRCs exports are to the US, EU, and Japan. Comparable shares or othercountries range rom % up. But these numbers may exaggerate the trueextent o competition, concentrated in consumer goods industries thatconstitute a smaller share o total exports (Box ..). Also, rms in thePRC have already shown themselves adroit in improving productivitylevels, which would help to oset any price and cost disadvantagescreated by a more expensive currency. Tere would be benets at home.Consumers would gain rom cheaper consumer goods imports, and thePeoples Bank o China would be better able to stem pressures on liquiditycoming rom rapidly accumulating oreign reserves. Pressures on thenancial sector would be eased i the share o lowly remunerated reservesand sterilization bonds on their balance sheets were reduced.

Capital controls

In December 00, Tailand imposed controls on capital inows withthe intention o stemming the bahts appreciation. Te initial ruleswere widely regarded as too stringent and triggered a rout in the equity

1.1.3 Trade and structural changein East and Southeast Asia

Te chapter, rade and structuralchange in East and SoutheastAsia: Implications or growth andindustrialization, in Part , providesan in-depth analysis o recentdevelopments in international trade inmanuactures in the region.

It shows that the rising share othe region, and especially o the PRC,in world exports and imports hasbeen ueled by the explosive growtho intra-industry trade in parts andcomponents in machinery sectors.Multinational enterprises are activein established production networks

with a vertical division o laborleading to trade in goods in dierentstages o processing. Te regionseconomies trade most intensively inthe manuacturing industries that havethe highest growth in world trade:electrical machinery, transportationequipment, chemicals and alliedproducts, and precision instruments.

Te region is also shown to behighly competitive in traditional labor-intensive manuactured products.Although intraregional trade is o

increasing signicancewith thePRC the point o assembly or nalproductsconsumption o thesenal products is overwhelmingly indestinations outside the region. Finaldemand in the United States, Europe,and Japan and other extraregionalmarkets is the driving orce behind therise o intraregional trade in East andSoutheast Asia.

Hence, globalization is driving theprocess o regional integration and theprocesses are mutually reinorcing. So,although the region is partaking in

the trend toward bilateral preerentialtrade agreements, it is market orcesrather than tari preerences that aremore inuential in determining whatis produced and where it is produced.

Te impact o the emergence othe PRC on industrialization andtrade perormance in other parts othe region, such as ASEAN, are alsoexamined.


30/387


market (Figure ..). In response, exemptions have been widened. It hasalso been claried that the aim is to eventually abandon the controls.Further relaxation o controls took place in mid-March 007: the 0%nonremunerated reserve requirement or investors in debt securities and

unit trusts, who ully hedge their investments through orward swaps oat least months, was abrogated.In principle, the case or a tax on destabilizingcapital inows is clear.

As oshore investors do not consider or internalize the costs o anydestabilizing eects o their behavior on the domestic economy, a tax oninows could be benecial.

But theory and practice can dier. First, identiying conditions thatwarrant the imposition o a tax on capital inows is not straightorward.Even i the Tai baht appreciated sharply against the US dollar in00 and reserves accumulated, it is uncertain that this threatened theeconomy or export businesses. Te appreciation did not deter healthyexport perormance in 00, and the trade balance moved rom decit to

surplus.When pressures or speculative capital inows do need easing, the

question arises o how to do this. Precisely because oreign exchangetransactions are ungible, designing regulations that are not porous isextremely dicult. Simple approaches that are based on at withholdingtaxes and that use existing taxation (and rebate) arrangements may haveat