3 Apr, 2001

The Future of Asian Economies

Imtiaz Muqbil

Just prior to the annual travel mart and conference of the Pacific Asia Travel Association (PATA) respectively in Singapore and Kuala Lumpur, the UN Economic and Social Commission for Asia and the Pacific (ESCAP) released its annual State of the Region report. It outlines a volatile economic scenario. Currency values, oil prices, public spending, trade and payments deficits and such ‘outside’ factors are affecting both the way people travel as well as investments in the industry. An executive summary is printed below.

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An executive summary of the UN ESCAP report “Asia: Economic Performance, Prospects and Policy Challenges

OVERALL ECONOMIC PERFORMANCE OF THE REGION

Following the impressive recovery in 1999, the economic performance of the ESCAP region strengthened further in 2000. The average growth rate of the developing economies of the region increased by one percentage point while the developed economies improved their collective growth rate by 1.3 percentage points. As in 1999, both developing and developed economies achieved higher GDP growth in a lower inflationary environment despite rising energy prices and weaker exchange rates in a number of countries. All the main geographical sub-regions contributed to the higher (GDP growth and enjoyed lower inflation with the exception of the Pacific island economies. Here collective GDP growth became negative in 2000 while in East and North-East Asia deflation in 1999 was followed by modest inflation in 2000.

Of the 25 developing economies in the region, 17 improved their GDP growth rates in 2000 compared to 1999 while one matched its 1999 performance in 2000. Economies enjoying higher growth were spread across the entire ESCAP region. However, the most impressive sub-region in growth performance was South-East Asia. It not only improved its 1999 GDP growth by over 2 percentage points but exceeded significantly the growth forecast made 12 months earlier.

The developed economies, too, led by Japan, substantially improved upon, or maintained, their 1999 performance. With respect to inflation, 14 developing economies enjoyed lower inflation in 2000 compared to 1999 while China saw a marginally positive inflation in 1999 after experiencing deflation in 2000. Hong Kong, China continued to experience deflation in 2000 as in 1999.

A favourable external environment, reflected in the buoyancy of world trade, combined with domestic measures to improve and sustain the momentum of growth in the region. These two factors, in turn, enhanced corporate and consumer confidence thus providing a more durable underpinning to the growth process.

On the external side, world trade surged by over 10% in volume terms during 2000. The strong growth of world trade embodied a robust export performance by the ESCAP region where the dynamism of intra-regional and intra-industry trade revived almost to pre-crisis levels. Several economies in the region registered export growth of 20% or more in value terms. The strong export growth was led by electronics, and electronic components, of which the ESCAP region is a major supplier. Foreign capital flows to developing countries as a group fell absolutely and as a share of total capital flows but flows to the ESCAP region rose marginally. More significantly, their share of flows to the developing economies nearly doubled, from 23% in 1998 to 40% in 2000. Such flows aided the process of financial and corporate sector restructuring.

On the domestic side, declining interest rates and continuing fiscal stimulus supported output growth while exchange rate weakness and improved capacity utilization enhanced competitiveness and stimulated export growth. Furthermore, there was evidence that private domestic demand was beginning to play a bigger role in the growth process than in 1999.

PROSPECTS

Notwithstanding the various positive features in the economic performance of the region in 2000 listed above near term prospects are mixed. On the external side, growth in the developed countries is likely to slow during 2001, a particular imponderable being the slowdown of the United States economy, which is the biggest single market for several economies in the region, and the strength of recovery of the Japanese economy. A sharp slowdown in the United States and any loss of momentum in Japan would inevitably have adverse effects on growth in the region, directly through lower demand for exports and indirectly through an easing of both overall commodity prices and of manufactures, such as electronics. However, continuing growth in the region itself and in EU could off-set the adverse effects to some extent. The effects of these developments would vary between individual economies depending upon the pattern of trade and output-mix of the countries concerned.

Oil prices are another source of risk and uncertainty. while some easing of oil prices has occurred in recent months they appear nonetheless to have stabilised at a relatively high level, more than twice their average level in 1998. Any pick-up in the global economy, say, in the second half of 2001, would, almost certainly, generate renewed upward pressure with adverse consequences for inflation and consumer demand in the oil importing countries. Moreover, the relative volatility of oil prices in 2000 and in the early part of 2001 creates uncertainty for business investment and household spending.

On the domestic side, three years of budget deficits have raised the level of public debt. Likewise, higher recovery-induced imports have narrowed the current account surpluses of several economies. This has resulted in weaker exchange rates and some increase in investor nervousness, the latter reflected in declining stock market indices in most countries of the region. On the other hand, external debt, especially short-term debt, has declined while external reserve positions have improved or stabilized in virtually all the economies of the region. These developments, combined with improving corporate balance sheets, suggest that vulnerability to a slowdown is much less than in 1997.

Taking all these factors into account, the prognosis is a moderate deceleration in the rate of GDP growth in the developing economies of the ESCAP region, of around one percentage point in 2001 compared to 2000. Two sub-regions, South-East Asia and East and North-East Asia, are likely to account for much of the slowdown. The developed economies of the region, South and South-West Asia and the Pacific island economies, on the other hand, are likely to maintain, or increase slightly, their growth rates in 2001.

Within the developed economies, the performance of the Japanese economy will have a considerable bearing on the overall outcome. In South and South-West Asia, external factors are comparatively less important; hence, the growth momentum of 2000 is likely to be maintained, or improved in 2001 provided implementation of the domestic reform agenda is sustained. In the Pacific island economies it is expected that the contractions in output that political problems caused in 2000 would be reversed.

The growth slowdown is forecast to be accompanied by a pickup in inflation of one percentage point in 2001. This phenomenon also is likely to be particularly evident in South-East Asia. East and North-East Asia should experience a modest increase in price pressures. The ‘flow through’ effect of firm oil prices superimposed upon weak exchange are likely to be the principal causes of a pickup in inflation. Amongst the developed countries in the region inflation is expected to remain stable. Japan is not expected to overcome price deflation during 2001.

POLICY CHALLENGES

The principal policy challenge confronting the region as a whole is to maintain the momentum of growth in 2001 and beyond in the face of potential unfavourable developments in the external environment. Slower GDP growth would add to the public debt, and possibly constrain vital social expenditures. Maintaining the momentum of growth within a framework of macroeconomic prudence requires action in a number of areas at the national or sub-regional levels.

At the national level, all governments need to maintain a strong commitment to macroeconomic balance. In view of the rising levels of public debt countries need to take a fresh look at streamlining and rationalizing public spending in order to avoid the debt trap in which debt servicing obligations rise faster than revenues. This has to be complemented by improved revenue collection. Measures to enhance domestic savings should continue to be emphasized alongside efforts to deepen and widen financial markets.

Some of the economies of the region have become very dependent on electronics as a source of export earnings. While a dynamic new source of export growth there appears to be evidence of over-capacity in this line of manufacturing making the relevant corporate entities and economies more vulnerable to an external slowdown. Governments need to help domestic businesses to prepare for a possible worsening in the external environment over the next few months through improved information on alternative markets and with advice on how to diversify their activities in the coming months.

Weaker exchange rates have stimulated exports but should they persist they will increase the risk of inflation. In addition, stable exchange rates are important as anchors for investment decisions, particularly by foreign investors. A moderate degree of instability in the exchange rate is unlikely to do significant harm in the short term; over the medium to long term it could reduce the flow of foreign investment and thus reduce access to vitally important foreign technology and markets. Some countries have adopted inflation targeting, and others are considering doing so, as an alternative to fixed exchange rates. However, countries need to carefully examine the efficacy of inflation targeting as an alternative to stable exchange rates.

At the sub-regional level, governments need to consult more frequently on a wider range of policy questions than before. One area in this respect could be progress in the implementation of agreements concerning regional trading arrangements and the maintenance of market access if international trade growth slows down. Another area is the need to avoid national actions in trade and financial matters that could have destabilizing impact on others.

A number of governments in the region are looking at bilateral deals to maintain the momentum of trade liberalization, in view of the fact that progress on global and regional trade liberalization appears not to have been satisfactory. In this connection, it is important to ensure that an increase in the number of bilateral trade pacts does not undermine regional trading arrangements or reduce pressure for a new round of negotiations at WTO itself.

An issue of particular concern is the problem of weak stock markets in the region and their growing correlation with developments in the stock markets of the developed countries, particularly the United States. Weak stock markets lower business and household confidence, induce stronger risk aversion on the part of investors, and make it harder to raise capital regardless of the prospects of particular companies or business sectors.

It would be very difficult to insulate regional stock markets completely from developments elsewhere. However, it would be useful to explore/find alternative routes for capital-raising by domestic businesses and thus maintain investment levels in the economies of the region. State-funded or state-guaranteed equity participation funds could be one short-term solution. Their viability needs to be critically examined. Another solution could lie in the investment of pension or provident funds in equities within prudent limits.

A connected problem in this regard is the perceived slow pace of progress in many countries in financial sector and corporate sector restructuring. This, too, is undermining the stock markets in the region. while much has been achieved in this area over the last three years, the sheer scale of the remaining problems, for instance, resolving the NPLs (non-performing loans) in the banking systems of several countries, suggests that a great deal remains to be done. Any perception of reform fatigue needs to be countered. It is therefore important to accelerate the pace of financial and corporate sector restructuring with time bound targets in the months ahead and to strengthen the relevant institutions and procedures, such as debt recovery agencies and bankruptcy courts.

Governments should insist on greater transparency in the corporate sector to facilitate greater participation by both domestic and foreign investors and to continue to improve standards of supervision and regulation in the financial and corporate sectors. However, governments themselves should also seek to meet the highest standards of governance.

Over the last few years the rise of the new economy and development of ICT-related activities has put a large premium on technological upgrading in both industry and services. As a consequence, many old economy skills are becoming obsolete. The enhancement of human resource skills to facilitate the introduction of ICT in order to remain competitive in world trade and to attract foreign capital has become an urgent necessity in the region. Governments need to make greater investment in education and training, particularly in those countries having to make a transition from labour-intensive, relatively low value-added activities to higher technology, relatively high value-added activities.

International financial system reform continues to be of critical importance for the region with its need for substantial access to global capital flows on a stable basis. The absence of concrete progress in this regard, has encouraged some countries in the region to strike out on their own. The Chiang Mai initiative by ASEAN is a case in point. While such initiatives have their merit, care must be taken to ensure that they do not lead to a weakening of the resolve of all countries to participate actively and meaningfully in multilateral initiatives in this area.

SOCIO-ECONOMIC IMPLICATIONS OF DEMOGRAPHIC DYNAMICS

The above highlights some of the policy challenges posed by recent developments, However, the governments cannot be oblivious of the need to deal with longer-term development issues. From this perspective, socio-economic implications of demographic dynamics deserve attention.

In 2000, 3.7 billion people lived in the ESCAP region, constituting more than three fifths (61.8%) of world population. Because of this large base, the population is expected to increase further by one billion by 2025, despite the fact that annual population growth will slow down considerably from 1.4% during 1990-2000 to 0.7% during 2020-2025. Regarding age composition, the share of younger population will fall from 29.1% in 2000 to 21.6% in 2025, the share of working age population will increase from 61.6% to 62.9% and the share of old age population will rise from 9.3% to 15.5% in the region.

There is considerable diversity in the demographic dynamics of the region. Two of the world’s most populous countries, China and India, are in this region, as are some with tiny size, mostly in the Pacific. The average population growth rate during the past decade ranged from over 4.0% to negative numbers. There are also wide differences in age structures and patterns of mobility.

The Economic and Social Survey of Asia and the Pacific 2001 examines the implications of demographic dynamics in terms of poverty, environment, labour force and employment, education, health and domestic savings. The analysis brings out some potential adverse consequences of the prevailing demographic dynamics in the region.

FINANCING FOR DEVELOPMENT

The subject of financing for development has engaged the attention of policy makers and development economists over the past several decades. However, it has acquired new importance of late necessitating a fresh look at the subject. Many developing countries are finding it increasingly difficult to raise sufficient domestic resources to finance investment and are dependent on foreign capital as a result. Against this, ODA flows have declined while private capital flows, although much increased, contain an easily reversible, and volatile, short-term component. More strikingly, the bulk of private flows have tended to be concentrated within a few countries.

Part II of the Survey 2001 discusses the subject of Financing for Development from the perspective of the ESCAP region. It examines the trends and pattern of i) Domestic resource mobilization; ii) External private resources; iii) Official flows and iv) International systemic issues; and offers suggestions for actions at both national and international levels. The following paragraphs highlight the main findings and recommendations.

Domestic Resource Mobilization

The largest share of financing for development originates domestically. Data for the ESCAP region show that the overall ratio of savings to GDP has risen from 21% in 1985 to 29% in 1999. However, much of the rise is accounted for by the high growth economics of East and South-East Asia. Elsewhere the picture is less encouraging. Furthermore, the contribution of government savings has been small or even negative. Most of the rise in savings has come from households. Savings and investment rates tend to be closely correlated but this is not so everywhere in the region. A significant number of countries have higher investment than savings rates. These countries require access to foreign capital for financing investment.

The determinants of household savings are complex. The level and growth of per capita income is an important determinant of savings. In addition, a diversified array of savings outlets and instruments provided by well-regulated and sound financial institutions encourages savings in a financial form. The banking system is the main vehicle for savings in most countries of the region and the main source of investment finance.

External Private Resources

There are basically two types of external resources: FDI and various forms of loans and securities (international bank loans, both short and long-term, international equity and bond issues and foreign participation in local capital markets). Besides adding to domestic financial resources, external resources have significant indirect positive spill-overs in the form of technology transfer, transfer of management and marketing know-how and strengthening of domestic financial markets.

The share of ESCAP developing countries in FDI rose from 48% of the total for all developing countries in the 1980s to peak at over 65% in 1995. It has fallen back to under 47% in 1999. In 1999, of FDI flows of $96 billion to the ESCAP developing countries, only nine developing economies of the region accounted for nearly 99%.

As with FDI, access to other forms of foreign private capital is concentrated in a handful of countries in the region. Yet such capital flows have become the principal sources of external finance in the ESCAP region. In 1999 bonds exceeded FDI flows by a factor of two, and bank loans outstanding exceeded FDI by a factor of more than five.

New modalities in external private capital, in infrastructure financing through structured finance, access to venture capital funds for SMEs and the use of derivatives for minimizing risk provide opportunities for developing countries to diversify their sources of financing and to reduce risk.

Official Flows

ODA has fallen both absolutely and relatively to private capital flows. However, for the vast majority of developing countries that do not (yet) have access to private capital, this is the only source of needed foreign capital. Other than moral imperatives, the justification of ODA lies in the provision of a global public goods and mutuality of economic interests.

ESCAP developing countries as a whole are not significant recipients of ODA but the least developed countries, the Pacific Island economies and the economies in transition are very dependent on this form of capital. Rather disturbingly, ODA has declined for these countries. “Aid fatigue” and a perception that recipient countries do not make effective use of ODA are considered to be factors in the decline.

International Systemic Issues

In view of several bouts of instability in the international financial system over the last two decades, its reform is integral to having a stable flow of international resources for development. The principal objectives of reform are to prevent periodic crises, contain contagion, provide liquidity to pre-empt crises, have an agreed framework for financial sector reform and establish principles for debt workouts. These objectives can be achieved through the provision of “public goods” at the international level to establish guidelines, benchmarks and rules for private capital flows and to overcome asymmetric information which adversely affects decision-making by investors.