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Asian Development
OUTLOOK 2008 UPDATE Moderate
growth and rising inflation have characterized Developing Asia
in the first 8 months of 2008. High international commodity
prices are likely to stay for the long haul and have exacerbated
homegrown inflation pressures. But containing inflation, in the
face of a serious global downturn, will lead to a slowdown in
regional growth in 2008 and 2009. This short-term sacrifice is
required for longer-term economic, social, and political gain.
Prudent macroeconomic management, with reforms tackling the
fundamental causes of tight commodity balances, is also
essential, if Developing Asia is to ride out the global storm,
weigh anchor, and set course for faster medium-term growth and
modest inflation.
Key messages
Developing Asia’s 9.0% expansion in 2007 was the highest in
almost two decades. However, the many years of robust growth,
supported by accommodative monetary policies, buttressed
excessive aggregate demand that nurtured price pressures.
Turbulence in global markets has fanned the flames of inflation.
Developing Asia’s consumer price inflation is, therefore, seen
rising from 4.3% in 2007 to 7.8% in 2008, before ebbing to 6.0%
in 2009. The confluence of these external and internal factors
is expected to slow growth to 7.5% in 2008 and 7.2% in 2009.
In many countries, demand-pull rather than cost-push factors are
causing high prices. Monetary policy thus has a major role in
containing these price pressures, and regional economies need to
address rising inflation, even at the expense of slower
(short-term) growth. Central banks should impose the requisite
tightening measures, to prevent inflation from becoming
entrenched in their economies.
Risks—such as a prolonged slowdown in major industrial
countries, continued elevated levels of international oil and
food prices, persistence of high inflation, and policy
reticence—are bearing down on the regional outlook, which is
more heavily tilted to the downside than in April.
The myth of uncoupling has been exploded. The worsening outlook
for major industrial economies is buffeting Developing Asia’s
export, equity, and offshore bond markets. The region clearly
remains heavily reliant on industrial countries for its exports
and has not uncoupled from their business cycles. The loss of
investor confidence in industrial countries’ equity markets has
crossed over to Asia. The Risk Premium on dollar-denominated
offshore Bonds of Asian issuers has risen sharply since the
outbreak of the subprime crisis in the United States. If the
global slowdown extends beyond 2009, therefore, the
repercussions for the region could be severe.
The global oil market remains tight. While oil prices are likely
to soften somewhat in the short run, they will stay high and
volatile. Since food prices are heavily influenced by oil
prices, the days of cheap food also seem to be over.
Developing Asia will have to learn to adjust to this high global
commodity price environment and to undertake the necessary
structural reforms. But first, it must re-establish
macroeconomic stability through sound monetary, fiscal, and
exchange rate policies.
Political pressures are building up in some countries, and these
could result in the authorities’ reluctance to pass needed
Reforms, and this risks deepening macroeconomic imbalances.
Prolonged periods of political instability could inhibit
investment and affect growth prospects in the medium term.
Outlook for 2008 and 2009
• Events in the first 8 months of 2008 suggest some major
changes in the external environment affecting the assumptions
made in April when Asian Development Outlook 2008 was released.
The slowdown in the G3 (United States, Eurozone, and Japan) is
now seen continuing until the end of 2009. As a result, growth
in the volume of world trade will slow. Both food and fuel
prices, which have surged this year, are forecast to come down
but will remain higher than in 2007 for the rest of this year
and next. With the continuing turmoil in financial markets, the
cost of new capital will become higher, and access harder, for
Developing Asia.
• In addition to the regional slowdown in growth and jumps in
inflation, current account surpluses are diminishing and
deficits are widening. Currencies are depreciating, putting
upward pressure on inflation. Another danger is that although
central banks have begun to tighten monetary policy, some may
have let the inflation genie out of the bottle by doing too
little, too late, since interest rates in most countries are
still lower than inflation.
• Containing inflation will take time as monetary policy works
with a lag. In 2009, when inflation is reined in, regional
growth will slow—also hit by the slowdown in export growth to
the G3.
• East Asia is expected to decelerate to 8.0% growth in 2008 and
to 7.7% in 2009, from 9.6% in 2007. Growth rates in all East
Asian economies are forecast to ease. Aggregate inflation in the
sub region is expected to rise from 3.9% in 2007 to 6.1% in
2008, before declining to 4.8% in 2009. But overall, a soft
landing is projected for East Asia.
• Weakening external demand and the impact of policy tightening
has trimmed GDP growth in the People’s Republic of China to a
still-rapid 10.4% in H1 of 2008. Private consumption remained
robust, because income growth outpaced inflation. The 10.0%
growth forecast for 2008 is maintained and that for 2009 is
brought down slightly to 9.5% on the expectation of a reduced
trade surplus and slower investment growth. After rising to 7.0%
in 2008, inflation is forecast to decelerate to 5.5% in 2009.
Southeast Asian growth is projected to slow from 6.5% in 2007 to
5.4% in 2008 and to stay around that rate next year. Rising
inflation is generally damping growth in consumption. Primary
commodity exporters in the sub region benefited from higher
commodity prices in H1 of 2008. For example, Malaysia’s exports
gained from rising prices of palm oil and crude oil. Southeast
Asia’s inflation is forecast to more than double from 4.0% in
2007 to 9.4% in 2008, before pulling back to 6.9% in 2009.
Double-digit inflation is projected this year for Cambodia,
Indonesia, Lao People’s Democratic Republic, Philippines, and
Viet Nam. Curbing inflation is the crucial macroeconomic
challenge in most Southeast Asian countries.
In Viet Nam, macroeconomic turbulence intensified in the first
several months of 2008. Inflation accelerated sharply and the
trade deficit widened. In response, the government changed its
priority from spurring growth to curbing inflation and reducing
the trade deficit. Growth is forecast to decelerate from 8.5% in
2007 to 6.5% in 2008 and to 6.0% in 2009. The corresponding
inflation rates are 8.3% in 2007, climbing to 25.0% this year
and still high at 17.5% in 2009. Risks to these projections are
tilted to the downside.
South Asia’s growth will decelerate from 8.6% in 2007 to 7.1% in
2008 and to 6.7% in 2009. Inflation is forecast to more than
double from 5.5% to 11.8%, and then recede to 9.2% in this
3-year period. Current account deficits are forecast to widen
significantly. Overheating from excessive aggregate demand,
aggravated by imported cost-push factors, has made inflation the
critical macroeconomic concern. South Asia needs to strengthen
its macro management as well, to rein in fiscal deficits and so
avoid a hard landing.
In India, growth in the April–June quarter of the current fiscal
year (ending March 2009) slowed to 7.9% from the 9.2% seen in Q1
of FY2007, for the slowest rate of growth since 2004. Inflation
in Q1 of FY2008 was 9.5%, compared with 5.3% in the same quarter
a year earlier. India’s monetary policy has been tightened
significantly. The inflation forecast for this and the next
fiscal year are 11.5% and 7.5%, respectively. Growth is forecast
to edge down from 7.4% in FY2008 to 7.0% in FY2009, as inflation
is ironed out. A pause in growth, accompanied by prudent
macroeconomic management and reforms to improve efficiency and
productivity, would set the stage for the pursuit of a higher
growth trajectory over the medium term.
• A slowdown is under way in Central Asia. From a strong rate of
11.6% in 2007, growth is forecast to be clipped to 7.6% in 2008,
before rising gently to 8.0% in 2009. Inflation is forecast to
rise from 11.3% in 2007 to 15.4% this year, before coming back
to 11.4% next year. Rising oil prices have boosted the current
account balances of hydrocarbon exporters such as Azerbaijan,
Kazakhstan, Turkmenistan, and Uzbekistan. As countries in the
Middle East have done, these countries should use their earnings
bonanza to diversify the structure of their economies.
Hydrocarbon importers such as the Kyrgyz Republic and Tajikistan
have suffered from high oil prices, but have been helped by
remittance inflows. Increasing food prices, however, are having
adverse consequences throughout the sub region.
Aggregate growth in the Pacific sub region is forecast to double
to 4.8% in 2008 from 2.4% in 2007, mainly because of a stronger
expansion in resource-rich Papua New Guinea, the biggest
economy. However, about half the 14 economies are expected to
grow at a slower pace or contract in 2008. Next year, aggregate
growth is projected to ease to 3.4%. Higher global oil and food
prices have contributed to sharply higher inflation, which is
now projected at 8.7% this year (from 3.3% in 2007) and 6.4%
next year. The higher cost of living is seriously hurting
vulnerable groups, such as those without fertile land or living
in remote areas. Greater efforts are required to reduce the oil
intensity of these economies and to turn back the clock and
produce more food domestically.
In the whole of Developing Asia, accelerating inflation,
moderating growth, and depreciating currencies call for a sober
assessment of macroeconomic priorities for the short and medium
term, and the design of a major reform agenda for the medium and
long term.
The immediate challenge is to rein in inflation pressures.
Inflation in the region is largely homegrown and is explained by
excessive aggregate demand fueled by years of accommodative
monetary policy. For many countries, although international
price shocks have added fuel to the fire, it was excessive
aggregate demand growth that kindled the flames.
Monetary authorities face a very difficult and complex
environment. The external price shocks that first made
themselves felt in 2003, have not been fully passed on to
domestic consumers and producers in many countries. But there is
no alternative to culling subsidies, in order to prevent major
fiscal imbalances. Even if international commodity prices ease
in the near term, the pass-through of higher prices will add to
inflation pressures. Therefore, the general bias across the
region toward monetary policy tightening is highly desirable.
To restore economies to a higher growth path over the medium to
long term, significant efficiency and productivity improvements
are required to meet the challenge of the finiteness of
resources, particularly land (and thus food) and fuel. The
effective implementation of a Reform agenda—one that focuses on
consumers responding to market-oriented price signals and on
producers improving efficiency and productivity—is imperative
for countries to strengthen competitiveness, foster growth, and
generate productive and decent job opportunities.
The downside risks to Developing Asia’s growth prospects are now
more apparent than in April. Global conditions are more
volatile—the financial crisis has not yet fully run its course.
High commodity prices and their increased volatility are likely
to stay and geopolitical concerns are always in the background.
Moderating growth and rising inflation in Developing Asian
countries require painful tradeoffs. Political realities in some
countries make the decision process difficult. As a result,
implementation of much-needed corrective policy measures may be
delayed to the detriment of both the short-and medium-term
outlooks.
Responding to commodity price shocks
• Elevated commodity prices and their pronounced volatility in
international markets have been features of the first 8 months
of 2008. Food and oil prices are closely interlinked. If high
oil prices are here to stay, so are high food prices. This has
important implications for Developing Asia.
Oil: Prolonged period of high and volatile prices
While oil prices have come down from their peaks of US$ 147 per
barrel in July 2008, they will stay high in the long run.
Inflation-adjusted oil prices will remain well above US$ 100 per
barrel, until about 2020, according to research commissioned by
the Asian Development Bank.
The price run-up in oil has been driven mostly by the
fundamentals of demand and supply. Surging global demand and the
inability of global supply to keep pace have relentlessly
generated upward price pressures.
Limited surplus capacity has led to greater price volatility,
amplifying the effects of even the smallest demand or supply
shocks. Financial speculation may have compounded price spikes.
In the future, global oil prices will continue to be determined
by fundamentals. Global demand growth will be increasingly
driven by demand from Developing Asia and the Middle East. The
growing appetite for transportation fuel will be of particular
importance. On the supply side, the near-term peaking of output
from oil producers who are not members of the Organization of
the Petroleum Exporting Countries (OPEC), and constraints on the
expansion of OPEC’s output capacity in the medium term, will put
severe strains on meeting incremental global oil demand.
The tightening of the supply-demand balance will push up prices
on a sustained basis, underpinning oil prices at above US$ 100 a
barrel. Failure by Developing Asia to make painful, but
necessary adjustments, today, will lead to much larger costs
tomorrow.
Oil price trajectory will have a macroeconomic impact
The surge in oil prices has hardly touched the macroeconomic
performance of Developing Asia so far. However, the predicted
long period of high and volatile oil prices is bound to affect
prospects.
Deterioration of terms of trade due to higher oil import costs
will take a bite out of regional growth. Steeper transportation
costs—from elevated fuel costs—will push up regional inflation.
Higher shipping costs, too, may hurt export performance.
Simulations point to the oil price shock crimping growth
throughout the region in both the short and long run. However,
this pullback will be limited, and insufficient to derail
Developing Asia’s long-run growth momentum.
These simulations also indicate that higher oil prices have a
much bigger impact on Developing Asia’s inflation than on its
growth, both short and long run. Therefore, taming inflation is
the region’s biggest macroeconomic challenge.
The limited effect of the oil shock on growth suggests that the
main cost of anti-inflation monetary tightening—slower
growth—should be bearable.
Food prices to stay high
The price of rice—the basic food staple for billions of
Asians—has fallen from peak levels reached earlier this year,
yet remains more than twice as high as it was at the start of
2008. The surge in prices of rice and other staple foods
reverses a decades-long decline in real prices.
The causes of this run-up are complex, but have four fundamental
drivers. First, rapid economic growth in emerging economies,
particularly, the People’s Republic of China and India, has put
upward pressure on prices of a range of commodities, including
food. Demand has simply outpaced supply. Second, a sustained
decline in the dollar since 2004 has added to upward price
pressure on dollar-denominated commodities—particularly on crude
oil—and this has fueled a search for hedges against a weak
dollar. Third, the combination of high oil prices and
legislative mandates to raise production of bio-fuel substitutes
for gasoline and diesel fuel has established a price link
between feedstocks, such as corn and vegetable oils, and fuel
prices. Fourth, to some degree at least, financial speculation,
arising from low interest rates, has motivated commodity price
changes.
The price increases of last year have some commodity-specific
causes. Weather and disease problems reduced wheat supplies in
2007, in the face of mounting demand. Sharp incremental demand
for corn as an ethanol feedstock, helped explain the corn price
rise, and the related shifts of cropland out of soybeans into
corn, partly explained the rise in prices of edible oils.
Asian Development Outlook and Asaian Development Outlook Update
are ADB’s primary economic reports analyzing the economic
conditions and prospects in Asia and the Pacific and are issued
in April and September, respectively. ****
The Economy of the Conflict Region:
From economic embargo to economic repression
BOOK REVIEW
by Muttukrishna Sarvananthan
The author attempts to study the nature and the
extent of the economy of the two provinces North & East ravaged
by a twenty five year old conflict. He has also undertaken the
near impossible task of explaining the causes and effects of the
social decline in the conflict region during the past quarter
century.
I was baffled by his desire to make a qualitative and
quantitative analysis of chaos, conflict and turmoil. In fact I
read the book twice purely to fully comprehend not the contents
of the book but to understand the purpose and the intent of this
remarkable piece of economic analysis.
Then I arrived at the unmistakable conclusion that Muttukrishna
Sarvanathan is a very courageous man. He has true courage to do,
without witnesses, every thing one is capable of doing before
all the world. He has done what he is eminently capable of doing
and produced a virtual road map for the restoration of the
Northern and Eastern provinces by drawing attention to what
needs are to prioritised.
He writes, “in terms of available infrastructure, the North and
the East have the lowest number of households with ELECTRICITY,
lowest ROAD density, and lowest TELEDENSITY (fixed line) in
comparison to other provinces”.
Reading this remarkable compendium of ratable statistical data,
I learnt that, “In 1980, the North & East produced 25 million
litres of milk, which increased to 31 million liters in 1990,
38-39 million liters yearly between 2000-2003 and then increased
to 40-41 million liters during 2004 and 2005”. There are some
more startling statistics that I cannot include in this brief
review.
Muttukrishna Sarvananthan offers no solution for resolving the
conflict. He simply contemplates the future.
He is equally concerned with the Tamils as well as the Moslems
who have been uprooted from their traditional habitat and are
now in either IDP camps or in temporary shelters. These people
once contributed to a vibrant economy and can do so again under
conditions conducive to resume their inherent entrepreneurial
skills and habits of thrift and hard work.
I have just picked some observations made in this book which is
in fact a narrative of a conflict between a myopic government
and a terrorist movement who had one thing in common. They were
not overly concerned with an unfortunate people who were firmly
held on the anvil of the de jure government, yet exposed to the
relentless hammer of the LTTE. While the anvil obliged by
remaining still the diabolical wielder of the hammer, had the
flexibility of deciding the direction from which it was flung
with added advantage of deciding whether the blow should be
fatal, near fatal or just intended to intimidate, a people were
held captive by fear and uncertainty.
It is this inhuman process that the author describes in the
subtitle; “From economic embargo to economic repression.” When
the government imposed the economic embargo on nearly a million
people who were living in the LTTE controlled north, the author
states that it broke the economic backbone and the social
stamina of the population. It also allowed the LTTE to take
control of the administrative, economic and social affairs of
Jaffna and the Vanni which ultimately resulted in a pseudo
administrative structure which gradually started dealing with
law and order, economy and health institutions under its
control. It was quick to seize the initiative in converting the
altered circumstances to its economic advantage. Smuggling of
contraband goods from India and many other activities were
undertaken by the LTTE in the backdrop of the embargo. The
author describes these developments with a detachment that makes
the narrative leave an indelible imprint if you happen to be
concerned with the subject as I was. Then at another point, the
entrepreneurial skills of the LTTE are again described in
greater detail. It is during the CFA. The opening of the A9 road
and the free access given to the LTTE cadres to do political
work resulted in the LTTE resorting to open extortion under the
guise of Tax collection.
If you are interested in learning of the tormented history of a
people whose only crime was that they called either the North or
the East of Sri Lanka their home, written in lucid prose with
irrefutable evidence painstakingly collated by a researcher who
has no theories to propound, “THE ECONOMY OF THE CONFLICT
REGION” is a must read. I find confronting reality an enriching
experience. It is highly recommended for those who are concerned
about the future of our nation, and its territorial integrity.
It is also an effective antidote to the devolution skeptics.
Reviewed by Sarath
De Alwis **** |
