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KEY ECONOMIC DEVEL OPMENTS DEVELOPMENTS AND PROSPECTS IN THE ASIA-P ACIFIC REGION ASIA-PACIFIC 2007
United Nations E S CAP New York, 2006
ECONOMIC AND SOCIAL COMMISSION FOR ASIA AND THE PACIFIC
ACKNOWLEDGEMENTS The Key Economic Developments and Prospects in the Asia-Pacific Region 2007 was prepared under the overall guidance of Ravi Ratnayake, Director, Poverty and Development Division. A team led by Shamika Sirimanne, Chief, Socio-economic Analysis Section, comprising Shuvojit Banerjee, Somchai Congtavinsutti, and Juthathip Jongwanich prepared this report. The comments and inputs from Michael Francis, Eugene Gherman, Muhammad H. Malik, Hiren Sarkar, and Amornrut Supornsinchai are noted with appreciation. Staff analysis was based on data and information available up to the end of October 2006. All graphics work was done by Somchai Congtavinsutti. The logistics of processing and administrative action were handled by Dusdeemala Kanittanon, Anong Pattanathanes, and Woranut Sompitayanurak. Contributions from the Editorial Unit and other Divisions in the ESCAP are noted with appreciation.
iv
KEY ECONOMIC DEVEL OPMENTS DEVELOPMENTS AND PROSPECTS IN THE ASIA-P ACIFIC REGION ASIA-PACIFIC 2007
United Nations publication Sales No. E.06.II.F.27 Copyright c United Nations 2006 All rights reserved Manufactured in Thailand ISBN: 92-1-120484-4 ST/ESCAP/2423
This publication may be reproduced in whole or in part for educational or non-profit purposes without special permission from the copyright holder, provided that the source is acknowledged. The ESCAP Publications Office would appreciate receiving a copy of any publication that uses this publication as a source. No use may be made of this publication for resale or any other commercial purpose whatsoever without prior permission. Applications for such permission, with a statement of the purpose and extent of reproduction, should be addressed to the Secretary of the Publications Board, United Nations, New York.
ii
FOREWORD Key Economic Developments and Prospects in the Asia-Pacific Region 2007 is the second publication in an annual series that provides an end-of-year report on the region’s economic performance in a rapidly changing global and regional environment. The report reviews the region’s economic performance and highlights the strengths and weaknesses of economies in the region. It then identifies the key policy issues and challenges likely to confront Governments in the near term, and provides policy options and recommendations that would help Governments to address these challenges effectively. Overall, developing economies in the Asian and Pacific region are set to record an impressive growth rate of over 7 per cent in 2006, the highest among all developing regions in the world. It is also promising to note that this growth has been widely shared with all subregions performing robustly. The rising economic powerhouses of China and India, along with a reviving Japan, are driving the region’s economic performance. The outlook for 2007 is one of continued dynamism amidst the downside risks of a slowing global economy, the possibility of a supply-side oil shock and a disorderly adjustment in global imbalances. The report identifies three key issues to be watched closely by policymakers across the Asian and Pacific region in the coming months. On the positive side is the revival of Japan. The report examines the impact of a resurgent Japan on the region’s trade, investments and growth prospects. Somewhat worrying for the region is the concern that China is “overheating”. The report evaluates the claims of “overheating” and quantifies the impacts of a stronger-than-expected downturn in China. Finally, the report analyses the implications of recent volatility in the regional financial markets and assesses how well the regional economies are equipped to handle a financial sector downturn. This series of reports is meant to serve as an early warning signal for major challenges, and hence stimulate policy debates and change. Last year’s report was well received across the Asian and Pacific region by a wide audience, and it is my hope that this year’s report will build on that foundation.
Kim Hak-Su Under-Secretary-General of the United Nations and Executive Secretary of ESCAP
iii
CONTENTS Page Foreword ................................................................................................. i i i Acknowledgements ................................................................................
iv
Abbreviations ......................................................................................... v i i i I.
Widespread economic gains in 2006 ..............................................
1
2006 growth driven by booming China and India, and reviving Japan ..............
2
East and North-East Asia tops subregional performance ......................................
4
Taking firm steps to curb inflation .................................................................................
5
Strong exports but high oil prices take toll on current accounts ..........................
6
Appreciation of currencies reflects confidence in the region ................................
8
Record level of foreign reserves ...................................................................................
9
II. Key economic issues on the watch list ............................................ 1 0 Asia-Pacific economies set to benefit from Japan’s revival ................................... 10 Is China “overheating”? ................................................................................................. 13 Financial market volatility risks ..................................................................................... 16 III. Outlook for 2007: continued dynamism ........................................... 1 9
v
BOXES Page 1.
Aftermath of the military coup in Thailand: assessing the economic impact ................................................................................... 21
TABLES Page 1.
2.
Rates of economic growth and inflation of selected developing economies and North and Central Asian economies of the ESCAP region, 2004-2006 ............................................................................................................
3
Current account balances as a percentage of GDP of selected developing economies and North and Central Asian economies of the ESCAP region, 2003-2006 ..................................................................................
7
3.
Impact of Japanese recovery on selected Asian economies ................................. 12
4.
Reversal to trend growth in China: impact on selected Asian economies .............................................................................................................. 15
vi
FIGURES Page 1.
2.
3.
Rates of economic growth of developing and developed economies in the ESCAP region, 2005-2006 .......................................
1
Rates of inflation of developing and developed economies in the ESCAP region, 2005-2006 ..................................................................................
6
Major holders of foreign reserves in the Asian and Pacific region, 2005 and 2006 ..............................................................................
9
4.
Real GDP growth, private consumption, investment and exports of goods and services of Japan, 2000-2006 ....................................... 11
5.
Asian emerging markets equities performance, 2005-2006 .................................. 16
6.
Reserve adequacy ratio of selected ESCAP member countries, 1990-2006 ....................................................................................................... 18
7.
Real GDP growth forecast for selected developing economies in the ESCAP region, 2006-2007 .................................................................................. 19
8.
Consumer price inflation for selected developing economies in the ESCAP region, 2006-2007 .................................................................................. 22
9.
Current account balance for selected developing economies in the ESCAP region, 2006-2007 .................................................................................. 23
vii
ABBREVIATIONS ADB
Asian Development Bank
ASEAN
Association of Southeast Asian Nations
CD-ROM
compact disk read-only memory
CIS
Commonwealth of Independent States
ECO
Economic Cooperation Organization
EIU
Economist Intelligence Unit
FDI
foreign direct investment
GDP
gross domestic product
IMF
International Monetary Fund
IT
information technology
NPLs
non-performing loans
viii
I. WIDESPREAD ECONOMIC GAINS IN 2006 Growth in developing Asia-Pacific economies will be an impressive 7.1 per cent in 2006, up from 6.9 per cent in the previous year. Growth has been broad-based across the Asian and Pacific countries (see figure 1). The East and South-East Asian export-based economies have benefited from strong global demand. South Asian countries continued to display robust rates of growth driven by strong performance in service sectors. Record high oil prices fuelled the growth of North and Central Asia. Outlook in 2007 for developing Asia-Pacific economies is one of continued dynamism with economic growth projected at 6.9 per cent. The global economic environment is expected to remain favourable. A slowdown in the United States economy, a moderate decline in global electronics demand, and a less accommodative macroeconomic policy stance across the world are expected to contribute to the slight reduction in growth prospects compared to 2006.
Figure 1. Rates of economic growth of developing and developed economies in the ESCAP region, 2005-2006
Developing economies of the region East and North-East Asia North and Central Asia Pacific island economies South and South-West Asia South-East Asia Developed economies of the region 0
1
2
3
4
5
6
7
8
Percentage 2005
2006
Sources: ESCAP, based on national sources; IMF, International Financial Statistics (CD-ROM) (Washington, D.C., IMF, 2006); ADB, Key Indicators of Developing Asian and Pacific Countries 2006 (Manila, ADB, 2006); EIU, Country Reports and Country Forecasts (London, 2006), various issues; and web site of the CIS Inter-State Statistical Committee, <www.cisstat.com>, 19 September 2006. Notes: Rates of real GDP growth for 2006 are estimates. Developing economies of the region comprise 38 (developing) economies (including the Central Asian countries) and calculations are based on the weighted average of GDP figures in 2000 United States dollars (at 1995 prices).
1
2006 growth driven by booming China and India, and reviving Japan
“
China, India and Japan contribute 62 per cent of GDP of the region and 44 per cent of imports, creating considerable opportunities for their trading partners
”
The rising economic powerhouses of China and India are driving the Asia-Pacific region’s good economic performance. Added stimulus has come from the continuing revival of the Japanese economy. Together these three countries contribute 62 per cent of GDP of the region and 44 per cent of imports, creating considerable opportunities for their trading partners. China’s economic boom is accelerating, despite policies to moderate its pace. Growth in the second quarter of 2006 stood at an annualized 11.3 per cent, the fastest since the mid-1990s. The August trade surplus of US$ 18.8 billion was the fourth consecutive record monthly surplus. Concerns regarding the sustainability of China’s growth prompted the Government to take measures aimed at slowing its economic expansion. These measures had not significantly affected the economy by the end of the second quarter of 2006. Administrative controls have been used, for example, to limit property investments and reduce export incentives. In recent months monetary policy measures have been increasingly used to limit economic expansion. The Indian economy, driven by industrial production and a booming service sector, is expected to grow at 8.2 per cent in 2006 (see table 1). With total consumption accounting for around two thirds of GDP, a vibrant domestic market provided the backbone for economic expansion. Industrial production targeted at the domestic market expanded rapidly. The growth of consumer durables accelerated in May to 18.3 per cent on a year-on-year basis, compared with 10.3 per cent in April. The booming property sector has boosted the production of the cement and steel sectors. The dynamism of consumption has been supported by the rising earnings of information technology (IT) workers and the availability of affordable credit. The ratio of commercial credit to GDP stood at 47 per cent at the end of May 2006, compared with 35 per cent in January 2003. Japan has emerged from its decade-long economic slump, with GDP estimated to grow at 2.8 per cent in 2006, up from 2.6 per cent in 2005. The Bank of Japan ended its policy of “quantitative easing” in early March 2006 and interest rates rose for the first time in three years in July. Data indicating the end of deflation by late 2005, together with positive GDP growth for the last three years, permitted the ending of ultra-loose monetary policy. Buoyant domestic demand, both for investment and consumption, has been the main factor underlying Japan’s resurgence. The robust growth of the United States and the continued recovery in the economies of the Euro Zone contributed to the good performance of the developing Asia and Pacific region. Despite high gasoline prices, a cooling housing market and the consequent slowing of consumption growth, the United States economy is expected to register a robust growth rate of 3.4 per cent in 2006, slightly lower than the previous year. Buoyed by domestic demand and exports, the Euro Zone is expected to grow at 2.4 per cent in 2006, up from 1.3 per cent in 2005.
2
Table 1. Rates of economic growth and inflation of selected developing economies and North and Central Asian economies of the ESCAP region, 2004-2006 (Percentage)
Developing economies of the ESCAP region c East and North-East Asia
Real GDP
Inflation a
2004 2005 2006 b
2004 2005 2006 b
7.4
6.9
7.1
4.7
4.8
4.7
7.8
7.2
7.6
3.2
2.1
2.0
10.1
9.9
10.2
3.9
1.8
1.6
Hong Kong, China
8.6
7.3
6.1
-0.4
0.9
1.8
Republic of Korea
4.7
4.0
5.2
3.6
2.8
2.7
Taiwan Province of China
6.1
4.1
4.4
1.6
2.3
1.8
North and Central Asia
7.4
6.9
6.6
10.2
12.0
10.0
Kazakhstan
9.6
9.5
8.3
6.9
7.6
8.5
Kyrgyzstan
7.1
-0.6
3.0
4.1
4.3
5.7
Russian Federation
7.2
6.4
6.2
10.9
12.7
10.3
Turkmenistan
9.0
11.0
9.0
5.9
10.6
10.0
Uzbekistan
7.7
7.0
6.5
1.7
6.9
7.5
China
South and South-West Asia d
7.3
7.7
7.0
6.4
6.7
7.1
Bangladesh
6.3
5.4
6.8
5.8
6.5
7.0
India
7.5
8.4
8.2
3.8
4.4
4.5
Iran (Islamic Republic of)
4.8
5.4
6.1
15.2
12.1
11.0
Pakistan
6.4
8.6
6.6
4.6
9.3
8.0
Turkey
8.9
7.4
5.1
8.6
8.2
10.5
6.5
5.5
5.7
4.0
5.9
6.8
Indonesia
5.1
5.6
6.0
6.1
10.5
13.3
Malaysia
7.1
5.3
5.7
1.4
3.0
3.6
Philippines
6.0
5.0
5.5
6.0
7.7
6.5
South-East Asia
Singapore
8.7
6.4
6.7
1.7
0.4
1.4
Thailand
6.1
4.5
4.5
2.8
4.5
4.6
Viet Nam
7.8
8.4
7.8
7.8
8.3
7.6
2.4
2.6
2.8
0.2
0.0
0.5
Developed economies of the ESCAP region
Sources: ESCAP, based on IMF, International Financial Statistics (CD-ROM) (Washington, D.C., IMF, 2006); ADB, Key Indicators of Developing Asian and Pacific Countries 2006 (Manila, ADB, 2006); EIU, Country Reports and Country Forecasts (London, 2006), various issues; web site of the CIS Inter-State Statistical Committee, <www.cisstat.com>, 19 September 2006; and national sources. a b c
d
Changes in the consumer price index. Estimates. Based on data for 38 (developing) economies representing more than 95 per cent of the population of the region (including the Central Asian countries); GDP figures at market prices in United States dollars in 2000 (at 1995 prices) have been used as weights to calculate the regional and subregional growth rates. The estimates for countries relate to fiscal years defined as follows: fiscal year 2003/04 = 2003 for India and the Islamic Republic of Iran; and fiscal year 2002/03 = 2003 for Bangladesh, Nepal and Pakistan.
3
East and North-East Asia tops subregional performance
“
Oil-exporting economies have fuelled the robust growth performance of North and Central Asia, while also creating challenges
”
East and North-East Asian economies, bolstered by the strength of China, have experienced solid expansion. Growth in Hong Kong, China, has been based on its re-exports of Chinese-made products. The textile industry in Hong Kong, China, has gained from the curbs placed on Chinese textile imports by the United States and the European Union. Growth in Taiwan Province of China has been supported by China’s demand for imports. Mongolia has been a beneficiary of high copper and gold prices, mainly due to Chinese demand. Growth has been supported by commodity exports and foreign investment in mining, which have helped to offset rising oil import bills and a shrinking textile sector. The Republic of Korea is expected to grow at 5.2 per cent in 2006, up from 4 per cent in 2005. However, the pace of increase slowed in the second quarter due to lower growth in domestic consumption and construction investment. Interest rate rises, to tackle high oil prices and administrative measures taken to cool the housing market, have affected private consumption and construction investment. Banks have tightened their rules for granting home loans and the Government has increased taxes on expensive homes. Mortgage holders have felt the pinch and the country is currently saddled with record levels of mortgage debt. The oil-exporting economies in North and Central Asia have fuelled the robust growth performance of the subregion, while also creating challenges. Surging current account surpluses in some of these economies have resulted in strong growth in the money supply, which has led to consumer price inflation and real appreciation of the national currencies, showing signals of so called “Dutch Disease”. The non-oil exporting nations of the subregion have experienced comparatively slower growth though non-oil commodity producers have benefited from favourable world prices. These countries have also benefited from remittances of workers employed in neighbouring countries’ oil industries. Pacific island economies have generally displayed good performance, through improved performance in the agricultural sector and commodities exports. Fiji is expected to do better this year compared to 2005 due to improvement in agriculture and tourism. The country continues to grapple with its fiscal debt, contraction in the textile sector, and low investment. Papua New Guinea has displayed better performance due to high prices for its coffee and fuel and non-fuel minerals. The Solomon Islands has seen solid growth from the recovery in the agricultural sector, as has Vanuatu, which has also profited from a continued increase in tourist arrivals. South and South-West Asia has experienced robust, though slower, growth this year. Bangladesh exhibited a strong performance in 2006 with an estimated growth of 6.8 per cent. This progress was supported by workers’ remittances and thriving garment exports. Pakistan is expected to grow at 6.6 per cent in 2006, down from 8.6 per cent in 2005. The decline was due to high oil prices and a slowdown in the agricultural sector caused by poor weather. GDP in Sri Lanka is expected to accelerate to 6.5 per cent in 2006 though there are concerns about the economic impact of the recent escalation in civil conflict on full-year growth. The Islamic Republic of Iran, as the only oil exporter in the subregion, is expected to grow at 6.1 per cent in 2006, owing to high oil prices.
4
South-East Asia is set to grow at 5.7 per cent in 2006, owing to buoyant electronics and commodities exports. Malaysia, the Philippines, Singapore and Thailand benefited from the current upswing in the global electronics cycle. The slight slowdown of the United States during the second half of the year has not had a major impact as of yet, despite it being the main export destination. Steady growth in the other major markets, such as Europe, Japan and China, has been of help. Commodity producers have profited from high international prices for fuel and non-fuel items. Indonesia, Malaysia and Viet Nam have recorded high export values across a range of natural resource and agricultural products. The textile and garment industries have performed well across the subregion in the current international environment, which is free of quotas, but with restrictions on Chinese imports into the United States and the European Union. TimorLeste has benefited from its oil resources, although recent political instability has had a negative impact on growth. Thailand is not forecast to suffer any growth effects this year from its military coup in September.
Taking firm steps to curb inflation Inflationary pressures for oil-importing economies have increased with oil price rises that continued until July (see figure 2). Inflation this year has been higher than government projections for these economies. Oil price rises in the earlier part of the year were largely driven by demand factors, while mid-year rises were mainly due to supply concerns stemming from conflict and instability in the Middle East.
“ ”
Governments across the region promptly responded to inflationary pressures by tightening monetary policy
Governments across the region promptly responded to the inflationary pressures from high oil prices by tightening monetary policy. Larger economies in particular have recently tightened monetary policy further due to continuing inflation concerns. India raised interest rates in August for the fifth time since April 2005. China increased rates in April and August, and has since implemented other monetary measures to combat overheating in some sectors. The rate rise in August saw interest rates in the Republic of Korea reaching their highest level in five years. All three economies share concerns about excessive housing market price increases. South-East Asian countries have been cautious about raising interest rates in recent months as overall inflation concerns have lessened. Thailand and Indonesia experienced their lowest rates of inflation of the year in September 2006. Malaysia ended interest rate rises in June and Thailand decided in August to halt rises for the first time in two years. Indonesia lowered its benchmark interest rate in October for the fifth time in 2006.
5
Figure 2. Rates of inflation of developing and developed economies in the ESCAP region, 2005-2006
Developing economies of the region East and North-East Asia North and Central Asia Pacific island economies South and South-West Asia South-East Asia Developed economies of the region 0.0
2.0
4.0
6.0
8.0
10.0
12.0
Percentage 2005
2006
Sources: ESCAP, based on national sources; IMF, International Financial Statistics (CD-ROM) (Washington, D.C., IMF, 2006); ADB, Key Indicators of Developing Asian and Pacific Countries 2006 (Manila, ADB, 2006); EIU, Country Reports and Country Forecasts (London, 2006), various issues; and web site of the CIS Inter-State Statistical Committee, <www.cisstat.com>, 19 September 2006. Notes: Inflation rates refer to changes in the consumer price index. Inflation rates for 2006 are estimates. Developing economies of the region comprise 38 (developing) economies (including the Central Asian countries) and calculations are based on the weighted average of GDP figures in 2000 United States dollars (at 1995 prices).
Strong exports but high oil prices take toll on current accounts Current account balances have deteriorated across the region mainly due to the rising oil imports bill. Most oil-importing countries have experienced declining current account balances (see table 2). Nevertheless, strong export performances in many countries have offset some of the effects of rising oil prices. South Asia has seen a worsening of its persistent current account deficit, with only Bangladesh and Nepal having surpluses in 2006. The deficit in India is of particular concern in the current environment of volatile international capital movements, as it is substantially funded by portfolio capital inflows.
6
Table 2. Current account balances as a percentage of GDP of selected developing economies and North and Central Asian economies of the ESCAP region, 2003-2006 (As a percentage of GDP) Current account balance as a percentage of GDP 2003
2004
2005
2006 a
3.1
3.5
7.2
6.8
East and North-East Asia China Hong Kong, China
10.4
9.5
11.4
10.7
Republic of Korea
2.0
4.1
2.1
0.5
Taiwan Province of China
9.8
5.7
4.7
4.8
North and Central Asia Kazakhstan
-0.9
1.1
-0.9
1.3
Kyrgyzstan
-5.2
-4.6
-8.1
-5.6
Russian Federation
8.2
9.9
11.0
11.2
Turkmenistan
2.8
0.7
3.7
5.8
Uzbekistan
8.7
9.7
9.8
7.8
Bangladesh
0.3
-0.5
-0.9
0.9
India
1.5
0.2
-1.5
-2.2
Iran (Islamic Republic of)
0.6
0.9
7.2
8.7
Nepal
2.5
2.9
2.1
2.8
South and South-West Asia
Pakistan
4.9
1.8
-1.5
-4.3
Sri Lanka
-0.6
-3.4
-2.8
-3.8
Turkey
-3.4
-5.2
-6.5
-7.1
South-East Asia Indonesia
3.5
1.2
1.1
2.7
Malaysia
12.9
12.6
15.2
13.3
Philippines
1.8
2.4
2.4
2.9
Singapore
29.0
25.9
28.4
26.4
Thailand
5.6
4.2
-2.1
-0.2
Viet Nam
-4.9
-2.0
0.4
-0.5
Sources: ESCAP, based on IMF, International Financial Statistics (CD-ROM) (Washington, D.C., IMF, 2006); ADB, Key Indicators of Developing Asian and Pacific Countries 2006 (Manila, ADB, 2006); EIU, Country Reports and Country Forecasts (London, 2006), various issues; and national sources. a
Estimates.
7
“
India is emerging as a force in manufacturing exports
”
The region’s exports benefited from global demand, a rebound in the IT sector and, for some countries trade restrictions on China in the apparel sector. Although it showed signs of weakening, robust growth in the United States for the year as a whole has been a key driver of the region’s exports. This has been supported by improving demand in Europe and Japan. There was therefore an ideal situation of solid demand from all of the region’s major traditional trading partners. South-East Asian economies particularly benefited from the cyclical upswing in demand for electronic products which began in mid-2005. Apparel exports across the region have performed better than expected after the global liberalization of the sector in 2005. This has been due in part to the enforcement of restrictions on Chinese imports into the United States and European Union. Also there is evidence that apparel-exporting countries have taken steps to diversify production and export destinations, and hence managed to maintain their price competitiveness in the world markets. The economies of the region are increasingly driven by trade linkages with China. Companies in the region are tied to supply chains with the Chinese production hub. Inputs are being sourced from abroad for further processing with China as the final export platform. Chinese imports from Asia were up 20 per cent in 2005, to US$ 440 billion, and accounted for 67 per cent of its total imports. The positive effect on regional exports is reflected in China’s growing trade deficit with the major economies of the region, except India. On the other hand, some countries are experiencing competition from China for their exports in third markets. The nature of production in the region is therefore being significantly altered by the Chinese economy. India is emerging as a force in manufacturing exports. Until recently, Indian services exports, especially those related to outsourcing and IT, have been the success story. Recently, manufacturing exports have surged, with expansion in June 2006 alone at 11.2 per cent over the preceding June. Manufacturing exports are notable for being dominated by capital-intensive products, such as engineering, chemicals and petroleum products. The main engineering products have been iron and steel, feeding large global demand, especially from China. The automotive sector is expanding rapidly, as India emerges as a developing country automobile exporter.
Appreciation of currencies reflects confidence in the region Asian currencies have performed strongly, reflecting confidence in Asian economies and investor appetite for risk. The major currencies appreciated at the beginning of the year as investors increased portfolio and direct investments in the region. Since mid-year, rising interest rates in the United States and the Euro Zone, and global liquidity tightening have generally reduced the attractiveness of Asian assets. As a result, the outflows of portfolio capital between April and July saw the Indian rupee depreciate by more than 5 per cent this year. The Indonesian rupiah depreciated by 5 per cent in May alone. Nevertheless, interest rate rises by the economies of the region and recently renewed portfolio capital inflows have led to the appreciation of the currencies of the majority of economies. In August, the Thai baht reached its highest level against the United States dollars since 1998. There has not been much movement in the Chinese yuan managed float since the removal of the currency peg in mid-2005. The currency had appreciated by 1.8 per cent by August this year.
8
Record level of foreign reserves The region has continued to add to its sizeable foreign exchange reserves, with China finally eclipsing Japan to become the world’s largest reserves holder. In April China’s reserves reached US$ 897 billion, US$ 53 billion more than those of Japan. The managed currency float in China in the face of a ballooning trade surplus and large capital inflows will ensure steady reserve accumulation, with the total expected to go above US$ 1 trillion by the end of 2006.
“
In April China eclipsed Japan to become the world’s largest foreign reserves holder
Figure 3. Major holders of foreign reserves a in the Asian and Pacific region, 2005 and 2006 897
China
821
Japan
844 834
”
Republic of Korea Russian Federation Taiwan Province of China India Hong Kong, China Singapore Malaysia Turkey Thailand Indonesia Philippines 0
50
100
150
200
250
300
350
In billion US dollars 2005
2006 b
Source: IMF, International Financial Statistics (CD-ROM) (Washington, D.C., IMF, 2006). a b
Excluding gold. Refers to April or available latest month.
9
II.KEY ECONOMIC ISSUES ON THE WATCH LIST
“
Japan’s revival will help the region to counteract the effects of a slowing US economy
”
Looking further ahead, there are three key economic issues to be watched closely by policymakers across the Asia-Pacific region. On the positive side is the economic revival of Japan. As discussed below, sustained recovery of the world’s second largest economy would create significant opportunities for trade and investment. It will also help counteract the effects of a slowdown in the United States economy. Somewhat worrying for the region is the concern that China is “overheating”. As economic relations with China are becoming ever more important for Asian economies, a severe downturn in China would present a drag on growth for the entire region. The analysis below addresses several unanswered questions: How generalized is the “overheating” problem? How effective are cooling policies? What impacts would a stronger-thanexpected downturn in China have on the region? Finally, recent volatility in the Asia-Pacific financial markets has raised questions about the stability of economies in the region. Although the markets have been relatively calm in the last few months, more volatility cannot be ruled out. What factors drive the current market volatility, and whether regional economies are protected against an economic meltdown are examined below.
Asia-Pacific economies set to benefit from Japan’s revival The end of deflation has confirmed the recovery of the Japanese economy. GDP growth has continued to be robust this year, following on the three previous years of good performance. Consumer price inflation has been positive in the first half of 2006 after seven years of negative price growth. The low but positive inflation rate augurs well for the healthy functioning of the economy as falling prices had discouraged investment as firms suffered from eroding profitability and rising real debt burdens. Japanese growth is being supported by consumption. Exports were the main driver of the economy in the past few years as the domestic economy remained subdued. Buoyant corporate profits have made room for companies to raise wages and hire new workers. Private consumption is now the main engine for growth (see figure 4). Consumption that accounts for 57 per cent of GDP remains central to the strength of the economy. Exports will be less of an engine in coming months as the United States economy slows down. In the second quarter of 2006, exports displayed declining yearon-year growth while consumption and investment growth remained steady.
10
Figure 4. Rates of growth of real GDP, private consumption, investment and exports of goods and services of Japan, 2000-2006 a 6
20 15
4 2
5 0
0 2000
-5
2001
2002
2003
2004
2005
2006Q1
2006Q2 -2
Percentage
Percentage
10
-10 -15
-4
-20
-6 Private consumption Real GDP growth (Right axis)
Exports of goods and services Investment (Right axis)
Source: Japan, Statistics Bureau and Statistical Research and Training Institute, Japan Monthly Statistics, September 2006, available at the web site <www.stat.go.jp>, 11 October 2006. Note: Data for real GDP growth, private consumption, investment and exports are based on gross domestic product (expenditure approach) at chained (2000) yen. a
Refers to data up to second quarter.
Japan’s revival will help the Asia-Pacific region to counteract the effects of a slowing United States economy. The United States remains the main market for most Asian economies and its slowdown would be a significant blow. However, exports from the region will benefit from the renewed vigor of Japanese consumers. The size of the Japanese economy, the world’s second largest and around twice that of China, implies that even a modest expansion will have enormous effects on the region. ESCAP simulations show that, if Japanese consumption were to grow at the same annual rate as in the late 1980s (4.4 per cent on average), GDP growth in Japan and developing Asian economies would increase by 1.4 and 0.2 percentage points respectively (see table 3). GDP growth in Singapore would increase by 0.6 percentage points as trade and investment are closely linked with the Japanese economy, followed by Indonesia (0.3 percentage points), Thailand (0.3 percentage points) and China (0.25 percentage points). Net exports of goods in developing Asian economies would improve by 2.3 percentage points while their current account balance as a percentage of GDP would increase by 0.1 percentage point. Due to improvement in consumption, net exports of Japan would decline by 12 percentage points while the current account balance as a share of GDP would deteriorate by 0.3 percentage points.
“
Sustained recovery in Japan will increase net exports of developing Asia by 2.3 per cent
” 11
Table 3. Impact of Japanese recovery on selected Asian economies a (Percentage change from the baseline forecast) GDP growth
Net exports of goods
Current account balance as a percentage of GDP
Australia
0.05
1.93
0.05
Japan
1.44
-11.85
-0.33
China
0.25
3.49
0.13
Hong Kong, China
0.21
3.02
0.32
India
0.10
0.04
0.06
Indonesia
0.30
1.55
0.10
Republic of Korea
0.20
3.03
0.06
Malaysia
0.14
0.48
0.04
Philippines
0.17
0.87
0.07
Russian Federation
0.05
0.21
0.01
Singapore
0.56
1.27
0.27
Taiwan Province of China
0.16
1.03
0.03
Thailand
0.30
3.67
0.05
Asian economies b
0.83
-4.98
-0.12
Developing Asian economies c
0.20
2.26
0.10
Source: ESCAP calculations. a
b
c
The computation is based on the assumption that Japanese consumption would grow at the same annual rate as in the late 1980s (4.4 per cent on average). Comprising selected developing Asian economies plus Australia and Japan; and calculations based on the weighted average of real GDP figures in 2004 United States dollars (at 2000 prices) of the above developing Asian economies plus Australia and Japan. Same as footnote b but excluding Australia and Japan.
Revival in Japan is both a cause and consequence of China’s success. A strategic trading relationship has developed between China and Japan whereby Japanese enterprises are producing final goods in China using inputs from Japan for sale in the United States. China was Japan’s second largest trading partner in 2005, representing 17 per cent of Japan’s total trade, a slightly lower share than the United States at 18 per cent. Japan is China’s third largest trading partner – with 12.9 per cent of China’s total trade – after the United States and European Union. Furthermore, China is by far Japan’s largest source of imports accounting for 21 per cent of Japan’s total in 2005. Japan also became the second largest foreign investor in China in 2005, replacing the United States. As such, Japan and China are bound together in their economic prospects. The Japanese revival has created significant export opportunities for other Asian economies too. East Asian exports (excluding those of China) to Japan have increased by 32 per cent in the last five years. These exports have been driven by increased demand for primary commodities as well as surging consumer demand for final goods. Commodity-producing economies, such as Indonesia and some of the Central Asian countries, will continue to benefit from this development. Increased demand for consumer goods will benefit ASEAN economies. These countries are particularly
12
favoured by Japanese enterprises as overseas manufacturing bases to satisfy demand for home electronics in Japan. Asian countries, other than China, are also benefiting from Japan’s robust increases in direct investment. Improving corporate financial health in Japan is spurring expansion overseas, particularly in Asia. Foreign direct investment from Japan to the rest of Asia recovered to its 1997 pre-crisis level of US$ 15 billion in 2005. Countries other than China account for the majority of Japanese investment stock in Asia, 72 per cent at the end of 2005. So far, China’s increasing importance as a destination for direct investment has not had a severe competitive impact on Japanese investment in the rest of the region. Many Japanese enterprises maintain a “China plus one” strategy to avoid overdependence on the fortunes of one economy. This strategy helps to ensure that the ASEAN countries will remain an important manufacturing hub. Thailand, for instance, has been chosen as a centre for automobile production and export. ASEAN’s attraction will be enhanced by the trade agreements currently under discussion between ASEAN and various parties, such as India, China and the European Union. Japan’s macroeconomic policy has important repercussions on Asian financial markets. The end of the “quantitative easing” policy in March 2006 and the raising of interest rates in July has reduced global liquidity. Investors bought heavily in Asian asset markets, taking advantage of Japan’s low interest rates. An important vehicle for these investments was the “yen carry trade” – the phenomenon of borrowing in currencies with low interest rates, especially the yen, to invest in foreign assets. This partly contributed to the recent Asian price boom in a diverse range of assets such as equities, bonds and housing. Japan’s reduction of liquidity, combined with increasing United States interest rates, led to a decrease in the risk appetite of investors and was one of the prime causes of the mid-year Asian equity market downturn.
“
FDI from Japan to Asia, excluding China, recovered to pre-crisis level of US$ 15 billion in 2005
”
Further effects on markets will depend on Japanese interest rate policy and currency movements. Japan has pledged to be moderate in raising interest rates in the coming months to ensure the country’s economic recovery and prevent deflation.
Is China “overheating”? The debate over China’s “overheating” will be one of the main policy concerns for the region in coming months. The Asia-Pacific economies are increasingly tied to the fortunes of the Chinese economy, most directly through trade and investment, as well as through a web of macroeconomic linkages. An accurate analysis of developments in China will therefore have important implications for policymakers across the region. Liquidity injections in efforts to maintain the value of the yuan may have partly contributed to the recent expansion of the economy. Money supply has increased by 19 per cent in the first five months of the year from a year earlier. The excess liquidity in the banking sector has led to a dramatic amount of lending. Loans by the end of July were already 94 per cent of the People’s Bank of China target for the year. Continuing increases in liquidity creates risks for the economic system through excessive lending. Easy credit is being directed to possibly unprofitable projects, particularly in housing and industrial fixed investment, instead of projects that support long-term growth such as infrastructure investment. Half of the lending growth in the first two months of the year was for real estate. Investment has continued to expand rapidly in recent months. In May of this year it was 30 per cent higher than the preceding 13
May. This may be resulting in a build-up of bad loans in the banking sector. Varying estimates of current non-performing loans indicate magnitudes which raise concern. Fitch Ratings estimates NPLs at US$ 206 billion and other problem loans of US$ 270 billion.1
“
China is currently witnessing sectoral, rather than generalized, overheating
”
The real sector is currently witnessing sectoral, rather than generalized, effects of overexpansion. At present there is little sign of generalized overcapacity. There is no clear indication of build-up of inventories or impact on corporate profits throughout the economy. Profits as a whole are still buoyant, with an increase in industrial profits in the first half of the year by 28 per cent from a year earlier.2 There is evidence of sectoral overheating, however, through profit declines for some industrial goods. Overcapacity has appeared in several sectors such as steel and cement. Profits for steel producers dropped 37 per cent in the first half of 2006 as compared to a year earlier. In cement, 36 per cent of producers suffered losses in 2005. A host of administrative measures have been implemented in an attempt to control rapidly expanding sectors. For example, in August, local governments were ordered to review all investments over 100 million yuan and investments in particularly fast growing sectors over 30 million yuan. Foreign investment in property has also been restricted. These non-banking based controls can be effective as much of investment has not been credit-financed. Retained profits of State-owned enterprises and local government spending have been a major source of non-credit based investment. The Government has attempted to utilize various monetary policy tools to control money supply growth. The People’s Bank of China has stepped up the pace of open market operations this year to contract money supply. It has also mopped up liquidity by special issues of central bank bills at below market interest rates to banks with especially high lending growth. Interest rates were raised in April and August by a modest 27 basis points each time. Lending was also curbed through the raising of the deposit reserve ratio by 0.5 percentage points in June and August to reach 8.5 per cent. The foreign currency deposit reserve ratio was raised from 3 to 4 per cent in mid-September. However, the use of monetary policy is restricted due to the effect of the resulting interest rate rises on the value of the yuan. Capital inflows attracted by a higher interest rate have to be combated by further reserve accumulation and issuance of liquidity, thereby counteracting the initial contractionary measures. Monetary policy is therefore necessary but constrained by the exchange rate regime. There are some signs that cooling policies are helping. Domestic demand may have started to slow down recently. Credit growth fell in September as compared to the previous month. There has been modest growth in machinery and equipment imports. Industrial output growth in August (year-on-year basis) was lower than in July. The increase in housing prices was slightly lower in the third quarter of 2006 compared to the previous quarter. If effective, current Chinese policy measures may have significant growth effects in the region. If the ongoing administrative and monetary policy measures prove successful, the economy will experience a sizeable decline in investment growth. China’s slowdown would have economic repercussions for the region. A reduction in Chinese domestic demand would lead to reduced exports and growth across the region. Countries would be affected according to the depth of their involvement with China. Both exports of final manufactured goods and manufacturing inputs would be affected. Commodity exporters would also be affected significantly as China accounts for a significant amount of world demand across a range of commodities.
14
ESCAP calculations show that if Chinese GDP growth declines to 7 per cent, its trend rate for the past two decades, the economic growth of developing Asia (excluding China) would be reduced by an average of 0.2 per cent, with effects varying widely across countries (see table 4). For this calculation, it is assumed that the decline in China’s GDP growth will come from a reduction in investments, as tightening policies are expected to slow investment growth in China. The most affected would be Taiwan Province of China, followed by Singapore, Hong Kong, China, and the Republic of Korea, as exports in these countries are closely linked with China. GDP growth in Taiwan Province of China and Singapore would decline by 0.4 percentage points, while in Hong Kong, China, and the Republic of Korea, it would slow by 0.3 percentage points. India would be affected much less as its share of exports to China is still low. GDP growth in India would decline by only 0.05 percentage points. Net exports in developing Asia (excluding China) would decline by almost 2 percentage points, while the current account balance as a percentage of GDP would deteriorate by almost 0.1 percentage points.
“
If Chinese GDP growth drops to its trend rate, net exports in developing Asia will decline by 2 percentage points
”
Table 4. Reversal to trend growth in China: impact on selected Asian economies a (Percentage change from the baseline forecast) GDP growth
Net exports of goods
Current account balance as a percentage of GDP
Australia
-0.02
-0.66
-0.02
Japan
-0.07
-2.39
-0.05
Hong Kong, China India
-0.30 -0.05
-3.84 -0.04
-0.32 -0.01
Indonesia Republic of Korea
-0.12 -0.25
-0.68 -3.23
-0.05 -0.06
Malaysia Philippines
-0.06 -0.07
-0.29 -0.47
-0.03 -0.03
Russian Federation Singapore
-0.08 -0.40
-0.28 -0.73
-0.03 -0.15
Taiwan Province of China Thailand
-0.40 -0.15
-4.40 -1.90
-0.13 -0.03
Asian economies b
-0.08
-1.75
-0.05
Developing Asian economies c
-0.20
-1.80
-0.07
Source: ESCAP calculations. a
b
c
Trend GDP growth rate for the past two decades is 7 per cent. It was calculated by applying the Hodrick-Prescott Filter to China’s real GDP during the period 1986-2006. Comprising selected developing Asian economies (excluding China) plus Australia and Japan; and calculations based on the weighted average of real GDP figures in 2004 United States dollars (at 2000 prices) of the above developing Asian economies plus Australia and Japan. Same as footnote b but excluding Australia and Japan.
15
Financial market volatility risks In mid-2006, Asia-Pacific financial markets experienced their greatest volatility since 2004. On 10 May 2006, global equity prices tumbled around the world. The AsiaPacific share markets continued falling throughout May and June, experiencing their biggest monthly decline since September 2002. After a brief respite at the end of June, equity markets were volatile again in July. All countries in the region were affected, suffering record falls for the year. Commodity markets also moved significantly downwards. By mid-June the copper price had declined 25 per cent and the price of gold by 23 per cent from their peaks in May. The volatility reversed a sustained period of increase in financial asset values. International portfolio investors have been steadily buying shares in Asia since 2004 and driving up prices in the process (see figure 5). The region received US$ 39 billion in inflows, or 63 per cent of developing country net portfolio equity investment, in 2005. The most popular equity markets were China, India and Thailand. Investors also bought a wide range of other assets, both developed and emerging market bonds and commodities. The initial trigger for the May equity market downturn was the interest rate hike by the United States Federal Reserve on 10 May 2006 to 5 per cent. This raised worries of a significant slowdown in the United States economy. Equity market instability in June and July was also caused by concerns about the political situation in the Middle East and its impact on oil prices.
Figure 5. Asian emerging markets equities performance, 2005-2006 160 150
Index
140 130 120 110 100 90
Source: MSCI Emerging Markets Asia Index. Accessed from
. Note: Data as of 10 October 2006.
16
,2 00 6
06
6
11 p Se
Ju
l1
7,
20
,2 00 ay
M
ar
22
27
30 n Ja
M
20 5, c De
,2 00 6
,2 00 6
05
5 ,2 00 10 O
ct
15 g Au
Ju
n
20
,2 0
,2 0
05
05
05 20 5, r2 Ap
b Fe
Ja
n
28
3,
20
,2 00 5
05
80
On the positive side, recent volatility may have corrected over-exuberant asset values. For some markets, the equity market decline has been viewed as a one-off episode – a healthy, necessary and relatively moderate correction. The price/earnings (P/E) ratio – the price of a company’s shares relative to the company’s future earnings – one of the main methods for investors to value share prices, shows that shares in some Asian markets had become overvalued as compared with the emerging market average. The correction therefore moved share prices closer to more sustainable levels. More turbulence in the coming months cannot be ruled out. Further rises in developed country interest rates, in particular in the United States, the Euro Zone and Japan, are possible if inflation shows signs of momentum in these economies. Further rises in oil prices could trigger such a response. An abrupt unwinding of global imbalances leading to a significant depreciation of the United States dollar would also trigger significant interest rate hikes (see chapter III). The result may be a global economic slowdown with Asian economies contracting due to a drop in demand for their exports and the pressure on them to increase the own interest rates. All these factors may reduce the appetite of investors towards Asian financial assets.
“
Recent volatility in financial markets may have corrected over-exuberant asset values
”
The effects of downside shocks may be multiplied by investor overreaction and by contagion from portfolio outflows in other countries. This behaviour is commonly observed in financial crises, such as in 1997, and is difficult to stop once it is in motion. In recent years, the risk has been heightened by the increase in hedge funds and creditfinanced investment in the region. A further sharp drop in asset prices can set off a negative cross-country chain reaction through these channels. Economies in the region are in a stronger position to avoid a repeat of the 1997 Asian financial crisis. In 1997, the selling of Asian assets was based on fears about the countries’ macroeconomic fundamentals due to their high external debt and untenable fixed exchange rate regimes. Countries now have more flexible exchange rates and high foreign exchange reserves (see figure 3). The region also has the world’s best growth prospects. Countries have better banking systems. The profitability of banks has been increasing in recent years. Non-performing loans have been reduced in most countries. Even though the Asian economies have accumulated significant foreign exchange reserves over the past decade, the adequacy of their reserves has tended to decline in some countries since 2005 (see figure 6). This indicator computed by ESCAP measures the vulnerability of a country to sudden reversal of mobile capital. A decrease in value of the index indicates an increase in the vulnerability of the country. It was computed for nine countries in the Asia-Pacific region, including five of the East Asian countries affected by the 1997 crisis – Indonesia, the Republic of Korea, Malaysia, the Philippines and Thailand – along with four other emerging countries – China, India, Pakistan and the Russian Federation.3 The indicator tended to decline in Thailand and Indonesia, implying that the accumulation of mobile capital stocks grew faster than that of reserves. The dollar value of these countries’ oil imports have increased, leading to weaker current account balances and slower accumulation of foreign exchange reserves. In Thailand, the current account balance, which was in surplus from 1998 to 2004, has turned to deficit for 2005-2006. In Indonesia, the current account surplus has also declined compared with the period 1998-2004.
17
Figure 6. Reserve adequacy ratio a of selected ESCAP member countries, 1990-2006 700 600
Ratio
500 400 300 200 100
2004
2005Q1
2005Q2
2005Q3
2005Q4
2006Q1
2005Q1
2005Q2
2005Q3
2005Q4
2006Q1
2005Q1
2005Q2
2005Q3
2005Q4
2006Q1
2003
2004
2002
2001
2004
China
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0
Indonesia
300 250
Ratio
200 150 100 50
Malaysia
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0
Thailand
120 100
Ratio
80 60 40 20
India
Republic of Korea
Pakistan
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0
Philippines
Russian Federation
Sources: IMF, International Financial Statistics (CD-ROM) (Washington, D.C., IMF, 2006); CEIC database (CEIC Data Company Ltd.) and ESCAP calculations. a
18
Reserve adequacy ratio is defined as the ratio of foreign exchange reserves to the stock of mobile capital.
III. OUTLOOK FOR 2007: CONTINUED DYNAMISM For developing Asia-Pacific economies, the economic growth outlook in 2007 is one of continued dynamism. Economic growth is projected at 6.9 per cent in 2007, marginally lower than in 2006 (see figure 7). The global economic environment is expected to remain favourable, particularly the ongoing domestic demand recovery in Japan. Economic growth in the United States is still projected to be strong, although signs of a slowdown have become clearer since the second half of 2006, as rising fuel costs, declining employment growth, and a cooling housing market are beginning to take a toll on the economy. A moderate decline is expected in global electronics demand in 2007 as well as a slightly less accommodative macroeconomic policy stance, reflected in a high level of domestic interest rates and a limited role for fiscal policy in many Asian economies. These developments are expected to marginally mitigate the positive impacts of global economic conditions on Asia-Pacific economies in 2007.
Figure 7. Real GDP growth forecast for selected developing economies in the ESCAP region, 2006-2007 China Hong Kong, China India Indonesia Malaysia Pakistan Philippines Republic of Korea Russian Federation Singapore Taiwan Province of China Thailand Developing ESCAP economies 0.0
2.0
4.0
6.0
8.0
10.0
12.0
Percentage 2006 a
2007 b
Source: ESCAP forecast. Note: Developing ESCAP economies comprise 38 (developing) economies (including the Central Asian countries) and calculations are based on the weighted average of GDP figures in 2000 United States dollars (at 1995 prices). a b
Estimates. Forecast.
19
“
Growth momentum in 2007 will come from strong growth in China, India and South-East Asia
”
The growth momentum in the Asia-Pacific region in 2007 is expected to come from strong growth in China and India, and a rebound in economic growth in the South-East Asian economies. In China, GDP growth is expected to be about 9.9 per cent in 2007, slightly less than the 10.2 per cent growth of 2006. The marginally easing growth in 2007 is a result of tightening domestic policy that would show its effects on the economy from the second half of 2006 in terms of a slowdown in investment and exports. India is expected to grow at 8.1 per cent in 2007, virtually unchanged from 2006. The service sector is expected to be the key engine of growth, while industrial production will also accelerate. The Government is set to follow the recommendations of its Committee on Pricing and Taxation of Petroleum Products. These recommendations include removing subsidies on petroleum products, except items that are heavily used by the poor. This will lead to an increase in the retail prices of gasoline and diesel, reflecting international prices. The Reserve Bank of India is likely to continue to nudge interest rates up over the next 12 months, and the programme of fiscal consolidation that is now under way is set to continue. Due to weakening demand for imports among the advanced economies, GDP growth in East and North-East Asia (except China) is projected to soften in 2007. The easing of demand for IT products is expected to contribute to this outcome. Even though domestic demand in these countries is expected to grow solidly in 2007, they will continue to rely heavily on the world markets and the Chinese economy. In North and Central Asia, growth is projected to ease slightly, to 6.5 per cent. Growth in the largest economy, the Russian Federation, is projected at 6.4 per cent in 2007. The country is expected to benefit from high commodity prices and correspondingly strong export earnings. Domestic demand would receive a continuous boost from high foreign exchange earnings. Meanwhile, significant progress in resolving banking system problems is also expected to improve private investment. A modest rebound in GDP growth in the South-East Asian economies is expected in 2007 as the factors constraining domestic demand recede. Domestic demand, particularly for investment, along with exports will become the engine of growth. In Indonesia, investment is expected to be boosted by lower interest rates and new probusiness regulations that are coming into effect. Strong electronics exports and higher development spending related to the Ninth Malaysia Plan (2006-2010) would help to boost investments in Malaysia. In the Philippines, energy sector reforms will help to strengthen the investment climate and investor confidence, leading to an increase in investment next year. Despite the September 2006 military coup in Thailand, GDP growth is expected to increase to 4.7 per cent in 2007. The new interim Government is likely to reduce uncertainty in government spending, especially in public investment, with spending expected to increase and play a key role in boosting GDP growth. Export growth is expected to remain at a high level as the global economic environment remains favourable. Investment and consumption are expected to grow at the same pace as in 2006. However, with the interim Government, the macroeconomic outlook in Thailand will still be subject to greater downside risks than in other South-East Asian economies (see box 1).
20
Box 1. Aftermath of the military coup in Thailand: assessing the economic impact On 19 September 2006, a military coup brought an end to the political impasse that had affected Thailand for most of the year. A new interim Government was appointed for one year in order to prepare a new constitution and organize democratic elections. The coup has had no significant impact on the Thai economy. The stock market has remained steady after suffering a mild fall (1.4 per cent) on 21 September, the first post-coup trading day on the Thai financial markets. The Thai baht stabilized by 21 September after a fall of 0.6 per cent against the dollar. Because the events of 19 September were seen as limited to Thailand and as being of a political rather than economic nature, contagion to other regional markets was limited. ESCAP forecasts a slight increase in Thailand’s GDP growth of around 4.7 per cent in 2007. This “base-case” prediction is built on the assumption that the new interim Government is likely to reduce uncertainty in government spending, especially in public investment expenditure, with government spending expected to increase and play a key role in boosting GDP growth. Although the macroeconomic forecast remains favourable, uncertainty remains regarding the short-term effect of the coup. The “worst-case scenario” could develop, with a series of short-lived interim governments triggering political instability as happened in 1992. This would significantly affect investor and consumer confidence. Under this “worst-case scenario”, ESCAP predicts that economic growth would fall to 3.1 per cent, while inflation would increase to almost 10 per cent in 2007. Similar to the experience of 1992, this scenario expects consumption and investment to decline by 2-3 percentage points while exports of services (mainly tourism) would drop by 4 percentage points. The baht would depreciate by more than 20 per cent, reaching almost 46 baht per United States dollar. Even though net exports could increase as a result of exchange rate depreciation, significant reduction in consumption, investment and tourism would outweigh these gains and retard economic growth. The next few months will be closely watched by investors. The interim Government has a heavy responsibility to maintain economic stability and investor confidence in the economy. It will be important in the short-term for the new administration to outline policies regarding the investment climate (i.e., macroeconomic policies and economic governance measures) and to provide clarification on government spending (particularly on the investment component of the fiscal budget).
The headline inflation outlook in developing Asia-Pacific economies is projected at 4.1 per cent in 2007, falling from 2006 levels. Asia-Pacific economies, except China; Hong Kong, China; Singapore and Uzbekistan will see lower levels of inflation in 2007 (see figure 8). Falling oil prices since mid-2006 and tight monetary policies across the economies of the region throughout 2006 are expected to begin affecting the region in 2007. Thus, even though the Governments of some countries, such as India, Indonesia and Malaysia, have further removed oil subsidies and allowed retail oil prices to reflect international prices, inflationary pressures are expected to be subdued. For some East
21
Figure 8. Consumer price inflation a for selected developing economies in the ESCAP region, 2006-2007 China Hong Kong, China India Indonesia Malaysia Pakistan Philippines Republic of Korea Russian Federation Singapore Taiwan Province of China Thailand Developing ESCAP economies 0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
Percentage 2006 b
2007 c
Source: ESCAP forecast. Note: Developing ESCAP economies comprise 38 (developing) economies (including the Central Asian countries) and calculations are based on the weighted average of GDP figures in 2000 United States dollars (at 1995 prices). a b c
Changes in the consumer price index. Estimates. Forecast.
and North-East Asian economies, such as China and Hong Kong, China, inflationary pressures from the removal of oil subsidies and tightening labour and land markets, would be partly offset by tightening monetary policy and exchange rate appreciation. This is particularly true for Hong Kong, China. The current account surplus for emerging Asian economies is expected to deteriorate slightly in 2007, though it will remain high. Based on the 12 emerging Asian economies (see figure 9), the current account surplus is projected to be 4.7 per cent of GDP, compared with 5.1 per cent in 2006. With the expected rebound in domestic investment and the continuing high level of oil prices, the current account surplus is expected to decline in all Asian economies. In particular, a moderate decline in the current account surplus is expected in China due to policy measures supporting consumption, reduction in oil subsidies, and greater exchange rate flexibility. The above forecast on the economic performance of the Asia-Pacific region is rather robust, but several downside risks still remain. The possibility of a supply-side oil shock and a disorderly adjustment in global imbalances, among others, cannot be ignored. As such, the base line forecast would be increasingly tilted towards the downside risks. The potential for a supply-side oil shock could provide impetus for further rises in international oil prices, thereby negatively impacting projected economic growth, inflation and the current account. In the baseline forecast, the international oil price (Brent crude
22
Figure 9. Current account balance for selected developing economies in the ESCAP region, 2006-2007 China Hong Kong, China India Indonesia Malaysia Pakistan Philippines Republic of Korea Russian Federation Singapore Taiwan Province of China Thailand Emerging Asia -5.0
0.0
5.0
10.0
15.0
20.0
25.0
30.0
Percentage of GDP 2006 a
2007 b
Source: ESCAP forecast. Note: Emerging Asia comprises selected developing Asian economies and calculations are based on the weighted average of real GDP figures in 2004 United States dollars (at 2000 prices). a b
Figures for 2006 are estimates. Figures for 2007 are forecasts.
oil) is expected to move to approximately US$ 65 a barrel in 2007. Nonetheless, as spare capacity remains low, even a moderate disruption in production capacity and/or a further escalation of security concerns in the Middle East, could raise oil prices above the baseline assumption. The widening of global imbalances is a concern. The current account deficit in the United States has steadily increased to 6.5 per cent of GDP in 2006 from 6.3 per cent in 2005. This deficit has been financed by economies registering current account surpluses. The surplus is, however, increasingly concentrated on a few countries – China, Germany, Japan and oil-exporting economies. A disorderly unwinding of global imbalances would lead to a sharp depreciation of the United States dollar together with a sudden increase in interest rates. A global recession with severe negative impacts on the Asia-Pacific region would be the result. Within the region there are some risks emerging from the two largest economies. Sustainable recovery of the Japanese economy depends on the ongoing process of fiscal consolidation to address ballooning domestic debt. Any disruption to fiscal consolidation could negatively affect consumer confidence and spending and, in turn, would threaten the Japanese recovery. As discussed earlier, the spectacular investment growth in China has raised worries about “overheating”. Given the increased importance of intraregional trade and investment linkages, a sharp slowdown in Japan and China could adversely affect other Asian economies.
“
Downside risks to 2007 growth from a supply-side oil shock and a disorderly adjustment in global imbalances cannot be ignored
” 23
The final potential risk is related to an avian influenza pandemic. The structure of the poultry industry, consisting of many small-scale, backyard operations, makes the region vulnerable. The outbreak of a full-blown pandemic could generate significant economic and social costs in the region.4
NOTES
24
1
Charlene Chu, Lynda Lin, Kate Lin, and David Marshall, “China: taking stock of banking system nonperforming loans,” Fitch Ratings (May 30, 2006). Found at http://www.fitchratings.com/dtp/pdf2-06/bchi3005.pdf.
2
There are some issues about the comparability of data as the latest data is with reference to an expanded number of companies. With the same companies as previously, profit growth would be lower.
3
Country coverage is constrained by data availability. Note that reserve adequacy assess the (stock) reserve level in relation to the stock of volatile (mobile) capital. In this study, ESCAP employs a broad definition of mobile capital that covers items of non-FDI inflows, namely portfolio investment, bank credits, balances on nonresident bank accounts and trade credits. The data series on this variable was constructed by carefully accumulating the relevant items in balance of payment records. For all countries, except for the Russian Federation, the starting year used in this compilation is 1980. For the Russian Federation, it is 1993 because of data limitations. However, it was found that the results were highly insensitive to the choice of starting year.
4
See the potential costs of this pandemic in ESCAP, Economic and Social Survey of Asia and the Pacific 2006 (United Nations publication, Sales No. E.06.II.F.10).
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