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Asian Development Bank

Broadening openness

or a resilient Asia

Update

ASIAN DEVELOPMENT

Outlook2009



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Asian Development Bank.

Asian Development Outlook 2009 Update.

Mandaluyong City, Philippines: Asian Development Bank, 2009.

. Economics. . Finance. . Asia. I. Asian Development Bank.

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

developing Asia and the Pacic.

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Foreword

Developing Asia as a whole is proving to be more resilient to the global

economic slowdown than was expected when Asian Development

Outlook 2009 (ADO 2009) was published in March this year.

Consequently, this Update sees somewhat stronger growth or both this

year and next than was earlier orecast. Te region’s economic expansion

or 2009 is projected to come in at 3.9%, up slightly rom the March

orecast o 3.4%, on the back o much stronger growth in East Asia and

South Asia. Te growth projection or 2010 is likewise upgraded to 6.4%

rom 6.0% in March.

Te global economy is experiencing its worst peace-time slump ineight decades. World trade and industrial production are set to decline

sharply this year, leading to a contraction o the world economy.

Unavorable events originating in the major industrial economies

have cascaded on to developing Asia. Te region’s more open economies

were hit the hardest, mainly rom alling global demand or their exports.

Double-digit declines in exports were common since the last quarter o

2008 through the rst hal o this year.

As in the major industrial economies, governments and central

banks in the region were quick to remedy the growth slack, providing

the necessary scal and monetary stimuli. Economic activity in the

large developing Asian economies rebounded and output looks set or a

V-shaped comeback.But even with a nascent recovery, the region should not be

complacent. Downside risks to the outlook remain. A prolonged global

recession will reduce the speed at which developing Asia can return to its

potential rate o growth. Hasty removal o scal and monetary stimuli

can likewise degrade the ongoing recovery.

Policy measures to broaden openness need to be adopted to support

economic resilience and sustained development. In the last 60 years,

the multilateral trading system has underpinned global growth and

prosperity. Globalization and openness must continue, but their scope

and structure need to be reviewed i the region is to soen some o the

economic jolts that hit it every ew years.

Beore both the 1997–98 Asian nancial crisis and the current global

downturn, developing Asia enjoyed years o rapid economic growth,

reaping the benets o its nancial and trade openness. Te onset o both

periods o turmoil, however, brought to the ore the perils o excessive

and unbalanced openness.

A major lesson rom the 1997–98 crisis is that openness must be

matched with well-entrenched institutions and regulatory systems

that can eectively manage nancial globalization. Developing Asia

successully reormed its nancial systems in the wake o the 1997–98

crisis, boosting its resilience to nancial shocks, which helped shield it

rom the adverse eects o the current global economic downturn.



iv Asian Development Outlook 2009Update

Yet the recovery rom the 1997–98 crisis carried the seeds o the next

dangerous harvest, coming as it did rom an overreliance on external

demand rom the major industrial economies. Te ongoing global

turmoil has thereore battered the region through plummeting export

demand, evaporating capital inows, and stalling remittance growth. ostrengthen its resilience and reduce its vulnerability to external shocks,

developing Asia needs to address the geographically unbalanced structure

o its trade, capital ows, and movement o workers by promoting closer

economic linkages within the region. Such moves, together with a more

balanced economy in which domestic demand plays a bigger role, can

help the region’s economies achieve rapid yet stable growth.

As developing Asia emerges rom the global downturn, its ootprint

on the world economy is becoming more pronounced. So, although

the longer-term uture looks promising, the region’s greatest challenge

in the medium term is to live up to the demands o this heightened

responsibility.

HARUHIKO KURODA

President



Acknowledgments

Te Asian Development Outlook 2009 Update was prepared by the sta o

the Asian Development Bank rom the Central and West Asia Department,

East Asia Department, Pacic Department, South Asia Department,

Southeast Asia Department, Economics and Research Department, as well

as the resident missions. Representatives rom these departments and the

Ofce o Regional Economic Integration constituted a Regional Economic

Outlook ask Force, which met regularly and coordinated closely to

develop consistent orecasts or the region.

Te economists who contributed the sections are bylined in each

chapter. Te subregional coordinators were Sadar Parvez and Kiyoshi

aniguchi or Central and West Asia; V.B. ulasidhar or East Asia;

adateru Hayashi or South Asia; Puran Rajapakse or Southeast Asia;and Craig Sugden or the Pacic.

A team o economists rom the Economics and Research Department,

led by Joseph E. Zveglich, Jr., Assistant Chie Economist, Macroeconomics

and Finance Research Division, assisted by Editha Laviña, coordinated

the overall production o the publication. echnical and research

support was provided by Shiela Camingue, Gemma Esther Estrada,

Nedelyn Magtibay-Ramos, Maria Cynthia Petalcorin, Pilipinas Quising,

Aleli Rosario, Eric Suan, Lea Sumulong, and Raquel abanao. Richard

Niebuhr and Anthony Patrick as the economic editors made substantive

contributions to the country chapters and other parts o the book.

Charles Adams provided helpul guidance on the development o the

theme chapter.Jonathan Aspin did the style and copy editing. Elizabeth E. Leuterio

was responsible or typesetting and data linking, as well as graphics

generation in which she was assisted by Maria Susan orres. Te cover

was designed by Joe Mark Ganaban. Zenaida Acacio and Lagrimas

Cuevas provided administrative and secretarial support. Te publication

would not have been possible without the cooperation o the Publishing,

Ino and Web Unit o the Department o External Relations and the

Logistics Management Unit o the Ofce o Administrative Services.

Ann Quon and Andrew Perrin o the Department o External

Relations planned and coordinated the dissemination o the Update.

JONG-WHA LEE

Chie Economist

Economics and Research Department



HighlightsADO 2009 Update

Part Coping with the global recession Long recession avoided?

Recovery at hand?

Developing Asia’s response to the turmoil

Developing Asia’s prospects

A new approach to openness or developing Asia?

Part Broadening openness or a resilient Asia Enhancing intraregional trade

Managing nancial globalization

Maximizing the benets o labor ows

Policies to achieve more balanced openness

Part Economic trends and prospects in developing Asia 8Subregional summaries

Bangladesh

People’s Republic o China

India Indonesia

Malaysia

Pakistan

Philippines

Tailand

Viet Nam

Statistical appendix 67Statistical notes and tables

Contents



Denitions

Te economies discussed in Asian Development Outlook 2009 (ADO 2009) Update are classied by major

analytic or geographic groupings. For purposes o ADO 2009 Update, the ollowing apply:

• Association o Southeast Asian Nations (ASEAN) comprises Brunei Darussalam, Cambodia, Indonesia,Lao People’s Democratic Republic, Malaysia, Myanmar, Philippines, Singapore, Tailand, and Viet Nam.

• Developing Asia reers to the 44 developing member countries o the Asian Development Bank and to

Brunei Darussalam, an unclassied regional member.

• Central Asia comprises Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyz Republic, ajikistan,

urkmenistan, and Uzbekistan.

• East Asia comprises People’s Republic o China; Hong Kong, China; Republic o Korea; Mongolia; and

aipei,China.

• South Asia comprises Islamic Republic o Aghanistan, Bangladesh, Bhutan, India, Maldives, Nepal,

Pakistan, and Sri Lanka.

• Southeast Asia comprises Brunei Darussalam, Cambodia, Indonesia, Lao People’s Democratic Republic,

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

States o Micronesia, Nauru, Republic o Palau, Papua New Guinea, Samoa, Solomon Islands, Democratic

Republic o imor-Leste, onga, uvalu, and Vanuatu.

• Unlessotherwisespecied,thesymbol“$”andtheword“dollar”refertoUSdollars.

ADO 2009 Update is generally based on data available up to 31 August 2009.

Acronyms and abbreviations

ADB Asian Development Bank

ASEAN Association o Southeast Asian Nations

bpd barrels per day

CPI consumer price index

EU European Union

FDI oreign direct investment

FY scal year

GDP gross domestic product

IMF International Monetary Fund

OECD Organisation or Economic Co-operation and Development

PRC People’s Republic o China

US United States

VAR vector autoregression

VA value-added tax

WO World rade Organization



HighlightsADO 2009 Update

Despite a notable slowdown in its economic expansion relative to

potential, developing Asia is leading the recovery rom the global

downturn. Its growth is underpinned by the relatively healthy state

o its fnancial systems prior to the fnancial crisis; by the fscal and

monetary stimuli that have been quickly provided by governments

and central banks across the region; and by the rapid turnaround in

its larger, less export-dependent economies.

However, risks remain on the downside: hasty withdrawal o the fscal

and monetary measures supporting aggregate demand would stunt

developing Asia’s nascent recovery, and any slippage in the major

industrial economies’ recovery would delay the region’s return to itslong-term growth path.

To develop more resilient economies, developing Asia should broaden

the scope and structure o openness. Reducing its vulnerability to

external shocks requires policy makers to tackle the geographically

unbalanced structure o its trade, capital lows, and movement o

workers. By promoting closer economic linkages within the region

and a more balanced internal economic structure with a bigger role

or domestic demand, policy makers in developing Asia will be able to

achieve rapid yet stable growth or the region.



2 Asian Development Outlook 2009 Update

Key MessagesT z he global economy may just be coming out o its worst peace-time downturn

since the Great Depression o the 1930s. Part 1 o this Update to the Asian

Development Outlook 2009 (ADO 2009) that was released in March, envisages a

global economic contraction this year on account o steep declines in world tradeand industrial production. While scal stimulus packages and easy monetary

policies have averted a collapse o the global nancial system and limited the

depth o the recession, conditions or a sustainable world economic recovery

are still uncertain.

The main channel by which the global nancial crisis and economic slump z

spread to developing Asia was the collapse o demand in major global markets,

hitting the region’s exports. With a large proportion o regional trade in parts

and components supporting supply chains, imports also buckled. The more

open economies o East Asia and Southeast Asiasuch as Hong Kong, China;

Republic o Korea (henceorth Korea); Malaysia; Singapore; Taipei,China; andThailandwere hardest hit, and their economies contracted signicantly rom

the second hal o 2008 until well into the rst hal o 2009.

But many regional governments’ quick and decisive response to the weak global z

environment prevented a reeall in developing Asia’s economic growth. Tax cuts,

greater public spending, targeted assistance, and easy monetary policies boosted

consumption and investment. The regional economy is now poised to achieve

a V-shaped rebound. The larger economies provided much o the impetus or

the region’s transition to recovery. In addition, stronger nancial systems in

the region than elsewhere at the onset o the nancial crisis underpinned the

region’s resilience to the global downturn.

Nevertheless, there is no room or complacency, and the region’s nascent z

recovery aces downside risks. Externally, a lengthier global downturn than

currently orecast would retard the region’s ull recovery, and without a revival

o the global economy, the region’s long-term growth potential would remain

unattainable. Internally, in its current economic structure, developing Asia cannot

be the sole driver o its own growth. Likewise, mistimed exit strategies or scal

and monetary stimuli would imperil the region’s rebound; and pulling away the

carpet o scal and monetary support beore the recovery has a rm oothold

may lead to a double-dip decline instead o the expected V-shaped rebound.

To strengthen its economic resilience and sustain its development, developing zAsia must adopt policies to broaden the scope and structure o its openness

to trade, capital ows, and movement o workers. Part 2 o this Update calls or

promoting intraregional economic links while maintaining vital existing links with

the rest o the world. Success in this twin-track approach will enable the region

to exploit the potentially vast but largely neglected gains rom closer relations

with its neighbors. Combined with a stronger domestic economy, broader

openness can help regional economies achieve rapid yet stable growth.



Highlights 3

Outlook or and Since the publication o z ADO 2009 in March, global economic conditions have

worsened, requiring an update o orecasts or the G3 economies o the United

States, eurozone, and Japan. A deeper contraction o 3.7% in 2009 is now seen in

the G3, ollowed by a modest recovery o 1.1% in 2010 as ination remains quiescent.The volume o world trade is set to decline more sharply this year but rebound

more quickly next year, both relative to ADO 2009.

Oil prices have been rising steadily since March 2009, but have stayed well below z

July 2008’s peak. Global demand remains subdued and inventory levels high. In

addition, production capacity o members o the Organization o the Petroleum

Exporting Countries is projected to increase substantially. Together these actors

should damp the scope or urther price increases in the short term. Nonenergy

prices have been less volatile, increasing only subtly since the beginning o this year.

The nonenergy price trajectory in the next 2 years depends on a host o actors,

including a recovery in demand, weather conditions, and supply setbacks.

While some signs o worldwide economic stabilization are beginning to emerge, z

risks to the global outlook remain tilted to the downside. Governments around

the world slashed interest rates and taxes and raised spending to boost sagging

aggregate demand. Yet exiting these measures too early may lead to a protracted

slowdown and derailment o the global recovery, and correct timing is key to

avoiding a double-dip downturn. Increased resort to protectionist measures and

the persistent stalemate in global trade negotiations is likewise threatening the

ragile trade rebound. In addition, the continued weakness in housing markets

could also cloud prospects or the world economy, while cost-push ination may

return with resurgence in global oil prices. Finally, the risk o a global emergency

rom H1N1 u may have diminished, but the virus could still mutate into a more

virulent strain, with ar more serious public health consequences.

Despite the notable slowdown in growth this year in most economies across z

developing Asia, the region has proved to be more resilient than earlier eared.

Part 3 o this Update projects economic expansion o developing Asia to come in

at 3.9%, revised up by 0.5 percentage points rom the ADO 2009 orecast o 3.4%,

on the back o much stronger growth in East Asia and South Asia. The growth

projection or 2010 is likewise upgraded to 6.4% rom 6.0% in March.

This resumption o growth has taken place amid a low to mild ination environment z

across the region. Coming o last year’s peak, ination in developing Asia is orecast

to come in at just 1.5% in 2009, down rom the March projection o 2.4%. More

robust growth is likely to push prices up aster in 2010, raising the orecast to 3.4%.Central bankers in the region will thereore want to put a tight watch on monetary

policies so as not to encourage asset bubbles that would inate prices to levels that

are no longer justied by undamentals.




Slower growth in industrial countries has resulted in a weak recovery in developing z

Asia’s exports. But imports were even more sluggish as demand or intermediate

goods waned. Overall, the region’s current account is expected to register a surplus

o 5.0% o GDP in 2009. With developing Asian economies increasingly relying on

domestic demand to boost growth, their current account surplus is projected to

all urther to 4.3% o GDP in 2010.

There are notable divergences in the outlook across subregions and economies. z

In particular, the Update upgrades projections or East Asia and South Asia, while

downgrading those or other subregions. Likewise, it has raised orecasts or the

larger regional economies, such as the People’s Republic o China (PRC), Korea,

India, and Indonesia, while lowering those or the smaller, generally more open

economies.

Economic expansion in East Asia is now projected to reach 4.4% in 2009, supported z

by stronger growth in the PRC and a shallower contraction in Korea, than oreseen

in ADO 2009. The PRC’s massive scal stimulus package announced last year and the

aggressive monetary easing in 2009 bolstered economic growth in that country.

The Government’s 8.0% growth target set at the start o the year now looks within

reach, with the Update projecting the economy to expand by 8.2%. Similarly, Korea’s

scal stimulus has been eective, and the economy is orecast to shrink by just 2.0%

this year, compared with March’s 3.0% orecast.

Subregional ination is set to decline to 0.2% in 2009, largely because the PRC and z

Taipei,China will see deation. In 2010, consumer prices are expected to rise to 2.6%

on account o a gradually strengthening subregional recovery. Current account

projections are slightly downgraded or the next 2 years, relative to March.

Prospects or growth this year in South Asia have improved to 5.6%, up rom the z

ADO 2009 orecast o 4.8%, with the Update shiting up the outlook or ve o the

eight subregional economies. India’s economic expansion, in particular, has been

upgraded by 1 percentage point to 6% due to the expected positive eects o a

continued large scal stimulus announced in its July 2009 budget and the emerging

signs o recovery in private business condence. Subregional ination has been

contained ollowing the drop in oil prices in the second hal o last year, with some

economies starting to record deation in recent months. Consumer prices are thus

orecast to increase at 4.7% in 2009, below the 5.6% expected in March.

In 2010, subregional growth is likewise upgraded to 6.4% rom 6.1% in z ADO 2009.

Stronger growth is projected to lit prices, raising the ination orecast to 4.9% rom

4.4% in March. In current-account terms, the drop in global oil prices rom last year’speak provided much relie or South Asia’s economies, curtailing the projected

subregional decit to 1.7% and 2.2% o GDP in 2009 and 2010, respectively.

Aggregate growth in the 10 Southeast Asian economies is now expected to slow z

to 0.1% in 2009 compared with the March growth orecast o 0.7%. More positive

prospects or Indonesia and Viet Nam ailed to counterbalance the deterioration

among the more open, as well as the smaller, economies in the subregion. Next

year, overall growth is put at 4.3%, similar to the March orecast.



Highlights 5

Considerably weaker domestic demand and lower oil and ood prices are expected z

to lead to a sharper than earlier expected decline in ination across the subregion.

In 2009, the orecast is revised downward to 2.5% rom 3.3% in ADO 2009. The

ination projection or 2010 is maintained at 4.1%. As a precipitous decline in exports

is likely to be more than oset by a steeper decline in imports, the subregion’s

current account surplus in 2009 is now expected to be 5.4% o GDP, against the4.4% predicted in March. Next year, the surplus is orecast to come in at 4.6% o

GDP owing to a mild recovery in demand or the subregion’s exports rom industrial

countries and a pickup in imports.

Across Central Asia, projections or economic growth are now much bleaker than z

in ADO 2009 due to lower commodity prices; a deeper downturn in the Russian

Federation (the subregion’s main trade and nancial partner); and weaker capital

inows, investments, and remittances. Subregional growth is orecast to slow to

0.5% in 2009 and 3.6% in 2010, compared with 3.9% and 4.8% projected in March.

The largest Central Asian economy, Kazakhstan, is seen contracting by 1.0% in 2009,

a reversal rom the 2.0% growth earlier expected in ADO 2009, as it grapples withthe allout rom a banking crisis and lower oil prices.

Ination pressures in the subregion have been curbed by sharp drops in domestic z

demand and lower commodity prices. As a result, the Update revises downward the

ination orecasts or 2009 and 2010 to 7.6% and 7.3%. The overall current account

position o the subregion is also very likely to deteriorate, as hydrocarbon exporters

labor under lower oil prices and hydrocarbon importers suer rom greatly reduced

remittance inows.

Economic growth in the Pacic in 2009 is slightly downgraded to 2.8% rom 3.0% z

expected in March, largely as a result o a less optimistic growth orecast or the

Democratic Republic o Timor-Leste (the subregion’s third-largest economy). Onlythree o the 14 subregional economies are likely to expand by more than 1.0% this

year. Weaker prospects stem rom alling incomes rom tourism and remittances

brought by the global slowdown. The Update pencils in minor adjustments or

subregional ination and the current account.

Overall, developing Asia is set to emerge rom the global slump ahead o the rest o z

the world. Progress in rehabilitation eorts ater the Asian crisis in 1997–98 ensured

that the region’s nancial systems were relatively healthy when the global nancial

crisis erupted, and allowed the region to manage, in the main, a sot landing. Fiscal

stimulus measures and easy monetary policies also proved to be highly eective

in bolstering regional growth.




Broadening openness or a resilient AsiaOpenness to oreign trade and capital ows has underpinned world economic z

growth in the last 60 years, and will continue to do so in the uture. Developing

Asia’s economic success, including robust growth that raised per capita incomes

and lowered poverty levels, likewise depended on its outward orientation. But the1997–98 Asian nancial crisis and the latest global slump have exposed the risks that

the region aces rom a narrow application o openness. Broadening the scope and

structure o openness is needed to support developing Asia’s economic resilience

and sustained development.

During the Asian crisis, the massive reversal o oreign capital inows underlined z

the risk o excessive nancial openness. A key lesson learned rom that crisis was

the need or strong domestic institutional capacitythat is, sound and efcient

nancial systemsto eectively manage nancial globalization. In the atermath

o the crisis, developing Asia reormed its nancial systems, boosting its resilience

to nancial shocks, and to a large degree shielding itsel rom the eects o the

recent tumult.

However, the region’s recovery rom the 1997–98 crisis came at the expense o z

overreliance on extraregional demand, a dependency that, in the last year or so,

has battered the region’s exports, reduced capital inows, and slashed remittance

growth. A key lesson is that regional policy makers need to address the geographically

unbalanced structure o the ows o its trade, capital, and workers.

Mechanisms need to be put in place to saeguard domestic economies against z

excessive and unbalanced openness. Policies to build up domestic capacity and

enhance regional cooperation are required to bolster the resilience o regional

economies and reduce their vulnerability to external shocks.

Strengthening intraregional trade (especially or nal goods) can help reduce z

developing Asia’s overdependence on exports to industrial countries and can

provide an additional engine o short-run recovery and long-run growth. Achieving

this entails boosting domestic economies through a wide range o rebalancing

policies as outlined in ADO 2009; removing barriers to intraregional trade, particularly

behind-the-border obstacles to reer trade in goods and services; and promoting

regional cooperation to institutionalize concrete and specic eorts toward

acilitating intraregional trade.

Eectively managing nancial globalization can ensure that capital ows are z

less destabilizing to regional economies. This requires encouraging a shit in the

composition o oreign capital to less volatile longer-term inows by improvingthe investment climate; strengthening domestic nancial markets with requisite

oversight mechanisms, and keeping appropriate levels o oreign exchange reserves

(especially those economies with managed exchange rate systems); and supporting

the establishment o regional capital markets, to be able to successully tap and

mobilize the regional savings pool.



Highlights 7

Migration is increasingly important in the global landscape, and Asian countries are z

well known labor exporters. Also, remittances are a more stable source o oreign

currency than many other nontrade sources. Developing Asia’s governments should

thereore maximize the benets o labor ows by ensuring that the migrationchannel is kept open, enhancing the saety and security o ormal systems or unds

transers, and providing an environment that encourages households to invest more

o the unds that they receive. Regional cooperation to avoid protectionist policies

would also enhance the interests o both home and host countries.




Table 1 Growth rate of GDP (% per year) Table 2 Inflation (% per year)

Subregion/Economy 2008 2009 2010 2008 2009 2010

ADO

2009

Update ADO

2009

Update ADO

2009

Update ADO

2009

Update

Central Asia . . . . . . . . . .

Azerbaijan . . . . . . . . . .

Kazakhstan . . -. . . . . . . .

East Asia . . . . . . . . . .

China, People’s Rep. o . . . . . . . -. . .

Hong Kong, China . -. -. . . . . . . .

Korea, Rep. o . -. -. . . . . . . .

Taipei,China . -. -. . . . . -. . .

South Asia . . . . . . . . . .

Bangladesh . . . . . . . . . .

India . . . . . . . . . .

Pakistan . . . . . . . . . .

Sri Lanka . . . . . . . . . .

Southeast Asia . . . . . . . . . .

Indonesia . . . . . . . . . .

Malaysia . -. -. . . . . . . .

Philippines . . . . . . . . . .

Singapore . -. -. . . . . . . .

Thailand . -. -. . . . . -. . .

Viet Nam . . . . . . . . . .

The Pacific . . . . . . . . . .

Fiji Islands . -. -. . . . . . . .

Papua New Guinea . . . . . . . . . .

Developing Asia . . . . . . . . . .

Notes: Developing Asia reers to developing member countries o the Asian Development Bank and Brunei Darussalam, an unclassiied regional

member; East Asia comprises People’s Republic o China; Hong Kong, China; Republic o Korea; Mongolia; and Taipei,China; Southeast Asia comprises

Brunei Darussalam, Cambodia, Indonesia, Lao People’s Democratic Republic, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Viet Nam; South

Asia comprises Islamic Republic o Aghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka; Central Asia comprises Armenia,

Azerbaijan, Georgia, Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan; and The Paciic comprises Cook Islands, Fiji Islands, Kiribati,

Republic o the Marshall Islands, Federated States o Micronesia, Nauru, Papua New Guinea, Republic o Palau, Samoa, Solomon Islands, Democratic

Republic o Timor-Leste, Tonga, Tuvalu, and Vanuatu.

Data or Bangladesh, India, and Pakistan are recorded on a iscal year basis. For India, the iscal year spans the current year’s April through the next

year’s March. For Bangladesh and Pakistan, the iscal year spans the previous year’s July through the current year’s June.



Part 1Coping with the

global recession



Coping with the global recession

A year has passed since the collapse o Lehman Brothers in September

2008a watershed event or the world economy. Global nancial markets

had been sputtering or more than a year up to that pointwith exposure

to low-quality mortgage-backed securities leading to several high-prolenancial ailures in the United States (US) and United Kingdom (UK).

Although many major industrial economies had already slipped into

recession by mid-2008, the month o September still stands out. Te de

acto nationalization o mortgage lenders Fannie Mae and Freddie Mac,

ollowed in quick succession by the closure o Lehman Brothers and the

bailout o insurer AIG, sent world nancial markets reeling. With global

nance seizing upand risk premiums on new lending spikingthe

weaknesses that were dragging down the US and UK nancial sectors

urther undermined real economic activity, and spread globally.

Tis impact is clearly seen in the two gures at right. For the rst

time since the end o World War II and its aermath, in 2009 global

gross domestic product (GDP) will contract, by an estimated 1.4%(Figure 1.1.1). Te collapse in world trade has been even more dramatic

(Figure 1.1.2). Merchandise trade will decline by a magnitude that has not

been matched in peace time since the Great Depression. No part o the

world has been spared. Yet within the tumult, developing Asia’s growth

has been surprisingly buoyant.

Authorities across the globe responded quickly and decisively to

the threat o a potential replay o the Great Depression. Tey took

extraordinary steps to shore up the tottering international nancial

system and restore condence, opening wide the taps on money supply

to combat the credit drought, while boosting public spending plans and

slashing taxes to prop up economic activity. In some cases, they adopted

unprecedented methods to stave o disaster.

Now, in September 2009, there are signs o an emerging global

recovery, though it is still too early to say i the momentum has ully

shied or the major industrial economies. Tis raises a critical question

or developing Asia: Will the region manage to keep its buoyancy until a

sustained global recovery takes hold?

This chapter was written by Benno Ferrarini, William James, Juthathip Jongwanich,

Donghyun Park, and Akiko Terada-Hagiwara o the Economics and Research

Department, ADB, Manila.

1.1.1 Long-run world GDP growth

-10

-8

-6

-4

-2

0

2

4

6

8

092000908070605040301922

%

Forecast

World War II

The Great Depression

Sources: Sta calculations based on A. Maddison, 2009,Historical Statistics o the World Economy: 1–2006 AD,available: http://www.ggdc.net/maddison/; InternationalMonetary Fund, World Economic Outlook database, April2009.

Click here or fgure data

1.1.2 Long-run world merchandise trade

growth

-40

-30

-20

-10

0

10

20

30

40

50

092000908070605038301923

%

Forecast

World War II

The Great Depression

Note: There are no data rom 1939 to 1947 due to World

War II and its atermath.

Sources: World Development Indicators online database;

United Nations Statistics Division, International Merchandise

Trade Statistics, available: ht tp://unstats.un.org/unsd/deault.htm; World Trade Organization, Short-term TradeStatistics database, available: http://www.wto.org; alldownloaded 9 September 2009; sta estimates.


http://www.adb.org/Documents/Books/ADO/2009/Update/figs/f1-1-1.xls






Long recession avoided?

Te recession in many o the major industrial economies has already

set several records. In the case o the US, this recession is the longest

since the Great Depression. Te continuing housing crisis, rising

unemployment, and crippling o major industries as consumers retrench

has made it very difcult to ascertain whether the trough has been

reached.

Across the major industrial economies, there is reason or cautious

optimism regarding recovery, as GDP growth in the second quarter o

2009, industrial production, and trade have distinctly improved relative

to previous quarters (Figure 1.1.3), but it is still too early to declare an end

to the recession. Even i one could, the outlook is or a weaker than usual

recovery and there are even those who predict a double-dip recession asthe impact o scal stimulus wears o and governments ace the realities

o managing huge increases in public debt and revenue losses. Te

nancial sector remains ragile as many banks in the US, UK, and some

eurozone countries retain loan portolios tainted with nonperorming

assetsincluding toxic residential and commercial mortgage-backed

securitiesand ace increasing delinquency on credit card debt and

automobile loans.

Coherent policies or recovery and

growth rebalancing

Policy actions by central banks and governments to prevent a complete

collapse o the nancial system and to provide stimulus to demand

were enacted in a timely ashion. Monetary policy adopted “quantitative

easing” to provide banks with additional reserves and cash in addition to

the slashing o policy rates to historic lows. Expansionary scal policy in

the orm o tax rebates and massive government expenditure programs,

together with the normal operation o automatic stabilizers such as

unemployment insurance and reduced income tax witholdings, added

to the stimulus. Tese bold policies were successul in pulling the world

economy back rom the brink o a second great depression.

Discretionary scal stimulus and automatic stabilizers may have

cushioned the rate o decline in economic activity and the loss o

employment, and are likely pushing growth into positive territory in the

second hal o 2009, or at least stabilizing it.

Te share o the US, Japan, and European Union (EU) in world imports

as well as other important western economies has been declining since

the turn o the century, and it is apparent that the share o developing

Asia and other emerging economies has been rising, but rom a low base

(Figure 1.1.4). Te industrial economies are losing their sway over global

trade relative to developing economies. Tus it is imperative that both

industrial and developing economies seek to boost growth in world trade

together in order to spur recovery in global industrial production and

1.1.3 Economic indicators,

selected major industrial economies

United StatesUnited KingdomSpain

JapanGermanyFrance

-30

-20

-10

0

10

Q2Q1

09

Q4Q3Q2Q1

08

Q4Q3Q2Q1

2007

%, quarter on quarter, seasonally adjusted

Industrial production growth

-15

-10

-5

0

5

10

Q2Q1

09

Q4Q3Q2Q1

08

Q4Q3Q2Q1

2007

%, quarter on quarter, saar

GDP growth

-40

-20

0

20

Q2Q1

09

Q4Q3Q2Q1

08

Q4Q3Q2Q1

2007

%, quarter on quarter

Merchandise trade growth

saar = seasonally adjusted annualized rate.

Sources: CEIC Data Company Ltd.; US Department o

Commerce, Bureau o Economic Analysis, available http://bea.gov; Economic and Social Research Institute, CabinetOce, Government o Japan, available http://www.esri.cao.go.jp/en; World Trade Organization, Short-term TradeStatistics database, available: http://www.wto.org, alldownloaded 10 September 2009.






Coping with the global recession 5

growth. I either or both instead resort to protectionist measures, this will

make it more difcult to achieve a robust global recovery.

Households in the US and much o the eurozone and the UK are

heavily indebted and much less wealthy than beore the nancial crisis,

and so it is not going to be possible to return to the precrisis imbalancesbetween income and expenditure, and investment and savings. In

particular, households in decit countries such as the US and UK will

have to consume less out o their disposable income and save more.

With the US budget now in decit by over 10% o GDP and with

virtually all the eurozone economies having scal decits well above the

3% stability and growth pact limit (Ireland, or example, has a decit o

7% o GDP), other sources o demandparticularly private investment

and net exportswill need to drive growth. Tis means that high-surplus

economies such as People’s Republic o China (PRC), Germany, Japan,

and the Gul States will have to save less, and consume and import more.

Signs are there that this process is beginning to take rootor example,

the trade decit o the US has narrowed while the trade surplus o thePRC has allen.

Still, better international coordination o policies will be required to

ensure that recovery does not relapse into stagnation or even double-dip

recession, so as to reduce imbalances between spending and income;

to minimize the opportunities or regulatory arbitrage, which may

prompt adverse nancial ows; and to undertake specic actions or

strengthening global economic institutions and governance. Te decision

by G20 nance ministers at the September meeting in London to

continue to enact scal stimulus measures until a robust recovery was

evident is an important step in this direction.

In the current situation it is imperative that major industrial

economies maintain coherent policies aimed at strengthening demandin order to avoid a prolonged recession and a weak and ragile recovery.

One lesson to draw rom previous deep global downturns, including the

Great Depression, is that central banks must avoid tightening monetary

policy prematurely and taking steps that undermine banking system

stability. As Japan’s experience in 1997 demonstrated, governments must

also avoid premature increases in taxation and maintain scal stimuli

until sustained output growth is clear. Once private demand recovers,

monetary and scal stimulus can be withdrawn, gradually.

Te outlook or recovery rom the economic slump has been greatly

improved by the decisive policy actions in the major G3 economies (US,

eurozone, Japan) to ease monetary conditions and to provide a strong

scal stimulus. Moreover, the agreement o the G3 to work closely with

developing countries in the G20 to maintain scal stimulus policies

and to keep economies open to oreign investment bodes well or the

global outlook. Tis combination o policies plus the avoidance o blatant

beggar-thy-neighbor trade actions has kindled hopes or a V-shaped

rebound in global output.

However, there are still major policy issues causing concern over

the medium-term prospects or a robust return to sustained growth,

especially as regards consolidating nancial market recovery, preserving

trade openness, timing exit strategies rom unsustainable scal stimulus

and money creation, and resolving global imbalances, as discussed below.

1.1.4 Share in world imports

0

10

20

30

40

50

CanadaFranceUnited Kingdom

United StatesJapanGermany

08 05 2002 99 96 93 1990

%

Selected industrialized countries

0

5

10

15

Rep. of KoreaIndiaPeople's Rep. of China

08 05 2002 99 96 93 1990

%

Selected developing Asian economies

Note: 2009 data as o April.

Sources: International Monetary Fund, Direction o TradeStatistics online database; CEIC Data Company Ltd.; bothdownloaded 10 September 2009.






6 Asian Development Outlook 2009Update

Financial market recovery in the cradle o the crisis

Te outbreak and rapid spread o the nancial market turmoil rom the

US and the UK to the rest o the world, as well as a general collapse o

condence in nancial markets, nearly led to catastrophe. Early measures

were eective in avoiding deeper problems (Box 1.1.1).Normalization slowly began to return in early 2009, but concerns

remained. Positive signs included reduced spreads between overnight

lending rates o the commercial banks and reasuries in both the US and

UK (Figure 1.1.5). Lower risk premiums are indicative o the restoration

o some measure o nancial stability. In addition, equity market

capitalization had also begun to recover by the second quarter o 2009

(Figure 1.1.6).

However, there are still indications that housing market problems

in the US will continue to put a damper on bank balance sheets and to

depress household expenditure as the number o oreclosures mounts

(Figure 1.1.7). Similarly in the UK, banks’ write-os o household

dwellings have been on the rise (Figure 1.1.8).Te continuing problems in the US housing market and the difcult

circumstances that many households are experiencing in a context o

sharply rising unemployment are leading to increases in deault rates

on consumer loans, credit card debts, student loans, and automobile

loans. Te problem is maniested in an increased number o ailures

among the smaller commercial banks, as reported by the Federal

Deposit Insurance Corporation. Te number o banking ailures in 2009

compared with 2008 has yet to level o (Figure 1.1.9), even though the

size o the institutions ailing is much smaller in terms o assets and

liabilities.

In the UK, banks’ unding difculties remain. Te Bank o

England has expressed concern about the marked all in bank lendingto nonnancial corporations in the second quarter, which may

pose difculties or companies that need to renance existing loans

(Figure 1.1.10). Similarly, household lending remains subdued, and lending

1.1.5 TED spreads

0

1

2

3

4

5

United KingdomUnited States

1 Jul 1 Jan

09

1 Jul 1 Jan

08

1 Jul

1 Jan

2007

Basis points

Note: The TED spread is the dierence between 3-monthLIBOR and the yield on 3-month Treasuries.

Source: Bloomberg, downloaded 3 September 2009.


Only massive injections o liquidity into nancial marketsand institutions in the aected economies and the extensiono direct swap lines between central banks in the G andelsewhere, including developing Asia, prevented the collapseo the payments system and widespread ailure o commercial

banks and other nancial institutions.Te reduction o policy rates to historic lows in the Gin late was accompanied by a swathe o innovativeprograms and actions to put huge quantities o new money into the nancial markets.

In the US, providing liquidity support through new centralbank lending vehicles, paying interest on bank reserves,and extending the maturity o short-term loans through thediscount window were helpul in providing commercial bankswith resh unds but were insufcient in themselves to restorenancial stability.

Also needed to stem the panic were direct balance sheet

support through outright purchases o assets and directinjections o new capital into ailing nancial institutions andthrough the de acto nationalization o the large mortgagelenders Fannie Mae and Freddie Mac as well as other nancialentities judged “too big to ail.”

In the UK, measures included a program to provide bankswith a credit guarantee scheme and a liquidity programallowing institutions to swap their assets or reasury bills.

As long as the potential or inationary consequencesis kept in check and long-term interest rates stay low, it islikely that the Federal Reserve and the Bank o England willmaintain low (near zero) policy interest rates and provideother support to strengthen their still-ragile nancial sectors.

As o the third quarter o , some o the largercommercial banks in both countries seem to be recovering asprots begin to rise, enabling them to repay loans and buildstronger capital bases.

.. Measures to stave o meltdown

1.1.6 Equity market capitaliz ation, United

States and United Kingdom

0

7

14

21

0.0

1.5

3.0

4.5

United KingdomUnited States

JulAprJan

09

OctJulAprJan

2008

$ trillion $ trillion

Note: The data pertain to the Bloomberg-calculated totalmarket value o exchanges covering all indexes traded andcompanies listed in each country’s exchanges.










rates continue to be high and largely inelastic to cuts in the ofcial rate by

the Bank o England. Partly as a result, UK housing market activity has

improved only slightly rom the very low levels seen around the turn o

the year, and increases in housing prices have been tenuous so ar.

Preserving trade openness

Te rst major policy issue causing concern is that o preserving and

strengthening the world trading system. Te severe contraction in world

trade is raying the consensus against protectionism. Governments are

tempted to cave in, both to domestic lobbies seeking protection and

to those opposing oreign companies and immigrants (particularly

immigrants entering occupations traditionally lled by the domestic labor

orce). Government procurement bias in scal stimulus measures is also a

bone o contention. Nearly every domestic sector that is suering losses o

prots and jobs rom automobiles to arms is demanding help in the orm

o protectionand policies are oen shaped to appease such important

constituencies.In North America, or example, trade relations among partners in the

North American Free rade Agreement (NAFA) have deteriorated, with

preerential trade suering as a result. Te US tightened border restrictions

on intra-NAFA overland transportation, and Mexico retaliated by placing

penalty duties on 80 US export items. Mexico has seen its GDP contract

sharply, as has Canada to a lesser degree. In the EU, there is mounting

pressure rom those less aected by the economic malaise objecting to

bailouts o those who have been hit, and trade within the EU has been

severely reduced as incomes and employment have allen.

Te temptation to raise legal trade barriers in the orm o saeguards,

antidumping measures, and export restrictions (Box 1.1.2) is also cause or

concern. Te World rade Organization (WO) reported that 24 o itsmembers and the EU introduced 83 new trade-restricting measures in the

rst 3 months o 2009, more than twice the number o measures aimed

at easing barriers to trade during the same period (WO 2009). Nor do

these new restrictive measures include “gray area” restrictions such as

those on pork imports rom suppliers in countries with human cases o

swine u (H1N1).

Te multilateral trading system has underpinned global growth and

prosperity or the past six decades. But whether the Doha round o global

trade talks, currently in deadlock, can be jump-started will be a key test

or governments around the globe. Failure to do this will have serious

implications or developing countries, not least those in Asia.

Timing o exit strategy

A second major concern is the appropriate implementation o exit

strategies. Getting their timing right will be crucial to avoid a double-dip

recession and to move the G3 economies back toward trend growth by

reducing the dierence between actual and potential GDPthe output

gapwithout igniting ination. Te massive expansion o central bank

balance sheets has enormously boosted commercial banks’ lending

capacity. Tis has potential inationary consequences, even though at

present prices are ebbing with the collapse in consumer spending, in

private investment, and in international trade. And, although deation

1.1.9 Bank ailures, United States

0

350

700

1,050

1,400

0

10

20

30

40

Failed banksTotal assets

Total deposits

Q3Q2Q1

09

Q4Q3Q2Q1

2008

$ billion Number

Note: Data or Q3 2009 reer to 1 July–21 August.

Source: Federal Deposit Insurance Corporation, available:http://www.dic.gov, downloaded 31 August 2009.


1.1.8 Bank write-os and loan revaluations

on household dwellings, United Kingdom

-100

0

100

200

300

Q1

08

Q1

06

Q1

04

Q1

02

Q1

2000

£ million

Source: CEIC Data Company Ltd., downloaded 31 August 2009.


1.1.7 Housing mortgage oreclosures,

United States

0

5

10

15

20

PrimeSubprimeAll

JulJan

09

JulJan

08

JulJan

07

JulJan

2006

% of total delinquent accounts

Source: Bloomberg, downloaded 31 August 2009.


1.1.10 Contribution to growth in loans to

private nonnancial corporations over past

3 months, United Kingdom

-10

0

10

20

30

Jan

2006

Jul Jan

07

Jul Jan

08

Jul Jan

09

Percentage points, annualized

Other lendersMajor banks Total

Notes: Includes sterling and oreign currency loans. Themajor banks consist o Banco Santander, Barclays, HSBC,Lloyds Banking Group, and Royal Bank o Scotland. Otherlenders computed as a residual.

Source: Bank o England, available: http://www.bankoengland.co.uk, downloaded 2 September 2009.













Increased use o legal protectionist instruments mighttemporarily boost domestic production and consumption incertain sectors, but overall, they could have adverse eects,

especially on resource allocation. Still, protectionist pressuresglobally have seen a marked increase, but those seen duringthe second hal o through the rst hal o tendedto dier rom traditional approaches, which mostly ocusedon tari barriers.

Tese nontari approaches include use o antidumpinginvestigations and measures, global saeguards, countervailingduties, and PRC-specic saeguards (as well as restrictionson government procurement). Tey are costly (in terms o scarce human resources in international trade negotiationsand jurisprudence) and tend to undermine competitionand reduce trade volume. Teir eects could be prolongedsince it takes time to le petitions and initiate investigations

aer which denitive measures then may be implemented.In addition, once in place, they are difcult to remove,potentially creating a host o uture complications. Tey arealso likely to provoke retaliation, thereby undermining thetrading system and discouraging economic recovery.

Since late , there has been a rise in newly initiatedinvestigations o nontari barriers (Box gure ). Teir

number rose rom ewer than cases in the rst quarter o to cases in the last quarter o , beore decliningto around cases in the rst quarter o . Antidumping

contributed primarily to a rise in nontari barriers but leveledo aer the initial escalation. In contrast, global saeguardmeasures increased noticeably, which is a new and strikingeature o protectionist pressure. For the rst hal o ,initiated investigations o global saeguard measures rose to cases rom only seven in , a gure that Bown ()projects could rise to or the whole year.

Countries have taken recourse to antidumpinginvestigations as the main orm o legal protectionism, butglobal saeguard investigations have recently become moreimportant. Antidumping covered several sectors, but ironand steel dominate ( o total initiated investigations)mainly because o the global downturn’s severe eects on the

automotive industry. Next come plastics and rubber (),chemicals (), machinery (), wood (), othermetals (), and textiles (). In contrast, o initiatedinvestigations on global saeguard measures were concentratedin nonsteel products (Bown ).

Developing countries initiated most trade remedy measures during the downturn (Box gure ). (Antidumpingrom developing economies has, in act, increasedsubstantially since , that is, since well beore the globaldownturn [James ]). In the rst hal o , they launched o total investigations, with the PRC and Indiaaccounting or almost . Among industrial economies, theUS was the largest initiator while the European Union, havinglaunched investigations in launched only two in the

rst hal o . Japan has initiated no recent investigation.

.. A rise o nontari barrier protectionism

1 Newly initiated investigations

0

30

60

90

PRC-specific safeguards

Global safeguards

Countervailing duties

Antidumping

Q2Q1

09

Q4Q3Q2Q1

08

Q4Q3Q2Q1

2007

Number

Source: Global Antidumping Database, Version 5.0, July2009, available: www.brandeis.edu/~cbown/global_ad/.


is not yet a serious threat to macroeconomic stability in the US and the

eurozone, it may well be more o a threat to Japan.

Unchecked deation rom a continuing all in aggregate demand is

also a threat, and is a threat precisely because it elevates the real value

o debt, erodes prots o businesses, and induces consumers to delay

purchases in expectation o uture price cuts. It also tends to exacerbate

unemployment when unions and workers resist cuts in nominal wages,

because a decrease in the price level results in higher real wages. However,

once the recovery begins in earnest, and unless monetary easing is

reversed, ination pressures and expectations may take hold and lead

to a rebirth o “stagation”an uncomortable combination o elevated

unemployment and price increases.

Te debate over the outlook or ination has global consequences

1 Data on initiated investigations are compiled rom C. P. Bown, 2009,“Global Antidumping Database.” Detailed raw data through the secondquarter o 2009 are or the 21 WO members that initiated 91% o allantidumping investigations launched by WO members in 1995–2008. Forcountervailing duty, detailed data through the second quarter o 2009 areor 12 o the larger members (but not the PRC). For all global saeguardsand PRC-specifc saeguards notifcations, data are rom WO.

http://www.adb.org/Documents/Books/ADO/2009/Update/figs/bf1-1-2-1.xls





Developing countries, especially the PRC, were targetedby these trade remedy instruments. Developing countries

accounted or around o total targeted exporters,and almost hal o these were directed at the PRC (morethan o the newly initiated investigations in )(Box gure ). Initiated investigations o these trade remediesalso rose in other East and Southeast Asian economies. In, Indonesia; India; Malaysia; aipei,China; and Tailandwere named in o the investigations. For industrialcountries, almost hal o the instruments were targeted at theG economies, particularly the US.

All in all protectionist pressures, especially nontari barriers, have shown a marked increase since late .However, this creeping protectionism has not yet caused a

urther slowdown o global trade or created a protectionistspiral. Nevertheless, rampant protectionism still needs to beguarded against.

In addition to the nontari approaches mentioned above,“buy domestic” provisions associated with scal stimuluspackages may indirectly distort global trade and thereoreincrease concerns over protectionism. For example, inFebruary this year, the “buy American” provision that eaturedin the $ billion stimulus package requires public workssuch as inrastructure improvement to use iron, steel, andother goods made in the US, as long as the provision does notcontravene commitments to trade agreements. Te stimuluspackages introduced by the PRC and Tai governments also

contain “buy domestic” provisions.In practical terms, a “stand-still” on new protectionistmeasures should be agreed upon to promote economicrecovery. It would be preerable i countries rerained romuse o antidumping as retaliation in a time o trade stressand instead rely on the WO dispute resolution mechanism,as Japan does. In cases where temporary measuresdiscriminating against oreign products have been imposed,the appropriate review mechanism should be conducted toensure the orderly unwinding o such measures once therecovery is in train.

Reerences

Bown, C. P. . “Protectionism Continues Its Climb. A MonitorUpdate to the Global Antidumping Database.” July, available:www.brandeis.edu/~cbown/global_ad/.

James, W. E. . “Have Antidumping Measures o EU and NAFAMembers against East Asian Countries Provoked Retaliatory Responses?” ADB Economics Working Paper Series No. , AsianDevelopment Bank, Manila.

.. A rise o nontari barrier protectionism (continued )

3 New investigations by aected country

0

40

80

120

160

Against developingAgainst industrial

H1 200920082007

Number

Source: Global Antidumping Database, Version 5.0, July

2009, available: www.brandeis.edu/~cbown/global_ad/.


(Box 1.1.3), because i authorities tighten monetary policy prematurely,

they may stop the recovery in its tracks. Yet i they allow monetary easing

or too long, long-term interest rates may rise and strangle investment,

thus dooming the economy to sub-par growth. Attempts to sustain scal

stimulus over too long a period may also backre as too much debt drives

long-term yields upward, choking private investment. Yet inertia and

political pressures are likely to prolong the period o low interest rates

and increase the danger either that asset bubbles will start to reemerge or

that ination expectations will rise.

Resolving global imbalances

As pointed out in Asian Development Outlook 2009 (ADO 2009) in March

this year (ADB 2009), the third concern relates to attaining a robust and

2 New investigations by initiating country

0

20

40

60

80

From developingFrom industrial

Q2Q1

09

Q4Q3Q2Q1

08

Q4Q3Q2Q1

2007

Number

Source: Global Antidumping Database, Version 5.0, July2009, available: www.brandeis.edu/~cbown/global_ad/.









How and when will central banks reverse monetary easing? Even though it is still too early to start exitingnow, because o the stimulus measures’ size and scope, exit

strategies need to be careully laid out.Balancing ination concerns (due to excess liquidity)

and the risk that liquidity is prematurely withdrawn is noteasy, as seen in the experience o two past exit strategies.Te dangers o tightening too early are deation and areturn to recession, as clearly evidenced by the experienceso the US in and and Japan in and (Box gure ). In both cases, the economies ell back into recession, with deation as a result. Yet the dangerso tightening too late are hyperinationand a return torecession.

Te Federal Reserve, acutely aware o these dangers,in March this year started a program to accelerateacquisitions o securities in order to keep long-terminterest rates low. It has largely replaced the liquidity acilities with securities held outright, mainly mortgage-backed securities, while keeping its balance sheet atthe expanded level o about $ trillion (Box gure ).reasuries and agency debt continued to increase.

It is now in a process o exiting rom the short-term

credit operations. Credits that had been expanded throughterm auction credits, the Commercial Paper FundingFacility, and central bank liquidity swaps have been

reduced signicantly since January this year.Yet concerns about the ability o markets to absorb

the supply o new reasuries appear evident in the rise inbond yields. While this shi indicates a sign o improvedmarket sentimenta condition necessary or a successulexitoverall nancial conditions remain tight.

Te Bank o Japan, in contrast, has not initiated anapparent exit out o the short-term operations that itintroduced aer the collapse o Lehman Brothers. Tismainly reects the continuing tight credit conditions o those hit hard by the collapse o exports, and partly thelessons learned rom the experience o and

(when policy was tightened too early).In G economies generally, growth in bank credit to theprivate sector continues to slow; debt markets (particularly those with asset-backed securities and those not supportedby the public sector) remain weak; and lower-quality borrowers have limited access to capital market unding,which suggests that any hasty exit out o short-term creditoperations would be premature.

Another concern is that the recent improvements inthe nancial markets could lead to complacency. Althoughthe risk o dipping into a deationary spiral seems to havereceded, price movements are still in negative territory.Condence remains ragile, and risks could reemerge,

especially since the improvement in the G nancialmarkets stems rom the massive public sector support.

In particular, ensuring adequate bank capitalization iscrucial, and cleaning troubled assets will take a long time.Unless the G central banks tread warily, the economicrecovery will be dragged down, as seen in the pastepisodes in the US and Japan.

.. Central bank exit strategies

1 Past experiences o exit strategies,United States and Japan

-14

-7

0

7

14

InflationGDP growth

403938373635343332311930

%

United States

-4

-2

0

2

4

InflationGDP growth

05040302012000999897961995

%

Japan

Sources: US Department o Commerce, Bureau o EconomicAnalysis, available: http://www.bea.gov; US Departmento Labor, Bureau o Labor Statistics, available: http:// www.bls.gov; Economic and Social Research Institute, CabinetOce, Government o Japan, available: http://www.esri.

cao.go.jp/en; all downloaded 11 September 2009.


2 Assets o the Federal Reserve

0

1

2

3

Central bank liquidity swaps

Commercial Paper Funding Facility

Term auction credit

Securities held outright

JulAprJan

09

OctJulAprJan

08

OctAug

2007

$ trillion

Source: Federal Reserve, available: https://www.ederalreserve.gov, downloaded 2 September 2009.









sustainable global recovery, which will require major adjustments to the

composition o GDP growth. Tese changes will have serious implications

or developing Asia. Te US trade decit has already allen by almost

52% in the rst hal o 2009 compared with the same period in 2008, but

only because imports have allen aster than exports. For GDP growthto recover sustainably, trade will have to return to growth and US net

exports will have to become a major contributor, along with private xed

capital ormation.

As the US cuts spending relative to income and consumes less out o

current income (hence saving more), the rest o the worldin particular

the high-surplus economies mentioned abovewill also have to switch to

new, chiey domestic, growth engines and to import more. Longer term,

the US will also have to curb its growing dependence on imported oil and

energy through efciency, conservation, and development o clean and

competitive energy sources, thereby reducing its decit with oil-exporting

countries.

Te US output gap is already approaching 5% (Figure 1.1.11). TeOrganisation or Economic Co-operation and Development (OECD) has

orecast that it will reach 5.4% in 2010, while its estimates or Japan and

the eurozone are around 6%implying a 5.8% output gap or the major

industrial economies. Tis has implications or exit strategies rom the

current massive scal stimulus and easy monetary policies in industrial

countries. Te nancial crisis may exacerbate the alling growth trend as

investment slumps, decits grow, and debt burdens increase. However,

there may be mitigating actors because households will have incentives to

work longer hours so as to rebuild wealth and reduce their indebtedness.

Policies, too, will aect outcomes. Eorts to keep nonviable banks

and inefcient industries alive would do much to scuttle growth, as seen

in Japan’s “lost decade” o the 1990s. In the US case, eorts to reormhealth care, social security, and other entitlements as well as the act that

many enterprises have cut costs to the bone will work in the direction

o restoring some growth potential during the recovery by reeing up

resources or more efcient uses. Clearly, hard choices are ahead or

policy makers worldwide.

1.1.11 Output gap, major industrial

economies

-8

-4

0

4

JapanEurozoneUS

10090807062005

% of potential GDP

Projection

Source: OECD Economic Outlook No. 85, June 2009, available:http://www.oecd.org, downloaded 10 September 2009.






Recovery at hand?

Te assumptions regarding global economic conditions underlying

the regional outlook, which this Update revises, have changed since

ADO 2009 was published in March this year (able 1.2.1). In particular,

actual growth in 2008 in the G3 economies was much slower than

orecast in ADO 2009. Tis Update also substantially reduces estimates

o world trade growth. With ination subdued, it assumes that central

banks will maintain low interest rates or the oreseeable uture and that

this will encourage a mild recovery in 2010 in the G3 and a rebound in

world trade.

Financial indicators have begun to improve as authorities have

managed to avert nancial disaster through massive interventions that

increased liquidity and helped reduce the cost o unds or major banks

and insurance providers. Banks and other nancial institutions that

were in deep trouble in the wake o the collapse o Lehman Brothers in

September 2008 are now liquid and most have been able to raise capital.

Fears o imminent breakdown o the payments system have clearly

subsided. Spreads between interbank lending rates and reasuries have

consequently narrowed (Figure 1.1.5 above) and short-term rates are now

below long-term reasury yields due to aggressive easing o monetary

policy. Yield curves have steepened, indicating that recovery may be in

the ofng.

.. Baseline assumptions or external conditions

Actual Actual ADO

2009

Up date ADO

2009

Update

GDP growth (%)

Major industrial economiesa . . -. -. . .

United States . . -. -. . .

Eurozone . . -. - . . .

Japan . -. -. -. . .

Memorandum items

US Federal unds rate

(average, )

. . . . . .

EU renancing rate (average, ) . . . . . .

Japan interest rate (average, ) . . . . . .

Brent crude spot prices (average, per barrel)

. . . . . .

Nonuel commodity prices

( increase)

. . -. -. . .

CPI infationa (G average, ) . . -. -. . .

World trade volumeb

( increase)

. . -. -. . .

a Average growth rates are weighted by GNI, Atlas method. b Merchandise exports.

Sources: US Department o Commerce, Bureau o Economic Analysis, available: www.bea.gov; Eurostat,available: http:// epp.eurostat.ec.europa.eu; Economic and Social Research Institute o Japan, available:

www.esri.cao.go.jp; Consensus Forecasts; Bloomberg; International Monetary Fund, World Economic

Prospects Update July 2009; World Bank, Global Economic Prospects 2009 and Commodity Price Data (Pink

Sheet), available: www.worldbank.org; sta estimates.




Other indications o nancial stabilization are seen in rallies in

major stock indexes (the Dow Jones Industrial Average has risen above

9,000 and the S&P 500 above 1,000 in recent months). Although stock

prices are still considerably below pre-September 2008 peaks, the

recovery in equities may be a leading indicator that the worst o thedownturn is now over.

Job losses have moderated in the US and the eurozone although not

yet in Japan. Preliminary estimates o GDP growth or the second quarter

o 2009 in the G3 and some other OECD economies are stronger than in

the rst quarter, indicating that the degree o contraction is moderating

and that the trough o the recession may be at hand in the last 2 quarters

o 2009. For example, in its July World Economic Outlook, IMF modied

its 2009 orecast or G3 GDP contraction to be less severe (3.8%) than

it initially orecast in April (4.2%). Other real indicators such as retail

sales growth, housing starts, as well as indexes o consumer and business

sentiment began to show signs o improvement, or at least o stabilization,

toward the end o the second quarter.

United StatesDuring the rst quarter o 2009, GDP contracted at an annualized rate

o 6.4%, as industrial production plummeted at rates not seen since the

Great Depression. Te preliminary estimate o GDP in the second quarter

o 2009 was better than expected at just a 1.0% (annualized) contraction,

due largely to government expenditure and partly to a modest boost in

net export growth. Consumption and investment continued to pull back

overall economic growth during the second quarter (Figure 1.2.1).

Job losses mounted persistently, with June’s losses o 463,000 up

sharply rom the May decline o 303,000. Since the recession ofcially started in December 2007, 6.7 million workers have lost their jobs and

unemployment has spiraled to 9.7% in August 2009. Job losses moderated

to 216,000 in August, providing a glimmer o hope that the worst is over.

In addition, US households have borne a loss o wealth equivalent to more

thanayear’sGDP(around$14trillion).

In the ace o such massive losses o employment and wealth,

highly leveraged US households are reducing spending aster than their

disposable income is alling, marking a gain in the personal saving rate

rom near zero at the start o the downturn to 5% in the second quarter

o 2009, the highest rate in over a decade (Figure 1.2.2). Tese moves are,

however, being counterbalanced by a huge increase in the government

budget decit, which will likely hit 11–13% o GDP (Figure 1.2.3) or

the ull scal year ending 30 September. For the rst 11 months o the

scal year, the Congressional Budget Ofce reports that government

expenditure was already up by 19% and revenue down by 16% relative to

the same period o the previous year.

Overall, with households increasing their saving and the economic

slowdown reducing investment, the US external imbalances have been

tempered somewhat as less oreign borrowing has been required. Te

US current account decit has allen by hal rom peak levels in 2006

(6% o GDP) to 2.9% in the year to the second quarter (Figure 1.2.4). Te

unwinding o unsustainable current account imbalances, coupled with

1.2.4 Current account balance, United States

-8

-6

-4

-2

0

Q1

09

Q3Q1

08

Q3Q1

07

Q3Q1

06

Q3Q1

2005

% of GDP

Source: US Department o Commerce, Bureau o EconomicAnalysis, available: http://www.bea.gov, downloaded 17September 2009.


1.2.2 Personal saving rates, United States

0

2

4

6

Q1

08

Q1

06

Q1

04

Q1

02

Q1

2000

% of disposable personal income

Source: US Department o Commerce, Bureau o EconomicAnalysis, available: http://www.bea.gov, downloaded28 August 2009.


1.2.1 Contributions to GDP growth,

United States

-12

-6

0

6

Q1

2007

Q2 Q3 Q4 Q1

08

Q2 Q3 Q4 Q1

09

Q2

Percentage points, saar

GDP growth

Government consumption

Personal consumption

Net exports

Gross fixed capital formationChange in inventories


Source: US Department o Commerce, Bureau o EconomicAnalysis, available: http://www.bea.gov, downloaded 28August 2009.


1.2.3 Government budget balance,United States

-15

-10

-5

0

09080706052004

% of GDP

Projection

Sources: Actual data: CEIC Data Company Ltd., downloaded18 August 2009; The Budget and Economic Outlook: AnUpdate, Congressional Budget Oce, August 2009,available: http://www.cbo.gov.














United States (US) imports under preerential ree tradeagreements (FAs) started to contract earlier than importsas a whole when examined quarter on quarter; measuredyear on year, they contracted aster than world imports.

Quarter-on-quarter imports under the North AmericanFree rade Agreement (NAFA) began to slide in thethird quarter o even as overall imports continuedto rise. Imports rom Canada and Mexico under NAFApreerences started to contract in the third quarter o compared with the previous quarter, and the rate o

decline then accelerated (Box gure).

NAFA preerential imports o the US cumulatively collapsed by almost in the rst months o compared with the same period in a more rapidrate o contraction than imports rom all sources, whichell by about one third. US domestic exports to NAFApartners (down ) also ell more sharply than exports tothe rest o the world (down ) over the same period.

Te reason or the relatively rapid contraction o preerential imports appears to be that trade is highly concentrated in automobiles and textiles with Canada andMexico. Hence the collapse reects the ailure o largecorporations such as General Motors and the sharp declinein consumer demand in those sectors.

A lesson to draw rom this experience is that in sectorswhere applied most-avored-nation taris are high, suchas automobiles and textiles, trade is likely to be divertedto preerential partners on a large scale, and production

may become excessive within the FA concerned (in thiscase, NAFA). Tus when demand collapsed, such tradeand production were particularly vulnerable. ime will telli special programs such as “cash-or-clunkers” will helprevive intra-NAFA automotive trade.

Quarter-on-quarter imports rom all US bilateralFAs in orce in the third quarter o show a similarpattern o accelerating contraction rom . in theourth quarter o relative to the third, and urtherdeclining to . in the rst quarter o relative tothe previous quarter. Cumulatively, imports rom US FApartners ell more sharply than imports rom US non-FApartners in the rst months o .

US exports have also contracted more steeply withFA partners than globally, whether measured in nominalor real terms. For all FA partners, the collapses inUS exports were in the rst quarter o (realprices), or all destinations, and around ornonpreerential destinations.

Bibliography

William E. James. Forthcoming. “US International rade and theGlobal Economic Crisis.” ADB Economics Working Paper Series, AsianDevelopment Bank, Manila.

.. Preerential ree trade agreements

investors shiing their portolios to riskier assets, will be sources o

weakness or the dollar in the near term (Box 1.2.1).

Te impact o the recession on US international trade has been

severe (and interestingly, greater on preerential than nonpreerential

tradeBox 1.2.2). International trade was initially propping up USgrowth during 2008 as exports continued to rise in both nominal

and real terms even as imports slowed. In real terms, imports in 2008

contracted by 3.5% even as exports grew by 5.4% year on year, thus

boosting net exports. Te growth o trade, however, began to slow

sharply in the third quarter o 2008 and the contractions in the nal

quarter o 2008 and the rst quarter o 2009 were very sharp indeed.

Preliminary data or the second quarter o 2009 show that imports and

exports probably bottomed in the rst quarter o 2009 (Figure 1.2.5).

However, year on year, both imports (down 20.7%) and exports (down

22.9%) continued to contract sharply.

1.2.5 Real exports and imports,

United States

-600

-300

0

300

600

-24

-12

0

12

24

Exports, q-o-q change

Imports, q-o-q change

Exports

Imports

Q2Q1

09

Q4Q3Q2Q1

2008

$ trillion %

Note: Real values are derived using export and import priceindexes.

Sources: United States International Trade CommissionInteractive Tari and Trade DataWeb, Version 3.1.0,available: http://dataweb.usitc.gov; US Bureau o LaborStatistics, available: http://www.bls.gov; both downloaded

14 August 2009.


Growth in imports rom NAFTA,

United States

-50

-25

0

25

Total Mexico Canada

Q2Q1

09

Q4Q3Q2Q1

08

Q4Q3Q2Q1

2007

%

NAFTA = North American Free Trade Agreement.

Source: United States International Trade CommissionInteractive Tari and Trade DataWeb, Version 3.1.0,available: http://dataweb.usitc.gov/, downloaded1 September 2009.



http://www.adb.org/Documents/Books/ADO/2009/Update/figs/bf1-2-2.xls






Te improvement in the US trade balance (goods and services)

resulted rom a sharper all in imports than exports but in May 2009,

exports actually grew by 1.4% compared with April while imports

continued to contract (by 0.7%) bringing the monthly decit to just

$26.4billionthelowestamountsinceNovember1999.However,USimports rebounded in July over June, perhaps reecting the scal

stimulus and improved retail sales. US exports did not grow as rapidly as

imports, slightly widening the monthly trade imbalance.

Signs that the trough in the downturn had been reached were

becoming clearer at the beginning o the third quarter o 2009.

First, the Conerence Board’s Leading Economic Index had risen

or three consecutive months (April–June 2009) with seven o the 10

components showing improvementthe rst upturn in the index since July

2007 (Figure 1.2.6). Second, housing prices stopped alling in May 2009

and showed the rst monthly rise in 36 months (Figure 1.2.7). Tird, retail

sales have begun to rebound with automobile sales jumping under the

Government’s “cash-or-clunkers” program, although consumer sentimentremainsunsettled(Figure1.2.8).ebiggestpartofthe$787billionscal

stimulus package is expected to be elt in the last 2 quarters o 2009 and

may well propel GDP gures into the positive range by year-end.

Despite these signs o recovery, the orecast or US GDP growth is

unchanged rom ADO 2009: a contraction o 2.4% in 2009, with a weak

recovery o 1.6% growth in 2010.

EurozoneEconomic activity in the eurozone decelerated urther during the rst

quarter o 2009, with GDP contracting by 9.2% (q-o-q, annualized).

However, the contraction slowed to 0.5% during the second quarter,ueling hopes that the nadir has passed and that the economy is pulling

out o a recession. Eurozone GDP is currently expected to shrink by 4.3%

in 2009, and to resume anemic growth o 0.5% in 2010.

Te GDP contraction in the rst quarter o 2009 was driven

primarily by declines in gross xed capital ormation and in net

exports (Figure 1.2.9). Second-quarter investment spending continued

to retrench against a backdrop o excess capacity and low investor

condence; government consumption remained essentially unchanged.

Te eurozone’s trade balance turned positive in March 2009 and recorded

a more robust increase in June. ogether with a slight rebound in

private consumption, this switch has lied GDP growth rom its severe

contraction the previous quarter.

Industrial production during the rst hal o 2009 continued to

decline, by more than 20% year on year, and reected low industrial

condence, despite some timid signs o recovery in condence rom April

2009. Production remains weak across the eurozone as a whole, with

those countries depending strongly on export demand generally aring

the worst.

Germany is a case in point: the country started acing a sudden and

dramatic plunge in export demand around the second hal o 2008,

pushing the economy into recession and causing companies to cut down

investment plans drastically through the rst quarter o 2009. Weak

1.2.6 Conerence Board Leading Economic

Index, United States

96

100

104

108

Jan

09

Jan

08

Jan

07

Jan

06

Jan

05

Jan

2004

2004 = 100

Note: The index is a composite average o 10 individualleading indicators constructed to summarize and revealcommon turning point patterns in economic activity.



1.2.7 House price increases, United States

-30

-15

0

15

30

Jan

09

Jan

08

Jan

07

Jan

06

Jan

2005

%, year on year, seasonally adjusted

Note: Data refect the S&P/Case-Shiller Composite-10Home Price Index.

Source: Standard & Poor’s, available: http://www2.

standardandpoors.com, downloaded 10 August 2009.Click here or fgure data

1.2.8 University o MichiganConsumer Sentiment Index

50

70

90

110

Jan

09

Jan

08

Jan

07

Jan

06

Jan

05

Jan

04

Jan

2003

Q1 1966 = 100

Source: Federal Reserve Bank o St. Louis, available: http://

research.stlouised.org/, downloaded 3 September 2009.











exports, depressed consumption, and an investment slowdown in the

ace o substantial inventories have taken their toll. Te prospects or

recovery hinge mainly on a sustained improvement in export ordersand

encouragingly, the rst signs o a substantial rebound in orders and

industrial production appeared in the country statistics o June 2009.For the eurozone, data on industrial orders or June 2009 show

a rebound in total manuacturing orders, with a hike in capital and

nondurable consumer goods more than outweighing a continuing decline

in durable consumer goods orders (Figure 1.2.10).

Unemployment continued climbing, averaging 9.5% in July 2009

(Figure 1.2.11), and is expected to exceed 11% by 2010. Te labor market

situation tends to be worse or countries recovering rom burst domestic

asset bubbles, where the collapse o the domestic construction sectors

caused huge job losses. In Ireland and Spain, or example, unemployment

reached 12.5% and 18.5%, respectively, in July.

Growing unemployment and underutilized capacity are exerting

downward pressure on nominal wage growth within the currency bloc,nurturing ears o consumer price deation. Consumer prices ell by an

annual rate o 0.2% in August 2009, rom a 0.7% decline in the previous

month. Tis is in stark contrast to the 3.8% ination rate a year earlier.

Although deation is likely to persist over the coming months, the

European Central Bank (ECB) expects ination to reappear by end-2009,

particularly once the ull eects o its expansionary policy stance have

passed through, and the base eect rom the steep all in global energy

prices has moved out o the comparison period. Moreover, wage growth is

expected to remain positive.

o support its ailing banking sector and stimulate lending to the

nonnancial sector, ECB urther lowered its policy rate, the last time in

May 2009 by 25 basis points, to 1.0%. Tis brings the reduction in theECB key interest rate to a total o 325 basis points since October last

year. Moreover, ECB surprised nancial markets in June 2009 with a

massive allotment o €442 billion to banks over 12 months at a 1.0% xed

interest rate, in an eort to counter the sharp deceleration in monetary

aggregates and bank lending in the eurozone since early 2008. Te

move had the immediate eect o driving down overnight and longer-

term market interest rates, as well as temporarily weakening the euro.

However, it is too early to assess its ull eectiveness in restoring credit

channels and lending to the nonnancial sector, and in jump-starting

the process o recovery.

Public nances across the eurozone have deteriorated markedly, with

the aggregate budget decit expected to exceed 5% o GDP in 2010, more

than twice its rate in 2008. Out o 27 EU member states, at end-2008 21 had

a worsening government balance while 12 were in breach o the 3% stability

and growth pact decit limit. Te deterioration o government decits and

public debt is likely to continue all this year, largely driven by the impact o

automatic stabilizers and the boost in scal stimulus packages through the

European Economic Recovery Plan, launched in December 2008. Te plan

aims to boost demand and stimulate condence through budgetary outlays

o €200 billion, equivalent to about 1.5% o the EU’s GDP.

Te rst signs o a turnaround came into view in August 2009, as

the eurozone’s two largest economies, France and Germany, reported

1.2.10 Growth in industrial orders, eurozone

-6

-3

0

3

6

Nondurable consumer

Durable consumer

Capital

Intermediate

Total manufacturing orders

JunMayAprMarFebJan

2009

%, month on month

Source: Eurostat, available: http://epp.eurostat.ec.europa.eu, downloaded 4 September 2009.


1.2.11 Harmonized unemployment rate,

eurozone

5

10

15

20

Spain IrelandGermanyEurozone

JulAprJan

09

OctJul

2008

%, seasonally adjusted

Source: Eurostat, available: http://epp.eurostat.ec.europa.eu, downloaded 18 August 2009.


1.2.9 Contributions to GDP growth,

eurozone

-12

-6

0

6

Q1

2007

Q2 Q3 Q4 Q1

08

Q2 Q3 Q4 Q1

09

Q2


GDP growth

Net exports


Statistical discrepancy

Private consumptionGross capital formation


Source: CEIC Data Company Ltd., downloaded 3 September2009.











surprisingly strong annualized preliminary second-quarter growth rates

o 1.4% and 1.3%, respectively. Te latest data show Germany’s exports

to have rebounded by 11.9% in June and 3.9% in July rom their previous

levels a month earlier.

Improving private sector condence across the eurozone providesa urther indication that the bottom might have been reached: or over

ve consecutive months, the monthly Eurostat surveys o condence in

the industry, services, consumer, retail, and construction sectors have

moved upward, reversing the long and proound decline in condence

that lasted rom June 2007 to March 2009 (Figure 1.2.12).

Individual countries’ quarter-on-quarter growth perormances vary

substantially, however (Figure 1.2.13). Apart rom France and Germany,

only Greece managed to return to positive second-quarter output

growth, while Italy and Spain continued contracting, at 1.9% and 4.2%,

respectively. Outside the eurozone, the UK recorded a 2.6% shrinkage o

its GDP, substantially worse than the EU27 average o 0.9% contraction.

Dierences among eurozone economies’ growth rates are somewhatless pronounced when measured in the year to the second quarter.

Among the larger economies, only France recorded a milder decline

in its year-on-year growth perormance, mainly because o its stronger

insulation rom the nancial channel o crisis contagion. However, the

contraction in all the core European economies, including France and

Germany, points to the importance both o a rebound in exports or their

GDP growth to recover, and their governments’ capacity to maintain or

even expand scal stimulus.

o the extent that eurozone economies vary substantially with

regard both to their export dependence and to their scal constraints,

divergences or even reversals in quarter-on-quarter growth perormances

are likely to persist throughout the rest o 2009.

JapanTe prole o economic perormance in Japan in the rst 6 months

o 2009 was similar to that in many other industrial countries, with a

severe rst-quarter contraction in GDP ollowed by a recovery in the

second. Public investment (aside rom the statistical discrepancy) was the

only positive contributor in the rst quarter, but the rebound reected

a signicant strengthening in exports and private consumption, which

together brought the economy back to growth o 2.3% in the second

quarter (Figure 1.2.14). Private investment, however, continued to decline

during the rst 2 quarters.

Exports began to grow again in February, but remained well below

levels o the same period a year earlier (Figure 1.2.15). Shipments to all

major trading partnersUS, EU, and developing Asiarebounded,

especially the pickup in intermediate goods to the rest o Asia. However,

the sustainability o developing Asia’s import demand is uncertain as

rising demand reects temporary scal stimuli. For Japan, import growth

remained sluggish due to weak domestic and external demand. Te

trade and current balances turned to surplus in February aer recording

decits in January, but or the rst hal o 2009, the current account

balance was 46% below that in the year-earlier period.

1.2.13 Growth perormance, Q2 2009,

European Union

-6 -3 0 3

France

Germany

Greece

Italy

United Kingdom

Spain

Eurozone

EU27

%, quarter on quarter, saar

(-4.8)

(-2.6)

(-5.9)

(-0.2)

(-6.0)

(-5.5)

(-4.2)

(-4.7)


Note: Figures in parentheses reer to year-on-year

percentage change.



1.2.12 Condence indexes, eurozone

-45

-30

-15

0

15

30

Building

Retail Consumer

Services Industry

JulJan

09

JulJan

08

JulJan

07

JulJan

2006

%, seasonally adjusted

Source: European Commission, available: http://ec.europa.

eu, downloaded 31 August 2009.


1.2.14 Contributions to GDP growth, Japan

-20

-10

0

10

Q1

2007

Q2 Q 3 Q 4 Q1

08

Q2 Q 3 Q 4 Q1

09

Q2


GDP growth

Public investment


Private investment

ResidualNet exports

Private consumption


Source: Economic and Social Research Institute, CabinetOce, Government o Japan, available: http://www.esri.

cao.go.jp/en, downloaded 11 September 2009.











1.2.15 Trade balance, Japan

-6

-3

0

3

6

9

Q1

2007

Q2 Q3 Q4 Q 1

08

Q2 Q3 Q4 Q1

09

Q2

% of GDP

-2

-1

0

1

2

3

¥ trillion

Trade balanceRest of the world

Developing Asia

North America

Central and Eastern Europe

Middle East

Western Europe

Sources: Trade Statistics o Japan, Ministry o Finance,

available: http://www.customs.go.jp; Economic and SocialResearch Institute, Cabinet Oce, Government o Japan,available: http://www.esri.cao.go.jp/en; both downloaded11 September 2009.


A soening o import prices driven largely by the decline in the

oil price improved Japan’s terms o trade. In July 2009, import prices

were 30.4% lower than prior-year levels, while export prices were 12.8%

down. Weakness in consumption and external demand is worrisome

because it is pinching corporate prots, which ell by 53% year on yearin the second quarter with expectations that they will remain weak.

Consequently, capital spending in the next ew quarters will likely be in

the doldrums. Moreover, while uncertainty about the economic recovery

persists, rms remain reluctant to hire: the unemployment rate climbed

to 5.7% in July, exceeding the previous worst rate o 5.5% (seasonally

adjusted) in April 2003. In addition, salary income has contracted or

13 consecutive months, and at a worsening rate. General pessimism over

short-run business conditions and employment persists.

Machinery orders registered a sharp contraction o 42.6% in the rst

hal o 2009 relative to the same period in 2008, and capacity utilization

stayed low. Manuacturing production, however, began to recover in

March, albeit sluggishly. In addition, the ankan survey (o both largemanuacturers and nonmanuacturing industries) or the second quarter

showed little improvement in its negative sentiment (Figure 1.2.16).

Wholesale prices were o 8.5% year on year in August, the sharpest all

on record, due to weak domestic demand and the steep all in oil prices.

Against this gloomy backdrop, supplementary budget unding o

about¥14trillion($147billion)waspassedinMaythisyearasastimulus

that is set to help consumers and rms cope with a ading labor market

and weak external demand. Since mid-May, this package has centered

on giving incentives in the orm o “eco-points” to purchase eco-riendly

home electronic appliances, and on subsidizing consumers trading in

their old cars or more uel-efcient ones. Positive impacts are appearing,

with the measures boosting consumption demand and helping rms’inventory adjustments.

Household real consumption expenditure leveled o in May aer

alling or 14 consecutive months, but then ell by 2% year on year in July.

Consumption expenditure is likely to be weak in the coming months

because o deteriorating incomewages slumped by 9.7% year on year in

June, the sharpest drop on record. Tese alls are largely related to cuts in

bonuses and overtime pay, which, in turn, are hurting retail sales.

Te consumer price index (excluding resh ood) saw a record decline

o 2.2% year on year in July, in part due to lower uel prices than in 2008.

Falling equity prices have been taking a toll on rms and consumers.

Nonetheless, rom its end-year 2008 close, the Nikkei average showed

a gain o 14.5% by end-July (Figure 1.2.17) amid expectations o some

improvement in corporate protability (Figure 1.2.16 above). Tis gain

may help rms attract new unding, yet it will take time to be elt in

consumers’ pockets or to aect domestic spending.

Te Democratic Party o Japan, which came to power at end-August,

hopes to boost the domestic economy by encouraging consumer spending

directly through households via, or example, subsidies to amilies with

children.

Japan’s growth outlook remains ragile on concerns about the

sustained impact o the current scal package and rising oil prices. Te

new Government plans to reprioritize the measures in the package,

1.2.16 Corporate prots and Tankan survey

-160

-120

-80

-40

0

40

-48

-36

-24

-12

0

12

Tankan survey

Manufacturing

All sectors

Q1

09

Q3Q1

08

Q3Q1

07

Q3Q1

2006

%, year-on-year

profit growth

Percentage points,

diffusion index

Note: The diusion index is the dierence between thepercentage share o enterprises perceiving businessconditions as avorable or unavorable.

Sources: Policy Research Institute, Ministry o Finance,Government o Japan, available: http://www.mo.go.jp;Bank o Japan, available: http://www.boj.or.jp/en/; bothdownloaded 3 September 2009.


1.2.17 Nikkei index, Japan

5,000

10,000

15,000

20,000

JulJan

09

JulJan

08

JulJan

2007

Source: Nikkei.com, available: http://www.nni.nikkei.co.jp,

downloaded 3 September 2009.











and suspend implementation o the unused portion o supplementary

budgets, particularly o inrastructure projects, which might put the

economy on hold until the impact o a second supplementary budget to

be passed later this year is elt. rade growth is expected to pick up, but

sluggishly.Downside risks to growth are set to persist through 2009 and

are likely to overshadow deation concerns. Te economy in 2009 is

expected to contract by 5.8% with a weak recovery to 1.1% growth in 2010.

Consequently, no monetary tightening by the Bank o Japan is expected

either this year or next.

Commodity pricesGlobal commodity pricesenergy and nonenergysaw extraordinary

volatility in 2008. In the rst 7 months and led by crude oil, they scaled

near-record highs. Tey then collapsed (Figure 1.2.18) as the nancial

crisis and slump hit. During the rst quarter o 2009, they stabilized andin the second began to rise moderately, primed by brightening global

economic prospects.

Energy

Te index o energy commodity prices (oil, coal, and natural gas) closely

mirrors global oil prices (Figure 1.2.19). Te recent surge in crude oil

prices appears to be inuenced by the beginnings o a modest recovery

that may increase transport demand as world trade begins to pick

up. Production cuts by the Organization o the Petroleum Exporting

Countries (OPEC), oil-inventory adjustments, a weakening o the US

dollar, and expectations o urther economic recovery are also seen as

playing a role. Oil prices have rebounded strongly over the rst 8 monthso 2009 as global oil demand has begun to rm, but they are not expected

to rise much urther as long as global demand growth remains subdued

(Box 1.2.3).

Te actors aecting oil have also impacted on other energy

commodity prices, coal in particular. Coal prices, which ell precipitously

rom the peak reached in mid-2008, have begun to turn up. Teir pickup

also reects strong PRC import demand in the rst hal o the year.

However, since the PRC has built up large inventories, it is expected that

coal prices will remain stable in the rest o 2009.

Nonenergy

Nonenergy commodity prices, including metals and minerals and

agricultural commodities, have been less volatile than those or energy.

Aer alling about one third rom peaks reached in mid-2008, they

gained 13% in the rst 2 quarters o 2009. Metals and minerals recovered,

largely as a result o restocking and high import demand in the PRC;

with recovery in global prices, mining activity may pick up and limit any

urther rise in prices.

Agricultural commodity prices have been sensitive to economic

conditions but also to the weather. Te balance o orces o supply

and demand has kept agricultural prices relatively stable this year

(Figure 1.2.20), though some supply setbacks may be caused by drought

1.2.18 Indexes or agriculture, energy, and

metals and minerals

0

100

200

300

Metals and mineralsAgriculture Energy

Jun

09

DecJun

08

DecJun

2007

2005 = 100

Source: World Bank, Commodity Price Data (Pink Sheet),available: http://econ.worldbank.org/, downloaded

14 August 2009.Click here or fgure data

1.2.19 Energy and oil indexes

0

100

200

300

Crude oilEnergy

Jun

09

DecJun

08

DecJun

2007

2005 = 100

Note: Crude oil is the average spot price o Brent, Dubai,and West Texas Intermediate, equally weighted.

Source: World Bank, Commodity Price Data (Pink Sheet),

available: http://econ.worldbank.org, downloaded14 August 2009.









and other adverse conditions in major producing countries. However,

recent bumper harvests have led to large stocks and these will cushion

any shortall in 2009’s harvests.

Te reduced volatility in ood prices reects the absence o speculative

and hoarding behavior that drove prices sharply higher rom 2007 tomid-2008. Some ood commodities may be vulnerable to price increases,

particularly those in demand as biouels. Sugar prices are also expected

to rise as the largest producer, India, aces adverse weather and a sharp

reduction in supply. Raw materials prices are expected to remain at

this year but may rebound next year as the global recovery gathers

momentum.

Hence, nonenergy commodity prices seem likely to enter a period

o greater stability and more moderate prices, compared with the

exceptional volatility and high prices seen rom 2007 to mid-2008.

Risks to the global economic outlook Some o the risks that conronted the world economy just a ew months

ago have attenuated as the global outlook has improved. For example,

the threat o deation, which was brought on by collapsing aggregate

demand, has aded as demand has begun to rebound. Still, the signs o an

improving outlook should not be mistaken or a ull-edged recovery, and

risks remain. Foremost among these are a misjudged exit rom stimulus

packages; a continued weak housing market in the US; resurgent global

oil prices; and greater virulence o the u pandemic.

Misjudged exit rom stimulus

Above all, policy makers around the world are aced with the delicate

issue o a correctly timed and appropriate exit strategy, or when and howto withdraw the huge scal and monetary stimuli administered to revive

ree-alling economies at the depth o the global slump. How eectively

they manage this and other risks will determine how soon, and how

securely, the world economy regains its ooting. For, although the huge

expansionary macroeconomic policies had their desired eect in helping

turn around global prospects, retaining such expansionary stances or too

long can undermine uture macroeconomic stability.

In the short term, the expansion o liquidity arising rom excessively

loose monetary policy can uel ination, especially when aggregate

demand is picking up and reducing the economy’s spare capacity.

Although it is probably too early to worry about ination, keeping

interest rates too low or too long will eventually lead to inationary

consequences or a return o asset bubbles. Te risk is not negligible since

the eect o monetary policy is elt only aer a long lag, which means that

the earlier interest rate cuts may urther stoke aggregate demand.

In the long term, higher spending and lower taxes will store up scal

problems or the uture as public debt-to-GDP ratios rise to unhealthy

levels. It may take years or governments to repay the debts incurred in

a ew months. Tis not only implies higher taxes in the uture but it also

limits the capacity o governments to pursue countercyclical scal policy

when the next downturn threatens.

No less important than the issue o when to exit is how. For

1.2.20 Food, beverage, and raw materials

indexes

50

85

120

155

190

225

Raw materialsBeveragesFood

Jun

09

DecJun

08

DecJun

2007

2005 = 100

Source: World Bank, Commodity Price Data (Pink Sheet),available: http://econ.worldbank.org, downloaded14 August 2009.







Risk rom rising oil prices to global recovery

Global oil prices are reecting the global business cycle.Having tumbled as the global economic downturn

intensied during the ourth quarter o and the rstquarter o , they have since begun a tul recovery. Teincipient recovery o the world economy is liing them,and as developing Asia is a signicant net importer o oil,it stands to suer terms-o-trade losses. More worryingly, arebound in oil prices may contribute to ination pressuresthat are likely to reassert themselves as the region’s recovery takes hold. For this reason, rising oil prices are one o thebiggest downside risks to developing Asia’s recovery.

Tandem recovery o oil price and global economy

Te trajectory o global oil prices has closely trackedthe state o the world economy since the second hal o (Box gure ). Aer a breathtaking climb rom $per barrel in January to $ in July , they ellsharply to $ by end-, reecting the slump in theworld economy and global trade. Te global slowdown o late and early had a sizable adverse eect onglobal oil demand, which ell by a staggering . millionbarrels per day (bpd) in the rst quarter o relative toa year earlier.

Te recovery o oil prices in the rst months o has been much gentler than the decline during the secondhal o . o some extent, this is because the globalrecovery, unlike the global slowdown, has so ar beenuneven.

Support rom resurgent Asian demand

Developing Asia seems to be recovering aster and strongerthan other regions. Even beore the global nancial crisis,growing demand rom the People’s Republic o China(PRC) and India was a key driver o rising global oil prices.In , the revival o demand rom the region is helpingprop up global oil prices. Tere has been signicant growtho oil demand in PRC, India, and Republic o Korea inrecent months, reecting the resilience o those economies(Box gure ).

In contrast, oil demand has continued to contract in theUnited States (US), Japan, and European Union (EU), albeitat a slower pace. Te net result is that or as a wholeoil demand will most probably all, by around millionbpd (Box gure ). Still, recovering global oil demandueled largely by recovering Asian demand is tightening thegap between supply and demand, and contributing to risingglobal oil prices. Global oil prices are also beneting romthe current mood o optimism engulng global equity and

commodity markets.

Short term: Still-high inventory stocks

Global oil prices have paralleled the global business cyclesince July , and demand has been the dominant driver.However, high levels o inventories are one supply-sideundamental that will damp upward price pressures in theshort run. A key measure o inventory levelstotal OECDcompany stocks on landis expected to remain above its level through December this year, and comortably

.. Recent oil price trends and implications or the world economy

1 Brent crude oil prices

30

60

90

120

150

Jan

09

Jan

08

Jan

07

Jan

06

Jan

2005

$/barrel

Source: Bloomberg, downloaded 31 August 2009.


2 Oil demand growth in selected major

markets

-20

-10

0

10

20

June 2009May 2009

April 2009Q1 20092008

IndiaPeople's

Rep. of

China

OECD

Europe

Rep. of

Korea

JapanUS

%

Note: OECD Europe consists o Austria, Belgium, Canada,Czech Republic, Denmark, Finland, France, Germany,Greece, Hungary, Iceland, Ireland, Italy, Luxembourg,Netherlands, Norway, Poland, Portugal, Slovakia, Spain,Sweden, Switzerland, Turkey, and United Kingdom.

Source: Energy Market Consultants (UK) Ltd., “World Oil

Market Report,” 7 August 2009.


3 Growth in world oil demand

-6

-3

0

3

2010Q3Q1

09

Q3Q1

08

Q3Q1

07

Q3Q1

06

Q3Q1

2005

%

Forecast

Source: Energy Market Consultants (UK) Ltd., “World Oil

Market Report,” 7 August 2009.Click here or fgure data










above the “unofcial” target o the Organization o thePetroleum Exporting Countries (OPEC) o – days(Box gure ). Te buildup o OECD stocks averaged

around , bpd in as a whole and is expected tobe smaller, but still positive, this year.

On the demand side, it would take an improbably robustglobal recovery to make a signicant dent in inventories.On the supply side, i OPEC leaves output unchanged,inventories will reach even higher levels. Even i OPECmanages to agree on signicant production cuts, say o up to million bpd, inventory stocks should remain highenough to limit the scope or price increases.

Medium term: Spare OPEC capacity

OPEC’s production capacity is projected to increasesubstantially, by about million bpd, during –.Tis increase translates into higher spare capacity that willdamp the scope or price increases, even in the ace o rising demand rom the PRC and India, until around themiddle o next decade.

Further reinorcing the moderation o price pressures inthe medium term is an increase in non-OPEC productioncapacity in the short term. Although non-OPECproduction ell by about , bpd in , it is expectedto rise by about the same amount this year (Box gure ).

New elds coming online in the Gul o Mexico and Brazilwill raise non-OPEC production capacity until .

Long term: Reemergence o price pressures

As argued in Asian Development Outlook (ADB ),the global nancial crisis and subsequent slump havedone nothing to alter the long-term undamentals o theoil market. Against the backdrop o a structural increasein demand rom the PRC and India, both OPEC andnon-OPEC production capacity are expected to peak by themiddle o next decade. Te combination o demand growth

and supply constraints will become the primary driver o prices. In particular, the reduction o OPEC’s spare capacity means that a rerun o the price surge o – cannot

be ruled out. However, precisely when prices will begin toclimb again on a sustained basis remains highly uncertain.

Remote risk o short-run oil price surge

In principle, the incipient world economic recovery entailsa substantial risk o an oil price surge. A pronounced surgemay even derail or at least seriously impede the recovery.In practice, there are two undamental actors that suggestthat any increase in global oil prices will be moderate inthe short run.

First, global recovery itsel is uncertain and ragile,especially in the G. Second, high inventory levels, whichare likely to persist in the short run, will limit the scopeor price increases. However, the prospect o relatively moderate oil price rises should not lull policy makersinto complacency. Even moderate increases in oil pricescan help trigger ination, especially since the regionhas recently pursued expansionary monetary policy.Governments should also continue to phase out costly uelsubsidies and, more generally, encourage more efcient useo oil beore the next big surge o oil prices arrives.

Bibliography

Asian Development Bank (ADB). 2009. Asian Development Outlook. Manila.

Energy Market Consultants (UK) Ltd., 2009. “World Oil MarketReport.” 7 August 2009.

Facts Global Energy. 2009. “Oil Price Outlook: Updated Analysiso Critical Factors Driving the Oil Market.” Background paperprepared or Asian Development Outlook . Asian DevelopmentBank, Manila.

.. Recent oil price trends and implications or the world economy (continued )

4 OECD commercial inventories

40

50

60

70

2009200820032007

Nov Sep Jul May MarJan

Number of days’

supply at end-month

OECD = Organisation or Economic Co-operation andDevelopment.

Source: Energy Market Consultants (UK) Ltd., “World OilMarket Report,” 7 August 2009.


5 Change in supply o selected non-OPEC

producers

-600 -300 0 300 600

20092008

United States

United Kingdom

Russian Federation

Norway

Mexico

Kazakhstan

Canada

Brazil

Azerbaijan

Total

Thousand barrels/day

Note: Total reers to all non-OPEC oil producers.

Source: FACTS Global Energy (2009).









example, sharp reversals o the scal stance or hikes in interest rates

may undermine business and consumer condence. Policy makers

should withdraw the monetary and scal stimulus in a way that does not

jeopardize the nascent recovery. Yet, too much caution in reversing the

expansionary policies may be ineective in preventing overheating andination pressures.

Te optimal speed and strength o stimulus withdrawal is inevitably

a tricky decision that requires a great deal o sound judgment on the part

o policy makers. Further complicating their calculations is the risk that

recovery is neither sustainable nor robust enough to withstand a huge

stimulus cut. Tat is, i the recovery has been driven by expansionary

macroeconomic policies, reversal o policies may slow or even derail it.

Continued weak US housing market

Te global nancial crisis and economic slump are rooted in the bursting

o the US housing bubble. Many key indicators, in particular GDP growth

trends, suggest that the US economy has bottomed and is beginning topick up. However, one enduring source o concern is the US housing

market (Figure 1.1.7 above). More specically, oreclosures are continuing

to rise as workers lose their jobs and wages remain at. Since pickup

in employment tends to lag an economic recovery, the labor market is

unlikely to pick up soon and support the housing market.

Te value o US mortgages oen exceeds the value o homes, which

implies negative net worth or equity in homes. In act, more than

15.2 million mortgages, or 32.2% o all mortgaged properties, were in

negative equity as o 30 June 2009. Furthermore, the aggregate property

valueformortgageswithnegativenetworthwas$3.4trillion,which

represents the total property value at risk o deault. (Te baseline

scenario used in able 1.2.1 implicitly assumes that this risk will not berealized on a widespread scale.)

One solution is to restructure these mortgages, but restructuring

is not in the nancial sel-interest o the mortgage servicers who

administer the mortgages. So ar the Government has ailed to take

any action to eectively alter the incentives o the mortgage servicers.

Just as rising home values spurred US private consumption prior to the

crisis, oreclosures and negative equity in homes will constrain private

consumption, in turn delaying the onset o a ull-edged recovery.

Similarly, weak housing markets will also curtail the recovery o the EU

economies that experienced housing bubbles o their own.

Resurgent global oil pricesTe one bright spot o the nancial crisis and economic downturn was

that together they stopped the astonishing escalation o global oil prices,

which reached record levels in July 2008. By helping hold down overall

prices, cheaper oil enabled monetary authorities to pursue expansionary

policies without their having to worry about ination. Although global

oil prices plunged as the turmoil intensied in the ourth quarter o

2008, they have made a tul recovery this year. Tey may gain urther

momentum when the global recovery gains traction.

Supply and demand undamentals, in particular large inventories,

suggest that a sharp runup in prices, such as that seen beore the nancial




crisis, is unlikely (Box 1.2.3, above). Nevertheless, i global consumption

grows more rapidly than currently orecast because o a aster than

expected global recovery and i geopolitical events create major supply

disruptions, a much steeper price ascent cannot be ruled out. In this

case, the specter o cost-push ination, which had dissipated along withthe collapse o oil prices, may rematerialize to cast its gloom over global

recovery.

Even i, as is more likely, oil prices remain at or rise only slowly,

they may combine with strengthening aggregate demand and loose

monetary conditions to lay the oundation or another bout o ination.

Tat is, higher oil prices can contribute to ination pressures in an overall

environment that is conducive or a revival o ination.

Flu pandemic

Te initial global scare over H1N1 u (swine u) seems to have subsided,

although H1N1 can still mutate and become more dangerous in the

northern hemisphere’s winter. Yet in light o the pandemic’s ease o transmission, lowering the guard in any part o the world will have

spillover eects elsewhere. Indeed, with H5N1 (avian u) entrenched

in several Asian countries (PRC, Indonesia, Viet Nam, and probably

some parts o northern India and Bangladesh), developing Asia needs

to strengthen surveillance. As East Asia’s experience with the SARS

epidemic showed, a pandemic can have dire economic repercussions.




1.3.4 Industrial production growth,

newly industrialized economies

-40

-20

0

20

40Taipei,ChinaSingaporeRep. of KoreaHong Kong, China

Q1

09

Q3Q1

08

Q3Q1

07

Q3Q1

2006

%



contracting in Singapore and Tailand and are rebounding in Malaysia

and Viet Nam. Sales o durables such as motor vehicles remain depressed

in much o the region, but have begun to rebound somewhat in some

countries. ourism throughout the region continues to suer the eects

o the global recession, although Malaysia and aipei,China are showingsome growth.

Unemployment in much o the region has risen, particularly in the

more export-dependent economies o Hong Kong, China; Singapore;

and aipei,China (Figure 1.3.7). However, the prospects or labor market

improvement seem avorable as industrial production continues to

accelerate.

Despite the relatively strong dependence on exports and investment

in the region, in the second quarter o this year most Asian developing

economies were seeing both a rapid rebound in economic growth, driven

by recovery in industrial production, and rallies in equities and other

assets (see below). Developing Asia last aced a debilitating nancial

crisis and regional recession in 1997–98, which originated within theregion. But it emerged rapidly as a result o avorable global economic

conditions.

Tis time around, quite dierent circumstances prevail. First, the

nancial crisis originated in the western industrial economies and spread

to Asia largely through a collapse in world trade. Second, while Asian

nancial systems are robust, the collapse in external demand has hit

the region hard as industrial production contracted sharply with a all

in exports. Tird, extreme volatility in global commodity markets has

created additional uncertainty. Te question is: Will developing Asia be

able to escape the slump rapidly and by what means? Clearly, it will have

to generate new demand through sources other than exports to the G3

economies.

Fiscal and monetary actionsAlmost every large economy in developing Asia has implemented

measures to stimulate aggregate demand through scal and monetary

expansion. In turn, households were relatively quick to spend scal

windalls that came in the orm o tax cuts and income support, giving a

llip to consumption that began to boost GDP by the second quarter o

2009.

Fiscal stimuli in 11 Asian developing economies averaged 7.1% o

nominal 2008 GDP. Te emphasis o governments’ eorts to boost

demand through discretionary scal measures diered, but the boost

rom the stimulus was strong enough to arrest the decline in GDP

growth, even though automatic stabilizers are airly weak across most

countries in the region. For example, almost all the PRC’s CNY4 trillion

package was invested in inrastructure projects or other types o

construction activities. In contrast, the authorities in Hong Kong, China

emphasized tax cuts, public-housing rent reductions, and other orms

o household income support. Korea opted or a mix o tax cuts and

expenditure measures.

Monetary authorities have reduced interest rates (Figure 1.3.8) to

provide liquidity so as to boost investment and expenditure on durable

1.3.5 Export growth,

newly industrialized economies

-50

-25

0

25

50

Taipei,ChinaSingaporeRep. of KoreaHong Kong, China

Jan

09

Jan

08

Jan

07

Jan

06

Jan

05

Jan

2004

%, 3-month moving average



1.3.6 Change in retail sales in selected Asian

economies, Q3 2008 vs latest

-10 0 10 20

Malaysia

Viet Nam

Rep. of Korea

Taipei,China

People's Rep. of China

Hong Kong, China

Singapore

Thailand

%

Note: Latest data or Hong Kong, China; Rep. o Korea; andTaipei,China (May–July 2009); People’s Rep. o China andViet Nam (June–August 2009); Thailand and Singapore(April–June 2009); and Malaysia (Q2 2009).



1.3.7 Change in unemployment rates in

selected Asian economies, Q3 2008 vs latest

0.0

0.5

1.0

1.5

2.0

2.5

SINHKGTAPMALKORSRITHAPHI

Percentage points

Abbreviations: As Figure 1.3.1 plus SRI = Sri Lanka; and

TAP = Taipei,China.

Note: Latest data or Philippines and Singapore (Q2 2009);Thailand (April–June 2009); Sri Lanka and Malaysia(Q1 2009); and Hong Kong, China; Rep. o Korea; andTaipei,China (May–July 2009).













Developing Asia’s prospects

Developing Asia is leading the global economic recovery with a

strong rebound in GDP growth that began in the second quarter o

this year. Underpinning the resurgence was the impetus to demand

rom expansionary scal and monetary actions (Figure 1.4.1) taken

by governments throughout the region, especially the PRC and India.

Indonesia and Viet Nam also saw solid economic growth.

Te Update raises the orecasts or GDP growth or developing Asia

as a whole rom those given in ADO 2009. Te region is now projected to

grow by 3.9% in 2009 and 6.4% in 2010 (Figure 1.4.2), up rom 3.4% and

6.0%. O course, individual perormance in 2009 is likely to vary, with

some subregions deteriorating relative to the earlier orecasts (Central Asia,

Southeast Asia, Pacic) and others gaining (East Asia and South Asia).Similarly or 2010, the Update upgrades orecasts or East Asia and

South Asia as a result o aster than expected growth in the two largest

economies. Pacic growth is also expected to be better than earlier

orecast, and Southeast Asia is virtually unchanged. For Central Asia,

the orecast is lowered rom ADO 2009. But in short, the 2010 outlook

is or growth in all subregions to come back strongly relative to 2009,

giving a V-shaped trajectory to developing Asia’s recovery rom the world

recession (Figure 1.4.3).

One reason that developing Asia has recovered aster than the rest o

the world is the relative robustness o its nancial sector. Tis provided

a buer against the global nancial turmoil. Te strong scal position

o most large economies in developing Asia also enabled them to pursueexpansionary scal policies. Existing high saving rates and low levels o

household debt made consumers in developing Asia more amenable to

spending the additions to income rom the scal stimulus. In contrast,

the outlook or the industrial countries is or a more modest recovery,

with growth in 2010 still much slower than in 2007 and only slightly

aster than in 2008.

With external demand rom the main industrial countries still

relatively weak, it will be difcult or developing Asia to return to the

high growth rates achieved in 2006–2007. Growth in 2010 will only

return to about 6–7% rather than the 9–10% rates that were recorded prior

to the crisis.

Te resumption o growth has taken place against a backdrop o low

ination or even mild deation (Figure 1.4.4). Te region as a whole has

beneted rom the steep slide in oil prices and rom improved supply o

ood and raw materials. Despite the sharp reduction in short-term interest

rates engineered by central banks and the pumping o liquidity into

nancial markets, the threat o ination remains muted.

ight global credit conditions during the depth o the nancial

crisis led to a substantially slower net inow o oreign investment into

emerging markets, including developing Asia. More recently, there has

been apparent recovery o portolio capital owing into the region as

equities markets have rallied (Figure 1.3.9, above). Less oreign direct

1.4.1 Money supply growth, selected

economies

6

12

18

24

30

Indonesia

People's Rep. of ChinaIndia

Rep. of Korea

AprJan

09

OctJulAprJan

08

OctJulAprJan

2007

%

Source: CEIC Data Company Ltd., downloaded 31 August2009.


1.4.2 Five-year average and orecasts o

GDP growth, developing Asia

0 3 6 9 12

201020092004−2008

The Pacific

Southeast Asia

South Asia

East Asia

Central Asia

Developing Asia

%

Sources: Asian Development Outlook database; sta estimates.


1.4.3 GDP growth, developing Asia and

G3 economies

-8

-4

0

4

8

12

Eurozone

JapanUnited States

Developing Asia

1009082007

%

Forecast

Sources: Asian Development Outlook database; sta

estimates.











1.4.4 Infation, selected developing Asian

economies

-3

0

3

6

9

Rep. of Korea

Taipei,China


JulAprJan

09

OctJulAprJan

08

OctJulAprJan

2007

%

East Asia

-15

0

15

30

Bangladesh India Pakistan

JulAprJan

09

OctJulAprJan

08

OctJulAprJan

2007

%

South Asia

-10

0

10

20

30

Viet NamThailand

PhilippinesMalaysiaIndonesia

JulAprJan

09

OctJulAprJan

08

OctJulAprJan

2007

%

Southeast Asia

Source: CEIC Data Company Ltd., downloaded 11 September

2009.


investment is owing into the region but there are early signs that

multinational enterprises have sharply reduced unwanted inventories

and are now in a position to ramp up production. In addition, industrial

output is now on the rise in PRC, Korea, and Singapore aer the deep

plunges in the ourth quarter o 2008 and the rst quarter o this year.Banking systems have not buckled under the strain o the crisis o

condence and there are signs that lending is reviving. Much o the

lending is going into domestic demand–driven sectors such as consumer

credit or purchases o durable goods, but much o it may also be going

into stock and real estate markets. Authorities will thereore have to

monitor the situation careully when making credit available or large-

ticket items, so as to avoid new asset surges in those markets. Fortunately,

commodity prices have been moderate and show ew signs o the

volatility seen in the past year.

Once the impetus rom scal stimulus packages wears o, it will be

essential that domestic consumption and private investment take over

as the drivers o growth. Rebalancing Asian growth through increasinginvestment and consumption expenditures relative to income (and thereby

saving less out o income) will help keep momentum behind the global

recovery. In some instances, structural reorms need to be stepped up to

rekindle growth. Fortunately though, most developing Asian economies

have relatively low debt-to-GDP ratios and are on a sound scal ooting,

such that prolonged stimulus will not undermine uture growth.

Tis is not the time or an exit rom expansionary policiesthe

recovery remains ragile and subject to serious downside risks. Global

trade is a case in pointeven though the trough in world trade volume

may have been reached in the rst quarter o 2009, both imports

and exports are still well below levels attained a year earlier. Hence,

continuing the expansionary stance is warranted until global markets anddemand are on a rm recovery path.

o ensure a robust revival o world trade in coming years, large

Asian economies could take up the mantle o the Doha Round. An

example is India’s hosting o the meeting o trade ministers in New

Delhi in September, aiding the G20’s goal o reaching agreement on the

Doha Round by end–2010. Eorts to head o protectionist tendencies

are still important as governments continue to implement stimulus

packages that involve procurement o tradable goods and services. Te

G20 consultations provide an excellent opportunity or developing Asia

to push the trade talks orward. Tere are opportunities or successul

agricultural negotiations as the G3 economies have proposed to step up

assistance or agricultural development.

Te outlook or developing Asia’s recovery is encouraging, but it is

likely that growth will remain well below attainments o recent years.

Developing Asia will only be able to regain a high-growth trajectory i the

global economy is growing closer to its potential. A major challenge in

this context is whether Asia can adjust to changing global conditions by

striking an appropriate balance between openness and increased reliance

on domestic demand–driven growth.





A new approach to openness or

developing Asia?

Developing Asia’s rising prosperity is closely associated with its openness to

oreign trade. Indeed, many developing countries outside the region have

attempted to emulate the successul export-led structural transormation

that was earlier made by the newly industrialized economies o Hong Kong,

China; Korea; Singapore; and aipei,China. From the late 1960s to 2008,

per capita incomes in those our economies had risen on average by a actor

o nine (Figure 1.5.1), nearly eliminating poverty or their residents. Te

region’s economies on the next rung o the development ladderthe rapidly

growing economies in Southeast Asia as well as the PRChave also had a

measure o success in applying the open-economy approach.Although trade openness became the hallmark o the Asian model,

openness to cross-border ows o capital and labor also played an

important part in the region’s success. Yet openness is not without risks

or the region, as is especially evident during episodes o crisis.

Te 1997–98 Asian nancial crisis had its roots in the sudden

reversal o capital inows. It exposed weaknesses in the region’s nancial

institutions, which were overexposed to oreign borrowinga strategy

that hinged on maintenance o stable exchange rate pegs. Because the

major industrial economies remained strong, the region was able to export

its way out o the downturn. However, the export-led mode o recovery

became the weak point or developing Asia during the recent crisis.

More specically, the region’s heightened reliance on externaldemand or growth hindered consumption and catalyzed reserves

accumulation, which was widely viewed as insurance against a repeat o

the 1997–98 devastation. Tis heavy reliance le the region vulnerable

to the synchronized collapse o the major industrial economies. rade

within Asia, which largely reects cross-border production networks

manuacturing goods or sale outside the region, collapsed in turn. As a

result, the most open, trade-dependent economies were hit the hardest by

the global downturn.

For merchandise trade, a broader customer base or nal goods is

needed. Strengthening intraregional trade can help reduce developing

Asia’s overdependence on the major industrial economies and support

the shi away rom unsustainable current account imbalances. Financial

globalization needs to be eectively managed so that capital ows do not

become a source o instability. Tis requires policy changes and domestic

nancial market development to create an environment that both osters

Asian intermediation or its savings and that attracts long-term oreign

investment. Labor mobility has provided oreign exchange ows that have

proven to be reliable even in times o crisis. Policies and institutional

changes to ease the transer o remittances can enhance the benets o

tapping into the international labor market.

For policy makers, the decision to open the economy urther

to international exchanges o goods and services, capital, and labor

1.5.1 Real per capita income, selected

developing Asian economies

0

10

20

30

40

Taipei,ChinaSingapore

Rep. of KoreaHong Kong, China

0805200095908580751970

Thousand

Newly industrialized economies

0

2

4

6


Malaysia

Philippines

Thailand

Indonesia

0805200095908580751970

Thousand

Southeast Asia a nd People’s Rep. of China

Note: Data are in constant 2000 dollars.

Sources: World Development Indicators online database,

downloaded 16 September 2009; Asian Development Outlook database; sta estimates.







must be seen as a means to enhance economic resilience through

diversication o markets.

Te human toll rom economic crises cannot be exaggerated, yet the

efciency-augmenting, growth-enhancing aspects o openness lie at the

very heart o developing Asia’s economic achievements. No alternativedevelopment model has rivaled the success o the open, Asian approach.

At the same time, developing Asia’s experience in the recent crisis

underscores the risk o a narrow openness. Part 2 o the Update takes a

closer look at the role o openness in developing Asia, outlining a broader,

more resilient approach that would deliver rapid, yet stable, growth or

the region.

Reerences

Asian Development Bank (ADB). . Asian Development Outlook :

Rebalancing Asia’s Growt h. Manila, pp. –.World Bank. . “Prospects or the Global Economy.” June. Available: http://go.worldbank.org/PFVWYXS.

World rade Organization (WO). . “Global Crisis Requires GlobalSolutions.” News Item Report on Recent Development. July. Available:http://www.wto.org/english/news_e/news_e/tpr_jul_e.htm.

http://www.wto.org/english/news_e/news09_e/tpr_13jul09_e.htm

http://www.wto.org/english/news_e/news09_e/tpr_13jul09_e.htm



Part 2

Broadening

openness or a

resilient Asia



Broadening openness or a

resilient Asia

This chapter was written by Shikha Jha, Juthathip Jongwanich, Donghyun Park, Guntur

Sugiyarto, and Akiko Terada-Hagiwara o the Economics and Research Department,

ADB, Manila. It draws on background papers that they prepared with Vaqar Ahmed,

Alvin Ang, Hiro Ito, Selim Raihan, Kwanho Shin, and Carlos Vargas-Silva, consultants.

Te global nancial crisis and the economic slump have togetherhighlighted issues surrounding “openness” in three areasinternational

trade, nancial globalization, and remittances. Although the impact on

developing Asia has been elt primarily through the trade channel, this

part o Asian Development Outlook 2009 (ADO 2009) Update takes stock

o the region’s level and structure o openness in all three interconnected

areas, as uture external shocks could aect the region through nancial

or other channels rather than trade, including remittances.

Now is an opportune time to revisit the issue o openness in

developing Asia. Te recent turmoil exposed the substantial risks o

openness to a region long accustomed to eectively leveraging it to

achieve economic success. In contrast to the Asian nancial crisis o

1997–98, which was precipitated by reversal o oreign capital inows,the slowdown o economic activity in 2008 and 2009 was caused by the

collapse o exports to the industrial economies, in particular the United

States (US). Despite the nancial origins o the downturn, developing

Asia’s nancial systems did not suer severe disruptions. It was only when

the nancial crisis spread to the real economies o the industrial world,

crimping their appetite or imports, that the region’s real economies

were battered. From developing Asia’s perspective, the global tumult

maniested itsel as a trade crisis rather than a nancial crisis.

Although the Asian crisis, unlike recently, was nancial in nature,

it nevertheless helps explain why developing Asia’s economies were hit

so hard by the recent global turmoil. Prior to 1997, developing Asia as

a whole ran current account decits, but since then it has run large

and persistent surpluses. Tis reversal was motivated partly by regional

policy makers’ desire to build up an ample war chest o oreign exchange

reserves. Te reversal implied a higher level o dependence on exports

to the US and other industrial economies as a source o demand and

growth. Te region’s desire to protect itsel rom one type o risk rom

openness and globalizationnancial instability due to volatile capital




owsinadvertently magnied its exposure to another type o risk

excessive dependence on exports. Te deceleration o exports and growth

in 2008 and 2009 was largely a realization o this risk.

From the viewpoint o developing Asia, the global maelstrom

originated outside the region while the Asian crisis was partly homegrown. In contrast to the ormer period, the undamentals o

developing Asian economies have recently been in relatively good shape,

as reected in generally healthy current account and scal positions,

adequate oreign exchange reserves, rapid growth, macroeconomic

stability, and sound macroeconomic policies. Still, the region has suered

or its openness recently, despite strong undamentals.

Te most open, most export-dependent economies have been hit

the hardest (Figures 2.1.1 and 2.1.2). Since those same economies have

outperormed their less open neighbors, regional policy makers ace a

trade-o between the returns o openness (aster output growth) versus

the risk o openness (greater volatility in output growth). Te recent

shock has brought this trade-o into sharp relie and added a new senseo urgency to improving its terms.

With respect to trade, evidence suggests that developing Asia’s level

o openness may be less than optimal, in the broad sense that demand is

geared excessively toward external demand (ADB 2009). More specically,

the region may be consuming too little and saving too much, and

consequently relying disproportionately on oreign markets to purchase

its output. Rebalancing domestic economies will move the region

toward a level o openness where exports continue to make signicant

contributions to growth but a more vibrant domestic economy provides a

measure o resilience against external shocks.

Te nancial crisis and slump have underscored some important

eatures or policy makers. For example, the costs o openness are likely to be high or an economy that has no internal dynamism and that

alls apart whenever the global business cycle turns down. In addition,

the appropriate level o openness and the capacity to reduce the costs

o openness through rebalancing will dier rom country to country.

Finally, developing Asia suers rom a skewed trade structure that

depends disproportionately on demand rom the US and other industrial

economies. Tis is especially true or nal goods, which is why the region

has been hit so hard, despite the healthy growth o intra-Asian trade in

recent years.

Although the nancial impact o the crisis was weaker than the

trade impact, some signs o nancial stress were clearly evident. For

example, in many countries borrowers with weaker credit ratings aced

more difcult access to credit, while pullbacks o capital ows and sharp

currency depreciations in some countries urther highlighted the risks o

nancial globalization (Figure 2.1.3). Coordinated policy responses, such

as US dollar swap lines, were introduced.

Nonetheless, these economies seem to have withstood the eects

o instability, and this success points to the importance o their solid

macroeconomic undamentals and sound nancial systems. In particular,

sound and efcient nancial markets and institutions are indispensable.

In addition to trade and nancial linkages, migration and remittances

are a third area hit by the nancial crisis and economic downturn. Tese

2.1.1 Merchandise exports , selected

economies

0

50

100

150

200

20082007

THATAPSINMALKORHKG

% of GDP

HKG = Hong Kong, China; KOR = Rep. o Korea;MAL = Malaysia; SIN = Singapore; TAP = Taipei,China;

THA = Thailand.



2.1.2 GDP growth, selected economies

-12

-6

0

6

12

ThailandTaipei,ChinaSingapore

MalaysiaRep. of KoreaHong Kong, China

Q2Q1

09

Q4Q3Q2Q1

08

Q4Q3Q2Q1

2007

%



2.1.3 Capital fows to and rom

developing Asia

-1,000

-500

0

500

1,000

OutflowsInflows Net flows

080604022000989694921990

$ billion

Sources: CEIC Data Company Ltd.; International MonetaryFund, International Financial Statistics online; both

downloaded 12 August 2009.










Broadening openness or a resilient Asia 37

events have orced employers to lay o workers, including oreigners,

threatening remittance ows to some countries that send workers abroad.

Tese migrant-sending countries are also acing increasing protectionist

policies rom migrant-receiving countries. Since the economic downturn,

increasing unemployment has pitted the interests o receiving-country nationals against oreigners, as host-country governments tighten

immigration policies to protect jobs or their nationals.

In the past remittances have proven to be a relatively stable source o

oreign currency inows to developing countries (Figure 2.1.4). Although

remittances entail economic and social costs, they can contribute

substantially to growth and poverty reduction, and they provide credit-

constrained households means to smooth consumption. Te key question

or policy makers is how to capitalize on migration and remittances

or growth, poverty reduction, and consumption smoothing while

successully managing potential costs.

Returning to the core issue o trade, the lopsided role o extraregional

trade in the region’s growth creates a serious risk that the gains romgreater trade with neighbors will not be ully exploited. Given the region’s

rapid growth in recent years and the consequent emergence o a large

middle class with growing purchasing power, the gains rom greater

intra-Asian trade in nal goods is potentially large. Te People’s Republic

o China (PRC) and India are reaching income levels where millions o

consumers are buying their rst car or making their rst trip abroad.

Tere are also large potential gains rom greater ows o capital and

remittances among developing Asian economies. Closer integration o

regional nancial markets will create more opportunities or investing

developing Asia’s ample pool o savings within the region. In addition,

measures to acilitate migration and remittances will benet both young

labor-abundant countries and aging labor-scarce countries.However, addressing the geographically unbalanced structure o

trade, capital ows, and remittances through the promotion o closer

intraregional economic links need notindeed, should notcome at

the expense o vital longstanding links with industrial economies. Te

choice acing developing Asia is not between intra- and extra-Asian trade.

Te challenge is to strengthen intraregional trade up to a level that is

commensurate with the rising prosperity o the region.

Intuitively, in light o its ast-growing income and purchasing power,

the excessive dependence o developing Asia on extraregional demand is

somewhat puzzling. Te dependence is both structural and strategic, and

the consequence o a decades-old growth strategy based on exports to

industrial economies. As the region continues to grow and become even

richer, more robust intraregional trade will naturally evolve alongside

stronger domestic demand. Strategic policy measures to rebalance the

economy will accelerate the emergence o sel-sustaining domestic

economies (ADB 2009). As experience o the European Union (EU) and

North American Free rade Agreement shows, vibrant intraregional and

interregional trade can coexist.

Developing Asia’s governments should not just sit back and wait

or strong domestic economies to emerge, but should instead make

real eorts to create a more conducive environment or intraregional

integration. Te resultant policies would speed up developing Asia’s move

2.1.4 Remittances and capital fows to

developing countries

-150

0

150

300

450

600

Private nonguaranteed external debt

Official development assistancePortfolio equity

Foreign direct investmentRemittances

080604022000989694921990

$ billion

Sources: World Bank, Migration and Remittance data, July2009, available: econ.worldbank.org; World Development Indicators online database; Global Development Finance online database; and Organisation or Economic Co-operation and Development, Ofcial and Private Flows

data, available: http://stats.oecd.org, all downloaded17 September 2009.







toward a broader openness, which would enable it to reap the gains rom

more intra-Asian trade, capital, and remittances.

Developing Asia has beneted enormously rom its interaction with

the rest o the world and will continue to do so in the uture. However,

its rapid growth and rising living standards imply large and growingpotential gains rom greater intraregional integration. But i the region

ails to ully exploit these gains, it will be depriving itsel o a valuable

tool, both to protect itsel rom external shocks in the short run and to

build up an additional source o economic dynamism in the long run.

Unlike growth and stability, the level and structure o openness do

not constitute a policy objective in their own right. Instead, openness

is the outcome o a set o policies and conditions that support growth

and stability. Nevertheless, over time, various distortions may have

contributed to overdependence on exports, to unbalanced trade patterns

that avor trade with countries outside the region, to high dependence

on extraregional nancial markets and institutions, and to obstacles to

migration and remittance ows within the region. Tose distortions notonly aect the level and structure o openness but can also adversely

aect the trade-o between growth and stability, and so removing them

may have a positive impact on this critical trade-o.

Te implication is that a stronger domestic economy and more

linkages within the region can help countries achieve rapid, yet

stable, growth. Te combination o rebalancing and intraregional

integration will give to developing Asia greater resilience in the ace o

extraregional shocks.



Enhancing intraregional trade

The role o intraregional trade in developing AsiaTe global nancial crisis and economic slump together have hit hard

developing Asia’s exports and growth. Although the slump was nancial

in its origins, trade has been the dominant channel through which the

nancial crisis has been transmitted rom the US to developing Asia.

Given that the root cause o developing Asia’s slowdown is the contraction

o aggregate demand due to the contraction o external demand, the

logical solution to short-run recovery and long-term growth is to nd

alternative sources o demand.

In the short run, the only realistic policy option is or governmentsto cut taxes and increase spending, serving as consumer o last resort,

as they in act did throughout the region. In the long run, as discussed

in ADO 2009 ( ADB 2009), one strategy is to strengthen domestic

demand so that countries in the region consume more o what they

produce. However, building up a more vibrant domestic economy is

a long-term structural process that involves removing deep-seated

structural impediments, such as weak nancial and inadequate social

protection systems.

Tis section explores another long-run potential source o demand

and growth or developing Asia, namely intraregional trade, which is

intimately related to domestic demand. More robust domestic demand

within the countries o the region will enable them to buy more o each other’s goods, as is the case among EU countries. Stylized acts

suggest that while trade among developing Asian economies has grown

impressively in recent years, much o the trade reects trade in parts and

components as opposed to trade in nal goods. In particular, the PRC’s

role as the workshop o the world means that economies around the

region ship parts and components to the PRC, which assembles them into

nal goods and exports them to the US and other industrial economies.

Consequently, the growth o intra-Asian trade remains heavily

inuenced by growth o demand in the rest o the world. Tis is especially

so or trade among East Asian and Southeast Asian economies, which

trade extensively with each other. Upon closer analysis, lack o more

substantive intraregional trade based on nal goods, along the lines o the

EU, is a direct result o weak domestic demand in regional economies. By

the same token, the strengthening o domestic economies will stimulate

more substantive intraregional trade.

Te central objective o this section is, thereore, to empirically

investigate whether intraregional trade can serve as an engine o recovery

and growth or developing Asia. More specically, it examines the issue o

whether the PRC can serve as that engine.

Te next subsection will make it clear why the PRC has a unique

potential to drive regional growth through trade. Te empirical analysis

concentrates on manuactured goods rather than commodities since




.. Geographic scope

“Asia” reers to Asia excluding Japan.

“East Asia” comprises People’s Republic

o China (PRC); Hong Kong, China;Republic o Korea; and aipei,China.

“Southeast Asia” comprises BruneiDarussalam, Cambodia, Indonesia,Lao People’s Democratic Republic(Lao PDR), Malaysia, Mongolia,Myanmar, Philippines, Singapore,Tailand, and Viet Nam.

“East and Southeast Asia” excludesJapan.

“High-income” economies compriseHong Kong, China; Korea; Singapore;and aipei,China; the rest are “others”.

“Non-East and Southeast Asia”includes most developing Asianeconomies outside these twosubregions.

“Intra-Asian” trade reers to tradeamong Asian economies other thanJapan.

manuactured goods account or a majority o intraregional trade. More

signicantly, the analysis is largely limited to the economies o the two

subregions o East Asia and Southeast Asia, which have reached a airly

high degree o trade integration with each other.

While the analysis looks primarily at East and Southeast Asia, theresults have implications or other parts o developing Asia as well.

For example, although intra-South Asian trade is still relatively low,

Bangladesh, Pakistan, Sri Lanka and other subregional economies are

likely to reap increased benets as trade integration among South Asian

countries progresses urther in the uture.

In particular, just as East and Southeast Asia stand to benet rom

the PRC’s rapid growth, South Asia stands to benet rom India’s ast

growth. More generally, any evidence that trade integration in East Asia

and Southeast Asia is contributing to the two subregions’ recovery and

growth will provide some grounds or optimism about the prospects o

intraregional trade to do the same or other parts o developing Asia.

Growth o intra-Asian trade and the rise o the


Tis section is motivated by the hopes and optimism surrounding a new

potential source o demand and growth that may compensate or the

weakening o an existing source o demand and growth. Tose hopes

and optimism are predicated on two stylized actsthe rapid growth o

intra-Asian trade and the rise o the PRC as an economic orce o global

signicance.

In purely quantitative terms, intra-Asian trade, especially among

East and Southeast Asian economies, has increased notably in recentyears. Although much o this trade is currently in parts and components

rather than in nal goods, the very act that Asian economies are trading

increasingly with each other provides some grounds or optimism about

the uture emergence o more substantive intraregional trade in which

nal goods play a bigger role. In other words, the quantitative growth o

intra-Asian trade holds the promise that it may someday become a source

o demand and growth in the region, as it is in the EU.

Te stunning rise o the PRC as a global economic heavyweight

potentially means the rise o a large and growing market or Asian

exports. Although the PRC tends to be stereotyped as the workshop o

the world, the country’s sheer size and growth mean that it is also an

importer o global inuence. For example, the PRC’s voracious appetite

or raw materials has had a perceptible eect on global commodity

markets.

More generally, the PRC is not only growing at a very rapid and

sustained pace, but it is also a huge country that is home to more than a

quarter o humanity. Tereore, in contrast to, say Malaysia, Singapore,

or even Korea, the PRC is seen as a continental economy where both

domestic demand and the economy are vibrant. Tis vigor is apparent

in the act that the PRC’s growth rate slowed to “only” 9.0% in 2008

and a projected 8.2% in 2009 while the rest o East and Southeast Asia

is barely managing to grow at all. In act, Hong Kong, China; Korea;




Malaysia; Singapore; aipei,China; and Tailand are all projected to

contract in 2009.

Te combination o the two stylized acts has breathed lie into

the “PRC-as-an-engine-o-recovery-and-growth” hypothesis (in short,

the “PRC-as-engine” hypothesis). Tis is a special variant o the intra-Asian “trade-as-an-engine-o-recovery-and-growth” hypothesis, which

recognizes the special role o the PRC as the dynamic center o the

growing trade-based integration o the region’s real economies. Te

remarkable resilience o the PRC in the ace o the nancial crisis and

economic slump has given urther impetus to the notion that the PRC

can supplement the US as a new growth center or developing Asia.

o be sure, the rise o the PRC not only presents opportunities but

also challenges. Above all, the PRC’s rise as a global manuacturing center

poses a serious competitive threat to the third-country exports o regional

countries. However, there is a growing tendency to view the PRC as a

large and growing market rather than a competitor in other markets. Te

rethinking among the PRC’s neighbors is born o urgent necessitytond a new source o growth; and rooted in cold hard realitythe

remarkable transormation o the PRC.

Growth o intraregional trade in East and Southeast Asia

Despite the multidimensional origins o developing Asia’s economic

success, the one common theme that stands out is its trade dependence.

East and Southeast Asian economies in particular have successully

integrated themselves into the global real economy by trading extensively

with the outside world. Between 1990 and 2008, their exports grew rom

$424.6billionto$3.6trillioninnominaltermsandfrom$559.6billion

to$2.8trillioninrealterms,andimportsgrewfrom$429.0billionto

$3.3trillioninnominaltermsandfrom$565.4billionto$2.6trillioninreal terms (Figure 2.2.1).

Furthermore, the share o those economies’ exports in global exports

rose rom 12.3% in 1990 to 21.9% in 2008, and the share o their imports

in global imports rose rom 12.0% to 19.4% during the same period

(Figure 2.2.2). Mirroring the rise in East and Southeast Asia’s share o

global trade, the region’s share o global GDP increased rom 5.5% in 1990

to 12.3% in 2008.

In short, developing Asia is a highly trade-dependent region that has

exported and traded its way out o all-too-typical developing-country

poverty to become one o the centers o gravity in the world economy.

In recent years, the region’s countries have been trading increasingly

with each other rather than with countries outside the region.

Supercially, this suggests that intraregional trade has already become

a major source o demand and growth. Supercial or not, aggregate

bilateral trade data unambiguously point to a rise in the relative share

o intra-Asian trade. Again, this trend is particularly evident or East

and Southeast Asian economies. For this group o countries as a whole,

the share o intraregional trade has risen rom 31.7% in 1990 to 42.0% in

2008 (Figure 2.2.3). For each member o this group, the unmistakably

clear overall pattern is one o an increase in the relative importance o

intraregional trade at the expense o extraregional trade (Figure 2.2.4).

Tis pattern is also evident or all subgroups o countries within

2.2.1 Merchandise trade, East and

Southeast Asia

0

1,000

2,000

3,000

4,000

Real importsNominal imports

Real exportsNominal exports

080604022000989694921990

$ billion

Notes: For composition o East and Southeast Asia, seeBox 2.2.1. The base year or real exports and imports is 2000.

Sources: Sta estimates based on data rom CEIC Data

Company Ltd., downloaded 4 August 2009; InternationalMonetary Fund, Direction o Trade Statistics, May 2009.


2.2.2 Global shares o output, exports, and

imports, East and Southeast Asia

0

5

10

15

20

25

GDP, current PPP $

GDP, current $ Imports

Exports

080604022000989694921990

%

PPP = purchasing power parity.

Note: For composition o East and Southeast Asia, seeBox 2.2.1.

Sources: Sta estimates based on data rom CEIC DataCompany Ltd., downloaded 4 August 2009; InternationalMonetary Fund, Direction o Trade Statistics, May 2009.


2.2.3 Intraregional trade, East and

Southeast Asia

0

9

18

27

36

45

080604022000989694921990

% of total trade


Sources: Sta estimates based on data rom CEIC DataCompany Ltd., downloaded 4 August 2009; International

Monetary Fund, Direction o Trade Statistics, May 2009.











the regionthe PRC, the newly industrialized economies (NIEs), as

well as the major ASEAN economies. Te implication is that in purely

quantitative terms, East and Southeast Asian economies are trading more

with each other and less with the rest o the world. Tereore, not only is

trade important or the region; in addition, the geographic prole o theregion’s trade is shiing toward trade with neighbors.

Tis quantitative shi has been used as the primary supportive

evidence o the decoupling hypothesis, according to which the dependence

o Asian growth on the US business cycle has allen markedly. Te

underlying idea was that increasingly rich Asian countries were now

selling more o their goods to each other rather than the US, so that a US

recession would have a smaller impact on their economic perormance

than beore. Te story was plausible but it suered rom a critical awit

ailed to look at the structure o growing intra-Asian trade.

In act, according to the overall balance o evidence, a large part

o intra-Asian trade reects intra-Asian production ragmentation,

in which dierent stages o the production process are carried out indierent Asian economies.1 More specically, the PRC has emerged as

the preerred location or assembling parts and components produced

in other East and Southeast Asian economies. International production

ragmentation is, in eect, international vertical specialization in which

each country specializes in a dierent stage o the production process.

As such, East and Southeast Asian economies are likely to enjoy gains

rom the intraregional specialization and division o labor. Nevertheless,

the production ragmentation-oriented nature o intra-Asian trade casts

serious doubts on the validity o the regional trade-as-an-engine-o-

recovery-and-growth-hypothesis.

Surge o the People’s Republic o China and implications ordeveloping Asia

One o the most signicant developments in the global economic

landscape over the last 30 years has been the integration o the PRC

into the world economy and its stunning growth. What makes the

PRC’s rise so special is the sheer size o the country and hence its global

and regional clout. Te transormation o the PRC, which began 30

years ago, has accelerated in recent years. Between 1990 and 2008 or

example, the share o the PRC GDP in world GDP rose sharply rom

1.7% to 7.3% (Figure 2.2.5). Given the central role o trade and openness

in the relentless expansion o the country’s economy, its trade has also

experienced similarly rapid growth. Te share o PRC exports in total

world exports rose rom 1.8% in 1990 to 9.1% in 2008, and its share o

world imports rose rom 1.5% to 7.0% during the same period. Te PRC’s

emergence as a global economic power thus closely parallels its emergence

as a global trading power.

In the context o East and Southeast Asia, the rise o the PRC

signals the arrival o a neighborhood heavyweight with ar-reaching

ramications. Te PRC’s share o developing Asia’s GDP rose rom 23.4%

in 1990 to 47.6% in 2008. During the same period, its share o East and

Southeast Asian GDP rose rom 31.0% to 58.9% (Figure 2.2.6). Similarly,

the PRC’s exports are accounting or a larger share o East and Southeast

Asian exports, and the same holds true or its imports (Figure 2.2.7).

2.2.4 Intraregional trade, selected East and

Southeast Asian economies

0

24

48

72

Thailand

Taipei,ChinaSingapore

PhilippinesMalaysia

Rep. of KoreaIndonesia

Hong Kong, ChinaPeople's Rep. of China

080604022000989694921990

% of total trade

Sources: Sta estimates based on data rom CEIC DataCompany Ltd., downloaded 4 August 2009; InternationalMonetary Fund, Direction o Trade Statistics, May 2009.


2.2.5 Global shares o output, exports, and

imports, People’s Republic o China

0

4

8

12Imports

ExportsGDP, current PPP $

GDP, current $

080604022000989694921990

%

Sources: Sta estimates based on data rom CEIC DataCompany Ltd., downloaded 4 August 2009; InternationalMonetary Fund, Direction o Trade Statistics, May 2009;

International Monetary Fund, World Economic Outlook database, April 2009.


2.2.6 Share o gross domestic product in

selected regions, People’s Republic o China

0

13

26

39

52

65

East and Southeast Asia GDP, current PPP $

East and Southeast Asia GDP, current $

Developing Asia GDP, current PPP $

Developing Asia GDP, current $

080604022000989694921990

%

Note: For composition o East and Southeast Asia, see

Box 2.2.1.

Source: International Monetary Fund, World Economic Outlook database, April 2009.











the center o a regional production network rather than an independent

source o demand or the region.

Te sheer size and dynamism o the PRC means that even aside rom

its central role in intra-Asian production ragmentation, it has a unique

role to play. Even though, say, Singapore (or Hong Kong, China) may trade extensively with other Asian countries and is highly integrated into

the regional economy, it is a small, open economy with no perceptible

impact on regional trade and growth. Te same can be said or even

larger regional economies, such as Korea.

In illustrating the presence or absence o a robust domestic economy,

the exact share o domestic demand in total GDP matters much less than

resilience in the ace o a severe external shock. In a sense, the recent

crisis is a stress test o the highest order or the domestic economy.

Te PRC’s growth perormance in 2008 and so ar in 2009, despite

decelerating rom 2003–2007, means that the PRC has passed the stress

test with ying colors. Te perception o the PRC as a continental

economy with a sustainable, resilient domestic economy has thus ounda great deal o support. Te big question is this: How likely is it that the

promise o the PRC-as-engine hypothesis will become reality? Te next

two sections attempt to answer it.

Impact o demand rom the People’s Republic o

China or imports on developing Asian GDP

Te PRC-as-engine hypothesis is a theory about the PRC’s GDP exerting

an independent and positive eect on the GDP o other countries in East

and Southeast Asia. Te reason or largely limiting the analysis to those

two subregions is that the general level o regional economic integration,and in particular integration with the PRC, is more advanced there

than in other parts o developing Asia. A key tangible result should be a

positive relationship between the PRC’s imports rom, and output levels

in, the rest o the region.

Te main interests are the relative magnitude o the impact o the

PRC’s imports on the GDP o its neighbors and the evolution o this

magnitude over time. In particular, an impact that is not visibly smaller

than the impact o US imports would support the emergence o a second

engine o growth in the region. Furthermore, an impact that is growing

over time, especially relative to the US impact, would also support a twin-

engine growth paradigm.

A vector autoregression (VAR) was used to identiy the US and

PRC import demand shocks, which are export demand shocks rom the

viewpoint o East and Southeast Asia. Te VAR model is based on that

o Haltmaier et al. (2007), who analyze macroeconomic data rom the

third quarter o 1993 to the ourth quarter o 2006, to assess the impact

o PRC and US demand on GDP growth in Indonesia; Korea; Malaysia;

Philippines; Singapore; aipei,China; and Tailand. Teir two major

ndings are that external shocks have played a major role in the domestic

output uctuations o their sample o developing Asian economies, and

that PRC demand shocks have been as important as US demand shocks in

explaining the domestic growth uctuations o many regional economies.

2.2.10 Trade with East and Southeast Asia,


10

20

30

40

50

60

Imports

Exports

080604022000989694921990

% of total exports or imports

Note: For composition o East and Southeast Asia, see

Box 2.2.1.

Sources: Sta estimates based on data rom CEIC Data

Company Ltd., downloaded 4 August 2009; InternationalMonetary Fund, Direction o Trade Statistics, May 2009.







Tese major ndings remain largely valid even when the authors account

or the possibility that PRC demand or Asian exports is a derived

demand based on US demand or nal goods.

Trough the VAR model, it was attempted to assess the relative

contributions o shocks to US import demand and shocks to PRC importdemand to GDP in nine regional economies rom the rst quarter o 1990

to the ourth quarter o 2008. Te sample o economies consists o the

our NIEs (Korea; Hong Kong, China; Singapore; and aipei,China); the

ASEAN-4 (Indonesia, Malaysia, Philippines, and Tailand); plus India.

India is included in the sample in light o its large and growing economic

weight. A high PRC contribution would support the PRC-as-engine

hypothesis, and a growing contribution would suggest that the PRC is

becoming more o an engine over time.

A three-variable structural VAR was estimated or each country

in the sample. Using Malaysia as an example, the VAR model includes

the three ollowing variables: domestic real GDP, US real imports rom

Malaysia (that is, Malaysia’s real exports to the US), and the PRC’s realimports rom Malaysia (that is, Malaysia’s real exports to the PRC). For

ull technical details o the VAR analysis, including impulse response

unctions and variance decomposition results, reer to Park and Shin

(2009a).

Te most signicant result is that PRC demand has become a more

important source o GDP uctuations in ve out o the nine sample

economiesHong Kong, China; Indonesia; Philippines; aipei,China;

and Tailand. In and o itsel, this would lend support to the PRC-as-

engine hypothesis. Another somewhat predictable nding is that the role

o PRC demand as a source o GDP uctuations diers a lot across the

sample economies. For example, the PRC does not matter at all or India

but matters hugely or Singapore. Overall, the three-variable VAR resultsindicate that the PRC’s import demand already has a big impact on the

output o economies in the region, not noticeably smaller than the impact

o US import demand. Furthermore, its role has strengthened appreciably

since the Asian crisis.

While such results bode well or the PRC-as-engine hypothesis, there

is a serious risk that they overestimate the extent to which the PRC serves

as an independent source o demand and growth or the region. Tis

pertains to the basic structure o intra-Asian trade alluded to earlier.

More specically, that structure suggests that the PRC’s demand or

imports rom its neighbors is a derived demand that is based on nal

demand in the US and elsewhere. What is driving the PRC’s demand or

imports rom, say, Malaysia is not the PRC’s own demand but US demand

or nal goods rom Asia. o control or this possibility, the three-variable

VAR model was expanded to our variables. Te additional variable is US

real imports rom the PRC, which contains large inputs o intermediate

goods (parts and components) rom the rest o the region.

Te clear overall pattern that emerges is that the PRC’s exports to the

US emerge as a new signicant source o GDP uctuations. Critically,

once one controls or the possibility that the PRC’s demand or Asian

exports is largely demand derived rom US demand, exports to the PRC

are no longer a signicant determinant o GDP in Asian countries. Te

results are most pronounced or the our NIEs. Te only three countries




where exports to the PRC remain signicant even aer controlling or

derived demand are Korea, Philippines, and Tailand.

In short, the evidence rom the regressions casts doubt on the validity

o the PRC-as-engine-o-growth hypothesis. Te results o the three-

variable model indicate that exports to the PRC have a positive andsignicant eect on the GDP o East and Southeast Asian economies.

However, the results o the our-variable model suggest that the PRC’s

apparently positive impact reects US demand or Asian goods, rather

than independent demand rom the PRC.

Still, the evidence rom the regressions provides only indirect

evidence or the hypothesis that PRC demand or Asian goods is

primarily derived rather than direct demand. It is thereore necessary to

turn to an analysis o trade data to obtain direct inormation about the

structure o intra-Asian trade.

Relative importance o parts and componentsversus nal goods

One must analyze the trade data or two main reasons. First, the derived

demand hypothesis is undamentally a hypothesis about the structure

o intra-Asian trade. Second, the PRC-as-engine hypothesis is also

ultimately a trade-based story that relates how growing demand or

imports rom a ast-rising PRC lis the rest o the region to a plateau o

reduced vulnerability to extraregional shocks and a higher sustainable

growth rate.

At a conceptual level, the key issue is whether the share o parts and

components in the PRC’s imports rom the rest o the region is rising,

alling, or stable. A rising share would support the notion that the PRC’srole in intra-Asian trade is primarily that o an assembler o parts and

components, and thus lend support to the derived demand hypothesis. A

alling share would indicate that the PRC’s role as an assembler or the

region is weakening, which can be interpreted as indirect evidence o the

emergence o a more substantive trade between the PRC and the rest o

Asia based on demand or nal goods rom the PRC.

A vast literature based on standard trade data analysis unambiguously

points to a secular increase in intraregional trade among East Asian

economies since the early 1980s. Examples o this literature include Kwan

(2001), Drysdale and Garnaut (1997), and Frankel and Wei (1997). Te

standard trade data analysis used in this literature implicitly assumes

trade based on horizontal specialization, that is, exchange o goods

which are produced rom start to nish in one country. International

production ragmentationcarrying out dierent production activities

in dierent countrieshas become an increasingly signicant structural

characteristic o economic globalization in recent decades.3 In particular,

trade based on ragmentation or vertical specialization is playing a key

role in trade among East and Southeast Asian economies. 4

Various studies have examined the structure o the PRC’s trade

with its Asian neighbors to gauge the extent to which such trade is

driven by demand rom the US and other economies outside the region.

Decomposing trade into basic products, parts and components, and nal




goods, Haltmaier et al. (2007) nd a large role or parts and components

in intra-Asian trade, in particular between the PRC and the rest o Asia.

Tey conclude that this evidence supports the conventional wisdom that

the PRC is the endpoint o a giant Asian assembly line or exports to the

US and elsewheremeaning that the PRC serves as a conduit rather thanengine o growth or the region.

Similarly, Athukorala and Yamashita (2009) nd that the PRC is the

nal assembly center in global production networks based in East and

Southeast Asia. Athukorala and Yamashita (2008), Ng and Yeats (2001),

Athukorala (2005), and Pula and Peltonen (2008) all reconrm the central

role o vertical specialization in intra-Asian trade and conclude that

extraregional trade is likely to remain the region’s engine o growth in the

oreseeable uture.

Description o disaggregated trade data

Te data or the analysis are o monthly requency and derived rom

ofcial PRC customs agencies’ merchandise trade export and importstatistics. Tese are the ofcial international trade statistics released by

the PRC Government. Te data rom January 1996 to December 2005

are held by radeData International. Te data cover trade in goods or

merchandise, and exclude trade in services. Merchandise trade statistics

only record goods that add to or subtract rom the stock o material

resources o a country by entering (imports) or leaving (exports) its

territory.5

Following Haltmaier et al. (2007), a comprehensive decomposition

o trade into our categories is adopted: basic goods, construction

materials, parts and components, and nal goods. Te critical

distinction is between parts and components on the one hand and

nal goods on the other. Parts and components are manuacturedintermediate goods that are combined with other inputs to produce

nal goods. With ew exceptions, parts and components cannot be used

as nal goods. In contrast, nal goods are goods that can be directly

consumed with little or no processing.

Te two other categories o goods are basic goods (ood and

beverages, natural resources, and raw materials) and construction

materials (cement). As Haltmaier et al. (2007) point out, classiying the

goods into parts and components as against nal goods necessarily

involves some room or subjective discretion and judgment. It is also

impossible to know how a good was used as a part or component or a

nal good once it has been imported.

Haltmaier et al. (2007), as well as most o the other studies that

examined the structure o intra-Asian trade, classied goods according to

Standard International rade Classication Revision 3. However, the data

or this analysis is collected on the basis o the International Harmonized

Customs Classications.6

Shares o parts and components versus nal goods: Key ndings

Te PRC-as-engine hypothesis is predicated on the assumption o a

dynamic domestic economy rooted in robust domestic demand. Te

underlying idea is that o a large and ast-growing PRC absorbing more

imports rom its neighbors, and thus speeding up their recovery in the




short run and enabling more rapid growth in the long run. Te validity o

this hypothesis depends crucially on whether the PRC directly consumes

the imports or processes the imports or export to other countries. Other

things equal, nal goods are more likely to end up being consumed

domestically while parts and components are more likely to end upbeing consumed abroad. O course, it is entirely possible that parts

and components are used as inputs in producing nal goods that are

consumed domestically while nal goods such as capital goods are used

to produce goods that are exported to other countries. Tereore, the

relative share o parts and components versus nal goods is an imperect

measure o the relative importance o derived demand versus direct

demand in a country’s demand or imports.

Nevertheless, because trade data cannot state the nal use o imports,

the decomposition o imports into parts and components versus nal

goods is probably the best measure available or making inerences

about nal use. A smaller share o parts and components in the PRC’s

imports would indicate a lower relative importance o derived demand,which would weaken the derived demand hypothesis and thus indirectly

support the PRC-as-engine hypothesis. Furthermore, a alling share o

parts and components over time would suggest that the PRC’s role as an

assembler is diminishing, with a corresponding increase in its role as a

consumer. Tis is true with respect to the world as a whole but especially

with respect to East and Southeast Asia, given the extensive intraregional

production ragmentation discussed earlier.

Beore a review o the share o parts and components, the PRC’s

importance in world trade, as well as East and Southeast Asia’s

importance in the PRC’s trade, is examined. Te PRC’s share in global

trade has been continuously increasing (Figure 2.2.5 above). Its share

o global exports has shot up rom a little less than 1.9% to 9.3% and itsshare o global imports has risen rom 1.5% to 7.1%. Although the PRC

tends to be stereotyped as an export machine, the growth o its imports

has been almost as impressive. However, a notable gap between the

export and import shares opens up around 2003, in line with the large

current account surplus experienced by the PRC in recent years. East

and Southeast Asia’s relative importance as a trading partner seems to

have decreased somewhat during 1996–2008 (Figures 2.2.11 and 2.2.12).

However, the decline is much more pronounced or East Asia’s share o

PRC exports, rom 35.5% to 27.2%, than it is or PRC imports, rom 34.2%

to 32.9%. o a large extent, the alling share o East Asia in the PRC’s

trade reects the PRC’s successul integration into the world economy, in

particular its growing success in exporting to more distant markets.

Between 1996 and 2008, as shown in Figures 2.2.13 and 2.2.14, the

share o parts and components in the PRC’s total imports is much higher

(averaging 32.8%) than in its total exports (averaging 17.9%). Te share

o nal goods in the PRC’s imports (averaging 45.2%) is correspondingly

much lower than the share o nal goods in its exports (averaging 70.0%).

Tis can be viewed as evidence o the PRC’s global role as a net importer

o intermediate goods or assembly and reexport to the rest o the world.

However, the share o parts and components in imports has been alling

while that in exports has been rising. Te share o nal goods in exports

has been alling throughout the sample period. Te pattern or the share

2.2.11 Exports by economy or region,


0

20

40

60

80

100

Others

EU27

United States

Japan

East and Southeast Asia

080604022000981996

% of total exports


Source: Sta estimates based on data rom CEIC DataCompany Ltd., downloaded 4 August 2009.


2.2.12 Imports by economy or region,


020

40

60

80

100

Others

EU27

United States

Japan

East and Southeast Asia

080604022000981996

% of total imports


Source: Sta estimates based on data rom CEIC DataCompany Ltd., downloaded 4 August 2009.


2.2.13 Exports by commodity classication,


0

20

40

60

80

100

Final goods

Basic products

Construction materials

Parts and components

080604022000981996

%

Source: Sta estimates based on data rom TradeData

International Pty. Ltd.











o nal goods in imports is more mixed. Although the share was rising

until about 2003, it has allen sharply since then.

Te most interesting and signicant part o the analysis o the

PRC’s trade structure pertains to the structure o its trade with East and

Southeast Asia. As was the case or the world as a whole, as shown inFigures 2.2.15 and 2.2.16 or East and Southeast Asia the share o parts and

components in the PRC’s imports (averaging 38.8%) is substantially higher

than in the PRC’s exports (averaging 21.2%).

Similarly, or the most part, or East and Southeast Asia the share o

nal goods in the PRC’s exports (averaging 62.0%) exceeded the share in

its imports (averaging 51.0%). Tis suggests that part o the nal goods

assembled in the PRC is exported to the rest o developing Asia, which

is consistent with the plethora o “made-in-China” manuactured goods

ound in markets throughout developing Asia. More important, the

shares o parts and components and o nal goods in the PRC’s imports

rom East and Southeast Asia average 38.8% and 51.0% or the whole

sample period, respectively.Tereore, while trade in parts and components is indeed a key element

o intra-Asian trade, so too is trade in nal goods. Both derived demand

and direct demand may be important drivers o the PRC’s demand or

Asian imports, and there is no reason why a ourishing trade based

on production ragmentation cannot coexist alongside a ourishing

trade based on PRC domestic demand. Crucially, the share o parts and

components in the PRC’s imports rom East and Southeast Asia decreased

substantially rom 43.6% to 33.8% rom 1996 to 2008, and the share o nal

goods increased appreciably rom 43.6% to 54.7% during the same period.

Tese changes can be viewed as a weakening o the PRC’s regional

role as an assembler and a corresponding strengthening o its role

as a consumer. Equivalently, the declining import share o parts andcomponents suggests that direct demand may be playing an increasing

role in PRC demand or imports rom its neighbors, and thereore the

PRC’s prospects to act as an engine o recovery and growth seem to have

improved in recent years. Overall, the recent pattern o trade between

the PRC and East and Southeast Asia indicates that the PRC may be

becoming more o a consumer and less o an assembler in the region.

An important caveat in the declining share o parts and components

in the PRC’s imports is the possibility that the PRC is moving up the

technological and skills ladder to domestically produce more previously

imported sophisticated parts and components. o the extent that this is

happening, the alling share o parts and components reects not so much

the diminishing role o the PRC as the end point o the intraregional

Asian production network as the intensication o PRC competitive

pressures or the rest o Asia.

Furthermore, as said, the share o nal goods in the PRC’s imports

is at best an imperect measure o the share o imported goods

that are consumed in the PRC rather than reexported. Ditto parts

and components. Tereore, while the declining share o parts and

components in imports is signicant and interesting, one must exercise a

great deal o caution in interpreting this trend as evidence o a decline in

the importance o derived demand relative to direct demand.

Within East and Southeast Asia, the decline in the share o parts

2.2.14 Imports by commodity classication,


0

20

40

60

80

100

Final goods

Basic products



080604022000981996

%

Sources: Sta estimates based on data rom TradeData

International Pty. Ltd.


2.2.15 Exports to East and Southeast Asia bycommodity classication, People’s Republic

o China

0

20

40

60

80

100

Final goods

Basic products



080604022000981996

%


Source: Sta estimates based on data rom TradeDataInternational Pty. Ltd.


2.2.16 Imports rom East and Southeast

Asia by commodity classication, People’s

Republic o China

0

20

40

60

80

100

Final goods

Basic products

Construction materialsParts and components

080604022000981996

%













and components in the PRC’s imports is most pronounced or the our

high-income East and Southeast Asian economies (Figure 2.2.17). Te

share ell sharply rom 50.2% in 1996 to 34.5% in 2008 or that group.

Tis is signicant because intra-Asian trade based on derived demand

is most relevant or those countries. Tese countries as a group aretechnologically more advanced than the PRC and hence capable o

producing high-tech parts and components that the PRC is not yet

capable o producing. At the same time, their high labor costs render

relocating the assembly stage o the production process most protable.

Tis explains why the share o parts and components is visibly higher in

the PRC’s imports rom the our high-income economies than it is or

imports rom other East and Southeast Asian economies.

Tereore, the act that the decline in the share o parts and

components is most visible or East Asian economies that are most likely

to engage in vertical specialization with the PRC can be viewed as urther

evidence o a weakening o the PRC’s regional role as an assembler.

But again, one must exercise caution in making such an interpretationto the extent that the decline in parts and components may be driven

by the PRC’s closing o the technological gap with its more developed

neighbors and producing more sophisticated parts and components. Te

share o parts and components in the PRC’s imports rom other East and

Southeast Asia has also declined (Figure 2.2.18) rom 23.1% to 19.5% during

1996–2008, although not as sharply as or imports rom high-income East

and Southeast Asia.

Finally, despite East and Southeast Asia’s dominant role in developing

Asia’s production ragmentation, the share o parts and components in

the PRC’s imports rom regional economies outside those two subregions

is also quite highaveraging 33.2%. However, the share o nal goods

is ar loweraveraging 10.6%and the share o basic products is arhigheraveraging 54.3% (Figure 2.2.19).

Trade balance between the People’s Republic o China and the rest o developing Asia

Another key trade indicator that can give inormation on the impact o

trade with the PRC on the growth o other Asian countries is the trade

balance. In an accounting sense, it is net exports rather than exports that

capture the positive impact o trade on a country’s aggregate demand.

Although trade is in and o itsel benecial, unbalanced tradewhere one

side exports disproportionately more to and imports disproportionately

less rom the other sideraises questions about the distribution o

benets. Tere are widespread concerns that the PRC’s massive trade

surplus represents a large stimulus to the PRC’s own aggregate demand

and hence growth but an equally large leakage o demand rom the rest

o the world. In act, such concerns underlie the calls or protectionism

against the PRC in the US and elsewhere. In short, trade balance with the

PRC matters much to the rest o Asia in terms o the magnitude o the

stimulus to demand and growth provided by trade with the PRC.

able 2.2.1 shows that the PRC runs a trade surplus with East Asia.

However, this surplus is mainly due to the surplus rom its trade with

Hong Kong, China, reecting the special administrative region’s role

as a major transshipment center or the Pearl River delta, which is the

2.2.18 Imports rom other economies by

commodity classication, People’s Republic

o China

0

20

40

60

80

100

Final goods

Basic products



080604022000981996

%




2.2.19 Imports rom Non-East and

Southeast Asian economies by commodity

classication, People’s Republic o China

0

20

40

60

80

100

Final goods

Basic products



08 06 04 02 2000 98 1996

%

Note: Non-East and Southeast Asian developing economiescomprise Aghanistan, Armenia, Azerbaijan, Bangladesh,

Bhutan, Cook Islands, Fiji Islands, Georgia, India,Kazakhstan, Kyrgyz Republic, Maldives, Nepal, Pakistan,Sri Lanka, Tajikistan, Turkmenistan, and Uzbekistan.



2.2.17 Imports rom high-income economies

by commodity classication, People’s

Republic o China

0

20

40

60

80

100

Final goods

Basic products



080604022000981996

%













.. Trade balance with developing Asian economies, People’s Republic o China, $ billion, and

Total trade Basi c products Cons truction

materials

Parts and

components

Final goods

East and Southeast Asia . . . -. . . -. -. . .High-income East and Southeast Asia . . . . . . -. -. . .

Hong Kong, China . . . . . . . . . .

Singapore . . -. . . . . -. . .

Rep. o Korea -. -. . . . . -. -. -. -.

Taipei,China -. -. . -. . . -. -. -. -.

Other East and Southeast Asia -. -. -. -. . . . . . -.

Brunei Darussalam . -. . -. . . . . . .

Cambodia . . . . . . . . . .

Indonesia -. . -. -. . . . . . .

Lao PDR . . . -. . . . . . .

Malaysia -. -. -. -. . . -. -. . -.

Mongolia -. - . -. -. . . . . . .

Myanmar . . - . - . . . . . . .

Philippines . -. -. -. . . . -. . -.

Thailand -. -. -. -. . . . -. . -.

Viet Nam . . -. -. . . . . . .

Non-East and Southeast Asia . . -. -. . . . . . .

Source: Sta estimates based on data rom TradeData International Pty. Ltd.

hub o the PRC’s export-oriented manuacturing. I one excludes Hong

Kong, China, the PRC runs a trade decit with East and Southeast Asia.

Tis decit is primarily due to trade decits with more developed East

Asian economies such as Korea and aipei,China. Te PRC’s trade decit

with more developed East Asian economies, in particular Korea and

aipei,China, has been steadily increasing. However, whereas in 1996 most

o the PRC’s trade decit with Korea and aipei,China occurred in the

parts and components trade, by 2007, the nal goods trade accounted ormore o the decit.

Tis change closely mirrors and is consistent with the declining share

o parts and components in the PRC’s imports rom the our high-income

economies. Te PRC has continued to run trade decits with these

economies in 2008 and 2009, but the projected decits or 2009 are lower

than or 2008 (able 2.2.2). Te PRC also runs a trade decit with other

East and Southeast Asian economies, but this is primarily due to trade in

basic goods, especially in 2008 and 2009. Te PRC runs a trade surplus in

parts and components with other East and Southeast Asia and non-East

and Southeast Asia, which supports the earlier argument that the PRC’s

role as a regional assembler pertains primarily to high-income East and

Southeast Asia. Te PRC runs a trade surplus in nal goods vis-à-vis

these our economies. (Once again, however, this is mainly due to its

trade surplus with Hong Kong, China. Excluding that economy, the PRC

runs a large trade decit in nal goods with them.) Te PRC’s nal goods

trade with other East and Southeast Asia is more or less balanced, and

posts a surplus in nal goods trade with non-East and Southeast Asia.

Te overall pattern that emerges rom the trade balance data is that,

in striking contrast to its trade with the rest o the world, in particular

with the US and EU, the PRC does not run a large and persistent trade

surplus with developing Asia. In act, once the PRC’s large trade surplus

with Hong Kong, China is excluded (which reects that economy’s role




fact,thePRC’simportssurgedby85%from$51.3billionto$94.8billion

rom January to July this year. Developing Asia and the rest o the world

stand to benet rom the PRC’s reinvigorated appetite or imports.

More direct evidence about the PRC’s role as a regional engine o

recovery rom the global crisis can be ound in data on trade between thePRC and East and Southeast Asia. Te PRC’s imports rom that group

fellfrom$49.9billioninJuly2008to$19.9billioninJanuary2009inline

withtheintensicationofthecrisisbeforereboundingto$37.4billionby

June 2009. PRC exports to East and Southeast Asia have also ollowed a

similar pattern o decline and recovery but, signicantly, the magnitude

o the recovery in the rst hal o 2009 was much more limited, rising

from$29.1billionto$35.0billion.

In this way, the PRC has been a signicant source o additional net

demand or the region in 2009. Te pattern o import revival is similar

in every grouping in Asiahigh-income East and Southeast Asia, other

East and Southeast Asia, and non-East and Southeast Asia. Te biggest

beneciary o the PRC’s renewed appetite or imports between January and June 2009 was high-income East and Southeast Asia, which saw

exportsrisefrom$9.9billionto$17.9billion.OtherEastandSoutheast

Asia and non-East and Southeast Asia experienced more modest gains

intheirexportstothePRC$3.5billionand$0.4billion,respectively

during the same period. Overall, Asian countries seem to have beneted

substantially rom the revival o PRC imports in the rst hal o 2009,

which can be viewed as evidence that the PRC is leading the region out o

the global crisis.

Overall, the analysis o the PRC’s trade patterns lends some support

to the PRC-as-engine hypothesis. In particular, the share o nal goods in

the PRC’s imports rom East and Southeast Asia has grown recently, and

the share o parts and components has correspondingly declined. Tissuggests that the PRC’s direct demand or imports is growing relative to

its demand derived rom nal demand in the industrial economies.

Toward a broader trade opennessTe empirical evidence suggests that the PRC is not yet an independent

source o demand and growth or East and Southeast Asia, but that it is

beginning to become one. Te VAR analysis indicates that, in the past,

the supercially positive impact o the PRC’s imports on its neighbors’

output largely reected the role o the PRC as an assembler o Asian parts

and components or exports to the US. While such intraregional trade

benets the region by allowing or specialization and division o labor,

it casts doubt on the PRC’s capacity to serve as an independent regional

engine o recovery in the short run and o growth in the long run.

Te analysis o more recent trade patterns between the PRC and its

neighbors, howeverin particular a secular shi in the composition

o the PRC’s imports rom parts and components toward nal goods

suggests that the PRC is becoming more o a consumer and less o an

assembler. Tis gives some hope that demand rom the PRC can help

oset the impact o extraregional shocks (such as the recent crisis) and

provide its neighbors with an additional independent source o growth.

Te rest o developing Asia could also benet rom greater

2.2.20 Global imports

0

50

100

150

200

250

AustraliaRep. of KoreaJapan

People's Rep. of ChinaEU-27 US

JulJan

09

JulJan

08

JulJan

07

JulJan

2006

$ billion








intraregional trade. Tis is especially true or South Asia where a large

and ast-growing Indian economy has the potential to li the entire

subregion to a higher plateau through more intraregional trade.

Te impact o the global economic slump on developing Asia’s

growth is partly a result o two structural imbalances: in regional trade(overdependence on a ew extraregional markets, especially the US);

and in aggregate demand (excessive dependence on external rather than

domestic demand). Te resolution o one imbalance is bound up with the

other. Te emergence o a stronger and dynamic sel-sustaining domestic

economy will acilitate the growth o a more substantive intraregional

trade based on nal goods.

Regional policy makers can speed up intraregional trade in nal

goods by removing barriers to trade and taking other measures such

as improving the transportation inrastructure. Te Greater Mekong

Subregion and Central Asia Regional Economic Cooperation are two

examples o regional cooperation programs that are creating a conducive

environment or intraregional trade.7

An even better strategy would be toliberalize trade with both intraregional and extraregional partners.

Whether the region continues to rely on an unreormed export-led

growth strategy that is predicated on ever-rising extraregional demand

or the region’s exports, or whether it moves toward a broader openness

that relies more on domestic demand and intraregional trade, matters

enormously or the welare o the region.

Following the old strategy implies doing nothing and waiting or

the US economy to ully regain its vitality, and points to a continued

vulnerability to the US business cycle. It also implies a decline in the

region’s long-term growth i the US appetite or imports shows a secular

decline.

Adjusting toward a broader openness implies the sel-enlightenedpursuit o a more balanced growth strategy that enables domestic demand

and intraregional trade to become more signicant sources o demand

and growth. Tis requires the removal o a wide range o deep-seated

structural distortions on domestic demand and intraregional trade.

Whether the region succeeds in its quest or a broader and more resilient

trade openness will have a big inuence on the success o its more

undamental quest or rapid yet stable growth.

Developing Asia is vulnerable to external shocks transmitted through

the nancial channel, as well as through international trade. On this

ront, too, there are ways to shield economies rom such external blows.



Managing nancial globalization

Te recent pullbacks o capital inows to developing Asia and sharp

currency uctuations in some o the region’s more nancially integrated

economies have brought renewed attention to the role and benets o

nancial globalization. Although the adverse eects through the nancial

channel have been slight in developing Asia compared with those seen

through the trade channel, nancial stress was clear. Its spillover eects

to domestic nancial markets, however, have been limited and, or the

most part, successully managed.

In order to draw out critical elements o

nancial openness, the analysis here categorizes all

developing economies into subgroups dened along

two dimensions (Box 2.3.1). Te rst dimensionhas a nancial globalization ocus: How well is the

economy integrated into international nancial

markets in terms o actual capital ows? Te second

dimension has a geographic ocus: Is the economy

in Asia?

Te main group o interest is developing Asia’s

highly integrated economies (Box 2.3.2). Tese

12 developing Asian economies have been the major

recipients o capital ows to the region. Over the

past two decades, nearly 90% o total regional capital

inows have been directed to them. In particular,

they have been the dominant players in receivingFDI inows, accounting or nearly 95% o the total.

In addition, these 12 economies account or the vast

majority o developing Asia’s GDP and oreign trade.

Drivers o capital fowsTe highly integrated developing Asian economies have successully

attracted considerable oreign capital, both short-term unds and longer-

term direct investment. However, year-to-year ows have uctuated

considerablyparticularly in response to nancial crises. Understanding

the drivers o capital ows will help governments manage them better.

Capital fows during crises

Inows and outows. In developing Asia, capital inows into the highly

integrated economies8 were interrupted in 2008 as the global nancial

crisis deepened, resulting in a net capital outow rom the region

(Figure 2.1.3 above). Portolio and other investment ows, including bank

loans, accounted or the decline, which was particularly notable in Hong

Kong, China; India; Korea; and aipei,China (Figure 2.3.1).

Nevertheless, total FDI inows into developing Asia’s highly

integrated economies increased in 2008, mainly because o the continued

high rates o oreign investment in the PRC, but at a declining pace

.. Twelve highly integrated

developing Asian economies

Cambodia; People’s Republic o China;

Hong Kong, China; India; Indonesia;Republic o Korea; Malaysia;Philippines; Singapore; aipei,China;Tailand; and Viet Nam.

.. Country groups

TotalHighly integrated Less integrated

Financial integration dimension

Asia

Non-Asia

Geographic dimension 33

111

12 21

32 79

Total

44 100 144

Note: Figures indicate the number o economies in each group in the largest sample.Actual sample sizes vary depending on data availability.




(Figure 2.3.2). Te slowdown o inward FDI continued in the rst quarter

o 2009especially in Korea; Philippines; Singapore; and aipei,China,

where electronics manuacturing and exports in general were hit hard.

Direct investment abroadoutowsin 2008 rose sharply rom the

group as a whole, dominated by investments made by the PRC. However,or those economies where contagion eects rom the global slowdown

were more pronounced, investment abroad eased. Tis continued into

the rst quarter o 2009. A similar pattern was also seen in cross-border

mergers and acquisitions.

Comparing the crises. When one compares the global nancial crisis

and the Asian crisis, one key similarity that emerges is that FDI (both

inows and outows) is more resilient to shocks than other orms o

capital ows. Portolio investment and bank loans saw sharper declines

than FDI during the two crises, as well as higher volatility. Such resilience

is shown by the coefcient o variation (the standard deviation divided

by the mean). Te coefcient o variation associated with FDI was by ar

lower than that or other orms o capital ows, especially during the twocrisis periods (Figure 2.3.3).

Yet several clear dierences between the two crises stand out. First,

the breadth o the eect across economies in the region has been much

wider in the recent global turmoil than in the 1997–98 crisis, though

countries that have been hit hardest by the global economic downturn

were also the most aected by nancial tightening. Te deteriorating

external nancing environment has halted much oreign investment, and

is also aecting cross-border mergers and acquisitions.

Second, the response o FDI ows is quite divergent. In the earlier

crisis, investors rom outside developing Asia swooped in to buy assets or

which prices had imploded, to the extent that FDI inows to the region as

a whole continued to increase.9 In contrast, in the latter crisis, developingAsia’s investors seized the opportunity to acquire cheap assets outside the

region. Tis increased outward investment can be seen or PRC, India,

and Tailand.

Tird, even though the collapse o capital ows rom the global

turmoil has been more widespread than during the Asian crisis, strong

nancial institutions have served to shield the region rom much o the

damage. With solid indicators or nonperorming loans, risk-weighted

capital adequacy, and ratio o loans to domestic deposits (Figures 1.3.1–1.3.3

in Part 1), nancial institutions have remained resilient to the recent

stress. Moreover, the region’s huge holdings o oreign reserves have

helped protect its exchange rates rom speculative attacks.

Finally, quick policy responses during the turmoil helped minimize

the adverse impact on the region’s economies. Many central banks

expanded local currency liquidity support, guaranteed nancial

institutions’ liabilities, and injected capital into some banks. Current

account surpluses, high sovereign ratings, and expanded deposit

insurance also acted as buers by supporting repatriation o capital

and by allowing domestic lending to substitute or external lending.

Moreover, central banks established dollar swap arrangements

bilaterally with the Federal Reserve as well as cooperative swap

arrangements within the region,10 which helped bolster condence in

local currencies.

2.3.2 Foreign direct investment fows

Q2 2009Q1 20092008

200307199799199096

0

50

100

150

HKGPRCHKGPRC

Inflows Outflows

$ billion

-15

0

15

30

45

THATAPSINPHIMALI ND I NO KOR

$ billionInflows

0

5

10

15

20

THATAPSINPHIMALIND INO KOR

$ billion

Outflows

PRC = People’s Rep. o China; HKG = Hong Kong, China;IND = India; INO = Indonesia; KOR = Rep. o Korea;

MAL = Malaysia; PHI = Philippines; SIN = Singapore;TAP = Taipei,China; THA = Thailand.

Sources: CEIC Data Company Ltd.; International MonetaryFund, International Financial Statistics online; bothdownloaded 1 September 2009.


2.3.1 Portolio and other investment infows

Q1 20092008

200307199799199096

-100

-50

0

50

100

TAPSINKORHKGPRC

$ billion

-20

0

20

40

THAPHIMALIND INO

$ billion

PRC = People’s Rep. o China; HKG = Hong Kong, China;IND = India; INO = Indonesia; KOR = Rep. o Korea;MAL = Malaysia; PHI = Philippines; SIN = Singapore;TAP = Taipei,China; THA = Thailand.

Sources: CEIC Data Company Ltd.; International MonetaryFund, International Financial Statistics online; bothdownloaded 1 September 2009.









2.3.3 Volatility o capital fows in selected

Asian economies

0

1

2

3

4

5

OutflowsInflows

CBACBACBACBA

Coefficient of variation

199096 200708200006199799

A = FDI; B = Portolio; C = Others.

Note: Coecient o variation is measured by dividing the

standard deviation by the mean.

Source: Authors’ estimates.


2.3.4 Responsiveness o capital fows to

G3 growth

0

3

6

9

Bank loans

(outflows)

Portfolio

outflows

Bank loans

(inflows)

Portfolio

inflows

Foreign

direct

investment

%

1.5

5.2

8.6

5.75.4

Note: The dependent variables are defated by GDP in the

corresponding economy.

Source: Authors’ estimates.


Some conclusions. Te trends mentioned above seem to underscore

the importance o the ollowing conditions in a country’s resilience to

volatile capital ows in a nancially globalized world: solid domestic

institutions, especially in the nancial sector; swi policy responses; and

a sound macroeconomic environment with adequate reserves.

External versus internal actors

o what extent are capital ows determined by global events and to

what extent do domestic policies matter? Both actors play a role, but

i external eventsthe global actorsdominate, policy makers can

do little to inuence the ows o oreign capital. However, i internal

conditionsthe country-specic actorsdrive capital ows, putting

sound macroeconomic policies in place has heightened importance. Te

recent collapse o capital inows to developing Asia raises the question o

the relative importance o external and internal actors or the region.

In the analysis,11 external actors are proxied by growth prospects

in the G3 economies as well as investment returns there. Te internalactors include growth prospects; labor costs; level o human capital

development; the business environment (including trade and nancial

openness); and adequacy o inrastructure in the highly integrated

developing Asian economies.

Foreign direct investment. An estimation was carried out or FDI

using bilateral data rom the UNCAD/ransnational Corporations

database or 1994–2007. Te sample comprises eight12 highly integrated

developing Asian economies and 61 other countries, both industrial and

developing.

In terms o attracting FDI inows, the estimation results show that

internal actors dominate. Yet external actors are still relevant. In the

estimation period, a 1% increase in real income o G3 economies ledto a 1.5% rise in FDI inows in the highly integrated developing Asian

economies (Figure 2.3.4), and this relationship held true even during the

Asian crisis period. FDI inows or this group come rom G3 economies

(around 30% o the total inows into the eight countries); rom developing

Asia (around 35%); and rom other countries, including oshore nancial

centers (the balance). Te importance o the international production

network reinorces the link between oreign investment returns and the

growth outlook o the G3 economies.

In terms o outward FDI, growth prospects o the FDI home country

(highly integrated developing Asian economies) generally play a key

role. Although G3 markets have become a more important investment

destination as investors rom the region acquire strategic assets,13 around

our hs o total outward investment is invested within developing Asia.

Over the past two decades, the PRC has emerged as a key destination or

many developing Asian economies’ FDI, mainly because o its relatively

low labor costs. Cambodia and Viet Nam have also emerged as new

destinations or the same reason. Te important consequence is that the

relatively small proportion o strategic asset–augmenting investment

results in a limited role or the G3 economies as a destination or

developing Asia’s FDI.

Other orms o capital ows. Balance-o-payments data or the capital

and nancial account (specically portolio investment and bank loans)








were analyzed or the highly integrated developing Asian economies14

during 1990–2008. Te growth prospects in the G3 economies and key

regional trading partners are clearly separate in the estimation model.

Te model also includes the internal actors mentioned earlier.

In contrast to FDI, the estimation results show that G3 economies’growth prospects signicantly inuence movements o portolio inows

and bank loans. A 1% increase in G3 GDP leads to a 5.7% rise in bank

loan inows and a 5.4% increase in portolio inows. Te relationship

is stable beore and aer the Asian crisis. An increasing number o

institutional investors, including insurance companies, pension unds,

and hedge unds rom the major industrial economies, ensure that

the economic prospects o these economies aect portolio and bank

inows. O the internal actors, the country’s growth prospects, nancial

openness, the investment–saving situation, and risks and returns on

investment are also important in aecting portolio investment and bank

loans, although the coefcients corresponding to these variables tend to

be lower than those or G3 GDP growth prospects.As regards outows, a 1% increase in G3 GDP stimulates portolio and

bank loan outows by 8.6% and 5.2%, respectively. Economic prospects

o the home country as well as government policy, especially on nancial

liberalization, are also crucial.

Some conclusions. Te results show that external actorsgrowth

prospects in the G3 economiesare generally still crucial in determining

movements o short-term capital inows (portolio investment and

bank loans) into developing Asia but their impacts on long-term capital

(FDI) are relatively limitedas seen in the recent nancial crisis. Te

importance o such external actors may suggest that global and regional

policy eorts could become more important or developing Asia to

reap the benets o nancial globalization. Nevertheless, the estimationresults point to the importance o internal actors, especially or longer-

term capital, suggesting that country-specic actors are still crucial or

attracting such capital ows.

Policy considerations or managing fnancial

globalization

Establishing a governing ramework that would allow greater nancial

openness cannot be made independently rom other macroeconomic

policy objectives. Te extent o capital account openness needs to be

considered in light o the government’s objectives or exchange rate

and monetary policy. Tis interdependencethe so-called policy

“trilemma”sets up an inherent trade-o among policy choices. Te

policy choices that authorities make among the three elements also have

implications or exchange rate management.

The policy trilemma

Te idea o the trilemma posits that a country cannot have independent

monetary policy, maintain a xed exchange rate regime, and

simultaneously remain open to oreign capital ows (Figure 2.3.5). I

policy makers opt or xed exchange rates and nancial openness,

2.3.5 The “trilemma”

E x c h

a n g e r a t e

s t a b i l i t y

Mon

etary

inde

pend

ence

Closed financial markets and

pegged exchange rate e.g.,

Bretton Woods system

Capital account openness

Monetary union or

currency board,

e.g., euro system

Floating

exchangerate





monetary policy must be sacriced to maintain the peg. A nancially

open economy can pursue independent monetary policy, but the

exchange rate will have to bear the brunt o adjustment. And

independent monetary policy can only be pursued under a xed

exchange rate regime i the country erects barriers to insulate itsel romoreign capital markets.

Policy choices are rarely absolute. For example, central banks that

actively manage money supply to achieve ination objectives may

occasionally intervene in oreign exchange markets to manage the level o

the exchange rateessentially shiing between two sides o the triangle.

Tere are two approaches to measuring a country’s openness to

nancial globalization. One approach looks at actual cross-border

nancial movements, which were the main criteria used to identiy the

highly integrated economies in this analysis. Tis “de acto” approach

looks at the quantity o oreign capital ows as well as the accumulation

o external assets and liabilities. Te other approach considers the

country’s policy ramework governing cross-border capital owsinits essence. Tis “de jure” approach relies on an analysis o the capital

account restrictions in place.

Te two measures can give divergent views o a country’s openness

to nancial globalization. De acto openness indicators can uctuate due

to price and exchange rate changes, while de jure openness indicators

do not reect the degree o enorcement o the legal ramework. With its

ocus on policy, the trilemma discussion below is anchored in the de jure

approach.

Tree trilemma indexes are constructed to illustrate the extent to

which each policy is used in developing Asia (Aizenman et al. 2008).

Te monetary independence index considers how closely a country’s

interest rates are correlated with a base country, that is, the country or which its monetary policy is most closely linked. Te exchange rate

stability index uses annual standard deviations o monthly exchange

rates between the country’s currency and that o the base country.

Finally, the capital account openness index is a composite measure

encompassing the presence o multiple exchange rates, restrictions on

current account transactions, restrictions on capital account transactions,

and requirements to surrender export proceeds (Chinn and Ito 2008). All

indexes range between 0 and 1, and higher values indicate greater use o a

particular policy.

For highly integrated developing Asian economies, all three policies

are pursued to a certain degree. Aer the late 1980s, convergence o

these three indexes illustrates that progress in opening up the capital

account went hand in hand with exchange rate stability and more

monetary independence (Figure 2.3.6). In the immediate aermath o

the Asian nancial crisis, monetary independence was sacriced in avor

o greater exchange rate stability. Tis shi in emphasis rom monetary

independence continued well aer the economies had recovered, with the

policies again converging in recent years.

Given that these highly integrated developing Asian economies take

the middle ground, combining these policies is crucial, since each o

them has merits and demerits. Monetary independence allows monetary

authorities to have autonomy over macroeconomic management,

2.3.6 Capital account openness, exchange

rate stability, and monetary independence

Monetary independence

Exchange rate stability

Capital account openness

0.2

0.4

0.6

0.8

1.0

0805200095908580751970

Index

Highly integrated developing Asian economies

Index

Less integrated developing Asian economies

0.0

0.2

0.4

0.6

0.8

1.0

0805200095908580751970

Source: H. Ito, J. Jongwanich, and A. Terada-Hagiwara.Forthcoming. “What Makes Developing Asia Resilient ina Financially Globalized World?” ADB Economics WorkingPaper Series. Asian Development Bank, Manila.







potentially leading to sustainable economic growth. Exchange rate

stability can lead to price stability by providing an anchor, and lessen risk

premiums by mitigating uncertainty, thereby ostering investment and

international trade. However, greater levels o exchange rate exibility

could allow policy makers to use the exchange rate as a tool to absorbexternal shocks (Prasad 2008).

Financial liberalization is probably the most contentious policy among

the three in having clear benets or goals. Teory predicts that more open

nancial markets should lead to economic growth, and that economies

with greater nancial openness should be able to stabilize themselves

through risk sharing and portolio diversication. However, as nancial

liberalization increased its pace over the last two decades, nancial

openness was blamed or economic instability, particularly during crises.

Financial globalization and output volatility

How does nancial globalization aect macroeconomic stability? On

the ace o it, there seems to be a positive relationship (Figure 2.3.7).Te industrial economies and the highly integrated developing Asian

economies have had much less volatile output than the rest o the world

in the last 35 years. Volatility clearly jumps or the highly integrated Asian

economies during the 1997–98 crisis, and yet the recent global nancial

crisis, with the drying up o liquidity in oreign capital markets, did not

translate into a nancial crisis within the region. Tis suggests a complex

underlying relationship between nancial globalization and stability.

Moreover, nancial openness must be considered in tandem with

the other policy elements o the trilemma: monetary independence and

exchange rate stability. Regression estimates show the eect that the

various pairwise combinations o the trilemma policies have on output

volatility (able 2.3.1).15 Te model controls or other macroeconomicvariables. Actual capital inows (the de acto measures) are also included

to test or the impacts on output stability. Estimates or two dierent

country samplesall developing countries and highly integrated

countries onlyhighlight the dierent way that the nancial openness–

output volatility link operates in the economies that receive most o the

global capital ows rom the developing world.

Te estimates or all developing economies show that greater de jure

openness tends to be associated with lower output volatility. Exchange

rate stability by itsel is ound to have a destabilizing eect on output

stability, that is, a statistically positive coefcient corresponding to

exchange rate stability is revealed. However, the interaction term o this

variable with oreign reserves is ound to have a statistically negative

eect, suggesting that countries can mitigate the destabilizing eect o

pursuing greater exchange rate stability i they hold levels o oreign

reserves o about 20% o GDP.

In terms o composition o capital ows, which are accounted or

by the de acto variables, bank lending (part o other capital ows) and

net portolio investment have a statistically negative impact on output

volatility. In other words, increases in net “other” capital inows or net

portolio inows destabilize output, reecting the “hot money” argument

regarding cross-border bank lending and portolio investment. FDI ows

do not necessarily destabilize the economy, though stabilizing eects do

2.3.7 Output volatility by region

0.00

0.02

0.04

0.06

0.08

Non-Asian developing economies



Industrial countries

200206

19972001

199296

198791

198286

197781

197276

5-year standard deviation

of per capita output growth

Note: Output volatility is measured by 5-year standarddeviation o per capita output growth.

Sources: Alan Heston, Robert Summers, and Bettina Aten,Penn World Table Version 6.2, Center or International

Comparisons o Production, Income and Prices at theUniversity o Pennsylvania, S eptember 2006; authors’calculations.







.. Explaining output volatility with trilemma variables

Developing economies Highly integrated developing economies

Output volatility Output volatility

() () () () () ()

Currency crisis . . . . . .[.]* [.]* [.]* [.] [.]** [.]

Private credit creation -. -. -. . -. .

[.] [.] [.] [.] [.] [.]

Total reserves (as o GDP) . -. . . -. .

[.] [.] [.]* [.] [.] [.]***

Monetary independence (MI) -. -. -. -.

[.] [.]** [.] [.]**

MI x reserves . . . .

[.] [.] [.] [.]

Exchange rate stability (ERS) . . . .

[.] [.]* [.]** [.]***

ERS x reserves -. -. -. -.

[.]* [.]** [.]** [.]***

Capital Account Openness (KAOPEN) -. -. -. -.

[.]** [.]* [.] [.]

KAOPEN x reserves . . . .

[.]* [.] [.] [.]

Net FDI infows/GDP . . . -. -. -.

[.] [.] [.] [.] [.] [.]

Net portolio infows/GDP . . . -. -. -.

[.]** [.]** [.]** [.] [.] [.]

Net ‘other’ infows/GDP . . . . . .

[.]** [.]** [.]** [.] [.] [.]

Short-term debt -. -. -. -. -. -.

(as o total external debt) [.] [.] [.] [.] [.] [.]

Total debt service . . . . . .

(as o GNI) [.]* [.]** [.]** [.] [.] [.]

Observations

Adjusted R-squared . . . . . .

ERS = exchange rate stability; FDI = oreign direct investment; GDP = gross domestic product; GNI = gross national income; KAOPEN = capital account openness;

MI = monetary independence.

Note: Robust regressions are implemented on combinations o trilemma variables dened as: (1) MI and ERS, (2) MI and KAOPEN, (3) ERS and KAOPEN; * signicant at

10%; ** signicant at 5%; *** signicant at 1%.

Source: H. Ito, J. Jongwanich, and A. Terada-Hagiwara. Forthcoming. “What Makes Developing Asia Resilient in a Financially Globalized World?” ADB Economics

Working Paper Series. Asian Development Bank, Manila.

not seem to be signicant either. However, this eect is not present when

the sample o highly integrated economies is considered.

Role o domestic nancial markets

One hypothesis suggests that a country needs to have certain minimum

conditions in place to reap the benets o nancial globalization. In

particular, Kose et al. (2009) nd that the structure o the domestic

nancial sector matters greatly in harnessing the benets o nancial

globalization. A country needs to pass a threshold level o nancial

institutional development beore it can derive the indirect benets

and reduce the risks o volatile ows. Mendoza et al. (2007) also nd

that countries with less developed nancial markets may experience




welare losses by liberalizing capital markets unless the liberalization is

accompanied by other benets such as the transer o technology, speedier

nancial market development, and risk sharing, which take time to be

realized. Tis evidence is supported by Kim et al. (2008) and Fujiki and

erada-Hagiwara (2007), particularly on the issue o risk-sharing benetssuch as consumption smoothing, o which very little has been seen in

developing countries.

o test this hypothesis, indicators o domestic nancial market

development were incorporated into the model. Among highly integrated

economies, lower levels o nancial market development were associated

with higher volatility when capital account openness was pursued.

Tis result held whether this openness was paired with monetary

independence or exchange rate stability in the regression analyses.

A similar exercise was conducted using de acto measures or three

dierent components o capital ows. Te results generally support the

main ndings previously discussed: an underdeveloped nancial market

combined with a more open capital account tends to destabilize theeconomy.

Tese results indicate that highly integrated developing economies

need to be equipped with deep credit markets i they want to see the

benets o nancial liberalization on their output volatility. Having a

higher level o capital account openness and a deep credit market can

yield a synergistic impact to damp output volatility, presumably by

acilitating allocation o capital and ameliorating inormation asymmetry,

thereby reducing the cost o capital. Te worst and more signicant

case is that a country with shallow credit markets can exacerbate output

volatility caused by nancial liberalization.

Where do developing Asia’s economies stand in terms o nancial

development? Figure 2.3.8 compares the level o nancial development,measured by dierent aspects o the nancial markets, across dierent

groups o economies. In the banking sector or stock markets, the

nancial development o the highly integrated developing Asian

economies is quite comparable to that in industrial economies, but among

less integrated Asian countries it lags behind. Tis implies that the highly

integrated developing Asian economies could liberalize their nancial

markets and reap the benets, especially in terms o reducing output

volatility, while gains rom opening up the nancial market or the less

integrated developing Asian economies could be limited.

Yet the picture is completely dierent in terms o bond markets.

Underdevelopment o bond markets is ound in both highly and less

integrated economies in developing Asia. Clearly, in both private and

public bond markets, there is still room or developing Asia’s economies

to catch up with industrial economies.

Managing oreign reservesProgress in nancial globalization has maniested itsel on the asset

side o developing Asia in the past several years as accumulated oreign

reserves. Te region’s reserves are held primarily in the orm o assets

denominated in US dollars; the US dollar has been the dominant reserve

currency in the region. Tis section revisits how oreign reserves have so

2.3.8 Measuring nancial development

Non-Asian developing economies



Industrial countries

0.0

0.5

1.0

1.5

2002−06

1997−2001

1992−96

1987−91

1982−86

1977−81

1972−76

Private credit creation

% of GDP

0.0

0.5

1.0

1.5

2002−06

1997−2001

1992−96

1987−91

1982−86

1977−81

1972−76

Stock market capitalization

% of GDP

0.0

0.5

1.0

1.5

2002−06

1997−2001

1992−96

1987−91

1982−86

1977−81

1972−76

% of GDP

Private bond market capitalization

Source: H. Ito, J. Jongwanich, and A. Terada-Hagiwara.Forthcoming. “What Makes Developing Asia Resilient ina Financially Globalized World?” ADB Economics WorkingPaper Series. Asian Development Bank, Manila.







ar been managed, and reviews underlying issues in improving the way

they are used.

Obsteld et al. (2008) argue that reserves accumulation is a key tool

or dealing with domestic nancial instability as well as exchange rate

variability under a managed oating plus policy regime. In other words,a primary reason or a central bank to hold reserves is to protect the

domestic banking sector, and domestic credit markets more broadly,

while limiting external currency depreciation.

Te same paper also points out that the need or such protection

is much greater in countries with a ragile nancial system and a

currency mismatch. As most developing countries are orced to hold

external liabilities in oreign currencies, the currency mismatch problem

o external assets and liabilities is more serious than in industrial

economies. With underdeveloped local currency bond markets,

developing Asia is no exception.

One measure o reserves adequacy is the ratio o reserves to broad

money (Figure 2.3.9). By this criterion, the picture is still mixed withmost economies having less ull coverage. Yet other traditional measures

o reserves adequacyshort-term debt cover and import covershow

that developing Asia now has high levels o oreign exchange reserves

(Figure 2.3.10).

While the high level o reserves was crucial to cushion against

external shocks during the recent nancial crisis, carrying excessive

reserves entails costs due to its poor management (Bird and Rajan 2003).

Regional central banks have made eorts to reduce the need or

holding excessive oreign reserves. In particular, extensive banking

sector reorms, with strict enorcement o regulation and supervision,

have proven to be a crucial actor to shield against the volatile ows

seen over the last year or so. Meanwhile, development o local currency–denominated bond markets has been promoted, mainly to mitigate the

risk o currency mismatch.

Recent approaches

In developing Asia, a combination o a strong current account surplus

and (to a lesser extent) capital inows has resulted in a large expansion

in oreign reserves holdings. In reserves management, holdings can

be categorized into two portionsone that prioritizes liquidity or

precautionary needs, and one that ocuses on earning returns over a

medium- to long-term investment horizon in less liquid markets.

In act, most economies in highly integrated developing Asia already

meet the adequacy criteria suggested by conventional measures in terms

o precautionary needs. Tese indicators include whether a country has

sufcient liquid oreign exchange reserves to cover oreign currency debts

payable within 1 year and whether reserves are sufcient in relation to

import needs.

For the portion o reserves held or precautionary needs, holding

highly liquid assets is appropriate. For this reason, the practice has been

to hold US securities (such as dollars and reasury securities) as these

markets are the most liquid. In 2008, US dollar assets made up 64% o

world reserves, although there has been some shi toward more diverse

holdings. While the country breakdown o the currency denomination

2.3.9 Reserves adequacy, broad money

cover, end-2008

0 22 44 66 88 110

Pakistan

BangladeshRep. of Korea

Hong Kong, China

Indonesia


Taipei,China

Mongolia

Malaysia

Thailand

Philippines

Singapore

India

% of M2



2.3.10 Reserves adequacy, short-term debt

and import cover, end-2008

0

5

10

15

20

25

0

5

10

15

20

25

Import coverShort-term debt cover

PRC TAPIND KOR

HKG SIN THAMAL

PHI

% of short-term debt Months of imports

INO

PRC = People’s Rep. o China; HKG = Hong Kong, China;IND = India; INO = Indonesia; KOR = Rep. o Korea;MAL = Malaysia; PHI = Philippines; SIN = Singapore;TAP = Taipei,China; THA = Thailand.

Source: CEIC Data Company Ltd., downloaded 25 August

2009.









o oreign reserves is not available, the share o US reasury security

holdings as a share o total reserves does indicate that developing Asia’s

reserves are largely in dollar-denominated assets. Tis level is more than

what is warranted by precautionary needs. Consequently, either liquidity

considerations are overemphasized in the region or alternative nancialinstruments are not available.

For the portion where liquidity considerations are less important,

any asset class consistent with their risk and return objectives are

potentially appropriate. Tis portion might be managed on the balance

sheet o the monetary authority or through a separate entity, such as a

sovereign wealth und. Such unds have been set up as a natural reaction

to increasing concerns over returns orgone when central banks keep

their oreign reserves in sae and liquid but low-yielding assets. Except

or Singapore and Hong Kong, China, where sovereign wealth unds have

established histories, most o the unds in the region have been created in

the last decade, the period that coincides with the rapid accumulation o

oreign reserves in these economies (able 2.3.2). Assets o these unds aretranserred rom oreign reserves with the aim o making more strategic

longer-term investments and o securing higher returns. However, the

role and portolio size o such sovereign wealth unds have been limited

so ar.

Te bulk o developing Asia’s reserves thereore appear to be managed

very conservatively. Given the current medium- to long-term concerns

over the US scal position, this is beginning to worry policy makers. How

might reserves be more efciently managed?

Issues or better reserves management

Demand or US reasuries rom developing Asia remains strong

(Figure 2.3.11). Especially in view o the devastation o the Asian crisis,this conservative stance makes sense because the US dollar remains

the centerpiece o any reserves management policy in which liquidity

is a principal determinant. But with the worrisome US scal outlook,

i liquidity is gained at the expense both o possible overexposure to a

.. Sovereign wealth unds in developing Asia

Economy Name o und Year o

inception

Singapore Temasek Holdings

Singapore Gover nment o Singapore Investment Corporation

Brunei Darussalam Brunei Investment Agency Malaysia Khazanah Nasional Bhd.

Hong Kong, China Investment Portolio (Hong Kong Monetary Authority)

Azerbaijan State Oil Fund

Kazakhstan National Oil Fund

Taipei,China National Stabilization Fund

Korea, Rep. o Korea Investment Corporation

Timor-Leste Petroleum Fund

Uzbekistan Fund or Reconstruction and Development

China, People’s Rep. o China Investment Corporation

Source: Donghyun Park. 2007. “Beyond Liquidity: New Uses or Developing Asia’s Foreign Exchange

Reserves”. ADB Economics Working Paper Series No. 109. Asian Development Bank, Manila.




potentially depreciating dollar and o reduced reserves diversication, the

advantage o the stance becomes less clear cut.

Indeed, current debates reect these concerns, and the global

nancial crisis has created incentives or central banks to reshape reserves

management. For example, some analysts advocate greater use o specialdrawing rights to promote greater diversication.

One major mechanism or the region to manage its reserves more

efciently is regional reserves pooling. In particular, multilateralization

o the Chiang Mai Initiative (CMI) is designed to create a single

regional reserves pool among CMI members, that is, ASEAN+3.

CMI multilateralization received a big boost in May 2009 when CMI

members reached agreement on the size o the pool, respective member

contributions, borrowing conditions, surveillance mechanism, and other

key details. Te agreement will be implemented beore the end o this

year.Givenitssubstantialsizeat$120billion,theregionalreservespool

may help discourage CMI members rom building up excess reserves.

Asian local currency bond markets could also play a bigger role i central banks insisted less on liquidity, particularly or their medium- to

long-term investments. Tere are eorts in train to help develop Asia’s

bond markets, or example the Asian Bond Market Initiative under the

aegis o ASEAN+3 and the Asian Development Bank, as well the Asian

Bond Fund initiative under the EMEAP (Executives’ Meeting o East

Asia and Pacic Central Banks group, an organization or central banks

in the region).

Nonetheless, the limited size o the region’s local currency bond

markets is preventing intraregional trade in nancial assets rom

becoming more comparable to extraregional trade. Te share o portolio

investments to neighboring countries more than doubled rom 2000 to

2007, but only to 13% o total investments (Figure 2.3.12). Several practicalimplementation issues remain, which include the difculty o access to

markets such as the PRC, and the difculty o reserves reallocation to

increase Asian bond exposure.

Further development o local currency bond markets, both in size

and accessibility, is crucial or three main reasons. First, it would provide

additional nancial instruments to diversiy risks. Second, it would help

reduce the risk o currency mismatch by allowing countries to issue

debts in their own currency, which in turn would reduce the need to

accumulate excess oreign reserves. Tird, it would generate additional

nancial channels that would oster Asian intermediation o its savings,

and make Asia more attractive to outsiders.

Concluding remarks and policy implicationsDeveloping Asia is now a very dierent economic entity in terms o

nancial ows rom what it was little more than a decade ago. Tis is

seen clearly in the dierent eects o the Asian nancial crisis o 1997–98

and the recent global nancial crisis and slump. Inward FDI, or example,

declined in the recent turmoil but increased in the earlier period as

non-Asian investors took advantage o “re-sale” assets in the region. Te

boot may now be on the other oot: cheap assets worldwide present an

2.3.11 Change in US Treasury holdings,

August 2008 to June 2009

-40 -20 0 20 40 60 80 100

Rep. of Korea

Philippines

Thailand

Malaysia

Taipei,China

Singapore


Hong Kong, China

India

Foreign official 18.0

%

-13.8

-5.7

-2.3

15.8

16.3

27.9

35.3

51.7

94.6

Note: Foreign ocial pertains to holdings o US Treasuriesby oreign ocials and institutions.

Sources: Treasury International Capital System, available:

http://www.treas.gov/tic/mh.txt, downloaded 31 August2009; authors’ calculations.


2.3.12 Intraregional portolio investments

0.0

0.2

0.4

0.6

20072001

THASIN

PHIPAK

MALKOR

KAZJAP

INOIND

HKG

% of total portfolio investments

HKG = Hong Kong, China; IND = India; INO = Indonesia;JAP = Japan; KAZ = Kazakhstan; KOR = Rep. o Korea;MAL = Malaysia; PAK = Pakistan; PHI = Philippines;SIN = Singapore; THA = Thailand.

Source: International Monetary Fund, Coordinated PortolioInvestment Survey data, available: http://www.im.org,

downloaded 31 August 2009.Click here or fgure data








opportunity or Asian economies to undertake outward FDI, and some

Asian countries seem to be seizing it.

Despite the steeper collapse o capital inows than during the Asian

crisis, strong economic undamentals in developing Asia, especially

among its nancial institutions, helped its economies successully managemost o the adverse eects. Greater exchange rate exibility and huge

oreign reserves played a major role, as did quick policy responses.

Gaining access to external nancing by opening up the capital

market can be benecial i it is advanced in a cautious manner, and

i it moves hand in hand with the development o domestic nancial

markets. However, bond market development, in particular, has been

playing only a limited role so ar. Better management o oreign reserves

requires urther development o local currency bond markets both in

size and terms o accessibility. Such a move is crucial or three main

reasons: it would provide additional nancial instruments to diversiy

risks; it would help reduce the risk o currency mismatch; and it would

create a pool o unds and additional nancial channels to nanceinvestments in the region.



Maximizing the benets o

labor fows

IntroductionDeveloping Asia is a major provider o oreign workers and beneciary o

remittances. Te region received more remittances than any other part

o the world in 2008, and remittance ows to the region have become an

increasingly important source o oreign exchange. According to ofcial

estimates, international remittances to developing Asia multiplied about

18timesinatwo-decadespanfrom$9.3billionin1988(about1%of

regionalGDP)to$162billionin2008(about2%ofGDP).Partofthisincrease reects greater use o ofcial channels to remit unds and the

improved ability o central banks to record these ows.

Te region has evolved into both a source o, and a host to, migrant

workers. Recent trends reveal that Asian migrants are no longer

restricting themselves to industrial-country jobs, and intra-Asian

migration has become more pronounced (ADB 2008).

As with cross-border ows o goods and capital, the allout rom

the global economic turmoil has undermined international migration.

Declining employment in the major industrial economies, the Middle

East, and the Russian Federation is tempering the demand or migrant

workers rom developing Asia. Unskilled and semiskilled workers in

highly cyclical sectors such as construction, nance, manuacturing,retail, and tourism are being hit particularly hard.

Te global recession is slowing remittance ows to the developing

world. Remittances to all developing countries grew by only an estimated

15% in 2008, compared with 25% in 2007 and 15% on average annually in

the decade beore that. Te World Bank orecasts a decline o 7–10% in

remittances in 2009 (Ratha et al. 2009).

Developing Asia has not been immune to the slowdown in

remittances since the onset o the tumult, and the deceleration is

aecting most subregions (Figure 2.4.1). Countries in Central, South, and

Southeast Asiawhere remittances contribute substantially to economic

activityare particularly exposed. Yet developing Asia has not suered as

severely rom decelerating international labor migration and remittance

ows as it has rom the collapse in trade and the slowing o nancial

ows. But there has been a decline in the new deployment o migrants

rom most Asian countries, a act that may undermine remittance growth

in the near term.

Te recession has lied international migration high on the agenda o

governments in host countries, which are trying to protect employment

opportunities or their own nationals. In this environment, migrant

workers are acing increasing discrimination and rising hostility, since

they are seen as depriving local workers o jobs. Teir problems are

compounded by the tightening o immigration rules in some host

2.4.1 Annual growth in remittances

-15

0

15

30

45

60

PacificSoutheast Asia

South AsiaEast AsiaCentral Asia

0807062005

%

Note: Pacic excludes Cook Islands, Nauru, and Tuvalu.

Source: World Bank, Migration and Remittance data,July 2009, available: w ww.worldbank.org, downloaded31 August 2009.







countries in response to increasing unemployment due to the economic

slump. Some countries have restricted immigrants’ access to the labor

market (by, or example, cutting the numbers o migrant work permits),

while others are oering incentives or unemployed migrants to return

home (such as paying the cost o a return ight). Te restrictions arebeing imposed by host countries both outside and inside the region

(Fix et al. 2009).

Tese restrictions limit opportunities or developing Asia to benet

rom increased labor mobility and the deepening integration o labor

markets. Worsened economic conditions back home and the nancial

and social costs o returning may orce many migrants to stay in host

countries. While remitters are employing various strategies to cope with

the recession, such measures will be ineective against an extended

period o poor employment opportunities. Te uncertain conditions o

migrants are adversely aecting their amilies that rely on remittances.

Slowing remittance ows may both drag down economic growth in

countries that benet heavily rom remittances and raise the risk o greater poverty.

Remittances as an engine o growth and

poverty reduction?

As a source o nancial capital in poor regions, earnings sent home

by migrants can avorably aect the receiving country’s growth

prospects. Remittances have been shown to oster economic growth by

spurring entrepreneurial activity, improving labor productivity, and

stimulating consumption and investment. Such receipts also help smooth

consumption and promote human capital development by increasingthe capacity o households to spend on education, health, and nutrition.

Furthermore, i they raise incomes o poorer households, these ows may

well reduce poverty and income inequality.

Using data rom 29 developing Asian economies or the period

1998–2007, Vargas-Silva et al. (orthcoming) examine the link between

remittances and growth as well as the link between remittances and

poverty. Te results indicate that a 1% increase in the ratio o remittances

to GDP leads to about 0.03% increase in the per capita GDP growth rate

(Figure 2.4.2).16

Further analysis o the data or developing Asia showed signicant

poverty-reducing benets o remittances, in terms o decreasing the

poverty gap (the income by which amilies all short o the poverty line,

expressed as a percentage o the poverty line). For example, a 1% increase

in remittances as a share o GDP decreases the poverty gap in developing

Asian economies by about 0.05%.17

Analysis o household survey data in Bangladesh, Philippines, and

Pakistanthree Asian economies that rely heavily on remittances

support the cross-country regression ndings (Ahmed et al. 2009; Ang

et al. 2009; Raihan et al. 2009). Te three country studies consistently

revealed positive eects o international remittances on household

income, consumption, investment, and poverty reduction. However, the

studies also showed that the poorest o the poor households (the bottom

2.4.2 Eect o remittances on growth and

poverty

-0.08

-0.04

0.00

0.04

Random

effects

Fixed

effects

Random

effects

Fixed

effects

%

0.03

-0.04-0.07

0.02

GDP growth Pover ty gap

Notes: Growth reers to the annual GDP per capita growthrate (%). The poverty gap is calculated at the $1.25 perday poverty line, purchasing power parity (% o povertyline). The elasticities are taken with respect to theremittance-to-GDP ratio, evaluated at the mean.

Source: C. Vargas-Silva, S. Jha, and G. Sugiyarto.Forthcoming. “Remittances in Asia: Implications or theFight against Poverty and the Pursuit o Economic Growth.”

ADB Economics Working Paper Series. Asian DevelopmentBank, Manila.







20%) benet least rom remittances. Tis stems rom such actors as the

relatively high cost o migration and the specic requirements or migrant

workers (or example, the need or host-country language competency or

required job skills).

In light o the slower growth in remittance ows, the links discussedabove suggest that poor households are more likely to remain mired in

poverty as a result o the recent global downturn. Moving on rom a

household perspective, what is the impact o remittances on economies

more widely, especially in terms o smoothing out shocks?

Remittances as a source o stability in oreign

currency infows?

Recorded remittances are in general less volatile than other nontrade

oreign currency inows, and oen shore up macroeconomic stability

(Figure 2.1.4 above). Te three country studies show that remittancesoster macroeconomic stability by supporting domestic demand.

Migrants’ remittances have been particularly responsive to major

crises in their home countries. For instance, Sri Lanka reported a

substantial increase in migrant transers ollowing the 2004 tsunami. Tis

jump occurred despite poorly unctioning nancial channels at the time

(as many important money transer agencies and banks were closed or a

long period in some areas because o the tsunami). Remittances played a

similarly supportive role aer the 2005 earthquake in northern Pakistan.

Similarly, remittances to the Philippines generally respond to rainall-

related shocks or disasters.

Remittances are by ar the most stable source o private oreign

currency receipts. From 1990 to 2008, the coefcient o variation o remittance ows to developing countries was 0.77 as against 0.80 or

oreign direct investment, 1.34 or private debt, and 1.17 or portolio

equity ows (lower values indicating more stable ows).18

Te stability o remittance ows can counter the eects o alling FDI,

debt, and equity ows during an economic downturn in the recipient

country. Figure 2.4.3 compares remittances with other private capital

ows in the Philippines. Te relative stability o remittance ows stands

out in the gure, even when the global turmoil began in earnest.

While remittances are less volatile than other ows, can the stronger

claim be made that they can help smooth oreign currency ows over

the business cycle? Here, the evidence is mixed. Studies such as Chami

et al. (2005) nd strong evidence in cross-country data that remittances

are countercyclical.19 However, the behavior o remittances depends

partly on the motives or remitting. For example, Lueth and Ruiz-Arranz

(2007) nd that remittances in Sri Lanka are procyclical, increasing when

economic activity in the home country accelerates.

Te recent global turmoil has led to a synchronous recession o the

major industrial economies, which has led to a slowing in growth in

most economies in the world. In such extreme circumstances, it is not

surprising that remittances, too, have suered. As with employment

generally, the eect o the global downturn on remittances may be most

severe aer a lag. For example, remittances to ajikistan, the world’s

2.4.3 Recent trends in remittances and

other private fows, Philippines

-800

0

800

1,600

2,400

Foreign portfolio inflows

Foreign direct investment

Remittances

AprJan

09

OctJulAprJan

08

OctJulAprJan

2007

$ million

Note: The oreign direct investment series representsnonresidents’ investments in the Philippines, as taken romthe balance o payments.








largest recipient in terms o GDP, are projected to all by 35% in 2009,

equivalent to a huge 15% o GDP. In contrast, Bangladesh, Philippines,

and Pakistan experienced sudden spurts in remittance receipts in

mid-2009. However, this may reect repatriation o the savings o

returning migrants. I this turns out to be the case, this upward blip may be a harbinger o slower growth o remittances in the near uture as their

source shrinks.

During the past two decades, the only noticeable period o sluggish

growth in remittances was during the aermath o the 1997–98 Asian

nancial crisis. Nonetheless, they were quick to recover and returned

to their long-term growth path in a year. Since 1997, there has not been

a single year in which aggregate remittances to the region decreased

in comparison with the previous year. While there may be a drop

in the immigrant population in industrial economies due to return

migration (as a result o lack o good employment opportunities there),

these migrants are likely to return to the host country once the global

economy stabilizes (Papademitrou and errazas 2009; Fix et al. 2009).Estimates o the impact o the crisis on remittances (or example, Ratha

and Mohapatra 2009; Calì and Dell’Erba 2009) point to a airly ast

resurgence o these ows.

Overall, although migrants are being aected by the global downturn,

remittances have held up so ar. Even i migration ows were to stop at

some point, remittances would continue to ow or many years, though

their growth would likely stagnate (Funkhouser 1995). Based on past

crises, growth in remittances is likely to bounce back quickly during the

ensuing recovery.

Maximizing the benets o labor fowsEconomic migration has become an increasingly important element

o the global landscape, and Asian countries are well known net

exporters o labor. In act, the six main emigration countries in the

region have over 100 million o their citizens living abroad. Moreover,

remittances are a more stable source o oreign currency than many

other nontrade sources.

In this light, developing Asia’s governments should maximize the

benets o labor ows by ensuring that the migration channel is kept

open, by enhancing the saety and security o unds transers to home

countries (through strengthening ormal transer systems), and by

providing an environment that encourages households to create assets

through investing more o their remittance income.

Keeping open the migration channel

Te global turmoil has led to rising unemployment in host countries,

which are now showing increasing preerence or employing their own

nationals. Tese countries are also discriminating against oreign workers,

who in some places are suering rom tighter immigration rules. Some

migrants will see out the current downturn in their host country without

a proper job, while those migrants who have already returned home are

likely to go back once the global economy stabilizes. Until then, what can

developing countries do to make the most o migration’s benets?




One o the reasons or the relatively quick recovery o remittances

aer the 1997–98 crisis was the wide diversity o countries hosting

migrants rom developing Asia. Tose regional countries that send their

workers to a wide diversity o destinations will likely see remittance ows

bounce back aster than other sending countries. Governments shouldthereore work to keep the channels or oreign workers open, which will

help preserve that diversity. In addition, regional cooperation to avoid

protectionist policies would enhance the mutual interests o both home

and host countries.

Governments o countries such as Bangladesh, Philippines, and

Pakistan have initiated policy actions to help migrant amilies cope

with the adverse impact o the global downturn. Notable among these

are online transers to ease the remittance ows and public–private

partnerships or skills development projects in Bangladesh; nancial

assistance, investment, and education support in Pakistan; and alternative

livelihood programs or economically displaced returning workers in the

Philippines. Other countries could consider similar moves.

Boosting ormal remittance fows

Faster, cheaper, and more secure ways o sending remittances can acilitate

greater remittance ows through ormal channels. Te evidence on the

large volume o remittances worldwide and the impact o these ows on

receiving countries has encouraged many receiving-country governments

to closely ollow the patterns o these transers. Tis increased supervision

and tighter enorcement is also a reaction to concerns regarding money

laundering and the nancing o terrorism groups.

In the past, ofcial channels or remitting in Asia ailed to meet the

needs o many migrants and households. Te advantage o unofcial

channels is ease o accessibility or migrants in the host country and theirability to reach remote areas o the home country. Ofcial channels, in

contrast, are usually concentrated in large metropolitan areas.

Te situation is improving. Te cost o remitting through ormal

channels has been decreasing and, as a consequence, wire transers now

account or a larger share o transers. Te reasons or the reduction in

the cost o remitting include increased efciency and a larger network o

ormal channels that involve both state-owned and private banks. Te

latter have been attracted by the prospect o revenue rom the transers

themselves and the possibility o providing banking services to migrants

and their amilies.

Central banks can record these ormal channel transers much more

easily than the sums that individuals carry. Governments need to take

care not to create disincentives to using the ormal nancial system or

transerring unds. Policies that raise the cost o remitting, such as heavy

taxes, mandatory remittance schemes, or xed exchange rate policies,

encourage remittance black markets resulting in unrecorded ows.

Improving investment rom remittances

Policies that encourage remittances or productive use require an

improved investment climate that allows markets to work efciently. A

well-organized nancial system would also allow remittance-receiving

amilies to leverage remittances so as to access small loans or investment.




Longer term, a avorable investment environment would help direct

remittances to productive investments such as smaller businesses.

Improving legal aspects to lessen the nancial cost o international

migration and to provide access to potential migrants rom the

lower income groups can also increase the equity-enhancing eect o remittances.

Millions o dollars o remittances to households in Asia can make a

signicant dent in poverty. Encouraging the use o remittances not only

or consumption but also or investment in areas such as health and

education can enhance domestic demand and boost economic growth,

as well as develop human capital, contributing to long-term growth. In

addition, remittance-boosted household consumption will generate extra

demand in the receiving economy.



Policies to achieve more

balanced openness

Enhancing intraregional tradeStrengthening intraregional trade can help reduce developing Asia’s

excessive dependence on exports to the US and other industrial

economies, and so provide an additional engine o recovery and growth.

rade in parts and components seems to have accounted or much o the

intra-Asian trade in the past, though more recent trends indicate trade in

nal goods beginning to play a more important role.

In particular, the PRC has seen an increase in the share o nal goodsand a corresponding decline in the share o parts and components in its

imports. Tus it may well be starting to show some signs o promise as an

independent engine o growth or the region. Given this budding promise,

developing Asian economies should take the initiative to speed up its

realization. Some o these measures will be purely national while others will

require a degree o regional coordination. Tree specic steps are as ollows.

Strengthening domestic economies. National governments should

aim or this through a wide range o rebalancing policies (ADB 2009).

Tis objective involves demand-side policies that encourage households

to spend more and save less, as well as supply-side policies that promote

smaller companies and service industries catering to domestic demand.

A dynamic and vibrant domestic economy in each regional country willnaturally lead to more intraregional trade based on nal goods.

Stronger domestic economies and more vigorous intraregional

trade can then orm a virtuous circle. Te result will be a more resilient

regional economy that is less vulnerable to the vicissitudes o the

global business cycle. But without robust domestic economies that have

strong demand or nal goods, there will be a limit to the capacity o

intraregional trade to serve as an engine o growth.

Creating a more conducive trade environment. Intraregional trade

liberalization has been under way or some time in Asia, as evident in

relatively low tari and nontari trade barriers, and a growing number o

regional trade agreements. However, a wide range o border and behind-

the-border obstacles to trade still prevents the region rom ully realizing

the potentially large gains rom intraregional trade. For example, complex

rules-o-origin requirements and burdensome customs procedures may

discourage countries rom trading with each other.

Te ailure o the multilateral Doha talks gives an even greater sense

o urgency to removing behind-the-border obstacles to trade. Tereore,

governments must take additional supportive and complementary trade-

acilitation measures, such as simplication and harmonization o customs

procedures, to convert the growing intraregional trade liberalization

moves into an overall trade-acilitating environment. Furthermore,

regional governments should improve the transportation inrastructure




such as establishment o bilateral swap arrangements with the Federal

Reserve and cooperative initiatives or bilateral swaps among Asian

countries, proved useul recently. Formalizing regional and international

cooperation would help improve access to liquidity when immediate needs

arise. Creating a multilateral reserves pool under the Chiang Mai Initiativecould also mitigate US dollar shortages, and would reduce the need or

excess reserves. Tis policy would allow a country to gradually pursue a

more exible exchange rate with less concern or external shocks.

Developing a local currency bond market. Foreign reserves

management has been conservative in developing Asia largely because o

the limited development o national and regional securities markets, and

partly because liquidity needs are overemphasized.

A local currency bond market in particular needs to be developed

urther, both in size and accessibility, so that developing Asia can

diversiy the region’s assets and avoid overexposure to dollar-

denominated assets. A ully developed local currency bond market would

also address the currency mismatch problem o developing Asia that has,arguably, caused the excessive holding o oreign reserves.

Maximizing the benets o labor fowsWith economic migration an increasingly important element o the

global landscape and remittances a more stable source o oreign

currency than many other nontrade sources, it is in the interests o both

home and host countries to maximize the benets o labor migration.

It is vital, especially now, that the migration channel is kept open. In

addition, the saety and security o unds transers must be enhanced.

And an environment that encourages households to create assets through

investing more o their remittance income needs to be encouraged.Keeping open the migration channel. With rising unemployment in

host countries, some o them are discriminating against oreign workers,

and developing countries need to work assiduously to keep the migration

channel or workers open. In addition, regional cooperation to avoid

protectionist policies would enhance the interests o both home and host

countries. Policy actions to help migrant amilies cope with the adverse

impact o the global downturn should be expanded to more countries.

Boosting ormal remittance ows. Faster, cheaper, and more secure

ways o sending remittances can acilitate greater remittance ows

through ormal channels. Indeed, the situation is getting better in this

regard: costs o remitting through such channels have been alling. But

governments need to take care not to disincentivize use o the ormal

nancial system or transerring unds (by imposing, or example, high

ees). Policies that raise the cost o remitting encourage black markets,

leading to higher volumes o unrecorded ows.

Improving investment rom remittances. Te millions o dollars that

households in Asia receive in the orm o remittances can help reduce

poverty. Encouraging the use o remittances or investment in areas

such as health and education can enhance domestic demand and boost

economic growth, as well as develop human capital. Efcient nancial

systems in remittance-receiving countries would also allow amilies to

leverage the remittance income so as to access small loans or investment.




Endnotes

A large and growing number o studies have used disaggregated trade data to examine the

structure o intra-Asian trade. See, or example, Athukorala and Kohpaiboon () and

Athukorala and Yamashita ().

Eichengreen et al. (), and Greenaway et al. (), or example. For example, Brown and Linden (), Brown et al. (), and Sturgeon ().

As discussed in, among others, Kimura and Ando (), Ng and Yeats (),

McKendrick et al. (), Borrus (), and Dobson and Chia ().

Park and Shin (b) give details about the data used in the empirical analysis.

Te reconciliation between the two sets o SIC codes and HS codes is explained in detail

in Park and Shin (b).

www.adb.org/gms and www.adb.org/carec provide more inormation.

Cambodia and Viet Nam are excluded rom this group in this analysis because o data

limitations. For example, FDI data or Viet Nam rom IMF and the CEIC database began in

, while portolio investment began in .

Apart rom Malaysia and Indonesia. In the ormer, FDI inows were relatively at during

the crisis while in the latter they declined. Te multilateralization o the Chiang Mai Initiative, which is expected to be in operation

by end-, will allow ASEAN countries plus PRC, Japan, and Korea to draw rom

(large countries) to (small countries) o their contribution to a $ billion

multilateral reserves pooling arrangement.

Details o the estimation methodology and a uller discussion o the determinants o

capital ows are ound in Jongwanich (orthcoming).

Cambodia; Indonesia; aipei,China; and Viet Nam are excluded rom this group in this

analysis because o data limitations or bilateral FDI.

Firms undertake strategic asset–augmenting FDI to create or strengthen their competitive

position by acquiring the proprietary assets o another oreign company, oen in industrial

economies.

Cambodia and Viet Nam are excluded rom this group in this analysis because o data

limitations.

Te data and estimations are detailed in Ito et al. (orthcoming).

Te evidence o the remittances-growth link using larger samples o countries is mixed.

Barajas et al. (), or example, using similar estimation techniques to Vargas-Silva et al.

(orthcoming), examined a dataset or more than countries worldwide, and nd no growth

eects. However, Giuliano and Ruiz-Arranz (), analyzing data or about developing

countries, note that remittances promote growth in less nancially developed countries and

thus present another way o nancing investment. Catrinescu et al. () use a dynamic panel

estimation to show that remittances exercise a weak positive eect on long-term macroeconomic

growth, and the impact increases in the presence o sound economic policies and institutions.

Adams and Page () nd that there is a link between remittances and poverty reduction,

but that remittances reduce the depth o poverty more than poverty headcounts. In a similar

study using data or developing Asian economies or –, Jongwanich () nds

that remittances have a signicant impact on poverty reduction by raising income, smoothing

consumption, and reducing the capital constraints o the poor. Similarly, Brown (), using

counteractual experiments, suggests that remittances are important in reducing poverty in

the Kyrgyz Republic and ajikistan, but less so in Armenia and Azerbaijan.

Ofcial development assistance ows have, in act, the lowest coefcient (.), but are not

really comparable because they include expenditure planned sometimes years in advance.

Sayan () shows that remittances to Bangladesh and India are countercyclical, though

with a -year lag or India. Frankel (), using several multicountry datasets, notes that

remittances respond negatively to the cyclical position o the receiving country.

http://www.adb.org/gms

http://www.adb.org/carec

http://www.adb.org/carec

http://www.adb.org/gms




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Part 3Economic trend

and prospects in

developing Asia

Subregional summarie

Central As

East As

South As

Southeast As

The Paci

Banglades

People’s Republic o Chin

Indi

Indonesi

MalaysiPakista

Philippine

Thailan

Viet Nam



Economic trends and prospects in

developing Asia

Subregional summaries

Central Asia

Subregional assessment and prospects

Te global downturn is having asymmetric impacts on the eight countries

o Central Asia. Growth in the countries with more open economies and

greater links to international nancial markets in general is slowing. For

these countries, lower oil and other commodity prices, marked reductions

in workers’ remittances and investment inows, and difculties in the

banking sector have undermined growth. But hydrocarbon-exporting

countries with relatively closed economies and capital markets (primarily

urkmenistan and Uzbekistan) have been more insulated rom the

deterioration in the global economy (Figure 3.1.1).Monetary authorities in many countries in the subregion have allowed

their currencies to depreciate because their major trading partners

externally the Russian Federation and internally Kazakhstandevalued

their currencies early in 2009. Economic circumstances aced by the

subregion in 2009 are bleaker than anticipated in the Asian Development

Outlook 2009 (ADO 2009) in March, and the Update revises down the

earlier projections. In 2009, growth is now expected to be only 0.5%, rom

3.9% earlier, and in 2010 a 3.6% expansion is now orecast, rom 4.8%.

Trough trade and nancial linkages, the Russian Federation’s deep

recession this year has severely crimped trade, investment, and workers’

remittances to countries in the subregion, oen with a substantial

depressing impact. According to that country’s central bank, remittances

to the eight countries ell by about 25.5% year on year during the rst

hal o 2009. Since remittances are a major source o income or some

subregional countries, lower ows adversely aect domestic demand and

are deteriorating current account balances.

Furthermore, even though no ofcial statistics are available, many o

the migrant workers rom Kyrgyz Republic, ajikistan, and Uzbekistan

who are employed in the Russian Federation (and in Kazakhstan) have

3.1.1 GDP growth, Central Asia

-12 -6 0 6 12

201020092008

Uzbekistan

Turkmenistan

Tajikistan

Kyrgyz Republic

Kazakhstan

Georgia

Azerbaijan

Armenia

Central Asia

%



This chapter was written by Kiyoshi Taniguchi or Central Asia, Anthony Patrick or

East Asia, Tadateru Hayashi or South Asia, Purnima Rajapakse and Benno Ferrarini or

Southeast Asia, and Craig Sugden or the Pacic, with contributions rom various ADB

Resident Mission sta.





Subregional summaries 85

pulled down industrial output by 10.5%, mainly because o decreased

output in the export-oriented mining and chemical industries, as well

as construction materials. Given the severity o these developments,

Armenia’s projected GDP in 2009 is now revised to a 9.9% contraction

rom the marginal 0.5% expansion orecast in ADO 2009. For 2010,growth o 0.9% is penciled in, down rom 3.0% projected earlier.

Te dram depreciated by about 20% aer the 3 March announcement

by the authorities that they were returning to a exible exchange rate

regime, limiting intervention to countering extreme volatility. Ination

spiked but ell back to low single digits, reecting very weak domestic

demand conditions. Projected ination is now revised down, to 3.0%

rom 7.5% in 2009 and to 3.5% rom 7.5% in 2010, owing to a much weaker

economy than ADO 2009 expected.

Exports shrank by 48.2% year on year in the rst quarter, with sharp

reductions in mining, metals, and processed-ood exports. During this

period, imports contracted by 22.9%, primarily due to decreases in

prices o intermediate goods and oil products, as well as lower domesticdemand. Te services trade decit widened and private remittances

dropped heavily, mainly attributable to the downturn o the Russian

economy, bringing the current account decit to 18% o GDP in the rst

quarter. Given the major impact o external developments, the Update

revises its orecast or the current account decit to about 13% o GDP in

2009 and 2010, rom about 9% in ADO 2009.

Azerbaijan

Azerbaijan has been experiencing repercussions rom the global economic

turmoil through continuing weaker oil prices and declining oreign and

private domestic investment. GDP growth ell to 3.6% year on year in the

rst hal o 2009 as growth in industrial output declined to 1.0% and xedcapital investment contracted by 7.1%. Te public investment program and

social spending remain key sources o economic growth and employment,

but budget resources are under pressure rom the lower oil prices. Despite

a marked reduction in the central bank’s renancing rate, credit to the

economy is being constrained by commercial banks’ difculties in raising

unding rom abroad. Largely in view o these problems, the GDP growth

orecast or 2009 has been taken down rom 8.0% in ADO 2009 to 3.0% in

the Update; or 2010, expansion in GDP is revised to 4.5% rom 6.7%.

Consumer prices ell in the rst hal o 2009. Weak domestic

demand presents a risk o deation pressures, though these will likely

be countered by higher public expenditure or salaries and pensions.

With a weaker economic expansion now expected, ull-year ination is

also adjusted rom 12.0% to 4.0% or 2009; or 2010 the projection is le

unchanged at 7.0%.

Hydrocarbon export volume is expected to rise in 2009 and 2010,

partly because the Russian state gas monopoly, Gazprom, agreed to

purchase Azerbaijan gas rom 2010. However, since global oil prices

are much lower than in 2008, revenues rom hydrocarbon exports

are alling sharply, and the trade and current account surpluses

have deteriorated, despite decreased spending on imports because

o shrinking public inrastructure investments and delays in capital

expenditure by non-oil investors. Te Update lowers the current

3.1.3 Current account balance, Central Asia

-30 -15 0 15 30 45

201020092008

Uzbekistan

Turkmenistan

Tajikistan

Kyrgyz Republic

Kazakhstan

Georgia

Azerbaijan

Armenia

Central Asia

% of GDP


estimates.







account surplus projections rom 25.5% to 15.0% o GDP in 2009, while

maintaining the 2010 orecast at 17.7%.

Georgia

Te Update revises the GDP projection or 2009 rom a 2.5% expansion toa 4.0% contraction and or 2010, growth rom 6.0% to 2.5%. Te economy

was hit hard by the simultaneous shocks o the conict with the Russian

Federation in August and the global slump. Te revisions reect the

5.9% all in GDP in the rst quarter o 2009 and continued weakness in

the second. Damaged inrastructure, alling exports, lower remittance

inows, a drop in capital inows, and reductions in bank lending are

major contributing actors.

Fiscal revenue is alling sharply due to the weakening economy.

Even with some reallocation rom less prioritized items to social and

capital spending, the scal decit in 2009 is projected at 9.4% o GDP.

It is expected that the budget decit will be supported by external

assistance; IMF in August augmented unding available under its standby arrangement.

Due to weak domestic demand as well as lower ood and energy

prices, ination trended lower to 2.3% year on year in June. Reecting

depressed economic conditions, the Update lowers the ination

projection in 2009 rom 7.0% to 1.8% and maintains the previous orecast

o 7.5% in 2010.

Weak demand rom the United States (US) and Europe has resulted

in a large all in Georgia’s major exports, including errous metals

and copper, while depressed economic activity has caused imports to

shrink. Tese developments are in line with ADO 2009’s projections. Te

Update maintains the orecasts or the current account decit at 18.8% o

GDP in 2009 and 20.0% in 2010.

Kazakhstan

GDP contracted by 2.3% in the rst hal o 2009. Te major actors were

a sharp drop in manuacturing output and a weakening o domestic

and external demand. Retail sales plunged and unemployment climbed.

However, industrial production rebounded sharply in June to grow by

7.0% year on year and, on the basis o improvements in manuacturing

and mining, the contraction appears to have bottomed. ADO 2009 GDP

projections are now revised to a 1.0% contraction in 2009 rom a 2.0%

expansion earlier, and expected growth in 2010 is downgraded to 2.5%

rom 3.3%.

Despite capital injections early in 2009 rom the state, distress in

the banking sector has intensied, and three large banks are negotiating

with external creditors to restructure their debts. Te Government

responded to macroeconomic difculties (that at rst stemmed rom

excessive oshore borrowing by banks to und domestic lending and that

intensiedin2008withloweroilprices)witha$10billionanticrisisplan,

nanced by the National Oil Fund.

Te tenge was devalued by about 20% in February 2009, matching

a January adjustment by the Russian Federation. Subsequently, the

monetary authorities have successully maintained a de acto peg to the

US dollar at 150 tenge per dollar without major loss o oreign reserves.




Te viability o the banking system is playing a critical role in helping

the economy recover rom the current downturn as well as maintaining

a stable exchange rate. Fiscal policy in 2009 is expected to remain

expansionary in view o the downturn in the economy.

Weak domestic demand oset price pressures rom the devaluation,and year-on-year ination ell to 6.9% in July rom 9.5% at end-2008. In

view o a much weaker economy than oreseen earlier, the Update eases

the ination projection or 2009 rom 10.0% to 8.0%, but retains the 2010

rate o 6.4%.

Even though oil prices have advanced rom their December 2008 low

and oil export volume has increased, a much sharper drop in exports

than imports reduced the trade surplus in the rst 5 months o 2009 to

$3.1billion,comparedwith$14.4billionforthesameperiodin2008.

Because these developments are consistent with the prognosis outlined in

ADO 2009, the orecasts or the current account decit o 2.0% o GDP in

2009 and 0.5% in 2010 are maintained.

Kyrgyz Republic

Te Update revises down the GDP growth projections, rom 4.0% to 1.0%

in 2009 and rom 6.0% to 2.0% in 2010. During the rst hal o 2009,

GDP grew by only 0.3% and industrial production ell by 18.9%, year on

year. Tis slowdown reected a power supply shortage in winter and

adverse spillover eects rom Kazakhstan and the Russian Federation

through the trade, investment, and remittance channels. In particular,

Kazakhstan’s nancial sector difculties had detrimental eects through

the large Kazakh bank branches in the Kyrgyz Republic.

Grantassistanceof$150millionfromtheRussianFederationallowed

the Government to conduct a countercyclical scal policy by increasing

government expenditure, mainly on social saety net programs.Due to lower oil, commodity, and ood prices as well as a general

slowdown in economic activity, ination has trended down. Te Update

revises its ination orecasts, rom 15.0% to 7.5% in 2009 and rom 12.0%

to 9.0% in 2010.

Te local currency, the som, depreciated by around 9.4% in the rst

hal o the year. o prevent excessive depreciation, the central bank

intervened extensively, mainly by selling US dollars. Nevertheless, oreign

exchangereservesrosebyaboutonethirdto$1.6billionduringthe

rsthalfof2009.IMFhasapproveddisbursementof$25.5millionofa

$100millionfacility.

Even though exports ell in the rst hal o 2009, imports dropped by

even more and the current account decit narrowed. Te Update lowers

the projected current account decit or 2009 rom 10.0% to 8.5% o GDP

and that or 2010 rom 10.0% to 9.5%. Tis revision reects the expected

slower growth o the economy.

ajikistan

Te global downturn has straed this economy, largely because remittances

plunged by about 50% in the rst hal o 2009 relative to the same period

in 2008. Industrial output ell by about 13% in the rst hal o 2009 with

the drop mainly attributable to demand or the country’s major export

aluminum. Agriculture has been an engine o growth this year due to good




Investment contributed to 9.9% growth in industrial output and 142%

growth in construction services in the rst hal o 2009.

Ofcial statistics indicate that ination in the rst 5 months o

2009 was 4.5%, below the Government’s annual orecast o 7.9%. Global

disination in consumer goods prices and a state-imposed cap onincreases in utility taris helped alleviate price pressures. Te Update

maintains its 2009 orecast at 12.5%, while revising down the 2010 orecast

rom 13.0% to 11.0%.

Te trade surplus narrowed as a result o a 4.8% decline in exports

and a 24.1% increase in imports during the rst 5 months o 2009. Imports

rose due to higher demand or capital goods caused by intensied public

and private inrastructure development. However, it is expected that

rising demand or gas in Europe and a continuing high gold price will

boost exports in the second hal o 2009, allowing the country to sustain

a strong trade surplus. Te Update maintains the ADO 2009 current

account surplus orecasts o about 11.0% o GDP or 2009 and 2010.

East Asia


Subregional economic growth will slow in 2009, but not as much as

was orecast in ADO 2009. Te biggest o the ve economies in East

AsiaPRC and Republic o Korea (hereaer Korea)are perorming

better than was expected in March. Consequently, subregional GDP is

now orecast to increase by 4.4% (Figure 3.1.4), revised up rom 3.6%.

Nevertheless, the global nancial crisis and slump in world trade have

seriously dented growth in this subregion, which relies on export-oriented

manuacturing to drive much o its expansion. Te growth orecast orthis year is less than hal the rate o 2006–2007. Indeed, the orecasts or

the three other East Asian economiesHong Kong, China; Mongolia; and

aipei,Chinaare downgraded rom ADO 2009. Economies will contract

relative to 2008 in Hong Kong, China; Korea; and aipei,China. GDP is

expected to increase only a touch in Mongolia. Subregional growth this

year is attributable to the PRC.

When world trade dwindled in late 2008–early 2009, merchandise

exports plunged in all ve economies. In aipei,China, or example,

exports dropped by 34.2% in the rst hal o 2009, and in Korea they ell

by 22.7%. In reaction, manuacturers cut production, laid o sta, and

delayed expansion plans. All these actions depressed investment and

consumption, particularly in the rst 3 months o 2009.

Te PRC and Korea implemented particularly eective scal

stimulus packages that kick-started domestic demand. Strong scal and

debt positions in both countries enabled them to boost government

spending and reduce some taxes. Te PRC coupled scal stimulus with

a very aggressive monetary stance, ooding the banking system with

liquidity.

aipei,China and Hong Kong, China also rolled out scal stimulus

measures to varying degrees. However, Mongolia, which had run a

procyclical scal policy during the commodity boom in recent years,

aced a severe scal squeeze when global prices o commodities dived,

3.1.4 GDP growth, East Asia

-5 0 5 10

201020092008

Taipei,China

Mongolia

Rep. of Korea

Hong Kong, China


East Asia

%








slashing its government revenue. Te bigger economies also lowered

interest rates as the economic downturn deepened. Partly as a result

o these actions, there were indications that the downturn in East Asia

reached a trough early in 2009.

Aggregate GDP growth in the subregion is orecast to speed upconsiderably next year, to 7.1% (raised rom 6.5% in ADO 2009), based on

the expected pickup in global trade, improvement in nancial markets,

and stronger domestic demand. Fiscal and monetary stances are expected

to be expansionary, although not to the same extent as in 2009.

All ve economies are projected to grow in 2010, with the PRC’s

expansion rate now orecast at a vigorous 8.9%, supported by the

continuation o its large scal stimulus. Growth in other economies

will likely be suppressed by the projected modest recovery in industrial-

country export markets. Te Korean economy is orecast to expand by

4.0% next year, while growth in Hong Kong, China is put at about 3%

and in aipei,China at 2.4%, modest rates given that these economies will

shrink in 2009, setting low bases rom which to recover.External accounts in East Asia are in surplus, except in Mongolia,

where the drop in prices or its commodity exports will contribute to a

current account decit o 6–7% o GDP in the orecast period. In some

economies, imports ell more sharply than exports in the rst hal o

2009, mainly a result o much lower prices or oil and commodities

than in 2008 and a reduced need to import inputs or manuacturing

industries. A substantial subregional current account surplus equivalent

to 7.0% o GDP is projected or 2009, easing to 6.0% in 2010 as import

growth picks up (Figure 3.1.5).

Ination has aded this year: the subregional rate is orecast at just

0.2% (Figure 3.1.6), revised down rom March. Consumer price indexes

will all a little rom 2008 levels in the PRC and aipei,China. (Again,Mongolia is an anomaly: its ination has decelerated rom over 20% in

2008, but is expected to remain in double digits.) Te orecast or East

Asian ination next year is raised to 2.6%, mainly because PRC ination

is revised up to 3.0% in view o its highly expansionary monetary policy

in 2008 and aster GDP growth than previously anticipated.

Country highlights


Expansionary scal and monetary policies spurred a li in economic

growth to 7.9% in the second quarter o 2009 rom a two-decade low o

6.1% in the rst quarter. Growth or the rst hal was 7.1%. Investment

in xed assets soared in the second quarter, reecting the impact o the

large scal stimulus and rapid credit expansion. Industrial production

picked up in that period too, as rms rebuilt inventories aer a signicant

destocking that stemmed rom the impact o the global economic slump.

Consumption also rose, underpinned by rising household incomes and

government subsidies, particularly or rural areas. However, a decline in

net exports acted as a drag on growth through the rst hal.

Te aggressive monetary stance adopted in late 2008 sparked a

huge surge in new lending, equivalent to around 50% o GDP or the

rst 6 months o 2009. State-owned enterprises and large businesses

3.1.5 Current account balance, East Asia

-10 -5 0 5 10 15

201020092008

Taipei,China

Mongolia

Rep. of Korea

Hong Kong, China


East Asia

% of GDP








tapped most o the new lending. Te scal stimulus measures, valued

at CNY4 trillion, include extensive public investment and subsidies to

armers and some industries.

Public investment is expected to remain at high levels under the scal

stimulus that runs through 2010. Private investment, though, may remainsubdued, particularly in manuacturing, until external demand improves

signicantly. Te Government proposes to increase access to credit

or small and medium-sized enterprises, which should boost private

investment. A recovery under way in the property market is sparking

growth in construction. Robust growth is seen or consumption now that

the labor market is recovering aer rounds o layos seen late in 2008

and early 2009.

aking these inuences into account, the GDP growth orecast or

2009 is upgraded to 8.2%, rom 7.0% in ADO 2009. Maintenance o the

scal stimulus and a likely moderate recovery in the global economy

in 2010 is seen liing the PRC’s growth rate next year to 8.9% (revised

rom 8.0%).Te authorities ne-tuned monetary policy rom July 2009, and

growth in new lending eased in July and August. It is assumed that policy

will be tightened somewhat when ination returns and economic growth

can be sustained without such a highly stimulatory monetary stance. I

the monetary stimulus were to be pulled back aster than assumed, there

would be a risk o an unintended abrupt slowing in growth. Te challenge

is to balance the need to maintain the monetary stimulus against the

risks o the ood o bank lending, i extended or too long, becoming

diverted into unproductive purposes, such as speculation in stocks and

property and a misallocation o resources that erodes bank asset quality.

Merchandise exports ell by about 22% in the rst 7 months o

2009, and imports dropped by about 23%, but the pace o the monthly declines bottomed by midyear. rade surpluses look likely to be smaller

than expected in March, and the orecasts or the current account are

revised down slightly to a surplus o 7.1% o GDP this year and 6.5% in

2010. Nevertheless, oreign exchange reserves are expected to rise to

$2.6trillionbyend-2010.

Lower ood prices and increases in ood production were largely

behind a 1.2% year-on-year all in the consumer price index during the

rst 7 months o 2009. For the whole year, the index is orecast to decline

by 0.5% (revised rom a rise o 0.8% in ADO 2009). Considering the

pickup in growth, low-base eect rom a deceleration in ination late in

2008, and large monetary stimulus, the index is expected to turn upward

by the end o 2009, and to rise by about 3.0% during 2010 (this orecast is

also revised up).

Hong Kong, China

Bueted by the global nancial crisis and the slump in world trade, this

economy, which is based on trade in goods and services (particularly

trade, travel, and nancially oriented services), contracted or three

consecutive quarters, year on year. Te pace o contraction eased

considerably in the second quarter o 2009 rom the rst, to 3.8% rom

7.8%. For the January–June period, GDP ell by 5.8%, with private

consumption and xed investment both declining.

3.1.6 Infation, East Asia

-7 0 7 14 21 28

201020092008

Taipei,China

Mongolia

Rep. of Korea

Hong Kong, China


East Asia

%








Employment stabilized in the second quarter, slowing the pace o

increase in the seasonally adjusted unemployment rate (it was 5.4% in the

second quarter compared with 3.3% a year earlier). Wages remained under

downward pressure through the rst hal.

Te better second-quarter perormance (GDP rose by 3.3% on asequential basis) was attributed to a quickening o growth in the PRC and

was assisted by scal stimulation measures taken in Hong Kong, China.

Public sector investment is expected to pick up in the second hal to

provide some oset to slack private investment. Te stock market rose by

37.1% in the rst 8 months o 2009 and the market or residential property

is strengthening, supported by low interest rates.

However, the sharper than expected GDP decline in the rst hal has

led to a revision in the orecast or the ull-year GDP contraction to 4.0%,

rom 2.0% in ADO 2009. Modest growth o about 3.0% is projected or

2010, when world trade in goods and services will likely be much more

robust.

Ination decelerated to 0.5% in the rst 7 months o 2009, a result o lower prices or imported oil and ood, muted domestic demand, and a

temporary subsidy or household electricity bills. For the whole o 2009,

ination is expected to be about 1.0%, edging up to about 2.0% in 2010.

Substantial current account surpluses o about 10% o GDP are projected

or both years.

Republic o Korea

GDP declined or three consecutive quarters, year on year, through

mid-2009. However, the pace o contraction slowed considerably in the

second quarter o 2009, to 2.2% rom 4.2% in the rst. For the rst hal o

the year, the economy contracted by 3.2%.

Recession in major industrial economies and a consequent allin Korea’s exports was the immediate cause o the downturn. Tis

external shock spread to already sluggish private consumption and xed

investment: in the rst hal o 2009 the ormer ell by 2.6% and the latter

by 5.1%. In contrast, government consumption spending rose by 7.2% as

budget disbursements were stepped up. Also, the Government rolled out a

substantial scal stimulus package to temper the economic downturn.

Exports o goods and services in volume terms slid by about 7% in the

rst hal, but imports shrank at double that rate, boosting net exports.

Exports received some support rom a signicant depreciation o the won

against the US dollar in 2008.

Among signs that a rebound is under way, private consumption, xed

investment, imports, and exports all increased in the second quarter

relative to the rst. In July, the index o industrial production broke

through its prior-year level or the rst time this year, and the seasonally

adjusted unemployment rate eased to 3.8% rom 4.0% in June (although it

was still 0.6 percentage points higher than its year-earlier rate). Indexes o

business and consumer condence also turned up early this year.

Tese indicators point to a stronger recovery than was previously

anticipated, and the GDP orecast or 2009 is revised to a shallower

contraction o 2.0% rom 3.0%. Growth is expected to resume in 2010 at

about 4.0%, reecting a likely recovery in both external and domestic

demand.




aipei,China

Tis economy, which depends heavily on exports o machinery and

electronic products, contracted year on year or our consecutive quarters

through mid-2009. GDP went down by 8.8% in the rst hal o 2009

rom the same period o 2008, the steepest contraction or this periodin East and Southeast Asia. Exports and imports both ell by more than

20% in volume terms in the rst 6 months, and xed investment plunged

by about 28%. Private consumption was weak, hurt by a deterioration in

the labor market (the unemployment rate rose by 2 percentage points to

6.1% in July 2009 rom a year earlier). Only public consumption recorded

growth on the demand side.

Te downturn reached a trough in the rst quarter, when GDP

plunged by 10.1%. In the second quarter, private consumption stabilized

and the pace o decline in trade and investment eased, moderating the

GDP contraction to 7.5%. yphoon Morakot, which hit the island in early

August, le more than 700 people dead or missing and inicted damage

to agriculture, inrastructure, and tourism. Its impact on GDP in 2009will depend on how ast reconstruction eorts get under way.

Fiscal stimulus measures have been implemented to support both

consumers and businesses, and the monetary authorities cut the policy

interest rate by a total o 238 basis points to 1.25% rom September 2008 to

February 2009. Te economic perormance began improving in the second

hal o 2009, but in view o the steeper than expected rst-hal decline,

the ull-year outcome is expected to be a contraction o 4.9%, worse than

was projected in ADO 2009. Growth is orecast to resume in 2010 at 2.4%,

based on a pickup in global demand and supported by strengthening

business links with the robustly expanding economy o the PRC.

While merchandise exports slumped by 34.2% in the rst 6 months

o 2009, imports crashed by 42.3% as demand shrank or importedintermediate goods or the export industries and as prices ell or imported

oil and commodities. Te trade surplus nearly doubled rom the year-

earlier period. Te orecast or the current account surplus is revised up to

9.1% o GDP or this year, easing to 7.9% in 2010 as imports bounce back.

Weak domestic demand and lower prices or imported oil and

commodities pulled the consumer price index below prior-year levels

rom February to August this year. Te index is orecast to all by 0.7% in

2009, and to rise by only 0.2% in 2010.

South Asia


Although South Asia is less integrated in the global economy than

East Asia and Southeast Asia, the global nancial crisis and economic

downturn have still had an impact on the subregion, via two main

channels: capital outows and limited access to nancing; and weak

external demand. Capital began to ow out right aer the nancial crisis

intensied in September 2008, particularly rom India and Sri Lanka.

Regional economies aced a sudden reversal o portolio investment

associated with the sharp drop in equity prices in the major stock

markets in the region, particularly India and Sri Lanka, which have




relatively more advanced nancial systems and substantial international

investments. Many o them also had difculties in accessing normal

trade nance. Moreover, cross-border bank lending ell, reecting the

deleveraging process by major international banks.

Quarterly balance-o-payments data show that both India and SriLankasueredfromanetoutowintheirnancialaccounts$4.3billion

and$5.3billionforIndia,and$1.1billionand$0.3billionforSriLanka,

during the ourth quarter o 2008 and the rst quarter o 2009,

respectively. As a consequence, many investment projects in these two

countries were suspended due to lack o private unding. Many ongoing

projects nanced by short-term unding have also been put on hold as

such unding has not been rolled over. Since March 2009, stock indexes

in India and Sri Lanka have rallied along with most markets worldwide.

Tere has been some recovery in portolio investment, reecting a

recovering risk appetite among global investors. However overall,

capital inows have not marked a substantial recovery, and cross-border

commercial bank lending remains restricted. Bangladesh and Nepal, incontrast, did not experience signicant capital outows.

Weak external demand exerted its impact on South Asian economies

as industrial economies ell into recession. Merchandise exports

contracted in India, Nepal, Pakistan, and Sri Lanka, while Bangladesh

export growth slowed substantially over the year through June 2009. Te

Maldives saw a drop in tourism.

Workers’ remittances, which play a major role in Nepal, Bangladesh,

Sri Lanka, and Pakistan (accounting or 20%, 11%, 7%, and 5% o GDP,

respectively), have shown considerable resilience to date compared with

exports, supporting domestic consumption demand and the current

account. Remittance growth slowed but has maintained double-digit

growth in Bangladesh and Nepal, although in Sri Lanka, remittancesexpanded by about 5%. Weak external demand (together with a power

supply decit in some countries) is reected in regional countries’

manuacturing indexes, with year-on-year growth turning negative in

Pakistan, while in India and Sri Lanka industrial production decelerated,

almost reaching zero growth in early 2009.

Reecting the downward trend in industrial production in the

year through March, GDP growth slowed to 2.5% in Sri Lanka during

its rst quarter o 2009, while India maintained 5.8% growth during

the January–March quarter and saw an improvement to 6.1% in the

April–June quarter, although demand-side indicators showed slowing

private consumption and investment. In all countries except Aghanistan,

statistical indicators show a marked decline in economic activity rom

2008 levels.

While the global economic difculties had a signicant adverse

impact on India, Maldives, Pakistan, and Sri Lanka, it was somewhat

less on Aghanistan, Bhutan, Bangladesh, and Nepal. Central banks in

South Asia generally adopted more accommodative monetary policy and

lowered policy rates to promote private investment and boost growth, the

decline in ination pressures rom alling commodity prices bolstering

their room or action. Countries with a currency peg to the Indian rupee

(Bhutan and Nepal) have been able to benet rom the accommodative

monetary policy stance ollowed by the Reserve Bank o India.




Some countries adopted scal stimulus measures to complement

monetary policy. Bangladesh announced a stimulus package in April

2009 (worth 0.6% o GDP). Measures include increased subsidies in

agriculture; enhanced cash incentives or recession-aected sectors

such as jute, leather, and rozen ood; and higher allocations or socialsaety net programs. Te budget or FY2010 continued these measures,

expanding their size by 0.8% o GDP.

India’s three stimulus packages (announced in December 2008, and

January and February 2009) have general interventions with policy

measures that include a substantial cut in their value-added, service, and

excises taxes; additional inrastructure and social saety net expenditure;

measures to support an inrastructure nancing institution; and an

increase in the state government borrowing limit. India’s revised ederal

budget or FY2009 announced in July 2009 continued its expenditure-led

growth strategy.

Pakistan announced a large increase in its public sector development

program (PSDP) in its FY2010 budget, about 62% over the actual PSDPin the previous scal year. Sri Lanka also announced two stimulus

packages: one in December 2008 and the other in May 2009 (worth

0.2% and 0.4% o GDP, respectively), which targeted the agging tea,

rubber, cinnamon, and garments export sectors or incentives (as well

as including a ertilizer subsidy), and boosted rewards under an export

development program.

South Asian economies suering rom structural constraints prior to

the global turmoil and weak macroeconomic undamentals have proven

to be more vulnerable to external shocks and have more limited policy

options to counter the global economic downdra. In early 2008, many

countries used scal measures to mitigate the pass-through o higher

international commodity prices (especially or oil, ertilizer, and basicood) at substantial cost.

Large scal decits in Maldives, Pakistan, and Sri Lanka have led to

acute external imbalances and large losses o international reserves. In

August 2009, IMF announced a sta-level agreement with the Maldives

forastandbyarrangement.InNovember2008,IMFprovideda$7.6billion

emergency nancing package to Pakistan (which was augmented to

$11.3billioninAugust2009).SriLankaalsosoughtIMFassistanceanda

$2.6billionstandbyarrangementwasapprovedinJuly2009.

Te South Asian GDP growth projection is revised upward to 5.6%

in this Update rom 4.8% in ADO 2009 (Figure 3.1.7). Tis reects the

improved growth prospects in India (which accounts or 80% o GDP

in South Asia), as India’s growth projection was raised to 6.0% rom

5.0%. Growth projections were revised down or Maldives, Pakistan, and

Sri Lanka, while the outlooks or Aghanistan, Bangladesh, Bhutan, and

Nepal were upgraded, though generally by small amounts.

Ination pressures were markedly reduced except in Nepal and

Pakistan ollowing the drop o international oil prices in the second hal

in 2008. Te Update revises down the ination projection or South Asia

to 4.7% or 2009 (Figure 3.1.8) rom 5.6% in ADO 2009 despite the upward

growth revisions on account o lower international commodity prices in

2009; the estimate or 2010 is slightly changed to 4.9% (rom 4.4%).

Nevertheless, concern over ination should not be completely o the

3.1.7 GDP growth, South Asia

-4 0 4 8 12 16

201020092008

Sri Lanka

Pakistan

Nepal

Maldives

India

Bhutan

Bangladesh

Afghanistan

South Asia

%








radar as year-on-year monthly ination rates are bottoming (as the high

base passes) and oil prices have moved up. Te outlook or price stability

will thereore crucially depend on the authorities’ ability to withdraw

scal stimuli and central banks’ highly expansionary monetary policies in

a timely manner, as economic activity revives.Despite lower exports, the decline in oil prices provided substantial

import relie (supplemented by weak domestic demand), and trade decits

o South Asian countries have shrunk in Bangladesh, India, Pakistan, and

Sri Lanka. Moreover, while growth in workers’ remittances has slowed,

amounts remain substantial and have grown in relative importance

with respect to the large drop in the trade decit. In India, inormation

technology and business processing sales have been resilient.

Reecting these developments, the current account decit or South

Asia is now projected at 1.7% o GDP or 2009, slightly improved rom

2.0% orecast in ADO 2009 (Figure 3.1.9). Te projected current account

decit or 2010 is now estimated at 2.2% o GDP, marginally lower than

orecast earlier.

Country highlights

Aghanistan

Te best harvest o the decade is likely to be achieved in FY2009

(started on 21 March 2009) due to good rainall and partly improved

irrigation. Tis, along with continued external assistance, will bring

GDP growth to 15.7% in FY2009 compared with the projection o 9.0%

in ADO 2009. Te average annual change in the consumer price index

will likely show deation, which is now estimated at 8.9% as a result

o the large drop in global ood prices, while end-period ination or

FY2009 is estimated at 6.0%.Te current account decit (including grants) is now estimated at

1.7% o GDP or FY2009, slightly improved rom the earlier estimate. Te

large trade decitassociated with donor-nanced activities and security

spending as well as oreign currency expenditure on development projects

and consumer importsis oset by inows o donor grants.

Since Aghanistan’s nancial system and economy are small and

weakly integrated with global markets, external economic impacts are

slight. Te amount o donor assistance available or the country, however,

might be aected by the recessionary conditions in donor countries.

In FY2010, assuming good weather and urther improvements in

irrigation systems, GDP growth is likely to be 8.5%, higher than the 7.5%

orecast in ADO 2009. Ination will stabilize at around end-FY2009 levels,

averaging 6.5% during FY2010, and the current account decit (including

grants) is now estimated at 2.7% o GDP. Both these revised orecasts

represent slight improvements in perormance rom earlier projections.

Political uncertainty stemming rom the presidential election in August

2009 could have an adverse impact on the Government’s reorm agenda

and on growth. However, this point is not expected to be a signicant

drag on growth in the current scal year. Creating a base or sustainable

economic growth, dealing with insecurity, improving weak governance,

suppressing the opium trade, overcoming inrastructure bottlenecks, as

3.1.8 Infation, South Asia

-10 0 10 20 30

201020092008

Sri Lanka

Pakistan

Nepal

Maldives

India

Bhutan

Bangladesh

Afghanistan

South Asia

%


estimates.







well as improving overall aid management and its eectiveness, remain key

challenges or the economy.

Bangladesh

GDP growth or FY2009 (ended June 2009) is estimated at 5.9%.Agriculture perormed better than expected, beneting rom avorable

weather conditions and strong policy support rom the Government,

which enabled armers to access inputs and credit. Industrial growth

was aected by slower export growth because o the global slowdown

and damped investor sentiment. Expansion in services was hindered by

slowing export and import activities.

Te growth in the import bill decelerated aster than that or export

receipts, narrowing the trade decit. Still, strong remittance growth oset

the smaller trade decit and raised the current account surplus (to 2.8%

o GDP). Ination eased, averaging 6.7% in FY2009, down rom 9.9% in

FY2008. Te sharp decline in import prices, the rise in domestic ood

production, and the successive cuts in domestic uel prices led to the dropin ination.

For FY2010, the Update maintains the earlier GDP growth projection

o 5.2%. Industry and services are unlikely to pickup in the rst hal o

the scal year, and remittance growth is expected to slow, which will

contain consumer spending. Te Update also retains the earlier ination

projection o 6.5%, as increases in import prices are moderate and the

crop outlook remains healthy. Growth in exports will slide urther and

the import bill will rise, but remittances will eliminate the trade decit,

to enable the current account to post a small surplus (0.8% o GDP) rather

than a decit (0.5% o GDP) as projected in ADO 2009.

BhutanTe global nancial crisis and economic downturn have had a limited

impact on Bhutan as the economy is driven largely by construction o

hydropower stations and power production exported to India. Power

exports grew by 9% during July 2008–May 2009 compared with the same

period the previous year. Given power hunger in India, it is unlikely that

these exports will be aected by the global slump.

Te budget estimate or FY2009 (ended June 2009) included

additional grants rom the Government o India triple the original

budgeted amount. As a result, the scal decit was contained at 3.0% o

GDP rom the original estimate o 11.0%. Te budget or FY2010 ocuses

on achieving core objectives related to poverty reduction. It plans higher

expenditure than in the FY2009 estimate, while maintaining the scal

decit at 5.0% o GDP.

Against this backdrop, the Update adjusts the projection o GDP

growth to 6.0% rom the earlier orecast o 5.5%. Te current account

decit or FY2009 is unchanged rom that given in ADO 2009 (5.5% o

GDP), while average ination is now expected to be around 7%, reecting

the impact o ination in India. No change is made in projections or

FY2010: the economy will grow by 6.5%, with a current account decit

o around 9% o GDP as imports rise, reecting a gradual increase in

domestic demand and international oil prices, while ination will ease to

4%, marking price developments in India.

3.1.9 Current account balance, South Asia

-60 -40 -20 0 20

201020092008

Sri Lanka

Pakistan

Nepal

Maldives

India

Bhutan

Bangladesh

Afghanistan

South Asia

% of GDP








Although Bhutan is largely immune to global economic events, it

has a concentration risk in power production and exports to India. Any

disruption to operations due to technical problems, natural disasters, or

rainall shortages could have a large impact on overall growth.

India

Macroeconomic management continues to remain pivotal in India against

the backdrop o an uncertain global economic situation. With slow

transmission o policy-rate cuts to lending rates, India’s countercyclical

policy options ocused on a public expenditure–led growth strategy. Te

central Government provided scal stimulus to boost growth over and

above the monetary accommodation provided by the central bank. Tere

are clear signs o a recovery in the economy and in business condence.

External unding constraints have also eased notably.

Tese developments have led to an upward revision in growth to 6.0%

in FY2009 (started in April 2009). Exports are running substantially

below prior-year levels because o recession in industrial economies,though a larger all in imports is expected to keep the current account

decit in check at 1.5% o GDP as projected in ADO 2009. For FY2010,

the Update upgrades projected growth to reect a greater strengthening

o the recovery than earlier oreseen. It makes no change in the ination

orecast.

Although the growth strategy is appropriate given global economic

weakness, it could prove counterproductive i the large scal decits

are not reined in over the next ew years (as the Government intends

to do). Apart rom global uncertainty, the key downside risk to the

outlook emerges rom nancial crowding out o private investment. Tis

issue is most likely to arise in FY2010 and underscores the need or the

Government to concretize its plans to consolidate scal policy.Ination in FY2009 is now orecast to be 2.5%, slightly below the

orecast in ADO 2009; however, year-on-year ination is expected to be

4–5% by March 2010, and ination pressures are likely to persist, driven

by high ood prices and expansionary monetary and scal policies.

Monetary management needs to strike the right balance between

providing adequate liquidity to support economic recovery yet keep

ination at bay. Tere is a risk that domestic ood price ination may

create a dilemma or monetary management in FY2009, but late rains

appear to be lling water reservoirs to an adequate level to ensure a

reasonable winter crop. A return to sustained high growth will require

the Government to address the country’s inrastructure decit and

implement structural reorms.

Maldives

Te economy has suered rom expansionary scal policy aer the

tsunami in 2004. Rising public sector wages and power subsidies in Malé

pushed up current spending, resulting in a deterioration in the scal

balance, which is exerting signicant pressure on the balance o payments.

Te economy is particularly vulnerable to the global slowdown because

tourism accounts or more than a quarter o the country’s GDP and

has signicant knock-on eects on aggregate demand. Notably, tourist

bednights contracted by 10% during the rst seven months in 2009.




Pakistan

Macroeconomic stress was mitigated in FY2009 (ended June 2009) as the

IMF-backed stabilization program took eect in November 2008. Fiscal

and external imbalances improvedthe scal decit ell to 5.2% o GDP

rom 7.6% in the previous scal year, and the current account decitdeclined to 5.3% o GDP rom 8.4%. Te exchange rate stabilized and

oreign reserves revived. However, ination remained stubbornly high

and averaged 21% in FY2009, even as year-on-year ination started to see

a trend decline rom March 2009.

Te growth rate ell precipitously, and at 2.0% was less than the

ADO 2009 projection o 2.8%. Te impact o large power outages, tight

domestic demand management, and global recession contributed. Te

reduction in imbalances itsel was largely a consequence o the slowdown

o the domestic economy and expenditure cutting rather than an

improvement in economic undamentals. Otherwise, domestic revenue

generation and export perormance remained weak.

A modest rebound in growth to 3.0% is expected in FY2010, supportedby a planned larger public expenditure program and an anticipated

urther easing o monetary policy. Agriculture is expected to continue

robust growth but it will not be as high as the previous year. Growth in

industry is expected to turn marginally positive and the services sector is

also expected to record modest growth.

Ination is expected to decline to 10.0%, and the current account

decit to shrink to 4.8% o GDP, in FY2010. Te economy, however,

remains vulnerable to the impact o expected higher international

oil prices, its signicant energy supply–demand gap, and lagging

competitiveness o its exports, which are also aected by weakness in

global economic conditions. Structural reorms at the macroeconomic

and sector levels need to be consistently implemented and accelerated toput the economy on a sustainable growth path.

Sri Lanka

Although the economy remains under severe strain, partly because

o the global nancial crisis and recession, the outlook has improved

with the end to a quarter-century o civil war in May 2009. Still, the

current economic situation remains raught with large scal and external

imbalances that have accumulated over the years. In addition, the country

aces the costs o postconict relie and reconstruction eorts.

Following a marked all in oreign exchange reserves, in July 2009

IMFapproveda$2.6billionstandbyarrangementandreleasedthe

rsttrancheof$332millioninsupportoftheGovernment’sambitious

program o scal, monetary, and exchange rate reorms. With movement

toward economic stability envisaged in the program, potential investors

will receive a positive signal or undertaking the investment needed or

recovery and rapid economic growth.

First-quarter GDP growth slowed to 1.5%, with all sectors experiencing

a downdra. Falling global prices and weakening demand pulled down

Sri Lanka’s high ination signicantly during the rst hal o 2009,

with point-to-point ination alling to 0.9% in June 2009 rom 14.4% in

December 2008. Tis allowed the central bank to reduce policy interest

rates three times during the period.




Preliminary estimates indicate that second-quarter growth improved.

Economic activity is expected to gradually pick up over the rest o the

year to bring ull-year expansion to 4.0%, a shortall rom the 4.5%

projected in ADO 2009. With strong economic management and an

improving global economy, GDP growth is expected to reach 6.0% in 2010as projected earlier.

With price pressures abating aster than expected, average ination is

now estimated to be 5.0% in 2009 rather than 8.0% projected in ADO 2009;

the orecast o 6.0% in 2010 is maintained. Reecting weak investment,

lower oil prices and reduced demand or inputs or plummeting export

activity, imports have dropped rapidly and the trade decit contracted

sharply through the rst hal o 2009. Given the deterioration in economic

conditions, the current account decit is now estimated to be 3.0% o GDP

in 2009; expanding to 5.0% in 2010 as the economic growth revives (rom

7.5% and 7.0% o GDP, respectively, in ADO 2009).

Southeast Asia


Economic output in this subregion is now expected to be virtually at in

2009, its weakest perormance since the Asian nancial crisis in 1997–98

when subregional GDP ell. Growth has decelerated rom 4.1% in 2008,

and this year is projected at just 0.1% (Figure 3.1.10), a result o the global

slump in demand or manuactures and commodity exports, as well as

the nancial crisis. Hal the Southeast Asian economies are projected

to shrink this year, with those most exposed to international trade

Malaysia, Singapore, and Tailandcontracting the most.

Te aggregate growth orecast is revised down rom the ADO 2009 orecast given in March, o 0.7%. However, Indonesiathe largest

economy in Southeast Asiaand Viet Nam are perorming better than

ADO 2009 oresaw.

Te collapse in external demand in late 2008 and early 2009 led to

double-digit contractions in exports across the region. Lower exports

prompted cutbacks in manuacturing production that, in turn, sparked

layos that eroded consumption spending. As businesses delayed their

expansion plans, investment dived. Lower commodity prices damped

production and incomes in rural areas, while inward remittances

decelerated or actually declined, depending on the country.

Some oset to the long list o negative actors has been provided by

increased government spending (most countries rolled out scal stimulus

programs), and by a plunge in imports that in several cases outpaced the

export all, generating higher net exports. Interest rates have been cut

across the subregion, but with limited economic impact given generally

depressed domestic demand.

Te Southeast Asian economies that are expected to shrink this

year are the three larger trade-oriented ones listed above, plus Brunei

Darussalam, which relies on energy exports, and Cambodia, which

is vulnerable to slowdowns in tourism, clothing exports, and FDI.

Downturns relative to 2008 are more moderate in Indonesia, Lao PDR,

Philippines, and Viet Nam, which are generally less dependent on

3.1.10 GDP growth, Southeast Asia

-6 -4 -2 0 2 4 6 8

201020092008

Viet Nam

Thailand

Singapore

Philippines

Malaysia

Lao People's Dem. Rep.

Indonesia

Cambodia

Brunei Darussalam

Southeast Asia

%


estimates.







Ination has been lower than expected, brought down rom double-

digit levels last year by alls in global commodity prices, good domestic

harvests, and a rm rupiah. Forecasts or ination are revised down to

5.0% this year and 6.0% next.

Malaysia

Te economy contracted by 5.1% in the rst hal o 2009, more sharply

than expected, as the impact o a plunge in exports spread to xed

investment and private consumption. Exports in volume terms ell by

16.3%, reecting much weaker global demand or Malaysia’s exports

o manuactures and commodities. Private consumption declined

marginally and xed investment ell by about 10%. On the production

side, only services grew (even then, only just), while manuacturing

output, which is dominated by export-oriented industries, contracted

sharply and agricultural production declined.

Te pace o GDP contraction slowed in the second quarter relative

to the rst, partly owing to increased public spending. Te Governmentlaunched two scal stimulus packages (although some measures got o

to a slow start), and interest rates were lowered to spur the economy.

However, GDP is expected to shrink by 3.1% in 2009, revised rom a

contraction o 0.2% in ADO 2009. Year-on-year GDP growth is likely to

return toward end-2009 and gradually pick up to average 4.2% in 2010.

Te better outlook is underpinned by the scal stimulus and the expected

recovery in world trade and commodity prices.

A declining trade surplus will likely trim the current account

surpluses to a still-substantial 14.0% o GDP this year and 12.5% in 2010.

Ination decelerated to just 1.7% in the rst 7 months o 2009 owing

to lower global commodity prices and slack domestic demand. While the

consumer price index has declined year on year in some months, it ispicking up on a monthly sequential basis. Ination or the whole year is

pegged at 1.1% (a touch lower than ADO 2009) and is projected to gather

pace to 2.6% in 2010, in tandem with higher domestic demand and global

commodity prices.

Philippines

GDP growth o 1.0% in the rst hal o 2009 was weaker than expected.

Private consumption growth pulled back abruptly rom a year earlier as

concerns over job security eroded consumer condence. Remittances,

a major prop or this economy, continued to grow in US dollar terms,

but at a much reduced pace. Government spending grew, supported

by a scal stimulus package, but xed capital investment ell and net

exports acted as a drag on GDP growth. By sector, services constituted

the main contributor to growth. Agriculture and public construction also

expanded, but industrial production and private construction contracted.

A somewhat better perormance is projected or the second hal

o 2009. Consumer condence has turned upward because o low

ination, an easing in interest rates by the central bank, and an improved

international economic outlook. Public investment is gaining impetus

under the scal stimulus. GDP growth or the whole year is projected at

1.6%, about 1 percentage point below the ADO 2009 orecast.

In 2010, the modest rebound in global trade and rmer domestic




demand are expected to raise growth to 3.3%. Business condence should

improve aer national elections in May 2010, on the assumption that the

election process and transition in government go smoothly. Given scal

and debt constraints, the Government plans to rein in its budget decit in

2010, which may mean that scal support or the economy will not be asstrong as in 2009.

Merchandise exports slumped by just over 30% in the rst 6 months

o 2009led by a sharp drop in shipments o electronic productsand

imports ell by a similar degree. As in other subregional economies,

the contraction in trade appears to have bottomed early in 2009. Te

ull-year merchandise trade decit will likely be narrower than expected

in March. rade in services is projected to be in surplus, largely reecting

earnings rom business process outsourcing. Combined with growth in

remittances, these inuences are expected to produce a current account

surplus o 2.8% o GDP this year and close to this level in 2010.

In view o a steep deceleration in ination in the rst 8 months o

2009, the ination orecast is revised down to 3.2% or this year, pickingup to 4.5% in 2010.

Singapore

As a nancial center and manuacturing hub, this economy was

particularly hard hit by the global nancial crisis and slump in world

trade. GDP plunged by 9.5% year on year in the rst quarter o 2009 and

by 3.5% in the second. Te relatively better perormance in the second

quarter (GDP expanded by 20.7% on a seasonally adjusted annualized

basis rom the very weak rst 3 months) was driven by a pickup in

production o pharmaceutical products and by inventory restocking. For

the rst hal o the year, GDP contracted by 6.5%.

A better perormance is expected in the second hal. Manuacturingproduction rose in July rom the prior-year level and the slide in exports

moderated. A large scal stimulus is working its way through the

economy. GDP is expected to contract by about 5% or the whole year,

unchanged rom ADO 2009. In 2010, the orecast global upturn, coupled

with the scal stimulus, is expected to return the economy to growth, o

about 3.5%.

Ination slowed sharply to just 0.6% in the rst 7 months o 2009,

suppressed by lower global oil prices and weaker domestic demand. Te

consumer price index ell year on year or several months around midyear

and is now orecast to be at on average in 2009 (revised rom 0.5%

ination projected in ADO 2009). Next year, higher average oil prices and

rmer domestic demand are seen liing ination to about 2%.

ecurrentaccountsurplusfellto$9.0billioninthersthalfof

2009,from$14.7billionayearearlier,aresultofreducedsurplusesin

both goods and services trade. For the whole year, a still-large current

account surplus equivalent to 10.0% o GDP is expected, rising to 14.0% in

2010 in tandem with the improvement in trade in goods and services.

Tailand

Te onset o the global trade slump sparked a steep decline in Tailand’s

exports, which drove down industrial production and investment in

the rst hal o 2009. Business and consumer sentiment was urther




undermined by political uncertainty: private consumption and private

xed investment both contracted. Reecting these actors, GDP ell by

6.0% in January–June, a sharper all than was orecast in March.

o moderate the decline, the Government quickened the pace o

budget disbursements and raised wages or its employees, which boostedgovernment spending. From March, the Government also rolled out the

rst o two scal stimulus packages. By production sector in the rst hal,

output o services and industry ell, while agriculture was virtually at.

As elsewhere in the subregion, the slump in trade and manuacturing

reached a trough early in the year. Te scal stimulus, plus interest-rate

reductions by the Bank o Tailand and the improved global outlook,

will likely stabilize GDP in the second hal o 2009. Te ull-year orecast

is or a contraction in GDP o 3.2%, still a deeper decline than expected

in ADO 2009. Te economy is expected to grow by about 3% in 2010,

a very modest rate given the low base set in 2009. Te Government

plans a substantial public investment program rom October 2009 to

underpin the recovery. However, that program would be at risk i politicalturbulence disrupts policy making and scal disbursement.

Merchandise exports ell by about 23% in the January–June period

o 2009 as external demand dwindled. Imports tumbled by just over

35%, reecting reduced purchases o imported inputs or manuacturing

industries, lower oil prices, and so domestic demand. Te trade surplus

ballooned and the current account surplus was more than three times the

prior-year level. A current account surplus o about 6% o GDP is orecast

or this year, narrowing to about 1% in 2010 in the context o rising costs

or imports both o capital goods or investment projects and o oil.

Te consumer price index ell by 1.9% in the rst 7 months o this

year, rom high levels in 2008 when global ood and oil prices surged.

Prices are expected to turn upward by year-end. Still, the consumer priceindex is now orecast to all by 0.5% in 2009, revised rom March when

slight ination seemed likely. Next year, ination is put at around 2%, on

the basis o higher oil and commodity prices and a gradual recovery in

domestic demand.

Viet Nam

Expansionary scal and monetary policies supported growth o 3.9%

in the rst hal o 2009. Fiscal stimulus measures bolstered public

consumption and domestically nanced investment. Import volumes ell

more steeply than exports, so that net exports contributed to GDP growth.

Furthermore, oil production turned up, aer several years o decline. Te

impact o the global turbulence was reected in a all in merchandise

exports and in remittances, layos, and weaker inows o FDI.

Growth accelerated in the second quarter rom the rst, suggesting

that the economy bottomed early in the year. Given that the scal

stimulus, net exports, and oil output outstripped expectations, the 2009

GDP growth orecast is bumped up to 4.7% rom 4.5% in ADO 2009.

Next year, growth is seen stepping up to 6.5%. Investment is likely to

strengthen in view o the scal and monetary stimuli put in place in 2009

and an expected revival in FDI as the global economy improves. A pickup

in hiring and incomes will stimulate consumption.

Imports dropped much aster than exports in the rst hal, reecting




the slowdown in economic activity, lower import prices, reduced

availability o trade credit, and a shortage o oreign exchange in the

ormal market. Te current account decit or 2009 is now projected at

about 7% o GDP, narrower than projected in March. It will likely widen

to about 9% in 2010 because growth in imports is expected to outstripthat in exports as the economic expansion picks up pace.

Ination decelerated to 8.3% in January–August 2009 rom 23.0% in

all 2008 owing to lower world oil and ood prices and soer domestic

demand. Still, the high-ination inertia was stronger than expected. Te

2009 ination orecast is raised rom that given in ADO 2009 to 6.8%,

and the 2010 orecast revised up to 8.5%, in part owing to rapid growth in

money supply this year.

Other economies

Brunei Darussalam

Tis economy, which relies on exports o oil and natural gas or abouthal its GDP, is expected to contract by 1.2% in 2009 owing to lower world

demand or energy and the all in energy prices rom last year. Tat

would be a more moderate decline than the 1.9% all in GDP estimated

or 2008. Government spending is tempering the contraction and the

nonenergy sector is expected to perorm better in 2009.

Growth is set to resume in 2010 at just over 2%, supported by higher

global energy demand and prices and by the start o exports rom a

$450millionmethanolplant.eGovernmentissteppingupitseorts

to diversiy the economy: one result will be an increase in the number o

Brunei Halal Brand products exported next year.

Ination is expected to stay subdued in view o lower prices this year

or imported commodities and the Government’s policy to subsidizea broad range o products and services. Te ination projections are

maintained at 1.5% or 2009 and 1.2% or 2010. Large current account

surpluses based on exports o energy are expected to moderate in the

orecast period as a result o lower oil prices and reduced income ows

rom investment abroad.

Cambodia

A sharper than expected downturn in clothing exports, construction

activity, and tourist arrivals has prompted a downward revision in the

GDP orecast. Te economy is now expected to contract by 1.5% in 2009,

rather than record slight growth as anticipated in ADO 2009.

US Department o Commerce data show that Cambodian clothing

exports to the USthe leading marketdropped by 27% in the rst

5 months o 2009 rom the corresponding period o 2008, and order

books or clothing in May were signicantly lower than a year earlier.

Construction activity declined as a consequence o alling FDI, notably

rom Korea. ourist arrivals ell by 3% in the rst 4 months o 2009.

Growth is projected to resume in 2010 at about 3.5%, as a gradual

recovery in the global economy stimulates clothing exports and tourism.

Tat should provide support or growth in incomes and consumption.

Ination has decelerated aster than expected, owing to lower

international oil and ood prices and weaker domestic demand as the




economy contracts. Te ination rate or 2009 is now orecast at just

0.8%, revised down rom ADO 2009. It is expected to quicken to about 5%

in 2010, reecting higher prices or imported oil and the improvement in

domestic demand.

In the external accounts, imports ell by 18.1% in the rst hal o 2009,a sharper decline than that recorded or exports (10.3%). ourism arrivals

are expected to pick up in the second hal o 2009 and the rate o decline

in exports may well slow. Te current account decit will be narrower

than orecast in March, at about 5.0% o GDP this year and 7.0% in 2010.

Grossinternationalreservesedgedupto$2.18billionatmidyear,from

$2.16billionatend-2008.

Lao People’s Democratic Republic

Economic growth is easing in 2009 rom rates in excess o 7%, driven

by expansion o mining and hydropower, seen over recent years. Lower

global mineral prices have damped mining activity and construction has

been dented by reduced ows o FDI. Te global economic downturn hasalso hurt clothing exports and tourism earnings.

Government spending, including outlays on inrastructure or the

Southeast Asian Games scheduled to be held in Vientiane later this year,

is helping moderate the slowdown. Te budget decit target has been

widened to 5.0% rom an original target o 3.4%. Economic growth is

orecast at 5.5% in 2009, in line with the ADO 2009 projection, picking up

to 5.7% in 2010 as world commodity prices recover and investor sentiment

improves.

Lower ood and uel prices caused ination to slow to 0.2% in the rst

hal o 2009. Ination orecasts are revised down to 0.7% or 2009 and

4.5% in 2010.

Te current account decit is now projected to narrow to 14.6%in 2009, reecting a aster all in imports than in exports owing to

lower uel and commodity prices and reduced imports o construction

materials and machinery. A narrower trade decit will be partly oset

by a smaller surplus in services due to lower tourism receipts. Te

current account decit is expected to remain at around 14% next year.

Externalreservesof$583millioninMay2009represented3.5monthsof

nonresource import cover.

The Pacic

Subregional assessment and prospectsTe aggregate growth projection or 2009 is edged down to 2.8%

(Figure 3.1.13) rom the 3.0% that was orecast in March’s ADO 2009. Tis

year’s likely outcome represents a sharp slowdown rom 5.2% growth in

2008, when resource exporters in the Pacic beneted rom high global

oil and commodity prices. Only the region’s mining and hydrocarbon

exporters (Papua New Guinea and imor-Leste) and a key reormer

(Vanuatu) are expected to grow at a reasonable rate in 2009.

Five economies (Cook Islands, Fiji Islands, Palau, Samoa, and onga)

are projected to contract, primarily because the global economic slump

has eroded income rom tourism and remittances. Solomon Islands is

3.1.13 GDP growth, the Pacic

-4 0 4 8 12 16

201020092008

Vanuatu

Tuvalu

Tonga

Timor-Leste, Dem. Rep. of a

Solomon Islands

Samoa

Papua New Guinea

Rep. of Palau

Fed. States of Micronesia

Rep. of Marshall Islands

Kiribati

Fiji Islands

Cook Islands

The Pacic

%

a Non-oil, non-United Nations GDP.








now expected to record no growth because its log exports have dropped

sharply. Te growth outlook or Papua New Guinea has improved since

March in tandem with the pickup in global prices or mineral and

petroleum products. imor-Leste also is set to grow signicantly, based

on its income rom hydrocarbons.Governments in the Pacic have generally been overoptimistic this

year in their revenue projections and slow to counter the deterioration in

the economic outlook. Weaker tax and other revenues are hampering the

ability o some o them to meet budget commitments. Most governments

have made across-the-board cuts to unding or goods and services and

maintenance as revenue weakened. Tis nonprioritized approach to

adjustment is expected to impair the delivery o basic services and damp

economic recovery. While restraint has generally been achieved on public

sector pay, thereby avoiding a urther source o scal pressure, in some

cases unsustainable increases have been made. Only a ew governments

have been able to increase needed capital expenditure in order to support

investment and aggregate demand.In 2010, the subregion is expected to post aggregate growth o 3.1%,

a slightly higher outturn than projected in ADO 2009. Forecasts or

the three biggest Pacic economiesFiji Islands, Papua New Guinea,

and imor-Lesteare raised rom March. Higher average global oil

and commodity prices assumed or 2010 in the Update are behind the

improved outlook or Papua New Guinea and imor-Leste, while Fiji

Islands is expected to resume growth aer this year’s contraction in GDP.

Average growth or the Pacic islands (the countries excluding Papua

New Guinea and imor-Leste) is projected to remain low at 0.8% in 2010

in the context o a slow, gradual pickup in earnings rom tourism and

remittances. Te speed o recovery will also depend on urther policy

responses to this year’s slowdown.Lower prices this year or imported uel and ood have trimmed

ination rom the high average level o 9.5% seen in 2008 (although

ination has increased in Fiji Islands this year because o devaluation).

Subregional ination is projected to slow to 6.1% in 2009 (Figure 3.1.14),

slightly below that anticipated in ADO 2009. Te higher average global

oil and commodity prices assumed or 2010 have bumped up the 2010

aggregate orecast rom March to 5.2%.

Te decline in prices this year or ood and other essentials is

providing some relie to vulnerable groups that were seriously hurt by

high prices o these items in 2008. Such groups include people living in

squatter settlements, those lacking their own ertile land, and those living

in the most remote areas.

Country highlights

Fiji Islands

Te economy is expected to contract in 2009, weakened by a decline in

earnings rom tourism and exports partly a result o the global economic

slowdown. Political uncertainties have hurt the economy since a military

coup in 2006 installed an interim government. Lack o progress toward

a government commitment to holding elections since then has led donor

countries to hold back economic assistance and has damaged investor




caused by technical problems at the mines, but that will in part be oset

by higher than expected output rom the Lihir mine.

Reecting the global slowdown and commodity price declines, the

value o exports ell by an estimated 33% in the rst hal o 2009 rom

the prior-year period, suppressing incomes and government revenueand lowering GDP growth rom the pace set in 2008. Growth in private

sector credit slowed to about 25% year on year in June 2009 (rom 40%

in June 2008) and growth in employment moderated to about 6% in the

12 months to March 2009 (rom 10% in the 12 months to June 2008).

Te Government, aced with lower than expected income rom

commodities, widened its targeted budget decit to 3.3% in 2009, unded

by additional drawdowns rom public trust und savings generated

during the commodity boom. It has broadly maintained its operating

expenditure, but cut development spending by about 3%.

Next year, GDP is orecast to grow by 3.9%, raised a touch rom

ADO 2009 on the basis o the Update’s assumptions o higher average

global oil prices.Ination has decelerated in step with the all in global ood and uel

prices, and the 2009 orecast is maintained at 7.0%. Monetary and credit

growth rates remain high, but have decelerated rom late-2008 levels. In

2010, ination is orecast to ease to 5.5% as the economy slows.

Te current account ell into decit in the rst quarter o 2009 as

export values dropped. A decit is still projected or the whole year,

although the pickup in prices o exports, coupled with weaker than

expected imports, has prompted a revision to 6.0% o GDP (rom 7.0%

in March, Figure 3.1.15). Te external decit is orecast to stay at around

thatlevelin2010.Foreignreservesroseto$2.2billion(about14months

o nonmineral imports) at end-May, supported by central bank buying o

oreign currencies in the market to moderate an appreciation o the kina.

Democratic Republic o imor-Leste

Te preerred measure o this economy, that is, excluding petroleum

production and the operations o the United Nations, was revised up

or 2008 rom the preliminary estimate o 10.0% to 13.0%. Development

is based on high levels o public spending that is unded mainly by the

Government’s revenue rom hydrocarbon production. In view o eorts to

trim public spending to more sustainable levels since the easing o world

oil prices, economic growth is expected to slow to about 8% in 2009,

lowered rom the ADO 2009 orecast.

Tis still-robust rate is supported by increases in public sector salaries

and gradual improvements in agriculture, which accounts or about 85%

o employment. Economic growth is expected to edge higher to about 9%

in 2010.

Ination has subsided at a much aster rate than orecast in

ADO 2009, driven by sharp alls in international prices o ood and uel.

(Te use o the US dollar as the national currency has helped in this

regard.) Te consumer price index ell by 1.3% on a year-on-year basis in

the second quarter o 2009. For the ull year, ination is now orecast at

1.5%, revised down sharply rom ADO 2009, and or 2010 the orecast is

lowered to 3.1%.

Withdrawals this year rom the Petroleum Fund, which holds national

3.1.15 Current account balance, the Pacic

-50 -25 0 25

201020092008

Vanuatu

Tonga

Solomon Islands

Samoa

Papua New Guinea

Fed. States of Micronesia

Rep. of Marshall Islands

Kiribati

Fiji Islands

Cook Islands

The Pacic

% of GDP








savingsexceeding$4billionfromoshorehydrocarbonproduction,are

budgeted to exceed estimated sustainable income. Te key challenge is

to use these withdrawals or broad-based development to reduce poverty,

while ensuring that adequate savings are retained to und the budget or

uture generations. Agriculture will likely be the main source o incomeor most o the population or some decades and urther investment is

required in this sector. However, current government intervention in

the market as a buyer and seller o agricultural produce may not be as

productive as conventional policies to invest in agricultural extension

services, improvements to access to markets, and human capital.

Other Pacic economies

Samoa

Te outcome or 2008 has been revised down to show a contraction o

3.4%. Several negative inuences had a more severe impact than had been

estimated. Tese included job losses at the Yazaki plant that assemblesautomobile parts or export, a all in remittances, weakness in tourism,

and the erosion o purchasing power due to high ination.

Tis year, tourism has beneted rom Fiji Islands’ problems o

ooding and political uncertainty, as well as rom increased airline

services and recent hotel developments in Samoa. Tese eects, combined

with the lming in Samoa o the television series “Survivor,” are expected

to raise tourism receipts. However, the real value o remittances ell by

about 9% in the 12 months to June.

Te economic contraction is projected to extend through this year

and next, although the pace is projected to moderate to 0.8% in 2009 and

0.6% in 2010. Government spending on inrastructure will avert a sharper

contraction.Ination eased to 9.2% year on year at June 2009, hal last year’s

peak. Te ull-year orecast is revised down to 5.7%. Ination is expected

to decline urther to 3.2% in 2010 (but raised rom the March orecast

because o the higher oil price assumption in the Update). International

reserves increased to the equivalent o 5.1 months o imports as o

June 2009, above the target o 4.0 months. However, the outlook or

the current account is o concern. Te Government’s macroeconomic

ramework suggests current account decits o 14–16% o GDP in the next

2 years. Tat would put extra pressure on debt levels and so requires a

plan to prioritize capital investment and strengthen revenue.

Solomon IslandsTe economy has been hit by the global downturn as well as by bad

weather in 2009. Exports (mainly logs), sh, palm oil, and copra ell by

11% in value in the rst quarter o this year. Logging volumes dropped

sharply in the rst hal and look likely to all by about 30% to 1.1 million

cubic meters in 2009. GDP is expected to be at in 2009, revised rom an

expansion o 2.2% projected in ADO 2009.

Growth is now seen resuming in 2010 at 2.6%, a slightly aster pace

than previously orecast, provided there is a determined response rom

the Government to the economic slowdown. Agricultural production is

expected to pick up and the decline in logging in 2010 might not be as




severe as in 2009. Still, high population growth implies no per capita

GDP growth in the orecast period. Prospects or overall economic

growth remain modest thereaer given a long-term decline o native

orest resources caused by overlogging.

Te weakness in exports suggests that current account decits willbe worse than oreseen in March, now projected at 10.6% o GDP this

year and 18.6% in 2010. Foreign reserves stabilized at about 3 months o

import cover in July 2009, aer alling to 2.5 months earlier in 2009, in

part a result o substantial aid disbursements. Tese eects will wane

as the aid unds are spent, and oreign reserves may again come under

pressure.

Flooding in Guadalcanal caused ination to surge to 16.5% in the rst

quarter o 2009, beore it decelerated to 9.3% in June. Te year-average

orecast or this year is lowered a shade to 8.3% in the context o the

slack economy. However, the orecast or 2010 is revised up to 6.9% on

the basis o assumed increases in global prices o oil and other imported

commodities.Government revenue ell short o expectations by 11% in the rst

quarter o 2009, the result o an erosion o tax income caused by the

slowing economy and drop in oil prices, coupled with the sharp decline

in logging revenue. Te Government is committed to avoid borrowing,

so will need to consider a combination o trimming expenditure, raising

additional revenue, and reocusing public resources to prioritize basic

needs such as health and education.

onga

Remittances ell by 14% in the 12 months to June 2009, reecting

recessions in two main source markets, the US and New Zealand, and

soening demand or seasonal workers in Australia. Furthermore, bank lending is constrained because commercial banks tightened credit policies

aer a rapid increase in bad loans. Te economy probably contracted by

about 0.5% in FY2009 (ended 30 June 2009), but by less than was orecast

in March.

Growth is expected to resume in FY2010 at about 0.5%, a revision

rom the ADO 2009 orecast or a continued contraction. Te domestic

content o capital works that are being supported by concessionary

unding rom the People’s Republic o China is now expected to be

higher than originally thought, raising its contribution to GDP. However,

the economy remains highly vulnerable to external conditions, notably

changes in remittance inows.

Ination in FY2009 is estimated at 6.2%. Te ination orecast or

FY2010 is raised to 3.1%, given the increase in global oil prices over

recent months.

Government revenue and grants received at the end o the rst

quarter were about 20% under budget. otal expenditure was also below

budget, resulting in a scal surplus at end-May 2009. Te surplus appears

to reect controls on spending or operation and maintenance, which

could reduce delivery o public services, rather than controls on the

Government’s wage bill. In the external accounts, the level o oreign

reserves rose to 4.7 months o import cover in the rst hal o 2009.




Vanuatu

ourist arrivals rose in the rst 5 months o 2009: those on cruise ships

by 58% and those via air travel by 18%, partly a result o the problems

experienced in Fiji Islands. Te strength in tourism and signs o a rming

in domestic demand suggest that GDP growth will be about 4% in 2009and 3.5% next year, both revised up rom ADO 2009.

Te economy expanded by an average o 6.5% in the 5 years to 2008,

driven largely by private-sector investment in tourism and construction

and underpinned by policy reorms that included the opening o the

telecommunications and aviation markets.

However, the pace o credit growth is worrisome. Credit to the private

sector grew by 35.3% over the 12 months to May 2009, slowing only

slightly rom 44.0% earlier this year. Entry o new banks in the economy

has contributed to this surge in credit. Tere is a risk that the level o

nonperorming loans will rise as economic growth pulls back.

Fiscal surpluses and strong economic growth have reduced the ratio

o public debt to GDP by more than hal over the past 7 years to 18.4%.Tis gives the Government room to take countercyclical scal measures i

the economy slows more sharply than expected.

Ination remained quite high at 6.1% year on year in the rst quarter

o 2009, despite lower global prices or ood and uel. Te orecast is

revised up to 4.3% or this year and to 3.0% in 2010, based on upward

revisions to GDP as well as to international oil prices.

Foreign reserves, equivalent to 5.0 months o import cover in June

2009, were down rom 5.8 months at end-2008 but above the central

bank’s minimum target o 4 months.

Others

For Cook Islands, the outcome or 2008 and outlook or 2009 are reviseddown. Economic data or last year, when tourist arrivals ell, has been

revised to show a GDP contraction o 1.2%, rather than a slight expansion

as previously estimated. Low investment and the erosion o real incomes

rom high ination point to the contraction extending into 2009. But the

extent o the decline is expected to moderate to about 0.1%, with tourism

getting some support rom subregional sporting events and conerences

held in the Cook Islands. Growth is orecast to return in 2010 at the low

rate o 0.8%. Te Update raises the ination orecast to 6.5% or 2009, but

still oresees a deceleration o price pressures next year.

Updated GDP estimates or Federated States o Micronesia in FY2008

(ended 30 September 2008) now show a sharper GDP contraction o 2.9%,

compared with a 1.0% decline in ADO 2009. Nevertheless, the outlook

has improved because o a pickup in externally unded inrastructure

projects. ourism and remittance inows are sluggish, largely owing to

recessions in the US and Japan. GDP is now expected to grow by about

0.5% in FY2009, revised rom a March orecast or a slight contraction,

and also expand by about 0.5% in FY2010.

Te growth estimate or Nauru is downgraded to 1.0% in FY2009

(ended 30 June 2009) and its GDP in FY2010 is orecast to be at.

Downward revisions (rom 1.5% growth in both years in ADO 2009) stem

rom a slowdown in external demand or Nauru’s phosphate, particularly

rom Australia, and the consequent decline in phosphate prices. In line



Bangladesh

Bangladesh experienced adverse eects rom the global downturn, primarily through slower growth o

exports and workers’ remittances, and damped investment sentiment. Still, it has maintained relatively

strong expansion, reduced infation, and kept a current account surplus. For FY, this Update maintains

the projections made in March or moderately slower growth and infation relative to FY, but now

orecasts a small current account surplus rather than a decit. The medium-term trajectory will depend

heavily on the Government’s ability to implement reorms, which include substantially boosting budget

revenue and raising inrastructure investment.

Updated assessmentGDP growth o 5.9% is estimated or FY2009 (ended June 2009), below

the perormance o the previous year but somewhat higher than the

projection o 5.6% made in the Asian Development Outlook (ADO 2009)

released in March this year (Figure 3.2.1).

Tis stronger outturn is due to better than expected agricultural

expansion, at 4.6%. Te output o aman, the second rice crop (harvested

in November–January), rose to 11.6 million tons, a 19.6% rise over the

previous scal year and reecting a strong recovery rom the severely

damaged FY2008 crop. Boro, the major rice crop (harvested in April–

May), is estimated at 17.8 million tons, marginally exceeding FY2008’s

record output. Crop production beneted rom avorable weatherconditions as well as strong support rom the Government that enabled

armers to access inputs and credit. Services sector growth (at 6.3%, down

rom 6.5% in FY2008) moderated, largely as a result o slower export and

import activity.

Industrial growth o 5.9% ell below both the ADO 2009 projection o

6.6% and the 6.8% outturn o FY2008, as export production in the second

hal o the scal year slowed more sharply than expected. Weakening

construction activity and power outages pulled back manuacturing

growth. Slow implementation o energy projects continued to restrict

industry’s expansion, although the new Government (elected in January

2009) has given power generation and gas development a high priority, as

outlined in the ruling party’s election maniesto and reected in a new

public–private partnership (PPP) scheme.

GDP growth in FY2009 was again driven by consumption

expenditure (Figure 3.2.2). Accounting or about our hs o GDP,

it grew by 5.8%, up rom the previous year’s 5.4%. Growth in private

consumption, which constitutes about three quarters o GDP, was, at

6.0%, stronger than FY2008’s 5.5%. Public consumption as a share o GDP

declined or the third consecutive year.

Private investment, growing by 7.2%, lied its share rom 19.3% o GDP

3.2.1 GDP growth by sector

0

2

4

6

8

10

0908072006

%

6.65.96.26.4

GDP growth

Services

Agriculture

Industry

Source: Bangladesh Bureau o Statistics, National Accounts

Statistics , May 2009.


This chapter was written by Mohammad Zahid Hossain, Md. Golam Mortaza, and

Shamsur Rahman o the Bangladesh Resident Mission, ADB, Dhaka.

3.2.2 Contributions to growth (demand)

2005 06 07 08 09

Percentage points

-2

0

2

4

6

8

GDP growth

Statistical discrepancy

Consumption

Net exports

Investment

Source: Bangladesh Bureau o Statistics, National AccountsStatistics, May 2009.









in FY2008 to 19.6% in FY2009, reecting improved business condence

ollowing the orderly return to elected government. Public investment,

in contrast, declined urther, sliding rom 5.0% o GDP to 4.6%, as

implementation o the annual development program (ADP) remained

weak. Overall investment remained unchanged at 24.2% o GDP.I Bangladesh is to attract greater investment, particularly rom

abroad, it will need to address some increasingly binding constraints.

Tese are elt especially in inrastructure and the business environment,

and include acute power shortages, transportation bottlenecks, inadequate

and inefcient port acilities, high business startup costs, and slow

institutional reorms.

Ination ell steadily through the scal year, rom 10.8% year on year

in July 2008 to 2.3% in June 2009 (Figure 3.2.3). Annual average ination

declined to 6.7% in FY2009 (slightly lower than the ADO 2009 projection

o 7.0%), rom 9.9% in FY2008. Te sharp decline in import prices

and the rise in domestic ood production were the main actors. Te

successive cuts in domestic uel prices in October and December 2008and in January 2009, in line with the all in global oil prices, also helped

(though the xed administrative prices o uel have not since been raised

as oil prices rose subsequently). Although ood ination has declined

sharply, nonood ination has edged up since January 2009, reecting the

accommodative monetary policy o Bangladesh Bank, the central bank.

Reaching 24.0% in June 2009, the growth o net credit to government

was high throughout FY2009, reecting lower availability o external

nancing. Te 19.2% growth in money supply (M2) in June 2009 was

higher than the central bank’s annual program target o 17.5%. Private

sector credit rose by 14.6% in June 2009; this was less than the annual

program target o 18.5% and was largely on account o the slowdown in

credit demand as the global recession damped domestic economic activity (Figure 3.2.4).

Yields on reasury bills rose marginally during the year to March

2009, but then ell sharply along with commercial banks’ call money rates

as bank liquidity surged (Figure 3.2.5). Banks’ weighted average lending

rate remained unchanged at 12.3% rom the beginning o the scal year.

o bolster credit conditions and the economy, Bangladesh Bank cut

both the reverse repo and repo rates (1–2-day maturity) by 25 basis points

in March 2009 to 6.5% and 8.5%, respectively. Moreover, in the March–

June quarter, it adjusted its open-market operations to allow a marked

runup in reserve money, which immediately ed through to much lower

short-term money market rates. However, with no corresponding decline

in commercial lending rates, Bangladesh Bank decided to use mandatory

measures and directed banks to lower their maximum lending rate to

13% in a urther eort to lower the rate structure and boost credit to the

private sector. (Until that decision, the maximum rate had been 16% on

agricultural loans.)

Te weighted average deposit rate rose to 7.5% in March 2009 rom

7.0% in June 2008. Te interest spread o the banking system narrowed

to 4.8 percentage points in March 2009 rom 5.7 percentage points in

March 2008.

Revenue collection in FY2009 is estimated at 11.2% o GDP, similar to

FY2008 (Figure 3.2.6). Revenue growth missed its target because o a all

3.2.3 Change in consumer price index and

components

0

2

4

6

810

12

14

AprJan

09

OctJulAprJan

08

OctJulAprJan

2007

%

NonfoodbFoodbOverallbOveralla

a Year on year. b 12-month moving average.

Source: Bangladesh Bank, Economic Trends, June 2009,available: http://www.bangladesh-bank.org, downloaded24 August 2009.


3.2.4 Growth o monetary indicators

5

11

17

23

29

35

Credit to private sector

Credit to government

Broad money

MayFeb

09

NovAugMayFeb

08

NovAugMay

2007

%

Source: Bangladesh Bank, Economic Trends, July 2009,available: http://www.bangladesh-bank.org, downloaded28 August 2009.


3.2.5 Interest rates

0

4

8

12

16

20

LendingCall money

12 day reverse repo12 day repo

Q2

09

Q4Q2

08

Q4Q2

07

Q4Q2

06

Q4Q2

2005

%

Sources: Bangladesh Bank, Economic Trends, June 2009;

Major Economic Indicators: Monthly Update, July 2009,available: http://www.bangladesh-bank.org, both











South Asia Bangladesh 119

in import prices that eroded the import-stage tax base, which accounts

or over 40% o tax receipts. Domestic indirect taxes also perormed

below target as economic activity decelerated in response to the global

economic downturn. Te revenue outturn is low compared with countries

at a similar stage o development and limits essential public spendingon inrastructure and human development. Te poor perormance

stems rom the narrow tax base, excessive exemptions, and weak tax

administration.

Te new Government announced several tax measures in the FY2010

budget, among others expanding the tax base, withdrawing exemptions

and exclusions, simpliying procedures, amending laws, and streamlining

tax administration. As a step toward eliminating tax holidays, it

introduced a system o reduced corporate tax rates or certain sectors in

lieu o existing tax holiday schemes. In an eort to expand the tax base,

the Government will also conduct surveys covering cities, districts, and

subdistricts to identiy those who have avoided tax (by not ling). It also

announced a tax amnesty program or FY2010: a modest 10% tax is leviedon the declared amounts i they are invested in areas specied by the

authorities, such as the stock market.

Savings on ood, uel, and ertilizer subsidies enabled by the all

in international commodity prices and by underspending in the ADP

saw FY2009’s public spending come in at 15.3% o GDP, lower than the

budget target o 16.3%. As savings on public spending were larger than the

shortall in revenue, the scal decit o 4.1% o GDP was narrower than

the budget target o 5.0%. O the total decit, 2.3% o GDP was nanced

domestically and 1.8% externally.

In FY2009, the net losses o the 44 nonnancial state-owned

enterprisesshranksharplyfrom$1.5billiontoonly$22.5million.A

high prot earned by the Bangladesh elecommunication Regulatory Commission (rom auctioning licenses to telecoms utilities) and higher

earnings by Bangladesh Oil, Gas and Mineral Resources Corporation

(rom international oil companies aer cost recovery was completed)

largely oset the combined losses o all other enterprises (Figure 3.2.7).

Bangladesh Petroleum Corporation generated a prot or part o

the year when international oil prices were low, but incurred losses

again when these prices rose but administered domestic prices were le

unchanged.ItsoveralllossinFY2009wasabout$520million,compared

withabout$1.4billionayearearlier.ecorporationisexpectedto

record large losses in FY2010 i oil prices remain high and administered

prices unadjusted. Bangladesh Power Development Board also registered

sizable losses in FY2009.

Te trade decit narrowed markedly in FY2009 (by 1.4% o GDP

rom a year earlier) as import payments grew more slowly than export

earnings. Export growth decelerated steadily as FY2009 unolded due to

weak global demand and declining prices, rom 42.4% in the rst quarter

to 19.4% in the rst hal and urther to 10.3% or all FY2009 (Figure 3.2.8).

Weak retail sales in industrial economies caused a slowdown in garment

export orders over the year. Moreover, as product prices ell by more

than raw material prices, exporters’ prot margins shrank, retarding

sales o some products. Earnings rom “other” exports ell rom a year

earlier, largely due to a sharp drop in demand or processed leather,

3.2.6 Government revenue

0

3

6

9

12

NontaxTaxTotal

09080706052004

% of GDP

10.111.211.1

10.210.710.5

Source: Asian Development Outlook database.


3.2.7 Prots and losses at selectedstate-owned enterprises

-1,500

-1,000

-500

0

500

Bangladesh Petroleum Corporation

Bangladesh Telecommunication Regulatory Commission

Bangladesh Power Development Board

Bangladesh Oil, Gas and Mineral Resources Corporation

09080706052004

$ million

Note: Data or 2009 are up to 29 April only.

Source: Ministry o Finance, Bangladesh Economic Review

2009.


3.2.8 Growth in exports and components

-10

0

10

20

30

40

Total

OthersWoven garments

Knitwear products

09080706052004

%

Sources: Bangladesh Bank, Annual Report 2007–08 and

Major Economic Indicators: Monthly Update, July 2009,available: http://www.bangladesh-bank.org, downloaded

13 July 2009.











and or rozen ood, which is an item with a high income elasticity o

demand.

Imports rose by only 4.1% in FY2009 because o alling commodity

prices, particularly or oil, and a sharp decline in rice imports attributable

to the excellent domestic crop harvests (Figure 3.2.9). Although growthin remittances slowed, inows rom that source still climbed by 22.4%

to$9.7billioninFY2009(Figure3.2.10),inviewofthejumpinworkers

who went abroad in 2007 and 2008 (and who are sending money back

home). Given the substantial improvement in the trade decit and the

continued increase in remittances, the current account surplus ballooned

to$2.5billion(2.8%ofGDP),from$680millioninFY2008.

Te combined capital and nancial account switched to a decit

of$357millioninFY2009fromasurplusof$119millioninFY2008,

reecting a net outow in portolio investment, a decrease in net inows

o medium- and long-term loans, and an increase in net outows o

short-term loans, trade credit, and other assets, despite the rise in net

oreign direct investment. Net o errors and omissions and valuationchanges,grossforeignexchangereservesroseto$7.5billionatend-June

2009,about$1.3billionabovethelevelayearearlier(Figure3.2.11).

Te exchange rate remained largely stable against the US dollar in

FY2009, with the taka depreciating by about 0.8%. Te real eective

exchange rate appreciated by around 8%, in part reecting relatively

higher domestic ination and implying some erosion in export

competitiveness.

Te Dhaka Stock Exchange general index experienced ups and downs

in FY2009, though its end-June level was essentially unchanged rom a

year earlier (Figure 3.2.12). As at end-July 2009, the index had registered

a gain o 4.3% in 7 months. Te expected listing o GrameenPhone, the

country’s largest mobile phone company, in October 2009 will deepenthe market, encourage other large companies to list, and boost investor

condence. Lower corporate tax rates in FY2010 or mobile phone

operators, provided that they list on the stock exchange, should encourage

other mobile phone companies to ollow. Market capitalization rose by

36.1%duringFY2009toreach$19.0billioninJune2009(orover21.0%of

GDP), reecting the listing o companies and declaration o bonus shares

in lieu o cash dividends.

ProspectsTe orecasts or FY2010 depend on some key assumptions. It is assumed

that political stability will prevail, and that the Government will be able

to move orward in ullling its development priorities, sustain its ocus

on prudent macroeconomic management, and deepen economic reorms.

It is also assumed that the measures outlined in the FY2010 budget to

accelerate ADP utilization (streamlining project approval processes and

raising institutional capacities in key line ministries) will be implemented,

and that the private sector will invest more in inrastructure through the

new PPP scheme.

It is urther assumed that the Government will be able to mobilize

adequate external assistance and improve revenue mobilization, and

3.2.10 Workers’ remittances

0

3

6

9

12

0

3

6

9

12

% of GDPValue

09080706050403022001

$ billion %

Source: Bangladesh Bank, Annual Report 2007–08, available:http://www.bangladesh-bank.org, downloaded 13 July2009.


3.2.11 Gross oreign exchange reserves

0

2

4

6

8

JunFeb

09

OctJunFeb

08

OctJunFeb

07

OctJun

2006

$ billion

Source: Bangladesh Bank, Economic Trends, June 2009,available: http://www.bangladesh-bank.org, downloaded

24 August 2009.


3.2.9 Growth in imports and components

-50

0

50

100

150

200

Total

Others

Fertilizer

Crude and refined petroleum

Other food items

Foodgrains

09080706052004

%

Sources: Bangladesh Bank, Annual Report 2007–08 and

Major Economic Indicators: Monthly Update, August 2009,available: http://www.bangladesh-bank.org, downloaded

29 August 2009.











or concealing normal income so as to take advantage o the much

lower tax rate applied, and could urther undermine compliance as

taxpayers underpay current tax in anticipation o uture amnesties. Te

new revenue-enhancing measures in the budget may also take time to

yield results.Because o the substantially higher public expenditure (16.6% o

GDP), the overall decit will rise to 5.0% o GDP rom 4.1% in FY2009

(Figure 3.2.13). Foreign nancing is 2.0% and domestic nancing 3.0% o

GDP, with over our hs coming rom the banking system. Te absence

o an active secondary bond market limits nonbank investors’ interest in

this source o noninationary nancing. Stunted tax receipts are proving

costly as borrowing shrinks the scal space through high budgetary

allocations or interest payments, which amount to 18.2% o revenue in

FY2010. In the event o shortalls in revenue and external nancing,

the Government would either have to borrow more heavily rom

bankssqueezing private investment and ueling inationor cut public

spending, which would aect its growth and poverty reduction programs.For FY2010, this Update retains the ADO 2009 average ination

projection o 6.5% (slightly lower than FY2009’s actual 6.7%), as import

price increases are expected to be moderate and the projected growth

in crop output, though decelerating rom FY2009, will remain healthy.

In addition, moderation in domestic demand growth due to slower

remittance inows will soen price pressures. Tis projection does not,

however, take into account the possibility o an adjustment to domestic

uel prices or the eects o any excessive government borrowing rom the

banking system.

In its hal-yearly Monetary Policy Statement or July–December 2009,

the central bank sought to continue its accommodative policy: supporting

the Government’s borrowing needs to nance its countercyclicaldevelopment program while ensuring an adequate ow o credit to

the private sector. Its monetary program is aimed at 6.0% growth with

ination projected at 6.5% by June 2010, largely on continuation o the

lowered policy rates, open-market operations, and the banks’ ceiling

lending rate. Te statement indicated that the monetary policy stance

would be modied i ination or growth prospects were to substantially

deviate rom program goals.

Imports in FY2010 are expected to grow by 10.0%, in part reecting

increased global commodity prices. Export growth is projected to be

sluggish at 8.0% because o alling garment export orders and the lower

prices oered by buyers, as well as the declines in most other export

categories. Growth in workers’ remittances is expected to slow to 12.5%

because o increasing numbers o overseas workers returning home and

because o the marked slowdown in the outow o migrant workers. Yet,

because o the likely moderate trade decit, a current account surplus o

0.8% o GDP is still orecast.

Bangladesh aces several risks that could result in the economy

ailing to achieve the projections: a delay in the global economic

recovery; shortal ls in revenue collections and mobilization o external

nancing, especially given the high targets set on each; political turmoil;

and natural disasters.

.. Public–private partnerships

Te new Government in its electionmaniesto stated that it wants to seethe country growing at by FY

and at by FY. It estimatesthat investment o $ billion abovecurrent levels will be needed orinrastructure investment by FY toachieve these high growth rates.

Te Government realizes that thisgreater investment will not be made i it continues to rely on the traditionalannual development program (ADP)approach o public sector–led projects.Te public–private partnership (PPP)scheme included in the FY budgetis designed to address weaknesses inthe ADP-based approach or deliveringinrastructure, which is characterizedby complex project-clearanceprocedures, inadequate implementationcapacity, and lack o monitoring. Teseweaknesses have resulted in substantialshortalls in ADP spending and theailure o inrastructure to grow in linewith the economy’s needs.

Based on encouraging experiencewith PPPs in various other countries,the Government has taken threespecial measures in the FY budgetto involve the private sector alongside

itsel in the PPP initiative. It eelsthat successul implementation o thePPP concept will open opportunitiesor higher ows o local and oreigninvestment in inrastructure,particularly in transport and power.

Te three measures are PPPechnical Assistance to provide nanceor easibility studies; a Viability GapFund to provide subsidies or certainsocially benecial projects such ashospitals, schools, and roads; and anInrastructure Investment Fund to

provide equity or loan nancing toprivate investors in PPP projects.Yet setting up a sound PPP

initiative will be a challenge. Tecapacity problems that have bedeviledthe ADP approach will need to beaddressed in PPPs as well, particularly in regard to the high level o technicaland analytic capacity that will beneeded to examine PPP projects.




the rst hal and real rural incomes by 8.7%, both above GDP growth.

Retail sales grew by 16.2% in real terms in the rst hal (Figure 3.3.4),

supported by these income gains and by government incentives to buy

household appliances and, in rural areas, motorcycles. Automobile

sales rose by 28.5% in nominal terms in the rst 8 months o 2009. TeGovernment cut the purchase tax on smaller passenger cars and oered

subsidies in cities to replace older cars.

Residential property sales jumped by 57.1% in value terms during

January–June (though the prior-year base gure was airly low, a result

o policy tightening through 2007 and early 2008 to damp a surge in

housing prices). Tis recovery was spurred by low interest rates, abundant

credit, tax breaks, and lower down-payment requirements. Residential

construction starts, as measured by oor space, increased by 11.4%, as a

result o strong demand.

Te global trade slump hit external trade: merchandise exports started

to all rom prior-year levels in November 2008, and dived by about

22% year on year in the rst 7 months o 2009. Te pace o contractionbottomed in May (Figure 3.3.5). Merchandise imports also dropped, but

by June the decline in import values, too, had slowed, a result o the

pickup in industrial production. Te decline in import volumes was more

moderate than their values, reecting the slump in world prices or raw

materials.At$34.9billion,thetradesurplusinthesecondquarterwasthe

smallest in 3 years.

Foreign direct investment (FDI) inows were also aected by the

global nancial crisis and economic downturn. FDI declined year on

yeareachmonth,forafallof20.3%to$48billionintherst7months

of2009.Foreignexchangereserves,climbingby$185.6billionto

$2.13trillionintherst6months,grewfasterthanthetradesurplusand

FDI, prompting concerns about rising speculative capital inows. Tenominal yuan exchange rate was virtually pegged to the US dollar in the

rst 7 months, while the real eective exchange rate depreciated by 4.5%

(Figure 3.3.6).

With global prices or commodities and uels well below year-earlier

levels, both the producer price index and the consumer price index

(CPI) ell, by 6.2% and 1.2%, respectively, in the rst 7 months o 2009

(Figure 3.3.7). Te CPI decline largely reected lower ood prices and

higher ood production than in the previous year. Prices o residential

property, aer several months o declines, rose by an average o about 1%

year on year in July in 70 big cities as demand gained momentum.

Te expansionary monetary stance adopted in late 2008 sparked a

huge surge in lending in the rst 6 months o 2009 (Figure 3.3.8). New

lendingjumpedtoCNY7.37trillion,or$1.08trillioninJanuary–June

rom CNY2.45 trillion in the year-earlier period, ar exceeding the

Government’s ull-year target o CNY5 trillion. Indeed, new lending was

equivalent to around 50% o GDP or the 6 months, double the average

levels o the previous 2 years.

State-owned enterprises and large private businesses were the major

borrowers, particularly those involved in inrastructure, business services,

and real estate development. Te Government approved a large number

o investment projects as part o its scal stimulus and it reduced the

minimum equity requirements or xed-asset investment projects.

3.3.3 Fixed asset investment growth

9

18

27

36

45

Q2Q1

09

Q4Q3Q2Q1

08

Q4Q3Q2Q1

2007

%

Real

Nominal

Sources: CEIC Data Company Ltd., downloaded 31 August2009; sta estimates.


3.3.4 Retail sales growth

5

10

15

20

25

RealNominal

JulAprJan

09

OctJulAprJan

2008

%



3.3.5 Trade indicators

-60

-30

0

30

60

-44

-22

0

22

44

Trade balanceImport growthExport growth

JulAprJan

09

OctJulAprJan

2008

% $ billion



3.3.6 Exchange rates

6.7

6.9

7.1

7.3

100

110

120

130

Real effectiveNominal

JulAprJan

09

OctJulAprJan

2008

CNY/$ 2005 = 100


2009.












East Asia People’s Republic o China 125

Growth in broad money supply (M2) accelerated to 28.4% in July,

exceeding the Government’s annual target o 17%, and M1 rose by 26.4%

(Figure 3.3.9). Rapid growth in money supply and bank lending supported

increases in stock and property prices. Shanghai’s Composite Index o

stocks rose by about 47% in the rst 8 months o this year. Te strongermarket prompted the authorities in June to li a ban on initial public

share oerings that was imposed in October 2008 in an eort to support

a weak market at that time.

Te ood o credit also raised concerns about its potential to inate

asset bubbles and to raise the nonperorming loan ratio at banks. In July,

the China Banking Regulatory Commission asked lenders to li reserves

to 150% o their nonperorming loans by end-2009 rom 135% at midyear

and urged banks to ensure that loans or investment in xed assets are

not diverted to speculative activities. Te People’s Bank o China, the

central bank, drained excess liquidity rom the money market and guided

money market interest rates higher in July.

Te pace o growth in new lending slowed in July and August romthe torrid rate set in the rst 6 months. Data rom the central bank

show new lending o CNY355.9 billion in July and CNY410.4 billion

in August, compared with a monthly average o CNY1.23 trillion in

January–June.

Fiscal stimulus measures being rolled out rom November 2008

through end-2010, costing about CNY4 trillion (13% o 2008 GDP),

include social and inrastructure spending, reconstruction o public

acilities damaged by the May 2008 Sichuan earthquake, and subsidies

to armers and some industries. Te Government has committed

CNY1.18 trillion; the rest comes rom local governments, banks, and state-

owned enterprises. According to the Ministry o Finance’s disbursement

schedule, about hal the central Government’s contribution will be spentby end-2009 and the other hal in 2010.

About 24 million new jobseekers will enter the labor market in

2009, at a time when millions o workers have lost their jobs as a result

o the economic slowdown. Te Government estimated in February that

about 20 million migrant workers were unemployed at that time. Te

labor market started to pick up in the second quarter; about 6.7 million

jobs were created in the rst 7 months. Many o the migrant workers

who lost their jobs have been rehired since February, although some o

the new jobs are in lower-wage positions or involve reduced working

hours. Out-o-work migrant workers have been at risk o alling into

poverty because they are ineligible or social protection programs

(Box 3.3.1).

Te PRC has taken steps in 2009 to gradually increase the role o

the yuan in international nance and trade. In September, the Ministry

o Finance disclosed plans to sell yuan-denominated government bonds

in Hong Kong, China or the rst time. Tat ollowed the granting o

permission or banks there to issue yuan bonds. Te People’s Bank o

China established bilateral currency swap agreements with several other

central banks, mainly in Asia, that will enable oreign rms to pay or

imports rom the PRC in yuan. It has also allowed the yuan to be used in

certain trade settlements.

3.3.7 Monthly infation

-10

-5

0

5

10

15

Producer prices

Consumer prices

JulJan

09

JulJan

08

JulJan

2007

%



3.3.8 Bank lending

16

21

26

31

36

41

6

12

18

24

30

36

GrowthLevel

JulAprJan

09

OctJulAprJan

2008

CNY trillion %



3.3.9 Money supply growth

0

10

20

30

M1

M2

JulAprJan

09

OctJulAprJan

2008

%












.. Selected economic indicators (%)

ADO

Update ADO

Update

GDP growth . . . .

Infation . -. . .

Current acct. bal.

(share o GDP)

. . . .

Source: Sta estimates.

ProspectsTe orecasts assume that the scal stimulus will be maintained through

2009 and 2010. It is also assumed that monetary policy, aer some ne

tuning, will be kept at highly stimulatory levels until ination returns

and economic growth can be sustained without such strong monetary stimulus, when policy will be tightened somewhat.

Public investment will remain at high levels under the scal stimulus

package. Furthermore, as part o a program to improve the efciency

o industries including steel and textiles, the Government plans to

contribute CNY600 billion toward research and technical innovation in

these industries. Expansionary monetary policy is expected to provide

ample unding or state-owned enterprises, especially those engaged in

inrastructure development.

Private sector investment may remain subdued, particularly in

manuacturing, until external demand improves signicantly. Ofcial

proposals to widen access to credit or small and medium-sized

enterprises, i realized, should stimulate private investment. So will the

rebuilding o inventories. In real estate, recoveries in sales and prices o

residential property are encouraging developers to invest in new projects,

and the outlook or commercial property is also improving.

Drawing these strings together and taking into account that

government-led investment in the rst hal o 2009 was stronger than was

anticipated in ADO 2009, investment growth this year will rise aster than

oreseen in March.

Solid growth is expected in private consumption. Rural incomes are

beneting rom government subsidies or agriculture and or purchases o

Te scal stimulus package includes measures to preserveemployment, assist city-registered residents who arejobless, and provide reemployment services. However,migrant workers, who are more likely than others to losetheir jobs during a downturn, are oen excluded romsuch programs in both labor-receiving cities and labor-exporting rural areas.

For example, most migrant workers are ineligible orvocational training allowances. Also, as many are youngadults, their children are oen too young to qualiy orree primary school education.

Tose most at risk o alling into poverty are joblessmigrant workers who either stay in cities and lack accessboth to government support programs and to their amily networks, or those who return to the countryside but do

not have suitable arming land or a means o livelihood.Limited data make it difcult to estimate the magnitude

o these two groups, but they are clearly sizable. Asenior ofcial at the National People’s Congress in Marchestimated that a quarter to a third o migrant workers wereunemployed in some regions. According to a survey by

the National Bureau o Statistics, the total number o ruralmigrant workers was million at end-, o whom million had moved outside their counties to seek jobsin cities while million had moved to work in village andtownship enterprises within their counties.

Te Government has the capacity to tackle the mosturgent vulnerabilities by building on existing programs.Some measures the Government could consider include:

Providing migrant workers without incomes access to•temporary income assistance programs;Providing assistance or the education and nutrition o •their children;Allowing migrant workers access to vocational training•and reemployment services; andCoordinating social assistance programs provided by •

dierent levels o government to ensure that migrantworkers are covered.Tese interventions could complement existing

employment initiatives, such as support or labor-intensivesmall and medium-sized enterprises and provision o public service jobs.

.. Social assistance or migrant workers




3.3.13 Monetar y policy indicators

5

10

15

20

4

6

8

10

Base lending rateBank reserve requirement

JulAprJan

09

OctJulAprJan

2008

% %

Sources: People’s Bank o China; CEIC Data Company Ltd.,downloaded 31 August 2009.


were signicantly weaker than currently oreseen, PRC exports and

industrial production would be lower than anticipated, as would GDP

growth.

Te scal stimulus package looks likely to be maintained through

2010. Tere seems little risk o an earlier than expected withdrawal, whichwould damp growth. As or the monetary expansion, some moderation

in the aggressive stance is assumed. Policy ne tuning was seen rom July

2009 and ofcials have said that they are considering a range o policy

tools to adjust bank lending.

At some point, the authorities will also likely reconsider the cuts

made in late 2008 in the bank reserve requirement ratio and in the base

lending rate (Figure 3.3.13), implemented when the global nancial crisis

and economic slump intensied. I the monetary stimulus is withdrawn at

a aster pace than assumed, and beore economic growth can be sustained

at high levels without the stimulus, an unintended abrupt slowing in

economic growth becomes a risk.

he authorities ace the challenge o balancing the need tomaintain the monetary stimulus against the risk that the lood

o bank lending, i extended or too long, may be diverted into

unproductive purposesspeculation in stocks and real estate and

a misallocation o resources that erodes bank asset quality and

eventually causes inlation pressures. Such a scenario might trigger a

round o severe monetary policy tightening in the medium term that

would pull growth down again.

Te response to the global economic slumpratcheting up investment

through highly stimulatory scal and monetary policieshas interrupted

the longer-term eort to restructure the economy away rom investment

and export-led growth toward more private consumption. Indeed,

investment in 2009 will contribute a much higher proportion o GDPgrowth than in recent years (Figure 3.3.14).

Regression is likely this year in some other rebalancing goals as well,

such as energy saving and environmental protection. (Te slump in

global demand has at least temporarily reduced the economy’s reliance

on exports or growth, and the trade surplus will decline this year.)

Te Government’s midterm evaluation last year o its 11th Five-Year

Plan (2006–2010), which set goals or restructuring, already showed

that progress lagged in several areas. A challenge is, thereore, or the

Government to swing attention back to the restructuring eorts aer the

economy is weaned o the scal stimulus.


-25

0

25

50

75

100

2005 06 07 08 09

%

Forecast

Net exportsInvestment

Government consumptionPrivate consumption

Sources: National Bureau o Statistics o China; sta estimates.









July, according to preliminary reports (Figure 3.4.3). However, subdued

perormance in April and May restricted growth in the index to only 3.9%

in the rst quarter, though the consumer durable goods sector recorded

robust expansion. Signicantly, the upturn in the index was broad-based

with basic, capital, and intermediate goods registering impressive growth,indicating a general revival in activity.

A preliminary analysis based on 3,126 companies shows that their

net prots climbed by 19.9% in the rst quarter o FY2009 rom a 2.5%

increase in the same period o FY2008, apparently mainly due to cost

savings. Te quarter also marked a return o ready access to international

capitalmarkets.Nearly$4billionwasraisedbyIndiancompanies

throughqualiedinstitutionalplacementsandmorethan$2billion

through global and American depository receipts in June–July 2009.

Externalcommercialborrowingroseby19%to$1.92billioninJune2009,

the highest since September 2008.

Year-on-year wholesale price ination turned negative (1.6%) in June

2009, a rate largely unchanged in July (Figure 3.4.4). Te latter month’sdeation reected lower uel prices than a year earlier, even though

the Government increased domestic prices o gasoline and diesel by

almost 10% in June. Te impact o the uel hikes was oset by a all in

manuactured goods prices to below year-earlier levels. By the October–

December quarter o FY2009, the upward pressure on prices will likely

exceed the downward pull rom the high base o a year earlier. Indeed,

the authorities expect year-on-year ination to be 4–5% by March 2010.

A worrying eature o the price structure is that primary commodity

ood ination remains high at around 7.1%. In addition, a weak monsoon

(likely to be the worst in 7 years) and droughts in many parts o India

are stunting ood production and so will exert upward pressure on ood

prices in the coming months. Te Government expects to cushion theweather impact by using its large oodgrain stocks (at 53 million metric

tons, well above the buer stock norm) and by importing essential

commodities. High ood prices (with a heavy eect on the poor) in an

economy operating well below capacity urther complicates the monetary

management required to keep ination expectations in check.

From October 2008 through April 2009, the Reserve Bank o India

(RBI) cut its main lending rate, the repo rate, by 425 basis points to 4.75%

(when it made its last adjustment). It cut the rate or reverse reposthe

RBI acility that absorbs bank reservesto 3.25% and lowered the cash-

reserve ratio during this period (Figure 3.4.5). It made no change in policy

instruments in the July monetary policy review, signaling an end to

monetary easing.

Te policy measures had a discernible eect on the call money

market rate, which ell rom 10.6% in September 2008 to 3.2% by April

2009 (a rate maintained through August), and term deposit rates, which

declined by up to 375 basis points. However, the ve largest banks reduced

benchmark prime lending rates by only 200–225 basis points, rom 13.25–

14.0% to 11.0–12.0%, over the same period.

Te RBI has expressed dissatisaction about the sluggish transmission

o the changes in policy rates to the changes in the benchmark prime

lending rates. Bank credit increased by only 1.0% in the rst 5 months o

FY2009, compared with about 3.3% in the year-earlier period. While RBI

3.4.4 Contributions to infation

Jan2007

Jul Jan08

Jul Jan09

Jul

Percentage points

-5

0

5

10

15

Manufactured products

Fuel group Primary articles

Overall

Source: Ministry o Industry and Commerce, available:http://eaindustry.nic.in, downloaded 11 September 2009.


3.4.3 Growth o industrial production index

-5

0

5

10

15

20

Jan

09

JulJan

08

JulJan

07

JulJan

2006

%, year on year



3.4.5 Policy rates

2

4

6

8

10

Cash-reserve ratio

Repo rate

Reverse repo rate

JulJan

09

JulJan

08

JulJan

07

JulJan

2006

%


2009.










South Asia India 131

open market operations have been highly expansionary, banks have used

the reverse repo acility to park (rather than lend) much o the unding

that was provided. Tis situation is indicative o weak demand or credit

and illustrates a limit on the eectiveness o monetary policy during a

slowdown in activity.Reecting high commodity prices, the budget decit ballooned in

FY2008 under the weight o large subsidies or oil, ertilizer, and ood early

in the period, while shortalls in revenue and the need or scal stimulus

were elt later on as economic growth slowed (Figure 3.4.6). Apart rom

initial payments rom a large hike in wages or civil servants stemming

rom the Sixth Central Pay Commission award, the scal stimulus

eort (about 1.5% o GDP) ocused on a substantial reduction in indirect

taxation, social security programs, and rural inrastructure spending.

Te revised central government budget or FY2009, presented on

6 July (ollowing parliamentary elections in May) was prepared against

the background o a marked slowdown in the domestic economy and the

global recession. Te budget, however, envisaged a recovery in growth to7.0% or the scal year rom 5.8% recorded in the second hal o FY2008.

Te central government scal decit is targeted to increase to 6.8% in

FY2009 rom 6.0% in FY2008 and rom 2.7% in FY2007. otal expenditure

is planned to rise by 16.1% (to 17.5% o GDP), including large increases

or public investment in inrastructure, the National Rural Employment

Guarantee Scheme (which provides 100 days o employment or a member

o a rural household below the poverty line), and Bharat Nirmana

program or rural inrastructure (Figure 3.4.7). Spending priorities

reect the Government’s goal to support the rural poor and to accelerate

inrastructure development while continuing the scal stimulus. O-budget

outlays are expected to amount 0.2% o GDP in FY2009 compared with

1.8% a year earlier, as lower commodity prices allow a sharp reduction inthe cost o support or uel and ertilizer price subsidies.

Te revised budget projects revenue to grow by 12.8%, to 10.5% o

GDP, but proposes no new major tax changes. Yet a revamp is under way:

the Government plans to introduce a national goods and services tax on

1 April 2010 (to replace the multiplicity o central and state indirect taxes

and rate structures) in eorts to move toward a unied national market

and to strengthen the revenue base. Separately, the Ministry o Finance

has proposed or public discussion a signicant reorm o the direct tax

system, which would markedly lower corporate and personal tax rates

while ending a complex web o special exemptions and exclusions. Te

new system is expected to be in eect rom 1 April 2011.

Te central government decit (including o-budget nancing o

subsidy programs) is targeted at 7.0% o GDP or FY2009, a decline

rom 8.0% a year earlier and reecting the all in o-budget nancing.

Including the state governments, the overall decit or FY2009 would

likely be about 10–11% o GDP. While India’s decits are no wider than in

some other major economies that have mounted strong countercyclical

eorts, the Government recognizes that they cannot be sustained as the

combined ederal and state public debt amounted to nearly 73% o GDP at

end-FY2008. It has announced plans to reduce the ederal decit to 5.5%

o GDP in FY2010 and to 4.0% o GDP in FY2011, relying on the mooted

tax changes and a strengthening economy.

3.4.6 Central government decit

0

2

4

6

8

Off-budgetBudget

1110090807062005

% of GDP

Note: Figures or 2009 are budget estimates; 2010 and 2011data are planned decits.

Source: Ministry o Finance, available: http://indiabudget.nic.in, downloaded 2 September 2009.


3.4.7 Central government scal indicators

8

12

16

20

Expenditure

Revenue

0908070605042003

% of GDP

Source: Ministry o Finance, available: http://indiabudget.nic.in, downloaded 2 September 2009.









An expert group “to advise on a viable and sustainable system o

pricing oil products” was announced at the presentation o the FY2009

budget. In view o large swings in global oil prices, reorm in the present

administered pricing o petroleum products is essential or control o

the decit, sound macroeconomic policies, and the long-term healtho the domestic petroleum industry. Difculties in the present system

were evident in FY2008: o-budget bond issues to und subsidies to

oil-marketing companies amounted to 1.3% o GDP in FY2008; and

state-run upstream companies’ price discounts (or which they were not

compensated by the Government) amounted to 0.6% o GDP.

Te global nancial crisis and economic slowdown caused a marked

deterioration in the external position in FY2008. Monthly exports

dropped sharply rom October 2008 depressing their growth or the

scal year to only 5.4%, while net capital inows plummeted to about

$10billionfromnearly$110billionayearearlier.Adropinimports,

in part owing to lower oil prices, held the current account decit to

$29.8billionor2.6%ofGDP(1.4%inFY2007).Nevertheless,foreignexchangereservesfellsharplyby$58billion(includinglargevaluation

losses).

Balance-o-payments estimates or the rst quarter o FY2009 are not

yet available. Monthly customs data indicate a bottoming in the allo

in trade ows and marked improvements in both net capital inows and

oreign exchange reserves. Unlike some other Asian countries, India

saw little improvement in export perormance in the rst quarter o

FY2009.Exportsduringtherst4monthsaveraged$12.0billion,little

dierent rom the average o the previous 4 months and still about 30%

below levels seen a year earlier (Figures 3.4.8 and 3.4.9). Still, a steady

improvementwasrecordedfromtheAprillowof$10.7billiontoJuly’s

$13.6billion.Imports weakened aer July 2008 with alling oil prices and slower

economicgrowth,totouchalowinMarch2009of$15.6billion.ey

subsequentlyreboundedto$19.6billioninJuly2009,thoughtheyremain

substantially below year-earlier levels (Figure 3.4.10).

Portolio investment has recorded a sharp turnaround with a net

inowof$8.3billionintheApril–Junequartercomparedwithnet

quarterlyoutowsinFY2008thataveraged$3.5billion.Foreigndirect

investmentat$7.1billioninthesamequarteressentiallymaintainedthe

previous year’s solid perormance. Nonresident Indian deposits have

been boosted by RBI’s upward adjustments in interest rates or such

savings.Foreignexchangereservesincreasedby$12.6billionintherst

quarterandto$19.5billionintherst5monthsofFY2009(compared

witha$13billionfallinthesameperiodthepreviousyear),indicating

a substantial improvement in the overall balance o payments to date in

FY2009 (Figure 3.4.11).

Following a downward dri in the rupee during the previous scal

year against the US dollar, the local currency appreciated by about 4.4%

duringtherst5monthsofFY2009toRs48.8/$1(Figure3.4.12).isgain

reected renewed capital inows and the Government’s reelection. As o

August, in real eective terms the exchange rate was roughly 8% below

that o a year earlier. While the increase in global investor risk appetite

augurs well or continued capital inows, the authorities are likely to

3.4.10 Import indicators

-40

0

40

80

-200

0

200

400

Value, 12-month moving averageYear-on-year growth

JulJan

09

JulJan

08

JulJan

2007

% $ billion


2009.



Jan2007

Jul Jan08

Jul Jan09

Jul

$ billion

-40

-20

0

20

Exports

Non-oil imports Oil imports

Trade balance

Note: Total exports and imports based on customs data.

Sources: CEIC Data Company Ltd., Ministry o Commerce,available: http://commerce.nic.in/index.asp, both



3.4.8 Export indicators

-40

-20

0

20

40

60

-200

-100

0

100

200

300

Value, 12-month moving average

Year-on-year growth

JulJan

09

JulJan

08

JulJan

2007

% $ billion


2009.










South Asia India 133

resist urther strengthening in the domestic currency given the continued

weakness in exports.

Following substantial gains over several years, the Sensex, the main

index o the Bombay Stock Exchange, lost about 60% o its value rom

its all-time high in early January 2008 through about mid-March 2009.Subsequently through end-August, the Sensex (and Asian stock markets

in general) participated in a worldwide rally in equities, and was up by

about 63% or the year (Figure 3.4.13). Apart rom a reduction in risk

aversion by global investors and an upturn in portolio investment,

the market has beneted rom a general renewal o Indian investors’

condence based on the country’s ability to handle the global turmoil

with minimal dislocation (to post the second-highest growth rate or

a major economy in 2009), a strong consensus on improved domestic

growth prospects, and nascent signs o recovery in the world economy.

ProspectsADO 2009 Update’s orecasts or FY2009 and FY2010 are based on ve key

assumptions: monetary conditions will continue to be accommodative;

agricultural output will be stunted in FY2009 but the domestic ood

supplywillremainadequate;oilpriceswillaverageabout$63perbarrel

in2009and$73in2010;nonfuelcommoditypriceswilldeclinein

2009 but rise in 2010; and industrial economies will show a moderate

growth recovery in 2010. Te main dierences in assumptions between

this Update and ADO 2009 are a sharper contraction in 2009 or major

industrial economies; higher than expected oil prices in both 2009 and

2010; and a steeper decline in world trade volume in 2009 and a sharper

rebound in 2010.

Te positive response to monetary policy adjustments and scalstimulus as well as a quicker than expected return o capital inows

have provided a li to the domestic economic environment. Tis rising

optimism has been reected in numerous business sentiment surveys

as well as the Industrial Outlook Survey that the RBI conducted in

April–May 2009 (Figure 3.4.14). Moreover, the Purchasing Managers

Index in April changed its signal to expansion aer indicating contraction

in the previous 5 months.

Improved business condence is primarily attributed to reduced stress

in nancial markets with easing o credit availability; the large scal

stimulus; strong nancial perormance o the corporate sector in the rst

quarter o FY2009; and expectations o strengthened economic policies

based on an enlarged and more cohesive coalition majority in Parliament.

Te combination o countercyclical scal policies and renewed investor

condence is expected to sustain growth in private consumption and

investment in FY2009. Te impact o the poor monsoon and drought on

rural incomes and consumption will be partly oset by various programs

to aid rural households in the budget and, possibly, by supplementary

assistance or armers, which is under study by the Government.

Growth will continue to be driven by government spending but its

impact in FY2009 will be less than in FY2008 when expenditure and

the decit ballooned. GDP growth in the second and third quarters is

expected to all below the 6.1% rst-quarter expansion because o weak


55

50

45

40

35

90

95

100

105

110

Nominal Real effective

JulJan

09

JulJan

08

JulJan

07

JulJan

06

Jul

2005

Rs/$ Index, 2005 = 100

Sources: Reserve Bank o India, available: http://www.rbi.

org.in; Bank or International Settlements, available: http://www.bis.org, both downloaded 2 September 2009.


3.4.13 Stock price indexes

5,000

10,000

15,000

20,000

25,000

0

200

400

600

800

Developing AsiaSensex

1 Jan

09

1 Jan

08

1 Jan

07

1 Jan

2006

1979 = 100 1987 = 100

Note: The index or developing Asia is represented by theMorgan Stanley Capital International All Country Asia,excluding Japan, price index.



3.4.11 Foreign exchange reserves

125

175

225

275

325

JulJan

09

JulJan

08

JulJan

07

JulJan

06

Jul

2005

$ billion











Indonesia

Robust growth in private consumption, underpinned by easing inlation and a surge in election-

related government spending, drove better than expected economic growth in the rst hal o .

Fiscal stimulus measures supported growth. Net exports also contributed to the expansion as imports

contracted aster than exports. Investment weakened. Relative to orecasts made in March this year, the

ull-year growth projections are revised up or and , and infation will likely be lower. Risks to

the outlook include higher than expected oil prices, which would propel infation and hurt consumption,

and dry weather, which could damage harvests.

Updated assessmentWith year-on-year GDP growth o 4.2%, Indonesia outperormed other

major economies in Southeast Asia in the rst hal o 2009, mainly

because its large domestic market and its relatively low dependence on

external trade (exports represent about 30% o nominal GDP) provided

some insulation rom the global economic turmoil. However, the impact

o the global nancial crisis and the slump in world trade took growth

to well below the 6.3% rate recorded in the rst 6 months o both 2007

and 2008.

Private consumption, accounting or almost 60% o GDP, grew by

5.4% in the rst hal o 2009, only slightly below the year-earlier rate,

and made the biggest contribution to GDP growth on the demand side.Consumption received a li rom slowing ination, good harvests that

supported arm incomes, and election-related spending (parliamentary

elections were held in April and presidential elections in July). Also, the

Government provided cash transers to 18.5 million poor households

in January and February and lowered some taxes as part o a scal

stimulus package aimed at mitigating the impact o the global downturn.

Nevertheless, tighter credit hurt sales o consumer durables such as

motor vehicles.

Government consumption soared by 18.0% during the rst hal

(Figure 3.5.1), or our times as ast as a year earlier, a result o pay

increases or civil servants, the election-related spending, and an

improvement in the disbursement rate o budgeted outlays. Imports o

goods and services contracted aster than exports, thereby generating

positive net exports, which also contributed to GDP growth. Tis was

in contrast to the rst hal o 2008, when a all in net exports acted as a

drag on growth.

But investment, aer growing by double-digit rates since mid-2007,

edged up by a meager 0.9% in the rst hal o this year. Fixed investment

rose by only 3.0%: investment in buildings increased by 6.3% but

investment in machinery and equipment ell by 10.1%. Borrowing

3.5.1 Growth o GDP components (demand)

-27

-18

-9

0

9

18

ImportsExportsInvestment

Government consumptionPrivate consumption

H1

09

H2H1

08

H2H1

2007

%


2009.


This chapter was written by Jörn Brömmelhörster and Priasto Aji o the Indonesia

Resident Mission, ADB, Jakarta.






or investment contracted, reecting rms’ unwillingness to expand

production and the tighter bank credit.

On the production side, the services sector grew by 5.9% in

January–June and contributed 2.6 percentage points o total growth

(Figure 3.5.2). Continued rapid expansion o the communicationssubsector oset slowing growth in some other services. Industry grew by

only 2.6%, with the important manuacturing subsector increasing output

by just 1.5%, largely a consequence o weak export demand. Mining output

(including crude oil) increased by 2.4%. Oil production rose to 957,000

barrels a day rom 846,000 barrels in the rst hal o 2008. Industry as a

whole contributed 1.1 percentage points to GDP growth.

Agriculture expanded by 3.7% in the rst hal and this added

0.5 percentage points to GDP growth. Food crops perormed well, but

production increases rom plantations (mainly natural rubber and

palm oil) decelerated because o a decline in global demand. In 2008,

agriculture expanded at the astest rate in about one and a hal decades

(by 4.8%), in response to high prices or agricultural commodities andgood weather.

Falling world prices or export commodities and the slump in global

trade pushed down merchandise exports by 27.9% in the rst 6 months

o 2009. Merchandise imports ell even more steeply, by 38.7%. Monthly

trade data suggest that the pace o decline or exports and imports

bottomed out during the rst hal (Figure 3.5.3). In particular, exports o

primary commodities including coal, copper, and crude palm oil picked

up in tandem with world demand and prices or these products.

Te trade surplus, against a backdrop o the steep slide in imports,

increased by 21% in the rst hal o 2009 rom the prior-year period and

bynearly60%fromthesecondhalfof2008,to$15.7billion(Figure3.5.4).

ecurrentaccountrecordedasurplusof$6.0billion(2.5%ofGDP),reecting the big trade surplus and narrower income and services

decits, which outweighed a decline in current transers (including

remittances).

Net oreign direct investment inows, mainly driven by investments

inoilandgasandacquisitionsintelecommunications,totaled$3.5billion,

about the same as in the rst hal o 2008. Net portolio investment

inowsof$3.3billionmarkedaturnaroundfromnetoutowsintherst

hal o 2008, a sign o improved international investor condence. Te

overallbalanceofpaymentsrecordedasurplusofabout$5billion.

Te portolio investment outows in 2008 were the main reason or a

declineinIndonesia’sinternationalreservesto$50.6billionbyOctober.

ByJune2009,thereserveshadrecoveredto$57.6billion,or5.5months

o imports o goods and services and ofcial debt service payments. Te

external situation has been urther bolstered through a memberwide

allocation by the International Monetary Fund o special drawing rights,

ofwhichIndonesiareceived$2.7billion,aswellasbycurrencyswap

arrangementstotalingmorethan$30billion.

Ination abated rom 12.1% year on year in September 2008 to 2.7%

in July 2009 (Figure 3.5.5), as global prices o uel and commodities ell.

Te Government lowered the subsidized prices o uels and reduced

some commercial electricity taris. A slowing in ood price ination,

assisted by the good harvests, was a welcome relie or the roughly hal

3.5.3 Merchandise trade growth

-60

-30

0

30

60

90

ImportsExports

AprJan

09

OctJulAprJan

2008

%


2009.Click here or fgure data

3.5.4 Current account components

H1

2007

H2 H1

08

H2 H1

09

$ billion

-20

-10

0

10

20

Current account balance

Services trade

Current transfers

Income

Goods trade

Source: Bank Indonesia, available: www.bi.go.id,



3.5.2 Contributions to growth (supply)

0

2

4

6

8

Agriculture

Industry Services

GDP growth

H1

09

H2H1

08

H2H1

2007

Percentage points

6.3

4.2

5.86.36.2











Southeast Asia Indonesia 137

ofthepopulationwholiveonlessthan$2aday.epovertyincidence

measured by the national poverty line declined to 14.1% in March 2009

rom 15.4% in March 2008, reecting the January–February cash transers,

easing ood price ination, and cuts in uel prices.

Domestic scal stimulus measures and other government spendinghelped support the labor market, at least early in the year. Te

unemployment rate ell to 8.1% in February 2009 rom 8.4% in August

2008. Te inormal sector accounts or about 70% o the workorce and

usually absorbs most layos rom the ormal sector.

In the context o the slowing in economic activity and ination, Bank

Indonesia cut its policy interest rate by a total o 300 basis points rom

December 2008 to August 2009, to 6.5%. Commercial banks lagged in

lowering lending rates, so that rom February to May rates charged or

working capital and investment declined by less than 60 basis points, and

lending rates or consumption increased slightly during that time.

Year-on-year growth in lending to businesses and individuals slowed

during November 2008 to May 2009 rom 45% and 30%, respectively, to16% and 22%. Tis deceleration reected both lower demand or credit

in the ace o a slowing economy and still-high bank interest rates,

and banks’ greater caution. Commercial banks’ nonperorming loans

increased rom 3.8% o the total in December 2008 to 4.5% in June 2009

(Figure 3.5.6). Year-on-year broad money supply growth picked up rom

14.9% to 16.1% over the same period (Figure 3.5.7).

otaling Rp73.3 trillion or about 1.4% o GDP in 2009, the scal

stimulus package consists mainly (83.7%) o tax breaks and subsidies

that could be implemented quickly to support private consumption and

businesses. Within the rst quarter o 2009, most o this ast-disbursing

stimulus had been implemented. Te measures included waivers o

income and value-added taxes, subsidies or cooking oil and genericmedicines, waived import duties, a diesel subsidy, electricity discounts,

and a credit acility or small and medium-sized enterprises.

Nearly all the rest o the stimulus package (15.5%), is or labor-intensive

inrastructure works involving water supply projects, low-cost housing,

roads, and ports. It is intended that most o this part will be disbursed in

the second hal o 2009. Eorts by the Government to accelerate capital

spending raised the disbursement rate slightly in the rst hal o this year

to 23.2% o budgeted spending rom 20.9% a year earlier.

Stimulus package unds (0.8%) were also allocated to extend

a community empowerment program, which encourages village

participation in planning and carrying out inrastructure, education, and

health projects.

Te Government is sourcing unding or the additional expenditure,

as well as or debt-amortization payments, rom debt markets and rom

budgeted unds that were not spent in 2008. By mid-August, it had

raised more than 80% o this year’s gross nancing needs. Moreover, it

insured itsel against a worsening nancing climate by securing access to

contingency nancing rom development partners, which can be drawn i

nancial markets become restrictive again.

Budget revenue in the rst hal o 2009 was about 14% below

prior-year levels, mainly because o lower receipts rom oil and gas, the

tax breaks, and reduced income rom value-added tax and rom import

3.5.6 Nonperorming loan ratio o

commercial banks

2

4

6

8

AprJan

09

OctJulAprJan

08

OctJulAprJan

2007

%


downloaded 2 September 2009.Click here or fgure data

3.5.7 Broad money supply growth

0

7

14

21

AprJan

09

OctJulAprJan

08

OctJulAprJan

2007

%





0

3

6

9

12

15

JulAprJan

09

OctJulAprJan

2008

%

Sources: Asian Development Outlook database; CEIC DataCompany Ltd., downloaded 14 August 2009.











and export duties. Te scal decit in 2009 is expected to widen to a

still-manageable 2.6% o GDP.

In line with global trends, Indonesia’s nancial markets started to

recover in March 2009. Te stock market index, which dropped by 50% in

2008 as investors moved out o emerging markets, surged by more than70% in the rst 8 months o 2009 (Figure 3.5.8). Te rupiah depreciated

by about 15% against the US dollar in the last 3 months o 2008, then

appreciated by 12% in the rst 8 months o 2009, partly bolstered by

condence in macroeconomic management.

Yields on government bonds have allen signicantly since March

and credit deault swaps are almost back to levels seen beore the

global nancial crisis that erupted late last year (Figure 3.5.9). Moody’s

raised Indonesia’s oreign and local-currency sovereign debt ratings in

September 2009 to Ba2 rom Ba3.

ProspectsProjections or 2009 and 2010 assume that the Government will

implement major policies outlined during the election campaign, such

as ostering inrastructure development and reorming the bureaucracy.

Te Government plans to support development o inrastructure in

2010 through new tax incentives and expenditure o Rp93.9 trillion

($9.4billion).Anadditionalscalstimuluspackagefor2010isnot

planned, but the proposed 2010 budget provides space or urther growth-

stimulating measures i required.

As or monetary policy, the policy interest rate is assumed to remain

around current levels until ination picks up together with the global

recovery, so that the authorities will likely need to start tightening

monetary policy during 2010. Te orecasts urther assume that planningor a likely El Niño weather pattern, which could cause drier than usual

weather and damage harvests, succeeds in preventing ood prices rom

rising rapidly and in maintaining ood sufciency.

Private consumption growth is expected to be maintained, supported

by the easing o ination. Condence indexes were showing upturns at

midyear (Figure 3.5.10). Te rollout o projects under the inrastructure

part o the stimulus package will bolster public investment. Private

investment is expected to pick up rom low levels given the solid

economic growth, successul completion o the elections, and the

rebound in the stock market. Banks are expected to lower their lending

rates, too.

Prices o several important export commodities, such as coal,

copper, oil, and palm oil, have turned up and, as noted, the pace o

decline in monthly exports has bottomed out. Tis improved outlook

should stimulate commodity production. Furthermore, the index

o manuacturing production has been rising since early this year

(Figure 3.5.11).

aking these actors into consideration, GDP growth is orecast to

edge up to 4.4% in the second hal o 2009 relative to the rst. Given that

the economic perormance has been stronger than expected in Asian

Development Outlook 2009 (ADO 2009) in March, the ull-year orecast is

raised rom 3.6% to 4.3% (Figure 3.5.12).

3.5.9 Credit deault swaps

0

300

600

900

1,200

1,500

JulAprJan

09

OctJulAprJan

2008

Basis points



3.5.8 Stock market perormance

750

1,500

2,250

3,000

JulAprJan

09

OctJulAprJan

2008

Index




ADO

Update ADO

Update

GDP growth . . . .

Infation . . . .

Current acct. bal.

(share o GDP)

-. . . .


3.5.10 Consumer and business indexes

75

85

95

105

115

125

0

6

12

18

24

30

Business activity expectationsConsumer confidence

JulAprJan

09

OctJulAprJan

2008

Index %


2009.










Southeast Asia Indonesia 139

In 2010, the expected modest rebound in global economic growth

and stronger world nancial markets are seen underpinning expansion

in external and domestic demand (particularly some urther recovery

in investment), liing GDP growth to 5.4%, which is also above the

ADO 2009 orecast. Te corporate tax rate is scheduled to be loweredby 3 percentage points to 25% next year, which should also support

investment. GDP growth could exceed this projection i the Government

manages to accelerate its rollout o inrastructure investment by

addressing constraints such as legal uncertainties and land acquisition or

projects.

rade surpluses are orecast to remain high, although they will

decline in 2010 as imports pick up in tandem with economic growth. Te

income account decit is seen widening as oreign rms that benet rom

rising commodity prices repatriate prots. Remittances rom Indonesian

workers abroad are expected to decline moderately in 2009, but to recover

in 2010. Tese actors are projected to leave the current account in surplus

at around 2% o GDP this year and next, revised up rom ADO 2009.Te overall balance o payments is orecast to remain in surplus, partly

a consequence o the return o portolio inows since global nancial

markets stabilized.

Lower than expected ination in the rst hal o 2009, coupled

with the rm rupiah and good harvests (July’s rice stocks, or example,

stood at 2.6 million tons, or 9 months o consumption) have prompted

a downward revision in the ination orecast or 2009 to a year-average

5.0%, which would be the lowest rate since 2000. Ination is projected to

edge up next year to about 6.0%, reecting rming economic growth and

higher global commodity prices.

While the Government aims to rein in its budget decit to 1.6% o

GDP in 2010, a more expansionary scal position could be accommodatedi the global economic recovery alls short o expectations. Central

government debt (oreign and domestic) is estimated to decline rom 33%

o GDP in 2008 to about 31% in 2009 and to just above 30% in 2010.

One risk to the orecasts is a much higher than expected world oil

price. Tis outturn would add to the cost o the Government’s energy

subsidies, leading to cuts in other public spending (on development and

social support), a wider scal decit, or a mixture o the two.

Te rupiah is sensitive to investor sentiment, as shown by its sharp

depreciation in October 2008. Another bout o global risk aversion would

undermine the currency, hurting investment and raising ination.

A urther risk relates to the expected El Niño conditions and

associated dry weather. An El Niño event in 1997 caused serious damage

to crops that sent up the price o rice by 30%. Given that rice, as the

country’s staple ood, has a signicant weight in the consumer price

index, such a price rise would li ination and push more people into

poverty. A serious El Niño event would also hurt rural incomes and

spending. Finally, security issues and natural disasters are continuing

risks.

3.5.12 GDP growth

0

2

4

6

8

1009080706052004

%

Forecast



3.5.11 Manuacturing production index

116

120

124

128

132

AprJan

09

OctJulAprJan

2008

2000 = 100









Malaysia

The economy contracted more sharply than expected in the rst hal o , the result o a plunge

in exports that spread to domestic demand such that both xed investment and private consumption

ell. Government action to mitigate the decline included two scal stimulus packages (though a ew

o the measures got o to a slow start), an easing o monetary policy, and a relaxation o local-equity

requirements or some oreign investment. The GDP contraction orecast or in this Update is steeper

than anticipated in March, and the recovery in a shade slower than was then projected. Infation is

predicted to remain low and current account surpluses high in both years.

Updated assessmentAgainst the backdrop o the severe slump in global trade, GDP contracted

by a steep 6.2% year on year in the rst quarter o 2009. (Te economy is

particularly sensitive to changes in world trade: exports and imports o

goods and services are equivalent to more than 100% o GDP.) Te output

decline eased to 3.9% in the second quarter (Figure 3.6.1). During the

rst 6 months o this year, the economy contracted by 5.1% in a broad-

based downturn that saw weakness spread rom exports to investment

and private consumption (Figure 3.6.2). Only a decline in imports and

increased government consumption provided some oset.

Exports in volume terms ell by 16.3% in the rst hal o 2009 rom the

prior-year period, reecting dwindling demand rom most o Malaysia’simportant export markets. Tis was, however, oset by a 21.5% all in

import volumes, and thus net exports registered growth or the period.

Fixed investment contracted by 10.3%, a sign that many rms deerred

or canceled proposed investments, seeking to saeguard their balance

sheets. Private consumption, which accounts or around one hal o GDP,

declined by 0.1% on account o a all in disposable incomes in several

sectors o the economy.

Manuacturing, which is dominated by the export-oriented electrical

and electronics subsector, contracted by 16.2% in the January–June period

in tandem with the downturn in external demand. Falling global prices

or palm oil and other agricultural commodities led to reductions in

production, such that agricultural output ell by 2.0%. In contrast, the

services sector grew by a marginal 0.7%.

Te more moderate pace o GDP contraction during the second

quarter owed much to increased public expenditure and growth in

private consumption. Public consumption rose by 1.0% in the quarter

as the Government implemented two scal stimulus packages, the rst

drawn up in November 2008 and a second, larger set o measures in

March 2009. Te higher public spending, together with some stabilization

in the labor market and lower consumer prices, improved consumer

3.6.1 Contributions to growth (supply)

Q12006

Q3 Q107

Q3 Q108

Q3 Q109

Percentage points

-8

-4

0

4

8

Agriculture Industry ServicesGDP



This chapter was written by Purnima Rajapakse o the Southeast Asia Department,

ADB, Manila.


H1

2006

H2 H1

07

H2 H1

08

H2 H1

09

-10

-5

0

5

10

15

Percentage points

GDP growth


Private consumption

Investment

Net exports









Southeast Asia Malaysia 141

sentiment and led to a 0.5% increase in private consumption, aer a

decline o 0.7% in the rst quarter.

All production sectors perormed better in the second quarter than

the rst. Services recorded slight growth due to a pickup in nance and

insurance activity. Te rate o decline in mining moderated because o smaller cuts in output o crude oil and natural gas. Construction activity

expanded by 2.8%, supported by stimulus measures, and the contraction

in manuacturing eased owing to the pickup in exports and increased

inventory replenishments ollowing signicant cuts in production

and inventory drawdowns in the rst quarter. Month-on-month

manuacturing activity strengthened by 2.9% in June 2009 (Figure 3.6.3).

Reecting the economic slump, the number o people employed ell

slightly rom December 2008 to March 2009 and the unemployment rate

increased rom 3.1% to 4.0% during this period. More recent data point

to a turnaround in some labor market indicators: the number o new job

vacancies exceeded the number o jobseekers at end-June 2009. Apart

rom agriculture, where seasonal actors dominate employment patterns,all sectors recorded increased vacancies. Manuacturing, which employs

around 20% o the workorce, saw the largest upturn.

Ination has decelerated sharply rom a peak o 8.5% in July–August

2008 (year on year), so that the consumer price index rose by just 1.7%

in the rst 7 months o 2009. Indeed, the index declined by 2.4% rom

its year-earlier levels in July 2009 (Figure 3.6.4) due to alling global

commodity prices, slower domestic demand, and the base eect o an

increase in administered uel prices in June 2008. However, on a month-

on-month basis consumer prices edged up by 0.1% in July, suggesting an

easing in deation pressures.

Available data or the rst quarter o 2009 show a large current

accountsurplusof$8.6billion(20.2%ofGDP),up$1.4billionfromthecorresponding period o 2008. Tis rise was mainly due to a higher

surplus in the trade and services accounts, which reinorced a narrower

decit in the income and transer accounts. Merchandise exports ell

by 20% on account o a slowdown in global demand or electrical and

electronic products and lower prices or palm oil, liqueed natural

gas, and crude oil. Te export decline was more than oset by a 25%

contraction in merchandise imports stemming, in large measure, rom a

steeper drop in imports o intermediate goods, most o which are used in

making electrical and electronic goods.

Te improvement in the services account was mainly attributable to

lower net payments on reight and other services; tourism receipts

remained stable. Te narrower decit in the income account was due

to lower net payments on investment income, while the more moderate

decit in the transer account was due to lower remittances sent abroad

by oreign workers in Malaysia. Te higher current account surplus

was, however, partly oset by a wider decit on the nancial account as

signicantly higher net outows o portolio investment outweighed a

more modest net inow o oreign direct investment. As a result o these

developments,theoverallbalance-of-paymentssurplusfellto$895million

atend-March2009from$15.3billioninMarch2008.

rade data or the rst 6 months o 2009 show that the trade surplus

in the second quarter narrowed rom the rst quarter because the

3.6.3 Manuacturing indicators

-12

0

12

24

-45

0

45

90

MIER capacity utilizationManufacturing

JunJan

09

JulJan

08

JulJan

2007

Month-on-month growth Index

MIER = Malaysian Institute o Economic Research.


2009.


3.6.4 Infation

-5

0

5

10

-3

0

3

6

Month on monthYear on year

JulAprJan

09

OctJulAprJan

2008

% %



3.6.5 Trade growth

-14

-7

0

7

14

ImportsExports

JulAprJan

09

OctJulAprJan

2008

%, month on month

Notes: Exports and imports are based on customs data;growth rates are computed using 3-month moving

averages.

Source: CEIC Data Company, Ltd., downloaded 19 August

2009.











year-on-year contraction in exports outpaced that o imports. However,

month-on-month data indicate that both exports and imports have picked

up since February (Figure 3.6.5 above), with import growth generally

outpacing that o exports. International reserves at mid-August amounted

to$91.4billion,acomfortable9monthsofretainedimportsand3.8timesshort-term external debt.

In response to the deteriorating domestic economy and slowing

ination, Bank Negara Malaysia, the central bank, reduced its policy

interest rate in steps rom 3.5% at the beginning o November 2008 to

2.0% in February 2009, and its reserve ratio or commercial banks to

a record low o 1.0% rom 3.5% in November 2008. A trade-weighted

depreciation o the currency has urther relaxed nancial conditions.

Te monetary authorities said in July that the easing o monetary policy,

coupled with the two scal stimulus packages, are sufcient to support

economic activity.

Te nancial system remains liquid: year-on-year growth in deposits

and loans stood at 6.2% and 8.4%, respectively, in July 2009. Bankingsystem capitalization is healthy: the risk-weighted capital-adequacy

ratio rose to 14.2% in July 2009 rom 12.6% in December 2008. Te net

nonperorming loan ratio ell slightly to 2.1% in June 2009 rom that at

end-2008.

Te ringgit, having depreciated by 5.2% against the United States (US)

dollar between end-2008 and end-March 2009when increased risk

aversion and deleveraging by international investors increased demand

or US dollarsthen appreciated by 3.6% up to end-August 2009. Te

strengthening o the ringgit was mainly due to an easing in risk aversion

ollowing signs o stabilization o some US economic indicators, and

growing condence that the global economic downturn had bottomed.

Having remained broadly stable during the rst quarter o 2009, theKuala Lumpur Composite Index o stock prices increased by 34.5%

through end-August 2009, reecting lower risk perceptions on emerging

market assets, a recovery in commodity prices, and a government

decision to liberalize some investment (Box 3.6.1).

Yields on government bonds, which stayed remarkably stable amid the

turmoil in global nancial markets, edged up as the Government raised

debt issuance to nance the scal decit. Spreads on credit deault swaps

ell rom 230.1 basis points at end-2008 to 97.0 basis points at end-August

2009 (Figure 3.6.6).

As or the scal stimulus, an RM7 billion package in November

2008 was ollowed in March 2009 by a larger RM60 billion (9% o GDP)

set o measures to be disbursed over 2009 and 2010. Te second package

mainly involves additional direct budget spending and guarantee unds

or corporations, especially small and medium-sized enterprises. It also

provides unding or public–private partnerships and other o-budget

projects, and includes some tax breaks.

During the rst hal o 2009, revenue collection came in at 47% o

budgeted receipts. Operational and development expenditures were 46%

and 36%, respectively, o budgeted amounts, indicating delays in rolling

out some o the scal stimulus. Te ull-year budget decit is projected to

exceed the target o 7.6% o GDP given that the economy has contracted

more severely than the Government envisaged.

.. Boosting competitiveness

In an eort to improve the efciency o the economy and promote investment,

particularly in the services sector, theGovernment made several changes toinvestment regulations in the rst hal o .

Among other moves, it relaxeda bumiputra (ethnic Malay)equity requirement or investment in services subsectors, including healthand social services, tourism, transportservices, and business services.

Te economy has in recent yearsrecorded a surplus on the externalservices account, but this stemmedlargely rom growth in tourism.Tere have been persistent decitsin the transport and other servicescategory: the latter includes all servicessubsectors not related to transport andtravel, a number o which are coveredunder the new investment policy.

In other changes, the Governmentreduced the minimum stake to bereserved or bumiputra investors ininitial public oerings to . rom, and eased rules on oreigninvestors buying stakes in Malaysiancompanies and property.

Furthermore, the central bank liberalized oreign investment innancial companies to supportnance sector growth, which hasaveraged . a year in the past years. Changes cover the issuanceo new licenses; increases in oreignequity limits; and greater operationalexibility or locally incorporatedoreign commercial banks, insurancecompanies, and takaul (Islamicinsurance) operators.

One emphasis o the reormshas been to promote Malaysia as aninternational Islamic nancial hub.Over the next years, the central bank plans to issue new licenses or twoIslamic banks, ve commercial banks,and two Islamic insurance institutions.

Islamic nance is increasingly seenas providing stability to the nancialsystem by anchoring banking practicesto underlying economic transactionsand by limiting leverage.



Southeast Asia Malaysia 143

Te ratio o central government debt to GDP, at 48% o GDP in June

(Figure 3.6.7), is relatively high and market concerns over the size o the

decit and an apparent lack o a scal consolidation plan led to the rst

local currency debt downgrade since the 1997–98 Asian nancial crisis.

Fitch rating agency in June 2009 lowered Malaysia’s long-term localcurrency rating rom A+ to A, citing a rise in the overall and primary

decits, alling government revenue, and slow progress in implementing

revenue reorms. Fitch maintained Malaysia’s long-term oreign currency

rating at A- with a stable outlook. Most o the public sector debt is

domestic debtonly 4% was external debt at end-June 2009.

ProspectsTe orecasts are predicated on the authorities maintaining an

expansionary scal policy during 2009 and into 2010, and the scal

stimulus gaining traction rom the second hal o 2009 (given its

generally slow start). Monetary policy is expected to remain broadly accommodative, with the policy interest rate remaining unchanged

or the remainder o 2009 in a context o muted ination and excess

production capacity. In view o the economy’s heavy reliance on global

demand, growth prospects will, to a large extent, be inuenced by

external developments.

In this regard, deep and prolonged contractions in the US, Japan,

and eurozone will suppress Malaysia’s exports because together

these economies absorb around 35% o its exports. Moreover, GDP in

Singapore, the country’s largest trading partner, will contract sharply in

2009, implying that growth in Malaysia will remain below trend during

the orecast period.

GDP now is expected to shrink by 3.1% in 2009, revised roma orecast decline o 0.2% in March’s Asian Development Outlook

2009 (ADO 2009), mainly because the deep slump in world trade and

commodity prices had a much bigger impact on Malaysia than expected.

However, the rst-quarter contraction o 6.2% was likely the bottom

o the recession, and prospects appear to have been picking up rom

the second quarter. Te Government’s index o leading and coincident

indicators showed month-on-month gains in June, while the 6-month

smoothed growth rate o both indexes also improved rom May to June

(Figure 3.6.8). Consumption growth is likely to gradually strengthen

during the rest o 2009 as a consequence o a rmer labor market and

low ination.

While exports are seen continuing to contract year on year, albeit at

a declining rate, they are expected to pick up month on month, given the

inventory buildup in the US. Imports on the latter basis are likely to rise

aster than exports in the context o Malaysia’s dependence on imported

inputs or its export industries and a pickup in consumer condence. Te

external sector is thereore likely to remain a drag on GDP. Although

business sentiment is set to gradually improve over the rest o 2009,

private investment will remain in negative territory due to excess capacity

in the economy.

Ination pressures are orecast to remain subdued through 2009,

reecting so domestic demand, excess capacity, lower imported

3.6.6 Credit deault swaps, 5-year

0

100

200

300

400

500

JulAprJan

09

OctJulAprJan

2008

Percentage points



3.6.7 Public nance indicators

-4

-2

0

2

4

-60

-30

0

30

60

Government debtFiscal deficit

Q2Q1

09

Q4Q3Q2Q1

2008

% of annual GDP % of annual GDP

Note: Figures or 2009 were computed using current GDP

orecasts or the year.

Sources: CEIC Data Company Ltd.; Ministry o Finance,available: ht tp://www.treasury.gov.my, both downloaded7 September 2009.


3.6.8 Growth o leading and coincident

indexes

-10

-5

0

5

10Leading

Coincident

JunJan

09

JulJan

08

JulJan

07

Jul

2006

%

Note: Growth rates o indexes are computed as 6-month

moving averages.

Source: Department o Statistics Malaysia, available: http://

www.statistics.gov.my, downloaded 7 September 2009.











3.6.11 Current account balance

0

10

20

30

40

1009080706052004

% of GDP

5-year moving average

Forecast



3.6.10 Annual infation

0

2

4

6

10090807062005

%5-year moving average

Forecast


estimates.


3.6.9 GDP growth

-4

0

4

8

10090807062005

5-year moving average %

Forecast




ADO

Update ADO

Update

GDP growth -. -. . .

Infation . . . .

Current acct. bal.

(share o GDP)

. . . .


ination, and the base eect o high consumer prices in 2008. However,

monthly data show signs o ination picking up and, in the context o

the expansionary monetary and scal policies, the economy is unlikely to

remain in deation or long. Average ination this year is orecast at 1.1%,

a touch lower than projected in ADO 2009.Te current account surplus will decline, but in 2009 it will remain

large at about 14.0% o GDP (unchanged rom the March orecast).

Both exports and imports will contract this year, but exports by more.

Consequently, the trade surplus will all.

Year-on-year GDP growth is likely to return toward end-2009

and gradually pick up to average 4.2% or 2010 (Figure 3.6.9), slightly

lower than expected in ADO 2009. Te outlook is underpinned by the

Government’s scal stimulus and the expected recovery in world trade

and commodity prices. Domestic demand will strengthen in 2010 as

improved labor market conditions lead to higher private consumption,

while a gradual closing o the output gap will encourage some increase in

private investment toward the end o next year.Public investment will be supported by spending under the scal

stimulus packages. Investment-to-GDP ratios will, nevertheless, remain

modest compared with those o recent years as the output gap will remain

large. Te pace o recovery would have been aster were it not or the act

that the expected pickup in exports and domestic demand will lead to a

signicant increase in consumer, intermediate, and capital goods imports,

which will generate a urther deterioration in the net external balance

and continue to be a drag on GDP growth.

Ination is projected to gather pace to average 2.6% in 2010

(Figure 3.6.10), reecting higher domestic demand, a rise in global

nonuel commodity prices, and the disappearance rom the year-on-year

comparison o the steep drop in commodity prices.In the external accounts, a decline in the trade surplus ollowing

an expected rise in imports is orecast to moderate the current account

surplus to 12.5% o GDP in 2010 (Figure 3.6.11). Te services balance

should improve as a stronger global economy leads to an increase in

tourist arrivals, but the decit in the income account will likely widen i

outows o prot remittances and dividend payments increase, pacing the

economic recovery.

Te main risk to these orecasts involves the nature and duration o

the global recession. I global demand is weaker than assumed in this

Update, the prospects or Malaysia’s exports and thereore its economy

will be eroded. Te country’s high level o external reserves and its strong

banking sector would position it relatively well to deal with any renewed

bout o global nancial instability, provided that it was short.

On the domestic ront, there is a risk that slow disbursement o the

scal stimulus measures could undermine condence and demand. I

the global recovery in 2010 gains momentum and leads to stronger than

expected domestic demand, monetary policy could tighten abruptly

and interest rates could rise quickly beore the output gap begins to

close. Tis, in turn, could hurt domestic consumer condence and slow

the economic recovery.









Pakistan

The country’s economic crisis eased a little in FY as the Government’s stabilization program took eect.

Fiscal and external imbalances narrowed, the exchange rate stabilized, and oreign reserves rose. But infation

remained stubbornly high and growth plunged as the economy reeled rom the impact o crippling power

outages, tight domestic demand management, uncertain security, and the global recession. The reduction in

imbalances was a consequence o expenditure cutting and economic slowdown rather than improvements

in underlying economic undamentals. Military operations against extremists and spending related to the

welare o internally displaced people put additional strain on the budget. A modest improvement in growth

is expected in FY, but even that is subject to substantial risks. Major macroeconomic and structural

reorms must be decisively implemented i the economy is to climb onto a sustainable growth path.

Updated assessmentTe growth rate in FY2009 (ended 30 June 2009) plummeted, and at 2.0%

was even less than the low projection o 2.8% given in Asian Development

Outlook 2009 (ADO 2009) in March this year. (Recent data revisions have

markedly lowered FY2008 growth rom the 5.8% used in ADO 2009.) Tis

recent weak perormance comes aer an average expansion o over 7%

during FY2004–2007 (Figure 3.7.1).

Te main demand-side contributor to slower growth in FY2009 was

alling investment, which subtracted rom growth; investment’s share

in GDP declined in comparison to the previous scal year (Figure 3.7.2).Private investment as a share o GDP ell or the third consecutive

year to 13.2% o GDP; reasons or this decline include tighter demand

management policies, lower availability o domestic credit, continued

power shortages, the uncertain security situation, and the global

economic slowdown. Te impact o lower private investment on growth

was compounded by a declineor the rst time in 7 yearsin the

share o public investment in GDP, as the Government curtailed its

budget or the public sector development program (PSDP) to control the

scal decit.

Public consumption in FY2009 also declined as the ederal

Government cut subsidies and contained operating expenditure.

Consequently, the share o total consumption in GDP ell compared with

the previous scal year, even as private consumption remained strong.

Te terms o trade improved ollowing lowered oil prices, and with a

sharp compression in imports (relative to a smaller decline in exports) the

share o net exports in GDP rose.

From the production side, a large part o the decline in growth

in FY2009 was attributable to a sharp contraction in large-scale

manuacturing, which caused a 3.6% all in industrial growth

(Figure 3.7.3). Almost all major industry heads slumped, including textiles,

3.7.1 GDP growth

0

2

4

6

8

10

1009080706052004

%

Forecast

7.5

3.02.0

4.1

6.85.8

9.0

Source: Ministry o Finance, Pakistan Economic Survey 2008–09.


This chapter was written by Sadar Parvez o the Pakistan Resident Mission, ADB,

Islamabad.

3.7.2 Expenditure components, share o GDP

-25

0

25

50

75

100

ImportsExports

Total investmentTotal consumption

09080706052004

%










automobiles, ood and beverages, and electronics. While some exporting

industries, such as textiles, were aected by slower or stagnant export

orders because o recession in trading partners, industrial production

catering to domestic markets also ell. Te country’s economic slowdown,

power shortages, and increased nancial costs arising rom higher interestrates aected all industries. Te large cut in the PSDP was a actor that

caused construction output to contract sharply.

Poor perormance o manuacturing overshadowed an otherwise solid

recovery in agriculture, which saw 4.7% growth in FY2009. Te recovery

was led by a bumper wheat crop o over 23 million tons, abetted by a 52%

increase in the Government’s procurement (support) price or armers.

Te rice crop set a new record at 7 million tons, allowing a strong

$1.8billioncontributiontoexports.Farmersincentivizedbyhigherprices

were able to beat the odds posed by water and ertilizer scarcity.

In FY2009, the all in manuacturing production and the contraction

in imports stunted growth in services, a sector that accounts or over 50%

o GDP. At 3.6%, it expanded at around hal the rate o the previous scalyear with decelerating growth in all subsectors. In nance, aer several

years o strong perormance, expansion slowed as the subsector absorbed

the impact o the economic downdra in the shape o lower protability,

higher nonperorming loans, and reduced deposit mobilization. Banks

became more risk averse against a backdrop o poorer lending portolio

perormance and more attractive terms that the public sector oered or

nancing the scal decit. Consequently, private sector credit stagnated

in FY2009, having grown strongly in recent years.

While nominal tax revenue grew by 15% relative to the previous scal

year, recessionary conditions in industry, coupled with the slowdown

in nance and telecommunicationsall large tax sourcesresulted

in a signicant shortall in tax collection by the Federal Board o Revenue (FBR) vis-à-vis the budgetary target. Falling imports lowered

customs duties. All major tax heads recorded shortalls in achieving

budget targets. With an ination-bloated nominal GDP (up by 27%), the

tax-to-GDP ratio or FBR taxes ell to only 8.8% in FY2009 (Figure 3.7.4).

Although part o the FBR revenue shortall was made up by proceeds

rom the petroleum development levy, the FY2009 decit target o 4.3%

o GDP was missed by 0.9 percentage points. Te decit, however, was

signicantly narrower than the 7.6% o GDP recorded a year earlier

(Figure 3.7.5). Te improvement was a result o cutting spendinglargely

on the public sector development programwhich came in at 28% below

target or the year. Expenditure on subsidies also ell as a share o GDP

compared with the previous scal year. Deense spending however,

although contained as a share o GDP, overshot the budget allocation due

to additional costs incurred in military operations against extremists in

the tribal areas and North-West Frontier Province. Moreover, provinces

showed overruns in current expenditure.

Looking ahead, the scal position needs to be strengthened

by improvements to revenue perormance and reductions to

nonproductive expenditure. Cutting development spending is not a

desirable or sustainable way to reduce the decit. Indeed, Pakistan has

to ramp up such spending i it is to upgrade basic inrastructure and

oster growth and investment. Such high development outlays are also


-5

0

5

10

15

20

ServicesIndustryAgriculture

09080706052004

%



3.7.4 Tax collection by Federal Board

o Revenue

600

800

1,000

1,200

8

9

10

11

Ratio to GDPLevel

0908072006

PRs billion %



3.7.5 Fiscal position

-8

0

8

16

24

Fiscal balanceTotal revenueTotal expenditure

09080706052004

% of GDP











South Asia Pakistan 147

necessary to strengthen access to, and quality o, social services (so as

to reduce poverty).

Ination pressure persisted in FY2009 despite the economic

slowdown, alling international commodity prices, a tight monetary

policy, and signicantly reduced central bank nancing o the scaldecit. Overall consumer price ination shot up to an average o 20.8%

rom 12% the previous scal year and rom only single-digit ination in

earlier years. Much o FY2009’s ination was driven by higher domestic

ood prices, which eventually seeped into core ination through upward

pressure on wages.

Tis pressure was evident in a signicant hike in the house rent index

where the cost o labor has a 40% weight. Marked depreciation in the

currency and price adjustments to reduce subsidies also contributed to

ination. Ination peaked year on year in August 2008 at 25.3% and ell

thereaer, although only at a measured pace as stabilization measures

slowly took hold (Figure 3.7.6). By July 2009, overall and core ination

rates had allen to 11.2% and 14.0%, respectively.Te State Bank o Pakistan increased the policy discount rate by

as much as 450 basis points to 15% during February–November 2008

(Figure 3.7.7) with the main objective o stemming ination. Te resulting

higher market rates made government debt attractive or commercial

banks (reducing demand on the central bank or nancing), restrained

imports, and helped build oreign exchange reserves. Te central bank

subsequently lowered the discount rate by 100 basis points in both April

and August 2009 as a countercyclical measure, even though ination

pressure persisted. Interest rate policy will have to continue balancing the

demand or price stability and the need to revive the economy.

ighter demand management policies and lower international oil

prices led to a contraction in imports in FY2009 by over 10% rom ayear earlier and an improvement in the trade account, but in the context

o a 5.9% drop in exports (Figure 3.7.8). Te power crisis and the global

economic downturn hit textile exports in particular, which account

or about hal o exports. (Te Pakistan rupee ell by 18.7% against the

dollar in FY2009, essentially osetting the impact o high ination on

competitiveness.) Te drop in exports would have been even larger had

it not been or an increase in rice exports made possible by the bumper

crop. Cement exports also surged (by 71%) on the back o strong demand

rom Aghanistan and India and rom expanding new markets in Arica

and elsewhere.

Despite expectations to the contrary, workers’ remittances showed a

21% increase in FY2009. Tis, together with the improvement in the trade

and services accounts (the latter helped by payments by the United States

or logistical support) translated into a sharp narrowing in the current

account decit to 5.3% o GDP rom 8.4% in FY2008.

However, a marked weakening in the nancial account made it

difcult to nance this narrower current account decit. Foreign direct

investment ell by a third in FY2009 and portolio investment recorded a

largenetoutowofnearly$1.1billion(Figure3.7.9).Still,creditfromthe

International Monetary Fund (IMF) under a standby arrangement agreed

to in November 2008 and increased disbursements rom multilateral and

bilateral institutions boosted oreign nancing.

3.7.7 Policy rate

8

10

12

14

16

JulAprJan

09

OctJulAprJan

08

OctJulAprJan

2007

%

Source: State Bank o Pakistan, available: http://www.sbp.org.pk, downloaded 25 August 2009.



-12

0

12

24

Trade balance ImportsExports

09080706052004

% of GDP



3.7.6 Infation

0

10

20

30

Year on year 12-month moving average

JulAprJan

09

OctJulAprJan

2008

%












With the narrowing in the current account decit and the increase

in external ofcial disbursements, oreign exchange reserves, which had

fallentoalowof$6.7billioninOctober2008,recoveredto$12.3billionby

end-FY2009 (Figure 3.7.10). At this level they were sufcient to cover about

5 months o imports. By 15 August 2009, oreign reserves had increasedfurtherto$13.0billion.

ProspectsPakistan’s economic outlook in FY2010 will be shaped by both internal

policies and global economic developments. Internally, economic

outcomes will depend on the Government’s ability to achieve the desired

balance between scal consolidation and revival o growth. Externally,

the outlook will depend on the degree o improvement in major trading

partners; the consequent impact on Pakistan’s exports and on receipts o

workers’ remittances; and developments in global oil prices.

On balance, a modest revival in economic growth to about 3.0% isprojected or FY2010, predicated on the planned larger public expenditure

program announced in June 2009 in the budget or FY2010 and on some

easing o monetary policy. Agriculture is expected to continue its strong

growth on the back o higher procurement prices or the main crops and

increased public spending in the sector as announced in the budget. But

agricultural growth will not be as high as in FY2009 due to the high base

eect and continued water scarcity that will limit crop expansion.

Growth in industry is expected to turn marginally positive in

FY2010 as the commissioning o new power plants reduces electricity

outages, and as adjustments in power taris generate cash ow or power

companies to expand their operations. Te pace o growth in the main

exporting industrial subsectors, such as textiles, will depend on the extento a pickup in consumer spending in main trading partners. Te services

sector is expected to post moderate growth in FY2010 on the back o good

agricultural growth and the modest pickup in industry.

o uel expansion, the Government has set a scal decit target o

4.9% o GDP in the budget or FY2010, a level higher than the 3.4% o

GDP originally targeted under the standby arrangement. O the new

scal decit target, up to 1.2% o GDP o additional nancing is expected

to be made available under the pledges made by donors at the Friends

o Democratic Pakistan meeting in okyo in April 2009. Tis pledged

assistance is to provide the scal space necessary or implementing a

countercyclical response in the orm o higher development spending.

Consequently, a massive 54% hike is planned or the PSDP in

FY2010. (Under an augmentation o the standby arrangement approved

by the IMF Board on 7 August 2009, IMF has agreed to provide bridge

nancing o up to 0.8% o GDP to support the budget in case o delays

in the receipt o unds pledged at okyo.) Te Government in FY2010

also plans additional spending o 0.3% o GDP unded by donor grants to

support rehabilitation o internally displaced people in areas aected by

operations against militants.

Te large planned development expenditure overshadows the real

contraction in current spending envisaged in the budget and results

in an overall expansionary scal stance (Figure 3.7.11). Te budget

3.7.10 Foreign exchange reserves

0

6

12

18

Total liquid reserves

Reserves with State Bank of Pakistan

JulAprJan

09

OctJulAprJan

2008

$ billion

Sources: State Bank o Pakistan, available: http://www.sbp.org.pk, downloaded 31 August 2009.



ADO

Update ADO

Update

GDP growth . . . .

Infation . . . .

Current acct. bal.

(share o GDP)

-. -. -. -.


3.7.9 Net oreign investment

-2,000

0

2,000

4,000

6,000

PortfolioDirect

09080706052004

$ million









South Asia Pakistan 149

proposals project a modest eort to generate additional tax revenue.

Development expenditure is set to increase by 1.6 percentage points o

GDP in FY2010, while additional receipts to be raised by the FBR amount

to 0.4 percentage points o GDP. Te external resource requirement

in the budget is thereore large and equivalent to about 80% o theplanned PSDP, indicating an unsustainable dependence on oreign

inows. A ailure to obtain external resources at the planned level could

consequently lead, once more, to a sharp drop in development spending.

Te increases in the consumer price index showed a trend decline

to 11.2% in July 2009, year on year. Te anticipated robust agricultural

crops, the economic program’s demand management policies, and a

high base eect rom the previous year are actors expected to lead to a

urther moderation in ination in FY2010. Conversely, planned increases

in electricity taris and government wages announced in the budget will

provide some upward pressure. On balance, ination is orecast to average

10% in FY2010, alling to about 9% (year on year) by June 2010.

Lower domestic ination and continued nominal depreciation o the exchange rate are expected to help sustain export competitiveness

(Figure 3.7.12). While some stabilization in exports is seen, they are

seen contracting by 2.5% owing to subdued demand in trading partner

countries and continued structural bottlenecks, such as power shortages

and lack o product diversication. Imports are expected to continue

shrinking (by about 2%), although that pace will slacken as the economy

recovers modestly and as international oil prices increase. Te trade

decit will narrow marginally rom a year earlier.

Te services account is projected to improve, mainly reecting

higher logistical payments. It is uncertain whether the trend increase

in workers’ remittances will be sustained (Box 3.7.1). However, based on

the continued strong growth o workers o 25% in the rst 2 months o FY2010 and evidence o strong numbers o workers proceeding abroad or

employment, workers’ remittances are assumed to hold steady in FY2010.

Te current account decit is expected to be 4.8% o GDP in FY2010,

somewhat improved rom a year earlier (Figure 3.7.13).

As non-debt-creating inows in the orm o new oreign direct and

portolio investment remain little improved in FY2010, the nancing o

the current account decit will need to continue relying on debt-creating

inows. Tese will include nancing through the standby arrangement,

augmented by disbursements rom development partners.

Te economic outlook carries downside risks and challenges.

Although Pakistan’s economic imbalances were reduced in FY2010,

structural improvements in the underlying undamentals are needed,

without which it will be difcult to sustain nancial stability and growth.

In particular, scal sustainability requires critical measures to

improve revenue mobilization through broadening the tax base and

removing exemptions, improving tax policy and administration, and

quickly adopting a ull-edged value-added tax. Meeting the scal decit

target purely by cutting development expenditure is not a viable policy

option or a country that requires large-scale spending on inrastructure

and social sectors to sustain growth and reduce poverty.

Likewise, improvement in the current account through a contraction

in imports alone is unsustainable. Te current account will be

3.7.11 Federal budget

0

600

1,200

1,800

FY2010 targetFY2009 actual

Nontax

revenue

Tax

revenue

Development

expenditure

Current

expenditure

PRs billion

Sources: Ministry o Finance, Federal Budget in Brie 2009–10

and Pakistan Fiscal Operations 2008–09.



70

80

90

100

110

50

60

70

80

90

Interbank Real effective

JulJan

09

JulJan

08

JulJan

07

JulJan

06

JulJan

2005

PRs/$ 2000 = 100

Sources: State Bank o Pakistan, available: http://www/sbp.org.pk; International Monetary Fund, International Financial Statistics online database; both downloaded1 September 2009.









undamentally improved only when the Government pushes through with

eective measures to build a much larger export base that is sufcient to

nance oil, machinery, and other essential imports. Tis issue is crucial in

an era o rising global oil prices.

Pakistan’s growth prospects continue to be stymied by its lingeringpower crisis. Both immediate and long-term measures are required to

address the crisis including improving governance; reducing leakages and

losses; rationalizing electricity taris to cover sector costs and eliminate

subsidies; and resolving the problem o “circular debt” (arrears that have

developed among participants in the sector), which has drained the

nances o the power companies and has orced cuts in their operations

and investments.

Multilateral development partners are supporting power sector

reorms and are nancing critical investments to improve and

augment electricity transmission, distribution, and generation systems.

However, the size and eectiveness o this assistance will depend on the

Government’s ability to implement its reorm agenda.Global recession, i prolonged, poses an obvious risk to Pakistan’s

economic recovery and stabilization through weakening exports, workers’

remittances, and inows o private capital. It is critical that the pledges

made by donors in okyo are realized to nance the PSDP in support o

Pakistan’s growth and poverty reduction strategy.

Finally, revival o higher growth is predicated on continued

improvement in the domestic security situation, which is critically

important to oster both domestic and oreign investment and to

strengthen private sector participation in key sectors o the economy.

Workers’ remittance inows have been on the rise sinceFY and have played a key role in supporting growthand reducing poverty in the country. Growing more thansixold since FY, they amounted to . o GDP inFY, up rom . in FY.

Such inows have been instrumental in boosting privateconsumption o households and have supported a property and real estate boom. Tey amounted to over o privateconsumption expenditure during FY–.

Te United States, Saudi Arabia, and the United ArabEmirates are the largest source countries o remittances,contributing almost two thirds o total inows.Remittances rom these countries increased signicantly due to reaction to the events surrounding September, when, among other actors, governments placedheavy emphasis on ofcial channels or internationalpayments (Box gure).

In particular, remittances rom the United States rosevery strongly and their share in the total more thandoubled during FY–, rising rom to o total receipts, beore alling to in FY. Te latterrelative decline was made up or by an increased share o

remittances rom the United Arab Emirates, which rose to in FY rom a year earlier.

Remittance inows have provided critical support toPakistan’s balance o payments by helping keep its currentaccount decit in check. In FY, they nanced o the trade decit and were equivalent to twice the level o oreign direct investment. In the two previous scal years,remittances on average nanced about hal the trade decitand were higher than oreign direct investment.

Workers’ remittances

0

3,000

6,000

9,000

Other countries United Arab Emirates

Saudi Arabia United Kingdom United States

090705032001991997

$ million

Source: State Bank o Pakistan, available: http://www.sbp.org.pk,



.. Workers’ remittances

3.7.13 Current account indicators

-12

-9

-6

-3

0

3

Trade balanceCurrent account balance

1009080706052004

% of GDP

Forecast

Sources: State Bank o Pakistan, available: http://www.sbp.

org.pk, downloaded 31 August 2009; sta estimates.








Philippines

A sharper than anticipated slowdown in private consumption in the rst hal o , coupled with a

slump in exports and weakness in xed investment, cut the GDP growth rate more than expected such

that ull-year growth will be lower than orecast in March. Activity should pick up through the second hal

o and reach modest growth rates in , supported by scal stimulus measures and the gradual

global recovery. Infation has declined more steeply than was earlier expected and the orecasts or

and are revised down. Current account surpluses will be maintained or these years.

Updated assessmentGDP growth slowed to 1.0% year on year in the rst hal o 2009 rom

3.8% in ull-year 2008 (revised down rom an originally reported 4.6%).

Gross national product growth also decelerated, although at 3.8% in the

rst hal it was well above the GDP rate owing to relative strength in

net actor income rom abroad. In a sign that the slowdown may have

bottomed earlier this year, year-on-year GDP growth accelerated rom

0.6% in the rst quarter to 1.5% in the second. Te Philippines is less

reliant on external trade (the export-to-GDP ratio is about 30%) than

other economies in Southeast Asia that contracted in the rst hal o 2009

as a result o the global recession.

Private consumption growth in the rst hal pulled back to 1.8%

year on year, rom 4.6% in the rst hal o 2008. Te pace o increasein remittances rom overseas workers slowed to 2.9% in United States

(US) dollar terms, although this translated to growth o 17.1% in pesos.

Concerns over job security eroded consumer condence. Still, the

remittances plus lower ination provided the basis or the expansion in

private consumption, which remained the major contributor to rst-hal

GDP growth.

Government spending, supported by the rollout o a scal stimulus

package, grew by 7.0% in the rst hal o 2009, though this was amplied

by the low base in government outlays in the prior-year period.

Investment, however, was weak. otal xed capital investment declined

by 4.4% and investment in equipment slumped by 18.6%, illustrating the

reluctance o rms to expand capacity at a time o global recession and

slowdown in domestic demand. Net exports ell and acted as a drag on

GDP growth.

On the production side, services constituted the major contributor

to GDP growth in the January–June period, though its expansion rate o

2.5% was about hal that o the same period in 2008 (Figure 3.8.1). Tis

deceleration reected sluggish private consumption and weakness in

transport, nance, and trade-related services, partly oset by growth in

communications and business process outsourcing.


-3

0

3

6

9

GDP ServicesIndustryAgriculture

H1

09

H2H1

08

H2H1

2007

%7.6

1.0

3.6

4.0

6.6

Sources: Asian Development Outlook database; NationalStatistical Coordination Board, available: www.nscb.gov.ph,downloaded 27 August 2009.


This chapter was written by Teresa Mendoza o the Philippines Country Ofce and

Purnima Rajapakse o the Southeast Asia Department, ADB, Manila.






Industrial production contracted by 1.3% in the rst hal, weighed

down by a 7.4% drop in manuacturing caused in large part by weaker

global demand or electronic goods and clothing and by much slower

expansion o ood processing. Public construction jumped by 24.1%,

spurred by the scal stimulus program, but private constructioncontracted by 1.4%.

Agriculture, accounting or about a third o employment and a h

o GDP, grew by only 1.3% in the rst hal. Rice production increased

by 3.6%, but corn output ell by 2.3% as its low price led some armers

to switch to rice and other crops. A slowdown in agricultural exports

to industrial economies, which account or nearly two thirds o total

agricultural exports, damped production o coconuts and sugar.

Labor-market data suggest that unemployment was contained, mainly

because laid-o workers moved into low-quality jobs. Te unemployment

rate ell rom 8.0% in April 2008 to 7.5% in April 2009. But close to

a million ull-time jobs were lost in that period, while 2.4 million

part-time jobs were created (the proportion o part-time workersincreased to 41% o the employed population rom 36%) (Figure 3.8.2).

Many o those made unemployed in manuacturing and services switched

to lower skilled work, and others reported working ewer hours or

becoming sel-employed. Tere were also signs that more members o

households sought work to supplement amily incomes, aer a amily

member had been laid o or had working hours cut.

Ination declined rapidly to 0.1% year on year in August 2009 (the

lowest in over two decades) rom a peak o 12.4% in August 2008. Tis

was attributable to the drop in global prices or oil and commodities and

subdued domestic demand.

On the trade ront, merchandise exports in US dollar terms slumped

by 32.8% in the rst 6 months, on a customs basis. Electronic products(57% o total exports) plunged by 35.5% as recession bit in the two largest

export markets (the US and Japan). Other exports to register double-digit

declines were agro-based products, clothing, and minerals.

Merchandise imports ell to a similar degree (31.1%), with steep

contractions in the raw materials and intermediate goods used in making

exports such as semiconductors, and weaknesses in imports o capital

goods. Te value o oil imports dropped by 69.4%, largely owing to

the all in global oil prices. Tese developments le the trade decit at

$3.1billioninthersthalf,narrowingfromayearearlier.

Te contraction in trade appears to have bottomed early in 2009

(Figure 3.8.3). Month-on-month data show exports increasing by about

10% in both May and June. Shipments o electronics on a month-on-

month basis edged up rom January to June. Imports on this basis

increased in May (by about 19%) and June (14%).

Available data or the rst quarter o 2009 show that the current

accountsurplusroseto$2.2billion.Anarrowermerchandisetradedecit

was reinorced by a larger surplus in services. Earnings increased rom

business process outsourcing (such as back-ofce accounting and payroll

support), while payments or transportation services ell in tandem with

lower trade volumes. Te surplus on net transers increased modestly, given

that remittances grew, but at a much slower rate than a year earlier. Te

higher current account surplus was partly oset by a decit in the capital

3.8.3 Merchandise trade growth

-45

-30

-15

0

15

30Imports

Exports

AprJan

09

OctJulAprJan

08

OctJulAprJan

2007

%


2009.


3.8.2 Labor market indicators

0

2

4

6

8

10

0

14

28

42

56

70

Full-time workers

Part-time workers

Unemployment

AprJan

09

OctJulAprJan

2008

% % of total employment



3.8.4 Foreign investment infows

-750

-500

-250

0

250

500

750

1,000

1,250

Net portfolioDirect investment

20092008

$ million

JanMay

JanJul

JanMay

JanJul

Source: Bangko Sentral ng Pilipinas, available: ww w.bsp.

gov.ph, downloaded 4 September 2009.










Southeast Asia Philippines 153

and nancial accounts caused by net outows o direct and portolio

investments,leavinganoverallbalance-of-paymentssurplusof$1.73billion.

Foreign direct investment has recovered in more recent months,

recordinganetinowof$1.0billioninJanuary–May2009,stilllow

but above the year-earlier level, while oreign portolio investment hasalsopickedup,withanetinowof$265millioninJanuary–July2009,

in contrast to an outow in the previous year (Figure 3.8.4). Gross

internationalreservesat$41.3billionasofend-Augustrepresentedahigh

7.1 months o retained imports.

In response to the weakened economic outlook, the Government in

January2009unveiledaP330billion($7billion)scalstimuluspackage.

About hal is allotted to labor-intensive inrastructure and social

welare programs, 30% to public–private partnerships or building large

inrastructure projects, and the rest to tax reductions or individuals and

businesses.

Tese additional outlays bumped up national government expenditure

by 18.1% in the rst 7 months o 2009 (relative to the same period in2008). Revenue ell by 4.1% in this period, partly a result o the economic

slowdown and the tax breaks. Te Government revised its 2009 scal

decit target rom 2.2% o GDP in March to 3.2% in June, but the actual

gap may be slightly wider than that, given weakness in revenue. Te

rst-hal scal decit was 4.3% o GDP (Figure 3.8.5) and the primary

balance, excluding interest payments, ell into decit or the rst time

since 2003. Ample liquidity should enable the nancial system to absorb

any necessary increase in the Government’s gross borrowing requirement.

Te Government projects that requirement or 2009 to be 8.5% o GDP

(P451billionindomesticnancingandabout$4billioninexternal

nancing), higher than 6.7% in 2008.

In July 2009, the Philippines tapped international capital markets orasecondtimethisyearwitha$750million,10-yearbondissuewitha

yield o 6.625%, or 332.6 basis points above comparable US reasuriesa

narrowing rom about 600 basis points above US reasuries or a January

2009 10-year bond issue. With the additional borrowings, the ratio o

public debt to GDP is seen increasing by about 1 percentage point this

year to 57.6% (but that is still well below the 78.2% level reached in 2004).

Easing ination and growth paved the way or Bangko Sentral ng

Pilipinas, the central bank, to lower its policy interest rates in steps by 200

basis points rom December 2008 to July 2009, taking the reverse repo

rate to 4.0% (Figure 3.8.6), the lowest in two decades. Te central bank

also reduced bank-reserve requirements and took other steps to support

banking system liquidity and depositor condence in late 2008, when the

global nancial crisis intensied. Te peso depreciated by 2.9% against the

US dollar in the rst 8 months o 2009, aer a 12.8% decline in 2008.

With ample liquidity in domestic markets, more rms turned to the

debt market or unding. Te private sector sold P94 billion o bonds in

the rst hal, more than double the prior-year level. Te stock market

rallied in line with many o its regional peers: the composite index o

stock prices rose by 54% in the rst 8 months o 2009 (Figure 3.8.7).

Improved investor sentiment was also shown in the narrowing o yield

spreads between US and Philippine reasuries, to 299 basis points at

end-August rom 546 basis points at end-2008 (Figure 3.8.8).

3.8.6 Infation and policy rates

0

3

6

9

12

15

Inflation Reverse repo rateRepo rate

JulAprJan

09

OctJulAprJan

2008

%


2009.Click here or fgure data

3.8.7 Philippine Stock Exchange index

0

1,000

2,000

3,000

4,000

JulAprJan

09

OctJulAprJan

2008

30 Sep 1994 = 2,922.21



3.8.5 Fiscal perormance

-5.0

-2.5

0.0

2.5

5.0

Overall fiscal balance Primary balance

H1

09

H2H1

08

H2H1

2007

% of GDP












ProspectsTe outlook assumes that there will be a smooth political transition in

2010 ollowing national elections scheduled or May, and that the new

government pursues a credible economic program. As or monetary

policy, the central bank kept its key policy rates steady in August andnoted that the impact o the substantial monetary easing seen through

July had yet to be ully elt in the economy. Te orecasts assume that the

monetary stance will remain accommodative, and gradually tighten in

2010, with the timing depending on ination and growth trends.

Private consumption is projected to pick up in the second hal o

2009. Te consumer condence index published in September showed

an improvement in sentiment, based on low ination, easing interest

rates, and rmer international economic conditions. Illustrating this

improvement, motor vehicle sales rose by 6.8% in August year on year, the

astest pace so ar this year.

Remittances have held up better than expected, reaching a record

$1.5billioninJune(up3.3%fromayearearlierFigure3.8.9)andaggregatingto$8.5billioninthersthalfof2009.ePhilippine

Overseas Employment Administration estimated that rom October 2008

to June 2009 less than 1% o the 8.7 million Filipino workers abroad lost

their jobs. New job orders held up well in January–June, with just over

hal the available jobs intended or proessional and service workers,

generally more secure jobs than lower-skill ones.

Public investment is expected to gain impetus as scal stimulus

measures are stepped up (some aced delays in the rst hal o 2009). Te

index o business condence or the third quarter o 2009 increased or

the rst time in a year (Figure 3.8.10). Still, uncertainty leading up to the

elections, as well as the still-weak export environment, will likely keep

private investment subdued. Investment pledges reported or the rst hal o 2009 by the Board o Investments and the Philippine Economic Zone

Authority, which cover most o the investment pledges or the country,

ell by about two thirds rom prior-year levels.

From the supply perspective, services are orecast to expand by 3.0%

in 2009. Modest growth in private consumption and election spending

will support retail trade as well as transport and communications

services. Te industry association or business process outsourcing

expects23%growthinrevenuetoabout$7.5billionthisyear.

Manuacturing will recover gradually: an index o manuacturing

volume shows a slowing in the pace o decline since January. Moreover,

average capacity utilization rose rom 78.1% in January to 81.5% in June

(Figure 3.8.11). However, agriculture aces an expected El Niño weather

pattern, which can dent arm production.

aking these inuences into account, GDP growth is projected to

step up to 2.2% in the second hal o 2009. Tat would put ull-year

growth at 1.6%, below that anticipated in Asian Development Outlook

2009 (ADO 2009) in March, a consequence o the weaker than expected

rst hal perormance and the downgrading o the global trade volume

assumed in this Update.

In 2010, domestic demand will strengthen, supported by election

spending through May and some expected improvement in the labor

market resulting rom a li in business sentiment in the second hal, on

3.8.10 Overall business condence index

-30

0

30

60

Next quarterCurrent quarter

Q3Q2Q1

09

Q4Q3Q2Q1

08

Q4Q3Q2Q1

2007

Index

Source: Bangko Sentral ng Pilipinas, available: ww w.bsp.gov.ph, downloaded 4 September 2009.


3.8.9 Growth o remittances

-8

0

8

16

24

32

Peso

Dollar

AprJan

09

OctJulAprJan

2008

%



3.8.8 Risk sentiment indicators

0

300

600

900

Sovereign risk spreads Credit default swaps

JulAprJan

09

OctJulAprJan

08

OctJulAprJan

2007

Basis points











Southeast Asia Philippines 155


ADO

Update ADO

Update

GDP growth . . . .

Infation . . . .

Current acct. bal.

(share o GDP)

. . . .


the assumption o a smooth election and transition in government. Te

modest rebound assumed or next year in global growth and world trade

will provide some impetus. Net exports are expected to make a slight

contribution to GDP growth. Due to modest unding increases in social

services and a decline in inrastructure spending under the proposed2010 budget, the level o scal support to the economy may not be as

strong as in 2009. Economic growth next year is orecast at 3.3%, still a

hal percentage point shy o the 2008 pace (Figure 3.8.12).

Merchandise exports in the ourth quarter o 2009 are projected to

edge higher as demand abroad improves. Imports will also pick up, in line

with a rming in private consumption and the restocking o inventories.

Te trade decit or ull-year 2009 will likely be narrower than was

expected in March. rade in services is projected to produce a surplus,

largely reecting the perormance o business process outsourcing. Tese

actors, coupled with remittance inows, are orecast to keep the current

account in surplus equivalent to 2.8% o GDP or 2009 (revised up rom

ADO 2009), and at a similar percentage in 2010.Ination is projected to gradually increase rom August’s 0.1% rate,

given the base eect caused by the peaking o the consumer price index

in August 2008. It is now orecast to average 3.2% this year, revised

down rom ADO 2009 because domestic demand has been weaker than

anticipated. Te ination orecast or 2010 is also lowered a touch, to 4.5%.

Te Government aims to rein in its scal decit to 2.8% o GDP in

2010, targeting an increase in tax revenue to 14.3% o GDP rom 13.9%

in 2009 (this year’s goal looks ambitious considering the tax breaks and

sluggish economic growth). Actual tax revenues were around 14% in 2007

and 2008. However, the Government has not been able to win legislative

approval or revenue-strengthening proposals (such as excise tax reorms

and changes in scal incentives to investors).Moody’s upgraded its sovereign credit rating or the Philippines in

July 2009, rom B1 to Ba3, citing the resilience o the nancial system and

external payments position in the ace o the global slump. Te rating is

nevertheless below investment grade.

A key risk to the outlook is a weaker than anticipated global economic

recovery. Tat would hurt exports, oreign investment inows, and

consumer and business sentiment which, while showing early signs

o improvement, remain ragile. On the domestic ront, maintaining

investor and consumer condence requires the elections to go smoothly.

3.8.12 GDP growth

0

2

4

6

8

1009080706052004

%

Forecast



3.8.11 Average capacity utilization rate,

manuacturing

77

79

81

83

AprJan

09

OctJulAprJan

2008

Index









Thailand

A steep all in exports caused by the global trade slump drove down industrial production and investment

in the rst hal o . Business and consumer sentiment was urther undermined by political tensions.

Although there were signs the worst had passed by midyear, the economy is expected to contract by

more than was projected in March. Modest growth is seen resuming in . The tempo o recovery will

depend in large part on the Government ully implementing two scal packages, including a new public

investment program. Those plans would be at risk i political disruptions recur. The consumer price index

is now orecast to decline this year, beore low-level infation returns next year.

Updated assessmentDomestic political turbulence has aggravated the economic impact o

the global recession. On a sequential basis, GDP contracted by a steep

5.9% (seasonally adjusted) in the ourth quarter o 2008 and by a urther

1.8% in the rst quarter o 2009, beore picking up by 2.3% in the second.

Economic output or the rst hal o 2009 ell by 6.0% rom the prior-year

period, one o the sharpest declines in Southeast Asia.

Tis economic contraction was primarily caused by a drop in

industrial production (Figure 3.9.1) ollowing the slump in global demand,

and by a decline in consumer and investor condence. Te Government

adopted expansionary scal and monetary policies to temper the

contraction.Private consumption ell by 2.4% year on year in the rst hal o

2009, the result o a weakening labor market, a all in export prices

o agricultural commodities that hurt rural incomes, and eeble

consumer condence, particularly during times o political turmoil.

Antigovernment street protests in April, which ollowed an extended

period o rising political tensions, led to a temporary state o emergency

in the capital, Bangkok.

In contrast to the all in private consumption, government

consumption rose by 4.8% in the rst hal o 2009 as the Government

quickened the pace o its budget disbursement and raised wages or its

employees, and rolled out its rst scal stimulus package rom March.

However, investment slumped in the rst hal and this contributed

most to the contraction in GDP on the demand side. Private xed

capital investment dropped by 16.9%, reecting weak external demand,

the impact on business sentiment o the political uncertainty, as well as

more cautious lending by banks. Foreign direct investment applications

declined in value by 47% in the rst 7 months o 2009.

Public investment ell by 9.1% in the rst quarter, then rebounded by

9.6% in the second on aster disbursement by the Government and state

enterprises (Figure 3.9.2). A steeper all in the volume o imports than


-14

-7

0

7

14

ServicesIndustryAgricultureGDP

Q1

09

Q3Q1

08

Q3Q1

07

Q3Q1

2006

%

Source: National Economic and Social Development Board,

available: http://www.nesdb.go.th, downloaded 24 August2009.


This chapter was written by Luxmon Attapich o the Thailand Resident Mission, ADB,

Bangkok.

3.9.2 Gross xed capital investment growth

-24

-12

0

12

24

Public investment

Private investment

Gross fixed capital formation

Q1

09

Q3Q1

08

Q3Q1

07

Q3Q1

06

Q3Q1

2005

%

Source: National Economic and Social Development Board,available: http://www.nesdb.go.th, downloaded 24 August

2009.








Southeast Asia Thailand 157

in exports meant that net exports o goods and services had a positive

inuence on GDP in the rst hal.

From the supply side, industrial production ell sharply as exports

dived. Te important manuacturing component o industry dropped by

11.4% in the rst hal, with motor vehicles down a precipitous 40%. Insigns that the slump was bottoming, the decline in the manuacturing

production index slowed to 18.5% in the second quarter rom 32.7% in

the rst, and the rate o industrial capacity utilization increased to 59.2%

rom 58.1% in the same period (Figure 3.9.3).

Construction activity, which declined or our consecutive quarters

through end-March, started to pick up in the second quarter when the

Government and state enterprises accelerated their investment.

Services were hampered by subdued consumer condence and a

all o about 16% in tourist arrivals in January–June. Output rom the

sector declined by 2.8%. ransportation and communications, hotels and

restaurants, and wholesale and retail trading were among the weakest

subsectors. Agricultural and sheries output, damped by the drop inworld commodity prices, grew by just 0.4% in the rst hal. Tat meager

increase was mainly attributable to an expansion o livestock and shrimp

production. Rice production in the second quarter ell rom the year-

earlier level, which was elevated as a result o high rice prices at that time.

In the external accounts, the value o merchandise exports ell

by 23.1% in the rst hal rom the corresponding period in 2008

(Figure 3.9.4). Steep alls were recorded or shipments o automobiles

and parts, electronic and electrical appliances, as well as maize, natural

rubber, rice, and tapioca. Exports ell to the main destinationsUnited

States, European Union, Japan, and Southeast Asiabut some other

markets such as Australia and the Middle East were relatively rm. For

exports, too, the pace o decline eased in the second quarter rom therst, particularly or shipments to People’s Republic o China, India, and

Republic o Korea.

Merchandise imports tumbled by 35.2% in the rst hal, mainly a

reection o reduced purchases o imported inputs used by manuacturing

export industries, much lower prices or imported oil than a year earlier,

and the slack domestic demand. Tis aster all in imports than exports

propelledthetradesurplusfrom$1.8billioninthersthalfof2008to

$11.7billioninthersthalfofthisyear.Netoutowof$5.5billioninthe

capital and nancial accounts stemmed rom a rise in Tai investment in

overseas securities and rom debt repayments.

Largely as a consequence o the ballooning trade balance, the

currentaccountsurplusof$11.4billionwasmorethanthreetimesthat

recorded a year earlier, and the overall balance o payments registered a

surplusof$8.7billion.Foreignreservesroseto$123.4billionatend-July,

equivalent to 5.6 times short-term oreign debt and 10 months o imports

(Figure 3.9.5).

Large current account surpluses contributed to a 2.7% appreciation o

the baht against the US dollar in the rst 7 months o 2009, and to a rise

o about 1.0% in the nominal eective exchange rate o the baht. Te Bank

o Tailand in August relaxed regulations on Tai investment in oreign

securities and derivatives, a move aimed at acilitating capital outows

and easing upward pressure on the baht.

3.9.3 Manuacturing indicators

-50

0

50

100

Industrial capacity utilization rate

Change in manufacturing production index

year on year

JulJan

09

JulJan

08

JulJan

07

JulJan

2006

%

Source: Bank o Thailand, available: http://www.bot.or.th,downloaded 7 September 2009.


3.9.4 Current account indicators

-40

-20

0

20

40

-20

-10

0

10

20


Trade balance

Import growth

Export growth

H109

H2H108

H2H107

H2H106

H2H12005

% $ billion

Source: Bank o Thailand, available: http://www.bot.or.th,



3.9.5 Foreign reserves and import cover

0

50

100

150

0

5

10

15

Import coverReserves

JulJan

09

JulJan

08

JulJan

07

JulJan

2006

$ billion Months

Sources: CEIC Data Company Ltd.; Bank o Thailand,available: http://www.bot.or.th, both downloaded

7 September 2008.











Employers responded to the plunge in export orders and subsequent

weakness in domestic demand by reducing working hours and

employment, contributing to a rise in the unemployment rate to 2.1%

in the rst quarter o 2009 rom 1.3% in the preceding quarter. Te rate

eased to 1.8% in the second quarter o 2009 when hiring started to pick up, particularly in construction and some services.

Ination, which shot up to an 11-year peak in July 2008, ell away as

global prices or oil and ood slid, so that the consumer price index ell

by 1.9% in January–July 2009 year on year. Te all in July was a steep

4.4% on this basis (Figure 3.9.6). Government policies introduced in 2008

to assist those on low incomes at a time o high ination, including ree

electricity and water supply or small households and subsidies or public

transportation, were extended twice to stimulate private consumption.

Te rst scal stimulus package aimed at moderating the economic

contractioninvolvedmeasurescostingB116.7billion($3.4billion,or

about 1% o GDP). Coming into eect in March this year, it included cash

payments and subsidies or low-income people and assistance or ruralsmall enterprises. Almost hal the total amount was disbursed by July.

Te additional spending, at a time o weakness in government

revenue, is projected to widen the scal decit to about 4% o GDP in

FY2009 (ended 30 September 2009), rom 0.3% in FY2008. Revenue has

allen well below target during FY2009 as the domestic recession eroded

government income rom sources such as import duties and value-

added tax. Parliament in June passed emergency legislation authorizing

additional government borrowing beyond limits set under the budget law,

and it approved new debt issues o up to B800 billion.

Monetary stimulus came rom aggressive reductions in interest rates

by the Bank o Tailand: rom the start o December 2008 to April

2009 it lowered its policy rate by 250 basis points to 1.25% (Figure 3.9.7).Nevertheless, the impact on lending was muted. Commercial banks,

concerned about credit risks in a contracting economy, were cautious

in lending, while private sector demand or credit generally declined

in tandem with economic activity. Te rate o increase in loans by

commercial deposit-taking institutions slowed rom 8.4% in the rst

quarter to 6.1% in the second.

Stock prices as reected in the SE index, aer alling by 48% in 2008,

picked up in the second quarter o 2009. Te index rose by 45% in the rst

8 months o this year (Figure 3.9.8), a gain in line with other Asian markets.

Citing the political unrest, S&P in April lowered Tailand’s long-term

local currency debt rating to A- rom A. Fitch downgraded the long-term

oreign currency rating to BBB rom BBB+ that month, on the grounds

that political strie undermined the ability o the Government to

implement policies.

ProspectsTe orecasts assume that there are no disruptive changes in government

in the orecast period and that scal policy is implemented as planned.

In addition to the rst scal stimulus package, the Government has

approved a second package that comprises public investment and that

willcostB1.43trillion($42billion)over3scalyearsstartinginOctober


-6

0

6

12

Jan

09

Jan

08

Jan

07

Jan

06

Jan

05

Jan

2004

%

Sources: CEIC Data Company Ltd.; Bureau o Trade andEconomic Indices, available: http://www.price.moc.go.th,both downloaded 2 September 2008.


3.9.7 Policy rate

1

2

3

4

JulAprJan

09

OctJulAprJan

2008

%



3.9.8 SET index

200

400

600

800

1,000

JulAprJan

09

OctJulAprJan

2008

30 April 1975 = 100


2009.











to edge the policy rate back up in the second hal o 2010. Te main

nancial constraint or many rms is access to credit, rather than its cost.

Addressing this issue, the Government has asked state-owned nancial

institutions to give more attention to rms acing a liquidity squeeze and

provided credit guarantees to small and medium-sized enterprises andexporters.

Most o the nancing or the 3-year public investment program will

be o-budget, sought rom domestic debt markets and public–private

partnerships. Borrowing or the program is expected to increase the

ratio o public debt to GDP to a still-manageable 58% o GDP by 2012,

rom 37.4% in 2008. Te FY2010 budget targets a reduction in spending

rom FY2009, but when planned outlays or the public investment

program are added, the combined scal decit or FY2010 will be as

high as 7.4% o GDP.

Domestic risks to this outlook center on possible renewed political

turbulence that would disrupt policy making and delay disbursement o

budget spending and the public investment program. Bolstering domesticdemand is particularly important, considering that the outlook is or only

modest growth in industrial-country markets. (Tailand has oen relied

on exports to drive growth, but this is less likely to be an option in the

orecast period.)

Te public sector bears a heavy responsibility in reviving investment,

largely because the private sector has been weakened by recession and

political uncertainty. But the mediocre record o public investment in

recentyearsunderlinestheriskofrelyingonittoomuch.A$40billion

“megaprojects” inrastructure plan that was ormulated in 2005 and

that carried a similar responsibility was largely uncompleted because

o requent changes in government and political tensions. Some o that

plan’s projects have now been incorporated into the new 3-year program.Overall, public investment has been relatively low since the 1997–98 Asian

nancial crisis (Figure 3.9.12).

Any renewed political turmoil that disrupts the rollout o the public

investment program (and policy making in general) would hurt growth

directly and erode still-ragile consumer and investor condence. In these

circumstances, GDP growth would be lower than orecast, as would scal

revenue, which would put additional pressure on the budget.

3.9.12 Public invesment

0

3

6

9

12

080604022000981996

% of GDP

Source: National Economic and Social Development Board,

available: http://www.nesdb.go.th, downloaded 24 August2009.


3.9.11 Annual infation

-2

0

2

4

6

1009080706052004

%

Forecast

5-year moving average

Sources: National Economic and Social Development Board,

available: http://www.nesdb.go.th, downloaded 27 August2008; sta estimates.








Viet Nam

The economy is weathering the global economic crisis relatively well due largely to swit and strong

policy responses. The GDP growth orecast or is revised up rom that made in March and the

orecast is maintained, with growth expected to accelerate in the second hal o and into . The

projections or infation are raised, chiefy because o higher world commodity prices. Forecasts or current

account decits are narrowed, though the overall balance o payments is still expected to be in decit this

year, beore it returns to surplus next year. Thereore, the Government needs to strike a balance between

stimulating growth through demand-side measures and saeguarding macroeconomic stability.

Updated assessmentDespite the weak external environment, the economy has continued

expanding this year, albeit at a slower rate. GDP grew by 3.9% in the rst

hal o 2009, as against 6.2% in 2008 and more than 8% in 2005–2007

(Figure 3.10.1). Expansionary scal and monetary policies boosted public

consumption and domestically nanced investment. Imports ell more

steeply than exports, so that net exports contributed to GDP growth. At the

same time, a rise in unemployment and all in remittance inows damped

growth o private consumption, and a downturn in inows o oreign direct

investment (FDI) caused a decline in oreign-nanced investment.

Viet Nam’s economic slowdown appears to have bottomed out early

in 2009, with year-on-year GDP growth quickening to an estimated 4.5%in the second quarter rom 3.1% in the rst. Growth o agriculture pulled

back sharply in the rst quarter because o bad weather, but rebounded

in the second quarter, aided by a bountiul winter–spring rice harvest.

Manuacturing, which contracted in the rst quarter on account o weak

external demand, started growing again in the second, as expansionary

monetary and scal policies strengthened domestic demand. Growth o

services and construction accelerated in the second quarter owing to a

pickup in private consumption and domestically nanced investment.

Following several years o decline, output o crude oil grew by 17.9% in

the rst hal o 2009 (Figure 3.10.2). Falling output at some old elds was

more than oset by increases at new elds.

A soening in the labor market that started in late 2008 continued

in early 2009, as economic activity slowed and businesses shed labor.

Although most layos occurred in urban areas, unemployment and

underemployment increased in both urban and rural areas, as some o

those rom villages who had lost their jobs in cities returned home. Declines

in remittance receipts and wages pushed some households into poverty.

oward mid-2009, however, demand or labor appeared to pick up again.

Ination has decelerated sharply owing to lower world commodity

prices and relatively slow domestic economic growth. Period-average


0

3

6

9

12

ServicesIndustryAgricultureGDP

H1 090807062005

%

Source: General Statistics Oce o Viet Nam.


This chapter was written by Bahodir Ganiev o the Viet Nam Resident Mission,

ADB, Hanoi.

3.10.2 Crude oil output

0

5

10

15

20

H1 09H1 080807062005

Million metric tons

Source: General Statistics Oce o Viet Nam.









ination eased to 8.3% in January–August 2009 rom 23.0% in 2008. Year-

on-year ination ell to 2.0% in August 2009 rom 28.3% in August 2008

(Figure 3.10.3). However, ination pressures reemerged in the second quarter

as commodity prices edged up and growth accelerated. Seasonally adjusted

month-on-month ination rose to 0.8% in the June–July period, a airly high rate given that world commodity prices were well below their peaks.

o stimulate economic activity and limit the rise in unemployment,

the State Bank o Viet Nam (SBV), the central bank, eased monetary

policy signicantly in late 2008 and early 2009 and has kept it relatively

loose since then. Year-on-year growth o reserve money quickened rom

13.7% in the third quarter o 2008 to 26.7% in the rst quarter o 2009,

beore a decline in SBV’s oreign assets pulled it back to 21.2% in the

second quarter (Figure 3.10.4). Spurred by the introduction o government

interest rate subsidies, growth o credit and money supply accelerated in

the rst hal o 2009; in particular, growth o total liquidity (M2) stepped

up to 35.8% in the second quarter rom 20.3% in the ourth quarter o 2008.

Since the easing o monetary policy was not enough to prevent a sharpslowdown in growth, the Government approved several scal stimulus

measures in the rst hal o 2009 (Box 3.10.1). Tey include a temporary

30% cut in the corporate tax rate or small and medium-sized enterprises,

additional nancial assistance to poor households, a 4 percentage point

interest rate subsidy on certain bank loans, and a boost in planned

inrastructure spending. Te total cost o these measures is estimated at

D145.6 trillion, more than was expected when Asian Development Outlook

2009 (ADO 2009) was launched in March this year.

Te tax breaks, coupled with a all in oil income caused by lower

world oil prices, reduced budget revenue and grants in the rst hal o

2009 (Figure 3.10.5). Budget expenditure decreased as well, because the

scal stimulus mainly increased o-budget spending and lending. Tebudget ell into decit, rom a surplus a year earlier. Te overall scal

decit (including o-budget expenditure and lending) was likely much

larger than the budget decit.

SBV has kept its reerence oreign-exchange rate airly stable since

December 2008 (Figure 3.10.6). Declines in exports as well as in remittance

and oreign capital inows have reduced the supply o oreign exchange,

while expansionary monetary and scal policies have increased demand

or it. Consequently, there has been a shortage o oreign exchange in the

ormal market and the dong’s exchange rate against the US dollar has

remained at the upper bound o its trading band since October 2008.

Te band was widened to +/-5% rom +/-3% around SBV’s reerence rate

in March 2009, resulting in depreciation against the US dollar by about

2% in the ormal market. However, this depreciation was insufcient or

the market to clear. Te black market exchange rate has stayed above the

upper bound o the trading band most o the time since October 2008.

Te shortage o oreign exchange in the ormal market has helped

narrow the trade decit by suppressing imports. But it has also created

difculties or businesses, given rise to indirect payments or oreign

exchange in the ormal market, and hurt the business environment.

Furthermore, the shortage has ueled expectations o devaluation and

put depreciation pressure on the dong in the black market. Te spread

between SBV’s reerence rate and the black market rate widened to more

3.10.3 Infation

-10

0

10

20

30

-2

0

2

4

6

Seasonally adjusted monthly inflation

Year-on-year inflation

Period-average a inflation

JulAprJan

09

OctJulAprJan

2008

% %

a Year-to-date average.

Sources: General Statistics Oce o Viet Nam; sta

estimates.


3.10.4 Growth o money and banking

indicators

0

20

40

60

80

Total liquidity (M2)

Banking system net domestic credit

Reserve money

Q2Q1

09

Q4Q3Q2Q1

08

Q4Q3Q2Q1

2007

%

Sources: State Bank o Viet Nam; sta estimates.


3.10.5 Government nance

0

7

14

21

28

35

Budget expenditureb

Budget revenue and grantsa

H1 09H1 080807062005

% of GDP

a Excludes revenue carried over rom the previous year.b Excludes amortization o public debt and expenditure

brought orward rom the ollowing year.

Sources: Ministry o Finance and General Statistics Oce o

Viet Nam; sta estimates.










Southeast Asia Viet Nam 163

Te Government approved various scal stimulus measuresin January–May to ease the impact on the economy

o the global economic slump. Given the consensus-baseddecision making system, it approved policies in a piecemealashion to speed their implementation, rather than wait toget agreement on a package o measures.

Tis approach enabled the Government to start carryingout some stimulus measures as early as February. However,it also created some uncertainty about the impact o the stimulus on the budget, and the total amount raisedquestions about the implications or macroeconomicstability and sustainability o public debt.

Te total amount is indeed large, estimated atD. trillion, or . o projected GDP(Box table ). However, the direct impact on the

budget will be less than this amount, even i all measuresare ully carried out. Tis is because the measures includehousing assistance to the poor that will be mostly nancedby the Viet Nam Bank or Social Policies and interest ratesubsidies that will be partly disbursed in .

Te potential direct impact o the measures on the budget is positive, given that they include both deerment o

some tax payments and budget loan repayments rom

to and the bringing orward o some expenditure rom to .

In June , the National Assembly lowered the ofcialGDP growth target or rom . to . and raisedthe ceiling on the budget decit (based on the Government’sdenition) rom . o GDP to . o GDP (Box table). Tis in eect increased the planned overall scal decit(including net o-budget expenditure and lending) rom. to . o GDP. However, the Government’s revisedbudget plan is based on conservative projections o world oilprices and revenue perormance. Actual revenue is likely toexceed the planned amount owing to higher world oil pricesand improved tax administration.

In addition, planned capital spending is unlikely tobe ully disbursed due to implementation and nancingconstraints. Accordingly, the ADO orecast o theoverall scal decit in is revised up only slightly,rom . o GDP to . o GDP. Te gap is expectedto be nanced mainly by drawdowns on the Government’sdeposits at SBV and at commercial banks, and by borrowingrom multilateral and bilateral development agencies.

Te scal decit is thereore unlikely to put sustainability o public debt at risk. Nor is it expected to jeopardizemacroeconomic stability, assuming that SBV starts

tightening monetary policy toward the end o .

.. Fiscal stimulus measures and the budget

Fiscal stimulus measures, trillion dong,

Amounta Potential direct impact

on the budgetb

Measures aectinggovernment revenue

. -. .

Measures aecting government

expenditure and net lending

. . -.

Total . -. .

Billion US dollars . -. .

o GDP . -. .

a Excludes quasi-scal stimulus measures undertaken through the Viet NamDevelopment Bank (such as guaranteeing bank loans to small and medium-

sized enterprises). b Sta estimates based on the assumption that theannounced scal stimulus measures will be ully implemented. Excludes

the indirect impact o the measures on the budget through their eects onpublic debt, growth, etc.

Source: Government o Viet Nam; sta estimates.

Budget, % o GDP,

Government’s plan ADBrevised

projectionsOriginal Revised

Budget revenue and grants . . .

Budget expenditure . . .

Budget scal balance

(Government's denition)a-. -. -.

O-budget expenditure and

lending (net)

. . .

Overall scal balanceb -. -. -.

ADB = Asian Development Bank.a Includes carried over 2008 revenue (as revenue) and amortization o public

debt (as expenditure). b Excludes carried over 2008 revenue and amortizationo public debt but includes net o-budget expenditure and lending.

Source: Government o Viet Nam; sta estimates.

than 9% in mid-July 2009 rom about 3% at end-2008. SBV increased the

supply o oreign exchange in the ormal market in July, which cut the

spread to about 8% in August.

Weak external demand reduced merchandise exports by 10.2% in

the rst hal o 2009 (Figure 3.10.7). Exports o seaood, coee, crude

oil, and wood products, or example, ell by more than 10%. Tis drop

was partly oset by reexports o gold (about 9% o total exports) and an

increase in exports o rice. Imports dropped at the much aster rate o





15,000

16,000

17,000

18,000

19,000

20,000

Black market exchange rate

Lower bound of the trading band

Upper bound of the trading band

Reference rate of the State Bank of Viet Nam

JulAprJan

09

OctJulAprJan

2008

Dong/$

Sources: State Bank o Viet Nam; sta observations.



-60

-30

0

30

60

90

-8

-4

0

4

8

12

Trade balanceImport growth

Export growth

Q2Q1

09

Q4Q3Q2Q1

08

Q4Q3Q2Q1

2007

%, year on year $ billion



3.10.8 Current account and reserves

-13

0

13

26

Gross official reserves


H1 09H1 080807062005

$ billion

Note: Reserves exclude the Government’s oreign exchangedeposits at the State Bank o Viet Nam and the oreignexchange counterpart o swap operations.



34.1%, reecting the slowdown o economic activity, lower import prices,

reduced availability o trade credit, and the shortage o oreign exchange.

A downturn in FDI inows contributed to the sharp decline in imports

o capital goods. Te trade decit (balance-o-payments basis) narrowed

to$0.2billioninJanuary–June2009from$11.4billioninthesameperiodo the previous year. Despite declines in remittance inows and tourism

income, the current account recorded a surplus o 0.4% o GDP in the

rst hal o 2009, compared with a decit o 23.8% in the same period o

2008 (Figure 3.10.8). (Te rst-hal current account balance would be a

decit o 5.7% o GDP i reexports o gold were excluded.)

Te capital account balance turned rom surplus into decit due to a

downturn in FDI inows and outows o portolio investment and short-

term capital. Te overall balance o payments recorded a decit, and gross

ocialreservesfellto$17.6billionatend-June2009from$23.0billionat

end-2008. In terms o import coverage, however, gross ofcial reserves

increased to 16.4 weeks o imports at end-June 2009.

For the rest o 2009, it is assumed that the Government will nottake additional scal stimulus measures. It is urther assumed that SBV

will start tightening monetary policy toward the end o this year, as the

balance o risks shis rom growth to macroeconomic stability. Output at

new oil elds that came on stream in late 2008 is now expected to reach

its peak in 2009, rather than in 2010. Hence, total oil output is projected

to rise to 16.5 million metric tons in 2009, revised up rom March.

Based on these assumptions, the GDP growth orecast or 2009 is raised

to 4.7% rom 4.5% in ADO 2009, mainly a result o the larger than expected

scal stimulus, oil output, and net exports. Growth in the second hal is

orecast to accelerate to 5.4%. Ination in 2009 is now seen averaging 6.8%,

above that predicted in March because o stronger than expected ination

inertia as well as higher projections o global commodity prices. Te currentaccount will return to decit in the second hal as exports shrink urther

and imports pick up. For all 2009, the decit is likely to be 7.0% o GDP,

revised rom 11.5% in view o larger exports o oil and rice, gold reexports,

the sharper decline in imports, and larger GDP than projected in ADO 2009.

Te overall balance o payments is still expected to record a decit this year.

ProspectsForecasts o 2010’s outcomes are based on the assumption that the

Government will not adopt additional scal stimulus measures next year

and that SBV will pursue moderately tight monetary policy. It is urther

assumed that SBV will eliminate the shortage o oreign exchange through

greater exibility o its reerence rate, tighter monetary policy, and increased

sales o oreign exchange. Te projection or oil production in 2010 is

maintained at 15.5 million metric tons, an easing rom this year’s level.

On this basis, GDP growth is orecast to increase to 6.5% in 2010

(Figure 3.10.9), in line with the ADO 2009 projection. Growth o

consumption and domestically nanced investment will speed up as

the 2009 monetary and scal stimuli work through the economy. Te

anticipated improvement o global nancial conditions will bring about

an upturn in oreign-nanced investment. At the same time, net exports

o goods and services will all, with imports growing aster than exports.









Southeast Asia Viet Nam 165

3.10.10 Fiscal and current account decits

-15

-10

-5

0

5

Current account Fiscal

10090807062005

% of GDP

Forecast

Sources: Ministry o Finance; State Bank o Viet Nam; sta estimates.


3.10.9 Growth and infation

0

2

4

6

8

10

0

5

10

15

20

25

InflationGDP

10090807062005

%

Forecast

%




ADO

Update ADO

Update

GDP growth . . . .

Infation . . . .

Current acct. bal.

(share o GDP)

-. -. -. -.


Te labor market will pick up on the back o accelerating growth, and

incomes will increase. Ination is now orecast at 8.5% next year, revised

up rom 5.0%. Te reason is the rapid growth o money supply in 2009

and expected increases in world commodity prices.

Te overall scal decit is likely to narrow to about 4.5% o GDPnext year (Figure 3.10.10). Te orecast rise in world oil prices (hence oil

revenue), aster economic growth, and deerral o some tax payments

rom 2009 to 2010 as part o the scal stimulus will boost government

receipts. Expenditure will all because some outlays initially planned

or 2010 are being brought orward to 2009 (also part o the 2009 scal

stimulus), and no additional scal pump priming is expected next year.

Viet Nam’s stock o public and publicly guaranteed debt is likely

to be slightly higher than was orecast in March, at about 46% o GDP

in 2010, compared with 48% in 2009 and an estimated 44% in 2008

(Figure 3.10.11). Since much o the debt is on concessional terms, its

present value will remain below 20% o GDP.

Te current account decit is orecast to widen rom 7.0% o GDPthis year to 9.0% in 2010. Stronger external demand and higher prices

or goods shipped abroad will li exports, and remittance inows will

increase as economies in source countries improve. However, these actors

will be more than oset by increases in imports resulting rom stronger

economic growth, improved availability o trade credit and oreign

exchange, and higher import prices. Te overall balance o payments

should return to surplus i capital inows rebound as anticipated.

Risks to this outlook are mainly on the downside. A weaker than

expected global economic recovery would damp growth in Viet Nam,

and an unexpected spurt in world commodity prices would mean

higher ination. A conceivable domestic risk is that ination pressures

and expectations o devaluation could build up to an extent that they signicantly reduce demand or dong-denominated assets. In such an

event, the black market exchange rate would depreciate sharply and

ination could return to double digits. Te current account decit would

be wider than projected in this Update because speculative imports would

surge, as they did in the rst hal o 2008. Te resultant macroeconomic

turbulence and stabilization measures would likely cause slower economic

growth than orecast in the ADO 2009 Update baseline scenario.

Moving to guard against such an outcome, SBV has started

taking measures to keep ination in check and to damp devaluation

expectations. In particular, it has committed to limit growth o banking

system credit and total liquidity (M2) to 30% in 2009; asked state-owned

commercial banks to limit loan growth to 25% in 2009; and urged all

commercial banks to tighten credit or consumer spending and purchases

o real estate and stocks. It has also committed not to devalue its

reerence exchange rate in the near uture and has increased the supply

o oreign exchange in the ormal market. As noted, SBV is also likely to

start tightening monetary policy toward the end o 2009. It is expected to

pursue moderately tight monetary policy in 2010 to support the dong and

to counter ination pressures stemming rom accelerating growth and

rising world commodity prices.

3.10.11 Public and publicly guaranteed debt

20

30

40

50

10090807062005

% of GDP

Forecast

Sources: Ministry o Finance o Viet Nam; sta estimates.










Statistica

appendix



Statistical notes and tables

Te statistical appendix presents selected economic indicators or44 developing member economies o the Asian Development Bank (ADB)

and or Brunei Darussalam, an unclassied regional member, in three

tables: gross domestic product (GDP) growth, ination, and current

account balance as a percentage o GDP. Te economies are grouped

into ve subregions: Central Asia, East Asia, South Asia, Southeast Asia,

and the Pacic. Te tables contain historical data or 2006 to 2008 and

orecasts or 2009 and 2010.

Te data were standardized to the degree possible in order to allow

comparability over time and across economies, but dierences in

statistical methodology, denitions, coverage, and practices make ull

comparability impossible. Te national income accounts section is based

on the United Nations System o National Accounts, while the balance-o-payments data are based on International Monetary Fund (IMF)

accounting standards. Historical data were obtained rom ofcial sources,

statistical publications and databases, and documents o ADB, IMF, and

World Bank. Projections or 2009 and 2010 are generally sta estimates

made on the basis o available quarterly or monthly data, although some

projections are rom governments.

Most countries report on a calendar year basis, while South Asian

countries (except or Maldives and Sri Lanka) report all variables on a

scal year basis. Republic o Palau reports balance-o-payments data on a

scal year basis.

Regional and subregional averages are provided or the three tables.

Te averages are computed using weights derived rom levels o gross

nationalincome(GNI)incurrentUnitedStatesdollars(US$)following

the World Bank Atlas method. Te GNI data or 2006–2007 were

obtained rom the World Bank’s World Development Indicators Online.

Weights or 2007 were carried over through 2010. Te GNI data or Cook

Islands and uvalu were estimated using the Atlas conversion actor.

Myanmar and Nauru have no GNI data, and data or these two countries

are excluded rom the computation o all subregional averages and totals.

Te ollowing paragraphs discuss the three tables in greater detail.

able A1: Growth rate o GDP (% per year). Te table shows annual

growth rates o GDP valued at constant market prices, actor costs, or




Table A1 Growth rate of GDP (% per year)

Subregion/Economy 2006 2007 2008 2009 2010

ADO 2009 Update ADO 2009 Update

Central Asia . . . . . . .Armenia . . . . -. . .

Azerbaijan . . . . . . .

Georgia . . . . -. . .

Kazakhstan . . . . -. . .

Kyrgyz Republic . . . . . . .

Tajikistan . . . . . . .

Turkmenistan . . . . . . .

Uzbekistan . . . . . . .

East Asia . . . . . . .

China, People’s Rep. o . . . . . . .

Hong Kong, China . . . -. -. . .

Korea, Rep. o . . . -. -. . .

Mongolia . . . . . . .Taipei,China . . . -. -. . .

South Asia . . . . . . .

Aghanistan . . . . . . .

Bangladesh . . . . . . .

Bhutan . . . . . . .

India . . . . . . .

Maldives . . . . -. . .

Nepal . . . . . . .

Pakistan . . . . . . .

Sri Lanka . . . . . . .

Southeast Asia . . . . . . .

Brunei Darussalam . . -. -. -. . .

Cambodia . . . . -. . .

Indonesia . . . . . . .Lao People’s Dem. Rep. . . . . . . .

Malaysia . . . -. -. . .

Myanmar . . - - - - -

Philippines . . . . . . .

Singapore . . . -. -. . .

Thailand . . . -. -. . .

Viet Nam . . . . . . .

The Pacific . . . . . . .

Cook Islands . . -. . -. . .

Fiji Islands . -. . -. -. . .

Kiribati . -. . . . . .

Marshall Islands, Rep. o . . -. . . . .

Micronesia, Fed. States o -. -. -. -. . . .Nauru . -. . . . . .

Palau, Rep. o . . -. -. -. -. -.

Papua New Guinea . . . . . . .

Samoa . . -. -. -. -. -.

Solomon Islands . . . . . . .

Timor-Leste, Dem. Rep. o -. . . . . . .

Tonga . . . -. -. -. .

Tuvalu . . . . . . .

Vanuatu . . . . . . .

Average . . . . . . .

- = data not available.




Table A3 Current account balance (% of GDP)

Subregion/Economy 2006 2007 2008 2009 2010

ADO 2009 Update ADO 2009 Update

Central Asia . . . . . . .Armenia -. -. -. -. -. -. -.

Azerbaijan . . . . . . .

Georgia -. -. -. -. -. -. -.

Kazakhstan -. -. . -. -. -. -.

Kyrgyz Republic -. -. -. -. -. -. -.

Tajikistan -. -. -. -. -. -. -.

Turkmenistan . . . . . . .

Uzbekistan . . . . . . .

East Asia . . . . . . .

China, People’s Rep. o . . . . . . .

Hong Kong, China . . . . . . .

Korea, Rep. o . . -. . . . .

Mongolia . . -. -. -. -. -.Taipei,China . . . . . . .

South Asia -. -. -. -. -. -. -.