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| March 31, 2001 | atimes.com | ||
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Asian Crisis
East Asia update: Regional Overview World Bank report East Asia: An Overview March 2001 Summary 1. The region is at an important juncture. After sustained and exceptional growth East Asia suffered a major setback during the recent crisis. Yet the recovery from the crisis has been remarkable, helped by exceptional conditions of the global economy and the fruits of structural reform. At the same time, the past six months have seen a continuation of political change across East Asia, some orderly and anticipated, some completely unexpected. There have been new governments in Thailand and the Philippines, and challenges to governments in Indonesia and some Pacific Island countries. . Meanwhile, the region is now facing a major global slowdown. 2. Against this backdrop, confidence in economic prospects has faltered. Progress on structural and institutional reforms remains key to restore confidence and increase resilience to shocks. Business and investor confidence, as well as domestic household confidence, still suffers from the perceived slow pace and questionable quality of some financial and corporate restructuring. Talk about trade liberalization and regional integration has not yet been evenly matched by action and the required adjustments in the real economy. Awareness is growing of the difficulty of public sector reform - to effectively manage decentralization and public sector debt. Civil service, governance, and judicial reform will take a long time. Good progress has been made on reducing extreme poverty as measured by headcount ratios, but social vulnerability remains high: nearly half the population live on less than $2/day. Progress on other social development goals -which require institutional strengthening and good service delivery -- has been slower. . Other issues command attention, too. The environment remains a major impediment to sustainable growth. 3. Given these vulnerabilities, the cyclical weakening in the global economy is a cause for concern. East Asian economies are heavily dependent on exports to the U.S. and Japan. This is compounded by weakness in the global IT sector, with some East Asian economies heavily exposed to the sharp semiconductor slowdown. East Asia has seen sharp reductions in equity markets, which closely mirror NASDAQ developments. Hence, growth prospects for developing East Asia for this year are dampened but positive, ranging from 3-5 percent for EA5 countries, 5.5-7.3 percent for transition countries, and 1.2-5.7 percent for small economies. 4. Yet many of the macroeconomic vulnerabilities that were at the root of the crisis have been significantly reduced. External positions are strong enough to manage a normal cyclical downturn, with high domestic savings, sizeable -- albeit declining - current account surpluses, and high levels of international reserves relative to short term debt. Considerable pull-back from East Asia by international banks, including Japanese banks, already has occurred, leaving East Asia less vulnerable to further sharp contractions in bank lending. The exporting and electronics sub-sectors in East Asia most affected by the global slowdown have stronger financials and, hence, are better cushioned to absorb the downturn. Real wages remain competitive, with dollar unit labor costs below their pre-crisis levels except for China. International and domestic interest rates are falling, easing fiscal pressures and reducing the burden of high corporate indebtedness. 5. As long as reform programs remain broadly intact, the impact of the global slowdown could be mitigated. The following overview provides a brief update on the major developments in the Region over the past six months. 1. Region at an Important Juncture The past six months have seen a continuation of change across East Asia - some orderly and anticipated, some completely unexpected. The changes to the political, economic and social landscape have altered, perhaps irreversibly, the overall development agenda in East Asia. The region is now facing increased political uncertainty, including more reports of ethnic and sectarian unrest and political protests. Recognized throughout the 1980s and much of the 1990s for its steady, exceptional growth and as a stable destination for investment, the East Asia region now appears to have settled into a lower growth pattern. The major changes in the last six months include:
Greater-than-average fluctuations of currency rates in the Philippines, for example, showed however, that international markets will exact a price for signs of domestic instability, and the slowing of new investment to the region - especially to the countries of South East Asia - underscored the lingering wariness of investors, even as growth and exports showed healthy signs of recovery. In Indonesia, political uncertainty, regional and ethnic strife, a deterioration in law and order, and a continued weak judicial system are combining to undermine investor confidence. The longer term process of change, however, is important, for two reasons. First, it is clear that the changes in the region are effectively creating a new East Asia, one with more room for public debate (including in the political system itself) and for private sector-led growth supported by stronger public institutions. Second, there is reason to view these changes as leading to a more stable, more sustainable group of countries. Certainly, the upheavals in some countries have been great, and the reform agenda remains formidable. But it is important to see that East Asia's strong traditions of private savings, of investments in health and education, of outward-oriented development policies, and of reducing poverty - coupled with China's role in the region as an engine of growth - offer some ground for believing that these changes will lead to more responsive public institutions, thereby laying the ground for stability and more equitable, steady growth. Meanwhile, East Asia has begun to feel the impact of a global slowdown. 2. Against This Backdrop, Economic Confidence has Faltered. Progress on Structural and Institutional Reforms Remains Key to Restore Confidence and Increase Resilience to Shocks Financial and corporate restructuring agenda ... and impact on investor confidence Business and investor confidence, as well as household confidence, still suffers from the perceived slow pace and questionable quality of some financial and corporate restructuring. Key to Asia's future is the urgency of improving the business and investment climate. The most poignant reminder is the region's heightened vulnerability to the weakening external environment. Particularly for open economies, flexibility in production and investment decisions is an important attribute with which to address shifting external demand conditions. But if substantial resources are tied up in unrestructured or failing firms, the capacity to adjust is constrained. The implications of the East Asian financial crisis for financial and corporate restructuring have consistently been underestimated. Although substantial financial and corporate restructuring has occurred, the quality of that restructuring is hard to assess, and difficult parts of the agenda remain. Making the task more difficult has been a complex mix of institutional factors, including powerful political connections of major debtors, conglomerate ownership of banks and other financial institutions and the resulting subservience of the latter to their corporate owners, and government concerns about systemic or social implications of allowing important firms to fail. These have complicated the implementation of technical solutions. Weak judicial capacity has added to the backlog in court-supervised restructuring cases, as allegations of judicial corruption have undermined faith in judicial efficacy. A shortage of skilled personnel more generally, in areas such as bank regulation and supervision, accounting and auditing, also has slowed the process of achieving international prudential and corporate governance standards. And slowing economic growth will not make restructuring any easier. Unfortunately, none of these factors diminishes the importance of persevering with the restructuring effort. The difficult part of the corporate restructuring agenda still appears to lie ahead. First, the London rules-based resolution approach is primarily a voluntary process -- suggesting that the most difficult cases involving well-connected or recalcitrant debtors or substantially distressed firms are either being addressed through the courts or not at all. Second, the out-of-court workout resolutions themselves tend to focus on simpler cases first. Thailand's CDRAC, for example, was unable to resolve about half its cases after two years effort, and these are now being transferred to the courts. Third. despite ostensibly faster progress through out-of- court proceedings, the quality of restructuring is of concern, focusing as it primarily has on temporary easing of debt servicing rather than operational restructuring, asset sales, equity infusions, debt/equity conversions and write-offs. In many such cases there is concern that corporate debt classified as "restructured" could return to non-performing status once grace periods have been exhausted. Since the crisis, progress in financial and corporate restructuring has helped ease the problems of access to financial services. The World Business Environment Survey finds that access to financing is no longer considered a major constraint in most East Asian countries. Stress levels in the domestic banking systems were on a gradual downward path. Yet the vulnerabilities associated with high leverage remain, and many countries remain vulnerable to financial shocks. East Asian corporate balance sheets depend heavily on credit, as reflected in the relatively high ratio of private (non-bank, non-public) sector credit to GDP which is relatively high for East Asian economies. One indicator of problem loans is when the growth rate of credit exceeds that of GDP. In Korea and Malaysia, this ratio has changed little since the crisis. Only the most severely affected EA5 countries, Indonesia and Thailand, have brought down this ratio. In China, this ratio has continued to rise. Retained earnings, asset sales, new equity issues and debt write-offs are required before credit risk can return to reasonable levels. More probing assessments of emerging market risk by international creditors and investors points to the need for discernible progress on the restructuring front as competition for foreign capital intensifies. While external capital flows to developing East Asia appear to have improved in 2000, above 1999 levels, the flows continue to be dominated by those to China. For example, of the $11.6 billion in inflows into equity markets in the first half of 2000, $10.4 billion was for China, dominated by some large issues, with less than $0.6 billion into the equity markets of the East Asia-5 countries. The bulk of FDI flows continue to be directed to China, estimated at $41 billion in 2000, slightly above 1999 levels. Malaysia FDI remains well below historic levels, Thai FDI is estimated to have fallen by a third, and FDI is still flowing out of Indonesia, albeit at a much reduced pace (-$0.5 billion in 2000 compared with -$2.7 billion in 1999). In Korea, net FDI amounted to $3.3 billion through November 2000 compared to $3.9 billion in the same period in 1999. Continuing losses at the bankrupt Daewoo Motors, the deep declines in the corporate value of the other Daewoo affiliates, and the purchase of Hyundai Electronics bonds by Korea Development Bank (KDB) have generated much controversy in the markets. Asian economies also need to focus beyond relative prices in the labor force to upgrading the quality of education and enhancement of science and technology, in order to ensure competitiveness in the world market. Asian economies are relatively well-endowed with an educated population: economic literacy and secondary school enrollment is higher than comparable economies in other regions. However, on other indicators of competitiveness related to skill, scientific knowledge and infrastructure of information technology, most Asian countries lag far behind, particularly Southeast Asia and mainland China. Korea, albeit more advanced, was still lagging behind other NIEs in IT infrastructure. Malaysia, Thailand and the Philippines measure substantially lower than the U.S., Singapore and Korea in their per capita R&D personnel nationwide, measured in fulltime working equivalent. Another indicator of domestic base of scientific research - patents awarded to residents - shows an average number for 1996-97 of 61,406 in the U.S., 158,809 in Japan and 11,409 in Korea, but 1,458 in China and only about 25 in Malaysia, Thailand and the Philippines, and less than 10 in Indonesia. Increasing focus on trade reform and regional integration needs to be matched with required adjustments in the real economy ... Medium-term structural challenges are being addressed at not only the country level but also the regional level. Regional trade integration has further implications for domestic structural reform. To benefit from the gains from regional trade and investment liberalization, the production structure in the real economy throughout East Asia will have to adjust. The financial and corporate sector restructuring agenda as well as support for regulatory and competition policy is critical for efficient firms to be effective players in an increasingly integrated economy and region. Extent of trade integration has increased steadily in the 1990s. Trade within ASEAN is about 20 percent of total ASEAN trade. Trade within the large northern Asian countries of China, Korea and Japan is also about 20 percent of total trade of those countries. Recent intra-ASEAN+3 trade is estimated at 35 percent of total trade of these countries; including the economies of Hong Kong and Taiwan, China; intra-ASEAN+5 trade is estimated at nearly half of total trade. While falling from peaks pre-crisis, regional investment flows remain at significant levels. Interest has heightened recently in regional trade and investment arrangements, with regional free trade agreements (RTA) as well as several bilateral free trade agreements within the region under active discussion. RTAs, if properly designed for trade creation, can be positive forces, especially for smaller economies, and in the context of stimulating trade in a global context. One major channel for a positive economic impact of an RTA in East Asia is through an enlargement of the market as a whole and resulting economies of scale, improved efficiency and greater competitiveness of regional producers. Inclusion of China is particularly important for achieving a large-scale regional market. Realizing these gains requires that East Asian countries allow expansion and contraction of sectors and firms as the markets develop. Another channel would be through trade and location effects. Any negative impact from trade diversion to less efficient sources in particular for poorer countries is likely to be offset by the positive impact of relevant technology transfer and modernization of standards and procedures - as has been the case with the expansion of AFTA to countries such as Vietnam and Cambodia. Growing regional activities also can stimulate increased demand for inputs from non-regional sources. Hence, any RTA could have significant welfare gains for both the region and globally if based on trade creation. Gains also depend on extent of 'deeper' integration including investment issues and going beyond tariff reduction measures to reduction in non-tariff barriers, deregulation of domestic markets to enhance competition, and harmonization of regulations and standards. The model of 'deep' integration is that envisioned by AFTA and the new ASEAN Investment Area initiative. However, given progress on the ground has been uneven, one should not underestimate the challenges arising from regional integration - for example, the recent debate surrounding the Malaysian automobile industry. The development of China as a growing economic force in the region presents significant opportunities for the other countries of the region. Of course China will continue to compete. Continued reforms in the state-owned enterprise sector will be critical to help it cope with the competitive pressures from WTO accession. In China's export trade, some southeast Asian exporters will lose primarily due to the removal of quotas on Chinese textile and apparel products. Under the proposed WTO accession, China will be eligible for the phasing out of quota restrictions under the Uruguay Round Agreement on Textiles and Clothing, the successor to the Multi-Fibre Agreement. However, the projected growth in world trade leaves ample opportunity for growing exports for all countries of the region. More importantly, China with its growing economy represents a source of increasing demand, from which neighboring countries are well positioned to benefit. China's imports from ASEAN countries alone have grown nearly four-fold over the past ten years, with the share of China's imports from ASEAN countries in its total imports growing from a little below 6 percent in 1990 to 9 percent in 1999. The ASEAN countries that have benefited the most from China's phenomenal growth in the nineties include Singapore, Thailand, Malaysia, and Indonesia, and more recently the Philippines. In the near-term, China's imports are expected to increase sharply, particularly investment goods imports but also final consumer goods (while intermediate inputs for exports are expected to flatten in line with lower export growth), providing some offset to decreasing external demand elsewhere. A recent analysis of the impact of China's joining the WTO indicate that overall it will benefit exporters from all countries in the region, and the East Asia region more than other regions of the world.Japan, Taiwan-China, and other NICs are likely to have the strongest volume gains, exceeding 100 percent, but countries of southeast Asia also benefit by more than 20 percent. The commodities with the largest volume increases are textiles, petrochemicals, wood products, and other manufactures. On the investment front, China remains attractive to foreign investors, in part because of increased opportunities associated with WTO accession. Real estate, electronics and communications industries, and investment related to the services economy, have all experienced a surge. Regional investors are key players: Hong Kong-China, Japan, Malaysia, Singapore and Korea represent five of the six largest points of origin for FDI. This, however, also represents opportunities for gains for all countries based on 'deep' integration. Southeast Asian countries in particular have the opportunity to adapt their labor force and business environment to an increasingly technologically sophisticated global economy, and move up the ladder of comparative advantage in an increasingly integrated East Asian market. Awareness is growing of the difficulty of public sector reform. It is increasingly clear that civil service, governance, and judicial reform will take a long time. Yet these reforms are essential to manage decentralization which is occurring throughout the region. They also are essential for managing public sector debt. Most East Asian countries entered the crisis with very healthy public finances, and this undoubtedly helped contain the crisis. Public sector debt grew sharply, however, as a result of three factors: the initial sharp depreciation of the exchange rate (which raised the domestic currency value of government external debt), the resolution of troubled financial institutions, and fiscal stimulus programs. As a result, public sector debt levels have become high. As a ratio to GDP, public sector debt has tripled in Indonesia, Thailand, and Korea (excluding government guaranteed bonds issued for financial restructuring.). In Philippines, with a steady decline in government revenues, earlier progress in reducing the considerable burden of public debt has been partially reversed, representing a major challenge for the new administration. In China, although the public sector debt level is relatively modest, the rapid increase in fiscal deficits aimed at stimulus as well as regional development are adding to debt levels. Additionally, for all countries these public sector debt figures may not fully reflect all the governments' debt obligations because they exclude contingent liabilities, such as future additional needs of financial sector resolution and debts of troubled public infrastructure corporations and other state-owned enterprises. Several countries also face the challenge of fiscal decentralization, which can expand fiscal deficits unless managed prudently. In Indonesia, concerns over the impact of decentralization on already high public sector indebtedness has led the central government to ban regional borrowing, except through the center. High public-sector debts raise questions of debt sustainability, thereby raising risk premia on sovereign debt. Any high risk premia on sovereign debt in turn sets the benchmark for domestic corporate debt and can create a climate of high real interest rates which complicates recovery and restructuring efforts. In Indonesia in particular, such high levels of public debt have raised questions of debt sustainability. Indonesia, along with the Philippines, remain the two countries in East Asia which have not been able to bring the spreads on their external sovereign debt back to reasonable levels. High public sector debt has diminished capacity for a fiscal response to another shock. Large government debt servicing obligations also pre-empt development and social expenditures. Without financial and corporate restructuring, a sustainable economic recovery is difficult and, hence, there is a risk that these economies will develop problems similar to those of Japan, whose public sector debt is approaching 130 percent of GDP, limiting the government's options. While debt dynamics for developing East Asian economies in the short term are likely to be positive in line with declines in interest rates, public sector debt may remain a drag on medium growth. Progress on reducing extreme poverty reduction, but social vulnerability remains high, and other International Development Goals have been harder to meet East Asia made rapid progress in reducing poverty between 1990 and 1996, driven largely by the spectacular gains in China. But the economic crisis interrupted progress in some countries, and led to an increase in the share of the population in poverty in Indonesia, Thailand and Korea. The adverse impact of the Asian crisis has dissipated for the region as a whole. Yet, for some badly affected countries like Indonesia and Thailand, it will take up to 2002 or beyond till poverty incidence has returned to the 1996 levels. Despite the slowdown in poverty reduction, the East Asia and Pacific Region leads the world in progress toward meeting the International Development Goals, embraced by 160 nations. Already by 1998 the East Asia and Pacific Region had achieved the International Development Goal of reducing extreme poverty, defined as the proportion of the population living under $1/day, by half between 1990 and 2015. The proportion of population under this poverty line is estimated at 13.2 percent in 2000 compared with 27.6 percent in 1990. Yet social vulnerability remains high: nearly half the population (48 percent in 2000) live on less than $2/day. Progress in reducing extreme poverty has been uneven. Some smaller economies are falling behind, for example, PNG. There are also sub-national variations and serious regional disparities within countries. For instance, while the Philippines as a whole seems to be on track for attaining the poverty reduction goal, regions within the Philippines such as Eastern Visayas, and Central and Muslim Mindanao have lagged behind. In several countries, inequality and ethnic issues are undermining social stability, making sustained progress harder to achieve. Progress on other social development goals -- which require institutional strengthening and good service delivery -- has been slower. In terms of the education goals, such as achieving universal primary enrolment by 2015 and gender equality in primary and secondary education by the year 2005, the East Asia region is largely on track. But, this hides country-level variation. Net enrollment rates in Cambodia have actually declined between 1996 and 1998. Progress on achieving gains in health indicators has been disappointing, and hence progress towards reducing the infant and child mortality rates have not been rapid enough for the region to achieve the target of reducing these rates by two-third by 2015. Reductions in the under 5 mortality rates in China, Vietnam, Thailand and Laos have not been rapid enough to achieve the targets. It is particularly striking that despite the fastest gains in the region on poverty reduction in China and Vietnam this has not been matched by gains in health indicators. These challenges, and the associated issues of managing vulnerability, are the main poverty challenges for the region. Given ongoing uncertainties created by the short-term cyclical downturns, the social agenda remains key . While it is too soon to gauge impacts on wages and employment in the labor markets, there already are signs of unemployment creeping back up. Korea's unemployment wage rose to 5 percent in February, from 4.6 percent the previous month. The unemployment rate in the Philippines increased to 11.4 percent in the fourth quarter of 2000 from 10.1 percent the previous quarter. In the face of economic slowdown, the authorities will need to be prepared to continue strengthening the safety nets, many put into place recently in response to the 1997 crisis. The experience with social safety nets including public employment activities should put these countries in a good position to respond as needed to any temporary labor market difficulties. Reform of the social security system will be critical to addressing the challenge of redundant labor from enterprise restructuring and an essential precondition for reform of the public enterprise sector in the transition economies including China. Other issues command attention -- environment For decades, before the East Asian financial crisis, economies in the region experienced unprecedented rapid and long-lasting economic growth, despite diversity in natural resource endowments, geography, population size, and culture. However, policies that emphasized rapid economic growth based on high domestic savings and capital inflows tended to ignore the environmental consequences of rapid growth. This imbalance resulted in congested and polluted cities, rapid deforestation, and the erosion of natural resources. The accumulation of environmental problems has represented the "dark side of the East Asian Miracle", questioning its sustainability in the long term. In the immediate aftermath of the crisis, priority has rightly been given to restoring growth to reverse the decline in personal and national incomes and to continue the battle against poverty. As East Asia moves toward concerns of sustained growth, attention should extend to addressing critical environmental concerns (i.e. urban air and water pollution; sustainable use of natural resources; strong environmental compliance and enforcement at local level) to ensure that regional economies do not relegate environment to a secondary status on the policy agenda and backpedal into environmental neglect again. 3. Given These Vulnerabilities, Cyclical Weakening in Global Economy Is Cause For Concern Negative external developments hit East Asia hard, casting a shadow on heels of strong recovery Until recently, the pace of recovery in East Asia exceeded expectations, with growth for developing countries hitting 6.9 percent in 1999 and exceeding 7 percent in 2000. The strong external situation was an important contributing factor to this growth and helped to reinforce domestic macroeconomic policy and structural reform measures aimed at restoring consumer and investor confidence. Strong growth in the United States and Europe bolstered external demand in the East Asian economies, reinforced by the deepening trade linkage in the Region Export expansion and the favorable current account balance, together with a threefold increase in portfolio and foreign direct investment inflows, were sufficient to offset continuing outflows of bank loans. Now a reverse in those external developments is casting a shadow on the heels of that recovery. A cyclical slowdown in critical U.S. markets combined with a failure of the Japanese economy to recover is dampening the short-term growth outlook in East Asia. Projected GDP growth for the U.S. for 2001 -- which was over 3 percent six months ago--is now under 2 percent. Projected GDP growth for Japan for 2001 -- which was about 2 percent six months ago -- continues to be revised downward. In a few months, Japan could be back into 'official' recession. Industrial production for January dropped 3.9 percent (month on month, seasonally adjusted) instead of expected 0.5 percent growth. Industrial output is now expected to contract 7 percent in the first quarter (quarter on quarter). Compared to other emerging markets, East Asian economies are heavily reliant on exports to generate demand, especially on the U.S. and Japan markets. The East Asia 5 countries (Indonesia, Korea, Malaysia, Philippines, Thailand) are particularly dependent on exports to those markets, accounting for 16 percent of GDP, compared with 7 percent for transition economies and 8 percent for other small economies in East Asia). The increasingly integrated production and trade patterns in the Region will reinforce the negative cyclical impact. East Asia is particularly vulnerable in the current downturn to demand for electronic products, or more broadly, information technology (IT). IT sectors have their own sharp cycles not necessarily linked to broader economic cycles, yet in the current global environment the two cycles are linked. Among developing economies, the East Asian countries are the most exposed to swings in the IT sectors: the region, which accounted for a quarter of the world semiconductor market in 2000, behind North America, Japan and Europe; is increasingly active in the global consumer electronics market. The current global downturn in demand for IT is impacting the semiconductors sub-sector rather than consumer goods. East Asia semi-conductor sales tend to closely track world sales. And, while year-on-year growth rates of personal computer sales remain fairly stable (albeit exhibiting seasonal swings over the course of the year), semiconductor sales growth plummeted by the end of 2000. After a period of slowing yet still robust growth during the summer and into the fall months, (30 percent to above 60 percent growth year-on-year seasonally adjusted), global semiconductor sales year-on-year fell sharply from 4 percent in October 2000 to -27 percent in December . Growth of semiconductor sales in East Asia fell to -14 percent (saar) in October from 30 percent the month before, and by December had plummeted to -41 percent. Similar drops in semiconductor sales occurred in the other major markets except for Japan, which experienced a much shallower decline. Several countries in East Asia are particularly exposed to this global IT and semiconductor slowdown. Countries such as Malaysia and the Philippines have very high shares of IT exports, as a share of both total exports and GDP, and high shares of exports to the US and Asia (including the NIEs and Japan) Semiconductor exports in both countries comprise over 20% of each country's GDP. The other major IT exporters in the region - such as Korea, Taiwan-China, Thailand - are also vulnerable; semiconductor exports represent 6 percent of Korea's GDP and 4 percent for Thailand. At the same time, as the sectors have matured, the IT products are no longer exclusively concentrated in computers and computer components. Mobile electronics, electronic games, and customized micro- processors are playing an increasingly important role in the IT sector. Half of Malaysia's IT exports and a quarter of the Philippines' are in these more diversified consumer electronic products. The low-end, computer component based production is shifting towards low cost centers, such as China, Indonesia, and Thailand, where the share of IT in the economy, except for Thailand, is still relatively low. Asian equity markets also have weakened, mirroring to a large degree the decline in global markets. Asia's emerging markets have become much more closely correlated with those in NASDAQ, in line with globalization in financial markets and the IT and electronics industry, and accompanying increased dependence of some East Asia economies on these exports. The correlation between NASDAQ and Emerging Asia indices in 2000-01 is about 0.8, compared to 0.2 for the 1990s as a whole. Investors no longer find the same degree of risk diversification in East Asia emerging markets as previously. The correlation between returns on NASDAQ and Emerging Asia markets has increased from 0.11 in the 1995-96 pre-crisis period to 0.21 for 2000 to early 2001. There has been recent divergence between the NASDAQ and Emerging Asia market indices. However, this is due to political developments, in the Philippines and Thailand, the decision by the Chinese authorities to allow domestic investors into its B share market, and susceptibility of the Indonesia stock market to political events. The link between the equity markets and the real economy is muted in East Asia. East Asian firms have a lower reliance for raising money on equity markets, through IPOs or new share issues. Most investment is financed by debt, bank credits, and retained earnings - sources to which firms can continue to turn. Holdings of publicly listed shares are concentrated, with foreigners holding a significant proportion of floating shares in some markets, so the wealth effect on household consumption is low. Managers are less oriented to bottom-line stock market movements as options are not a substantial portion of their compensation packages, so they do not respond as directly to share price movement in comparison to managers in the US for example. On the other hand, there are still important effects of weakening equity markets which should not be ignored, for the following reasons. One, market declines lower confidence which can spill over into reduced investment and consumption. Asian households react to future uncertainties by increasing their savings which could stall growth. Two, corporate and financial sector balance sheets still need more equity to be returned to healthy positions. The fall in stock markets could complicate and slow financial and corporate restructuring. The way in which major developed countries manage these cyclical developments could mitigate the economic impact on East Asia. These international forces include: lower nominal and real interest rates, lower oil prices, and possible depreciating value of the US dollar - all of which help those East Asian economies most seriously affected by the global and IT slowdown. Developing East Asian economies are net external debtors, and, hence, declines in interest rates have a positive impact. Interest rate policy in key OECD countries in response to the slowdown has led to a decline in international interest rates. The fall in real rates is even starker than that of nominal rate cuts. The fall in US interest rates by 150 basis points in January-mid-March 2001 translates directly into savings on interest payments of variable-rate external debt on the order of $3 billion for East Asia. Fixed rate debt - in particular, short-term debt - will also reflect these lower rates. Moreover, the decline in international interest rates has permitted a downward adjustment of domestic interest rates. Lower domestic interest rates will provide some additional offsetting stimulus to the East Asian economies during the cyclical downturn. From the start of the year to mid-March, East Asia short term interest rates have fallen by 300 basis points in Philippines (also due to restoration of confidence) and by about 90 basis points in Korea and Thailand. With these interest rate declines, liquidity conditions have eased. This has been reflected in a strong upsurge in international bond issues from emerging markets, and steady decline in bond spreads - which builds on significant bond activity in 2000 for East Asia emerging markets after two years of virtual absence. The bond market provides an attractive financing source for East Asia over the more depressed equity markets during the cyclical downturn. Korea, Malaysia and Thailand remained active in early 2001. We have not yet seen any evidence of an increase in international spreads over concerns with a weakening East Asian economy. Recent events in Turkey temporarily tightened conditions, but not primarily East Asia emerging markets. An exception is Indonesia where the spreads in the secondary market have been increasing in recent months. Development of financial innovations including asset-backed securities is broadening access to capital markets, even if the primary market is weak. In Korea, for example, in 2000 domestic businesses doubled the won volume of corporate bond issues; with much of the increase among small-and-medium size enterprises. Asset-backed securities accounted for 70 percent of total, compared to 15 percent in 1999. Cyclical weakening in the global economy is putting downward pressure on oil prices. Further production cutbacks have been announced by OPEC in response, but non-OPEC supply is expected to increase. While oil prices are likely to remain highly volatile, we continue to expect oil prices to be in the range of $25/bbl in 2001 and $21/bbl in 2002, lower than the price level in 2000, This will provide additional relief especially for several of the countries most seriously affected by the slowdown: Korea, Philippines, Thailand, all major oil importers. The surge in oil prices in 2000 had quite differentiated impacts within the Region. Korea, at one end of the spectrum, with oil and petroleum derivatives representing about 18 percent of imports, saw its oil bill increase by as much as. $14bn (3.5 percent of GDP), closely matching the deterioration in its current account balance in 2000. With oil imports representing about 8 percent of total for the Philippines and Thailand, the decline in the oil bill for those countries also will be significant.. At the other end, Indonesia and Malaysia, which had been benefiting from higher prices, will be negatively affected by the oil price moderating. A number of smaller economies are heavily dependent on concentrated commodity exports. Non-oil commodity prices are unlikely to recover until 2002. However, mineral and metal prices are set to recover by year end - benefiting countries such as Mongolia and Papua New Guinea where metals account for about half of total exports. With many East Asian currencies linked to the dollar, any signs of dollar weakening will provide some offsetting stimulus to these countries' external sectors vis-a-vis other major trading partners. The role of the U.S. dollar as the most dominant target currency for exchange rate stabilization in East Asia was reduced during the 1997currency crisis, but its prominence has recently been restored, particularly since late-1998. Hence, a more depreciated dollar implies depreciation of East Asian currencies relative to a broader basket of currencies, which can help stimulate exports particularly to the EU. The Euro had been strengthening against the dollar until quite recently. The trend vis-a-vis the yen is more uncertain. The yen may weaken further as part of concerted efforts to stimulate the economy. 4. Given Improvements in Several Domestic Structural Risk Areas, Impact of External Shocks can be Mitigated As long as reform programs remain broadly intact, the impact of the external shocks is likely to be mitigated. The underlying fundamentals in many of the East Asian economies are substantially different than those which existed pre-crisis. Because of this, there is less risk that external developments will be magnified or spill over into a larger domestic crisis. This is the case in these major domestic risk areas: macroeconomy, corporate sector, fiscal position. Prior to the crisis, East Asian economies had a number of weaknesses in their external positions that allowed external shocks to have further destabilizing effects on the economy. A new phase of financial integration with the global economy in the early 1990s resulted in large inflows of capital and build-up in private debt, particularly short-term debt. Current account deficits began to widen as 6 See Kawai and Akiyama (2000). "Implications of the Currency Crisis for Exchange Rate Arrangements in Emerging East Asia", World Bank Policy Research Working Paper No. 2502. countries increasingly used inflows to finance investment, often less productively. Growth in international reserves slowed, leaving a smaller cushion against shifts by short-term lenders, as well as domestic depositors for those with open capital accounts. As a result, the ratio of short-term debt to foreign exchange reserves exceeded 100 percent in Korea, Indonesia and Thailand immediately before the crisis. Now, strong external positions have been built back up, strong enough to manage a normal cyclical downturn. Domestic savings have remained high. Current accounts of emerging East Asian countries continued to show strong surpluses in 2000. Despite the global and IT slowdown, economies are projected to show surpluses again in 2001,albeit declining. Lower income countries remain the exception, where concessional finance continues to play a major development role. International reserves continue to grow. In combination with an improved term structure of foreign debt, this has led to a substantial improvement in the external position of the region relative to pre-crisis. The ratio of short term debt to international reserves has fallen steadily all countries. For example, for Thailand and Korea, that ratio has moved from well over 100 percent to under 50 percent by end 2000. During the last year, with strong current accounts and capital inflows, pressure in fact for exchange rate appreciation had built up. That pressure now will be relieved, without necessarily introducing currency instability. Indonesia is an exception. Its current account surpluses reflect a collapse in imports and inability to attract capital, rather than a sign of declining vulnerability. From January to mid-March, gross international reserves have declined. A considerable pull-back from East Asia by international banks already has occurred, leaving East Asia less vulnerable to further sharp contractions. Total bank credit to developing East Asia has fallen by nearly a half between the start of the crisis in 1997 and late 2000 (from $385 billion to $205 billion for EA5 plus China). Net flows which have been negative began bottoming out in 2000. Japanese banks - major creditors to the region - have already cut their Asian portfolio rock bottom since the Asian crisis. Their exposure was reduced by half, from $124 billion as of second quarter 1997 to $58 billion by third quarter 2000. Japanese private commercial banks do not need at this stage to restructure drastically their emerging market portfolio and have made enough provisions for their non-performing loans (NPLs) on their remaining portfolio. Japanese banks may come under further pressure, especially if lack of confidence in recovery of the Japanese economy translates into sharp declines in value of their equity holdings (part of their tier 2 capital, where capital gains have been used to cushion provisioning needs and loan write-offs). However, the TOPIX index has been more stable than the Nikkei 225 index, where part of the 'fall' has been a change in composition toward new economy stocks rather than declines of individual stocks. If the real economy in Japan goes into recession, some intra-firm equity transfers and non-bank financing to East Asian subsidiaries might suffer, but by and large vulnerability to contraction of Japanese financing is far reduced. East Asian economies have been maintaining more flexible exchange rate arrangements. With the exception of Malaysia and China, East Asian economies have allowed their exchange rates to float more freely, an important step to reducing the likelihood of a crisis recurring. Yet Asian economies are facing a difficult dilemma in management of the exchange rate regime. For countries long accustomed to macroeconomic stability, the sharp movements in international interest and exchange rates of the crisis years caught businessmen in the region by surprise and led, in part, to a halt in new investment projects, thereby aggravating the crisis. The legacy of this still exists: a recent World Business Environment Survey finds, somewhat surprisingly, that businesses in East Asia felt that inflation and the exchange rate, as well as policy instability, were major constraints, particularly in Thailand, Indonesia, and the Philippines. East Asia's rankings in these are almost as high as those for Latin America and the Caribbean and developing Europe and Central Asia. Policy makers are still trying to find the right balance between allowing the currency to float and avoiding too much volatility in corporate balance sheets and operations. This highlights as major issues for the financial sector the deepening of financial markets and the strengthening of debt management. On the corporate side, the sub-sectors of the real economy that will be most directly affected by negative external developments are the exporting and electronics sectors. These sectors historically have had stronger financials and, hence, have been better cushioned than other sectors in East Asian economies to absorb cyclical downturns. In addition, the firms in these sectors are exactly the ones which have profited significantly from the recent boom, further strengthening their underlying financials. For example, in Korea in 2000 the electronics sector contributed more than half of the total growth of industrial production and exports. The EA IT sector already accounts for a small share of total loans (4 percent of total in Korea). In Malaysia manufacturing exports, as well as consumer goods and the manufacturing sector generally, have lower levels of debt than real estate, construction, and infrastructure sectors where corporate sector distress is concentrated. This puts the exporting and electronics sectors in a better position to weather temporary market slowdowns without adding to the non-performing loans of the banks. The monetary easing across region is also expected to provide some relief to firms which remain highly leveraged. The East Asian labor force generally is also more competitive than pre-crisis, providing an additional boost to the corporate sector as well as employment prospects. Crisis-hit economies in East Asia have become more competitive in their relative prices in the labor market, as reflected in both the lower real wages and depreciated currencies. For the EA5 countries, dollar unit labor costs fell during 1997-98 before edging up in 1999; the upward trend has continued into the year 2000 but their exchange-rate- adjusted real wages are still below pre-crisis levels. This is particularly the case for Indonesia and Thailand. In China, real wages have continued to rise, with real wages in the urban sector rising at 13-14 percent per year over the past two years. While this increase bears watching, not least because of the erosion of international competitiveness, China's relatively low wage labor force remains competitive internationally. On the fiscal front, governments have built up sizeable stocks of public sector debt which impose a heavy debt servicing burden. Lower international and domestic interest rates which will characterize the cyclical downturn will ease this fiscal pressure. Public debt dynamics overall will improve. Interest rates now are less than GDP growth rates for most countries, so that the public debt to GDP ratio will decline unless large primary deficits are produced. The negative external developments which are hitting East Asia hard this year are cyclical in nature. The expectation is for an end to the global slowdown by 2002. Based on Consensus Forecasts for March, the U.S. economy is projected to grow 1.9 percent in 2001, with growth picking up to 3.4 percent by 2002. For Japan, while there is risk of recession, the consensus is for GDP growth of 1.2 percent in 2001. The slowdown in the IT sector also is cyclical in nature and should reverse by 2002. While this cyclical downturn appears steeper than recent cycles and might last longer, the global downswing and spillover on East Asia sales associated with past semiconductor cycles has lasted anywhere from 6 to 9 months. Growth prospects for developing East Asia for this year and next are dampened but positive. Our projection for 2001 ranges from 3-5 percent for EA5 countries, 5.5-7.3 percent for transition countries, and 1.2-5.7 percent for small economies. Our projections for 2002 show some rebound, in particular for EA5 countries. Country Developments While external developments are worthy of note, domestic political and economic developments are central to restoring confidence. The mixed picture across the region reflects the importance of these country factors, as noted below. East Asia 5 Indonesia. According to official estimates, GDP grew by 4.8 percent in 2000 compared to its level a year ago. This was primarily driven by investment growth ( 17.9%) and exports (which rose by 16 percent) helped by a depreciating rupiah and higher oil prices. Increasing real wages, improving employment and the sharp decline in food prices - especially rice - has resulted in a decline in poverty levels from the crisis peak. However, the economic recovery is far from secure. Quarterly growth in manufacturing and construction has been decelerating sharply in 2000. The fragility is being demonstrated by: the gradual but continuing increase in domestic interest rates (with the 30-day SBI rate rising to 14.75% in mid-February, 2001, up from 14.5% at end-December 2000); susceptibility of the stock market to political events (with the Jakarta Stock Market (JSX) composite index down 36 percent by end February from December 1999); and the re-emergence of inflationary pressures. There also has been some slow down in export growth during the fourth quarter of 2000 and first months of 2001, mainly due to deceleration in world trade. Lower projected oil prices will compound this. Political uncertainty, regional and ethnic strife, a deterioration in law and order, and a continued weak judicial system are combining to undermine investor confidence. The first quarter of 2001 saw domestic uncertainties increasing as ethnic violence escalated in the province of Central Kalimantan. Fighting also continues in Aceh, Irian Jaya, and Maluku (the Spice Islands). The IMF's review mission that was scheduled for late December, 2000, has been delayed due to outstanding issues in four key areas: the Central Bank Law; fiscal decentralization; the privatization of Bank Niaga and BCA, and corporate restructuring principles. Korea. The rapid expansion of the economy seen during 1999 and the first half of 2000 has slowed substantially in the past months, from a combination of external and domestic factors. Fourth quarter GDP increased 4.6 percent year-on-year but contracted by 0.4 percent compared with third quarter, resulting in GDP growth of 8.8 percent overall in 2000. The sharp decline in domestic consumption has been the most visible, with a continuous slowdown in the growth of wholesale and retail sales since October. The Consumer Expectation Index is at a record low. After declining to a near-three-year low of 3.4 percent in October, the unemployment rate has picked up, reaching 5 percent in February. The current account surplus declined substantially to an estimated $10.5 billion in 2000, compared to $24.5 billion in 1999; it is expected to decline further as export growth moderates. However, slowing domestic demand will result in lower imports, with the current account surplus expected to remain a strong $5 billion. Capital account performance remains strong, and the level of international reserves has remained high, although the rapid rate of reserve accumulation is likely to diminish with the narrowing current account surplus and the expected repayments by Korea to the IMF in the amount of $6 billion this year. On the fiscal front, fiscal consolidation has proceeded more rapidly than expected, with a surplus estimated at 1.1 percent of GDP in 2000. Thus, fiscal balance has been achieved four years ahead of the target specified in 1999. This provides some scope to loosen fiscal policy if necessary. The improved social safety net should enable the economy to better weather any temporary dislocations, including the flexibility to expand the employment insurance fund if needed. Bank credit remained flat in the fourth quarter of last year, and the loan-to-deposit ratio remained essentially unchanged. Noting that the economy had contracted more rapidly than anticipated, the Bank of Korea lowered the target for the overnight call rate from 5.25 to 5 percent in February and further eased lending conditions by extending the preferential lending program for small and medium-size enterprises to second-tier conglomerates. While a more accommodating monetary policy stance may be appropriate given the weakening economic environment, it is important to ensure that this extension does not impair the balance sheets of the commercial banks. Continuing losses at the bankrupt Daewoo Motors, the deep declines in the corporate value of the other Daewoo affiliates, and the purchase of Hyundai Electronics bonds by Korea Development Bank (KDB) have generated much controversy in the markets. As uncertainty regarding the health of the corporate sector lies at the root of the decline in market sentiment, equally important is the need to push ahead with the corporate restructuring agenda. Malaysia. Growth has moderated sharply in the last three quarters but remains positive. The quarterly y-o-y increase in Q4 was 6.5 percent, down from the peak of 11.9 percent in Q1. Growth for 2000 as a whole was 8.5 percent compared with 5.6 percent in 1999. The change in momentum is largely due to exports which actually declined by 5.1 percent between Q3 and Q4, but are still up 5.7 percent in Q4 over the same period in 1999 including electronics exports. The current account is expected to deteriorate in 2001 in line with external developments, but remain positive, with GDP growth also projected to decline to more modest levels in 2001. Manufacturing project applications and approvals at MIDA were up sharply in the fourth quarter (314 and 64 percent, respectively), largely on the strength of domestic investment. Political uncertainty will influence whether foreign investment is forthcoming and whether the approvals translate into actual investment on the ground. Consumer sentiment remains muted with a decline in both the Consumer Sentiment Survey index and the Business Conditions Survey index in the fourth quarter. The government's projected fiscal deficit of 4.9 percent of GDP for 2001 reflects an anticipated need to provide additional stimulus. Development spending plans introduced in the 2001 budget, including the huge Bakun hydro electric dam, will have an impact lasting 2-3 years. Price pressures remain modest in the face of slackening demand. Interest rates have been steady to slightly downward trending since September 1999. Net lending has resumed, with disbursements outstripping disbursements during the last three quarters of 2000. Net international reserves - rebuilt from less than $US20 billion in the immediate aftermath of the crisis to a peak of $US 33.5 billion in April 2000 - have since declined despite continued trade surpluses. These recent declines reflect debt repayments, overseas investment by Malaysian companies, foreign exchange valuation losses and other factors. Portfolio flows related to political uncertainty and removal of capital controls may have played a part. Moral suasion may have been brought to bear on some large firms to repatriate capital to Malaysia during the crisis and recent outflows may also reflect these firms' desire now to rebuild their external balances. But the reserve position remains strong at 6.3 times short term external debt and 4.4 months of import cover. As a small open economy, Malaysia will need to continue to strengthen its ability to manage its boom and bust cycles and improve corporate governance to fully restore market confidence. Recent financial and corporate restructuring activities, including the buyout of Tajudin's share of MAS, the lease back of two bankrupt KL light rail companies to their developers, the purchase of loss-making firms by United Engineers Malaysia (UEM) and subsequent debt relief measures, give cause for concern. Philippines. Preliminary figures on economic growth in 2000 - 3.9 percent GDP growth, 4.2 percent GNP growth - indicate a modest increase over 1999. Despite higher growth in 2000, unemployment rose to 11.1 percent from 9.8 percent in 1999 as a result of a contraction in the agricultural labor force in 2000. The pattern of accelerating quarterly growth rates in 2000 observed through the third quarter was interrupted in the fourth quarter, impacted by the adverse reaction of investors to the political crisis. The events leading to the removal of former President Estrada were traumatic. Equity prices were deeply impacted, the peso hit an intra-day low of P55.75/US dollar on January 17, and interest rates were raised by 400 basis points to stem the flight from peso assets. The Philippines emerged from a four month period of political turbulence with the appointment of a new president on January 20, 2001. Financial markets have reacted favorably to the removal of political uncertainty. The peso has strengthened to about P48/US dollar, central bank overnight borrowing and lending rates returned to their pre-political crisis levels - 11 percent and 13.25 percent, respectively - and stock prices rose by nearly 18 percent on January 22. The new government is well aware that it faces pressing policy concerns in a number of areas. These include: reversing the deterioration in public finances, enacting and implementing power sector reforms, strengthening public sector management, accountability, governance and anti-corruption programs, and addressing structural weakness in the banking and corporate sectors. Government revenues have declined steadily since 1997 resulting in increases in the public sector deficits over the same period and loss of policy credibility from overshooting of fiscal targets by wide margins. Reversing these trends and bringing the public accounts into approximate balance over the medium term has been accorded high priority by the new administration. A budget deficit target of P145 billion for 2001 (3.7 percent of GNP) has been set; in the absence of new measures, the 2000 deficit of P136 billion was set to exceed P200 billion in 2001 by official estimates. The new administration has decided not to pursue passage of the draft 2001 budget prepared by the Estrada government, but to base 2001 spending on the 2000 budget. Government is preparing a supplementary budget for 2001 together with a fiscal adjustment plan for 2002. However, given dependence of Philippines' exports on US and Japan markets as well as the electronic sector, weaknesses in global and regional markets have partly overshadowed the positive sentiment stemming from local developments. Softer external demand could continue to pressure merchandise export performance, whose growth slowed to below 9 percent in 2000 from nearly 19 percent in 1999. GDP growth in 2001 is expected to slow to about 3.2 percent. Yet investors are clearly more favorably inclined to the policy thrust of the new administration. Particularly if sound intentions can be backed up by results, the prospects for stronger growth in the medium term have clearly improved. Thailand. Thailand's economic recovery is on track, but it remains fragile and uneven. Real GDP grew by 4.3 percent in 2000, with exports acting as the major driver. Despite growing imports, the current account generated a sizeable surplus of 7.5 percent of GDP, compensating for capital outflows. FDI flows are mellowing as extraordinary opportunities that have arisen with the crisis disappear. There are signs that the economy may be slowing. We now project real GDP to grow at 3 percent in 2001, and for Thailand to grow at the modest rate of around 4-5 percent in the medium-term. The current slowdown has been caused by several factors. First, the contribution of exports will be lower this year. Thailand posted a deficit on its trade balance in January 2001 for the first time in 30 months, as a consequence of the slowdown in US orders for computer parts and electronics, and the purchase of airplanes by Thai airways. We expect the trade balance to remain in surplus (as indicated by the February data) in 2001, although the magnitude of surplus will decline over time. Second, domestic demand has turned more sluggish. Consumer sentiments remain weak, despite the low interest rate environment (Thai banks cut interest rates by 50 basis points recently), as future job security is threatened by high unemployment rates. Private investment also remains sluggish given the excess capacity in the non-tradable goods sector, slow down in export growth, and the weak legal and regulatory regimes. Third, given the high level of public debt, there is limited room for using additional fiscal stimulus to support growth. It now is likely that it will take longer for Thailand to recover fully from the crisis than earlier anticipated. Strengthening of both investor and consumer confidence will be critical. Progress on financial and corporate sector reform continues to be characterized by (a) a declining trend in headline NPLs (20 percent), reflecting transfers to AMCs and some write offs. New NPLs continue to rise and the re-entry of restructured NPLs is increasing; (b) overhang of distressed assets remaining high in the public sector; (c) winding down of CDRAC process with a big bulge in court cases; (d) market restructuring deals consisting largely of rescheduling; and (e) firms remaining highly leveraged (averaging a ratio of 2-3 for non-financial limited private companies). Challenges ahead include the implementation of the national AMC, further strengthening the regulatory framework of commercial banks and improved supervision of government-owned specialized financial institutions. Importantly, government policy must enable banks to attract more private capital to cover losses and provide a platform for new lending, once capacity utilization picks up. Secured lending and the bankruptcy regime needs to be further strengthened to encourage voluntary restructuring. Transition Countries: China. Official estimates show that, after seven years of declining growth rates, GDP growth picked up in 2000 to 8 percent. Fiscal policy played an important role in supporting growth while structural reforms worked their way through the economy. Government consumption grew by 12.0 percent compared with private consumption which grew by 7.9 percent in 2000. State-sector investment rose faster than non-state investment. China's fiscal deficit has climbed quickly from 1.5 percent of GDP in 1996 to a budgeted 3.6 percent in 2000, or an actual of around 4 percent as a result of a supplementary fiscal packaged announced in late-2000 for western region development. Weakness in the rural economy continued, with agricultural growth continuing to decline to 2.4 percent in 2000, slowing improvements in the living standards of the poor. While there is some evidence that rural household consumption may have been protected by the fiscal stimulus program, the rate of increase in urban real income has grown more than double the rate of real rural income, exacerbating rural-urban income inequality. On the external front, the current account surplus for 2000 is estimated at 1.4 percent of GDP, on the back of a large trade surplus. By second half of 2000, the effects of a pause in exports became apparent. Global slowdown will affect the export sector, where growth is expected to decline to about 5 percent in contrast to import growth continuing to exceed 25 percent, projected to result in a slight current account deficit in 2001. The continued need for corporate restructuring and likely effects of WTO-accession will need to work their way through the system with bleaker prospects for employment and poverty. Chinese SOEs have shed some 14 million workers over the past two years, and urban unemployment has tripled to at least 10 percent in the past five years. While the pace of lay-offs might have slowed, the overall labor market situation does not show many encouraging signs. Reforms in the financial sector continue to be slow, partly held hostage to developments in the SOE and social security sectors. Hence, despite growth in 2000 higher than projected, recent data bring China's economic vulnerabilities into sharper focus: rural economy, global slowdown; slower-than expected pace of financial reforms; and likely effects of WTO-accession. Government's response is expected to be comprehensive, as evident from the Premier's speech of March 5 to the opening session of the legislature. However, over the medium term, the scope for action on the macroeconomic front is being reduced by a need for consolidation and emerging wage pressures in the urban economy so as to maintain international competitiveness. Vietnam. Three years after the outbreak of the Asian crisis, the economy has bottomed out. Since late 1999, GDP growth has picked up, helped no doubt by higher export growth, stronger consumer demand and a revival of private investment. GDP growth rose from around 4 percent in 1998 and 1999 to around 5.5 percent in 2000 (official estimates of GDP growth are higher than Bank's estimate, but the trend in both estimates is similar). Expansionary credit policy and an easing of the fiscal stance in 2000, made possible by higher oil revenues, contributed in part, to this recovery. The pick-up in the pace of reforms which prompted a revival in domestic private investment, clearly helped to support the recovery. Implementation of a more liberal Enterprise Law, removal of business licensing restrictions in 145 trades and industries, and the signing of the US bilateral trade agreement improved the climate for domestic investors. Around 14,000 new domestic private firms registered in 2000 (compared to 3000 registrations a year for the last three years) in response to these reforms. Though foreign investment inflows has continued to stagnate since 1998, the revised Foreign Investment Law permitted the approval of several large foreign investment deals in energy that is expected to increase inflows over the next three years. Nevertheless, the current recovery remains fragile. Foreign investment is yet to recover and growth of domestic credit is slowing down to reduce risk of inflationary pressures and weakening asset-quality in state-owned banks. There are also early signs of a slowdown in the growth of non-oil exports, due to a deteriorating external environment. The good news is that the recent pick-up in the pace of reforms is expected to be sustained. With the ratification of the US trade agreement, expected around the middle of this year, higher private investment - both domestic and foreign - is likely this year and beyond. Thus GDP growth is expected to rise to 6-7 percent a year in 2002 and beyond, even if it is unlikely to exceed 5-5.5 percent this year. The Small Economies: Transition economies Cambodia. For the first half of 2000, economic activity was buoyant, especially in the garment sector and tourism. However, in July-November, Cambodia was hit by severe floods, the worst in 70 years. Total damage was estimated at some $180 million, and expected to reduce GDP growth by about 1.5 percentage points. Growth in real GDP in 2000 is now estimated at 4 percent. CPI inflation reached about 8 percent due mainly to pick-up in food prices owing to flood damage. Fiscal policy has been prudent, with improved revenue mobilization (11.6 percent of GDP), and expenditure restraint but only limited progress was made in increasing social sector spending. Monetary developments have reflected the prudential fiscal policy, with broad money growth by 35 percent. External developments have reflected increased garment exports and tourism earnings, higher oil imports, and higher capital inflows. Further progress was made in the major structural reform areas, with the adoption of a new Financial Institutions Law; completion of a civil service census; discharge of 1,500 soldiers under a pilot demobilization program; and completion of a review of forestry concession management. Looking ahead, in order to reduce poverty significantly through broad-based economic growth - in addition to continuing and deepening reform efforts in macroeconomic and fiscal management - the Government now needs to move decisively toward a second generation of reforms, in particular civil service capacity building and strengthening governance. Post conflict: East Timor. The economy collapsed in 1999 in the aftermath of widespread violence and damage to property triggered by the results of the August 1999 independence referendum. In 2000, the recovery has been strong - estimated at over 15 percent growth - reflecting the aid-financed reconstruction effort and revival of commerce and basic services. But there are concerns about the sustainability of growth once the large expatriate community begins to depart and uncertainty grows about prospective aid flows. . Given its large ongoing requirements for technical and financial assistance, transforming East Timor from U.N. administration to a self-governed nation will represent a major development challenge for the East Timorese people and the international community. The present schedule calls for independence by year end, preceded by legislative elections in August 2001. Pacific Islands Fiji. The coup of May 2000 was followed by a period of military rule. An interim civilian government was ruled illegal by the High Court but has said that it would stay on until a political solution is found to bring Fiji back to parliamentary democracy. It has announced that fresh national elections would be held on August 27. The initial economic impact of the coup was smaller than anticipated. GDP is estimated to have declined about 8 percent in 2000 in contrast to an earlier official forecast of 15 percent. The smaller decline can be attributed in large part to the international trade sanctions being much weaker than initially feared. The government had imposed capital controls in the aftermath of the coup which have helped protect reserves to 6 months of imports. The austerity measures introduced by the mini-budget last year have helped stabilize the fiscal situation by restricting the deficit to 2.8 percent of GDP. With private spending not likely to pick up in 2001 the government has planned an expansionary fiscal policy and is targeting a deficit of 4 percent of GDP. A new investment package has been announced in the 2001 budget which significantly improves upon the existing regulations but is unlikely to have an appreciable impact until the considerable political uncertainty is resolved. Laos. During 2000 Laos made significant progress in stabilizing the economy and reducing inflation which peaked in early 1999 at a 12-month rate of 167 percent. The earlier problems had their roots in excessive expenditures aimed at establishing self sufficiency in rice production through massive investment construction and rehabilitation of irrigation systems. Sharply tightened macroeconomic policies were necessary to contain inflation which eventually fell to 10 percent year-on-year by September 2000. The authorities estimate GDP growth of 7.3 percent in 1999 and 6.5 percent in 2000 although actual growth may be about 2 percentage points less. The external deficit is running at about 3.8 percent of GDP and official reserves have risen to about 2.5 months of imports. Given that exports of agricultural products such as coffee make up half of total and roughly 13 percent of GDP, Laos likely will continue to see a decline in export revenue as a share of GDP until price recovery in 2002. The government will shortly finalize its 2001-2005 plan which is expected to emphasize the role of renewed economic growth in reducing poverty. However, to achieve this the government will have to overcome a number of challenges. These include deep restructuring of insolvent state banks; improvements in banking sector governance including phase out of directed lending; and management of decentralization for providing public services that are more responsive to local needs but in a way that ensures adequate fiscal control. Mongolia. Parliamentary elections in June 2000 resulted in an overwhelming victory for the Mongolian People's Revolutionary Party, 72 of 76 parliamentary seats. Despite adverse external conditions the new government is advancing on structural reforms. GDP contracted by 1.1 percent in 2000, after averaging over 3 percent yearly growth during 1996-1999, due to an unusually harsh winter (Dzud) in the early part of the year which claimed over 7 percent of livestock. The national poverty headcount index remained basically unchanged between 1995 and 1998, reflecting lackluster growth and worsening inequality as evidenced by the Gini coefficient which went up from 31 percent to 35 percent over the same period. Growth prospects for 2001 remain modest in the wake of another severe (Dzud) disaster, the worst in fifty years. The current account deficit in 2000 widened to 9 percent of GDP in 2000 from 6.7 percent in 1999 as a result of a sustained deterioration in the terms of trade. Higher costs of oil imports offset all gains from rising copper and favorable gold prices. Further recovery in copper prices combined with lower oil prices should provide some relief in 2001. Fiscal discipline weakened in the run-up to the parliamentary elections in mid-2000, leading to a heavy build up in local government arrears, 2.5 percent of GDP. However, preliminary fiscal data indicate the general government narrowed deficit to 6.5 percent of GDP in 2000. Increases in the VAT from 13 percent to 15 percent in 2001 and other additional revenue measures should offset expected increases in expenditure caused by the Dzud. Solomon Islands. A peace agreement was signed in October 2000 that has succeeded in halting hostilities among the warring groups from the islands of Guadalcanal and Malaita. Progress on arms surrender and returning stolen property has however been slow. The conflict has displaced about 30,000-40,000 people and has left about 80-100 people dead. GDP is estimated to have declined by about 15 percent in 2000. Key economic activities - a gold mine and a palm oil plantation - remain closed, while fishing has been very weak. Of concern is reports that logging activity has picked up again to well above the sustainable rate, some of which is unmonitored. The government faces the difficult task of resettling displaced people, rebuilding damaged infrastructure, and revitalizing the economy. While economic and social recovery, and fulfilling commitments under the peace agreement requires substantial expenditure, government revenues have collapsed. The government has already exceeded the limit set on borrowing from the central bank. Their immediate challenge is to formulate a budget that will help consolidate the peace process and facilitate economic and social rehabilitation. However, progress has been slower than anticipated. Considerable external assistance will be needed in financing and implementing the government's programs over the next 12 months. Papua New Guinea. Previous expectations of robust growth have not yet materialized. The government commenced a wide ranging stabilization and structural adjustment program in the first half of 2000 and has made significant progress in its privatization agenda and in a number of aspects of financial sector reform. But despite a number of positive achievements and the passing of a solid 2001 budget, the continuation of adverse business conditions and poor non-oil commodity prices have delayed the anticipated economic turnaround. Official estimates released in late 2000 estimated growth of 0.8 percent for the year, while recent evidence suggests that growth may in fact have been negative. This reflects sharp declines in coffee and oil production - by about 36 percent and 24 percent respectively - an absence of large new construction projects, and subdued consumer demand. Downward pressure on the kina in the second half of 2000 in part reflected a shortfall in commodity export receipts. More recently, market concerns regarding delays in credit disbursements from multilateral and bilateral sources may have contributed to currency depreciation. Retail interest rates remain near cyclical highs and credit growth has been stagnant. The forecast for 2001 is for GDP growth of 3.1 percent spurred by an expected increase in agricultural exports and initial construction work on the large Ramu Nickel and PNG-Queensland gas projects. The Regional Overview was prepared by Masahiro Kawai, Chief Economist, East Asia and Pacific Region, and Kathie Krumm, Adviser, with the assistance of David Bisbee, Chorching Goh, Elena Ianchovichina, Antonio Ollero, Vera Songwe, Peter Stephens, and Christina Wood. Additional support was provided by Nancy Mensah and Muriel Greaves. |
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