Developing Asia’s growth to moderate amid global uncertainty, says ADB

The Asian Development Bank (ADB) has cut its 2011 and 2012 growth forecasts for developing Asia amid ongoing worries about weak external demand from its key trading partners.
In its Asian Development Outlook Update 2011, released yesterday, ADB trimmed its full year forecast to 7.5% from 7.8% seen in April. The 2012 projection is also lowered slightly to 7.5% from 7.7% previously. Asian Development Outlook and Asian Development Outlook Update are ADB’s flagship economic reports analysing economic conditions and prospects in Asia and the Pacific, and are issued in April and September, respectively.

The slowdown in demand from the United States (US) and Europe continues to cast a cloud over the region, with export growth easing substantially in the second quarter of 2011 in leading economies, including the People’s Republic of China (PRC).
“At the same time, strong domestic consumption and expanding intraregional trade are helping to underpin still solid growth levels,” said Changyong Rhee, ADB’s Chief Economist. “Since the onset of the global recovery, the growth in exports to the PRC from several Asian economies has been stronger than their exports to the rest of the world.”
The share of intraregional exports among the largest economies in the region has increased from 42% in 2007 to 47% in the first half of 2011, the report noted.
Accelerating price pressures remain a threat to many economies, with the inflation rate for developing Asia expected to average 5.8% this year, up from an April projection of 5.3%. The rate should cool in 2012 to 4.6% as commodity prices recede but central banks will still need to keep a close watch and may need to take remedial action.
Capital continues to flow into the region, although the pace has eased in recent months, and remains at manageable levels. However policy makers should be prepared to act in the event of any upsurge in capital volatility once the US and European debt markets settle and advanced economies pick up again.
The report notes that many economies in the region are well placed to cope with soft global economic conditions for a while, provided the major industrial economies do not fall back into recession.
“Ample fiscal space, even after the recent spate of fiscal stimulus measures, and large foreign reserves provide a buffer against further downside risks,” said Rhee.
In the longer term, the region must press forward with structural reforms that encourage domestic-led, inclusive growth, as demand from advanced countries is likely to remain subdued.
East Asia remains the key economic driver for developing Asia with expected growth of 8.1% this year, although more moderate activity in the PRC has seen the forecast trimmed from the April estimate of 8.4%. Next year, a further easing of growth in the PRC will see overall growth for the five economies dip further to 8.0%.
Growth in South Asia is also slowing this year as monetary authorities move to combat still high levels of inflation. GDP is expected to expand 7.2%, with the inflation forecast marked up to 9.1%. Next year growth should pick up to 7.7%, led by India, after higher interest rates crimped consumer spending and investment in 2011. Growth projections for Southeast Asia and Central Asia have also been lowered slightly to 5.4% and 6.1%, respectively, for 2011, although overall economic activity in both regions remains buoyant on the back of solid private consumption, investment, and remittances, and favourable export prices. Oil production problems in Azerbaijan are weighing on Central Asia as a whole, while a pruning of estimates for Malaysia, Philippines, Thailand and Viet Nam has offset expectations for a stronger performance by Indonesia.
In the Pacific, the resource-rich economies of Papua New Guinea, Timor-Leste and the Solomon Islands will underpin expected growth of 6.4% this year, but this will be partly offset by lacklustre performances elsewhere, including the Cook Islands and Vanuatu. Next year the growth rate is likely to ease further to an aggregate 5.5% with inflation expected to average 8.3%.
Here are excerpts from the report and key highlights:
ADO 2011 Update — Highlights
Developing Asia maintained its growth momentum through the first half of 2011, putting it on course to grow by 7.5% over the whole year. Despite sluggish recovery in the major industrial economies, the region can continue to grow at that rate through 2012 on the back of its buoyant domestic demand and intraregional trade.
Still, policy makers need to be alert on two fronts. Inflation pressures built up in the first half, severely affecting some regional economies, and although the slowdown in international commodity price rises is providing some respite, managing inflation remains a priority. Additionally, capital has so far been flowing into the region at a manageable pace, but global economic uncertainty means policy makers should be prepared for greater volatility in capital flows. To compensate for anaemic growth in advanced economies, developing Asia must press forward with its structural reforms to cultivate domestic demand, promote price stability, and foster inclusive growth. The region also needs to start preparing for its demographic transition, given the major implications of its changing age structure for economic growth and for economic security among the elderly.
 

Key messages

• Developing Asia continued its steady growth in the first half of 2011. The sluggish recovery in the major industrial economies will moderate the region’s growth in the second half of the year and beyond.
• Despite this moderation, strong domestic demand and intraregional trade are likely to sustain the region’s growth momentum. Growth is forecast to reach 7.5% in 2011 and 2012, down slightly from April’s Asian Development Outlook 2011 (ADO 2011) projections of 7.8% in 2011 and 7.7% in 2012.
• Many economies in the region are well placed to cope with a soft global economy in the coming months, provided that the major industrial economies do not fall back into recession. Ample fiscal space and low debt — even after the spate of fiscal stimulus related to the recent global crisis — plus large foreign reserves provide a buffer against further downside risks.
• All sub regions posted solid growth in the first half of the year. While continued momentum in the two largest economies — the People’s Republic of China (PRC) and India — is driving the overall trend, the growth momentum is distributed widely across the region. East Asia is forecast to grow the fastest over the full year, followed by South Asia.
• Inflation is a continuing concern. Price pressures intensified in the first half of the year with the rapid growth in the region and the rise in international commodity prices. Inflation is forecast to hit 5.8% in 2011, somewhat higher than the 5.3% expected in ADO 2011, before settling back to 4.6% in 2012.
• Inflation pressures should abate with the slowdown in international commodity price rises and the expected weakness in the major industrial countries. However, unless global economic activity drops off sharply, the threat of inflation will remain. Managing inflation is a key policy task for inclusive growth.
• Large capital flows to developing Asia were expected in light of interest rate differentials and the region’s robust economic activity, and inflows have been manageable so far. With uncertainty in the global environment reducing investors’ risk appetite on the one hand, and the lure of developing Asia’s strong fundamentals on the other, it is difficult to predict how capital flows will react. Either way, regional policy makers need to prepare for more volatile capital flows.
• To compensate for anaemic growth in advanced economies, developing Asia must press forward with its structural reforms to cultivate domestic demand, promote price stability, and foster inclusive growth.
• It must also start now to prepare for the very different demographic landscape of the future. To reap the demographic dividend, countries with a younger age structure should create job opportunities through labour market policies and vocational training. Older countries need to pursue structural reforms, such as worker retraining and flexible working arrangements, to bolster the contribution of elderly workers especially. Enhancing worker mobility through regional cooperation and integration may benefit both sets of countries.
• As traditional family support to the elderly weakens, public old-age transfer systems will become more important. Governments of all countries must prepare to play a larger role in providing economic security for the elderly.

Growth outlook for 2011 and 2012

• Developing Asia is sustaining its growth momentum. The region’s steady growth in the first half of 2011 is likely to moderate in the second half and through into 2012, hampered by sluggish performance in the major industrial economies. Gross domestic product (GDP) growth is projected to reach 7.5% in 2011 — a strong performance, albeit lower than April’s 7.8% forecast — and should continue at that pace in 2012.
• The PRC and India have posted strong growth results so far in 2011, driving the overall regional performance, but the growth momentum is distributed widely across the region.
• The region is diversifying its sources of growth, with private domestic demand firming. During the worst of the crisis in 2009, public spending stepped in to offset the drop in private consumption and investment. Since 2010, there have been signs that more durable sources of growth are coming to the fore. Rising private consumption accounted for most of first-half 2011 GDP growth in Hong Kong, China; Malaysia; the Philippines; and Thailand, as well as a large portion of growth in other economies. Although slower to recover than private consumption, fixed capital investment recovered in 2010, and was a strong contributor to first-half growth in Indonesia, Malaysia, and the Philippines. The strength of private domestic demand bodes well for more durable, market-led growth in the region.
• Intraregional trade is picking up, which may make the region more resilient to external shocks. Underpinned by the PRC’s central role, trade among developing Asian economies is on the rise. Intraregional exports among the largest economies in the region increased from 42% of their total exports in 2007 — before the global recession — to 47% in the first half of 2011. These expanding trade links provide further confidence that the region’s momentum can continue.
• Despite the steady growth so far, policy makers must not become complacent. The region’s healthy underlying macroeconomic fundamentals — including sound fiscal positions, low debt levels, and high foreign reserves — help to protect the region from downside risks. To compensate for anaemic growth in the advanced economies, developing Asia must press forward with its structural reforms to cultivate domestic demand, promote price stability, and foster inclusive growth.

Inflation as a continuing concern

• Inflation accelerated throughout the region in the first half of 2011. Pressures from food and commodity markets and the pickup in the region’s economic activity pushed up consumer prices. Inflation is expected to hit 5.8%, up from a forecast 5.3% in ADO 2011. While cooling somewhat, inflation next year is forecast to stay relatively high, at 4.6%, with large variations across countries.
• Continued growth will keep inflation on the region’s policy agenda. The slowing rise in international commodity prices is providing some respite for policy makers. If commodity prices resume their climb and the current weakness in the global recovery turns out to be temporary, regional central banks will have to speed up the process of monetary tightening, especially where inflation is already high. Current developments of inflation and the output gap in Asia call for continued vigilance.

Managing unpredictable capital flows

• Capital is still flowing in, but more slowly. Inflows picked up sharply after developing Asia’s economy rebounded strongly in the second half of 2009 and stayed solid through 2010. But the rate of inflows has since moderated as fears of slower growth in the advanced economies, concerns over the path of fiscal consolidation in the United States, and anxiety over European sovereign debt problems intensified in the second quarter of 2011.
• The region’s policy makers must prepare for more volatile capital flows. With uncertainty in the global environment reducing investors’ risk appetite on the one hand, and the lure of developing Asia’s strong fundamentals on the other, it is difficult to predict how capital flows will react. Either way, regional policy makers need to prepare for more volatile capital flows. Well-targeted measures to improve financial supervision and regulatory rules would be appropriate. More flexible exchange rate regimes could also help to provide an automatic filter to fend off speculative short-term capital inflows. In addition, imposing selective and carefully designed temporary capital control measures that are conducted in a regionally coordinated manner could be part of the policy mix.

Outlook by sub region

• East Asia will again be the fastest-growing sub region. Aggregate growth in the five economies in 2011 is now forecast at 8.1%, trimmed from April’s 8.4%, mainly owing to a slight reduction in the projection for the PRC (from 9.6% to 9.3%). Growth in the sub region’s largest economy has moderated as a result of monetary tightening to curb inflation coupled with softening external demand, but the economy is still set to expand by a robust 9.1% in 2012. The forecast for the Republic of Korea, the second-biggest economy in East Asia, is clipped, too. Next year, the sub regional pace should manage a robust 8.0% in spite of mild easing in the PRC’s growth. Rising food prices drove inflation in the PRC higher than anticipated earlier in the year, which prompted an upward revision in the East Asian inflation forecast for 2011 to 4.9%. Projected declines in global food and fuel prices coupled with the lagged effects of monetary tightening are expected to bring next year’s inflation down to 3.8%.
• Combating inflation slowed South Asian growth. Despite firm tightening of monetary policies, inflation stayed high in 2011. Escalating food prices were the worry for most countries, risking a spill over into wage-price spirals. In India, 2011’s growth is now put at 7.9%, as higher interest rates crimped consumer spending and trimmed investment. Still, favourable export prices kept growth brisk in Bangladesh and Sri Lanka.
• Pakistan — the weakest GDP performer in 2009 and 2010, and likely this year, too — has yet to break out of its low-growth straitjacket. Dominated by India, the forecast for sub regional inflation is revised up to 9.1%, while that for sub regional growth is revised down to 7.2%. In 2012, growth is seen edging up to 7.7% (though down from the ADO 2011 forecast), again largely influenced by India. Inflation is expected to moderate to 6.9% as global price pressures fall and monetary policy stabilises domestic demand.
• Southeast Asia’s growth is underpinned by generally robust private consumption and investment. Solid domestic demand is supported by rising employment and buoyant global prices for export commodities. The growth forecast for Indonesia, the biggest sub regional economy, is edged up from April. This is offset by a pruning of projections for Malaysia, the Philippines, Thailand, and Viet Nam such that sub regional growth for 2011 of 5.4% is a touch off from the April forecast. Upward pressure on prices has been higher than anticipated (particularly in Viet Nam where inflation hit 23.0% in August) and monetary policies have been tightened. The sub regional inflation forecast is now 5.4%, raised only slightly. Sub regional inflation is expected to subside by about 1 percentage point in 2012.
• Central Asia is profiting from resource and remittance booms. Most countries are performing well due to favourable export prices (oil, gas, metals, and cotton) and strongly revived remittances. Unforeseen technical difficulties in Azerbaijan have hit oil production in 2011, bringing down the sub regional growth forecast to 6.1% in 2011 and 6.6% in 2012 (from 6.7% and 6.9% in ADO 2011). Sub regional price pressures firmed in the first half of 2011, but the strong policy response is likely to keep inflation to an average 8.6% this year and 8.2% next. The resource-poor countries hardest hit by the global recession are still fragile, however, and have yet to complete structural adjustments.
• High growth in resource-rich Pacific economies masks low growth in the rest. As expected, Papua New Guinea and Timor-Leste are benefiting from their resources of oil and natural gas, and Solomon Islands from its logging and gold. The forecast for aggregate growth is raised slightly to 6.4% in 2011, owing to a modest improvement in the outlook for Fiji, which outweighs downgrades in growth forecasts for Cook Islands and Vanuatu. Outside the resource-rich economies, however, growth remains subdued. In 2012, Papua New Guinea’s expansion rate is still projected to moderate, bringing down aggregate Pacific growth to 5.5%. Inflation has taken a steeper trajectory than was foreseen, mainly a result of higher global oil and food prices. The sub regional forecast is raised to 8.3% for 2011, with inflation decelerating in 2012 to 5.9%.