32951 East Asia Update April 2005 East Asia's Dollar Influx ­ Signal for Change Special Focus: Gender Equality in East Asia East Asia and Pacific Region The World Bank CONTENTS East Asia and Pacific Regional Overview 1. Introduction....................................................................................................3 2. East Asia ­ expansion amidst uncertainty ...................................................8 Growth ­ the cyclical outlook .....................................................................8 Poverty reduction and human development .............................................10 Natural disaster and disease risks ­ a new focus ......................................12 3. The international and regional environment ............................................14 Developed country growth ........................................................................15 China ­ closely watched.............................................................................17 Commodity markets ..................................................................................20 Trade policy developments ......................................................................25 International capital flows and global imbalances ....................................27 4. Domestic trends and policy challenges.......................................................34 Financial sector trends and reforms............................................................34 Corporate sector trends and reforms ..........................................................36 Country Sections ...................................................................................................38 Appendix Tables.................................................................................................... 51 Special Focus: Gender Equality in East Asia.....................................................60 Key Indicators Tables ...........................................................................................71 This Regional Update was prepared by Milan Brahmbhatt, Lead Economist, East Asia PREM, with the assistance of Antonio Ollero, Hiroshi Akama and Nancy Mensah, drawing on inputs and comments from country economists and sector specialists throughout the East Asia and Pacific Region of the World Bank. The report was prepared under the general guidance of Homi Kharas, Chief Economist, and Jemal-ud-din Kassum, Regional Vice President, East Asia and Pacific Region. East Asia Update 3 EAST ASIA AND PACIFIC REGIONAL OVERVIEW Introduction upswing in capital inflows during 2004. Economic growth in Emerging East Asia reached Of the two sources of East Asian balance of a cyclical peak of 7.2 percent in 2004 from which it is payments surpluses looking first at the current account, it expected to slow only moderately to about 6 percent in is clear that outside of China the big surge in East Asian 2005 and 2006.1 The tragic tsunami disaster, while it had surpluses after 1997 was principally due to the collapse of a horrendous impact in terms of loss of life, is expected to domestic fixed investment during the financial crisis. have only a limited impact on overall economic growth in However current account surpluses relative to GDP began the two most seriously affected East Asian economies, falling in a number of economies in 2004, as investment Indonesia and Thailand. Among the developing finally began accelerating, and should shrink further as economies in the region growth is expected to ease from the investment recovery gains hold, a desirable outcome. over 8 percent ­ the highest since before the financial For China, the story is different. Investment is already crisis ­ to around 7 percent in the coming period. very high and needs to be brought down. In itself, that Sustained expansion at these rates over a number of years will increase the trade surplus, and there are already signs would result in further major improvements in the living of this happening. In addition, China has just benefited standards of the population, and, in particular, would from a favorable shift in the global trading environment contribute to further sharp reductions in the number of due to the expiration of the MFA. This makes it unlikely poor in the region. We project declines in the number of China will be able to reduce its trade surplus rapidly in poor of 5-6 percent or by around 35 million a year. the short term. Over the medium term China's trade surplus will fall as a result of stronger private Last year's robust East Asian growth was also consumption and lower household saving. Underlying part of a strong recovery in world growth, which reached trends towards population aging and urbanization are 5 percent (using PPP GDP weights), among the highest in likely to work in this direction in the longer term. In several decades, and which is also expected to continue at addition policy efforts to create a strong well-diversified healthy rates of a little over 4 percent in 2005-06. financial sector and strengthen social safety nets can also However, the recent strength in global growth, while help create a more favorable environment for household welcome for its effect in reducing global poverty, has also consumption. been associated with the emergence of some sizable disequilibria in the world economy, including in global Emerging East Asia received net capital inflows balance of payments positions, and in the supply and estimated at over $100 billion in 2004, with inflows to the demand of primary commodities, notably oil. developing economies in the region estimated at $114 billion, mostly to China but also with smaller inflows to Global macroeconomic imbalances have other economies, many of which, until last year, had widened, in part as the U.S. economy has continued to experienced continuous net outflows since the financial contribute a disproportionate share of OECD demand crisis. The main contribution to the upswing on the growth, with growth in Japan and Europe actually capital account came from portfolio investment and other slowing sharply over the course of 2004. The U.S. lending flows, a part of the wider resurgence in financial current account deficit reached a record $666 billion or capital flows to emerging markets over the last two years. 5.7 percent of GDP in 2004. Among the principal Capital flows have revived both due to "push" factors, counterparts, East Asian and Japanese current account such as low interest rates in the developed world, and surpluses rose respectively to an estimated $189 billion "pull factors" in the recipient economies. The latter and $172 billion. However, East Asia experienced a include improved macro and microeconomic much larger widening in its overall balance of payments fundamentals in many East Asian economies, but also surplus last year, based not only on current account include speculative short term factors, such as the surpluses but now also on a large upswing in capital perceived opportunity to make profits from an inflows. East Asian foreign exchange reserves (ex-Japan) appreciation in currencies linked to the U.S. dollar like rose by over $300 billion in 2004, an increase equivalent the Chinese renminbi and the Malaysian ringgit. to about 9 percent of its GDP, to reach an unprecedented $1.46 trillion at year end. The increase represented an Managing capital flows in an environment where acceleration in the pace of reserve accumulation in East growth is strong is not easy. Typically, the response Asia, with most of the acceleration coming from the would be to have more monetary accommodation, and allow interest rates to fall, thereby reversing the flows. 1Emerging East Asia comprises Developing East Asia (China, But this would risk overheating the economy and Indonesia, Malaysia, Philippines, Thailand, Vietnam and some accentuating asset price bubbles in housing and stock smaller economies) and four Newly Industrialized Economies or markets. There is some evidence of this in the sharp NIEs (Hong Kong, Korea, Singapore and Taiwan, China). East Asia Update 4 increases in housing and land prices in China, and in the improved significantly in recent years, thanks in very strong performance of stocks in many other East significant measure to the growing contributions of Asian economies. Monetary policy in the region has women at all levels of the economy and society at large. appropriately moved towards some tightening, principally Expansion amidst uncertainty though a high level of sterilization of the accumulation of foreign reserves. However experience shows that the · Growth. Last year's strong East Asian growth came higher interest rates that can result from sterilization tend about when all the main engines of aggregate final to encourage more capital inflows, so that sterilization demand ­ exports, consumption and investment - tends to become increasingly ineffective over time. started firing together in most of the main economies ASEAN countries were in a similar position in 1995/96. of the region. Exports were buoyed by the boom in They resorted to a variety of measures, including China and intra-regional trade, by strong import sterilization and taxing short term capital, but were growth in the U.S. and the recovery in the global high hampered by a desire not to permit too much variation in tech industry. Consumer spending was robust exchange rates. Pressures in the system built up. In because of recent income gains, low interest rates, retrospect, most analysts believe that it was a major policy increased availability of consumer credit, wealth mistake for East Asian countries not to have permitted gains due to higher stock market and real estate prices, themselves supported by new inflows of more currency appreciation in the mid-1990s, to slow foreign portfolio and other capital. The largest swing down capital inflows by making domestic financial assets in contribution to growth however came from more expensive for foreigners, discouraging further investment in economies other than China, where it speculative capital inflows which could not be had been depressed ever since the 1997/98 financial productively absorbed. crises. Many smaller economies benefited Learning from the lessons of the 1990s, then, handsomely from high primary commodity prices. greater exchange rate flexibility will likely be a useful Copper and gold rich Mongolia, for example, grew policy instrument for many East Asian economies in by 10.6 percent, the fastest in the region. Regional dealing with the present wave of balance of payments growth is expected to be mildly slower in 2005-06 surpluses. In addition East Asian economies can also take due to slower growth in the developed world, a near advantage of the present period of robust growth and term correction in global high tech markets, high oil prices and China's efforts to cool its rapid economic capital inflows to pursue structural reforms that can growth. strengthen the basis for long run growth and also help reduce current account surpluses in the medium term. Table 1. East Asia Economic Growth Especially relevant here are reforms to strengthen the 2003 2004 2005 2006 financial sector and capital markets, since these are the East Asia 5.9 7.2 6.0 5.9 institutions through which capital flows are channeled Develop. E. Asia 7.9 8.2 7.2 6.8 into the domestic economy, which determine how S.E. Asia 5.6 5.9 5.3 5.6 efficiently capital is allocated to different uses, and the Indonesia 5.0 5.1 5.5 6.0 ease with which consumers are able to borrow and save. Malaysia 5.3 7.1 5.3 5.3 Reforms to improve the investment climate and Philippines 4.7 6.1 5.0 5.0 availability of infrastructure services are also important Thailand 6.9 6.1 5.2 5.6 priorities. Transition Econ. China 9.3 9.5 8.3 7.5 The rest of this Introduction highlights the cross- Vietnam 7.3 7.7 7.5 7.5 country trends and policy issues discussed in this Report. Small Economies 4.2 5.0 3.5 3.9 Developments at the country level are discussed in the Newly Ind. Econ. 3.0 5.9 4.3 4.6 "Country Sections" at the back of the report, while fuller Korea 3.1 4.6 4.2 4.8 Country Briefs are available at the website associated 3 other NIEs 3.0 6.9 4.3 4.4 with this report.2 The Special Focus in this report - "Gender Equality in East Asia" - coincides with the ten- Japan 1.4 2.6 0.8 1.9 year anniversary of the Beijing World Conference on World Bank East Asia Region; April 2005. Consensus Forecasts for NIEs other than Korea. Women. It summarizes both the dramatic improvement in the position of East Asian women in recent decades, as well as significant challenges that still remain to be · Poverty. The number of people living on $2 a day or addressed. As this report later discusses, the incomes and less in East Asia is estimated to have fallen to 631 financial positions of households in East Asia have million in 2004, about 5 million fewer than our estimate 6 months ago. The number of poor was 2 http://www.worldbank.org/eapupdate/ . down 8 percent from 2003, the most rapid rate of East Asia Update 5 annual decline in the period of recovery since 1999, was principally in Japan which, after a strong first supported by over 8 percent GDP growth. In China quarter, unexpectedly swung to marginally negative continued rapid growth and healthy income gains in or near zero growth for the remainder of 2004. both the rural and urban sectors contributed to a fall Growth in the Euro zone also slowed unexpectedly in the number of poor of some 55 million, to reach through the year. Improvements in underlying labor 416 million, or 32 percent of the population. There market and corporate sector conditions suggest that were also substantial reductions in poverty in prospects do remain favorable for some pickup in Indonesia, Thailand and Vietnam. Looking forward, quarter on quarter growth in Japan, and to some the number of poor at the $2 level is expected to fall extent (and for somewhat different reasons) in to about 595 million in 2005 or 32 percent of the Europe. Nevertheless the forecast for OECD growth population, down from 50 percent in 1999 and 67 in 2005 has been trimmed to 2.3 percent from 2.6 percent in 1990. percent six months ago, comprised of very unequal · contributions ­ the U.S. growing at near 4 percent, Natural disaster and disease risks ­ a new focus. Japan and the Euro zone growing in the The December 26 2004 earthquake and tsunami neighborhood of 1 percent. resulted in 290000 dead or missing in Indonesia, Sri Lanka, India, Thailand, Seychelles, Maldives and · China. China's economy continued to expand at a Somalia, with millions affected and substantial rapid pace in 2004, increasing 9.5 percent, after 9.3 damage to capital stock, infrastructure and percent growth in 2003. Investment spending, the environmental systems in the affected areas. The engine of the current economic boom, grew by disaster has called forth an unprecedented relief and around 17 percent in real terms, reaching a record reconstruction effort from national governments, civil estimated 45 percent of GDP. Buoyed by rising society and the world community at large. It has also current and capital account surpluses, foreign drawn more general attention to the problem of exchange reserves surged by over $200 billion. Since natural disasters as a major ongoing source of risks last year the authorities have undertaken a number of for the poor, of loss of life and destruction of fragile measures to avert potential economic overheating, by economic development gains in vulnerable administrative controls, open market operations and a developing economies. East Asia is in fact one of the small rise in interest rates. Recent data suggest that, regions of the world most at risk from natural while these measures have had some effect in curbing disasters, both relative to its land area and the credit and investment spending, GDP growth has proportion of population affected by disasters. remained quite robust, supported by accelerating Among the main policy lessons emerging from export and household consumption growth. As experience with disasters in recent years is the investment growth has slowed, imports have also importance of integrating disaster prevention and moderated, however. Growth in China's imports natural disaster risk management as integral parts of from other East Asian economies also slowed over development plans, poverty reduction strategies and the course of the year. Imports are projected to grow investment projects, rather than as special activities 16 percent in dollar terms in 2005, less than half the related to humanitarian emergencies. From June last rate of recent years. China's GDP growth is forecast year several East Asian economies started reporting to slow to a little over 8 percent this year and 7.5 new lethal outbreaks of avian influenza A (H5N1) percent in 2006, embodying the `soft-landing view'. infection among poultry. By early April 2005 79 Nevertheless the economy faces significant human cases had been reported, leading to 49 deaths. adjustments and reform challenges in the coming A key worry now is that a genetic reassortment period. Reform priorities include restructuring and between human and avian influenza virus genes reforms of the weak financial sector, and its could lead to efficient and sustained transmission incentives for excessive and inefficient allocation of between humans. In this event, given little credit. Monetary and credit aggregates remain under preexisting natural immunity to H5N1 infection in upward pressure because of large balance of the human population, an influenza pandemic could payments inflows, although for now the impact result, with high rates of illness and death. remains manageable. The authorities' announced policy to move over time to a more flexible exchange rate can play an important role in strengthening The international and regional environment China's ability to manage capital inflows and undertake a more robust and independent monetary · Developed economies. Growth among the OECD policy. Among other policy options for managing countries reached 3.1 percent in 2004, a strong capital inflows that could be considered are performance but rather less than the 3.5 percent temporary controls or taxes on portfolio and other consensus forecast of six months ago. The shortfall financial capital inflows, especially short term flows, East Asia Update 6 as other economies have occasionally done. however, as well as in some smaller ones like Investment spending is likely to decline from its Cambodia and Lao PDR, the recent commodity price present unsustainable rate of 45 percent of GDP. moves will be detrimental. The consolidated Creating more favorable conditions for private cumulative income losses for the region as whole consumption while increasing the efficiency of from terms of trade changes amount to around 1 investment offers a reliable medium term strategy for percent of GDP in 2004-05. growth. · Trade policy developments. 2005 is seeing a number · High tech cycle. The past year was one of continued of important trade policy developments in East Asia. expansion but decelerating momentum in the global On January 1 2005 the 30 year old system of quotas high tech industry. An unexpected slowing in the on world garment and textiles trade was finally pace of demand growth and a build up of excess phased out. As expected China's apparel and textiles inventories contributed to a sharp downshift in exports have received a powerful boost. China's exports and production of electronics in several East exports of these items to the U.S. rose 68 percent in Asian economies over the course of the year. the first two months of 2005, while, on the other Looking forward, the consensus expectation seems to hand, exports from economies like Hong Kong, be that this is a temporary adjustment in a continued Korea, Malaysia and Philippines contracted. While industry expansion, with industry forecasts of consumers in importing countries are already reasonably healthy growth rates in most segments in enjoying the benefits of reduced unit values, 2005, although at lower rates than during the cyclical protectionist tensions have also risen, with the U.S. upswing of 2003 and the first part of 2004. initiating safeguard inquiries in six product · categories. China has tried to reduce tensions and Oil and non-oil commodity prices. Oil prices reduce the adverse impact on other low income renewed their upswing in the first quarter of 2005, exporters by introducing an export tax on several of averaging almost $51 in March, another record in its lowest priced categories. China and ASEAN nominal terms. In real terms oil prices in the first economies also continue to make progress on the quarter were higher than in any quarter since the start "Early Harvest Program." Thailand, which has taken of 1986, though still lower than during the first half the lead in phasing out all tariffs with China on fruits of the 1980s. The main factor supporting high oil and vegetables, enjoyed hefty gains in exports to prices has been unexpectedly robust world oil China, while consumers in both countries enjoyed demand growth, in particular a more than doubling of lower prices for a variety of products. the annual increase in China's oil demand in 2004 compared to the trend in recent years, which has · Capital inflows ­ learning the lessons of the 1990s. almost eliminated global spare production capacity in An influx of liquidity over the balance of payments the near term. Looking forward, oil prices are now on the scale of the last year is unprecedented in East projected to average $42 a barrel in 2005, up from a Asia's experience, even compared to the boom days projection of $36 in 2005 six months ago. The of the early/mid 1990s. The return of large capital consensus view seems to be that growth in world oil inflows to the region poses complex macro demand will ease somewhat this year but will remain management issues. Foreign reserves for the region quite strong enough to keep the market under now total over $1.4 trillion (excluding Japan). pressure. Futures prices for oil delivered several Economies experiencing large inflows like China, years forward have recently risen closer to the high Korea and Malaysia have stepped up the pace of spot prices, indicating expectations of tight markets sterilization, broadly speaking by issuing bonds to in the medium term. Non-oil commodity prices also mop up liquidity. But experience ­ including that of resumed their upward move in the latter part of 2004 East Asian economies in the mid 1990s - shows that and early 2005, with metals prices making the largest sterilization is only a short term palliative. Drawing gains, again underpinned by expanding demand from on the experience of the 1990s, there is a good case China and other fast growing parts of the world to be made that greater exchange rate flexibility and economy. The effects of terms of trade changes on appreciation are required to discourage speculative national incomes in the region are quite diverse. inflows. Apart from economies like China and Exporters of both oil and non-oil commodities such Malaysia with close links to the dollar, even as Papua New Guinea, Mongolia, Vietnam, Indonesia economies with more flexible regimes have seen their and Malaysia, as well as substantial mineral exporters currencies rise only about 10 percent in nominal like Mongolia, are expected to have netted sizable terms against the dollar over the past three years (and commodity based income gains in 2004-05. In many have depreciated in real trade weighted terms). Of of the larger oil importing economies of the region course there are also good reasons why countries try like China, Korea, Philippines and Thailand, to maintain exchange rate stability, in particular to East Asia Update 7 avoid significant costs to the real economy that can wake of the financial crisis, and, more recently, the arise from excessive exchange rate volatility. emergence of domestic bond and equity markets as Financial institutions with weak risk management alternative sources of finance for corporations. Thus systems and potential moral hazard have been in some cases banks in the region have accumulated especially prone to losses from inadequate large holdings of government securities, which could management of exchange rate risk. Avoiding these however subject them to significant interest rate risk costs needs however to be weighed against the in a rising interest rate environment. And banks have benefits of better management of capital inflows and also focused on developing their retail and consumer domestic monetary policy. Among other policy lending business, for example housing finance, options for managing capital inflows that could be especially residential mortgages, loans for purchase considered are temporary controls on portfolio and of autos and other durables and credit cards. By other financial capital inflows, especially short term improving the borrowing and lending choices ones. The experience of Chile, Colombia, Malaysia available to the population these developments make and a number of other countries in the 1990s shows a signal contribution to consumer welfare and to that measures such as non-remunerated reserve financial modernization. However, household debt requirements, taxes or prudential limits can be quite has also been rising in many economies, and with it successful in limiting the volume of inflows, NPLs from household lending. This has already led especially of short term maturities. to significant problems in Korea, and, while the situation is less extreme in most other economies, it is a trend that bears careful monitoring. Domestic trends and policy challenges · Recent corporate sector trends and issues. The · Recent financial sector trends and issues. Banks in financial health of the East Asian corporate sector the previously crisis affected economies in East Asia generally continued to improve over the course of saw further improvements in profitability, capital 2004. Corporate returns on equity increased in most adequacy and asset quality during 2004, supported by of the economies for which data is available, while robust economic growth, improved operational debt-equity ratios continued to fall, at least in the efficiency and (in some cases) wider interest margins. universe of listed firms. Countries also continued to The non-performing loan rate continued to decline, make progress at varying rates and with varying although remaining significantly higher than in other emphases on corporate restructuring issues, as well emerging regions such as Latin America or as on strengthening the institutional and policy Central/Eastern Europe. Asset quality also varies framework of the corporate sector, in such areas as considerably across types of banks, with greater strengthening corporate governance and improving problems among state owned banks, whose lending bankruptcy laws decisions are more prone to political pressures. Banks have also had strong incentives to find new customers and lending opportunities in recent years, due initially to weak corporate loan demand in the East Asia Update 8 EAST ASIA AND PACIFIC REGIONAL OVERVIEW East Asia ­ expansion amidst uncertainty exports measured in real terms were also exceptionally robust. For most economies it was the third successive year Economic growth in Emerging East Asia has been when export growth accelerated from the previous year, trending steadily higher since the global `dot-com' crash rebounding from the low point of the last world economic and economic slowdown of 2001, reaching what is expected slowdown in 2001. During these recent years growth in to have been a cyclical peak in 2004, with growth of 7.2 intra-regional trade has been one of the most significant percent.3 Looking forward we expect growth to ease to a sources of export growth for most East Asian economies, still solid pace of about 6 percent in 2005 and 2006. The most notably through exports to China. In 2004 East Asian tragic tsunami disaster, while it had a horrendous impact in exports were further buoyed by strong growth in U.S. terms of loss of life, is not expected to have a significant domestic demand and imports. Viewed from the product impact on growth in the two most seriously affected East side 2004 was also the year of peak demand growth in the Asian economies, Indonesia and Thailand. Overall, then, global high tech industry, in which East Asia is a prime the most likely scenario is still one where the regional location for production and export. Global semiconductor economy moves from cyclical recovery into a phase of more sales, having contracted by one third in 2001 `dot-com' moderate but sustained expansion. But risks attached to the crash, have steadily accelerated since then, growing by 24 outlook have also risen. percent in 2004. Exhibit 1 East Asia - Quarterly GDP Growth Exhibit 2 (% Change Year Ago) Contributions to Growth in S.E. Asia 12.0 (% change year ago) 10.0 9.0 8.0 6.0 6.0 4.0 3.0 2.0 0.0 0.0 2003 2004 2003 2004 2003 2004 2003 2004 99 99 00 01 02 02 03 04 19 19 20 20 20 20 20 20 -2.0 1 4 3 2 1 4 3 2 Indonesia Malaysia Philippines Thailand -3.0 Q Q Q Q Q Q Q Q GDPGrow th: E. Asia NIEs -4.0 4.6 5.4 5.3 7.1 4.7 6.1 6.9 6.1 SE Asia China For Philippines, Statistical Discrepancy netted from Net Exports -6.0 -6.0 Priv. Consump. Pub. Consump. Investment Net Exports Growth ­ the cyclical outlook One way to look at the cyclical peak reached in Consumers were also in good form in 2004. In 2004 is that it was the year when all the main engines of most economies private consumer spending growth ran in a aggregate final demand ­ exports, consumption and range of 5-10 percent and was also the strongest in several investment - started firing together in most of the main years. The supporting conditions were many: higher economies of the region. On the external side regional consumer confidence buttressed by (in many cases) a third exports in nominal dollar terms rose by 26 percent to $1.8 year of significant gains in income, low interest rates, trillion, the highest growth pace in more than 20 years, and increased availability of consumer credit, wealth gains due to higher stock market and real estate prices, themselves supported by new inflows of foreign portfolio and other 3 Emerging East Asia comprises Developing East Asia (China, capital. As Exhibits 2 and 3 indicate, private consumption Indonesia, Malaysia, Philippines, Thailand, Vietnam and some increased its contribution to growth in most economies in smaller economies) and four Newly Industrialized Economies or 2004. The main exception to this picture was Korea, where NIEs (Hong Kong, Korea, Singapore and Taiwan, China). East Asia Update 9 private consumption actually shrank in both 2003 and 2004, be less sustainable. While semiconductor sales for 2004 as as consumers tried to pay down debts and repair household a whole hit a new record, their momentum was decelerating balance sheets in the aftermath of an earlier borrowing during the course of the year. Industry forecasts for the next binge, a timely warning to other economies that may be on year or two look to positive rates of expansion in demand, the verge of financial euphoria and excessive household though not at the pace during the upswing from recession in borrowing. global high tech markets in 2002-03. In addition, China's effort to slow its investment boom has already led to a slowing in the growth of its imports from the rest of East The largest swing in contribution to growth Asia. All these three reasons for slower export growth are however came from investment. Here it is necessary to explored more fully later in the report. distinguish between China, which has experienced a large investment boom over the last three years, and most other Exhibit 4 economies in the region, where investment fell sharply after the 1997/98 financial crises, and had hardly recovered in East Asia - Quarterly GDP Growth any sustained way. With recovery investment has gradually (% Change Quarter Ago, SAAR) revived. The median growth of real fixed investment in the 15.0 8 main economies other than China rose from 0.8 percent in NIEs SE Asia 2002 to 2.5 percent in 2003 to 8.4 percent in 2004. In 12.0 addition to the factors noted as supporting private consumption, one can add the likelihood of reduced business uncertainty as macroeconomic fundamentals have 9.0 improved, the gradual using up of spare capacity and the strengthening of corporate and financial sector balance 6.0 sheets in recent years. 3.0 Exhibit 3 Contributions to Growth in NIEs 0.0 01 01 02 02 03 03 04 04 (% change year ago) 20 20 20 20 20 20 20 20 10.0 -3.0 1 3 1 3 1 3 1 3 Q Q Q Q Q Q Q Q 8.0 -6.0 6.0 4.0 The primary impact of China's efforts to cool its 2.0 investment boom will of course be on its own growth. However, recent indicators suggest that even as investment 0.0 has slowed, the overall pace of growth has been sustained 2003 2004 2003 2004 2003 2004 2003 2004 by stronger retail sales and an acceleration in export growth. -2.0 Hong Kong Korea Singapore Taiwan China's exports of electronics and high tech products have -4.0 (China) also fared much better during the course of the current GDPGrow th: correction in global high tech demand as a result of its long -6.0 3.2 8.1 3.1 4.6 2.5 8.4 3.3 5.7 standing cost advantages and the high volumes of new Contributions may not sum to growth due to statistical discrepancies. -8.0 foreign investment in this sector in recent years. In addition, Priv. Consump. Pub. Consump. China's exports of garments and textiles to countries previously protected by the MFA have surged with the Investment Net Exports removal of the global system of quotas in this sector (though growing less quickly than exports in total). These are some Looking forward, the sources of the mild slowing reasons why China will likely be less affected by the factors in growth that we expect are fairly clear. First, export that may lead to slower export growth in the rest of the growth will be lower. Growth in the developed world has region, and why the current projections look to a `soft both slowed and become more unbalanced as a result of landing' for the Chinese economy, with growth slowing unexpected slowdowns in both Japan and Europe. This only mildly to over 8 percent in 2005 and 7.5 percent in means that the still robust growth in the U.S. economy is 2006. Nevertheless, the Chinese economy will have to more likely to be associated with higher (or not much lower) accomplish some difficult transitions in the years ahead. For U.S. current account deficits, which means that it may also example, it is difficult to conceive that investment could East Asia Update 10 remain near its present level around 45 percent of GDP. In estimated to have fallen by 46 million to 416 million, or the medium to longer term growth can be sustained by from 36 percent in 2003 to 32 percent in 2004. increasing the share of household consumption in GDP while increasing the efficiency of investment. The government is continuing its policy of reducing the financial burden on farmers by reducing or Among the other economies in the region, on the abolishing agricultural taxes, although this is also putting other hand, where the median investment to GDP ratio has some strain on local finances for public service delivery. fallen to barely above 20 percent, and where the recovery in The government is also pursuing policies to promote investment has hardly begun, it seems appropriate for policy transfer of surplus rural labor to nonagricultural jobs in a makers to seek to foster a continued revival of investment number of ways. spending. As noted, present conditions seem quite The reform of the urban social security is also favorable for both consumption and investment. As Exhibit continuing with increases in the number of participants in 4 indicates, quarter on quarter GDP growth in a number of the basic pension and unemployment insurance programs. these economies had dipped in the first part of 2004, but had Subsistence allowances for laid-off workers from state- already begun to pickup steam in the second half. owned enterprises are in the process of being incorporated Nevertheless, policy makers will need to keep a careful eye into the unemployment insurance system or the urban to ensure that accommodative monetary conditions and minimum subsistence program. Coverage of the latter continued capital inflows do not foster excessive program seems to have leveled off at about 21-22 million speculation, risk taking or inflation. Depending on urban residents over the last 2-3 years. conditions central banks may wish to tighten monetary policies as appropriate. However a great deal can be done Exhibit 5 to improve conditions for investment by reforms of the business environment, as well as further reforms to Poverty - Headcount Index strengthen and develop financial systems and capital ($2 a day poverty line. Percent) markets. East Asia China Other Small * Vietnam 80 S.E. Asia (4) Poverty Reduction and Human Development The number of people living on $2 a day or less in 65 East Asia is estimated to have fallen to 631 million in 2004, about 5 million fewer than our estimate 6 months ago. The number of poor was down 8 percent last year, the most rapid 50 rate of annual decline in the period of recovery since 1999 at the end of the regional financial crisis, a fact not unlinked to the over 8 percent pace of GDP growth achieved in 35 developing East Asia, also the most rapid in many years. Poverty at the $2 level is expected to fall to about 595 million in 2005 or 32 percent of the population, down from 50 percent in 1999 and 67 percent in 1990. (Exhibit 5.) 20 1990 1996 1999 2000 2001 2002 2003 2004 2005 2006 In China continued rapid growth and healthy * Cambodia, Lao PDR, Papua New Guinea income gains in both the rural and urban sectors contributed to further substantial reductions in poverty in 2004. The per capita incomes of rural households increased 6.8 percent in In Thailand strong economic growth, favorable real terms, while those of urban households' rose 7.7 farm prices and the government's active grassroots policies percent. The urban registered unemployment rate was 4.2 continue to help reduce poverty. In 2002 the poverty percent at end of 2004, 0.1 percentage point lower than that headcount rate fell below the 1996 pre-financial crisis level in 2003. By official estimates, rural population in absolute for the first time. Between 2002 and mid-2004 Thailand poverty (with annual per capita income of less than 668 further reduced its poverty headcount rate by almost 25 Yuan) declined by 2.9 million during 2004 (to 26.1 million), percent According to still preliminary estimates from the while rural low-income population (those with annual per National Economic and Social Development Board (based capita income between 669 and 924 Yuan) declined by 6.4 on the latest round of the Socio-Economic Survey), income million (to 49.8 million). The proportion of the population poverty fell from 15.6 percent in 2002 to 12 percent in the living below the international $2 a day poverty line is first half of 2004. These numbers use a new series of upward-adjusted national poverty lines, which raise East Asia Update 11 measured poverty by about 50 percent and reflect more rural areas than in urban areas, and faster in the north than in accurately the current consumption patterns of the poor. the center or south. In spite of the progress, poverty in Lao Using the international $2 a day poverty line, poverty is PDR remains among the highest in the region. Poverty in estimated to have fallen to 15 million people or 23 percent the uplands is 43 percent, compared to only 28 percent in of the population. the lowlands. Poverty in the government's designated 47 In Vietnam, growth in excess of 7 percent for the priority districts is twice as high as in the 70 non-priority last three years has contributed to an improvement in living districts. A vast majority of the poor are ethnic minorities. standards for most population groups, with preliminary Survey data suggests that Indonesia's poverty rate figures indicating a sharp decline in poverty. Estimates in February 2004 using the national poverty line was 15.2 combining data from the 2002 Vietnam Household Living percent, about the same as in 2003, but far below a poverty Standards Survey (VHLSS) with trends in the growth of rate of 27.1 percent in 1999, in the immediate wake of the provincial economic activity suggest that the poverty financial crisis. A bumper harvest in July 2004 would likely headcount ratio could have fallen to around 26 percent in have had a positive impact on poverty reduction during the 2004 from 29 percent in 2002. Early, but promising year, as would a pickup in 2004 economic growth to 5.1 indications from the 2004 VHLSS suggest that poverty percent, from 4.5 percent in 2003. could have fallen even more rapidly between 2002 and 2004. Several consistency checks are still needed before a It is difficult at this stage to gauge the longer-term final figure for the poverty headcount can be announced, poverty and livelihood impact of the earthquake and around April. tsunami that hit the northern tip of Indonesia on December 26, 2004, leaving over 200,000 people dead or missing and Vietnam has also seen considerable progress in some 400,000 more still displaced in the provinces of Aceh human development. Administrative data on school and North Sumatra. While the disaster is expected to have a enrollment shows that the number of children in primary modest impact on the national economy, the immediate education is roughly stable, despite a rapid fall in the size of impact on livelihoods in Aceh has been tremendous. Some the school age population cohorts. The infant mortality rate 15 percent of Aceh's population was known to be homeless was 36.7 per 1000 life births in 1998, down from 44.4 in and displaced immediately after the disaster. While 1990. A recent update of this figure shows a fall to only 18 significant funds have been pledged for relief and in 2000. Such an extraordinary decline requires cautious reconstruction, mitigating the long-term social, economic, interpretation because the figures for 2000 are based on a and poverty impact of the disaster will depend on relief different survey with a relatively small sample size. Even funds being promptly deployed for resettlement, the omission of a few deaths could bias the results. More resuscitation of livelihoods, restoration of services and precise estimates might not be available until the next employment of the Acehnese population in the tasks of population census in 2009. Still, even taking into account reconstruction. The government finalized a recovery very large measurement errors, the hypothesis that infant strategy for Aceh at the end of the first quarter of 2005 and mortality rates have fallen very rapidly cannot be rejected. reconstruction should be underway by June 2005. Important questions that need further study include The government's new January 2005 Medium whether ethnic minorities have benefited as much from Term Development Plan signaled a strong commitment to growth as other population groups, and whether the poorest poverty reduction as one of its central priorities. The Plan population quintile has also shared in progress towards the lays out a poverty reduction strategy to reduce poverty to attainment of human development goals. Other areas of only 8.1 percent by 2009. The Plan proposes a rights-based concern relate to the potentially widening gap in living poverty reduction strategy, with three prongs: (i) creating an standards between the booming regions in the deltas and the Indonesia that is safe and peaceful; (ii) establishing justice coastal areas, and the much less dynamic uplands. and democracy for all citizens; and (iii) creating a prosperous Indonesia. Priorities for enhancing prosperity Growth has also contributed to significant and reducing poverty include: maintaining macroeconomic reductions in poverty since the late 1990s in Lao PDR, stability; creating a healthy business climate; revitalizing although absolute deprivation remains high. GDP growth agriculture and rural development; increased educational averaged 5.6 percent between 1998 to 2003, while results access and quality; improved access to better healthcare for from the recently released 2002/3 Lao Expenditure and poor families; and strengthened family and community Consumption Survey show that the incidence of poverty fell services. from 39 percent in 1997/8 to 33 percent in 2002/3, an The Medium Term Development Plan signaled the average annual decline of -3.3 percent. This progress government's intent to switch spending "away from suggests that Lao PDR is well on track in terms of meeting untargeted subsidies such as fuel subsidies to social sector the poverty Millennium Development Goal by 2015. The and infrastructure spending". Indeed, with higher world oil Survey indicates that poverty reduction was more rapid in prices, Indonesia's fuel subsidy accounted for more than its East Asia Update 12 entire development budget in 2004. Moreover, fuel percent in 2000 to 26.1 percent in 2003. (The comparable subsidies have been heavily regressive, with households in figures were 25 percent in 1997 and 32 percent in 1994.) the top decile receiving five times as much as households in Official estimates using an income-based poverty line of the lowest. The government raised fuel prices by an average US$0.61 a day report that poverty fell from 33 percent in 29 percent on March 1, 2005, increasing all fuel prices with 2000 to 30.4 percent in 2003 (Earlier years are non- the exception of household kerosene. At the $35 per barrel comparable because of changes in methodology). oil price assumed in the budget, the fuel subsidy, while still large, was cut from about Rp. 60 trillion to Rp. 40 trillion. Human development indicators for the Philippines showed more substantial progress in recent years. Annual The Government announced that the resulting Poverty Indicator Surveys (APIS) show that attendance in budgetary savings will be reallocated to social and high school (age 13-16) among the poorest 40 percent of infrastructure programs for the poor. While the fuel price hike will impact household expenditures in the short term households rose from 57 percent in 1999 to 67 percent in (primarily thorough 1.5 to 2 percentage points higher 2002; while attendance in primary school (age 6-12) rose inflation), some $1.13 billion will be reallocated to these from 89.8 percent to 91.1percent. On the health front, there social programs -- including to large programs for better was generally broad progress in prenatal care and infant health care and educational access for the poor, as well as mortality but progress has stalled in immunization coverage. rural village infrastructure development. Going forward the The Demographic Health Surveys indicate that under-5 government faces several tests. One is to continue tackling mortality rates declined from 48 to 40 per 1000 between what are still large fuel subsidies. Another is to ensure that 1998 and 2003, while infant mortality rates fell from 35 to these funds are used for designated purpose and that 29. The proportion of infant deliveries at home fell from 66 program design and targeting ensures that intended services percent in 1998 to 61 percent in 2003, with a corresponding reach the poor. Successful design and delivery of these increase in deliveries at healthcare facilities. The proportion programs will also be key to further cuts in fuel subsidies. of births assisted by a health professional increased during this period, including among deliveries at home. However New household survey data show that Mongolia's there was lack of progress on immunizations, despite the poverty incidence in 2002 was about 36 percent, based on a government's expanded program to achieve universal poverty line of about US$0.70 a day. Poverty was higher in immunization. The overall immunization coverage (of 6 rural areas (at 43 percent) than in urban areas (30 percent). main vaccines) in 2003, at 70 percent, was lower that that Poverty incidence was the lowest (around 27 percent) in the recorded in 1998 (73 percent). The percentage of children capital Ulaanbaatar, where half the population resides, and of 12-23 months who had been fully immunized before their highest (at 51 percent) in the Western region. In terms of first birthday fell from 65 percent in 1998 to 60 percent in poverty characteristics, those with completed secondary 2003. education or higher and with fewer children of their own were significantly less likely to be poor. Poverty status did not differ between male and female headed households. Natural disaster and disease risks - a new focus Living standards in rural areas are an increasing function of livestock size. The December 26 2004 earthquake and tsunami resulted in 290000 dead or missing in Indonesia, Sri Lanka, In February 2005 the government began a new India, Thailand, Seychelles, Maldives and Somalia, with cash transfer program for poor families with three or more millions affected and substantial damage to capital stock, children that would distribute Tugrug 3,000 (US$2.5) per infrastructure and environmental systems in the affected month for every school-going child with mandatory areas. The disaster has called forth an unprecedented relief immunizations. The initiative followed discussions at a and reconstruction effort from national governments, civil high level November 2004 seminar attended by the Prime society and the world community at large. It has also drawn Minister, Deputy Prime Minister, Minister of Finance, and more general attention to the problem of natural disasters as Speakers of the Parliament (and convened by the World a major ongoing source of risks for the poor, loss of life and Bank), which studied international best practices and destruction of fragile economic development gains in methods of improving the targeting of the program to those vulnerable developing economies. The December tsunami, most in need. while among the largest natural disasters, was not unique. In 1970 a cyclone killed 300000 people in Bangladesh, Continuing analysis of the 2003 Philippines Family while 242,000 died in the 1976 Tangshan earthquake in Income and Expenditure Survey (FIES) indicates that China, and 550000 in 1984 as result of drought in Ethiopia, poverty headcount rates (using country-specific poverty Sudan and Mozambique. In 2003 the world experienced lines) fell modestly between 2000 and 2003. World Bank around 700 natural disasters large and small, which caused, estimates using a consumption-based poverty line of according to insurance company estimates, around $65 US$0.72 a day (in 2003) indicate that poverty fell from 27.6 billion in economic damage of which only about $16 billion East Asia Update 13 was insured. The impact tends to be greatest on the poor in Myanmar, China and Indonesia ­ in short virtually all of developing economies, who, among other factors, tend to East Asia.5 occupy the most vulnerable areas, like flood plains, river banks, steep slopes and reclaimed land, and who lack The tsunami has focused attention on policy efforts resources for early warning before the disaster or for to better mitigate natural disaster risks and improve the rebuilding their lives after it. In the last few years events effectiveness of disaster relief and reconstruction efforts. such as the 2003 SARS crisis and the ongoing concern Among the lessons emerging from recent experience is the about avian influenza have also focused attention on major importance of integrating disaster prevention and natural mortality risks and the potential for severe economic disaster risk management as integral parts of development disruption arising from disease epidemics. plans, poverty reduction strategies and investment projects, rather than as special activities related to humanitarian emergencies. The World Bank and the US Geological Survey estimate that economic losses worldwide from Table 2. Natural Disasters 1970-2004 4 natural disasters in the 1990s could have been reduced by $280 billion if $40 billion had been invested in preventative Number Affected measures. It is estimated that the $3.15 billion spent on of Number Population flood control in China over the past four decades of the 20th Disasters / Area * ** century averted losses of about $12 billion. East Asia & Pacific 1800 2.11 3.93 Northeast (inc. Japan) 700 1.74 4.69 Much of the recent discussion has focused on Southeast Asia 744 4.88 1.65 strengthening early warning and disaster relief systems. It seems clear that a warning system aimed at multiple hazards Oceania (inc. ANZ) 356 1.20 1.67 will be much more cost efficient and sustainable than one South Asia 788 4.71 7.05 just for tsunamis, which are a low probability event. Even Latin America 1037 1.48 1.07 with early warning, though, an effective response will Africa 826 1.00 1.94 depend on strong institutional capacities at the national and, Europe/Central Asia 418 0.52 0.30 especially, at the local level. It is the communities at risk Mid.East/N. Africa 193 0.49 0.51 that have the largest stake. Since most deaths occur within European Union 359 2.15 0.10 6 hours after a disaster, strengthening preparedness at the North America 524 0.81 0.14 sub-regional and local levels for first line search and rescue, * Frequency of disasters per year per million square kilometers first aid and medical relief could go a long way in reducing of land area. ** Affected population as % total population. deaths from disasters like earthquakes and cyclones. With respect to health care, it is worth noting that despite fears that disasters will be followed by epidemics of infectious Table 2 shows that East Asia is among the areas of disease such as malaria, cholera or dengue fever, such the world more prone to natural disasters, along with South events have in fact been rare. In general resources are better Asia and parts of Latin America (in particular Central deployed for other needs, for example diseases which are America and western South America). Southeast Asian almost invariably a major problem, such as acute respiratory economies are subject to high levels of disasters relative to infections, measles and diarrhea associated with exposure, their land area, while Northeast Asia has among the highest fatigue, lack of food, humid conditions, crowding, lack of shares of the population affected by disasters. The top 15 clean water and poor sanitation in displaced persons camps.6 economies facing 3 or more hazards include (by extent of exposure) Taiwan (China), Vanuatu, Philippines, Japan, Drawing on recent experience the recent U.N. Vietnam and the Solomon islands. The top economies World Conference on Disaster Reduction set out a exposed to two or more hazards include (in addition to the Framework for Action 2005-2015 based on an integrated East Asian economies mentioned above), Hong Kong approach to disaster risk reduction. (Box 1). (China), Korea, Cambodia, Thailand, Fiji, Lao PDR, 4Source: Emergency Events Database (EM-DAT), Centre for Research on the Epidemiology of Disasters (CRED), 5World Bank (2005). Natural Disaster Hotspots: A Global International Disaster Database, (www.em-dat.net), Risk Analysis. Disaster Risk Management Series No.5. Universitie Catholique de Louvain, Brussels, Belgium. 6 Natural disasters include droughts, earthquakes, volcanoes, Debarati Guha-Sapir (2005). Background Note. Natural wind storms, floods and wave surges and tsunamis. disasters and infectious diseases: where is the evidence? Mimeo East Asia Update 14 Asia poses an important public health threat" and that "possible person-to-person transmission of H5N1 viruses is Box 1. World Conference on Disaster Reduction being investigated in several clusters of cases in Vietnam" 7 (January 18-22, 2005, Hyogo, Japan). Efforts to find a vaccine against this strain of avian Framework for Action 2005-2015 influenza have accelerated. 1. Ensure that disaster risk reduction is a national and a local priority with a strong institutional basis for implementation. The international and regional environment 2. Identify, assess and monitor disaster risks and enhance Over the last few years East Asia has experienced early warning. its most sustained period of export expansion in the last 3. Use knowledge, innovation and education to build a decade and more. As Exhibit 6 indicates, aggregate East culture of safety and resilience at all levels. Asian exports in dollar terms have grown at year on year rates of 15 percent or more since the middle of 2002, with 4. Reduce the underlying risk factors. China's exports trending above that average and those from 5. Strengthen disaster preparedness for effective response at South East Asia and the Newly Industrializing Economies all levels. (NIEs) somewhat below it. Exhibit 6 http://www.unisdr.org/wcdr/intergover/official-doc/L- East Asia - Export Growth docs/Hyogo-framework-for-action-english.pdf (US$ 3Mo. Mov. Averages - % Change Year Ago) 60 E. Asia SE Asia Avian influenza China NIEs In late June 2004, a number of countries 40 (Cambodia, China, Indonesia, Malaysia, Thailand and Vietnam) started reporting new lethal outbreaks of avian influenza A (H5N1) infection among poultry. This worrying development followed a lull when most countries reported that the earlier major outbreak of avian influenza in 20 late 2003 had been contained. From August 2004 new human cases of H5N1 were reported in Vietnam and Thailand. In particular, a likely case of human to human transmission was reported in Thailand in September. In 0 December Vietnam reported a resurgence of poultry 04 outbreaks and human cases. By early April 2005, the CDC 2001r-2001l-2001t-2001 2002r-2002l-2002t-2002 2003r-2003 2003t-2003 2004r-2004l-2004t-20Jan-2005 Ju Oc Ju Oc Jul- Ju Oc reported that "there have been 79 human cases of avian Jan- Ap Jan- Ap Jan- Ap Oc Jan- Ap influenza A (H5N1) in Vietnam (60), Thailand (17), and -20 Cambodia (2) resulting in 49 deaths". Apart from the severe economic impact of the outbreak on the poultry and rural sectors in the affected East The middle and latter months of 2004 saw a Asian countries, a key concern is that, with the infection distinct downshift in the pace of export growth in several among birds likely to have become endemic, and with East Asian economies however. While export growth human infections occurring, there is a probability of genetic remained robust through the year in economies like China reassortment between human and avian influenza virus and Thailand, in others such as Korea, Taiwan (China), genes. In this event according to the CDC "If these H5N1 Hong Kong and Philippines export growth fell from near 20 viruses gain the ability for efficient and sustained percent in the second quarter of 2004 to less than 5 percent transmission between humans, there is little preexisting in the third at quarter on quarter seasonally adjusted annual natural immunity to H5N1 infection in the human rates. The slowdown affected Malaysia and Singapore a population, and an influenza pandemic could result, with little later, in the fourth quarter. high rates of illness and death." The CDC adds that "So far, no sustained human-to-human transmission of the H5N1 virus has been identified, and no evidence for genetic 7 reassortment between human and avian influenza virus Centers for Disease Control and Prevention. Recent Avian genes has been found", but that "the epizootic outbreak in Influenza Outbreaks in Asia. April 18, 2005. http://www.cdc.gov/flu/avian/outbreaks/asia.htm East Asia Update 15 The slowdown appears to reflect several factors that are considered further in the next 3 sections of this report. First, growth in Japan and Europe slowed unexpectedly in the second half of 2004. Second, China, Table 3. International Economic Environment which has been a major source of export market growth for 2003 2004 2005 2006 other East Asian economies in recent years, undertook measures to cool domestic demand in April 2004, resulting % Change from previous year, except interest rates in a sharp ­ though likely temporary ­ slowdown in its GDP Growth demand for imports. After an extraordinary surge in the World 2.5 3.8 3.1 3.1 first quarter of 2004 (at the height of the investment boom), World (PPP Weights) 3.9 5.0 4.3 4.2 quarter on quarter import growth in seasonally adjusted OECD 1.8 3.1 2.3 2.5 terms saw little further growth in the second and third United States 3.0 4.4 3.9 3.0 quarters. Lastly there was an easing in the momentum of Japan 1.4 2.6 0.8 1.9 demand growth in global high tech markets, which, Euro Area 0.5 1.8 1.2 2.2 combined, with an inventory correction, resulted in a World Trade (Volume) slowdown in East Asian high tech production and exports. 5.6 10.3 7.7 7.7 CPI Inflation - G7 a/ 1.6 1.8 1.6 1.6 Oil Price - $/bbl On the basis of current evidence (discussed in 28.9 37.7 42.0 36.0 subsequent sections) it seems most likely that these factors - % Change 15.9 30.6 11.3 -14.3 are temporary ones rather than presaging a more protracted Non-oil Commodity downturn in the world economy. Growth in the developed Prices 10.2 17.5 4.7 -5.2 LIBOR (US$. 6 Mo.) world, for example, while down from 2004's strong pace, is 1.2 1.6 3.5 4.6 Source: World Bank DEC Prospects Group update March 2005. a/ still expected to top 3 percent in 2005, with world trade In local currency, aggregated using 1995 weights. expanding a solid 7.7 percent in real terms. (Text Table 3). Import growth in China also revived in the last quarter of The unexpected sluggishness in these two key parts 2004 and the first quarter of 2005. Indicators of a stronger of the world economy does nevertheless cast a less export trend began to emerge in some economies at the end favorable light on the near term outlook for developed world of the year and in early 2005. China's own export growth growth in a number of ways. First, the forecast for OECD remained strong in early 2005 (Exhibit 6), boosted by growth in 2005 has been trimmed to 2.3 percent from 2.6 growing competitiveness and rising market share in global percent six months ago. Second, the growth outlook is also electronics and high tech products, steel, steel products, more unbalanced, with the U.S. economy continuing to garments and textiles. Quarter on quarter export growth also contribute a disproportionate share of OECD demand rebounded in Korea and Hong Kong (China). While signs growth. But this will also make it harder to start reducing of an export rebound are more tentative in the other global macroeconomic imbalances, the U.S. current account economies so far, the best judgment at present remains that deficit in particular. Lastly weaker and more unbalanced the world and East Asian regional economies are easing OECD growth will also tend to make the global expansion from a strong recovery in the last couple of years to a phase less resilient to new shocks, for example an unexpectedly of more moderate but sustainable medium term expansion. severe rise in world long term interest rates, or further large However as later sections also discuss, the level of risks increases in oil prices. Continued and stronger policy facing the expansion are also rising. efforts to achieve more robust and sustained growth in Japan and Europe are a key priority for the world. Developed country trends Turning to the major elements of the developed world economy: Growth among the OECD countries reached 3.1 percent in 2004, a strong performance but rather less than The United States economy continued to expand at the 3.5 percent or so we (and consensus forecasters) had a robust pace in late 2004 and early 2005. Real GDP grew expected six months ago. The shortfall was principally in by around 4 percent in the third and fourth quarters of 2004, the Japanese economy which, after a strong first quarter, and could exceed that pace in the first quarter of 2005 (at unexpectedly swung to marginally negative growth for the quarter on quarter seasonally adjusted annual rates ­ saar). remainder of 2004. Growth in the Euro zone also slowed Business investment spending on equipment and software unexpectedly through the year. Improvements in underlying has been especially strong, rising at 17-18 percent rates in labor market and corporate sector conditions suggest that the last two quarters of 2004, supported by exceptionally prospects do remain favorable for some pickup in quarter on low or negative real interest rates and buoyant business quarter growth in Japan, and to some extent (and for profits, which, as a share of national income, have returned somewhat different reasons) in Europe. to previous peak levels seen in the late 1990s. Private consumer spending was also robust, rising at 4-5 percent East Asia Update 16 quarterly rates (saar) in the second half of 2004, supported unwillingness by foreigners to add to their holdings of U.S. by gradually improving employment conditions, low debt could force unexpectedly large increases in U.S. interest rates and rising equity and housing prices. Abetted interest rates, leading to a more severe decline in growth. by robust domestic demand at home and weakening demand This subject is taken up again in the discussion of capital abroad, the U.S. current account deficit rose to $666 billion markets and global imbalances later in this report. or 5.7 percent of GDP in 2004. The momentum of growth was sustained in early 2005, with robust gains in payrolls, retail sales, housing Table 4. Developed Country Interest Rates starts and capital goods orders and shipments. However, 1980- 1991 ­ 01 02 03 04 Feb 05 despite the present strength of the U.S. economy, there are 90 00 reasons to think it could face more significant headwinds Money Market Rates going forward. While the U.S. fiscal deficit remains large, USA 9.8 5.0 3.9 1.7 1.1 1.3 2.5 it is not expected to increase, its short term stimulus on Japan 6.2 2.0 0.1 0.0 0.0 0.0 0.0 aggregate demand going forward being neutral or Germany 6.5 5.2 4.4 3.3 2.3 2.0 2.1 contractionary. The renewed rise in oil prices in early 2005 Government Bond Yields puts pressure on real incomes and consumer confidence. USA 10.4 6.4 5.0 4.6 4.0 4.3 4.3 Core consumer price inflation also rose to around 2 percent Japan 6.6 3.0 1.3 1.3 1.0 1.4 1.4 in 2004 and is expected to generally trend higher in 2005 as Germany 7.7 6.1 4.7 4.6 3.8 3.8 3.7 a result of the pass through of higher oil and other Real Money Market Rates * commodity prices, the lower dollar, tighter labor markets, USA 5.4 3.0 2.2 -0.2 -1.0 -0.6 0.6 Japan 4.0 2.4 1.1 2.6 1.4 0.7 0.7 rising unit labor costs, higher capacity utilization and greater Germany 3.2 3.4 2.7 2.3 1.7 1.0 1.0 pricing power by firms. Real Government Bond Yields * Greater concern about inflationary pressure ensures USA 6.0 4.4 3.3 2.7 1.9 2.3 2.3 that the Federal Reserve will continue to raise policy interest Japan 4.3 3.4 2.4 3.9 2.4 2.1 2.1 rates, and also makes it more likely that tightening will Germany 4.3 4.2 3.1 3.6 3.2 2.6 2.6 occur more quickly and in larger steps than hitherto. Market * Deflated by year ahead GDP deflator inflation. Consensus Forecasts for 2005 inflation expectations. expectations are for the Federal Funds rate to rise from the present 2.75 percent to somewhat over 4 percent within two years. Long term bond yields and mortgage interest rates, Solid growth in Japan at the end of 2003 and in after having fallen in the second half of 2004, have been early 2004 raised hopes that the economy was finally rising in 2005, with 10 year government yields reaching 4.5 breaking free from the long stagnation that had prevailed percent by mid March, despite which they remain at since the early 1990s. These hopes appeared to be put in exceptionally low levels compared to the levels of the 1980s question once again when real GDP fell in the second and and 1990s in both nominal and real terms. (Table 4). third quarters of 2004, and achieved only muted growth of Among a number of potential explanations for the 0.5 percent (saar, revised) in the fourth. (Exhibit 7.) low level of long term interest rates, two seems to be However the underlying fundamentals of the Japanese particularly important. First, recent increases in U.S. economy appear to remain quite strong, which, together corporate profits have been so much larger than increases in with a flow of more positive economic reports in early 2005, business investment that over the last three years the buttresses hope that the recent slowdown may be temporary. corporate sector has swung from being the net borrower it Among the factors contributing to the slowdown usually is to a net lender of funds. Long rates are likely to were exports, whose growth was affected by the downturn rise as U.S. corporate borrowing requirements return to in the global high technology demand cycle, the more normal levels, although, in this scenario, the adverse appreciation of the yen and slowing growth in import effects on interest sensitive housing and consumption demand from China and other East Asian economies. demand will tend to be offset by stronger investment. The Private consumer spending also slowed. Although analysts second main factor has been a large increase in foreign mention the impact of unexpected weather related factors purchases of U.S. government securities, in part by East and an earthquake in October, as well as the impact of Asian central banks, reflecting policy efforts to stabilize higher oil prices, it is not clear that these provide an exchange rates against the dollar and the large associated buildup of foreign reserves in East Asia.8 An increased adequate explanation for the reported consumer slowdown, especially since underlying conditions remain quite favorable for consumers. Consumer confidence remains 8The swing in corporate sector lending and in foreign purchases of U.S. government securities since 2000 amount together to about 10 the U.S. fiscal deficit over this period. (IMF World Economic percentage points of GDP, more than enough to cover the rise in Outlook, April 2005). East Asia Update 17 high, supported by improving conditions in the labor More data will of course be needed to confirm whether the market. Full time employment has risen above year earlier economy really is moving out of its slow patch. levels for the first time in years, the unemployment rate is falling and the ratio of job offers to applicants rose its Growth in the Euro Area also slid over the course highest since 1992. of 2004, falling to 1.1 percent (saar) in the third quarter of 2004 and a flash estimate of 0.8 percent in the fourth. Exhibit 7 European export growth was dampened by the rise of the euro. Consumer spending also weakened, affected by OECD Real GDP Growth higher oil prices and still weak labor market conditions, (% Change on previous quarter, SAAR) reflected in slowing nominal wage growth and an uptick in 8 unemployment rates. Euro area unemployment rose to 8.9 United States percent in December, while the German unemployment rate 7 Japan rose sharply to 11.4 percent in January 2005. On a more 6 Euro Area positive note, corporate profits rebounded in 2004 (although the recovery has been smaller and later than that in the U.S. 5 and Japan), supporting a return to positive territory in business investment growth. 4 3 China ­ closely watched 2 China's economy continued to expand at a rapid 1 pace in 2004, increasing 9.5 percent, after 9.3 percent growth in 2003. Investment spending, the engine of the 0 current economic boom, grew by 17 percent in real terms, 2003 2003 2003 2003 2004 2004 2004 2004 reaching a record estimated 45 percent of GDP, while net -1 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 foreign direct investment inflows rose to $53 billion, also a -2 record. Exports rose 35 percent in dollar terms, underpinned by the ongoing creation of new production capacities, but imports grew an ever higher 36 percent, The Bank of Japan's policy of aggressive fuelled by strong demand for industrial raw materials, quantitative easing also appears to have contributed to some components and capital equipment. For the third year in a dissipation of consumers' deflationary expectations, with row, import growth in China (and Hong Kong) was the survey respondents at the end of 2004 expecting positive largest single contributor to export growth in the rest of headline CPI inflation of over 1 percent in the coming 12 emerging East Asia. As the later section on commodity months. Higher inflationary expectations mean that real markets indicates, China was a key contributor to strong interest rates in Japan are falling, a further positive for global demand growth for energy, metals and minerals, consumption. (Actual core CPI inflation has been running in pushing prices for many of these products to record levels in a range of -0.5 to 0 percent over the past year, and is nominal terms. Meanwhile, China's foreign exchange expected to move into positive territory at some point in the reserves ballooned by over $200 billion. This was the coming year. The BOJ's target is to stabilize CPI inflation at largest element in an over half trillion dollar accumulation above zero). of foreign reserves in 2004 by East Asian economies Fundamental conditions for the Japanese economy including Japan (a subject considered further in a later also appear favorable because of the improved financial section). health of the corporate sector. Corporate profits rose by Last year the authorities undertook a number of around 15 percent in 2004, the third year of growth at policy measures to avert potential economic overheating around this pace, while the ratio of current profits to sales and, in particular, to curb excessive credit growth and rose to 3.6 percent, a level not seen since the boom days of investment spending, trends which if unchecked could the late 1980s. Underpinned by healthy profits, business exacerbate excess capacity in a number of sectors, as well as investment, while sometimes erratic, has continued to add to the bad debt problems of the banking system. These expand, increasing in the second half of 2004 by 8.1 percent measures included administrative guidelines issued last from year ago levels according to the Tankan survey. April to prohibit or discourage investment and lending in Consistent with arguments that underlying fundamentals over 500 sub-industries, as well as a tightening of monetary remain sound, data for January 2005 showed significant policy through higher bank reserve requirements, open improvements in industrial production, retail sales, capital market operations and a small increase in interest rates. In goods shipments, construction orders and housing starts. March this year concerns about an overheated real estate market led to an increase in the required down payment for East Asia Update 18 home loans (from 20 to 30 percent) and a 20 basis point rise easy to discern precisely how much slower. Year on year in mortgage lending rates. import growth fell from 40-50 percent rates in dollar terms in the first half of 2004 to around 30 percent in the second Exhibit 8 half. (Exhibit 8). In February 2005 imports fell to 5 percent East Asia - Import Growth below year earlier levels. This however seems to have been (US$ 3Mo. Mov. Averages - % Change Year Ago) mostly the result of an extraordinary surge in imports a year 60 earlier, at the height of the investment boom, and less a E. Asia reflection of current demand trends. As Exhibit 9 suggests, SE Asia in seasonally adjusted terms, imports were very strong in the first quarter of 2004, consolidated at somewhat lower levels China in the second and third quarters, as credit tightening and 40 NIEs administrative controls on investment took hold, and as firms which had built up inventories in the first quarter were able to slow purchases. Import growth revived in latter part of the year, running at 36 percent at an annual rate in the 20 fourth quarter of 2004, and at about 12 percent in the first quarter of 2005. Exhibit 9 0 China - Merchandise Imports Jan-20Apr-2001 01 01 (Monthly, US$ Bill.) Jul-20Oct-2001n-2002r-2002ul-20Oct-20Jan-20Apr-2003 l-20Oct-20Jan-2004r-2004ul-20Oct-20Jan-2005 02 02 03 03 03 04 04 Ja Ap J Ju Ap J 60 -20 Seasonally adjusted 50 Recent data suggest that, while these measures have had some effect in curbing credit and investment 40 spending, growth overall has remained quite robust, Not supported by accelerating export and household seasonally consumption growth, the latter fueled by solid income and 30 adjusted employment gains. GDP growth remained quite robust, running at 9.5 percent year on year in the fourth quarter of 2004 and the first quarter of 2005, only slightly below a 9.7 20 percent pace in the first half of 2004. Industrial production growth ran at 16.2 percent in the first quarter of 2005, only slightly lower than the 17.7 percent pace in the first quarter 10 of 2004. As noted, there has been a significant shift in the Jan-200Apr-2002Jul-2002Oc 2 Jan-200Apr-2003Jul-2003Oc 3 4 composition of aggregate demand. As administrative t-2002 t-2003 Jan-2004pr-200 A Jul-2004Oct-2004Jan-2005 controls and monetary tightening came into force, year on year growth in nominal investment fell from a breakneck 43 percent pace in the first quarter of 2004 to a still robust 20- We currently forecast that imports might grow 16 25 percent in the both the last quarter of 2004 and the first percent in 2005 as a whole, a healthy enough pace by cross- quarter of 2005. M2 money growth slowed from a 19 country standards, though less than half the pace of the last percent in the first quarter of 2004 to around 14 percent in few years.9 As a result the extraordinary boom in China's the first quarter of 2005. Even as investment slowed, imports from the rest of East Asia over the last three years ­ however, overall output growth was sustained by when they grew on average by 36 percent a year - is also accelerating consumption and, notably, export growth. likely to be winding down to more normal long run rates. Nominal retail sales were up 13.7 percent year on year in Exhibit 10 indicates that this downshift was already the first quarter of 2005, compared to about 17 percent in underway in the second half of last year, as year on year the first half of 2004. As noted previously, exports growth rates of China's imports from various other East remained strong with 35 percent growth in year on year Asian economies fell substantially compared to growth in dollar terms in the three months to February 2005. the first half. The more moderate pace of domestic demand growth has translated into a slower pace of import growth, 9China is estimated to have contributed almost a quarter of overall although the volatility of monthly numbers does not make it world trade growth in 2002 and 2003, and close to 15 percent in 2004. East Asia Update 19 Exhibit 11 Exhibit 10 Contributions to Export Growth China: Imports from East Asia in 8 East Asian Economies (US$. %Change year ago) 100 60 China + Hong Kong Total export growth in 8 2002 EA 8 East Asian economies 2003 50 USA % 80 Japan 2002 9.3 2004 H1 2003 13.9 40 2004 H2 2004 22.0 60 30 40 20 10 20 0 0 2002 2003 2004 * Korea Taiwan Indonesia Philippines Thailand -10 Source: IMF Directions of Trade. * Based on first 3 quarters (China) Even in such a scenario, though, it is apparent that Exhibit 11 shows the contribution that exports to the economy will need to accomplish substantial China have made in the overall export growth of 8 other adjustments and meet significant reform challenges in the East Asian economies over the last three years.10 In 2002, coming period. As noted, the recent slowing of credit and when other sources of world demand were still bogged investment growth has been principally accomplished by down in the wake of the global economic slowdown and the administrative controls, which create economic recession in the global high tech industry, exports to China inefficiencies of their own and tend to become less effective (and Hong Kong) contributed 40 percent of the meager 9.3 over time. However there remain important challenges in percent overall export growth the other 8 economies were addressing some of the underlying issues. These include able to achieve, with trade among these economies restructuring and reform of the very weak financial sector, contributing another 20 percent. China's contribution to and the incentives it has for excessive and inefficient East Asian export growth was a similar 40-41 percent in allocation of credit. Monetary and credit aggregates remain 2003, before easing to an estimated 29 percent in 2004, a under upward pressure because of large balance of result both of the slowing in Chinese import demand noted payments inflows on the current and capital account, while above, as well as stronger demand in East Asia's other real interest rates remain very low relative to the aggregate global markets. demand pressures in the economy. The appropriate policy As noted, the recent flow of data sometimes points response under these circumstances - a significant tightening in contradictory directions, leaving a good deal of of monetary policy - is however hampered by the present uncertainty about the direction of the next stage of the exchange rate link to the U.S. dollar, although the economic cycle in China. Some of the recent data - for authorities have managed to contain the impact of external example the significant reduction in credit and investment surpluses on money growth in 2004 through sterilization. growth, combined with the continuation of fast growth that As the more detailed discussion of these topics in the later now relies more on exports and private consumption ­ can section on Capital Flows and Global Imbalances indicates, be cited as evidence that the economy is heading for a "soft the authorities' decision to move over time to a more landing", that is a gradual deceleration to a more sustainable flexible exchange rate will play a critical role in and balanced growth path. The forecasts in this report, strengthening China's ability to better manage capital which see China's growth slowing to 8.3 percent this year inflows as well as to undertake a monetary policy that is and 7.5 percent in 2006, largely embody the soft-landing more robust and independent of international conditions. view. 10The 8 other economies are Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan (China), Thailand and Vietnam. East Asia Update 20 Exhibit 12 medium term strategy. As the later discussion on Adjustment in East Asia indicates, underlying trends China: Capital Formation and Growth towards population aging and urbanization are likely to 1979-2004 work in this direction in the medium to long term. In 16 46 addition policy efforts to create a strong well-diversified Gross capital formation (% of GDP; financial sector and strengthen social safety nets can also 14 44 right hand scale) help create a more favorable environment for household consumption. Finally, to sustain long term growth, 12 42 structural reforms to strengthen the efficiency of investment are also needed. 10 40 8 38 Commodity markets 6 36 High tech cycle For the global high tech industry the past year was 4 34 one of continued expansion but decelerating momentum. World semiconductor sales totaled $213 billion in 2004, a 2 32 GDP growth (%; left hand scale) 28 percent increase on 2003, exceeding the previous peak global sales of $204 billion in 2000, at the height of the pre- 0 30 recession `dot com bubble'. (Exhibit 13). Other measures of 1979 1982 1985 1988 1991 1994 1997 2000 2003 industry activity such as worldwide personal computer shipments, wireless handset sales and network server Further, the economy will also face an important revenues also saw robust growth. The momentum of cyclical adjustment even as these important policy reforms expansion began falling from around mid year however. towards creating a modern financial sector and monetary The year on year growth rate of world semiconductor sales policy framework are being implemented. The share of fell from around 40 percent in June to 15 percent by investment to GDP is estimated to have reached 45 percent. December, while the seasonally adjusted three month on Note that even though recent nominal investment growth (at three month rate of growth fell to zero or became somewhat around 20-25 percent) is much lower than it was a year ago, negative during the last few months of the year. (Exhibit it still implies a further increase in the investment to GDP 14). ratio. For that ratio to fall investment growth would have to Exhibit 13 fall below GDP growth. As Exhibit 12 indicates, investment (and growth) in China have been highly cyclical World Semiconductor Billings and large increases in the ratio of investment to GDP (for 20 (Bill US$. 3 Mo.Mov.Averages. 1/95-1/05) example in the early 1990s) have been followed by almost Asia ex Japan as % of World Sales: Asia x. JP equally large multi-year declines.11 If, then, the investment December 1995: 19.3% Japan ratio is likely to fall over the next several years for cyclical December 1998: 23.5% 16 Europe reasons, growth too will slow, although a significant offset December 2001: 33.3% January 2005: 42.7% Americas may be available if other sectors of aggregate demand accelerate. The government has already emphasized that growth should be more balanced, including more reliance on 12 consumption growth. However, a rise in net exports and the current 8 account surplus (which was already happening in late 2004, early 2005), could, if it occurred on a large scale, exacerbate trade tensions, and, by adding to the buildup of foreign 4 reserves, also complicate domestic monetary management. Creating more favorable conditions for stronger private consumption and lower household saving offer a better 0 95 59-l 96 69-l 97 79-l 98 89-l 99 99-l 00 00-l 01 10-l 02 20-l 03 30-l 04 40-l 05 11 Morris Goldstein and Nicholas Lardy. (2004). What Kind of an-J Ju an-J Ju an-J Ju an-J Ju an-J Ju an-J Ju an-J Ju an-J Ju an-J Ju an-J Ju an-J Landing for the Chinese economy? Institute for International Economics. (November.) Goldstein and Lardy find no examples of large developing countries that have attained an investment share of 40 percent, much less maintained it for any length of time. East Asia Update 21 The somewhat unexpected slowing in the pace of thus we are confident that inventory issues will not be a demand growth during the year led to a build up of excess significant factor in semiconductor sales beyond the first inventories, resulting in turn to a sharp ­ though likely quarter."12 temporary - downshift in global production and exports in the second half of 2004. This development has been a Non oil commodity markets contributing factor to the recent slowdown of East Asian After a pause in the middle of last year, dollar export growth. High tech exports from key East Asian prices for non-oil commodities turned higher, climbing 9 producers peaked at 30 percent growth in April 2004 (at a 3 percent between last August and February 2005. (Exhibit month on 3 month seasonally adjusted annual rate), falling 15). All told, the dollar index for non oil commodity prices to a contraction of 6 percent as of November. Electronics has risen over 50 percent over the course of the present exports from China held up much more strongly through the global cycle, since the start of 2002. The rally has been downturn, though, and have also picked up strongly at the underpinned by strong demand for industrial raw materials, end of the year and in early 2005. deriving from robust growth in China, other developing economies and the United States, an extended period of low interest rates and easy monetary policy in most developed Exhibit 14 economies, and the fall of the U.S. dollar against other major currencies. East Asian Exports and World Semiconductor Sales (Jan.1996-Jan.2005. % Change Year Ago) 60 Exhibit 15 Non-Oil Commodity Prices 40 (Dollar Indexes. Jan. 1996=1) East Asian 1.3 Exports Non energy 20 Food 1.1 Agr.Raw Materials 0 Metals 96 97 98 99 00 01 02 03 04 05 -20 n-aJ 69-l Ju n-aJ 79-l Ju n-aJ 89-l Ju n-aJ 99-l Ju n-aJ 00-l Ju n-aJ 10-l Ju n-aJ 20-l Ju n-aJ 30-l Ju n-aJ 40-l Ju n-aJ 0.9 -40 Semiconductor Sales 0.7 -60 0.5 Looking forward, the consensus expectation seems Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- Jan- to be that the demand slowdown and inventory correction in 96 97 98 99 00 01 02 03 04 05 the latter part of 2004 are a temporary adjustment in a continued industry expansion, rather than the start of a steep downturn such as occurred in 2001. Industry forecasts look Since last year there has however also been a to reasonably healthy positive growth rates in most perception among market participants and analysts of an segments in 2005, although at lower rates than during the increased probability that the commodity price rally could cyclical upswing of 2003 and the first part of 2004. be nearing its end because of changing economic Although it is too early to be confident, recent data has been fundamentals. The turn towards tightening U.S. monetary giving some indications that the industry adjustment may be policy is far from over and both short term policy interest bottoming out. World semiconductor sales in January rates and long term bond yields in the U.S. are generally picked up in both year on year and seasonally adjusted 3 expected to move significantly higher, which will tend to month on 3 month terms. According to the Semiconductor exert a dampening effect on both U.S. and global growth. Industry Association "The excess inventories that slowed Market participants have watched the efforts of Chinese growth in the second half of 2004 have been largely policy makers to prevent economic overheating by depleted ... excess inventories declined from $1.6 billion at the end of the third quarter to $1 billion at year end. In some 12SIA: "Global Semiconductor Sales Show Modest Sequential market segments, inventories are now below target levels, Decline in January". http://www.sia- online.org/pre_release.cfm?ID=354 East Asia Update 22 restraining domestic demand growth in China with even raw materials prices somewhat lower than the highs seen closer attention, because of the risk that an unexpectedly last year. However recent months have seen large price severe downturn in China could lead to a sharp downturn in gains for selected commodities. Coffee prices have surged demand for industrial materials. since last October due to unfavorable weather in Brazil and drought in Vietnam. Sugar prices are up about 20 percent Such concerns seem to have abated in recent since August due a two year drought in Thailand and India, months. Metals and minerals prices have been particularly lower production in Brazil, and increased use of cane in buoyant. Dollar prices for aluminum, copper and nickel ethanol production. Rice prices are up over 20 percent due rose 10-15 percent in the six months to February, while zinc to lower exports from Thailand and Vietnam. Offsetting prices surged 36 percent. At the end of February Nippon these gains among commodities exported by East Asian Steel and the Brazilian iron ore supplier CVRD settled on a economies, rising supplies have contributed to palm oil 72 percent price increase in their contract for fiscal 2005, a prices falling by over a third over the past year. deal which is expected to set the tone for contract price setting in the iron ore market this year. Underlying the buoyancy in metals market are renewed expectations of Oil markets continued strength in metals demand, in particular as it has become clearer that economic growth in China and the After a brief respite in November and December, United States is continuing at quite robust rates. This oil prices once more headed higher in the first quarter of matters because in recent years China has become the 2005, with average prices averaging almost $51 a barrel in world's largest consumer of most metals--the main March, another all time record in nominal terms.13 At this exception being nickel, where it ranks behind Japan and the level nominal prices were almost double the average United States. By 2004 China's demand for refined metals prevailing in the early part of this decade (say 2000 through made up 20 percent of the world total, having grown 15.6 2003) and approaching three time the average for most of percent per year on average over 1997-2004, contributing the 1990s (Exhibit 17). almost 60 percent of growth in overall world demand for refined metals during this period. (Exhibit 16). Metals Exhibit 17 prices are also buoyant because inventories for most metals have fallen quite sharply over the course of the past year as Monthly Average Crude Oil Price ($/bbl) a result of substantial destocking in 2004. As a result most (Jan 1990 - March 2005) metals prices are expected to reach new highs this year. 60 Exhibit 16 50 Average Sept. 1999 - World Refined Metals Consumption Sept 2003 - $26.2 (1993-2004. Mill. tonnes) 40 16 Average Jan. 1990 - 30 Aug 1999 - $18 12 20 8 10 4 09 19 n-aJ 9901-voN 19 19 p-eS 9921-luJ 9931-ya 499 59 999 00 10 400 50 r-1a 19 19 20 20 20 M M n-aJ 9951-voN 69 p-eS 9971-luJ 9981-ya r-1a M M n-aJ 0002-voN p-eS 0022-luJ 0032-ya r-2a M M n-aJ 0 1993 1995 1997 1999 2001 2003 Europe China N.America 13This reference price is an average of Brent, Dubai and West Texas Intermediate (WTI) crudes. This average has generally been Other Asia OECD Asia Latin Amer. lower than the more widely reported WTI price, which averaged over $54 in March, for example. Exceptionally strong demand for light crudes like WTI over the past year has boosted the price Most agricultural commodity markets are generally differential for light crudes over heavier crudes like Dubai. The well supplied, with overall indexes for food and agricultural WTI-Dubai differential was around $9 a barrel in March, compared to a more normal $3-4. East Asia Update 23 Viewed in real terms (relative to the U.S. consumer shock in 1973, for example. The appreciation of the euro price index) the picture is somewhat less alarming. (Exhibit and, to a lesser extent, the yen against the dollar has also 18). Although real oil prices in the first quarter of 2005 were helped offset the impact of higher dollar oil prices in those higher than in any quarter since the start of 1986, they were economies ­ in the case of the Euro zone by about a half. still much lower than during the second oil shock of 1979- 80, and, perhaps more to the point, lower than in say 1983- Finally, research finds that the economic impact of higher 85, a period when the U.S. economy experienced a strong oil depends not only on the absolute level of prices but also recovery. Thus it may not be quite so surprising that U.S. on prices relative to their own recent history. Hamilton and overall world economic growth have been able to (2003), for example, finds that it is the excess of current oil continue running at quite robust rates over the past year prices over their previous peak in recent history (for despite the recent level of oil prices. example the previous three years) that has a more significant impact on the economy.14 A plausible explanation is that a Exhibit 18 sharp oil price increase will tend to disrupt oil users' plans and activities much less if prices remain within a range that Average Real Dollar Oil Price those users have been able to adjust to in recent years. In (1970 Q1 - 2005 Q1. Constant 2004 Dollars) 100 the 1973/74 oil shock, for example, real prices more than Excess of peak price over earlier peak doubled in a single quarter, and at their peak were over 300 (in previous 3 years). Peak Previous % Change percent higher than the peak of the previous three years. 80 1973/74 $46.6 $11.4 309 (Exhibit 18). In the 1979/80 shock real prices doubled in 1979/80 $96.5 $42.3 128 two quarters and were about 130 percent above the earlier 3- 2004/05 $45.8 $32.6 41 year peak.. There has been nothing so dramatic in the recent elrraBrep$SU oil price event so far. It has taken fully three years for the 60 real oil price to double from a very low $21 a barrel (measured in constant 2004 dollars) in the fourth quarter of 2001, and current prices are also only about 40 percent 40 higher than earlier peaks in the previous three (or five) year periods. 20 Complacency would be ill-advised, though, since 3 year average of real oil further substantial increases from this point could well have price more serious economic impacts than experienced in the last 0 couple of years. A rise in prices to the $60-65 range would 0791- 2791- 4791- 6791- 8791- 0891- 2891- 4891- 6891- 8891- 0991- 2991- 4991- 6991- 8991- 0002- 2002- 4002- in real terms be about where they were in 1982, during the worst global recession of the post war era. It would be Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 double the previous peaks of recent years. Even if economies are more resilient to such prices now because of greater energy efficiency, they would still be left more There are a number of factors that help explain the vulnerable to any additional shocks that might come along, so far apparently limited impact of oil prices on economic for example a sharp rise in global interest rates generated by activity. First, as we elaborate below, the main cause of the the need for adjustment of global macroeconomic recent oil price rise has been unexpectedly robust world imbalances. Thus the risk of a global reversal and recession growth, leading to a surge in global oil demand relative to a will likely be rising more than proportionately with further tightly stretched global production capacity, which in the oil price increases. short run it is difficult to expand quickly. In this context higher oil prices serve to ration oil to those consumers and In line with most analysts the World Bank has businesses in the world who value it most highly, which will substantially raised its projections for oil prices, which are tend to put a constraint on how high global growth can go, now projected to average $42 a barrel in 2005, up from a rather than to independently push it lower, as might be the projection of $36 in 2005 six months ago. As noted, it is case with an exogenous reduction in oil supply. (Of course unexpectedly robust demand growth relative to limited short the fact that the world economy as a whole is still growing run production capacity that mostly explains the recent oil robustly will be little consolation to those consumers, price strength, and this also appears to be the main factor companies or countries that are less able to afford the higher influencing analyst and market expectations that prices will prices). remain relatively high over the next 12-24 months. As Exhibit 19 indicates, world oil consumption had been rising In addition, all developed and many developing by around 1.1 million barrels a day (mbd) in the 1990s and economies have become significantly more energy efficient over the last 3-4 decades. Oil consumption per unit of real 14 GDP among OECD economies has halved since the first oil James D. Hamilton. "What Is an Oil Shock?" Journal of Econometrics, April 2003, vol. 113, pp. 363-398. East Asia Update 24 early 2000s (falling well below that rate in recessionary 1991-2003. The International Energy Agency (IEA) also 2002). In 2004, however, with world growth surging to one projects a robust 1.8 mbd demand increase in 2005. of its strongest rates in many decades, oil demand jumped by 2.8 mbd, led by a 0.9 mbd (or 16 percent) increase in Both OPEC and non-OPEC crude oil production China, underpinned by GDP growth running at 9.5 percent, have ramped up to meet rising demand, increasing by about as well as special factors, such as severe bottlenecks at 1.9 and 1.1 mbd respectively in 2004. However, because of China's coal powered electricity power plants and in the strength of demand, the IEA estimates that margin of transportation of coal, which caused factories to install their spare production capacity in the OPEC-10 countries own oil powered generating capacity. Power sector demand (excluding Iraq) has fallen to only 0.8-1.3 mbd, compared to contributed over a third of the increase in China's oil 6-7 mbd a few years ago. Thus even as new capacity is demand in 2004. Other non-OECD (i.e. mostly developing) brought on stream, and even though the pace of new economies contributed another 1 mbd of the increase in upstream investment is now rising significantly because of 2004, also well above trend, with an 0.5 mbd increase in higher prices, the continuing strength of demand suggests U.S. demand comprising a third main contribution. the likelihood that the oil market may remain quite tight for the next 2-3 years, as well as abnormally volatile and Exhibit 19 sensitive to the threat of political, weather-related or other shocks to oil supply. (The possibility of oil supply World Oil Demand Growth disruptions due to rising political tensions between the United States and countries like Iran or Venezuela is (Million Barrels per Day) 3 unlikely to be entirely disregarded in the market). Others The recent pattern of oil futures' prices at least 2.5 U.S. seems consistent with expectations of a market that remains tight in the medium term. Futures prices have of course 2 China moved sharply higher during the first quarter alongside spot prices. (Exhibit 20.) A more interesting comparison is 1.5 between the futures price curve in late March this year against October last year, when spot and near term futures 1 prices were almost as high as today, but fell quite significantly one and two years out. Today on the other hand prices 3 months out are actually higher than the nearest 0.5 month, while prices 1, 2 and 5 years out show much less of a decline than was the case last October. 0 1991- 2000 2001 2002 2003 2004 2005 2006 Exhibit 20 -0.5 99 Source: U.S. EnergyIinformation Administration. Short-Term Energy Crude Oil Futures Prices Outlook, March 2005. 60 Looking forward, the consensus view seems to be that growth in world oil demand will ease somewhat this lerr 55 year (due to modestly lower economic growth in China and 50 at least a stabilization in the demand for oil generated by China's power sector bottlenecks, as well as somewhat barep 45 lower growth elsewhere in the world), but will remain quite strong enough to keep the market under pressure.15 The 000, 40 U.S. Energy Department's March 2005 Short Term $1 Outlook, for example, projects the increase in world oil 35 consumption falling to around 2 mbd in 2005, which 30 however would still be almost double the average pace in 1 7 13 19 25 31 37 43 49 55 61 67 73 79 85 Contract Expiration Date (in months from trading date) 15 The International Energy Agency's March 2005 Oil Market Report notes however that the outlook for oil demand from China's 10/15/2004 12/10/2004 04/22/2005 power sector is quite uncertain, and that this is one of the critical uncertainties affecting the 2005 world oil demand outlook as a whole. East Asia Update 25 Exhibit 21 in some smaller ones like Cambodia and Lao PDR, the recent commodity price moves will generally extend or Income gains/losses due to selected consolidate income losses which averaged around 1 percent commodity price changes (As % of GDP) of GDP in 2004. For the East Asian region in aggregate, as 10.0 well, the recent oil and commodity price increases are expected to cumulatively reduce income by about 1 percent 8.0 Actual & Forecast in 2004 and 2005 together. 2004 Price Changes (%): 2004 2005 2006 2005 6.0 Oil 30.6 11.3 -14.3 2006 Rice 20.3 5.2 -6.0 Trade policy developments. Edible Oils13.7 -13.6 -3.4 4.0 Iron Ore 18.6 71.5 -15.4 2005 is seeing a number of important trade policy Copper 61.1 4.7 -16.7 developments in East Asia. On January 1 2005 the 30 year Rubber 20.4 -5.3 -3.6 old system of quotas on world garment and textiles trade 2.0 was finally phased out, with significant implications for the many East Asian economies that participate in this market. 0.0 As part of the "Early Harvest Program" between China and Asean countries, tariff reductions on selected agricultural PNG products began during 2004 and will continue in 2005-06. -2.0 MongoliaMalaysiaVietnamIndonesia ChinaThailandhilippines Lao Korea Textile and Apparel Phase out P Cambodia -4.0 January 1, 2005 saw the final phasing out of the 30 year old system of quotas on world garment and textiles trade (first under the 1974 Multifiber Agreement - MFA - The economic impact of the recent and projected and then under the transitional 1995 Agreement on Textiles oil and non-oil commodity price increases are quite diverse. and Clothing). China whose exports had been most tightly With high prices being sustained for longer ­ through 2005 controlled under the quota system had been widely expected ­ than we had projected six months ago, these diverse to secure significant gains in the formerly protected markets. impacts are also expected to be sustained for longer. Early import data for 2005 from the U.S. and Europe Exhibit 21 summarizes the first order gains or losses in suggest this expectation was broadly on the mark. national income for East Asian economies due to changes in their terms of trade caused by the rise in commodity prices. In economies that export both oil and non-oil commodities Table 5 such as Papua New Guinea, Vietnam, Malaysia and U.S. MFA Imports of Textiles and Apparel ($ Bill.) Indonesia, recent price moves are likely to augment or at 1-2 1-2 least to mostly retain the income gains experienced over the 2003 2004 % 2004 2005 % last 1-2 years. Terms of trade based income gains have World 77.4 83.3 7.6 12.3 14.0 14.0 been especially important in stimulating faster growth in China 11.6 14.6 25.4 2.0 3.4 67.8 some of the smaller low income economies of the region Cambodia 1.3 1.4 15.3 0.23 0.26 10.7 such as PNG, Mongolia (where increases in copper and gold Hong Kong 3.8 4.0 3.7 0.59 0.51 -14.1 export prices have more than offset the higher cost of oil Indonesia 2.4 2.6 10.3 0.45 0.48 7.4 imports) and island economies like the Solomons. However, Korea 2.6 2.6 0.5 0.39 0.34 -12.7 the prudent macroeconomic management of such large but Malaysia 0.7 0.8 3.5 0.12 0.11 -6.0 most likely temporary windfall gains can also pose a Philippines 2.0 1.9 -5.0 0.32 0.30 -7.4 significant challenge. As discussed in more detail in the last T'wan (China) 2.2 2.1 -3.7 0.31 0.28 -7.8 October 2004 East Asia Update, the prudent course is Thailand 2.1 2.2 6.1 0.31 0.37 18.8 usually to save a significant part of the windfall gains. In Vietnam 2.5 2.7 9.5 0.36 0.43 18.8 PNG, the economy with the largest windfall gains, an India 3.2 3.6 13.1 0.59 0.74 25.3 estimated 15 percent of GDP cumulatively in 2003-05, this Source: U.S. Office of Textiles and Apparel. Major Shippers does seem to be the course adopted by the authorities. A Report cautious fiscal policy has generated a fiscal surplus, allowing a restructuring of domestic debt obligations, while externally a move to current account surplus has allowed a U.S. MFA imports of textiles and apparel from significant buildup of foreign assets in the form of foreign China rose 68 percent from a year earlier in dollar terms in exchange reserves. the first two months of 2005, up from 25 percent in 2004 as a whole. (Table 5). That compared to no growth in imports In many of the larger economies of the region like from OECD countries and about 4 percent from non OECD China, Korea, Philippines and Thailand, however, as well as East Asia Update 26 countries other than China. U.S. imports of these products cannot be shipped in a number of categories. This would from other East Asian economies such as Hong Kong, serve as an inducement for Chinese exporters to move into Korea, Malaysia, Philippines and Taiwan (China) all fell. higher niche exports leaving more basic apparel open to On the other hand Thailand and Vietnam did relatively well, cheap exporters. However, no action has been taken on this with near 20 percent increases, while Cambodia and proposal as of now. Indonesia also managed gains. Preliminary volume data for the first quarter showed imports from China up 63 percent Early Harvest and the FTA between ASEAN and China to 2.8 billion square meters. European Union textile and The past several years have seen a plethora of apparel imports from China were up also 46 percent in Euro proposals for new bilateral and regional trade arrangements terms in the first two months of 2005. involving East Asian economies. The most immediate and The impact of the MFA phase out will be perhaps influential is the November 2002 Economic determined in major part by the extent to which Chinese Cooperation Framework Agreement aimed at the exports are subject to safeguards or anti-dumping measures establishment of a free trade area by 2010 between China in the United States and the European Union.16 China's and the six original members of ASEAN, and by 2015 protocol of accession to the WTO in 2001 included a between China and the less-developed ASEAN members Textiles-Specific Safeguard Clause (TSSC). This clause (CLMV). Simulations by the ASEAN Secretariat using the allows for measures to be taken as a last resort to prevent a GTAP model suggest that the Agreement could increase sudden and sustained surge in Chinese textiles exports from ASEAN's exports to China by 48 percent and China's impeding the orderly development of trade in clothing and export to ASEAN by 55 percent, while boosting ASEAN's textiles products. It allows for such measures until 2008. A and China's GDP by 0.9 percent and 0.3 percent second provision embodied in the agreement, known as the respectively. A study by Scollay (2004) shows that each product-specific safeguard, allows WTO members to invoke ASEAN 5 country (except the Philippines) would have safeguards on behalf of most industries through 2013 higher percentage gains relative to China's gains.17 through tariff-rate quotas and higher duties if their market is The Early Harvest Program. To accelerate the disrupted. implementation of the Framework Agreement, China and In April the U.S. government initiated the China ASEAN agreed to first carry out an "early harvest package" textile safeguard process to determine whether the U.S. over three years (2004-2006). During this period, each market in six product categories has been disrupted by a country will cut import tariffs on selected products to surge in Chinese imports. A decision to request between 0 and 5 percent. The EHP comprises all agriculture consultations with China could be made as early as May, products under HS chapter 1-8 (mainly live animals, fish, which would automatically trigger a safeguard cap on the dairy products, live trees, vegetables, fruits and nuts), but products. Apparel purchaser industry sources say that one ASEAN countries negotiate bilaterally with China on which effect of any safeguard caps would be simply to shift products they want to exclude from this list, as well as imports to low cost suppliers not covered by the special which products they want to add. Quick progress on the safeguards, such as India, Bangladesh or Central American EHP has been facilitated by the complementary character of producers (or indeed to Chinese re-exports through China and ASEAN agricultural exports, with ASEAN countries not so covered). Also in April, the European members exporting tropical fruits and vegetables to China Union published guidelines on the conditions under which it while importing temperate ones. Trade in EHP products will consider safeguard action against imports from China. between China and the ASEAN 6 was already rising at a The guidelines establish procedures and criteria for the healthy 15 percent clip in 2000-03. objective and transparent use of safeguard proceedings, By end-2003, nine ASEAN countries except the clarifying when and on what basis action could be taken. Philippines had signed the Early Harvest Agreement. China is also limiting its own exports of low priced Thailand has taken the lead among ASEAN members in apparel to ease fears of competition around the world. Since initiating the free trade accord by phasing out all tariffs on the quotas were phased out, it has introduced a special fruits and vegetables with China starting October 2003. export tax on six different categories of products. The This bold move has resulted in great benefits. Thailand's export tax is a flat fee (of $0.02 to $0.04 per piece) that aims exports of fruits and vegetables to China increased more to discourage low price exports from China that are in price than 30 percent to from January to June 2004, accounting ranges currently being shipped from less developed for 64 percent of ASEAN's total exports. Prices of some countries, although it remains to be seen what impact it will tropical fruits imported from Thailand decreased by 50 have. There was also speculation that China might percent in Beijing, compared with the previous year, while implement a minimum export price below which products 17Scollay, Robert (2004) Regional Trade Liberalization in East 16Over 60 percent of world exports of textile and clothing go to Asia and the Asia-Pacific: The Role of China, LAEBA Working the Quad countries (US, EU, Canada, Japan). Paper no. 35. East Asia Update 27 the prices of Chinese pears and apples also fell 40-50 phases since the start of the 1990s. The first was the long percent in Thailand. emerging markets boom of the early and mid 1990s. Then Philippines has yet to conclude its negotiations large private capital inflows worth 3-4 percent of GDP a with China on EHP and has not started implementation, year helped fuel strong consumption and investment although it would not be in its interest to stay out of the demand, and a swing towards current account deficits, as EHP. Philippines is one of the largest tropical fruits well as less benign developments such as excessive risk suppliers to China, exporting more than 300 thousand taking and the buildup of corporate and financial sector metric tons of fruits to China in 2003, accounting for 30 vulnerabilities. During the subsequent financial crisis and percent of China's total fruit imports, and so would likely its aftermath in 1997-2001 (which overlaps with the benefit from easier access to the China market. Moreover, bursting of the `dot-com' bubble and the global slowdown China imports $2.5 billion worth of aquatic products and in 2000-01), capital flowed out of the region, while seafood annually, of which the Philippines has only taken a investment either fell sharply, or, as in China, grew much small portion so far. Since tariffs on these products will be less quickly than before. With depressed investment and rapidly reduced, the Philippines could expect to score imports, the regional current account swung into a large significant gains in its exports to China by joining the EHP. surplus. These surpluses were sufficient to finance the net Finally, Indonesia, Vietnam and other ASEAN countries capital outflows as well as allow a buildup of foreign also export similar agricultural and animal products to reserves. China, and Philippines could soon find it more difficult to Exhibit 22 compete with them in the Chinese market if it does not benefit from similar market access. East Asia* Balance of Payments: Overall Balance (US$ Bill.) WTO developments 350 * Excludes Hong Kong Most of the remaining East Asian countries that are 300 not WTO members are making progress towards accession. Vietnam aims to join the WTO by the end of this year, 250 although, despite good progress, many issues are still pending, not least the legal implementation agenda. In 200 November 2004, Laos obtained Normal Trade Relations from the United States. This opens up the US market to 150 Laotian exports under MFN rates (the non-NTR tariffs are 100 prohibitive); more importantly, it removes a stumbling block to Laos's accession to the WTO. The first Laos WTO 50 Working Party meeting was held in December 2004. 0 1990 1992 1994 1996 1998 2000 2002 2004 -50 International capital flows and global imbalances Emerging East Asian economies recorded an -100 overall balance of payments surplus of $312 billion in 2004, Current Account Capital Account Errors & Omissions up from about $200 billion in 2003. (This was also, by the rules of balance of payments accounting, equal to the increase in the region's foreign exchange reserves). A small The most striking feature of the last phase, 2002- part of the increase in the overall surplus was contributed by 04, is a swing back to surplus of capital inflows together an increase in the regional current account balance from with a further increase in the regional current account $148 billion in 2003 to an estimated $173 billion in 2004. surplus, an uncommon combination, especially on this scale. Much the greater part came however from a surge in the The regional overall balance has thus surged from 3.3 capital account, from only $30 billion in 2003 to $116 percent of GDP in 2001 to an estimated 9.3 percent of GDP billion in 2004.18 (Exhibit 22). in 2004. An influx of liquidity through the balance of payments in such volumes is unprecedented, even compared Before looking at recent developments a little more to the boom days of the early/mid 1990s. closely, it may be useful to glance back at "how we got here." Exhibit 23 shows there have been three distinct Table 6 provides more detail on the pattern of flows during 2002-04, breaking out groups of economies and types of flows. In China, in particular, the overall 18Hong Kong balance of payments statistics are only available balance is estimated to have soared to over 12 percent of from 1998. It was excluded from this discussion to preserve GDP, the larger part due to capital inflows. Other comparability of regional aggregates in longer term comparisons economies with large reserves increases included Malaysia over the past. East Asia Update 28 (over 18 percent of GDP), Singapore (over 10 percent), and rates in the developed economies and the efforts of Taiwan (China) and Korea (5-10 percent). Looking at the international investors to seek out higher yielding components of the overall balance, current accounts have investments ­ a so-called "push factor". This motive should risen in several economies as exports surged during this receive a natural check as U.S. short term interest rates period of global recovery, while real investment did not continue to rise and as longer rates also move higher from really gather pace till 2004. This was the case in Malaysia, their unusually depressed levels of the last 2-3 years. This Singapore and Taiwan (China). In Korea an additional is one reason why some analysts expect portfolio flows to factor was a sharp correction in consumption due to the emerging markets in 2005 to stabilize at around 2004 levels ending of a consumer credit boom. In China the current rather than mounting another large increase..19 account has risen because of a slowdown in the investment boom in the latter part of 2004, and because savings Exhibit 24 increased even faster than investment. Stock Market Indices Exhibit 23 Jan.2001-Mar.2005. (Jan. 2003=1) East Asia* Balance of Payments: Overall Balance 2.6 Indonesia Malaysia (% of GDP.) 10.0 Thailand Korea * Excludes Hong Kong 2.2 8.0 1.8 6.0 4.0 1.4 2.0 1.0 0.0 0.6 1990 1992 1994 1996 1998 2000 2002 2004 1 2 3 4 01 01 01 02 02 02 03 03 03 04 04 04 05 -2.0 20 an-J 200-rpA 20-luJ 20-tcO 20 an-J 200-rpA 20-luJ 20-tcO 20 an-J 200-rpA 20-luJ 20-tcO 20 an-J 200-rpA 20-luJ 20-tcO 20 an-J -4.0 On the other hand there are also a number of "pull Current Account Capital Account factors" attracting flows to the region. Some are related to Errors & Omissions economic fundamentals that should support a robust level of portfolio and other flows in the medium term. These include the improved macroeconomic position of many Portfolio and Other Capital Flows economies (including revived growth, reduced external debts and a very high protective buffer of foreign exchange Table 6 indicates that the main contributor to the reserves), the improved financial health of corporations and upswing on the capital account over the last two years came banks, continuing efforts (at varying rates) to improve the from portfolio investment and other lending flows, part of regulation and supervision of financial markets, and the the wider resurgence in financial capital flows to emerging deepening and improved technological and institutional markets that began in 2003 and gathered pace in 2004. Net infrastructure supporting capital markets in the region. portfolio and other flows swung from an outflow of $26 (Some of these trends are further reviewed in the discussion billion in 2002 to an inflow of $55 billion in 2004. Leaving of corporate and financial trends later in the report). out Singapore, which is itself a large net exporter of Another important `pull' factor is however likely more short portfolio and other capital, net inflows to the other term in nature, that is the perceived opportunity to make economies increased to an estimated $73 billion in 2004 speculative profits in the event of an appreciation in from -$10 billion in 2002. In absolute dollar terms by far currencies linked to the U.S. dollar like the Chinese the largest part of the capital influx went to China. renminbi and the Malaysian ringgit. However relative to GDP there were also significant increases in portfolio inflows (or swings from outflows to inflows) in Korea, Malaysia, Thailand and Indonesia. As in the early 1990s, portfolio and other capital flows have revived in part because of the very low interest 19For example: Institute of International Finance. Update on Capital Flows to Emerging Market Economies. March 31, 2005. East Asia Update 29 Table 6 ­ East Asia ­ Balance of Payments (US$ Billions) * Emerging Asia** China NIEs** ASEAN-4 2002 2003 2004 2002 2003 2004 2002 2003 2004 2002 2003 2004 Overall Balance*** 136 200 312 75 117 206 47 70 77 14 14 29 Current Account 112 148 173 35 46 69 50 70 74 26 32 29 Capital Account 24 30 116 32 53 111 1 -5 2 -10 -18 3 FDI 49 50 62 47 47 53 -2 0 4 4 2 5 Portfolio flows -11 16 24 -10 11 20 1 2 -9 -1 3 12 Other -15 -35 31 -4 -6 38 2 -6 7 -13 -21 -12 Errors & Omissions 0 22 24 8 18 27 -4 4 1 -3 0 -4 Memo: As % of GDP Overall Balance 5.0 6.6 9.3 5.8 7.9 12.5 5.1 7.0 7.1 2.8 2.5 4.6 Current Account 4.1 4.9 5.1 2.7 3.1 4.3 5.4 7.1 6.8 5.3 5.6 4.7 Capital Account 0.9 1.0 3.4 2.5 3.6 7.0 0.1 -0.5 0.2 -1.9 -3.1 0.6 FDI 1.8 1.6 1.8 3.6 3.2 3.5 -0.9 0.8 -0.2 0.8 0.4 0.8 Portfolio & other flows -0.9 -0.6 1.6 -1.1 0.4 3.9 -1.0 -3.1 -0.8 -2.7 -3.5 -0.2 * 2004 includes estimates. ** Excludes Hong Kong. *** Equals change in foreign exchange reserves. Source: IMF IFS, national sources and World Bank staff estimates. Exhibit 25 enterprises, as well as weakly developed market institutions and infrastructure). Spreads on emerging market debt have Stock Market Indices also fallen to exceptionally low levels in recent years as a Jan.2003-Mar.2005. (Jan 2003 = 1) result of the `search for yields' and the improvements in 2.1 underlying conditions in many economies. (Exhibit 26.) Philippines Singapore With rising interest rates in the developed world, the process 1.9 Hong Kong China of yield compression is likely to end, and spreads have indeed been in a range since later last year. On the other 1.7 hand a large reversal in spreads is not expected, at least for most East Asian economies, so long as the macroeconomic 1.5 position of economies remains favorable and policies are perceived as broadly prudent. 1.3 Exhibit 26 1.1 Emerging Market Spreads 1/2001 - 3/2005 0.9 900 China Malaysia 0.7 800 Thailand Indonesia Jan-200May-20Se 1 01p-200Jan-200Ma 1 2 y-2002p-2002n-200May-20Se 3 03 y-2004p-200Jan-2005 4 700 Philippines Se Ja p-200Jan-200Ma 3 4 Se 600 Recent trends in regional financial markets are 500 consistent with this picture of a somewhat conflicted transitional period, with fundamentals pulling in different 400 directions. Stock markets, which had nearly all risen during 2003, differed more widely in 2004 and early 2005. Some, 300 like Indonesia, Philippines, Singapore and Korea continued 200 to trend higher, while others, like Thailand, Malaysia and Hong Kong have been in a trading range for about a year. 100 (Exhibits 24 and 25.) (Interestingly, after a boom in the late 1990s, Chinese share prices have been sliding since 2001, 0 even as the real economy has boomed. This is attributed to 01 05 09 01 05 09 01 2003M 2004M01 09 05 09 01 a loss of confidence due to a very large overhang in the market of state-held non-tradable shares in state owned 2001M 2001M 2001M 2002M 2002M 2002M 2003M2003M05 2004M 2004M 2005M East Asia Update 30 Table 7 separates out gross FDI inflows and Foreign Direct Investment outflows for selected East Asian economies (including Hong Net foreign direct investment inflows have risen Kong for this comparison).. There are a couple of from a post crisis/post dot-com bubble low of $49 billion in interesting features. First, gross inflows rose rather more 2002 to about $62 billion in 2004 (or from $41 billion to sharply than net flows, from $73 billion in 2002 to $122 $56 billion if Hong Kong, a net FDI exporter, is included). billion in 2004. Second, gross inflows to the other As has been the case for some years, the net FDI total was economies together were comparable to those to China. Of dominated by China, which bagged $53 billion. In recent course the bulk of these other inflows were to Hong Kong years the predominance of China in net FDI flows to East and Singapore, and a significant fraction of these may no Asia has led to fears that it is diverting FDI that might doubt have been matched by outflows to other subsidiaries otherwise have gone to the other economies. Looking at net elsewhere in the region. On the other hand it is also flows can be misleading, however, since several East Asian generally accepted that FDI inflow figures for China are economies are now also significant exporters of FDI, not somewhat overstated due to `round-tripping' by indigenous least to China itself. It would theoretically be quite possible Chinese firms, as a way of exploiting the tax exemptions or for a group of countries to each have zero net FDI inflows, breaks available to foreign funded enterprises. One way to and yet have large, growing two way gross flows of FDI as get a sense of the extent of this phenomenon is to compare they become more economically integrated. Further, since Chinese data on FDI from particular countries with data the economic benefit of FDI lies less in its ability to provide from those countries of outflows to China. The latter are finance and more in its character as a source of new nearly always smaller than the former. In 2001-03, for technology and expertise, it often makes sense to look at example, data of inflows from Hong Kong, the EU, Japan gross inflows and outflows separately. Thus, while Korea's and the U.S. were about 80 percent higher than data on net FDI inflows averaged only $1 billion per year in 2002- outflows to China from those economies.20 04, its gross inflows averaged $4.7 billion (rising to $8.2 billion in 2004). Similarly while Malaysia's net inflows averaged $1.2 billion a year in this period, gross inflows Global Imbalances and East Asian Adjustment were a more robust $3.5 billion. East Asian and Japanese current account surpluses are the principal counterparts to the U.S. current account Table 7. Gross FDI Flows (US$ Bill). deficit, which reached $666 billion or 5.7 percent of GDP in 2001 2002 2003 2004 * 2004. Against this East Asian and Japanese surpluses Gross Inflows respectively totaled an estimated $189 billion and $172 billion in 2004. Leaving aside the technical ramifications of East Asia 95 73 80 122 the term, it is widely understood that this level of global China 44 49 47 56 imbalances is unsustainable in the long run. In the nature of Other Economies 51 24 33 66 the case, achieving the transition to greater global macro Korea 4 2 4 8 sustainability in a way that is less disruptive or costly for global growth will be more possible if consistent adjustment Hong Kong 24 10 14 34 efforts are jointly undertaken by all main actors in the world Singapore 15 6 11 16 economy. Taiwan (China) 4 1 0 2 It is also widely understood in broad terms what Malaysia 1 3 2 5 the direction of adjustment efforts needs to be. In the Thailand 4 1 2 1 United States the level of national savings needs to rise Gross Outflows through some combination of reducing the fiscal deficit and strengthening private savings. This will lead to a scaling East Asia -42 -34 -23 -68 back of the disproportionate contribution the U.S. has made China -7 -3 0 -3 to global aggregate demand growth in recent years and will Other Economies -35 -31 -23 -65 need to be offset by higher growth elsewhere, most notably Korea -2 -3 -3 -5 in Japan and the Euro zone, through continued efforts to reduce impediments to growth by improving structural Hong Kong -11 -17 -6 -40 policies, as well as maintaining supportive monetary Singapore -17 -4 -6 -11 conditions for business activity. Taiwan (China) -5 -5 -6 -7 Given their deep integration in the world economy Malaysia 0 -2 -1 -2 and their important role as net suppliers of savings to Thailand -0.3 -0.1 -0.5 -0.3 finance the U.S. current account deficit, emerging East *2004 contains estimates. Sources: as Table 5. Asian economies are also likely to be important actors in the 20 Min Zhao. Background Note on FDI in China. March 2005. Mimeo. East Asia Update 31 process of adjustment that lies ahead. Here it is necessary to but continue to be managed through significant Central draw a distinction between China and other East Asian Bank intervention in foreign exchange markets. There is economies. Among the NIEs and larger South East Asian clearly no single right answer to this issue. There are economies, current accounts moved into large surplus as a instead a variety of mechanisms and instruments through result of the steep fall in investment after the 1997-98 which adjustment can occur, with different costs and financial crises. Here policies to foster stronger growth and benefits that make them more or less appropriate according investment serve also to reduce external imbalances and to the different characteristics of the economies in question. support global adjustment. The remainder of this section looks at recent exchange rate The situation is more complex in China. Here one developments in the region and some of the factors that of the immediate policy challenges facing the authorities is policy makers are taking into consideration in thinking to maintain a curb on booming investment so as to avert about exchange rate policy. The section closes by looking over-heating, the build-up of over-capacity and the danger at the wider set of structural and other policies that are likely of a build-up of non-performing loans in the banking to be helpful to economies in meeting their internal and system. The authorities' ability to manage capital inflows external objectives. and cool down the economy by a significant tightening of Exhibit 27 shows that over the past three years, a monetary policy is however hampered by the present period when the U.S. dollar has fallen over 20 percent on a exchange rate approach, which entails maintaining a stable trade-weighted basis, the majority of emerging East Asian value against the U.S. dollar. In addition, a significant economies saw either no change or only a limited nominal cooling down of the investment boom, will, other things appreciation against the dollar of about 10 percent, with equal, contribute to a higher external surplus, a trend already only Korea experiencing a more significant appreciation of apparent in the sharp upturn in China's trade surplus about 20-30 percent. In real trade weighted terms most towards the end of last year. This too has given more economies experienced real depreciations over the same prominence to the option of greater exchange rate period, some of 10-20 percent. (Exhibit 28.) Only Korea flexibility, which, in the present context of significant and Indonesia saw some appreciation in real trade weighted current and capital account surpluses, would likely terms over the last three years. contribute to adjustment by reducing speculative inflows driven by expectations of currency appreciation in the short Exhibit 27 run (though experts differ on the extent to which the Exchange Rates vs. US$ renminbi is out of line with long run fundamentals). (Rise=appreciation, Jan 2002=1) 1.6 Among other policy options for managing capital Indonesia inflows that could be considered are controls on portfolio Korea and other financial capital inflows, especially short term 1.5 Philippines ones. The experience of Chile, Colombia, Malaysia and a number of other countries in the 1990s shows that measures 1.4 Thailand such as non-remunerated reserve requirements or prudential Yen limits can be quite successful in limiting the volume of 1.3 Euro inflows, especially in the short run (although the longer Taiwan (China) inflows persist the less binding such controls tend to 1.2 become.)21 In China, equalizing tax treatment of foreign and domestic investors would reduce the monetary pressure 1.1 resulting from FDI inflows. The authorities also consider relaxation of rules limiting domestic funding of foreign 1.0 invested companies, limiting the flow of funds associated China, Malaysia, Hong Kong = 1 with FDI, but not the managerial skills and technology that comes with the equity. Finally, with monetary policy 0.9 constrained by exchange rate considerations in the near 002 2 3 003 4 4 4 term, fiscal policy would have to bear more of the burden of Jan-2002pr-2 A Jul-2002Oct-200Jan-200Apr-2 Jul-2003Oct-2003Jan-200Apr-200 Jul-2004Oct-200Jan-2005 stabilizing the domestic economy. As the question of global imbalances and The counterpart of intervention by East Asian adjustment grows in prominence, discussion of the central banks to restrict the extent of currency appreciation appropriate exchange rate stance is also getting more (or to maintain exchange rate pegs) is the enormous and attention elsewhere in East Asia, both in economies like accelerated rise in the region's foreign exchange reserves Malaysia that maintain a close link to the U.S. dollar, and in over the last three years. Exhibit 29 indicates that foreign other economies with exchange rates that are more flexible reserves among the main East Asian economies had reached $1.46 trillion by December 2004, exactly double the level 21Carmen M. Reinhart and Vincent R. Rienhart. (1998). Some just three years earlier. There are of course good Lessons for Policy Makers Dealing with the Mixed Blessing of precautionary reasons to maintain adequate foreign reserves Capital Inflows. as an insurance policy against shocks or risks such as East Asia Update 32 volatility in a country's export or import prices, sudden investment have been curbed more by administrative declines in export demand, large increases in global interest controls and moral suasion, which are likely to have a rates or unexpected outflows of capital. However the level number of problematic side effects going forward. They do of reserves in most East Asian economies has generally not cure the roots of the problem, which are too low interest gone well beyond conventional benchmarks for adequacy of rates, the monetary stimulus from rising foreign reserves reserves from a precautionary standpoint, such as months and the weakness of the financial sector through which this worth of imports or the ratio of reserves to short term stimulus is translated into credit growth (although for now external debt. the central bank seems on track to meet its target of 15 Exhibit 28 percent M2 growth). The experience of such controls in other countries suggests that they tend to become more Real Effective Exchange Rate Indexes ineffective over time, and also to obstruct the adoption by (Jan. 1997 = 100) the banking system of the interest rate mechanism as the 140 principal means of allocating capital more efficiently among USA competing uses. Exhibit 29 120 East Asia - Foreign Reserves 1,600 (US$ Bill.) China China Indonesia Malaysia 100 1,400 Philippines Korea Taiwan (China) Korea Singapore Thailand Hong Kong 1,200 Increase in reserves US$ Bill.: 80 1,000 China Other Economies 5 Other Economies 2001: 47.3 21.3 (Average of Indonesia, Philippines, 800 2002: 75.5 78.8 Singapore, Taiw an (China), Thailand.) 2003: 117.0 117.0 60 2004: 206.3 129.4 1 600 11 9 7 5 3 1 11 9 7 5 3 1 11 9 7 5 3 1 90M 400 19 90M 91M 92M 93M 94M 95M 96M 97M 98M 99M 00M 01M 02M 03M 04M 05M 19 19 19 19 19 19 95M 19 19 19 19 19 20 00M 20 20 20 20 20 20 200 The key concern with the present pace of reserve accumulation is instead the implication for monetary 0 conditions and monetary policy in affected economies. A 96 96 97 97 98 98 99 99 00 00 01 01 02 02 03 03 04 04 country with a fixed exchange rate can alleviate the pressure 19- 19- 19- 19- 20- 20- 20- 20- 20- of capital inflows at least temporarily by a revaluation or re- 19-raM Sep 19-raM Sep 19-raM Sep 19-raM Sep 20-raM Sep 20-raM Sep 20-raM Sep 20-raM Sep 20-raM Sep pegging of its currency. In general, though, adjustment in an economy with a fixed exchange rate regime and an open From this perspective, the principal advantage of a capital account will occur through an alternative mechanism more flexible exchange rate regime is that it allows affecting monetary and credit aggregates. To maintain the economies to pursue an autonomous monetary policy by exchange rate peg in the face of capital inflows, the central insulating the money supply, credit and the banking system bank must buy foreign exchange in return for local from balance of payments inflows. Why then have the currency, creating an expansion in the domestic monetary majority of developing economies been so wary of using it base (for example reserves held by commercial banks at the more freely, both in the recent past and in the capital central bank). This in turn can underpin a broader inflows episode of the early/mid 1990s? The principal expansion of credit and aggregate demand. If the economy reason appears to be fear of excessive volatility or large is near full capacity the credit expansion can generate speculative swings in exchange rates that could be costly for overheating, higher inflation and an appreciation in the real the real economy, especially in developing country contexts (inflation adjusted) exchange rate, even though the nominal where markets for hedging are limited. Such considerations exchange rate remains fixed. In short the country tends to would be especially relevant for small or highly open lose control of its ability to pursue an independent monetary economies where the costs of high exchange rate volatility policy, for example as a means of offsetting adverse demand would be likely more significant.22 shocks or of undertaking countercyclical policies, which can represent a notable cost in loss of policy flexibility. In China at present, for example, the link to the 22Guillermo Calvo and Carmen Reinhart. (2000). Fear of floating. U.S. dollar makes it harder to use tighter monetary policy NBER Working Paper 7993. Jeffrey Frankel. (1999). No single and higher interest rates to curb credit growth and slow currency regime is right for all countries or at all times. NBER down investment spending. Instead credit growth and Working paper 7338. East Asia Update 33 This discussion tends to confirm that the choice of paper (China, Indonesia, Korea and Thailand), short-term the right exchange rate regime will depend on the differing foreign exchange swaps (Thailand), taking overnight or structural characteristics of the economies in question. In term deposits from banks (Indonesia and Malaysia), reverse particular a fixed exchange rate may be more appropriate repos (Thailand), and raising commercial bank reserve between countries that face similar shocks and have requirements (China, which raised them from 6 to 7 percent correlated economic cycles, since a monetary policy that is in September 2003, to 7.5 percent in April 2004). appropriate for one group member will tend to be appropriate for the others as well. It would also tend to be There is some evidence that sterilization policies in more appropriate between countries with a high level of developing countries can be effective in their intended bilateral trade intensity. However, both the degree of object of controlling domestic credit aggregates, especially cyclical correlation and the bilateral trade intensity between in the short term. However their effectiveness appears to China and the United States are rather low. Thus the benefit erode over time and they can also have unwanted side to China from maintaining a stable exchange rate to the effects.24 In particular sterilization policies tend to keep dollar may be significantly outweighed by the monetary domestic rates (and spreads with international rates) higher policy difficulties imposed by the policy.23 This also than otherwise, which can attract fresh capital inflows, suggests that linking to a basket of currencies could be a leading to a need for yet more sterilization. In their study of useful contribution to greater achieving flexibility. the early/mid 1990s emerging markets capital inflows episode, Montiel and Reinhart (1999) found that the degree While central banks have intervened in foreign of monetary sterilization was associated with an increase in exchange rate markets to moderate or prevent exchange rate the volume of aggregate capital inflows, especially short appreciation, they have also increased efforts to mop up or term inflows. The size of this effect was larger in Asia than sterilize the potential expansionary impact on domestic base in Latin America.25 The experience of the 1990s also money and credit, mainly through such measures as sales of indicates that sterilization can entail sizable quasi-fiscal government or central bank securities (open market costs for the central bank on occasion, because assets held operations) or increases in commercial bank reserve as foreign exchange reserves can earn less than the central requirements. In effect central banks are trying to get "the bank has to pay as interest on liabilities it issues to sterilize best of both worlds", to manage exchange rates while also inflows, although this is not the case for most East Asian retaining control of monetary policy. Such sterilized economies at present. Sterilization through higher reserve intervention was also the most widely used policy response requirements can also have unpredictable consequences, during the emerging markets capital inflows of the acting as a tax on the banking system, which banks pass on early/mid 1990s. through higher lending rates and lower deposit rates. This can, among other things, contribute to disintermediation Table 8. Reserves and Sterilization from the banking system and a shift of deposits into the Foreign Base Money Sterilization non-bank financial sector, which is harder to supervise and Reserves Growth (%) Indicator regulate. Overall then, there is a tendency for sterilized Growth (%) (% of GDP) intervention to become more ineffective and self-defeating 2003 2004 2003 2004 2003 2004 over time. China 34.0 50.8 17.6 13.0 -1.0 6.3 This discussion suggests that, taking due account Indonesia 6.7 9.7 12.8 24.3 -0.4 -0.8 of country characteristics, greater exchange rate flexibility Korea 24.9 18.9 7.3 -4.8 3.0 5.0 can play a significant role in facilitating external adjustment Malaysia 29.8 48.9 6.9 10 6.2 17.6 in East Asia while also permitting policy makers to pursue Philippines 8.8 -3.7 9.3 4.2 0.4 -1.1 key domestic goals, principally by allowing more autonomy in monetary policy. Of course these are far from the only Singapore 14.3 12.7 3.5 5.7 7.1 10.8 policies that can assist in achieving internal and external Thailand -.3 17.2 26.5 18.2 0.1 1.8 objectives. Policies to strengthen the business investment (1) Sterilization measured as change in foreign reserves less change in base money (as % of GDP). climate are important among the majority of East Asian economies, where the domestic focus is on fostering the recovery in investment and growth, for example by Table 8 provides a broad indicator of sterilization, simplifying business regulation, reducing lack of measured as the change in foreign reserves less the change transparency and certainty about government policies and in base money (as a percentage of GDP). By this indicator policies to improve supply of infrastructure, among others. sterilization reached quite high levels in several economies Stronger investment and growth can also be fostered by in 2004, running at 5-6 percent of GDP in China and Korea continued policy efforts to strengthen the quality of and over 10 percent of GDP in Singapore and Malaysia. financial intermediation and risk diversification in the Instruments for sterilization include issues of central bank economy, by dealing with remaining bad debt problems in 23 See World Bank East Asia Update April 2004 for a more 24Reinhart and Rienhart. (1998). Op. cit. detailed discussion of how various pairs of East Asian and 25Peter Montiel and Carmen M. Reinhart. (1999). "The Dynamics developed economies rate according to these criteria. of Capital Movements to Emerging Economies During the 1990s." East Asia Update 34 the system, improving financial sector regulation and The level of non-performing loans (NPLs) supervision and, perhaps most important, fostering the continued to decline in all the economies under review. further development of broader and more diversified capital (Exhibit 30). But it is worth pointing out some markets. qualifications to this broadly positive picture. First, in This of course does not mean that policies to several economies NPLs remain high compared to other strengthen the financial sector and improve the investment regions. The median NPL ratio among these five East Asian climate are not at the center of the reform agenda in China, economies of just under 11 percent compares to median where one of the immediate tasks is to further cool down the NPL ratios of around 4 percent in the larger emerging recent investment boom. They are, but their expected market economies of Latin America and Central and Eastern benefit is at the microeconomic level, to improve the Europe, and around one percent among developed allocation and productivity of new capital outlays, by economies such as the U.S. or Western Europe. (Exhibit developing a competitive environment in which borrowing, 31). Second, asset quality problems vary considerably lending and investment decisions are made on the basis of a across types of banks. They are often more marked among realistic cost of capital determined by market determined state owned banks, whose lending decisions are more prone interest rates, and of objective forward-looking assessments to political pressures. of risk and return. The longer term solution for external imbalances is not the continuation of excessive or inefficient investment Table 7: Bank Financial Ratios but rather to create conditions where households in China Capital feel able to raise consumption and reduce present high Interest Return on Adequacy savings. In part this is likely to occur in any case, for Margins Assets Ratio demographic reasons, as the working age share of population in China peaks at somewhat above 70 percent in 2003 2004 2003 2004 2003 2004 Korea the next 5-10 years and begins a fairly sharp decline 2.8 2.6 0.7 0.9 11.2 12.1 Indonesia thereafter, while the old age dependency ratio in China is 4.6 6.4 2.6 3.5 19.4 19.4 Malaysia expected to rise by 3.5 percentage points between now and 3.0 3.0 1.2 1.6 13.7 13.8 Philippines 2020. On a cross-country basis a rise in old age dependency 3.5 3.8 1.1 0.9 15.5 16.9 Thailand of this magnitude is associated with a fall in savings rates of 2.0 2.5 0.7 1.2 13.4 11.9 well over 2 percent.26 Precautionary saving also tends to National Sources. 2004 is latest available decline as various forms of uncertainty facing the population fall. Thus urbanization, another major trend in Exhibit 30 China, tends to be associated with lower saving, as fewer people have to rely on more volatile income from Commercial Bank Non-performing Loans agriculture. Policy efforts to strengthen social safety nets (% of Total Loans) and social insurance should also foster higher consumption 25 by reducing the level of insecurity facing the population. Indonesia Korea Malaysia Cross-country evidence also demonstrates that development of the financial system can have a significant effect on 20 Philippines Thailand * raising consumption, by expanding the supply of credit to previously credit-constrained private agents, allowing households and small firms to use collateral more widely 15 and allowing more lending for housing and consumer durables. 10 Domestic trends and policy challenges 5 Recent financial sector trends and issues. Banks in the previously crisis affected economies in East Asia saw further improvements in profitability, 0 capital adequacy and asset quality during 2004, supported 2000 2001 2002 2003 2004 by robust economic growth, improved operational efficiency * Thailand increase in 2002 due to change in definition. and (in some cases) wider interest margins. (Table 9). Third, conditions since the financial crisis have led banks to broaden and diversify their asset portfolios, which 26Luis Serven, Norman Loayza and Klaus Schmidt-Hebbel. should help strengthen financial sector health on risk (1999). Saving ­ What do we know, and why do we care? World diversification principles, as well as further the financial Bank. PREM Note 28. East Asia Update 35 development of the economy as a whole, but also opens credit card lending in 2000-02 was followed by a sharp rise banks to new sources of risk which need to be carefully in delinquencies and a correction in consumer spending monitored and managed. This trend was initially fostered large enough to significantly slow the economy as a whole. by very weak loan demand among the banks' traditional But the trend of household lending and NPLs bears careful corporate customers in the aftermath of the financial crisis. watching in a number of economies. Lastly, banks have also More recently, one of the important features of the present been pushing towards more fee-based business to augment investment recovery is a turn by corporations to a much revenue, making available a wide range of fee based more diversified set of sources for corporate finance, products such as mutual funds, insurance, and mortgages. notably the increasingly sophisticated domestic corporate This trend represents both opportunities for the banking bond and equity markets in the region. system as well a greater challenge for prudent risk management. Exhibit 31 In its April 2005 Global Financial Stability Commercial Bank Non-Performing Loans Report, the IMF observes that "there is a need for faster (% of Total Loans; Medians for Regions) convergence to international best practices in supervision 16 and regulation" in Emerging Asian economies, and that among the issues warranting attention are proper enforcement of prudential regulations, supervisory 12 independence, alignment of capital adequacy requirements with the international standard, consolidated supervision, prompt corrective action provisions, effective bankruptcy arrangements and transparency. To varying degrees 8 countries in the region continue to address these issues, to follow up on tasks of financial sector restructuring and consolidation left over from the financial crisis, and to 4 Source: IMF Global Financial Stability address issues of longer term financial sector development. Report April 2005; National sources Looking at developments in individual economies: 0 · In Indonesia, bank profitability improved sharply in 2002 2003 2004 2004 due to higher loan demand, wider interest rate Latin America (6) Central/E.Europe (8) margins and growth in fee based income. However, banks USA Japan remain vulnerable to interest rate risk due to significant East Asia (5) holdings of government bonds, as well as a large duration mismatch due to the short term duration of most bank liabilities. The government conducted a series of One side effect of these developments, though, is divestments towards the end of 2004, as a result of which that banks have had strong incentives to find new customers it has now sold off majority stakes in all ex-IBRA banks. and lending opportunities. Thus in some cases banks in the region have accumulated large holdings of fixed rate · Commercial banks in Korea continued to strengthen government securities, which could however subject them to their financial positions, though concern remains over significant interest rate risk in a rising interest rate potential losses on loans to small and medium sized environment. And banks all around the region have also enterprises. NPLs at commercial banks fell to 2 percent in focused on developing their retail and consumer lending 2004 while the capital adequacy ratio rose to a business, for example housing finance, especially residential historically high 11.3 percent. The six credit card mortgages, loans for purchase of autos and other durables companies were substantially recapitalized to enable and credit cards. By improving the borrowing and lending them to write-off bad loans. As a result, they showed an choices available to the population these developments improvement in their financial performance and results make a signal contribution to consumer welfare and to during the fourth quarter. financial modernization. They should also help in the deepening of capital markets as a whole. The increase in · In Malaysia commercial bank NPLs fell significantly to the volume of residential mortgages, for example, is 10.8 percent from 13.1 percent at the end of 2003 (or to contributing to the development of mortgage-backed 6.9 percent from 8.3 percent, net of interest in suspense securities (MBS) markets. Hong Kong, Malaysia and and provisions). Bank capital adequacy remained strong, Singapore are at the forefront in this area and the MBS at close to 14 percent at the end of 2004. The absolute market in Korea is also likely to grow with the creation of volume of NPLs increased slightly in the second half of the National Mortgage Finance Corporation. However, 2004, with a substantial increase in non-performing real household debt has also been rising in many economies, and estate loans being offset by a fall in manufacturing sector with it NPLs from household lending. The most well NPLs. With the corporate sector raising a significant known and extreme case has been Korea, where surging volume of funds through equity and bond market issues, East Asia Update 36 about 75 percent of new bank lending in the last two · In the Philippines corporate profitability continues to years has gone towards real estate, auto purchase and improve. Earnings per share of listed companies rose by credit card lending. The recent increase in NPLs about 28 percent in 2004. The average return on equity associated with this lending raises a note of caution. of companies included in the MSCI Index was 11.2 percent in 2004; up from 7.8 percent in 2003. · In the Philippines, the banking sector showed a modest reduction in NPLs to 12.7 percent in 2004 from 13.6 · In Korea the sales and operating income of listed percent in 2003, in part the result of a sale of P16.4 manufacturing companies rose by 19.4 percent and 51.7 billion of NPLs by the Bank of the Philippine Islands and percent respectively for the six months to September the Rizal Commercial Banking Corporation to investment 2004. The average debt-to-equity ratio fell to 93 percent bankers under the SPV Act. Most Philippine banks at the end of September 2004 from 101 percent six remain very liquid as loan demand remains weak. months earlier. By contrast, the indebtedness of SMEs Investment in government securities has been the more remains serious. An analysis by the Bank of Korea profitable alternative for banks, and has recently grown to indicates that in 2003 almost 27 percent of manufacturing over a quarter of the asset base of key commercial banks. SMEs were not generating enough earnings to cover interest payments, up from 23 percent in 2002. Amendments to the central bank charter to improve legal protection for bank supervisors and improve the · In Thailand the profitability of publicly listed firms has framework for resolution of problem banks remain not improved markedly in the last four years. Return on passed in the legislature. equity increased from a negative figure in year 2000 to over 20 percent in 2004. Similarly, the interest coverage · In Thailand, profitability of commercial banks has ratio has increased from a negative ratio to over 3 times continued to improve in 2004 due mainly to wider during the same period. Private investment grew more interest margins and stronger loan growth. Interest than 15 percent in 2004, increasing from 13 percent of margins have widened as abundant liquidity in the GDP in 2002 to over 16 percent in 2004. financial system has enabled banks to lower deposit rates faster than lending rates. Bank lending to the business sector picked up, reflecting the resurgence of private Corporate sector policies and restructuring investment. The NPLs of private banks fell about 14 percent, despite a tightening of loan classification rules Countries also continue to make progress at during the year, although the NPL ratio still remained in a varying rates and with varying emphases on strengthening the institutional and policy framework of the corporate double-digit range. NPLs at state banks remained high at sector, as well as on corporate restructuring issues: around 28 percent. The aggregate capital adequacy ratio of Thai banks at end 2004 dipped to 11.9 percent from · Corporate debt restructuring activities in Indonesia had 13.4 percent at end 2003, but remained well above the 8.5 been completed for the most part by 2004. However, percent minimum requirement by the Bank of Thailand high-profile cases such as Asia Pulp & Paper remain (BOT). The BOT continued a series of measures to curb outstanding without clear resolution, and the country's excessive individual borrowing including limits on largest garment manufacturer, Great River International, lending relative to borrower income, higher minimum defaulted on $1.2 million bond interest payment in monthly debt service minimums and prompt revocation January 2005, raising concern over the health of of credit cards in arrears. Indonesian textile and garment industries. On the positive side of the ledger, in March 2005 Philip Morris International offered to pay as much as US$5.2 billion to Recent corporate sector trends and issues. buy the local cigarette maker Sampoerna. This is an unusual case for Indonesia where family conglomerates Trends in corporate finance are almost never willingly put up for sale; hence the deal sets a new standard and caught the market by surprise. It The financial health of the East Asian corporate also marked a positive shift in investor sentiment towards sector generally continued to improve over the course of 200427: Indonesia. If successful, the takeover price alone would exceed the previous US$4.3 billion record for annual net · In Malaysia Bank Negara reports that the return on foreign direct investment set in 1995. equity in a sample of 350 listed non-financial companies · In Korea the national assembly passed a new (which represents almost 75 percent of the total market bankruptcy law in February which is designed to simplify capitalization of Bursa Malaysia) rose to 9.1 percent in and integrate the previous multiple codes. 2004 from 8.2 percent in 2003. · In Malaysia the government began a set of reforms last April to strengthen corporate governance and 27A more systematic assessment of corporate sector finance performance at Government-linked-companies (GLCs). will be presented in the October 2005 World Bank East Asia More than 40 GLCs are listed comprising over half Update. East Asia Update 37 Malaysia's GDP. Reforms include changes in management, introduction of performance based contracts, implementation of performance indicators and separation of the functions of shareholding and policy making between different government agencies. · In Thailand the Securities Exchange Commission (SEC) has intensified efforts to improve corporate governance in a number of directions since 2004: strengthening financial disclosure standards; increasing monitoring of compliance with standards; tightening controls on misappropriation of assets through connected transactions; and raising the quality and accountability of directors. From March this year all listed company directors and senior executives are required to register, can have questionable actions evaluated by an independent Director Disciplinary Committee, and can become ineligible to be directors if they are removed from the register. There was more limited progress on corporate debt restructuring in 2004. As of September a cumulative total of Bt3.0 trillion of NPLs had been restructured by financial institutions., up modestly from Bt2.9 trillion at the end of 2003, Bt2.8 trillion at the end of 2002, and Bt 2.4 trillion at end 2001. Several factors have contributed to a slowing in the pace of corporate restructuring in Thailand since 2003. These include the lack of a voluntary debt restructuring framework since the closure of the CDRAC voluntary debt workout framework in 2003. The NPL cases outstanding are more complex. There is an increasing volume of new NPLs in state banks and re-entry NPLs are not being resolved expeditiously. Finally the Thai Asset Management Corporation (TAMC) only afforded NPLs from state owned banks and AMCs, while a sizeable proportion of NPLs in private banks are left to bilateral negotiations and court-supervised workouts. Progress in legal and judiciary reforms to promote corporate restructuring has also remained slow.28 28Further details are provided in the World Bank's Thailand Economic Monitor April, 2005. East Asia Update 38 COUNTRY SECTIONS Major Economies29 Beyond growth, these now include improving the quality of growth and the creation of a harmonious society. New areas China of policy focus include: Domestic demand is cooling down, but external · Agriculture and rural areas; including by demand keeps GDP growth high. Real fixed asset increasing productivity, improving rural investment (FAI) growth was 17.2 percent year-on-year infrastructure, and speeding up the transfer of rural (yoy) in the first quarter of 2005, which is down from 24.9 surplus labor. The latter is key for boosting rural percent in the year 2004, although up from the 15.5 percent incomes and mitigating urban-rural inequality. in the final quarter of last year. Investments are shifting · "Weak links in social development", including away from sectors previously considered as overheated such (a) education, where a new initiative aims at as steel and cement. Retail sales growth is gaining improving access in poor areas, and (b) support for momentum, although consumption growth is still likely to counties and townships in financial difficulties. lag GDP growth for the year. Tax revenues also suggest slowing in domestic demand, and trade data confirm this · Changing the role of the government, with trend. At the same time, the rising trade surplus is boosting Premier Wen Jiabao emphasizing the need to move industrial production and keeps GDP growth rate at 9.5 toward a service-oriented government that withdraws percent in the first quarter, the same as that in the fourth from attracting business and investment and quarter of 2004. intervening in production. Slower money growth indicates that external surpluses pose as of yet little risk for China's monetary policy. Money growth in the first few months of 2005 is Indonesia compatible with the 15 percent growth target for the year, Sadly, the closing days of 2004 will be and the record balance of payment surpluses seem as of yet remembered for the tragic tsunami that claimed at least 200 to pose little complications for monetary control. The thousand lives in the Indonesian Province of Aceh. authorities have announced measures encouraging capital Economically the estimated impact of the disaster, measured outflows to dampen upward pressure on the exchange rate, at replacement cost, is calculated at US$4.5 billion, although this might result in increased vulnerability down equivalent to 2.2 percentage points of national GDP or 97 the road. The authorities have also taken steps to improve percent of Aceh's GDP. Absent the recovery effort the the operations of the foreign exchange market. direct impact of the tsunami would have lowered national The macroeconomic outlook for 2005 remains GDP growth by 0.1-0.4 percent in 2005. However, favorable. Global growth is expected to slow down from its unprecedented donor support is expected to fund activities record 2004 level, but still remain robust, barring sharp that will increase growth by 0.3-0.5 percent leaving the net adjustments in the dollar, global interest rates, and oil impact close to zero. The government is currently laying prices. For China, we expect further easing domestic out its relief and recovery strategy with continuing broad demand growth, notably investment, on the back of limited donor support. The donors grouped in the CGI (Consultative credit growth and sliding profits. Inflation is likely to Group on Indonesia) pledged US$1.6 billion of assistance to remain within the Government's target range, whereas Aceh related activities in late January. Additional China will retain its strong fiscal and external positions. We substantial assistance is coming from private donations from project a GDP growth of 8.3 percent and inflation of 3.5 companies and NGOs. On March 26th, the government percent. released a draft 11 volume Aceh Reconstruction Masterplan. Key recommendations include (i) a new reconstruction Given the constellation of risks, prudent economic implementing agency with broad oversight authority and policies are appropriate. Domestically, risks are on the strong governance controls located in Banda Aceh (capital upside, particularly on investment. Externally, downside of Aceh province), (ii) the development of community based risks appear to dominate, largely weaker than expected solutions to restoring land tenure and housing compensation world growth and complications stemming from the large and (iii) a decision against a widely debated exclusion zone trade surplus. that would have prevented people from returning to their homes. The National People's Congress' March session confirmed a broadening of Government policy objectives. However, despite the tragic tsunami, market sentiment has been very strong as indicators continue to 29More detailed individual Country Briefs for the major improve and confidence strengthens. The Jakarta stock economies can be found at the World Bank website: exchange composite index has risen 33 percent since the http://www.worldbank.org/eapupdate/ inauguration of the new government. Other positive signs East Asia Update 39 include improving international and domestic risk The government has just submitted a revised 2005 premiums, for example, a declining yield spread over US budget to address increased expenditures and revenues treasury bonds for Indonesian international paper. In related to Aceh, the Paris Club moratorium, higher oil and response, international rating agencies raised credit ratings, fuel prices (and their impact on subsidies) as well as some for example, Fitch raised the rating from B+ to BB- in changes to macroeconomic assumptions. In this new January 2005. S&P also raised rating from B to B+ in submission the budget deficit is estimated at 0.8 percent of December 2004. In Q4 2004, the economy expanded by 6.7 GDP, an increase of 0.1 percentage points over the current percent the highest quarterly growth rate since 1997. For the 2005 budget. Expenditures related to Aceh, on budget, are full year 2004 growth was 5.1 percent above expectations estimated at Rp.11 trillion (about 1.2 billion USD). and the budget projection at 4.8 percent. Economic drivers shifted from consumption to investment with second half The Bank foresees a continuing pick up in the 2004 investment growing a striking 19 percent, while economy, with real GDP growth rising to 5.5 percent in private consumption grew by 4.4 percent and government 2005 and 6.0 percent in 2006. The pick up in GDP growth consumption declined by 2.5 percent. The investment to will be based on the current economic and investment GDP ratio rose from 18.9 percent in 2003 to 21.0 percent in momentum and a relatively supportive external economic 2004, the first time it has been over 20 percent since the environment. Indonesia's capacity utilization is historically crisis, but still well below pre-crisis levels closer to 30 high, in other words, the potential demand for investment is percent. In 2004 Indonesia also reached highs in exports and strong. Fiscal policy is beginning to evolve from imports. Goods exports and imports reached US$71 billion `macroeconomic stability through fiscal consolidation' to and US$46 billion respectively. However, a long term lack `support for higher quality growth' and more resources will of investment worsened the oil balance from ­US$2.4 be available for capital spending. However sustaining billion in 2003 to ­US$5.0 billion in 2004, although the growth beyond the current cyclical upturn will require overall oil and gas balance remained positive at US$1.6 continued reforms to the investment climate. billion, due to offsetting gas sales. With rapidly rising imports, including capital goods, the current account surplus shrank significantly to US$2.9 billion, much less than Korea US$8.1 billion in 2003. Another positive sign was the turn Led by strong export demand, Korea's economy around in net FDI to a positive US$1.0 billion, again the rebounded to a 4.6 percent real GDP growth rate in 2004, up first positive balance since the crisis. from only 3.1 percent in 2003. Growth is expected to ease to The fiscal outlook also improved especially with 4.2 percent in 2005 because of slower growth in exports of the cut in fuel subsidies. On March 1st average fuel prices IT-related products. A revival in private consumption is key were increased by 29 percent. Household kerosene prices to a sustainable and broad-based recovery in growth, but were left unchanged at Rp.700 per liter (about 7 US cents) may take time to emerge fully, as households continue to while non-kerosene prices were increased between 22-39 repair their balance sheets. percent, for example premium gasoline was increased by 33 With weak domestic demand, policy-makers percent. The 29 percent average increase in fuel prices is continue to ease macroeconomic policies. The central bank estimated to reduce fuel subsidies by Rp.20 trillion or over 2 lowered its target for the benchmark call rate by 25 basis billion USD. The government is proposing to reallocate points in August last year and again in November, sending about half these savings to maintaining the budget deficit the rate to a historical low at 3.25 percent. The government target (below 1 percent) and half to programs designed to also intends to maintain a proactive fiscal policy in 2005 by alleviate poverty especially for programs on education frontloading fiscal expenditures and by reducing income (scholarships), healthcare, and rural development. tax rates and withholding tax rates on interest and dividend According to Bank estimates, the increase in fuel prices will income. For the year, the authorities are targeting a deficit add 1.5-2 percentage points to the inflation rate. While of 1.0 percent of GDP, compared to a deficit of 0.9 percent concerns about the effectiveness of program targeting in 2004. remain, the impact on growth is expected to be positive as resources are reallocated to more productive (and less Recent economic reports showed signs of a regressive) areas such as infrastructure and social spending. bottoming out of consumer spending. In the fourth quarter The preliminary 2004 budget outcome indicates a deficit of of 2004 consumption registered positive growth for the first Rp.29 trillion (1.2 percent of GDP) with fuel subsidies at time in the past seven quarters. Nonetheless, given the size Rp.69 trillion (3 percent of GDP). This decline in the and complexity of household debt overhang, recovery in budget deficit from 2003, when it was 1.7 percent, private consumption is forecast to be slow. Household debt combined with a 13 percent increase in nominal GDP remains substantially higher than in early 1999, before the resulted in a continued improvement in the government debt credit card boom commenced. The Korean authorities and to GDP ratio which fell from 60 percent in 2003 to 54 financial institutions have moved to establish several percent in 2004. programs through which credit card debts are restructured. However, so far, a small portion of debtors have benefited from these programs. East Asia Update 40 Investment in machinery and equipment recovered and private consumption is expected to moderate to 8½ moderately in 2004 from a contraction in 2003, supported percent in 2005 and 7 percent in 2006. Public sector by a strong profit performance and high capacity utilization consumption grew by 6.6 percent in 2004, and is projected at large firms. The recovery in investment is expected to to rise by 4½ percent in 2005 and by 3 percent in 2006. continue, although at a moderate pace, due to uncertainty Private domestic investment rebounded by 15.8 percent, about the future course of external demand and consumer though from a relatively low base. After having risen in the spending, and continued balance sheet adjustments in small first half of 2004, to 124 points, the business confidence and medium sized enterprises. index (BCI) declined to 97.3 points in the fourth quarter, Korea's banking sector remains healthy. Indeed, below the 100-point threshold level, and private domestic domestic banks registered record profits, and the average investment is projected to rise more moderately; by 9¾ capital adequacy ratio also rose to a record level last year. percent in 2005 and 7 percent in 2006. Real growth in Potential losses on loans to small and medium sized public investment is projected to decline by about 11½ enterprises (SMEs), which account for about 40 percent of percent in 2005 and 6½ percent in 2006, in line with further total bank loans, are not likely to be a threat to Korea's fiscal consolidation. Inward foreign direct investment (FDI) financial system, given that a large portion of loans to almost doubled in 2004, to US$4.7 billion (RM17.9 billion), industry is collateralized by real estate and guaranteed by directed evenly to services, manufacturing, and oil and gas the government credit guarantee agencies. Meanwhile, sectors. credit card companies have been returning towards financial Merchandise exports grew by 20.8 percent in value health, thanks to capital injections from their large parent terms, supported by both higher export volumes (16.1 firms and creditor banks. percent) and prices (3.6 percent). Exports of manufactures Korea's external position has strengthened further. were bolstered by a 15.3 percent increase in the demand for Continued surpluses on both current account and capital E&E products (accounting for over 53 percent of total account have resulted in a sharp reserve accumulation, exports), while wood products, steel and metal products, as amounting to more than three times Korea's short term debt well as chemicals and chemical products also recorded outstanding. With the sharp rise in reserve levels, the robust growth. Higher oil prices caused exports of crude oil government plans to establish an investment company to rise by 36.1 percent, reflecting higher prices which which will invest a fraction of its reserves in overseas stock strengthened by 34.8 percent to an average of $40.8 per and bonds. barrel. Exports of LNG also rose sharply. Agricultural exports rose by a moderate 7.4 percent, while exports of rubber posted very strong growth (45.1 percent), supported by rising prices and higher volumes. Looking ahead, in view Malaysia of the anticipated decline in the growth of external demand The Malaysian economy expanded by 7.1 percent for E&E products and the expected decline in commodity in 2004, the highest annual rate since the crisis, but the prices (crude oil, palm oil and rubber), export growth is outlook is for more moderate growth in 2005 and 2006 of projected to moderate to 7½ percent in 2005 and to 7 around 5¼ percent. percent in 2006. Merchandise imports rose by 26.3 percent in value terms, spurred by a surge in imports of capital Manufacturing production grew by only 9.8 goods (36.1 percent), and by sharply higher imports of percent in 2004, reflecting the slowdown in global demand consumption goods (24.1 percent). Imports of intermediate in semiconductors in the second half of the year. Value- goods rose by 22 percent. Looking ahead, import growth is added in the services' sector rose by 6.7 percent, while projected to average about 6½ percent in 2005 and 6 percent mining output increased by 4.1 percent, driven by higher in 2006, in line with the anticipated lower investment and production of natural gas and crude oil. The 5 percent export growth. growth in agricultural output was underpinned by an exceptionally strong performance of the palm oil sector in Net international reserves of Bank Negara the last quarter, reflecting higher prices. The construction Malaysia rose to $73.2 billion by mid-March 2005, sector contracted by 1.9 percent, as the completion of equivalent to over 8½ months of retained imports and over 6 several large projects and sharply lower civil engineering times short-term external debt. Reserves have continued to activities more than offset sustained growth in both the be bolstered by sustained repatriation of export earnings, residential and non-residential property segments. and rising inflows of portfolio investments. Portfolio inflows surged by RM 33.1 billion, reflecting renewed Private consumption grew by 10.1 percent, spurred active foreign participation in both Malaysian equities and by a combination of income effects from continued firm debt securities. Total external debt rose by $2.8 billion to commodity prices and export earnings; wealth effects from $51.9 billion by end-2004, or 44.1 percent of GDP. improved employment prospects and healthy returns from the Kuala Lumpur Stock Exchange and higher household Following a gradual increase since early 2004 debt financing in an environment of sustained low interest through September, year-on-year consumer price inflation rates. All of these effects are expected to abate somewhat, rose sharply in the last quarter of 2004 to 2.1 percent by end-December 2004, as a result of the imposition of higher East Asia Update 41 excise duties on cigarettes and alcohol, and the reduction in apply to the financial statements for the year ending subsidies on fuel products. Average inflation edged up to December 31, 2005, were issued on financial reporting for 1.4 percent in 2004, from 1.2 percent in 2003. The increase licensed institutions to ensure compliance with international in year-on-year annual inflation continued through end- accounting standards. Finally, as at end-2004, Danaharta has February 2005, reaching 2.4 percent. Core inflation (i.e. received RM29 billion of the total expected recovery of excluding price-controlled, as well as price-volatile, items RM30.8 billion. RM23.6 billion have already been and items subject to one-off price adjustments) remained converted to cash to help retire Government bonds, and subdued in 2004, averaging 1 percent. Producer price Danaharta has redeemed 93 percent of the zero-coupon inflation rose steadily throughout 2004, to an average of 8.9 bonds with which it financed its purchase of NPLs. percent. The overall fiscal deficit of the Federal Government declined further, to 4.3 percent of GDP, Philippines reflecting the sharp decline in development expenditures (to Philippine economic performance in 2004 6.4 percent of GDP, from 10 percent of GDP in 2003. improved on a number of fronts. Real GDP growth Monetary policy was accommodative throughout 2004, but increased to 6.1 percent in 2004, the fastest in 15 years. consistent with the peg, with the BNM conducting Public sector deficits were gradually reduced amidst contractionary liquidity operations throughout the year to increasing concern about the high public debt burden. offset the expansionary impact of rising reserves. With Financial markets also strengthened through the year. ample liquidity, financial institutions were able to lower However, unemployment and inflation increased in 2004, their average lending rates (ALR) (to 5.98 percent and 8.78 percent, respectively. and rising inflation through March 2005 prompted the central bank (BSP) to raise interest rates in early April for An integrated commercial banks and finance the first time in several years. company framework (the "Bafin" framework) was established under which domestic banking groups have the Growth in 2004 was broad-based, with the service option of conducting commercial bank and finance company sector, which accounts for nearly half of economic output, business through a single lending entity that holds both growing by 7.3 percent followed by industry (5.3 percent) licenses (five out of ten finance companies merged with and agriculture (4.9 percent). The strong growth their respective commercial bank during the year). Financial performance was aided by several factors, including a performance and service quality indicators were expanded favorable external environment characterized by a to include information on profitability, productivity, and turnaround in semiconductor electronics demand, which asset quality against institutional peers. On March 23, 2005, comprises two thirds of Philippine exports, very rapid the BNM announced a new framework for the creation of export growth to China, ample liquidity in government debt investment banks to rationalize merchant banks, stock- markets in both foreign currency and peso financing, as well broking companies and discount houses within the same as record agricultural growth despite a typhoon-related banking groups, along the lines of the "Bafin" framework. agricultural slowdown in the fourth quarter. Within Finally, effective April 1, 2005, the BNM foreign exchange services, the major drivers of growth were administration rules was liberalized further, including telecommunications, business process outsourcing and increases in the limits on overseas investments, retention of tourism. Within industry, manufacturing and construction foreign currency accounts, foreign currency credit facilities, were the major drivers. Personal consumption continued to hedging, and domestic borrowing by non-resident- grow at a robust pace, boosted by double digit growth of controlled companies. Approvals were issued to five foreign remittances. In the first quarter of 2005, however, consumer stock broking firms and one global fund for establishing spending appeared to be slowing, constrained by higher oil operations in Malaysia. prices and reported weakness in agricultural production. At end-2004, total non-performing loans (NPLs) of the banking system declined to RM60.4 billion, equivalent Strong economic growth in 2004 impacted to 7.6 percent of total loans, 30while risk weighted capital in favorably on corporate earnings. The average Return on the banking system remained strong at 13.8 percent of Equity of companies included in the MSCI Index was 11.2 banking system assets. In April 2004, the BNM announced percent in 2004 up from 7.8 percent in 2003. Firms in the that the new Basel Capital Accord (Basel II) will be adopted services sector--especially, transport and telecom--led in two phases. Banking institutions would need to improvements in sales and profitability. Improving implement the Standardized Approach for credit risk by corporate profitability coupled with progress on the fiscal January 2008, while those seeking to adopt the Internal policy front buoyed the stock market to a five-year high in Ratings Based approach would have until January 2010. February 2005, aided by a surge in portfolio inflows. Meanwhile, in October 2004, revised guidelines, which will However, as of mid-April, equity prices had fallen back to January levels. 30Loans overdue more than three months, net of interest in suspense and provisions. East Asia Update 42 The pace of employment picked up in 2004, but with the current account surplus easing only slightly to an with a heavy pool of underemployed labor and new entrants estimated 3.8 percent of GDP. External commercial adding to the labor force, the growth in non-agricultural borrowing requirements of the public sector in 2005 are employment in 2004 was not sufficient to reduce the estimated at about $4-4½ billion. unemployment rate which crept up to 11.2 percent in 2004. Inflation had risen to 8.5 percent during the 12 months Two recent government global bond issues of $1 ending in March 2005. Supply shocks--most notably the billion in September 2004 and $1.5 billion in January 2005 surge in world oil prices, rising prices for selected food indicate continued market access even at long maturities-- items and power tariff adjustments late in the year--have despite downgrades of the Philippines credit rating by two contributed to the higher inflation. The BSP raised its key international credit rating agencies to three notches below policy rates in early April by 25 basis points--to 7 percent investment grade--though at a stiff price. The recent 25- for the overnight borrowing rate and 9.25 percent for the year bond issue was priced at a spread of 505 basis point overnight lending rate. spread over the 30-year U.S. Treasury bond, indicating the considerable potential in savings from lowering investor Fiscal developments during much of the past year concerns. were dominated by increasing concern about the Recently-issued official estimates indicate a sustainability of public debt trends and the financing of decline in the incidence of poverty between 2000 and 2003, public sector deficits. The national government deficit after a period of no reduction during 1997-2000. Based on declined to 3.9 percent of GDP in 2004 from 4.6 percent in annual per capita income thresholds of P12,26731 in 2003, 2003. Both expenditure and revenue exceeded the nominal the number of poor declined from 25.4 million in 2000 to targets set for the year. However, tax revenue was up only 23.5 million in 2003, or from 33 percent to 30.4 percent of P2 billion relative to program, as higher than programmed the population. Both rural and urban poverty are reported to collections at the Bureau of Customs were offset by a nearly have declined over this period: rural from 18.6 million (47.7 parallel shortfall at the Bureau of Internal Revenue. percent) to 17 million (43.6 percent); urban from 6.8 million Expenditure and revenue both fell as a share of GDP; (17.8 percent) to 6.2 million (16.5 percent).32 Inequality, as current expenditure/GDP fell by nearly 1 percent as measured by the Gini coefficient, also declined from 0.4822 personnel costs were reduced by refraining from a general to 0.4678 in the same period. wage increase for the civil service and nominal transfers to local government units (LGUs) were stabilized. The consolidated public sector deficit (CPSD) also declined to Thailand about 5 percent of GDP in 2004. While deficits in the Thailand grew by 6.1 percent in 2004, but a power sector continued to rise, they were lower than slowdown to around 5.2 percent is expected this year, programmed, in part the result of electricity tariff given adverse shocks. The rebound in tourism after the adjustments in late 2004. Lower than targeted costs to SARS scare in 2003 and a jump in public investment after acquire fixed assets for other government corporations also many years of retrenchment, helped real GDP growth to helped ease the pressure on the CPSD. Non-financial public exceed 6 percent last year despite the higher oil prices and sector debt, which increased rapidly during 2002-03, is the uncertainties of a year prior to elections. But the estimated to have stabilized at about 100 percent of GDP in tsunami, the increasing unrest in the South, further 2004. increases in oil prices and of course the recent drought Amongst the Government's tax reform proposals, have all affected household and business confidence potentially the most significant in terms of generating adversely. revenue is an increase in the value-added tax rate from 10 Inflation could be close to 4 percent this year, percent to 12 percent coupled with cutbacks in exemptions up from 2.7 percent in 2004 driven largely by increases in to the VAT. As of mid-April, the House and Senate had oil prices. Upward adjustments of domestic prices of passed different versions of a revised VAT--an adjustment gasoline and diesel this year will have the largest negative in the rate to 12 percent (House); a reduction of exemptions impact on GDP growth, given the importance of oil- but retaining the existing 10 percent rate (Senate); these bills intensity of the economy and the jump in diesel prices. need to be reconciled before the new legislation can be Retail benzene prices have been floated since October last implemented. year. The higher world oil prices are translating into a 17 percent rise in domestic benzene prices from last year. The On the external front, nominal export growth grew Government has also raised the ceiling of the retail diesel 9 percent in 2004 but this was still well below the price in February and March by THB 3.60 per liter after performance in neighboring economies, and was aided by export growth of over 40 percent to China. Coupled with strong growth in remittances and tourism, the increase in 31Income thresholds are calibrated by region. higher priced oil imports was borne relatively smoothly, 32Urban and rural estimates for 2003 exclude certain provinces. East Asia Update 43 maintaining a fixed ceiling since January last year. This External vulnerability continues to fall. In will make retail diesel oil prices this year almost 20 percent 2004, the external current account surplus fell relative to higher than that of last year, though a subsidy of THB 3 2003 but at US$7.3 billion it was equivalent to 4.5 percent per liter continues33. of GDP. The trade balance fell by more than half that of The impact of other shocks, in combination 2003, but was offset by increases in receipts of services with the oil price rise would have reduced growth by more incomes from tourism by almost US$2 billion. International in 2005, if not for large increases in public investment. reserves reached almost US$50 billion by the end of 2004 or Severe drought early this year is reducing agricultural 4.4 times of short term external debt and 6.3 months of output and hurting farm incomes and rural consumption. imports. External debt at the end of 2004 was US$51.1 The tsunami disaster in the six southern provinces in late billion, similar to that of 2003, with short-term debt December 2004 is lowering tourism receipts significantly, increasing by 1 percent of total external debt to 22.4 even if they will be in large part offset by higher percent. This year, the current account surplus may decline investments to repair the tsunami damage. The unrest in by more than $2 billion, as the trade account goes into the South is affecting negatively not only tourism but also deficit due to higher imports in line with higher total investments and economic activity there and elsewhere. investment, and growth in tourism service receipts is halved because of the impact of tsunami. Total investment will rise again due to higher growth in public investment. As the mega-infrastructure Exports receipts last year grew by 23 percent projects begin to be implemented, public investment would year-on-year largely due to price increases, but are expand at almost twice the rate of last year's 11 percent expected to slow to 15 percent this year. Prices of Thai year-on year growth. This is assuming a much slower rate of merchandise exports grew by almost 16 percent last year actual investment spending relative to what is planned at the while volume expanded by 6.2 percent. Exports of goods beginning of 2005. and services together in real terms grew by 7.8 percent in 2004, largely due to the rebound in tourist arrivals. This Private investment is projected to grow like year, export value growth is expected to decelerate. last year, but reforms and concerted efforts will be needed to Merchandise export volume growth is expected to slow sustain such growth over the medium-term. A 15 percent down as growth in world output and world imports growth in private investment is likely, in part due to Board decelerate. Export price is also projected to rise, but at a of Investment (BOI) approvals of investments over the last slower rate than last year. Thus, exports receipts will likely two years. Within that, foreign direct investment growth expand not much more than 15 percent in 2005. Tourism may slow a trifle, by a wait-and-see approach of some receipts are expected to be halved due to the tsunami and investors in respect of the Southern unrest and how that escalating Southern unrest this year. evolves given the escalation and the new trust-building initiative of the Government. In addition there are structural On the structural reform side, there is some constraints on sustained growth of private investment that progress in different areas, but a significant part of the will need to be addressed. unfinished reform agenda is yet to be implemented. The Government remains focused on its strategy to improve Preliminary findings from the Government's Thailand's competitiveness. The Cabinet has approved the `productivity and investment climate survey" (PICS) National Socio-economic Restructuring Plan proposed by highlight three major constraints to private investment. A the NESDB, which aims to promote economic growth over high proportion of the 1385 firms that were sampled by this the next 4 years by improving Thailand's overall and survey in 2004 indicate that regulatory burden, skilled labor sectoral competitiveness. The findings of the recent PICS shortage, weaknesses in infrastructure and economic will no doubt encourage a more focused choice of actions uncertainties pose major challenges for investments by to enhance competitiveness ­ maybe initially in respect of private firms in Thailand, whether foreign or domestic. the niche sectors identified by the National Their performance ­ in respect of labor productivity and Competitiveness Committee i.e. automotive, food, and total factor productivity ­ is adversely affected by these fashion, including promotion of industry clusters. constraints in the investment climate faced by firms in Transport and logistics issues are also being addressed Thailand. As a consequence, unless these constraints are more generally to support exports. addressed adequately, growth in private investment into highly productive sectors will not be sustained and both The Bank of Thailand has tightened the loan investment and productivity growth will slow down over the classification rules, including qualitative assessment of medium-term loans, raising non-performing loans (NPLs) of banks. The implementation of this rule has raised NPLs by 40 percent in state-owned banks. Though the impact on private banks has been less obvious and may have been less in reality, 33So far, the subsidy has cost the Fund is TH80 billion or 1.1 NPLs of private banks have declined approximately by 14 percent of GDP, which would rise to a total subsidy-cost of percent; nevertheless the ratios of their NPLs to total loans THB100 or 1.4 percent of GDP. still remained in a double-digits. East Asia Update 44 Progress in legal reforms, especially in The relative importance of the state sector respect of financial and corporate sectors have been slow, continues to decline. The number of SOEs transformed in but appears to be gaining new momentum. The 2004 stood at 657 following 436 in 2003. The size of these Government however has launched an ambitious program SOEs has been small, but this will change as the to revise over 300 laws that are said to be "outdated" or transformation process has now been extended to large inconsistent with the 1997 Constitution, and a SOEs. While SOEs shrunk in number, an additional 35,000 comprehensive review is in process. new businesses were registered in 2004, representing a year- on-year increase of 26 percent in number and 24 percent in registered capital. FDI commitments rose sharply in 2004 Vietnam reaching a seven year high of $4.2 billion. This includes $2.2 billion of new commitments (an increase of 38 percent During 2004 and the first quarter of 2005, the y-o-y) and $2 billion for capital expansion by existing firms. performance of the Vietnamese economy remained strong, Disbursements, including domestic borrowing by joint in spite of recurrent adverse shocks, including a serious ventures, reached $3.1 billion. outbreak of avian influenza, severe floods and droughts, a sharp rise in the price of key imported commodities, and Exports grew by 30 percent in 2004 reaching 57 market barriers for export products. Notwithstanding those percent of GDP. Crude oil exports, which account for adverse conditions, GDP growth remained above seven nearly 21 percent of total export earnings, grew 48 percent percent for the third consecutive year, and indeed in value terms but only 14 percent in volume. Non-oil accelerated to attain 7.7 percent in 2004. In the first quarter exports rose 27 percent, a strong performance given that of 2005, GDP is estimated to have risen by 7.2 percent y-o- they met unfavorable external conditions. Exports of y. The resulting improvement in living conditions has been garments faced stricter quotas in the US market, while widespread, and preliminary figures form the Vietnam shrimp exports were slapped with anti-dumping tariffs. As Household Living Standards Survey (VHLSS) 2004 indicate a consequence garment exports rose by 19 percent in 2004 a substantial decline in the poverty headcount since 2002, compared with 34 percent in 2003, while seafood exports the year of the last survey. While it is still too early to slowed to 9.2 percent from 14 percent in 2002. This year, as report a poverty rate with confidence, there is a clear quota-free trade takes effect in the garments sector, Vietnam expectation to see sustained progress towards the attainment is expected to face stiffer competition. Not being a WTO of the Vietnam Development Goals (VDGs) and other key member Vietnam would continue to face quotas, but these development outcomes. would be lifted for other large exporters. However, this competition would be felt mainly in the US market as other The avian influenza outbreak in the first quarter of importers such as the EU and Canada have already lifted 2004 severely impacted the poultry sector, whereby nearly quotas on Vietnam's garment exports. An unforeseen source 17 percent of the birds had to be culled. Floods and of greater competition in the EU market stems from removal droughts further compounded problems for the agricultural of tariffs on garment imports from Tsunami-affected sector. A recovery in the sector, especially in the second competitor countries. In the first quarter of 2005, garment half of the year, resulted in agricultural value added growing exports grew by only 2.9 percent y-o-y which likely reflects by 3.5 percent in 2004. Avian influenza re-emerged in the not only tougher external conditions, but also domestic first quarter of 2005, but thus far the outbreak has not been problems in quota allocation. Overall, exports rose by 16.2 as widespread as in 2004. Also, the country's central region percent y-o-y in the first quarter of 2005, with crude oil has been hit by drought causing damage to the coffee and growing by about 30 percent y-o-y. rice crops. Vietnam's turning-point WTO offer discussed in The value of industrial production grew by 16 Geneva in June 2004 paved the way for the critical phase of percent in 2004, while value added rose by 10.5 percent, bilateral market access negotiations. In WTO terminology, with manufacturing recording a rise of 10 percent. This it led to the discussion of a full "draft working party" report continued strong performance increasingly reflects the in December 2004. The accession process received a major growing strength and buoyancy of the private sector. boost with the successful completion of bilateral Private sector industrial production rose 23 percent in 2004, negotiations with the European Union in October. Thus far compared with 12 percent for the state sector, and 16 bilateral negotiations have been finalized with six trading percent for the foreign invested sector. partners. An ambitious but still attainable target for Domestic consumption and investment have been Vietnam would be to wrap up its membership negotiations strong. The retail sales index rose by 18.5 percent in 2004. by the Hong Kong Ministerial Conference in December Investment, in current prices, grew 18 percent in 2004 to 2005. reach 36.3 percent of GDP. The state share in total The trade deficit (f.o.b. basis) declined to 5.0 investment stood at 54 percent while those of the domestic percent of GDP compared with 6.4 percent in 2003. The private and foreign invested sectors were 27 percent and 19 current account deficit, which stood at 4.7 of GDP in 2003, percent respectively. is estimated to have declined to around 4.4 percent of GDP in 2004. Remittances are expected to have reached over $3 East Asia Update 45 billion in 2004 rising from $2.7 billion in 2003. The deficit Smaller Economies is mainly financed through ODA and non-debt-creating FDI inflows. Foreign exchange reserves are estimated to have Cambodia remained roughly stable at around 10 weeks of imports or $6 billion. Cambodia's robust economic performance in 2004 was driven by strong growth in three major sub-sectors: An immediate effect of the avian influenza and tourism, construction, and garments. Real GDP growth adverse weather conditions was a rise in food prices. This unexpectedly reached 6.0 percent, as compared with 5.3 shock was further fuelled by an increase in international percent in 2003. International trade also expanded, growing prices of key imports such as oil, fertilizer, cement and steel. by 10.6 percent to US $5 billion, with exports rising by 9.8 Inflation soared from 3 percent year-on-year in January percent and imports by 11.4 percent. Gross foreign 2004, to over 10 percent in September, before declining to exchange reserves reached US $782 million (2.8 months of 9.7 percent by year end. Food prices, which comprise imports). nearly half of the consumption basket, recorded a year-on- year increase of nearly 19 percent by September. A prudent Cambodia entered the new post-MFA era on macroeconomic stance, aided by the recovery in agriculture, January 1, 2005, as worldwide quotas on textiles and helped limit inflation. Calls to resort to administrative price apparel came to an end. Garment exports, which had controls were not followed. By March 2005, inflation has accounted for 85 percent of Cambodia's total exports, rose trended downward to 8.4 percent. A faster decline in prices by 21 percent in 2004 but are expected to contract by as has been prevented by the re-emergence of adverse much as 12 percent this year due to intense competition conditions in the agricultural sector. Barring further shocks, from China and others in the US and EU markets. Thus, inflation is expected to decline to around 6.5 percent by the despite likely surges in both tourism and construction again middle of 2005. this year, the contraction of the garment sector--coupled with continued weak growth in agriculture--is likely to cast Budgetary policy remained prudent, and the budget a pall on overall 2005 GDP growth, which is not likely to deficit actually fell to 1.4 percent of GDP in 2004, below surpass 2.6 percent. both the target of 2.2 percent and the previous year's level of 2 percent. The key reason was the strong growth in Addressing these conjunctural concerns, as well as revenues related to crude oil exports which exceeded the long-standing structural weaknesses, the government is targeted level by nearly 50 percent. Revenues from trade committed to what could be far reaching reform programs taxes came in below target as the government temporarily on private sector development and public financial removed tariffs on imports of oil products and steel. management. The government has signaled its intention to Another reason was the reduction in tariffs on ASEAN undertake trade facilitation reform and to promote the imports as part of the free trade agreement. Expenditures, private sector through a more conducive investment climate both capital and recurrent, also exceeded their budgeted by reducing formal and informal costs that hamper trade by levels by around 10 percent each. putting Cambodia at a competitive disadvantage. A number of legal instruments are also under preparation, including Credit growth accelerated to nearly 42 percent by the Customs Law, the Company Law, the Law on November 2004, but this was after inflation had begun to Commercial Arbitration, and the Law on Concessions, all of decelerate. Credit from joint stock banks rose 51 percent, which are to be enacted this year. The Government has also while that from state owned commercial banks increased by taken recent action to improve its public financial 37 percent. The rise in the growth rate of commercial bank management system by moving away from cash transactions credit coincided with a deceleration in policy lending which to greater use of the banking system for Customs duty and may have resulted from stricter regulations. The on-lending civil service salary payments. The Ministry of Economy and of domestically raised resources by the Development Finance (MEF) has moved forward with deconcentration of Assistance Fund decelerated from 45 percent in 2003 to 22 procurement processes to the line ministries, which should percent in 2004. Meanwhile, policy changes to improve the allow for a more streamlined expenditure process. Structural assessment of commercial banks' portfolio quality have reform in agriculture, however, continues to lag, despite the been announced. This includes directives to classify NPLs importance of the sector in Cambodia's economy. in line with international standards, and aligning the overall Government and donors anticipate, however, that substantial prudential regulations closer to international practice for progress on the reform agenda will be made during 2005, banking safety and soundness. based on the commitments made at the Consultative Group meeting held in December 2004, at which donors pledged US$ 504 million in aid for 2005. Unless core structural reforms are tackled, growth will continue to be narrowly based and poverty levels will continue to be stagnant. Monetary policy has been basically favorable with a stable exchange rate, though year-on-year inflation rose to a recent high of 5.6 percent in 2004. Foreign currency East Asia Update 46 deposits in commercial banks jumped by 33.3 percent in another 7 percent in 2005. Total garment exports saw a 2004, while domestic currency (riel) deposits rose by 30 marginal increase in the year to October 2004 over the percent. The banking system has continued to earn greater corresponding period year ago period, but the industry is confidence from the public after recent major structural likely to be negatively affected by the expiry of the US reform--and further reform is underway. The MEF in preferential agreement in January 2005. Total sugar coordination with the National Bank of Cambodia has production was 4 percent higher over the comparable period drafted a law on government securities, including last season but the industry faces several challenges; government bonds and other government financial namely, the loss in 2005 of preferential trade arrangements instruments, and a law on non-government securities, which with the E.U., deterioration in sugarcane quality and covers corporate bonds and equity. These two pieces of quantity from the effects of prolonged drought, the ongoing legislation are crucial for developing a functional capital non-renewal of land leases, and the unfavorable trends in market framework. world market prices. Total gold production in 2004 Fiscal performance meanwhile has continued to be increased by 15 percent over the previous year's level and a prudent with greater effort made to increase revenue by further increase is expected. improving tax administration, including enforcement actions The fiscal deficit is estimated at 4.8 percent of against tax evaders. Total revenue recovered, rising to 10.9 GDP in 2004, as a result of unanticipated spending caused percent of GDP in 2004 (as compared with 10.4 percent in by flash floods in April, as well as higher allocations for the 2003), and is expected to reach 12 percent for 2005. The legislature, health, education and the military. Medium term level of expenditure remained conservative at 17.3 percent steps to reduce the deficit include cutting the wage bill by 2 of GDP in 2004, but is expected to rise to about 18.3 percent percent to 9 percent of GDP. Total public sector debt in 2005. The overall fiscal deficit, which is largely offset by remained high at almost 50 per cent of GDP in 2003-04, ODA, is expected to level off at 6.3 percent of GDP in 2005. exceeding the government's medium-term target of 40 per cent by 2005. Fiji Lao PDR The multi-party Cabinet dispute between the ruling party, Soqosoqo Duavata ni Lewenvanua (SDL) and the Fiji Real GDP growth in Lao PDR reached 6 percent in Labour Party (FLP) was resolved in November 2004 with 2004, up from 5.3 percent in 2003. Virtually all sectors the decision by the FLP to become the official Opposition. contributed to this improved growth performance. In January 2005, Ratu Joni Madraiwiwi was sworn-in as the Agriculture and hydro-power output recovered from drought new Vice President, replacing Ratu Jope Seniloli, who last year, tourism did better following lower arrivals in 2003 resigned after being released from prison on health grounds due to the SARS-outbreak and manufacturing picked up on just after serving three months of a four-year jail sentence, the back of strong domestic demand. In addition, private for his part in the 2000 coup. In February 2005, President investment and exports performed better too. Mining sector Ratu Josefa Iloilo launched the National Year of foreign investments in copper and gold, and gold exports Forgiveness where he encouraged others to join him in contributed most of the increase in growth. Higher foreign extending his apology to the hurt in the community. Fiji direct investments in mining and hydro-power, the resulting welcomed the counsel of the United Nations to establish a jump in mineral exports and of course rapid growth in Peacebuilding Commission. Thailand, Vietnam and China is likely to keep GDP growth Economic growth in 2003 has been revised down even more buoyant this year. Growth is projected to reach 7 from 4.8 percent to 3 percent, due to lower than expected percent in 2005. performance in fishing, non-cane crops, non-food The macroeconomic situation remains stable. manufacturing, wholesale, retail and construction. The Average inflation fell to 10.5 percent in 2004, and is previous 4.7 percent growth forecast for 2004 has also been expected to reach less than 8 percent in 2005. End-of- reduced to 3.8 percent, due to lower than expected growth in period inflation rates were lower at 8.6 percent in December the transport and the social services sectors. Growth is 2004 and 7 percent in February 2005. This was made expected to fall further in 2005 and 2006, reflecting the loss possible by a large fiscal adjustment of 2 percent of GDP in of trade preferences in the sugar and garment industries. 2003/04 and by a slow but steady improvement in revenue- Inflation eased marginally to 3.3 percent in the year to collection that is in progress. Domestic credit expansion December 2004. Any upward pressure on services' prices is moderated in the last quarter of 2004. The kip has likely to be moderated by low anticipated imported strengthened to 10,300 per dollar and the external reserves inflation, with the year-end 2005 forecast for inflation at 3 have remained at the comfortable level of 3.5 months of percent. imports. With higher foreign investment and exports, the The boom in tourism, Fiji's main foreign exchange external sector will remain buoyant in 2005 and 2006. earner, continues as visitor arrivals rose by 24 percent in Nevertheless continued vigilance will be needed to 2004 from the 2003 level, and are projected to increase by sustain macroeconomic stability, especially on three fronts. East Asia Update 47 First there are significant pressures to increase the low wage ASEAN summit was hosted by Lao PDR in Vientiane in rates of public servants and this has to be managed in a November. fiscally sustainable manner. Wages are being increased gradually, albeit from very low levels and total wage bill must rise at a rate lower than actual increases in revenue. Mongolia The total wage bill is expected to rise from 4.3 percent of GDP in 2003/04 to a projected 4.5 percent in 2004/05. Mongolia's real GDP growth surged to 10.6 Second, revenue collection needs to be strengthened to percent in 2004, up from 5 percent in 2003 and the highest reverse a decline due to falling non-tax revenue and forestry in East Asia. This is attributed to several factors. Good royalties. This will require implementation of reforms to weather conditions benefited Mongolia's livestock industry strengthen tax collection (e.g. centralize customs collection, and agricultural production. Livestock grew by 10 percent to improve management of provincial large tax-payer units, reach 28 millions head of cattle, while agricultural more frequent finance ministry monitoring of provincial production rose 18.9 percent. The mining sector ­ which revenue collection and better control of the granting of tax accounts for 31.9 percent of GDP ­ benefited from the exemptions) and the adoption of new revenue measures (e.g. sustained increase of international gold and copper prices VAT, following adequate preparation). These steps are also (by 13 percent and 62 percent respectively over the 2003- important to ensure fiscal sustainability of debt-servicing 2004 period), combined with a strong increase in gold over the medium-term. Third, the commercial banks remain extraction, which reached 19 tons (equivalent to a 74.6 vulnerable to pressures to extend credit on a non- percent increase). The Boroo gold mine started production commercial basis and at a rapid pace; this has to be and contributed 7.7 tons. Robust expansion continued in the managed carefully as failure to do so will generate services sector, including transport and construction. inflationary pressures as well as contingent fiscal liabilities. Given the favorable conditions in the livestock and There was continued implementation of reforms in mining sectors, total Mongolian exports increased by 36 public expenditure management, state-enterprises, banking, percent in 2004 while imports increased by 22.3 percent, trade and the private sector. Following several years of leading to a reduction of the trade deficit from 15.7 percent diagnosis, consensus-building and several reform-actions, of GDP in 2003 to 10.4 percent in 2004. Mongolia's main the Government adopted a comprehensive five-year Public trading partners are China (47.8 percent of exports) and Expenditure Management Strengthening Program (PEMSP) Russia (33.3 percent of imports). This, combined with in February 2005. The State Audit Office (SAO) is being sustained remittances from overseas Mongolian workers, led strengthened to help with timely implementation of PEMSP. to an almost balanced current account by the end of 2004. Restructuring actions for the 4 large state-owned-enterprises With sustained capital inflows, including private investment (SOEs) were also implemented, including the sale and and official capital inflows, net international reserves rose transfer of non-core assets, albeit at a slower pace than markedly from a low US$129 million at end-2003 to originally expected. SAO audits of these SOEs have been US$182 million by January 2005. As a result, Mongolia's completed and steps have also been taken to complete freely floating exchange rate appreciated slightly against the international standard audits -- to assess changes in US dollar (increasing by 3.5 percent in 2004 to reach Tg performance. State-owned-commercial banks (SCBs) 1,209 per US$). continued to restructure under their `Governance However, inflationary pressures have re-emerged. Agreements', including the use of International Banking The Consumer Price Index (CPI) increased by 11 percent in Advisors to review credit risk assessments and credit 2004, up from a 5 percent rise the previous year. This was decisions; but the financial condition of SCBs remains partly a result of higher priced oil imports. Given the fragile. Revised regulations for better loan classification and significance of energy in the typical household consumption loan loss provisioning have been issued, while amendment basket, and in particular high heating bills because of severe to the banking law, for opening up the banking sector to and long-lasting winters, the impact of energy prices on more private institutions, is awaiting the parliament's consumer prices is of special importance in Mongolia. The approval. 35 percent increase in the prices of imported diesel and Further steps were taken for opening up the private petrol in 2004 was quickly transmitted to domestic sector and trade. The recent revision of the investment laws consumer prices. Two domestic factors also contributed to provides for equal tax incentives for local and foreign higher inflation, namely, the adjustment of administered investors, removes remaining biases favouring SOEs, and telecommunication prices, and a rapid expansion of strengthens dispute resolution and contract enforcement domestic private credit in 2004 (by 40 percent over the mechanisms. However, the legal framework still falls short previous year). In February 2005 heating and electricity of that in Vietnam and Cambodia and the Government plans prices were also adjusted upwards by 8.3 to 19.3 per cent. further improvements. In trade, steps were taken to continue To counteract this inflationary pressure the authorities implementation of the AFTA agreement and the bilateral followed a tightening monetary policy stance. Broad money trade agreement with the US following the granting of growth has been restrained (the rate of growth of M2 was normal trade relations (NTR) in November 2004. The down to 20.4 percent in 2004 compared to 49.7 percent in East Asia Update 48 2003 and was 20.4 percent in January 2005 compared to the Economic Developments. The economic recovery same period of the previous year). of 2003 was maintained in 2004, when real GDP expanded Meanwhile, fiscal deficit remained in check, even by an estimated 2.8 percent. This outcome was buoyed by though the Grand Coalition Government (formed in strong world market prices for its primary commodity September 2004) endeavored to deliver on its election exports. With oil, gold, copper, timber, vanilla and coffee campaign promises. The overall fiscal deficit was 1.5 accounting for over 70 percent of its exports, Papua New percent of GDP in 2004. General government revenues Guinea's economic fortunes remain tied to global increased by 25 percent relative to the previous year (38.6 commodity price developments. Business confidence has percent of GDP), mainly due to an increase in tax revenue begun to recover from the lengthy economic downturn (37.5 percent), supported in turn by strong tariff revenues. which saw real GDP contract at an average of 1 percent Government expenditures also increased but to a lesser annually between 1997-2002. extent (by 16.5 percent in 2004) reaching 39.7 percent of Budget management efforts emphasizing GDP. This expenditure containment was made partly at the expenditure control measures were intensified in 2004, and expense of capital expenditures, and in particular, began to bear fruit with spending largely in line with the maintenance spending. At the end of 2004, total public debt budget plan. Buoyed by windfall revenue receipts, amounted to 96 percent of GDP (64 percent in NPV terms). principally from oil, gold, copper and timber, the budgetary Most foreign loans (more than 98 percent) are concessional, outcome for 2004 was an overall surplus estimated at about implying a lower risk and cost for the Government. 1 percent of GDP, an improvement over the planned deficit One of the main election promises that the of 1.5 percent of GDP. In addition, government also Government is implementing is a Social Transfer Program. benefited from the reduction in domestic interest rates Originally, a cash transfer of approximately Tg10,000 to which further bolstered the budgetary position. Part of the each child under the age of 16 was being considered. For revenue windfall was utilized to reduce arrears from earlier fiscal reasons the program was scaled back to Tg3,000 per periods, and part to restructure domestic debt obligations child for families with three or more children whose income which were heavily skewed toward short term maturities. was below the poverty line. Other significant recent policy The current account of the balance of payments measures include a tax policy review (of the two-tier registered a surplus estimated at 4.5 percent of GDP as a corporate tax rate); an increase in the number of years in result of the preceding developments. Currency stability public school (from 10th to 11th grade); and the was maintained in 2004 with the kina appreciating by about implementation of a Government Financial Management 5 percent against the U.S. dollar. Information System (GFMIS). The Government has also announced its overall regional development strategy, which Inflation began to abate from 8.4 percent in 2003 to involves reducing the number of provinces from 22 down to an estimated 3.5 percent in 2004. These developments 6. Finally, Mongolia is one of the countries which will have facilitated a monetary easing throughout 2004, which saw to adjust following the expiration of the Multi Fiber Treasury bill yields decline from 16 percent to just under 5 Agreement (MFA) quota system in the textile sector. As a percent over the year. These levels have been maintained result, it is envisaged that most foreign invested textile through the first quarter of 2005. The external reserve activities will look to move elsewhere outside Mongolia. position which improved significantly during the first three Meanwhile, Mongolia has initiated discussions with the quarters of 2004 was maintained to year-end, when reserves United States Government on a potential Free Trade stood at about US$600 million, equivalent to about six Agreement. months of non mineral imports. During the quarter to March 2005, reserves increased slightly to about US$620 million. Papua New Guinea Medium term economic prospects have been buoyed in early 2005, following commencement of the Political Developments. The coalition government Front End Engineering Design work on the Papua New appears to have consolidated its position after a cabinet Guinea Gas Project and Government's announcement that it reshuffle in November 2004, the sixth since the government had secured financing for its equity share from Japan. assumed office in mid-2002. This was reflected in the These developments augur well for this US$2 billion relatively easy parliamentary passage of the 2005 budget in pipeline project. A parallel development which should also December. Deployment continued under the Enhanced contribute to future economic prospects is that the Cooperation Program through which Australia is to provide previously announced US$680 million Ramu Nickel project direct personnel support to Papua New Guinea to stem the with China also appears to be moving forward. long term deterioration in law and order and to strengthen economic management. A legal challenge questioning the constitutionality of this program has been brought before the Supreme Court by a provincial governor. The Supreme Court is expected to make a ruling on this matter as early as the second quarter of 2005. East Asia Update 49 Solomon Islands plantations on Guadalcanal which are expected to create up to 7000 jobs. Other investors from Malaysia, Australia, The Regional Assistance Mission to the Solomon Islands PNG, Japan and Taiwan have expressed interest in mining, (RAMSI) was invited into the country in August 2003. It fishing and fish-processing, and hotel projects. has helped restore law and order and is now supporting implementation of reforms, particularly in the public sector, and in the institutional and legal framework. A priority for RAMSI this year will be to support the provinces in Timor Leste strengthening law and justice, financial management and Since becoming independent on May 20, 2002, rural areas services. The government has invited the Timor-Leste has made solid progress in nation-building, African Caribbean Pacific ­ European Union Joint maintaining peace and unity, and restoring public services Parliamentary Assembly Fact Finding Mission to consider and private sector activity. The country now faces the assistance for rehabilitation of victims and for strengthening challenges of building on this early progress in the context the infrastructure, utilities, health and education, and of very limited human resources, embryonic institutions, a financial sectors. stagnant economy, and high levels of poverty and After a contraction of 1.6 percent in 2002, economic growth unemployment. The National Development Plan, prepared rebounded sharply to 5 percent in 2003, as a result of rising shortly before Independence, outlines Government's exports and growth in primary commodity production, development and poverty reduction objectives. A Stability construction and services. Real GDP growth is estimated at Program, announced in January 2003, highlighted the areas 3.8 percent in 2004 and is projected at 4.5 percent in 2005. of the NDP which the Government considers its immediate Inflation fell to 6.6 percent in 2004, compared to 10.1 priorities, notably improvements in governance, service percent in 2003, and is expected to remain at 6 percent in delivery in the social sectors, and job creation. 2005. Subsequent to the ratification of the Timor Sea A projected 2004 fiscal surplus of 4 percent of GDP is Treaty in March 2003, development of the Bayu-Undan oil expected to reverse to a deficit of 1.5 percent of GDP in and gas field has proceeded and liquids production began in 2005, reflecting government overspending in January 2005 April 2004. The second phase, scheduled to begin in 2006, of SI$6.5 million, due mainly to the payment of two entails piping of dry gas to Darwin, Australia, for recovery months Provincial Grants; Health and Primary school as liquefied natural gas. Although there may be some grants, Parliamentarians micro project grants and utility bills opportunities for service activities in Timor, the principal for December 2004. Public debt is projected to fall from benefit will be from the significant revenues that the project 100 percent of GDP in 2003 to 83.9 percent of GDP in is expected to generate over the next two or three decades. 2005, while public external debt is projected to shrink to In a context of historically high oil prices, Timor- 57.4 percent of GDP in 2005 since newly contracted Leste's petroleum revenues were significantly higher than concessional debt is expected to be limited. expected, increasing from US$ 41 million in 2004 to a The strengthening of the balance of payments in 2003 projected US$ 244 million in 2005 (as compared to a budget continued in 2004 as the current account surplus increased of about US$ 75 million). Medium-term projections indicate from 1.5 percent of GDP in 2003 to 5.2 percent in 2004. that petroleum revenues will remain around US$ 200 The end-2004 international reserves is projected to be million for the next four years. In the interest of prudently equivalent to 5.8 months of import cover, up by 2.2 months managing the influx of revenues, the Government has from the previous year, reflecting higher export volumes prepared a draft savings policy and associated Petroleum and world commodity prices, the modest growth in import Fund Act consistent with the Extractive Industries demand, large inflows of foreign aid, and the depreciation of Transparency Initiative (EITI), for which Timor-Leste is a the domestic currency. pilot country. Consultations over these policies and laws have been broad-based, both externally and internally, Consultations on federalization are still ongoing, with the which has contributed to the creation of a national draft federal constitution expected to be presented in consensus over principles which will determine the shape of Parliament in June 2005 for debate. At a February 2005 Timor-Leste's future. The draft savings policy and Summit, issues such as government compensation, funding Petroleum Fund Act are expected to be submitted to for reconciliation in Guadalcanal, rehabilitation plans for Parliament in April 2005, with a view to having income generating projects, infrastructure, and the ex- arrangements in place for the start of the next fiscal year. combatants program were discussed With the initiation of petroleum production, Gross Despite an encouraging economic recovery, structural National Income is rising considerably. At the same time, reforms remain critical, particularly in private sector per capita GDP is stagnating. After declining around 6 development to maximise the growth potential in the gold percent per year for two years, non-oil GDP is expected to and mining, palm oil production, and tourism sectors. have grown by 3.4 percent in 2004. This modest recovery Private investment is looking upbeat following the plans by reflects an increase in agricultural production following a New Britain Oil Palm Company to revive the palm oil East Asia Update 50 period of drought as well as a significant expansion in high. In 2001, unemployment reached 20 percent in the banking sector activity. urban areas of Dili and Baucau, compared to 5 percent Non-oil exports rose to US$ 8 million in 2004, of nationwide. Unemployment has most probably increased which US$ 7 million was coffee. Coffee exports are since then, particularly as members of the rapidly growing expected to rise somewhat in the medium term in response youth population approach working age. to higher improved marketing; other exports are growing at While some interest has been shown in concessions a higher rate but from a much lower base. for exploitation of natural resources, such as fisheries and Inflation fell below 2 percent on a year on year forestry, there has been little new investment thus far. basis in December 2004 in response to moderate domestic However, financial sector activity has expanded rapidly in demand and the continued downsizing of the international the last year. Bank deposits increased to 25 percent of GDP presence and stable non-oil import prices. Inflation is in 2004, and there was a seven-fold increase in bank lending expected to remain at around 2.5 percent on the basis of low between January 2003 and March 2004. As of January 2005, international inflation and the continued absence of the largest bank, Banco Nacional Ultramarino (BNU) held domestic demand pressures. The overall wage level remains USD 63 million in outstanding loans, representing about 19 relatively high in comparison with neighboring countries, percent of GDP. undermining competitiveness and limiting job creation for unskilled labor. At the same time, unemployment rates are East Asia Update 51 APPENDIX TABLES Appendix Table 1. Quarterly Real GDP Growth - % Change Year Ago East China Hong Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Asia Kong (China) Q3 1999 7.0 4.6 2.8 11.1 9.1 3.8 8.4 4.3 8.4 7.1 Q4 1999 6.5 9.3 5.4 10.9 11.7 5.1 8.6 6.2 6.4 7.6 Q1 2000 8.1 13.6 4.1 13.1 11.7 5.3 9.6 7.9 6.5 9.1 Q2 2000 8.3 10.1 4.5 9.4 8.5 6.1 8.2 5.2 6.1 7.8 Q3 2000 8.2 10.3 5.3 8.2 8.4 7.2 10.0 6.6 2.4 7.6 Q4 2000 7.6 7.2 7.5 4.3 7.1 5.3 9.7 3.6 4.0 6.2 Q1 2001 8.4 2.2 4.4 3.5 2.9 1.3 4.1 0.7 1.7 4.8 Q2 2001 8.0 1.4 6.1 3.7 0.2 2.0 -1.3 -3.2 2.2 4.1 Q3 2001 7.1 -0.5 3.9 3.4 -1.2 1.4 -5.6 -4.9 2.1 2.9 Q4 2001 6.9 -1.1 1.0 4.6 -0.5 2.3 -6.1 -1.4 2.7 3.3 Q1 2002 8.0 -0.9 2.7 6.5 1.0 4.0 -0.4 1.1 4.4 5.0 Q2 2002 8.4 0.4 4.0 7.0 4.1 4.2 5.0 4.0 5.2 6.1 Q3 2002 8.5 3.1 5.4 6.8 5.8 3.3 4.7 5.8 5.7 6.6 Q4 2002 8.3 4.9 4.9 7.5 5.6 5.6 4.0 4.9 5.9 6.7 Q1 2003 9.9 4.4 5.5 3.8 4.6 4.8 2.7 3.2 6.6 6.4 Q2 2003 7.9 -0.6 4.8 2.2 4.6 4.2 -3.0 -0.1 6.3 4.3 Q3 2003 9.6 3.9 3.7 2.3 5.3 4.8 3.2 4.2 6.8 6.0 Q4 2003 9.9 4.8 4.5 4.1 6.6 5.0 6.9 5.9 7.7 7.0 Q1 2004 9.8 7.0 5.1 5.3 7.8 6.5 7.9 6.7 6.7 7.6 Q2 2004 9.6 12.1 4.5 5.5 8.2 6.6 12.3 7.9 6.4 8.2 Q3 2004 9.1 6.8 5.3 4.7 6.7 6.3 7.2 5.3 6.1 6.9 Q4 2004 9.5 7.1 6.7 3.3 5.6 5.4 6.5 3.3 5.1 6.5 Source: Haver Analytics and national sources Appendix Table 2: East Asia: Merchandise Export Growth (US $; % change form a year ago) Q4 Q1 Q2 Q3 Q4 Aug- Sep- Oct- Nov- Dec- Jan- 2003 2004 2003 2004 2004 2004 2004 04 04 04 04 04 05 East Asia (9) 19.0 25.7 23.4 23.7 28.7 27.0 23.8 28.4 25.4 22.3 28.4 20.8 27.9 SE Asia 10.9 18.2 13.1 12.3 17.2 23.2 19.5 23.3 26.2 23.6 19.4 15.4 13.7 Indonesia 6.6 14.7 3.6 -0.8 7.1 24.7 28.0 25.6 41.4 45.6 15.2 23.3 21.6 Malaysia 11.3 20.8 15.1 17.5 22.3 27.5 16.1 23.8 30.3 19.0 16.8 12.7 11.3 Philippines 2.9 9.3 6.1 6.3 10.8 8.4 11.5 13.7 8.4 12.3 19.5 2.9 15.4 Thailand 17.9 21.3 21.7 18.8 21.5 23.4 21.4 25.2 18.8 19.9 25.5 19.0 10.5 China 34.6 35.4 40.5 34.0 37.2 34.7 35.6 37.4 33.0 28.4 45.9 32.7 42.2 NIEs 14.2 22.8 18.0 22.9 28.0 23.4 17.6 24.6 19.9 18.2 20.3 14.5 25.2 Hong Kong 11.8 15.8 11.9 13.3 17.7 17.0 14.9 20.9 13.8 15.4 16.7 12.7 34.3 Korea 19.3 31.0 25.6 37.8 38.8 28.8 21.4 28.7 22.4 19.7 26.8 17.9 18.2 Singapore 15.2 24.6 18.9 18.7 29.0 28.5 22.3 30.5 27.0 21.1 25.6 20.7 19.0 Taiwan (China) 10.4 20.7 16.8 22.3 28.8 21.6 11.9 19.9 19.2 17.5 12.5 6.2 29.7 East Asia Update 52 Appendix Table 3. East Asia and the Pacific: GDP Growth Projections Forecast Forecast 1998 1999 2000 2001 2002 2003 2004 2005 2006 East Asia -0.1 6.3 7.6 3.8 6.1 5.9 7.2 6.0 5.9 Developing East Asia 1.7 5.7 7.2 5.6 6.9 7.9 8.2 7.2 6.8 South East Asia -9.3 3.3 5.9 2.4 4.6 5.6 5.9 5.3 5.6 Indonesia -13.1 0.8 5.4 3.8 4.3 5.0 5.1 5.5 6.0 Malaysia -7.4 6.1 8.9 0.3 4.1 5.3 7.1 5.3 5.3 Philippines -0.6 3.4 6.0 1.8 4.3 4.7 6.1 5.0 5.0 Thailand -10.5 4.4 4.8 2.2 5.3 6.9 6.1 5.2 5.6 Transition China 7.8 7.1 8.0 7.5 8.3 9.3 9.5 8.3 7.5 Vietnam 5.8 4.8 6.8 6.9 7.1 7.3 7.7 7.5 7.5 Small Economies 0.4 8.1 2.6 1.7 2.6 4.2 5.0 3.5 3.9 Cambodia 3.7 10.8 7.0 5.7 5.5 5.3 6.0 2.6 4.3 - East Timor 35.0 15.0 15.0 3.0 -3.0 1.0 1.0 2.0 Lao PDR 4.0 7.3 5.8 5.8 5.8 5.3 6.0 7.0 6.5 Mongolia 3.5 3.3 1.1 1.1 3.9 5.6 10.6 6.0 6.0 Fiji 1.5 9.6 -2.8 2.7 4.3 3.0 3.8 1.5 0.7 Kiribati 12.6 9.5 1.6 1.8 1.0 2.5 .. .. .. Marshall Islands 2.5 0.6 0.9 -1.3 4.0 2.0 1.5 .. .. Micronesia, Fed. Sts. -2.8 0.2 8.4 0.3 1.1 5.1 -3.8 0.3 .. Palau 2.0 -5.4 0.3 4.5 1.1 1.5 2.0 2.0 2.0 Papua New Guinea -3.8 7.5 -1.2 -2.3 -0.8 2.7 2.8 2.3 2.3 Samoa 2.4 2.6 6.8 6.1 1.3 3.5 3.2 3.2 3.2 - Solomon Islands 1.8 -0.5 14.3 -9.0 -1.6 5.1 3.8 4.2 4.7 Tonga 2.4 3.1 5.2 1.8 2.1 2.9 1.6 2.8 2.5 Vanuatu 3.0 -2.1 2.5 -1.9 -0.3 2.4 3.2 2.6 3.7 East Asia NIEs -2.8 7.0 8.1 1.0 4.9 3.0 5.9 4.3 4.6 Hong Kong (SAR) -5.0 3.4 10.2 0.5 1.9 3.2 8.1 4.6 4.3 Korea -6.9 9.5 8.5 3.8 7.0 3.1 4.6 4.2 4.8 Singapore -0.8 6.8 9.6 -2.0 3.2 1.4 8.4 4.2 5.0 Taiwan (China) 4.3 5.3 5.8 -2.2 3.9 3.3 5.7 4.2 4.3 Japan -1.2 0.2 2.8 0.2 -0.3 1.4 2.6 0.8 1.9 Source: World Bank data and staff estimates. East Asia is the sum of Developing East Asia and the Newly Industrialized Economies. East Asia Update 53 Appendix Table 4: Primary Commodity Prices (US Dollars - % change from a year ago) Actual Projections 1980- 1991- Commodity 90 98 1999 2000 2001 2002 2003 2004 2005 2006 - - Crude oil average 0.0 -5.7 38.3 56.2 13.7 2.4 15.9 30.6 11.3 14.3 - Non-Energy Commodities -0.8 0.4 11.2 -1.4 -9.1 5.3 10.2 17.5 10.2 17.5 - Agriculture -1.9 0.8 13.9 -5.7 -9.1 8.6 9.6 10.5 9.6 10.5 - - - Cocoa -7.3 4.0 32.3 20.2 18.0 66.4 -1.5 11.5 4.5 0.0 - - - Coffee, arabica -3.6 12.6 23.2 16.2 28.5 -1.2 4.3 25.3 11.8 -1.1 - - Coconut oil -1.4 10.6 12.0 38.9 29.4 32.4 11.0 41.4 -9.1 -3.6 - - Palm oil -3.0 12.3 35.0 28.8 -7.9 36.6 13.6 6.3 -4.5 -1.3 - - - Rice, Thai, 5% 0.8 2.1 18.3 18.5 14.6 11.0 3.0 20.3 5.2 -6.0 - - Sugar, world 16.4 -2.8 29.8 30.6 5.6 20.3 3.0 1.1 20.3 -5.3 - Logs, Malaysia 1.9 3.4 15.2 1.5 16.3 2.7 14.5 5.4 3.9 4.9 - Sawnwood, Malaysia 4.1 -0.1 24.1 -1.0 19.1 9.4 4.6 5.5 9.2 1.6 - - Rubber, RSS1, Singapore -1.7 0.5 12.9 6.2 13.8 33.0 41.5 20.4 -5.3 -3.6 Metals and minerals 2.9 -2.6 -2.3 12.6 -9.6 -3.1 12.7 37.1 12.7 37.1 - Tin -6.7 -0.7 -2.5 0.6 17.5 -9.5 20.5 73.9 -3.1 -9.1 - - Copper 4.3 -4.1 -4.9 15.3 13.0 -1.2 14.1 61.1 4.7 16.7 Source: Wold Bank DEC Prospects Group. Projections as of 3/1/05 East Asia Update 54 Appendix Table 5: East Asia: Exchange Rates (LCU/$) Taiwan, China Indonesia Korea Malaysia Philippines Singapore China Thailand Yen Apr-2004 827.71 8661.00 1167.70 3.80 55.86 1.70 33.37 40.01 110.20 May-2004 827.68 9210.00 1165.70 3.80 55.84 1.70 33.39 40.51 110.50 Jun-2004 827.66 9415.00 1152.50 3.80 56.18 1.72 33.78 40.94 108.38 Jul-2004 827.69 9168.00 1168.30 3.80 56.01 1.72 34.14 41.35 112.08 Aug-2004 827.66 9328.00 1153.80 3.80 56.22 1.71 34.05 41.64 109.65 Sep-2004 827.66 9170.00 1147.90 3.80 56.34 1.69 33.98 41.50 111.00 Oct-2004 827.65 9090.00 1126.00 3.80 56.35 1.66 33.44 41.04 106.13 Nov-2004 827.65 9018.00 1047.90 3.80 56.23 1.64 32.21 39.54 103.18 Dec-2004 827.65 9290.00 1043.80 3.80 56.27 1.63 31.92 39.07 104.12 Jan-2005 827.65 9165.00 1026.40 3.80 55.11 1.64 31.79 38.58 104.00 Feb-2005 827.65 9260.00 1008.10 3.80 54.72 1.63 31.18 38.32 105.24 Mar-2005 827.65 9470.00 1024.30 3.80 54.79 1.65 31.65 39.11 107.39 Appendix Table 6: East Asia: Foreign Reserves Minus Gold (US$ Billion) Taiwan, China Indonesia Malaysia Philippines Korea China Singapore Thailand Total Dec-1996 107.039 19.281 27.009 9.905 33.201 88.038 76.847 37.810 399.130 Dec-1997 142.762 17.396 20.788 7.178 20.369 83.502 71.289 26.254 389.537 Dec-1998 149.188 23.516 25.559 9.116 51.975 90.341 74.928 28.825 453.448 Dec-1999 157.728 27.257 30.588 13.122 73.987 106.200 76.843 34.063 519.789 Dec-2000 168.278 29.394 29.523 12.933 96.131 106.742 80.132 32.016 555.149 Dec-2001 215.605 28.016 30.474 13.319 102.753 122.211 75.375 32.363 620.116 Dec-2002 291.128 32.039 34.222 13.211 121.343 161.656 82.021 38.055 773.675 Dec-2003 408.151 36.296 44.607 13.525 155.282 206.632 95.746 41.077 1001.316 Dec-2004 614.500 36.320 66.418 12.981 198.994 241.738 112.232 48.665 1331.848 Source: Haver Analytics East Asia Update 55 Appendix Table 7: Regional Aggregates for Poverty Measures in East Asia $1 ­a-day $2-a-day Mean Consumption Headcount Number Headcount Number Population (1993 Index of Poor Index of Poor (mill.) PPP$/month) (%) (mill.) (%) (mill.) EAP 1990 67.95 28.9 457.9 67.0 1,059.9 1582.7 1996 99.79 14.8 252.9 49.6 850.4 1712.9 1999 101.88 15.6 276.9 50.0 886.5 1773.3 2000 113.26 14.0 250.2 45.9 821.4 1790.8 2001 121.47 13.1 236.2 43.3 781.7 1807.0 2002 131.78 11.8 215.1 40.2 733.0 1822.9 2003 140.01 10.6 195.2 37.3 686.3 1838.4 2004 150.76 9.3 171.9 34.1 631.4 1853.8 2005 160.62 8.5 158.6 31.9 595.6 1869.2 2006 170.50 7.8 146.8 29.8 561.0 1884.9 EAP less China 1990 96.33 22.1 97.3 59.3 260.3 439.4 1996 136.33 10.7 52.1 44.7 218.8 489.0 1999 123.39 11.3 58.5 51.0 262.8 515.5 2000 131.60 10.6 55.4 48.6 254.0 523.4 2001 135.45 10.0 53.2 47.5 252.0 530.8 2002 143.69 8.9 47.6 44.2 237.8 538.3 2003 146.90 7.9 43.0 41.3 225.6 546.1 2004 153.37 7.0 38.7 39.0 215.8 553.9 2005 158.86 6.3 35.7 37.0 208.0 561.7 2006 165.39 5.7 32.6 34.8 198.3 569.6 S.E.Asia 4 1990 82.29 17.8 55.7 60.3 188.8 313.1 1996 111.26 7.8 27.2 43.6 151.6 347.8 1999 97.28 10.1 36.9 52.8 193.7 366.7 2000 102.92 9.2 34.4 49.9 185.5 372.5 2001 104.32 8.6 32.4 48.7 183.7 377.8 2002 111.40 7.0 26.9 44.7 171.3 383.4 2003 115.97 6.2 24.1 41.4 161.3 389.2 2004 122.11 5.4 21.2 38.8 153.3 395.0 2005 126.96 4.8 19.3 36.8 147.6 400.8 2006 132.61 4.3 17.4 34.4 140.0 406.8 Lower Income EA (Cambodia, Laos, PNG, Vietnam) 1990 43.79 49.9 41.6 85.7 71.5 83.4 1996 63.62 26.1 24.9 70.3 67.2 95.7 1999 67.19 21.2 21.6 67.8 69.2 102.0 2000 70.26 20.2 21.0 66.1 68.5 103.6 2001 72.89 19.7 20.8 64.9 68.3 105.3 2002 74.25 19.4 20.7 62.2 66.5 107.0 2003 78.32 17.4 18.9 59.2 64.3 108.7 2004 81.87 15.9 17.5 56.6 62.5 110.4 2005 85.46 14.6 16.4 53.8 60.4 112.1 2006 89.19 13.3 15.1 51.1 58.3 113.9 East Asia Update 56 Appendix Table 8: Poverty in East Asia - Country Estimates $1 ­a-day $2-a-day Mean Consumption Headcount Number Headcount Number Gini Population (1993 Index of Poor Index (%) of Poor Coefficient (mill.) PPP$/month) (%) (mill.) (mill.) Cambodia 1990 48.29 48.3 4.4 83.7 7.7 -- 9.1 1996 57.77 36.7 4.0 76.9 8.4 -- 11.8 1997 56.97 38.4 4.7 78.0 9.5 41.6 12.2 1998 57.07 37.8 4.7 77.8 9.7 -- 12.5 1999 58.76 37.1 4.8 76.9 9.9 -- 12.8 2000 58.98 39.4 5.2 77.0 10.1 -- 13.2 2001 60.11 38.9 5.2 76.5 10.3 -- 13.5 2002 59.38 42.1 5.8 77.4 10.7 -- 13.8 2003 59.86 42.9 6.1 77.4 10.9 -- 14.1 2004 61.33 42.4 6.1 76.6 11.1 -- 14.5 2005 62.88 41.7 6.2 75.6 11.2 -- 14.8 2006 64.51 40.9 6.2 74.9 11.4 -- 15.2 China 1990 57.05 31.5 360.6 69.9 799.6 36.0 1,143 1993 67.24 29.0 343.9 65.0 769.8 41.2 1,185 1996 85.20 16.4 200.8 51.6 631.6 39.3 1,224 1998 91.32 16.1 201.2 49.8 620.8 41.0 1,248 1999 93.07 17.4 218.4 49.6 623.6 42.6 1,258 2000 105.69 15.4 194.8 44.8 567.4 43.9 1,267 2001 115.65 14.3 183.0 41.5 529.6 44.9 1,276 2002 126.79 13.0 167.4 38.5 495.2 45.7 1,285 2003 137.09 11.8 152.2 35.7 460.7 -- 1,292 2004 149.65 10.3 133.2 32.0 415.7 -- 1,300 2005 161.38 9.4 122.9 29.6 387.6 -- 1,308 2006 172.71 8.7 114.2 27.6 362.7 -- 1,315 Indonesia 1984 49.80 36.7 58.7 80.0 128.1 30.3 160.1 1987 55.63 25.7 43.4 74.2 125.4 33.1 169.0 1990 61.58 20.6 36.7 71.1 126.7 28.9 178.2 1993 68.54 14.8 27.8 61.6 115.5 31.7 187.6 1996 86.62 7.8 15.4 50.5 99.4 36.5 196.8 1999 66.80 12.0 24.9 65.1 135.0 31.0 207.4 2000 72.53 9.9 20.9 59.5 125.3 -- 210.5 2001 73.44 9.2 19.7 58.7 125.2 -- 213.2 2002 81.72 7.2 15.5 53.5 115.6 34.3 216.2 2003 87.27 5.7 12.5 48.8 107.1 -- 219.4 2004 92.10 4.8 10.7 45.4 101.0 -- 222.7 2005 96.50 4.2 9.5 42.6 96.4 -- 226.1 2006 101.45 3.7 8.5 39.9 91.6 -- 229.5 Laos 1990 39.16 53.0 2.2 89.6 3.7 -- 4.2 1992 41.35 48.8 2.1 88.1 3.9 32.7 4.4 1996 48.27 41.3 2.0 83.1 4.1 -- 4.9 1997 50.36 38.4 1.9 81.3 4.1 36.5 5.0 1998 49.46 39.8 2.0 81.9 4.2 -- 5.1 1999 51.56 36.6 1.9 80.5 4.2 -- 5.3 2000 53.31 33.9 1.8 79.4 4.3 -- 5.4 2001 55.48 31.3 1.7 77.4 4.3 -- 5.5 2002 56.91 28.1 1.6 75.0 4.2 34.6 5.7 2003 58.86 25.8 1.5 73.3 4.3 -- 5.8 2004 60.99 23.2 1.4 71.5 4.2 -- 5.9 2005 63.80 20.4 1.2 69.0 4.2 -- 6.1 2006 66.43 18.2 1.1 66.7 4.2 -- 6.2 East Asia Update 57 Appendix Table 8: Poverty in East Asia (Continued) $1 ­a-day $2-a-day Mean Consumption Headcount Number Headcount Number Gini Population (1993 Index of Poor Index of Poor Coefficient (mill.) PPP$/month) (%) (mill.) (%) (mill.) Malaysia 1984 172.09 8.9 1.4 29.5 4.5 50.5 15.3 1987 170.88 4.8 0.8 25.0 4.2 47.0 16.6 1989 176.21 3.2 0.6 22.4 4.0 46.2 17.7 1990 195.32 2.0 0.4 18.5 3.4 -- 18.2 1992 219.48 1.5 0.3 17.6 3.4 47.7 19.1 1995 253.64 1.0 0.2 14.0 2.9 48.5 20.6 1996 261.87 0.8 0.2 13.1 2.8 -- 21.1 1997 315.95 < 0.5 -- 8.8 1.9 49.1 21.7 1998 269.00 < 0.5 -- 12.9 2.9 -- 22.2 1999 271.70 < 0.5 -- 12.6 2.9 -- 22.7 2000 304.27 < 0.5 -- 9.7 2.3 -- 23.3 2001 304.09 < 0.5 -- 9.7 2.3 -- 23.8 2002 310.00 < 0.5 -- 9.2 2.2 -- 24.3 2003 325.77 < 0.5 -- 8.1 2.0 -- 24.7 2004 352.27 < 0.5 -- 6.3 1.6 -- 25.1 2005 368.37 < 0.5 -- 5.4 1.4 -- 25.5 2006 385.20 < 0.5 -- 4.5 1.2 -- 25.9 PNG 1990 72.95 35.4 1.4 64.3 2.5 -- 3.9 1996 93.15 24.6 1.1 54.4 2.5 48.4 4.6 1997 88.62 25.6 1.2 56.0 2.7 -- 4.7 1998 83.15 27.8 1.4 59.0 2.9 -- 4.9 1999 78.37 30.7 1.5 61.6 3.1 -- 5.0 2000 71.90 35.3 1.8 65.0 3.3 -- 5.1 2001 66.41 38.0 2.0 69.2 3.6 -- 5.3 2002 63.41 39.2 2.1 70.4 3.8 -- 5.4 2003 63.94 38.7 2.1 70.5 3.9 -- 5.6 2004 64.44 38.5 2.2 69.9 4.0 -- 5.7 2005 64.12 38.8 2.3 70.0 4.1 -- 5.9 2006 63.81 39.0 2.3 70.1 4.2 -- 6.0 Philippines 1985 74.92 22.8 12.4 61.3 33.3 41.0 54.2 1988 82.77 18.3 10.7 55.6 32.4 40.7 58.3 1990 90.32 19.1 11.7 53.5 32.6 -- 61.0 1991 87.75 19.8 12.3 55.0 34.3 43.8 62.4 1994 89.10 18.4 12.3 53.1 35.5 42.9 66.8 1996 107.15 14.8 10.4 46.5 32.5 -- 69.9 1997 110.21 12.1 8.6 45.2 32.3 46.0 71.5 1998 108.77 13.7 10.0 46.6 34.1 -- 73.1 1999 107.20 13.5 10.1 46.9 35.0 -- 74.7 2000 106.93 13.5 10.3 47.2 36.0 46.2 76.3 2001 106.10 13.5 10.5 46.7 36.3 -- 77.9 2002 109.12 12.4 9.9 45.1 35.9 -- 79.5 2003 106.37 13.1 10.6 45.5 36.9 44.5 81.1 2004 111.43 11.5 9.5 43.2 35.7 -- 82.6 2005 114.87 10.6 8.9 41.7 35.1 -- 84.2 2006 118.42 9.6 8.2 40.0 34.3 -- 85.8 East Asia Update 58 Appendix Table 8: Poverty in East Asia (Continued) $1 ­a-day $2-a-day Mean Consumption Headcount Number Headcount Number Gini Population (1993 Index of Poor Index of Poor Coefficient (mill.) PPP$/month) (%) (mill.) (%) (mill.) Korea 1990 301.09 < 0.5 -- < 0.5 -- 29.88 42.87 1991 330.38 < 0.5 -- < 0.5 -- 29.85 43.27 1992 362.09 < 0.5 -- < 0.5 -- 29.85 43.66 1993 383.03 < 0.5 -- < 0.5 -- 29.36 44.06 1994 411.09 < 0.5 -- < 0.5 -- 29.36 44.45 1995 440.03 < 0.5 -- < 0.5 -- 29.11 45.00 1996 480.46 < 0.5 -- < 0.5 -- 29.71 45.55 1997 483.84 < 0.5 -- < 0.5 -- 28.97 45.99 1998 400.86 < 0.5 -- < 0.5 -- 29.42 46.43 1999 450.06 < 0.5 -- < 0.5 -- 30.00 46.86 2000 492.04 < 0.5 -- < 0.5 -- -- 47.28 2001 520.54 < 0.5 -- < 0.5 -- -- 47.64 2002 556.59 < 0.5 -- < 0.5 -- -- 47.97 2003 551.00 < 0.5 -- < 0.5 -- -- 48.24 2004 570.89 < 0.5 -- < 0.5 -- -- 48.48 2005 590.30 < 0.5 -- < 0.5 -- -- 48.72 2006 615.09 < 0.5 -- < 0.5 -- -- 48.96 Thailand 1988 90.42 17.9 9.6 54.1 29.0 43.8 53.7 1990 102.88 12.5 7.0 47.0 26.1 43.8 55.6 1992 129.75 6.0 3.5 37.5 21.6 46.2 57.6 1996 143.92 2.2 1.3 28.2 16.9 43.4 59.9 1998 121.73 3.3 2.0 34.1 20.9 40.6 61.2 1999 123.50 3.1 1.9 33.6 20.8 -- 61.8 2000 125.42 5.2 3.2 35.6 22.0 43.2 62.4 2001 131.21 3.6 2.2 32.0 19.9 -- 62.9 2002 139.38 2.4 1.5 27.7 17.6 42.2 63.5 2003 145.46 1.6 1.1 24.0 15.3 -- 64.0 2004 149.73 1.5 1.0 23.3 15.0 -- 64.5 2005 153.83 1.4 0.9 22.6 14.7 -- 65.1 2006 160.55 1.1 0.7 19.6 12.9 -- 65.6 Vietnam 1990 41.73 50.8 33.6 87.0 57.6 -- 66.2 1993 48.85 39.9 28.3 80.5 57.2 35.0 71.0 1996 63.66 23.6 17.7 69.4 52.2 -- 75.2 1998 68.54 16.4 12.8 65.4 50.9 35.4 77.7 1999 68.90 16.9 13.4 65.9 52.0 -- 78.9 2000 73.16 15.2 12.1 63.5 50.7 -- 79.9 2001 76.62 14.6 11.8 61.8 50.1 -- 81.0 2002 78.67 13.6 11.2 58.2 47.8 37.5 82.1 2003 83.77 11.0 9.2 54.4 45.2 -- 83.2 2004 88.05 9.2 7.8 51.2 43.1 -- 84.3 2005 92.39 7.8 6.7 47.9 40.9 -- 85.4 2006 96.92 6.3 5.4 44.5 38.5 -- 86.5 East Asia Update 59 Notes for Tables 7 and 8 (1) The poverty lines are set at $1.08 and $2.15 per person per day (at 1993 PPP$) for all countries. For most countries, the PPPs are the 1993 World Bank PPPs. The PPP for the Philippines is from the Penn World Tables, while that for PNG is from the 1996 World Bank PPPs. PPPs for Vietnam, Lao PDR and Cambodia have been further adjusted using a calorie price ratio between Indonesia and Vietnam. Projections are based on World Bank growth rate forecasts for 2005-2006. Wherever possible, the projections utilize information on sectoral GDP growth rates, changes in the food CPI relative to the general CPI, changes in the GDP deflator relative to the CPI, and changes in the consumption-income ratio. The projections assume that there is no change in relative inequalities within sectors. For China, the projections are done separately for rural and urban China, and then aggregated using population shares. Estimates for all countries except Malaysia and China are based on surveys of household consumption. The estimates for Malaysia and China use income surveys. For China, a survey-based estimate of mean consumption is used in conjunction with the income Lorenz curves to derive poverty estimates. These poverty estimates differ from those commonly found in national poverty assessments for two reasons. First, country assessments use national poverty lines that differ from uniform international poverty lines used here. Second, national poverty lines also allow for spatial cost of living differentials within countries, but such adjustments are omitted here to maintain a consistent methodology across countries. For instance, in the case of Thailand, these differences explain why the above estimates indicate a small increase in poverty between 1998 and 2000 (in spite of adjusting the CPI by the change in the national poverty lines over this period), while national poverty line-based estimates indicate a decline. Also for Thailand, the 2002 estimate is based on a longer consumption module, which could lead to a small overestimation of consumption relative to 2000. (2) The estimates for Lao PDR utilize the new survey data for 2002 and the inflation rate as implied by the poverty lines of 1997 and 2002. For the Philippines, there is a small change in the estimates for the years 2001 and 2002. These are the two years in-between the surveys for 2000 and 2003. The numbers are now based on an average of forward projection from the survey data for 2000 and a backward projection from the survey data for 2003. Appendix Table 9: NPLs in the Commercial Banking System of the Crisis-Affected Countries (% of total loans) 1997 1998 1999 2000 2001 2002 2003 2004 Dec Dec Dec Dec Dec Dec Dec Mar Jun Sep Dec Indonesia (a) .. .. 64.0 57.1 48.8 31.1 18.1 18.9 17.9 n/a n/a excl. IBRA 7.2 48.6 32.9 18.8 12.1 7.5 6.8 6.3 6.2 5.6 4.5 Korea (b) 8.0 17.2 23.2 14.0 7.4 4.1 4.4 n/a n/a n/a n/a excl. KAMCO/ KDIC 6.0 7.3 13.6 8.8 3.3 2.4 2.2 2.5 2.2 2.1 2.0 Malaysia .. 21.1 23.4 22.5 24.4 22.4 21.2 21.0 20.1 20.7 19.2 excl. Danaharta .. 16.7 16.7 13.4 16.3 14.7 13.1 13.0 12.3 11.7 10.8 Philippines (c) 4.7 10.4 12.3 15.1 17.3 15.0 14.1 14.0 13.8 13.9 12.7 Thailand (d) .. 45.0 41.5 29.7 29.6 34.2 30.6 29.6 29.6 28.2 28.0 excl. AMCs .. 45.0 39.9 19.5 11.5 18.1 13.9 13.0 13.0 12.1 11.6 Memo: Malaysia (e) excl. Danaharta 10.6 10.6 8.3 10.5 9.3 8.3 8.3 7.7 7.4 6.9 (a) Only includes IBRA's AMC; (b) The NPL ratio increased in 1999 due to the introduction of stricter asset classification criteria (forward looking criteria); (c) From September 2002 onwards, the NPLs ratios are based on the new definition of NPLs (as per BSP Circular 351) which allows banks to deduct bad loans with 100 percent provisioning from the NPL computations; (d) Includes transfers to AMCs but excludes write-offs. (Note that the jump in headline NPLs in December 2002 was a one-off increase, reflecting a change in definition and did not affect provisioning requirements); (e) NPL series used by Bank Negara Malaysia, which is net of provisions and excludes interest in suspense.