31074

Public Disclosure Authorized

East Asia Update

November 2004
November 2004
Public Disclosure Authorized
Public Disclosure Authorized

Steering a Steady Course

Special Focus:
Public Disclosure Authorized

Strengthening the Investment Climate in East Asia

East Asia and Pacific Region

The World Bank
 CONTENTS

East Asia and Pacific regional overview ................................................ 1

1. Introduction......................................................................................................... 1
2. East Asia – at the peak of the cycle?................................................................. 6
Growth – securing the path to sustained expansion ........................................ 6
Poverty – down by 250 million in five years................................................... 8
3. The international and regional environment ............................................... 11
Developed country growth – the pause that refreshes?................................. 12
China – what kind of landing?. ...................................................................... 13
Commodity cycles and the oil price shock .................................................... 16
Box 1. Managing commodity windfall gains ........................................ 21
Trade policy developments .......................................................................... 22
Box 2. The end of quotas on garment and textiles trade....................... 23
Capital markets and global imbalances ........................................................ 23

4. Domestic trends and policy challenges........................................................... 27

Fiscal policy….................................... ........................................................... 28
Corporate sector - trends and reforms........................................................... 29
Financial sector............................................................................................... 30

Country Sections ............................................... …………………………33

Appendix Tables…………………………………...…..…… .... …………46
Special Focus: Strengthening the investment climate in East Asia ................. 54
Key Indicators Tables ............................................................................................. 63

This Regional Update was prepared by Milan Brahmbhatt, Lead Economist, East Asia PREM, with the assistance of Antonio Ollero,
and Nancy Mensah, drawing on inputs and comments from country economists and sector specialists throughout the East Asia and
Pacific Region of the World Bank. The report was prepared under the general guidance of Homi Kharas, Chief Economist, and
Jemal-ud-din Kassum, Regional Vice President, East Asia and Pacific Region.
 EAST ASIA AND PACIFIC REGIONAL OVERVIEW
Introduction
2004 has turned out to be a remarkable year for
East Asia on several dimensions.1 Economic growth is
expected to top 7 percent for the region overall, while
among its developing economies it should reach near 8
percent, the strongest since the regional financial crisis,
and more than one percentage point higher than we had
expected at this time a year ago. Exports have been
buoyant since late 2002, supported by unexpectedly
strong recovery in the developed world, cyclical rebound
in the global high tech industry and a surge in intra-
regional trade, led by booming exports from the rest of
East Asia to China. Uncertainties about the future of the
multilateral trading system - from which East Asia has
profited perhaps more than any other developing region –
appeared to diminish as WTO members agreed a
negotiating framework for the Doha Round. Importantly,
the driving forces of the recovery have also been
evolving, as late 2003 and early 2004 saw the first robust
and really widespread rebound in East Asian fixed
investment spending since the crisis, underpinned by
continued gradual improvements in the profitability and
balance sheets of corporations and financial institutions.
At some point this year or next, we estimate that
the number of people living on less than $2 a day in East
Asia will fall below one third of the population. As
recently as 1999 that proportion was 50 percent. That is,
around 300 million people will have escaped from
poverty in the years of recovery since the financial crisis.
Perhaps most strikingly, this is a time not only of
economic and social progress in East Asia, but also of
remarkable political advances. This year saw a sweep of
legislative and presidential elections right across the
region, including in Cambodia, Indonesia, Malaysia,
Korea, Philippines and Taiwan (China). Most recently
some 155 million voters – more than 80 percent of the
electorate – participated in Indonesia’s first ever direct
presidential elections, resulting in the peaceful transition
of authority from sitting president Megawati Sukarnoputri
to the winner, president-elect Susilo Bambang
Yudhoyono.
The Indonesian elections cap what has been in
essence a genuine political revolution over the last five
years, albeit – thankfully – a largely peaceful one,
bringing about a transition from a highly centralized
political system with autocratic powers concentrated in
the hands of the president, to a representative and
substantially decentralized one. Political accountability –
1 Nevertheless, the apparently remorseless rise in oil prices
East Asia comprises Developing East Asia (China,
Indonesia, Malaysia, Philippines, Thailand, Vietnam and
some smaller economies) and four Newly Industrialized
Economies or NIEs (Hong Kong, Korea, Singapore and
Taiwan, China).
the accountability of politicians to citizens - has been
tremendously strengthened through genuinely competitive
elections for the presidency, the legislature and regional
governments, contested by political parties that seem – by
East Asian standards - relatively cohesive and based on
differentiated political programs and ideas. A free press
and a vigorous civil society have emerged, providing
greater scrutiny and transparency over government
actions. At the global level Indonesia emerges as the
world’s third largest democracy and – not less important –
its largest Muslim majority democracy.
Yet, amid these triumphs, recent data also
suggest that the cyclical recovery in East Asia has peaked
and that activity is shifting or has already shifted into
lower gear, while a number of cross-currents and risks
noted in earlier editions of the World Bank’s East Asia
Update have intensified, some without and some within
the region. In a word, the environment facing East Asia is
more uncertain.
Some of these risks are discussed in more detail
later in the report. Perhaps the one of most concern is the
steep spike in world oil prices, which will reduce incomes
among the majority of economies in the region that are
net energy importers, as well as among the developed
nations which comprise Emerging East Asia’s major
extra-regional export markets – the United States, Japan
and Europe. Affected by oil prices, as well as by a variety
of domestic factors, growth in the developed world shifted
to a lower pace in the second quarter of 2004, most
notably in Japan, and to a lesser extent in the U.S., while
monthly indicators suggested softening activity in Europe
in the third quarter. Overlaid on the growth pause in the
developed world is the likelihood of another cyclical
downturn in the global high tech industry, a concern for
East Asia which is now the leading location for
manufacturing and assembly in this industry. East Asian
decision makers are also giving much attention to the
outlook for China. While efforts to slow China’s
investment boom have had some success, a re-
acceleration could increase the likelihood of a later, more
severe ‘hard-landing’ that could knock away a key source
of new export demand in the region over the next few
years. Even with a ‘soft landing,’ the growth of East
Asian exports to China will decline from their recent
soaring pace, a change that seems to have already begun.
The consensus view remains that the recent
slackening of activity in the developed world will prove a
temporary pause in a more sustained expansion, while
China will continue to expand at rates that – while lower
than recently – will remain high by world standards.
has heightened worries about a more serious downturn.
These concerns are exacerbated by worries about large
global macroeconomic imbalances, in particular record
sized and growing U.S. current account deficits and the
East Asia and Pacific Regional Overview 2

foreign financing they require, notably from the current reform and faster third-party arbitration can help establish
account surplus economies of Japan and Emerging East sounder rules-of-the-game.
Asia. Unpredictable changes in investor sentiment and
The priorities vary by country, but the potential
risk appetite could result at some point in interest rate
for policy reform to assist in the investment recovery
hikes, exchange rate swings and a sharp adjustment in
seems very real in most countries. An overview of the
U.S. aggregate demand and imports – a recession. That
Bank’s recent surveys and analysis in this area is
would be a costly outcome for all.
presented in the Special Focus section at the end of this
What should the focus of policy makers be in report, entitled “Strengthening the Investment Climate in
this sort of uncertain and potentially volatile East Asia”. Developments at the country level are also
environment? Rather than fretting too much about a discussed in the “Country Sections” towards the back of
cyclical slowdown that is inevitable to some extent, the the report, while fuller Country Briefs are available at the
focus is better placed on nurturing the emerging recovery website associated with this report.2
in private investment. This would enhance the supply
capacity of the economy and also has advantages from a East Asia - at the peak of the cycle?
near-term demand perspective. So far the regional • Economic growth in East Asia is expected to reach
recovery has been driven by exports and consumer 7.1 percent in 2004, over one percentage point higher
demand. Going forward, however, export growth may be than in 2003. (Table 1). The strength in activity has been
crimped by the cyclical factors and imbalances noted widespread, encompassing most of the diverse
above. Consumption has been boosted in part by rapid economies in the region. Fixed investment spending has
growth in credit to households, but, as recent experience also picked up in recent quarters, not only in fast
in Korea and Hong Kong (China) shows, this has its growing economies like China and Vietnam, where it has
dangers too. A key issue for policy makers, then, is to been strong for some time, but also in the middle and
nurture the recent investment recovery in the region by high income economies, where it has been erratic and
strengthening the investment climate, so that the recovery weak in the wake of the 1997-98 financial crisis and the
is sustained through the present period of global 2001 high tech crash. Annualized quarter-on-quarter
uncertainties and cyclical slowdown. growth in the second quarter of 2004 dipped to an
A recent series of Investment Climate Surveys average of only 3-4 percent among the 8 South East
undertaken by the World Bank helps document the key Asian and Newly Industrialized Economies. Regional
constraints and problems faced by firms and other growth is expected to decelerate in 2005, although
businesses in East Asia. One key finding is that in many reaching a relatively robust pace near 6 percent.
economies uncertainty about domestic macroeconomic
conditions or government policies is an important Table 1. East Asia Economic Growth
problem for firms, and more global uncertainty further 2002 2003 2004 2005
raises the premium on credible, transparent and East Asia 6.0 5.9 7.1 5.9
predictable domestic policies. For those East Asian Develop. E. Asia 6.9 7.8 7.9 7.0
countries with high public debt levels, like the S.E. Asia 4.6 5.3 5.8 5.5
Philippines, an example would be a pre-announced Indonesia 4.3 4.5 4.9 5.4
program to reduce debt, thereby bringing down the Malaysia 4.1 5.3 7.0 6.0
sovereign risk premium and borrowing rates for all Philippines 4.4 4.5 5.4 4.5
private investors. Many specific actions can be taken Thailand 5.4 6.8 6.4 5.8
immediately to both cut the costs of doing business and to Transition Econ.
China 8.3 9.3 9.2 7.8
reduce corruption and arbitrariness by simplifying
Vietnam 7.0 7.2 7.2 7.5
business regulation, cutting red tape and improving the Small Economies 2.6 4.2 4.1 3.4
transparency of procedures. There are likely to be high Newly Ind. Econ. 4.7 3.0 5.9 4.4
dividends from reforms to improve cost effective delivery Korea 7.0 3.1 4.9 4.4
of infrastructure and logistics services, as well as to 3 other NIEs 2.8 2.9 6.9 4.4
improve labor market outcomes through greater flexibility Japan -0.3 2.5 4.3 1.8
and better institutions for upgrading worker skills. World Bank East Asia Region; Oct. 2004. Consensus Forecasts
Continued efforts to address remaining private sector for NIEs
balance sheet vulnerabilities through financial and
corporate restructuring remain worthwhile. Efforts are
also needed to strengthen prudential regulation of the • Poverty. The number of East Asians living below $2
financial sector, and further develop capital markets, a day is estimated to have fallen to around 34 percent in
which will help diversify risk more broadly within the 2004, amounting to some 636 million people. As
economy, for example through leasing and factoring, recently as 1999 that proportion was 50 percent,
more institutional investment, pension funds, insurance
companies and mutual funds. More broadly, judicial
2
http://www.worldbank.org/eapupdate/ .
East Asia and Pacific Regional Overview
representing some 890 million people. With per-capita
real GDP growth in Developing East Asia having
averaged around 6 percent a year in the years since 1999,
there could hardly be more striking evidence as to the
power of sustained economic growth to reduce poverty.
Developments in China, which contains two thirds of the
poor in East Asia – some 418 million -naturally dominate
the regional picture. Poverty at the $2 a day in China is
estimated to have fallen to about 32 percent in 2004,
driven by significant recent gains in rural income. Rural
income gains in 2004 were mainly due to increased
agricultural output, a more than 30 percent increase in
grain prices, the introduction of direct subsidies to
farmers, and a reduction in agricultural taxes. Outside of
China, the bulk of recent poverty reduction in terms of
absolute numbers of poor has occurred in three other
economies, Indonesia, Thailand and Vietnam.
The international and regional environment
• A ‘growth pause’ in the developed world. Growth in
the OECD economies is expected to reach 3.5 percent in
2004, about one percentage point stronger than had been
expected a year ago. Growth in the United States and
Japan, is expected to reach over 4 percent in 2004, before
slowing in 2005 to a little over 3 percent and a little
under 2 percent respectively. In the U.S. consumer
spending had already shifted to a lower pace in mid
2004, likely reflecting the impact of higher oil prices,
lower tax rebates and a reduced pace of mortgage
refinancing. In Japan business investment, hitherto one
the strongest elements in the recovery, took a breather in
the second quarter, perhaps reflecting concerns about
higher oil prices, indications of a slowdown in global
high tech and slowing growth in exports to China and the
rest of Asia. During the third quarter downside surprises
were the largest in Europe, where industrial production
actually contracted. OECD growth is forecast to ease
significantly to 2.6 percent in 2005, although that would
still be well above the OECD growth pace in 2001-03,
the period of the last major global slowdown and
subsequent upturn.
• China – what kind of landing? In China the
authorities have used a growing array of instruments to
try and slow potentially excessive growth in investment
spending, including credit restrictions, administrative
controls on investment, and finally, in late October,
higher interest rates, with some success. Fixed asset
investment growth (in current prices) did indeed fall to
23 percent in the second quarter, although it recovered
somewhat in the third, after the completion of
administrative inspections, and several other demand
indicators remained strong. However, the quality of
adjustment in China might improve now that interest rate
caps have been removed. That will give much needed
support to SME lending and to the development of the
secondary market in mortgages. GDP growth slowed
from 9.6 percent in the second quarter to 9.1 in the third.
Some impact is being felt on China’s imports from East
3
Asia, which grew less quickly in July-August than in the
first half of 2004 or 2003, although in most cases still
running at 25 percent or more Beyond these cyclical
developments, however, trade between China and the
rest of East Asia is likely to be sustained by the growing
industrial integration of the region, and the continued
expansion of cross-border production networks and ties
among multinational companies, their suppliers and
customers. In the economic boom of the last two years
(2002 and 2003) China’s worldwide imports grew by 69
percent, led by an 80 percent increase in imports of
machinery and transport equipment. Imports of
machinery and transport equipment from other East
Asian economies (excluding Japan) however jumped 117
percent, implying a gain in market share of over 6
percentage points in just these two years.
• High tech cycle turning over? Concerns about
slowing OECD and China growth are amplified by
evidence of slowing demand growth in the highly
cyclical global high tech industry. East Asian tech
production growth slowed in the third quarter as
customers ran down unwanted inventories. New orders
for tech output in the G-3 countries slowed, as did
momentum in global semiconductor sales.
• Commodity markets and the new oil shock. Perhaps
the most alarming recent global development is the rise
in average crude oil prices over the past year from
around $27 a barrel in September 2003 to $46.7 in the
first three weeks of October 2004 (and to $50-55 for
specific crudes like WTI), although in real terms prices
still remain about half their peak level in the 1979-80
second oil shock. Prices have surged because of
unexpectedly strong and coordinated global demand
growth, led at the margin by rapid growth in China, low
spare production capacity due to a lack of investment in
the 1990s and a series of natural and political
disruptions. Oil prices are currently expected to average
$39 in 2004 and $36 in 2005, thanks to the growing
production and fall in price of crudes from the Persian
Gulf.. Strong world growth has also contributed to a
surge in metals and other non-oil commodity prices.
Studies of the impact of the oil shock suggest it could
knock 0.5 percent off world GDP growth, with a 0.8
percent impact in Asia. Impacts within the region will be
highly differentiated, with substantial net oil importers
like Korea, Philippines and Thailand suffering the largest
income losses. At the other extreme small net exporters
of both oil and non-oil commodities like Papua New
Guinea are expected to enjoy very large windfall gains.
Proper macroeconomic management and use of such
gains will be a major challenge in such economies.
• Trade policy developments. The July 31 WTO
General Council agreement on a negotiating framework
for the Doha Round of multilateral trade talks is good
news for East Asia, which is expected to be one of the
main beneficiaries of the Round. The agreement laid out
a road map for progress in four areas: agricultural trade
East Asia and Pacific Regional Overview
liberalization, non-agricultural market access, services
and trade facilitation. Most of the hard work of arriving
at specific detailed agreements still lies ahead, however.
East Asian economies, having much to gain, need to be
active in the negotiations, pushing for a speedy
conclusion.
• International capital markets and flows. After last
year’s return of large scale private capital flows to
emerging markets, 2004 has seen something of a pause,
with flows continuing at the levels reached in the second
half of 2003, but not growing as rapidly as before. The
pause is likely the result of the heightened uncertainties
affecting the global outlook, as well as the shift towards
higher interest rates in the U.S. That emerging capital
markets were taking a fairly relaxed view of these
developments was suggested by a number of other
indicators. Spreads on East Asian Eurobonds, which fell
sharply in 2002 and 2003, have been largely stable in
2004. Stock prices surged in 2003, peaked in January-
February this year, pulled back by 5-10 percent in the
second quarter, before starting to move higher once more
in the third quarter.
• East Asia and Global Rebalancing. If Emerging
East Asia is a recipient of private capital inflows, it,
together with Japan, is also one of the major suppliers of
finance for the main macroeconomic imbalance in the
world at present, the U.S. current account deficit, which
amounted to $568 billion in the year to the second
quarter of 2004. The Emerging East Asian economies
alone had current account surpluses of about $138 billion
over this period, which, combined with net capital
inflows, allowed them to accumulated over $250 billion
of official foreign exchange reserves, a significant
proportion being invested in U.S. financing instruments.
There is now a consensus that these imbalances cannot
continue in this fashion for too much longer, and that
policy makers need to find a means of achieving a
‘global rebalancing’ that is not disruptive of global
growth. A part of this obviously depends on U.S. policy
efforts to boost national savings by reducing the U.S.
budget deficit. But global imbalances have also
increased because of the sharp fall in domestic
investment in many emerging East Asian economies
after the regional financial crisis – averaging about 11
percentage points of GDP between 1997 and 2003.
Within the region, the major surplus economies are Japan
and the NIEs, but even developing Asian economies will
need to play a part. The best outcome is for East Asia’s
contribution to global rebalancing to center on fostering
much stronger domestic private investment, which would
also position these economies for sustained long run
growth. Continued adjustment in exchange rates can
also play a role, as can sustained trade liberalization
efforts, in particular in services sectors, where East Asia
has tended to lag other developing regions.
Domestic trends and policy challenges
4
• Strengthening fiscal positions. Governments in the
region continue to grapple with the burden of substantial
public sector debt built up after the 1997-98 financial
crisis as a result of governments shouldering the cost of
recapitalizing and restructuring insolvent financial
institutions, the calling of other contingent claims on
government, wider public sector deficits and real
depreciation of currencies. In light of the weakness of
the fiscal position, the most pressing challenge is in the
Philippines, where gross public debt has reached over
100 percent of GDP. President Macapagal-Arroyo
submitted a package of fiscal measures for approval to
Congress that, if fully implemented, would help stave off
a fiscal crisis. In Indonesia several years of prudent
fiscal management have helped nudge debt-GDP ratios
steadily lower in recent years, although significant
challenges remain, including reducing costly fuel
subsidies so as to free up resources for more
economically efficient and equitable uses (such as
infrastructure, development spending and debt
reduction). Malaysia also is focusing on significant
fiscal consolidation in its latest budget. In Thailand,
where budgets moved into surplus a couple of years ago,
the government has boosted public investment and is
pondering a five year program of large scale
infrastructure projects.
• Recent corporate sector trends and issues. The
profitability and balance sheet position of East Asian
firms have continued to strengthen, providing a more
secure foundation for the recent upswing in investment
spending observed around the region. Ordinary income
to sales ratios for listed non-financial firms have risen
substantially from their low points in 1998, while debt-
equity ratios have fallen, and are now broadly in line
with international norms. Countries continue to make
efforts to resolve the situation of weak firms and deal
with the remaining stock of distressed assets. Since the
special debt workout frameworks that were established in
the aftermath of the crisis have mostly been wound
down, progress on corporate restructuring increasingly
depends on the effective functioning of the legal and
judicial system, and, in particular of effectively
functioning bankruptcy systems and market-based asset
disposition. More generally, policy makers are
increasingly focusing on measures to strengthen the
broader investment climate, the subject of the ‘Special
Focus’ in this report.
• Recent financial sector trends and issues. Banks
have also benefited from the acceleration of economic
activity over the past one and a half years. The
profitability of commercial banks—as measured by the
rates of return to assets and equity—has improved
sizably in Indonesia and Thailand, and marginally in the
Philippines and Korea, and remains comfortable in
Malaysia. Average risk-weighted Capital Adequacy
Ratios (CAR) have also been above the 8 percent BIS
norm in all five countries for several years now, while
East Asia and Pacific Regional Overview 5

Non Performing Loan (NPL) ratios have continued to

decline, reflecting, to varying degrees, continued
restructuring efforts, improved capacity of borrowers to
repay, and new loan growth. Some caveats should be
noted. First, despite progress, NPL ratios remain in
double digits in Thailand and the Philippines. Second,
aggregate numbers on profitability and loan quality can
sometimes mask considerable differences across groups
of banks; some segments remain vulnerable. One trend
and potential vulnerability across countries in the region
has been rising household debt and with it, increases in
the share of NPLs from household lending. In Korea
household debt grew quickly between 2000 and 2002,
and subsequent problem with credit card delinquencies
have had a serious macroeconomic effect in slowing
consumer spending. Household debt has also grown in
Malaysia and Thailand, without so far running into
serious difficulties. Countries are also continuing to
make progress on various aspects of strengthening the
financial system in terms of regulation and supervision.
East Asia Update
EAST ASIA AND PACIFIC REGIONAL OVERVIEW
East Asia – at the peak of the cycle?
Growth in the East Asia region is expected to
rise to a little over 7 percent in 2004, more than a
percentage point higher than in the preceding two years,
and more than three percentage points higher than in
2001, the trough of the last global economic slowdown.
(Table 1 above). Growth has been especially robust
among the Developing East Asian economies, running at
near 8 percent for a second year, led by plus 9 percent
growth rates in China. Among these economies the last
two years have been the strongest period of growth since
before the 1997-98 financial crisis. As Exhibit 1 shows,
the year on year growth rate of quarterly regional GDP in
East Asia has accelerated almost continuously since the
middle of 2001 – interrupted briefly only by last year’s
SARS crisis – to reach around 7.5 percent in the first
quarter of 2004 and just over 8 percent in the second.
Growth – securing the path to sustained expansion
Yet, even as the recovery has flourished –
fostering the first widespread recovery in investment
spending since the financial crisis more than 6 years ago –
a number of cross-currents and risks have emerged or
intensified, mostly, though not entirely, associated with
the external environment. Policy makers in the region
now must carefully ponder the mix of policy efforts and
reforms needed to steer the regional economy from sharp
cyclical recovery of the last 2 years onto the path of
sustained medium term expansion.
Several features of the recent surge in growth
deserve attention. First, the acceleration or continuing
strength in activity has been geographically widespread,
encompassing many if not most of the diverse economies
in the region, ranging from a continent sized economy
like China to small island economies like the Solomons,
from high income economies like Singapore and Taiwan
(China) through middle income economies like Malaysia
and Thailand to low income economies like Lao PDR,
Vietnam, Papua New Guinea and Mongolia.
Second, recent quarters have seen a widespread
strengthening of fixed investment spending around the
region. Of course investment has already been rapidly
expanding for some years now in fast growing economies
like China and Vietnam, in the former case to such an
extent that curbing excessive investment has this year
become a central preoccupation for the authorities. In
many other economies, however, investment has been
much more erratic and weak over the last 5-6 years.
These include economies affected by the 1997-98
financial crisis such as Indonesia, Malaysia, the
Philippines, Thailand and Korea, as well as economies
6
such as Hong Kong, Singapore and Taiwan (China) that –
while less directly affected by the financial crisis –
experienced more serious effects from the deep recession
in the global high tech industry in 2001, as well as from
adjustments to changing comparative advantage and other
competitive challenges Annual average growth in fixed
investment among these economies averaged only 0.3
percent in 2001-03. Aggregate demand growth during
this period has instead been more dependent on private
consumption, which has been most robust in the South
East Asian economies, as well as on exports.
Exhibit 1
East Asia - Quarterly GDP Growth
(% Change Year Ago)
12.0
9.0
6.0
3.0
0.0
Q1-1999
Q3-1999
Q1-2000
Q3-2000
Q1-2001
Q3-2001
Q1-2002
Q3-2002
Q1-2003
Q3-2003
Q1-2004
-3.0
China NIEs
SE Asia E. Asia
-6.0
It is in this group of 8 middle and high income
economies that investment spending has rebounded in late
2003 and early 2004. Investment, which had made a
negligible or negative contribution to growth in most
economies in 2003, made the largest positive contribution
in many in the first half of 2004. (Exhibits 2 and 3). The
average year on year pace of GDP growth among these
economies increased from 4 percent in 2003 to 7.2
percent in the first half of 2004, while the contribution of
fixed investment increased from 0 percent in 2003 to 3.6
percentage points in the 2004 first half. In other words
fixed investment contributed half of the growth in
expenditures on GDP in the first half, with especially
strong outcomes in Malaysia, Thailand, Hong Kong,
Singapore and Taiwan (China).
A number of positive trends have helped foster
the investment revival in the region, some of which are
explored at greater length in this report. Exports
accelerated and have remained strong since late 2002,
 East Asia Update 7

foreign reserves have bolstered confidence and allowed

Exhibit 2 lower interest rates in many economies. Public sector debt
Contributions to GDP Growth in S.E. Asia has also trended lower or at least been stable in most –
(% change year ago) though not all – economies, the Philippines being an
12.0 exception here. Policy efforts to foster financial and
Net Exports
corporate sector restructuring and reform have continued
10.0 Investment
at various rates. Portfolio capital flows returned to the
Pub. Consump. region in large volume in 2003. As the review of
8.0 Priv. Consump. corporate sector trends later indicates, firms around the
region have used this exceptionally favorable climate to
6.0
reduce excessive debt and improve profitability. The
improved financial health of corporates has put in place
4.0
perhaps the final precondition for the present recovery in
investment.
2.0
The third important observation about the
0.0 recovery is that East Asian growth is expected to peak in
2003 2004 2003 2004 2003 2004 2003 2004 2004, indeed may already have done so in the first part of
-2.0 H1 H1 H1 H1 the year. While year on year growth in the first half of
Indonesia Malaysia Philippines Thailand 2004 reached the relatively high rates displayed in Exhibit
-4.0 1 above, seasonally adjusted rates of growth from one
GDP Growth:
4.5 4.7 5.3 7.8 4.7 6.3 6.8 6.4
quarter to the next were also turning down in several
-6.0 Contributions may not sum to growth due to statistical discrepancies in Nat. economies at this time. As Exhibit 4 below shows, the
seasonally adjusted annualized growth in output in the
Exhibit 3 second quarter of 2004 as compared to the first fell on
average to only 3-4 percent among the 8 South East Asian
Contributions to GDP Growth in NIEs and Newly Industrialized Economies. On a technical
15.0 (% change year ago) note, the apparent contradiction between the two types of
Priv. Consump. Pub. Consump. growth rates is explained by the fact that quarter on
Investment Net Exports quarter increases in GDP were extremely strong in the
third and fourth quarters of 2003, pushing up the year on
10.0
year comparisons in the first half of 2004, even as quarter
on quarter growth rates were starting to fall by this latter
point. The slower trend in growth will likely be reflected
5.0 in yearly growth rates for the second half of 2004, when
there will be a much tougher comparison to high levels of
output in the second half of last year. The flash estimate
for third quarter growth in Singapore indicated that GDP
0.0
actually contracted from the second quarter, while the
2003 2004 2003 2004 2003 2004 2003 2004
year on year pace dipped to 7.7 percent, down from 12.5
H1 H1 H1 H1
percent in the second.
-5.0 Hong Kong Korea Singapore Taiwan
(China)
A slower trend in East Asian growth would have
GDP Growth been expected to some extent in any case, the pace of
3.2 9.5 3.1 5.4 1.1 10.0 3.3 7.2 economic activity in the region making a normal
-10.0 Contributions may not sum to growth due to statistical discrepancies in Nat. transition from sharp upswing in the recovery phase of the
economic cycle to somewhat lower but sustained growth
in an expansion phase. However, 2004 has also seen the
supported by the recovery in the developed world, a emergence of several key risks or actual trends that are
strong cyclical rebound in the global high tech industry already tending to offset the positive factors underpinning
and a surge in intra-regional trade, led by booming the recovery in East Asia so far, or may do so in the
exports from the rest of East Asia to China. Regional foreseeable future.
export growth has run at 25-30 percent on a year earlier in
Among these factors, several of which are
dollar terms through much of 2004. Especially in South
discussed in greater detail later in the report, perhaps the
East Asia, firms’ cash flow has also been bolstered by
most immediately of concern has been the steep spike in
robust growth in consumer spending. (Exhibit 2).
world oil prices, from late 2003 onwards which is directly
Macroeconomic conditions have been benign in most
imposing significant income losses among the majority of
economies, an important factor in reducing business
economies in the region that are net energy importers, as
uncertainty. High current account surpluses and rising
well as among the major developed nations which
East Asia Update
comprise Emerging East Asia’s major extra-regional
export markets – the United States, Japan and Europe.
Affected by higher oil prices as well as by a variety of
specific domestic factors, growth in the developed world
had already shifted to a lower pace in the second quarter
of 2004, most notably in Japan, and to a lesser extent in
the U.S., while monthly indicators suggested a softening
pace of activity in Europe in the third quarter. In
addition, overlaid on the growth pause in the developed
world is the likelihood of another cyclical downturn in the
global high tech industry, a concern for a region like East
Asia which is now the leading location for manufacturing
and assembly in this industry.
East Asia - Quarterly GDP Growth
(% Change Quarter Ago, SAAR)
14.0
NIEs
10.0
6.0
2.0
Q1 2001
Q2 2001
Q3 2001
Q4 2001
Q1 2002
-2.0
-6.0
As if all this were not enough, East Asian
decision makers are likely devoting as much if not more
attention to the outlook for China – in particular the
efforts of the authorities to slow the investment boom in
that economy while averting a ‘hard-landing’ that could
knock away a key source of new export demand in the
region over the next few years. Even with a ‘soft landing’
however, the growth of East Asian exports to China will
decline from their recent soaring pace, a change that
seems to have already begun.
The consensus view remains that the recent
slackening of activity in the developed world will prove a
temporary pause in a more sustained expansion, while
China will continue to expand at rates that – while lower
than during the current boom – will remain very high by
world standards. But it must be admitted that the
apparently remorseless rise in oil prices has heightened
worries about the risk of a more serious downturn. These
concerns are exacerbated by the fact that the oil price
8
shock is occurring in a context of already large global
macroeconomic imbalances, notably the record and
growing U.S. current account deficits. These deficits, it
must be said, were a help during the last global
slowdown, when they injected a substantial demand
stimulus into the world economy and helped avert a worse
recession, but have required a growing flow of foreign
financing, most notably from the current account surplus
economies of Japan and Emerging East Asia. A sharp
disruption of these critical financing flows would likely
result in increases in dollar interest rates, swings in
exchange rates and a steep adjustment in U.S. aggregate
demand and imports – a recession in short. These would
be costly outcomes for all concerned. Finding economic
Exhibit 4 policies to defuse the mounting imbalances in a
cooperative and less costly way will be an increasing
preoccupation not just of one economy and government
but - necessarily – for all the economies and governments
that participate in this relationship.
SE Asia
Poverty – down by 250 million in five years
At some point in the latter part of this year or in
early 2005 we estimate that the number of people living
on less than $2 a day in East Asia will fall below one third
of the population. As recently as 1999 that proportion
was 50 percent. (Exhibit 5). Put another way, the number
of poor in East Asia (by the $2 a day definition) will have
fallen from around 890 million in 1999 to around 636
million just 5 years later, a fall of 29 percent during a
Q2 2002
Q3 2002
Q4 2002
Q1 2003
Q2 2003
Q3 2003
Q4 2003
Q1 2004
Q2 2004
period in which the total population of the region
increased by about 4 percent (to around 1.85 billion).
With per-capita real GDP growth in Developing
East Asia having averaged around 6 percent a year in the
years since 1999, there could hardly be more striking
evidence as to the power of sustained economic growth to
reduce poverty. Looking back over the last 15 years, the
period since 1999 is the second of two in which fast
economic growth has yielded major reductions in poverty.
The first was the economic boom of the early-mid 1990s,
when per-capita growth averaged close to 9 percent and
the poverty headcount rate was reduced from two thirds
(67 percent) in 1990 to 50 percent in 1996. In between
was the period of slow growth associated with the East
Asian financial crisis, when per-capita growth fell to
around 3 percent a year and the regional poverty rate
remained flat at 50 percent.
Looking more closely at the recent gains in
regional poverty reduction, developments in C h i n a
naturally dominate the regional picture. The number of
poor in China comprised three quarters of the poor in East
Asia in 1990, and even today, after years of faster than
average poverty reduction, there are still an estimated 418
million Chinese poor – mostly in the rural areas –
comprising two thirds of the regional total. Relative to
China’s own population, poverty at the $2 a day level is
East Asia Update
estimated to have fallen to about 32 percent in 2004.
About 90 percent of China’s poor live in rural areas, and
rural developments indeed continue to exercise a
predominant influence on poverty reductions trends.
Exhibit 5
Poverty - Headcount Index
($2 a day poverty line. Percent)
Other small * Vietnam
S.E. Asia (4) East Asia
China
75
50
* Cambodia, Lao PDR, Papua New Guinea
25
1990 1996 1999 2000 2001 2002 2003 2004
A recent detailed World Bank study of poverty
reduction in China by Ravallion and Chen calculates that
75-80 percent of national poverty reduction over the
period 1980-2001 is accounted for by poverty reduction
within the rural sector, with most of the remainder
accounted for by migration from rural to urban areas.3
The study finds that poverty reduction has been very
responsive to economic growth - in general a one percent
increase in average incomes has led to a 2.5-3.5 percent
fall in the poverty rate – but that the benefits of growth for
poverty reduction have been partly offset by widening
income inequality. As might be expected, the sectoral
composition of growth is also crucially important for
poverty reduction; growth in rural incomes is far more
important than urban, as is growth in the primary sector
(mainly agriculture) as compared to secondary or tertiary
sector growth. Policies affecting agricultural and rural
sector growth are therefore the most powerful from a
poverty reduction perspective. Ravallion and Chen argue
that China’s agrarian reforms of the early 1980s were
responsible for over half of all the poverty reduction in
the period 1980-2001. Agricultural pricing policies have
3
Martin Ravallion and Shaohua Chen. “ China’s (Uneven)
Progress Against Poverty”. World Bank Working Paper 3408.
September 2004. The study uses a poverty line of 850 yuan for
rural areas and 1200 yuan for urban, which are significantly
lower than the $2 a day benchmark.
http://econ.worldbank.org/working_papers/38741/
9
also had an important effect. Until recently the
government operated an extensive food grain procurement
system that effectively taxed farmers by setting quotas
and fixing procurement prices below market levels.
Increases in procurement prices had a strong positive
effect on agricultural output and incomes and served as a
powerful short term policy against poverty. Finally
Ravallion and Chen also find that periods of low inflation
had a beneficial effect on poverty reduction in China.
Rural living standards in China have indeed
shown significant recent improvements. Rural residents’
cash income increased by 11.4 percent year-on-year in the
first 9 months of 2004, compared to only about 2 percent
per year in 2002-2003. Rural incomes grew faster than
urban for the first time in 6 years. As a result, rural
poverty rates are estimated to have come down
significantly. Rural income gains were mainly due to
increased agricultural output, a more than 30 percent
increase in grain prices, the introduction of direct
subsidies to farmers, and a reduction in agricultural taxes.
While the fiscal costs of agricultural subsidies are
currently modest, experience in developed countries
shows the potential for such subsidies to become a
concern in the longer run. The government is also moving
to develop a coherent policy and legislative framework
for social assistance, on which it issued a white paper in
2005
September. This would help ameliorate the disparities in
the social protection system between urban and rural
areas, and could benefit migrant workers, who often “fall
between the cracks” of urban and rural systems. Recently
a growing number of provinces have been implementing
rural safety net schemes modeled on the urban dibao
system, which is a cash transfer system based on income
and asset testing.
Efforts to improve social safety net programs are
also afoot in Mongolia. The government’s social security
master plan aims to move from a system that targets
social categories or groups to one based directly on the
actual income and consumption situation of households.
The system’s ability to target support to those most in
need will be enhanced by the 2002-3 Living Standards
Measurement Survey, the first nationally representative
household-level survey for Mongolia. The results of the
survey, which will be available shortly, will establish
baseline poverty information and help in monitoring
implementation and results from the country's Economic
Growth Support and Poverty Reduction Strategy.
Outside of China, the bulk of recent poverty
reduction in terms of absolute numbers of poor has
occurred in three other economies, Indonesia, Thailand
and Vietnam. In Indonesia, economic growth rates have
gradually strengthened after the 1997-98 financial crisis,
reaching 4.5 percent in 2003 and near 5 percent in 2004.
The latest Susenas data show poverty using the national
poverty line down to 15.1 percent in 2003, finally below
pre-crisis levels. However, while economic management
has generally been sound during this critical election year,
East Asia Update 10

there are some specific areas where policy reforms could variation across the country. Spectacular progress (30
enhance the pace of poverty reduction. Although percent of the population moving out of poverty) has been
Indonesia adheres to a generally liberal trade policy made in some parts of the country such as Quang Ninh in
regime, some recent moves in a more protectionist the northeastern corner of Vietnam. (Exhibit 6). This area
direction could raise the cost of subsistence for the poor, has seen the development of a vibrant tourism industry
in particular the seasonal import ban on rice, which will and lies on an important trading route with China. It may
tend to raise retail prices for rice, to the detriment of poor also be benefiting from spillover effects of rapid
households who are largely net consumers of rice.4 economic growth in neighboring provinces. There are
similarly spectacular reductions in poverty in Binh Thuan
Increased minimum wages in recent years are
province, which neighbors very rapidly-growing
also having a negative impact on formal sector
provinces in the south east of the country. In other parts of
employment in Indonesia. Minimum wages increased in
the country the proportion of poor people barely changed.
real terms by 13 percent a year between 2000 and 2004.
These data were constructed using poverty mapping
Widening differentials between formal and informal
techniques (for 1998) and household survey data (for
sector wages have discouraged formal sector
2002). New data on living standards will become
employment. Formal sector employment has fallen from
available in mid 2005.
31.8 million in 2000 to 26.5 million in 2003. Open
unemployment, which increased to 9.5 percent in 2003, Exhibit 6
will be a major issue facing the new administration.
Finally, fuel subsidies, which now eat up 16 percent of the
government’s budget, are sometimes justified as being
pro-poor. Such subsidies are regressive, however,
benefiting the better off more than they do the poor. A
gradual reduction in the subsidy with compensation for
poorer households would allow the new administration to
generate significant budgetary savings that could be used
for development spending that actually benefits the poor,
while also allowing further fiscal consolidation.
Between 1998 and 2002 Vietnam saw eight
percent of its 80 million population move out of poverty,
using a poverty line based on a consumption basket that
provides 2100 calories per day and a set of non-food
items. However, progress was uneven, with little or no
poverty reduction in three out of the country’s eight
regions. The regional rate of poverty reduction appears
closely correlated with the proportion of ethnic minorities
among the population (the correlation coefficient is -
0.85). The persistent high poverty rate among ethnic
minorities at a national level (69 percent) is caused by a
series of factors including geographic isolation, low
human capital, lack of secure access to land, and poor
governance. The depth of poverty for ethnic minorities
(represented by the poverty gap) suggests that sustained
economic growth alone will be unlikely to lift these
groups out of poverty.
A recent calculation of the change in provincial In Thailand poverty at the $2 a day level has
poverty rates between 1999 and 2002 shows a large fallen from 22 percent in 2000 to an estimated 14 percent
in 2004, benefiting from stronger economic growth and,
since 2002, from the boost to rural incomes given by
4
The import ban on rice was introduced in January 2004 higher world prices for Thailand’s principal export crops.
and was only supposed to last till 2 months after the While poverty at the $2 level is still estimated at over 70
harvest, but has since been extended twice. Modeling percent in Lao PDR, at the $1 level it has fallen from 34
work suggests that the ban is equivalent to about a 100 percent in 2000 to an estimated 24 percent in 2004,
percent ad valorem tariff. Its initial impact on rice prices supported by growth in a 5-6 percent range. Recent data
was not very noticeable because of this year’s extremely published by the National Statistical Center provide some
good harvest, but this could change in the off-season evidence of rising living standards. The share of food in
period, and over time, as harvests return to more normal household expenditures fell from 64 percent in 1992/3 to
levels.. 55 percent in 2002/3, suggesting that people were able to
 East Asia Update
devote more of their growing incomes to non-food items.
As Exhibit 7 indicates the possession of durable consumer
goods is also increasing.
Exhibit 7
Lao PDR: Possession of Durable Goods
(% of Households)
Electric Rice
2002/03
Cooker
1997/98
Refrigerator
TV
Motorbike
0 10 20 30 40 50
Source: NSC. The Household of Lao PDR. March 2004.
Progress on poverty reduction may have been
less robust elsewhere in the region. In the Philippines
preliminary data from the 2003 Family Income and
Expenditure Survey (FIES) released by the National
Statistical Office in August 2004 indicate that average
family expenditures and incomes both decreased in real
terms between 2000 and 2003. Real average family
expenditures declined by about 7 percent during this
period. In 12 out of the 17 total regions, real average
family expenditures in 2003 declined relative to their
level in 2000. The decline was largest in the National
Capital Region, where real average family expenditures
fell over 17 percent during this period. National income
inequality decreased slightly, with a decline in the Gini
coefficient to 0.47 in 2003 from 0.48 in 2000, but income
inequality remains high, with average incomes in the top
decile over 20 times that of the bottom decile. It should
be noted that there is a significant discrepancy between
the preliminary FIES data, which indicate lower total and
average family incomes and expenditures, and the
national income accounts data which indicate increasing
per capita GDP over the same period. Resolving these
data inconsistencies will be important to obtain a clearer
picture of what has actually happened to poverty in the
Philippines during this period. Poverty incidence
estimates based on the FIES data are expected to be
released by the government shortly.
Progress on poverty reduction has also been
more limited in some of the smaller low income
economies of the region. In Cambodia, the latest Socio-
11
Economic Survey is still in the field and due to be
completed at the end of December 2004, but estimates
based on earlier household level data suggest that poverty
at the $1 a day level has been flat in a 40-45 percent range
in recent years. Even though overall economic growth has
run in a 5-6 percent range in recent years, growth in the
agricultural sector has been less robust. Poverty in its
non-income dimensions shows a bleak picture. Child
mortality rates are high at 138 per 1000 live births in
2002, almost three times the level for East Asia and
higher than the average for low income countries.
Maternal mortality rates at 450 per 100,000 are also three
times higher than the East Asia region. In Papua New
Guinea poverty at the $1 level is estimated to have drifted
higher from 35 percent in 2000 closer to 40 percent now.
The international and regional environment
The year on year pace of Emerging East Asian
export growth in dollar terms accelerated through much of
2004, picking up from the low 20 percent range early in
the year, to near 30 percent in the three months to August.
(Exhibit 8). The strongest performance overall was from
China and Korea where exports in the middle part of the
year were running at a year on year pace of 35-40 percent,
while, at the lower end, exports in Indonesia and the
Philippines were quite sluggish, growing at less than 10
percent rates. Most other countries experienced export
growth in a 20-30 percent range.
By the end of the third quarter there were
however signs of a deceleration in export growth In both
Korea and Taiwan (China) the year on year pace of dollar
exports in the three months to September was lower by
about 10 percentage points than the year on year growth
rate in the three months to July. (Exhibit 9). An even
sharper deceleration is apparent when these economies’
seasonally adjusted growth from one quarter to the next is
considered. China’s year on year export growth also
dipped about 5 percentage points in the three months to
September as compared to the three months to August.
Other economies, for whom export data were available
only through August at the time of writing, did not yet
show much indication of a slowdown.
Nevertheless there are at least three reasons why
a significant slowdown in East Asian export growth may
now be underway. First, there are indications that growth
in East Asia’s major developed economy markets slowed
in the second and third quarters of the year. The depth
and duration of this ‘slow patch’ in the developed world is
uncertain, but it is likely to have some effect on East
Asian exports. Second, there are indications that the
soaring pace of East Asian export growth to China over
the last two years is slowing this year. Partly this may
just reflect the fact that some East Asian economies
achieved very high growth rates from a very small initial
volume of exports to China, which was bound to decline.
East Asia Update 12

However, although the overall GDP growth rates for Developed country growth
China remained as high as 9.1 percent in the third quarter
of 2004, there was already a ‘soft landing’ underway in its Growth in the OECD economies is expected to
imports, whose growth rate decelerated quite significantly reach 3.5 percent in 2004, the second highest since the
at this time. Third, after two years of strong upswing, late 1980s (the highest being in 2000, the climax of the
growth in global demand for high tech products appears global high tech boom) and about one percentage point
to be decelerating, and this cannot but impact the region stronger than had been expected a year ago. (Table 2).
which is now the leading assembler and manufacturer of OECD growth is led by the United States and Japan,
high tech products. where it is expected to reach over 4 percent in 2004. As
indicated in Exhibit 10, growth in both countries was
especially strong in the second half of 2003 and early
Exhibit 8
2004, with quarter on quarter seasonally adjusted
East Asia - Export Growth annualized rates (SAAR) occasionally reaching over 6
(US$ 3Mo. Mov. Averages - % Change Year Ago) percent, before slowing in the second quarter of 2004.
50 However, one consequence of this pattern of strong
E. Asia SE Asia growth late last year and early this year is that in these
China NIEs two countries growth for the year 2004 as a whole will be
40
high as compared to 2003 under most circumstances, even
though growth from one quarter to the next during the
30 year may run at lower rates – as indeed occurred in the
second quarter, and as monthly data suggest was also the
20
case in the third quarter of 2004.

10
Table 2. International Economic Environment
2002 2003 2004 2005
% Change from previous year, except interest rates
0
GDP Growth
World 1.7 2.7 4.0 3.2
Ap 001

Ap 002

Ap 003

Ap 004
Ja 001

Ja 002

Ja 003
O 001

ct 2

O 003

4
Ju 01

Ju 02

Ju 03

Ju 04
00

00
0

0
2

2
-2

-2

-2
l-2

l-2

l-2

l-2
r-2

r-2

r-2

r-2
n-

n-

n-

n-

OECD 1.3 2.0 3.5 2.6

ct

ct

-10
Ja

United States 1.9 3.0 4.3 3.2

Japan -0.3 2.5 4.3 1.8
-20
Euro Area 0.9 0.5 1.8 2.1
World Trade (Volume) 3.6 6.7 11.1 8.7
Exhibit 9 CPI Inflation - G7 a/ 1.0 1.5 1.8 1.4
East Asia - Export Growth Oil Price - $/bbl 24.9 28.9 39.0 36.0
(US$ 3Mo. Mov. Averages - % Change Year Ago) - % Change 2.4 15.9 35.0 -7.7
50 Non-oil Commodity
Indonesia Philippines Prices 5.1 10.0 17.1 -3.3
40
LIBOR (US$. 6 Mo.) 1.9 1.2 1.6 3.5
Korea Taiwan (China)
Source: World Bank DEC Prospects Group update Oct. 2004.
a/ In local currency, aggregated using 1995 weights.
30

20
Recovery in the United States has been
underpinned over the last two years by exceptional
10
growth in productivity, recovering corporate profits, very
low interest rates, wealth gains due to higher equity and
0
house prices and the final doses of fiscal stimulus from
lower taxes. Growth eased in the second quarter of 2004,
Ap 001

Ap 002

Ap 003

Ap 004
O 001

O 002

ct 3

4
Ja 001

Ja 002

Ja 03
Ju 01

Ju 02

Ju 03

Ju 04
00

00
0
0

0
2

2
l-2

l-2

l-2

l-2
-2

-2

-2
r-2

r-2

r-2

r-2
n-

n-

n-

n-

-10 however, falling to 3.3 percent (SAAR), down from 4.5

ct

ct
Ja

percent in the first, the net result of a number of off-

-20 setting factors. The biggest contributor to the downturn
was lower consumer spending growth, likely reflecting
-30 the impact of higher oil prices, lower tax rebates and a
reduced pace of house refinancing. Lower net exports also
contributed to the slowdown, and were reflected in the
second quarter current account deficit of $166 billion, or
5.7 percent of GDP, both record figures. On the other
East Asia Update
hand, residential and business investments, which have
made a major contribution to the recovery over the past
year, accelerated further in the second quarter, helping
offset the downdraft from consumption and next exports.
A variety of monthly data in the third quarter appeared to
confirm that growth was likely to consolidate in a more
modest 3-4 percent range, including slower growth in
retail sales and industrial production, a downturn in
consumer confidence and a lower pace of job creation. In
line with this data, the flash estimate for third quarter
growth was 3.7 percent.
Exhibit 10
OECD Real GDP Growth
(% change on previous quarter; SAAR)
8 watching the evolution of the Chinese economy even
USA
Japan
Euro area
6 growth for many of the other regional economies. In
4 growth enjoyed by Korea and Taiwan, and about 25
2 economy, in particular potentially excessive investment
0
2003 Q1 2003 Q2 2003 Q3 2003 Q4 2004 Q1 2004 Q2
-2
Growth in Japan was especially strong in late
2003 and early 2004, reaching quarter on quarter annual
rates of 7.6 percent and 6.4 percent respectively, spurred
by exports, most notably to China, and a recovery in
corporate profits and business investment. But second
quarter 2004 growth fell to an unexpectedly low 1.3
percent (q-on-q annualized), pulled down by lower public
spending and a fall in the growth of business investment.
Monthly indicators in the third quarter also did not give a
clear signal as to trend, seeming to indicate that the
economy was sailing in a region of cross-currents.
Exports remained the strongest demand impetus, although
rates of growth – including those of exports to China and
the rest of East Asia - were easing. Consumption
spending has been modest in this recovery, since
households remain concerned about slow employment
growth and stagnant or falling wages - a trend confirmed
by a continuing weakness in third quarter retail sales.
Business sector activity also appeared to be restrained,
perhaps by concerns about rising oil prices, indications of
a slowdown in global high tech and the potential for a
sharp slowdown in China, although, on the other hand,
profits continued strong, boding well for an eventual
13
rebound in investment. Reflecting the ambivalence,
orders for machinery and industrial production continued
to weaken in the third quarter, while, on the other hand
the September Tankan survey indicated that the ratio of
corporate profits to sales had risen to match previous
highs. Business sentiment was also rising. Overall, the
Cabinet office concluded in October that there were signs
of a pause in the economy. Still, consensus views do not
so far project a return to stagnation, looking instead for
2005 growth in the region of 2 percent.
China – what kind of landing?
Other East Asian economies may perhaps be
more anxiously than they are economies in the developed
world. The reason of course is that in the last two years
China has been much the largest source of export market
2003, for example, growth in exports to China and Hong
Kong contributed 50-60 percent of the overall export
percent in economies like Malaysia and Thailand. The
Chinese authorities, however, are concerned about the
rapid pace of domestic demand growth in the Chinese
spending, which could lead to or worsen excess capacity
in various sectors of the economy, as well as add to the
bad debt problems of the banking system. Fixed capital
formation reached 43 percent of GDP in 2003, while
Fixed Asset Investment, a somewhat different measure of
investment, expanded by over 40 percent in nominal
terms in the first quarter of 2004.5 An unexpectedly sharp
deceleration in the economy, it is feared, could pull down
China’s imports and so remove an important source of
export market growth for the rest of the region.
The authorities have taken a variety of policy
measures to cool the economy. Monetary policy has been
tightened through increases in bank reserve requirements
and ‘window guidance’ from the central bank, the
People’s Bank of China (PBC). These measures seem to
have been effective in slowing growth in credit
outstanding from a peak of 25 percent in the first quarter
of 2003 to 7 percent in the second quarter of 2004.
Policy interest rates have recently been slightly increased.
However, with higher producer price inflation, real
interest rates remain negative, which may tend to
encourage further investment in areas like real estate.
This could be offset if banks take advantage of the greater
flexibility they now have to set interest rates at levels that
reflect underlying market conditions and risk. It is to be
hoped that this will provide a better market-based
5
Statistics on fixed capital formation are only available
on an annual basis, while data on fixed asset investment
(fixed capital formation plus sales of land) are published
on a higher frequency basis.
East Asia Update 14

mechanism through which monetary policy can operate, quarter, although it recovered somewhat to 29 percent in
balancing the administrative measures which have so far the third, after the completion of administrative
been the crux of the effort to slow demand. In April the inspections. Unfortunately, most of the impact on FAI
National Development and Reform Commission (NDRC) growth was concentrated in the private sector. Overall
issued an order prohibiting investment projects in 359 GDP growth is easing gradually – growth was 9.1 percent
sub-industries, while discouraging new projects in another in the third quarter, down from 9.7 in the first half of 2004
175 sub-industries, with construction, steel, and and 9.9 percent in the last quarter of 2003. Retail sales
aluminum the main targets. These sub-industries became remained buoyant, increasing 10 percent year on year in
subject to credit rationing and restrictions on land use. the January-August period. Industrial production at the
end of the third quarter continued to run at about 16
Exhibit 11 percent above year earlier levels, only mildly less than
East Asia - Import Growth earlier in the year. As noted above, export growth has
(US$ 3Mo. Mov. Averages - % Change Year Ago) generally remained strong.
60 The most accurate overall assessment might be
E. Asia that the Chinese economy is slowing but that, on current
SE Asia evidence, the slowdown is likely to be gradual and fairly
China mild. While inflation has accelerated this year, with CPI
40 inflation reaching 5.2 percent in September, much of the
NIEs
increase is attributed to increases in volatile food prices,
as well as higher raw material and fuel prices. The non-
food CPI was however only 1 percent higher in August.
20 Thus, so long as inflation is perceived to remain in check
and the problem of excessive investment is seen to be
easing, drastic measures to slow the economy are unlikely
to be imminent.
0 Given this sort of backdrop China’s import
demand growth is likely to fall from the heady 40 percent
ct 1

ct 2

ct 3

4
r-2 1

r-2 2

r-2 3

r-2 4
l- 1

n- 1

l- 2

n- 2

Ju 003

n- 3

Ju 004
O 200

O 200

O 200

00
Ap 200

Ap 200

Ap 200

Ap 200
Ju 00

Ja 200

Ju 00

Ja 00

Ja 200

plus rates in the first part of the year, but should continue
l-2
-2

l-
-

-
n

to grow at a relatively health pace so long as China’s

Ja

domestic growth does not stall, and so long as China’s

-20
own exports to the world maintain their relatively high
trend growth. The last point is relevant because a
Exhibit 12 substantial proportion of China’s imports are demanded
as inputs and components for China’s own exports – up to
China: Imports from East Asia half on some estimates. As Exhibit 11 indicates, the
(US$ - % change year ago)
slowing may already have begun with import growth in
100
the third quarter falling to 30 percent, compared to 43
2003
percent in the second. Import growth from other East
2004 1-3
Asian economies has also slowed. As Exhibit 12 indicates
75 2004 4-6
import growth from East Asia in July-August was
2004 7-8
generally lower than in the first half of 2004 or in 2003,
although in most cases still running at 25 percent or more.
50
A last point is that many East Asian economies
have been gaining market share in China’s imports over
25 time. The growing complementarity between the East
Asian economies may help sustain growth in their exports
to China even if China’s overall imports slow in the
0
aggregate. The last two years have seen a remarkable
jump in this process. Table 3 shows the growth in
na

nd
a

China’s imports between 2001 and 2003, broken down

si

ne
re

or

hi

ila
ne

Ko

ap
pi

,C

a
do

between broad commodity categories and the economies

ilip

Th
ng

an
In

Ph

Si

iw

from which they were imported.6 Table 4 shows the

Ta

These measures have had some success. The 6

Here ‘Raw materials’ comprise SITCs 0,1,2,and 4: food
most obvious impact has been on fixed asset investment and live animals, beverages and tobacco, crude materials
(FAI) growth, which fell to 23 percent in the second (inedible except fuel) and animal and vegetable oils.
East Asia Update 15

dollar value in 2003 of China’s imports of these broad and ties among multinational companies, their suppliers
commodity categories, as well as the market shares in and customers.
these categories achieved by the economies that export to
China. Table 4. Market Shares in China’s Imports 2003 (As
% of import category)
Table 3. China – Growth in Imports between 2001
Raw Manuf-
and 2003 (Percent Change)
Total Materials Fuels actures MTE*
Raw Manuf-
Total Materials Fuels actures MTE* World (US$ Bill.) 413 43 29 146 193
Market Shares (%)
World 69.5 55.2 67.2 63.2 80.3 USA 8.2 17.5 0.9 8.0 7.4
USA 29.5 70.2 123.2 50.9 3.7 EU 13.2 5.9 0.9 11.8 17.8
EU 50.0 22.3 -3.3 56.7 49.9 Japan 18.0 4.1 1.9 18.6 23.2
Japan 73.3 27.6 69.2 59.6 85.5 East Asia 36.5 18.3 26.6 41.7 38.3
East Asia 81.1 51.3 47.2 58.3 116.8 Korea 10.4 1.6 6.7 14.6 9.9
Korea 84.5 20.9 1.4 61.3 148.9 Taiwan, China 12.0 1.9 1.2 16.5 12.5
Taiwan, China 80.6 40.4 80.3 64.5 102.3 Singapore 2.5 0.2 5.3 2.2 2.9
Singapore 104.5 102.1 98.6 108.5 107.4 Hong Kong 2.7 1.5 0.6 3.4 2.8
Hong Kong 18.0 44.3 10.8 5.5 30.3 Indonesia 1.4 3.7 3.9 1.3 0.5
Indonesia 47.8 23.2 77.8 43.1 82.6 Malaysia 3.4 4.5 3.2 1.5 4.6
Malaysia 125.4 135.0 114.2 77.1 140.8 Philippines 1.5 0.4 0.2 0.3 2.9
Philippines 224.2 35.2 10.1 105.3 263.6 Thailand 2.1 3.3 2.4 1.7 2.2
Thailand 87.3 36.8 113.5 74.0 119.4 Vietnam 0.35 0.74 2.96 0.13 0.04
Vietnam 44.1 70.9 18.3 190.7 263.4 Cambodia 0.01 0.03 0.00 0.01 0.00
Cambodia -25.3 47.5 .. -51.1 -93.4 PNG 0.06 0.48 0.07 0.00 0.00
PNG 88.8 107.9 14.6 -70.7 .. * Machinery and Transport Equipment. Source: Comtrade
* Machinery and Transport Equipment. Source: Comtrade
As would be expected, the newly industrialized
high income economies in the region such as Korea,
China’s overall merchandise imports grew 69.5
Taiwan, China and Singapore were among the principal
percent in these two years to reach $413 billion in 2003,
beneficiaries of China’s investment boom, expanding
led by an 80 percent increase in what is now the largest
their share of China’s machinery and transport equipment
category, machinery and transport equipment, which
imports to a full 25 percent. However China’s imports of
includes all manner of high technology electronics, parts
equipment from middle income economies in South East
and components (as well as consumer electronics and
Asia like Malaysia, the Philippines and Thailand, while
passenger vehicles). China’s overall imports from
smaller in absolute value than those from the NIEs, also
Emerging East Asian economies gained even more
enjoyed some of the strongest rates of growth – more than
rapidly, increasing 81 percent, led by a more than
tripling in the case of the Philippines (although of course
doubling (116.8 percent) in imports of machinery and
this was from a low starting point). Even Indonesia,
transport equipment from East Asia. East Asia’s share in
whose non-oil exports have struggled with problems of
China’s machinery and transport equipment imports
declining competitiveness in recent years, achieved an 80
reached 38 percent, which in fact represented a
percent increase in this category.
remarkable gain in market share of over 6 percentage
points in just two years. Japan also slightly increased its China’s imports of other categories of raw
market share in this category to 23 percent in 2003. Thus materials and manufactures also expanded at a relatively
China now sources over 60 percent of its crucial healthy pace, in a 50-70 percent range. As the later
industrial, high tech and transport machinery, equipment discussion of commodity and oil markets indicates, rising
and components from the wider East Asia region, a mark demand from China has been an important contributor at
of the growing industrial integration of the region, and the the margin to the surge in oil and non-oil commodity
continued expansion of cross-border production networks prices over the past 1-2 years. Higher commodity prices
have been an additional channel through which China’s
growth has contributed to windfall income gains among
commodity exporters in East Asia and elsewhere (while
‘Manufactures’ comprise SITCs 5,6 and 8: chemicals, generating income losses for net commodity importers
manufactured goods and miscellaneous manufactures. like Korea and the Philippines). It is noticeable, though,
MTE is SITC 7: Machinery and Transport Equipment.
East Asia Update 16

that growth in China’s imports of these categories was
less than that in machinery and transport equipment.
Formal studies confirm that China’s income elasticity of
demand for imports is significantly lower for intermediate
products, raw materials and consumer goods than it is for
capital goods. A recent analysis by Eichengreen, Rhee
and Tong (2004) estimates that China’s income elasticity
for imports from Asia in 1990-2002 averaged about 0.6
for intermediates, 1.5 for consumer goods and 2.2 for
capital goods.7 Thus growth in China’s imports of raw
materials and consumer goods, especially manufactures
produced by low wage unskilled labor, is likely to
generally remain less dynamic than its demand for capital
equipment.
As Table 3 broadly suggests, East Asia’s overall
share in these more slow growing markets is also tending
to gradually decline as the region’s overall comparative
advantage shifts towards more sophisticated products.
East Asian economies that still tend to specialize in raw
materials and low wage manufactures are also likely to
face intense competition in the Chinese market from
domestic producers and exporters in other developing
regions. Nevertheless, East Asian economies that succeed
in seeking out and sharpening competitiveness in
Ju -19 5
global high tech boom. The year on year rate of sales
growth in August had however dipped to 34 percent,
down from 40 percent in June. As Exhibit 13 indicates
sales in this industry are highly volatile and, as would be
expected, are also closely correlated with exports from
East Asia, the leading region for production, assembly
and exports of electronic and other high tech products. A
more sensitive measure of momentum such as growth in
seasonally adjusted sales from the previous three month
period has also dipped in recent months.
Exhibit 13
East Asian Exports and World
Semiconductor Sales
(Dec 1994-Aug 2004; % change year ago)
60
World semiconductor
sales
40
20
0

Ju -19 6

Ju -19 7

Ju -19 8

Ju -19 9

Ju -20 0

Ju -20 1

Ju -20 2

Ju -20 3

04
D -19 4

D -19 5

D -19 6

D -19 7

D -19 8

D -20 9

D -20 0

D -20 1

D -20 2

n- 03
segments of unique comparative advantage, as well as in
ec 9

ec 9

ec 9

ec 9

ec 9

ec 0

ec 0

ec 0

ec 0
n 9

n 9

n 9

n 9

n 9

n 9

n 0

n 0

n 0

20
Ju -19

maintaining a favorable low cost business environment,

ec

-20
D

should still be able to do well. Examples of fast growing

East Asian exports to China among natural resource based
products include crude rubber from Malaysia and
Vietnam, cork and wood from Malaysia and Papua New
Guinea, vegetable oils from Malaysia, and vegetables and
fruits from Vietnam. Examples of fast growing
manufactured exports (other than machinery and transport
equipment) include professional and scientific
instruments from the Philippines and Malaysia, non-
ferrous metals from the Philippines, organic chemicals
and iron and steel from Malaysia and Thailand, and
rubber manufactures, textile yarns and footwear from
Vietnam.
Commodity Cycles and the Oil Shock
High tech
A variety of recent information including global
semiconductor sales, inventories, industry warnings on
demand, and weak new orders suggests that there has
been a downshift in momentum in the global high tech
industry in recent months. World semiconductor sales
have been on a rising trend since the recession lows of
mid 2001 and averaged $18.2 billion in the three months
to August 2004, not much less than previous global peak
sales of $18.7 billion in October 2000, at the height of the
7
Barry Eichengreen, Yeogseop Rhee and Hui Tong.
“The Impact of China on the Exports of Other Asian
Countries”. NBER Working Paper 10768. September
2004.
-40 East Asian
export growth
-60
Industry reports also suggested a build up of
excess component inventories during the second quarter.
J.P Morgan estimates that inventories of semiconductors
at PC component suppliers rose to 84 days in the second
quarter of 2004, even higher than a previous peak of 78
days in the first quarter of 2001. According to the
Semiconductor Industry Association (SIA), producers
have taken swift action to correct the overbuild by
trimming capacity utilization rates in the third quarter.8 In
line with these industry reports of inventory correction,
tech output among East Asian producers has dropped
(from 22 percent annualized month-on-month growth in
June to 3.7 percent in July.). Beyond the recent
inventory correction, industry participants appear to
generally expect that a cyclical peak in 2004 will be
followed by a significant slowing in the growth pace of
global semiconductor sales and in other market segments
8
J.P. Morgan North America Equity Research.
“Semiconductor 3Q04 Preview”. 07 October 2004.
Semiconductor Industry Association Press Release
“Industry Reacts Quickly to Reports of Excess
Inventories”. September 30, 2004.
East Asia Update 17

in 2005. Recent data also indicate some slowing in new Metals and agricultural raw material prices,
technology orders in the main developed economies. which are more closely tied to industrial demand than
High tech exports from East Asia are therefore likely to food prices, have tended to remain more resilient this
slow in coming months, although it remains to be seen year. Metals prices have been fairly flat since January,
how deep or protracted such a downswing will be. following their 50 percent surge in 2003. Imports and
apparent consumption of metals in China have eased
Primary commodity demands
substantially in recent months, due mainly to a slowdown
After significant increases between late 2001 and in the construction sector and tightened credit, making it
early 2004, non-oil commodity prices have been generally more difficult to finance imports. Apparent consumption
flat or have trended somewhat lower since the spring. It of the major metals fell to 4 percent growth in July
remains to be seen whether this represents only a (3mma), from 28 percent in April. Nevertheless low
temporary pause or marks the beginning of a more stocks and market deficits for most metals continue to
sustained retreat. Dollar prices for non-oil-commodity underpin prices, which could move higher if demand
prices had risen about 45 percent on average between the growth and imports to China accelerate once more. Prices
end of 2001 and March 2004 – that is, between the end of for agricultural raw materials exported from South East
the last global economic slowdown and what is likely to Asia such as rubber and timber have also been fairly
have been expected to be the peak of the current global resilient, not falling much from recent peaks at the start of
cycle. Prices for metals and minerals and agricultural raw the year. The impact of non-oil commodity price
materials were especially strong, rising 50 –60 percent in movements on economies in East Asia is considered at
this period. (Exhibit 14). The rebound in commodities the end of the next section, together with the impact of
has been underpinned by unexpectedly strong global higher oil prices.
demand for industrial raw materials, driven by robust
growth in China, other developing economies, the United Exhibit 14
States and Japan, as well as by capacity constraints
Non-oil Commodity Prices
resulting from low prices and low investment in various
(Dollar indexes. Jan.1996=1)
sectors in earlier years. Prices in dollar terms were also 1.30
supported by the fall in the U.S. currency against other Non-energy
major currencies, as well as by the extended period of low
Food
interest rates and easy monetary policy with which
governments sought to counter the bursting of the global 1.10 Raw Materials
stock market bubble and economic slowdown of 2000-01. Metals
Several of these underlying forces appear to have
at least shifted gear. Global demand growth has eased, 0.90
with some slowing in the U.S. and Japan in the second
quarter of 2004, as well as policy efforts to curb the
overly rapid pace of growth in China. After falling
through 2002 and 2003, the U.S. dollar also reversed 0.70
course and managed a mild appreciation in 2004. At the
margin the start of a moderate tightening in U.S.
monetary policy may also have contributed to restraining
0.50
further increases in commodity prices in 2004.
Jan-96
Jul-96
Jan-97
Jul-97
Jan-98
Jul-98
Jan-99
Jul-99
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Jul-04
The overall non-oil index fell 4 percent between
March and September 2004, led by declines in various
food commodities. Fats and oils prices in particular fell
25 percent, led by a 37 percent fall in soybean prices, on
reduced demand from China and improving supply
The Oil Price Shock
prospects in the U.S. Prices for South East Asian edible
oil exports such as palm and coconut oil were also down Perhaps the most alarming recent development
after the spring. Although prices for various grains such deriving from the global economy is the relentless rise in
as wheat, maize and sorghum have also fallen back on crude oil prices over the past year. The average price of a
higher global supply prospects, the price of rice – an number of different qualities of crude oil has risen from
export product for farmers in Thailand and Vietnam, and around $27 a barrel in September 2003 – which was also
a staple in household consumer budgets throughout the the average price of oil over the preceding three years – to
region – has not. Dollar prices have risen about 40 $42 in September 2004 and $46.7 in the first three weeks
percent from $168/mt in mid 2001 to a range of $230-
240/mt in 2004.
East Asia Update 18

of October 2004.9 As Exhibit 15 suggests, even before 1.3 mbd (or 25 percent) in the second, far higher than the
the latest hike, oil prices have generally averaged $8-9 a 7 percent annual average growth in the country’s oil
barrel higher during the 2000s than the $18 average of the demand over the past decade. Demand growth in China
1990s. Although in nominal terms recent prices has been highest for transport fuels like gasoline and
significantly exceed those before the 1991 Gulf War or diesel, but was strong across all segments, including fuel
those during the second oil shock of 1980, the comparison for power generation, naptha as feedstock for new
is somewhat less alarming in real or inflation-adjusted petrochemical capacity and LPG and kerosene for
terms. Oil prices deflated by the U.S. consumer price household and commercial use. Commercial stocking
index are only slightly higher than before the first Gulf also often has a large impact on demand in China,
War and still slightly under half those at the peak of the although it is unknown what role it played in the first half
1980 shock, when prices were over $90 a barrel in today’s of 2004. There were also large demand increases in the
prices. (Exhibit 16). rest of Asia and North America.

Exhibit 15 Exhibit 16
Monthly Average Crude Oil Price ($/bbl) Average Real Oil Price
(Jan 1990-Oct. 2004) (1970 Q1-2004 Q4. Real is Constant 2004 Dollars)
100
50.0 Real oil price - constant
2004 dollars per barrel

80
Average Sept. 1999 - 3 year average of real
40.0 Sept 2003 - $26.2 oil price
US$ per Barrel
60
Average Jan. 1990 - October 2004
30.0
Aug 1999 - $18
40

20.0
20

10.0
0
May-1993

May-1998

May-2003
Mar-1994

Mar-1999

Mar-2004
Nov-1990

Nov-1995

Nov-2000
Jan-1990

Sep-1991
Jul-1992

Jan-1995

Sep-1996
Jul-1997

Jan-2000

Sep-2001
Jul-2002

Q1-1970
Q1-1972
Q1-1974
Q1-1976
Q1-1978
Q1-1980
Q1-1982
Q1-1984
Q1-1986
Q1-1988
Q1-1990
Q1-1992
Q1-1994
Q1-1996
Q1-1998
Q1-2000
Q1-2002
Q1-2004
Reasons for the oil price increase Second, while OPEC and non-OPEC sources
have pushed production higher to meet rising demand, the
There appear to be three main sets of reasons for this cushion of available spare oil production capacity has
year’s oil spike. First, the unexpectedly strong and become very thin. OPEC crude oil production in the third
coordinated global recovery across most of the world has quarter is estimated to have reached 29.4 mbd, nearly 3
fueled sharply higher demand for oil. World consumption mbd more than a year earlier, while non-OPEC
averaged 81.8 million barrels per day (mbd) in the first production was also up by perhaps 1mbd. However
half of 2004, about 3mbd (or 3.9 percent) higher than the OPEC spare capacity is now down to some 1.5 mbd, as
same period of 2003, and well above the expected compared to 6-7 mbd in 2002, so that, in the near term,
increase of around 1-1.5 mbd. At the center of the OPEC’s capacity to manage prices has been weakened or
unexpected strength in demand has been China, where lost, and demand increases are increasingly having to be
apparent consumption increased from year earlier levels rationed by higher prices. The present low capacity is
by 1 mbd (or 19 percent) in the first quarter of 2004 and generally held to reflect low investment in developing oil
production capacity over the past decade, itself a
9
This is the average of West Texas Intermediate (WTI), Brent
reflection of low oil prices in the 1990s. The number of
and a Dubai crude oil price, which is rather lower than the new oil wells drilled in OPEC countries in 2003 fell by
widely reported WTI price, recently near $55. Demand and 6.5 percent, for example.
prices for light crudes like WTI have risen much more strongly Lastly oil prices have been pushed higher by a
this year than those for heavier crudes. The premium of WTI
series of political tensions and natural shocks that have
over the heavier Dubai, usually around $3-4, has recently spiked
up to $12-14. either directly disrupted production in different locations,
East Asia Update
or have increased the probability of such disruptions in
the future. These have included terrorist attacks in Iraq
and Saudi Arabia, the dispute between the Russian
government and the Yukos oil company, political strife in
Venezuela, strikes and violence in Nigeria, the simmering
dispute with Iran over its nuclear program, the disruption
of production in the Gulf of Mexico by Hurricane Ivan
and, most recently, power outages in Kuwait.
Oil price outlooks
Where now for oil prices? Differences of
opinion on the market outlook have widened, with some
analysts arguing that prices could reach $60 or even
higher over the next year, and could be sustained at over
$40 in the longer term. The view that the market has
undergone a fundamental structural change is given some
support by oil futures prices, which have moved higher
much more closely in line with spot prices than has
generally been the case in the past. In mid-October the
spot price for WTI was around $55 a barrel while the two
year forward price was around $44. Indeed even the
longest dated NYMEX contract for delivery of oil in 2010
was trading as high as $39, although this in particular is a
very thinly traded market.
On the other hand the majority or consensus of
oil market forecasts continue to look for prices to
gradually trend lower from current peaks, although likely
staying above $30 for at least the next two years. While
not underestimating the strength of demand and the reality
of limited capacity, it can be noted that world production
has in fact recently risen somewhat faster than demand
and that OECD crude stocks are in the middle of their
historic range. An additional 1.4 mbd of non-OPEC
supply and 0.4 mbd of OPEC supply are expected to enter
the market in the fourth quarter, with further capacity
increases expected in 2005. Indeed Iraq surprised the
market with an 0.5mbd production increase in September.
Demand pressures have been highest for light sweet
crudes, but these should abate with the end of the U.S.
driving season.10 More generally demand pressures
should also ease as consumers adjust behavior and
conserve in response to higher prices. It is notable that
China’s oil imports after increasing 39 percent in the first
eight months of 2004, and by 37 percent in August, grew
by only 5.7 percent in September.
The Bank’s current outlook is in line with the
general consensus view; it looks for prices to average $39
a barrel in 2004 and $36 in 2005, before falling to $32 in
2006 and $26 in the longer term. But it is almost needless
to add that in the present environment all oil projections
are even more than normally subject to major
uncertainties.
10
International Energy Agency. Oil Market Report. September
and October 2004.
19
Oil shock impacts and policy responses
It should be said that since this year’s oil price
increase is principally the result of rising demand, it is a
sign of global economic strength rather than weakness.
Nevertheless, with demand running up closer to oil supply
constraints, rising prices will serve as a mechanism to
slow world growth from its heated pace in 2004. For the
East Asia region higher prices will directly curb incomes
in the majority of larger economies because they are net
oil importers. East Asian economies will also be affected
by the impact of higher oil prices on the main export
markets in the developed world or OECD countries,
which overall is an oil importing region.
An analysis of the impact of high oil prices by
the International Energy Agency (IEA) estimates world
output would fall by 0.5 percent in a scenario in which oil
prices average $35 a barrel over the whole period 2004-
08, as compared to a base case scenario of $25 a barrel.11
Under this scenario higher oil prices lead to a transfer of
$150 billion a year from oil importing to oil exporting
economies. (The increase in the oil import bill for
Emerging East Asian economies will be around $20-25
billion a year in 2004-05). This is likely to have a net
negative effect on world aggregate demand and income,
because, while oil importers suffer an income loss and are
expected to cut domestic demand, oil exporters are
expected, as in earlier oil shocks, to save a significant
fraction of their increased income, at least initially. In
importing countries, on the other hand, the adverse impact
effect of the income loss may be exacerbated by structural
rigidities that lead to adjustment costs in the form of
temporarily higher unemployment of labor and other
resources. Inflation will rise, although the extent and
duration of the rise will depend on the extent to which
labor market rigidities and macroeconomic conditions
lead to a price-nominal wage spiral. The real exchange
rate of oil importers would typically depreciate.
As regards the impact on OECD economies, one
mitigating factor is that these economies have become
more energy efficient since the oil shocks of the 1970s
and early 1980s. The amount of oil used to produce a unit
of real GDP in the OECD halved between 1973 and 2002,
while these countries’ net oil imports fell by 14 percent.
Nevertheless as a group OECD economies still import
over half their oil needs, with net oil imports amounting
to $260 billion or about 1 percent of GDP in 2003. The
IEA study estimates aggregate OECD output would fall
by 0.4 percent relative to the base case in the first two
years of the scenario, with the impact somewhat less in
the U.S. and somewhat higher in the Euro zone.
The impact of the oil shock is expected to be
higher among developing countries, due to their generally
greater dependence on oil imports and higher
11
IEA. Analysis of the Impact of High Oil Prices on the Global
Economy. May 2004.
 East Asia Update 20

consumption of oil per unit of GDP. As indicated in
Table 5, net oil imports amounted to 4-5 percent of GDP
even before the recent price increases in economies such
as Korea. Philippines and Thailand. Energy intensity
among East Asian economies (measured here as BTUs
per 1995 dollar of GDP at market prices) is generally
higher than among the developed economies because the
share of industry in GDP is higher while that of services
is lower. Energy intensity among the larger Asian
economies shown in Table 5, for example, is about twice
the average among the G7 economies, and in most cases
has been rising over the last decade.
rise in inflation caused by higher oil prices being passed
into further wage and price increases, leading to a
permanent or longer term rise in inflation. At the other
extreme policy makers could focus exclusively on
neutralizing the inflationary impact of the oil shock, for
example by trying to stabilize overall or core inflation
rates. That could generate significant increases in
unemployment.
Exhibit 17
East Asia - CPI Inflation
(2001 Q1 to 2004 Q3)

China
14
Indonesia
Table 5. Energy Imports and Consumption
Malaysia
Net Oil Exports Energy Consumption Philippines
2002 (per dollar of 1995 GDP) 10 Korea
As % BTU per Avg. % Ch. Thailand
Mtoe*
of GDP dollar 2002 1990-02

China -61.7 -0.9 35764 -5.2 6

Indonesia 8.6 4.2 20331 2.1
Korea -109.0 -4.7 12340 0.8
Malaysia 11.9 4.5 20897 1.6 2
Philippines -13.1 -3.9 12560 1.2
Thailand -33.1 -5.1 16701 3.3
2001 Q1 2001 Q3 2002 Q1 2002 Q3 2003 Q1 2003 Q3 2004 Q1 2004 Q3
Japan -204.3 -1.6 3876 0.4
-2
Source: IEA Energy Balances, World Bank, U.S. Energy
Information Administration. * Mtoe - Million Tons of Oil
Equivalent.

In practice policy makers will be concerned

Output in the Asian region as a whole (including
India) is estimated to be reduced by 0.8 percent in the IEA
study, while inflation increases by 1.4 percent. The
estimated decline for China is also estimated at 0.8
percent, with somewhat larger output losses in the more
oil dependent economies of the region. As Exhibit 16
indicates, East Asian CPI inflation rates did indeed pick
up markedly in the second and third quarters of 2004. The
median inflation rate in the 9 largest economies rose from
1.6 percent in the last quarter of 2003 to just over 3
percent in the third quarter of 2004. Prices were boosted
not only by higher oil but also by higher food prices,
reflecting recent substantial increases in international
agricultural commodity prices, and in some cases by poor
domestic harvests.
For policy makers in oil importing economies
the oil price shock has consequences for which there are
few easy or straightforward policy responses. The oil
price increase will tend to both increase inflation as well
as reduce real income and create more unemployment. At
one extreme, policy makers could focus policy
instruments, in particular monetary policy, on trying to
neutralize the demand reducing effect of higher oil prices,
thereby stabilizing unemployment. This would risk the
about both inflation and unemployment, and so will have
to weigh the gains from policy actions that move one of
these variables closer to its target against the losses from
the other variable moving away from target. This means
policy makers may have to accept some temporary
increase in both inflation and unemployment while
keeping close watch that neither diverges too far from its
desired target value. The particular weight policy makers
attach to the inflation or unemployment target is likely to
be affected by the cyclical position of the economy before
the oil shock. In several East Asian economies the strong
growth of the last 1-2 years, the resulting reduction in
excess capacity and the low prevailing level of real
interest rates all suggested the need for tighter monetary
policies, a process that has already begun in China, and
more recently in Thailand. With this kind of background
of strong aggregate demand pressures, policy makers
might initially be more concerned about the inflationary
impact of the oil price rise, and so may wish to retain a
bias towards further tightening of monetary policy, while
keeping a close eye on the evolution of output and
employment. Macroeconomic adjustment among the oil
importers will also be assisted by some depreciation of
the real exchange rate (relative to where it would have
East Asia Update 21

been without the oil price increase), something that will But, on the other hand, windfall gains have quite often
be easier to accomplish in economies with a flexible been squandered, with few lasting gains for the public,
exchange rate regime. and could even lead to countries being worse off in the
long run. In oil rich Nigeria, for example, real per-capita
Policy makers in the oil and non-oil commodity
GDP in 2003 was no higher than in 1970, while the
exporting economies of the region will face a somewhat
economy was saddled with high debt. Policy makers in
different set of problems in dealing with the windfall
the small low-income East Asian economies like
gains generated by high oil and non-oil commodity prices.
Mongolia, Papua New Guinea and Timor-Leste that are
Exhibit 18 estimates the initial impact effect of both the
receiving large windfall gains this year may therefore find
oil and non-oil commodity price increases on several
it useful to look at the experience of other countries in this
economies in the region. A small economy such as Papua
area.
New Guinea, a net exporter of both oil and non-oil
commodities, could experience a windfall income gain A good starting point is that commodity prices
around 10 percent of GDP, while larger net exporters of are very volatile, so most commodity based windfall gains
both types of commodity like Indonesia, Malaysia and are only temporary – boom will likely be followed by
Vietnam could see windfall gains of perhaps 2-3 percent bust. However policy makers in developing countries
of GDP. An economy like Mongolia which is a net oil often mistakenly act on the assumption that a temporary
importer could also experience a large net income again income gain is permanent, consuming it immediately,
because the price of its main mineral export, copper, is allowing it to be misappropriated through corruption, or
expected to have risen almost 60 percent for 2004 as a spent on domestic investments with low rates of return.
whole. As Box 1 explains, if improperly managed, such Even worse, it is sometimes used to underpin more
large windfall gains can have a variety of unexpected foreign borrowing, which is then used for these purposes
economic ill effects. on an even wider scale. The real exchange rate often
appreciates, squeezing profitability in the non-natural
resource export sector or the import competing sector of
Exhibit 18 the economy. When commodity prices fall and the bust
Income gains/losses due to selected arrives, however, the country is left with heavy debts but
commodity price changes(As % of GDP) few offsetting assets, weaker and more corrupt
10.0 institutions, an overvalued exchange rate and
Assumed Price Changes (%): uncompetitive industries that may never fully recover.
2004 2005 Severe macroeconomic adjustment with sharp falls in
8.0 Oil 34.9 -7.7 living standards and growth then follow.
2004 Rice 16.4 -4.3
2005 Edible Oils 14.4 -10.8 The general rule for temporary windfall gains is
6.0 Iron Ore 18.6 8.2 that welfare over time can be improved by saving most of
Copper 58.8 -6.2 the gain and using the returns on this investment to enjoy
Rubber 18.1 -10.4
a smoother and somewhat higher level of consumption
4.0
over many years. Since the government is commonly the
‘trustee’ for the country’s resources, it is primarily
2.0
through fiscal policy that this rule can be implemented,
with the government smoothing expenditures over time to
avoid the need for large disruptive adjustments.
0.0
A variety of fiscal approaches to managing
booms have been attempted. Before getting to specifics,
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it is worth stressing that the success of any policy will

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depend on the incentives for its politicians and

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bureaucrats to actually implement it, rather than to find a

Box 1. Managing commodity windfall gains
It is hard to imagine that when rising commodity
prices sharply boost the income of a poor economy –
giving it a large windfall gain - that could turn out to be a
bad thing. If the gain is well managed it should not. At
different periods economies like Indonesia, Malaysia,
Chile, Botswana and Norway have in fact been able to
manage their natural resource wealth to foster
development and broad welfare gains for the population.
way around it, as well as on the quality of its budgetary
and other institutions. Some degree of public financial
accountability is needed simply to know what has come in
and where it is going. Decomposing the fiscal accounts
into a natural resource and a non-resource balance is also
important for designing good policies. Broad institutional
reforms to strengthen the quality and transparency of
fiscal decision-making are thus an essential foundation.
Many countries have found the simplest
expedient to boost savings (after paying off any foreign
commercial debt) is to establish some form of
East Asia Update
stabilization or savings fund. Commodity revenues are
paid into the fund when commodity prices exceeds a
certain reference level (as with Chile’s Copper
Stabilization Fund), or according to a fixed proportion (50
percent of oil revenues for the Alaska Permanent Fund),
with the funds being used to accumulate a portfolio of
long term financial assets. Of course all this will only
matter if the government actually constrains its spending
within the limits implied by the rule (rather than ‘saving’
revenues in the fund, on the one hand, and continuing
high spending and foreign borrowing on the other!)
Julia Devlin and Michael Lewin. “Managing Oil Booms
and Busts in Developing Countries”. In World Bank
(2004). Managing Volatility and Crises: A Practitioner’s
Guide.
Trade Policy Developments
This has been a banner year for world trade. It is
estimated that world trade volumes will increase by over
11 percent in 2004, almost twice the trend rate of growth
in 1990-2003. East Asia has played a central role in this
year’s trade boom, not only as a key supplier of import
demands elsewhere in the world, but as itself a new major
source of import demand. This year China alone is
estimated to have contributed around 15 percent of the
overall increase in world imports volumes, while
Emerging East Asia as a whole is estimated to have
contributed somewhere between one third and 40 percent
of world trade growth.
Yet, even as trade itself has boomed, there has
been a nagging worry that the multilateral system of rules
upon which the expansion of trade ultimately rests is
under pressure, and might erode if progress fails to be
made on the present Doha round of global trade talks.
Such concerns were heightened by the failure to reach
agreement at last year’s Cancun meeting of the WTO, but
they may be relieved by the WTO General Council’s
adoption of a negotiating framework for the talks at its
meeting of 27-31 July. This is of general importance for
East Asia, which studies find to be among the principal
beneficiaries of a successful new global trade round. The
start of 2005 will also see another important trade policy
development, the end of the Multifiber Agreement system
of quotas on trade in garments. Box 2 below considers
the consequences.
The WTO Framework Agreement
The WTO General Council meeting agreed on a
negotiating framework for the Doha trade negotiations; its
importance lies in getting the talks back on the road,
though it must be admitted that most of the hard work of
arriving at specific detailed agreements still lies ahead.
There were four principal points:
• Agricultural trade. The agreement lays out a road
map for the elimination of agricultural export
22
subsidies, better disciplines on export credits and state
trading enterprises, and introduction of new
commitments to reduce trade-distorting farm subsidies,
with deeper cuts in countries with higher subsidies and
significant cuts early on. The impact on East Asia of
this part of the agreement may be limited because most
of the region is not a major exporter or importer of
some of the commodities most heavily subsidized in
the developed world, such as beef, dairy, wheat or
corn. On the other hand there was no specific
agreement on rice, the most important agricultural
commodity in the region. Even though it would
generate large welfare gains for their own consumers,
there seems little likelihood that East Asian countries
that heavily protect their domestic rice producers will
allow improved access to domestic markets. One issue
of concern for East Asian economies is tariff escalation
in developed economies, whereby higher tariffs are
imposed on more highly processed products, thereby
constraining diversification into food processing by
developing economies. Another is the use by
developed economies of high and non-transparent
specific duties on agricultural and agro-processed
products. Even though the framework agreement
contains no specific plan for these issues, it would be to
East Asian countries’ advantage to push for progress
on them.
• Non-agricultural market access. The framework
agreement sets the stage for the pursuit of tariff cuts
according to a non-linear formula and the reduction or
elimination of non-tariff barriers. Although many
issues are still open concerning the next steps in the
NAMA negotiations, there is clear understanding about
the importance of achieving progress in this area,
which accounts for more than 60 per cent of
international trade.
• Services. WTO members agreed to intensify efforts
to increase market access for services. Revised offers
must be tabled by May 2005. East Asia has lagged
behind other developing regions in opening its services
markets, even though evidence suggests that the
productivity gains associated with more efficient
services are particularly high. International trade
agreements in services can offer East Asia several
benefits: increasing the credibility of reforms as the
result of binding international commitments, and
facilitating regulatory cooperation. Improved access to
markets abroad can also be important.
• Trade facilitation. There was also agreement to
initiate negotiations in this area, The agreement calls
for less red tape, more efficiency in the movement of
goods across borders, and clarification and
improvement of WTO rules governing customs
procedures to expedite the movement, release, and
clearance of goods. In East Asia port and
infrastructure bottlenecks are one of the most
significant factors raising costs for potential exports.
East Asia Update
Red tape and an antiquated approach to customs
procedures in some countries can equal a 5-15 percent
tariff.12 Logistics improvements, essential for moving
up the value chain, have very high payoffs in East
Asia. High-value agriculture (flowers, fruits, seafood)
and manufacturing (electronics) demand sophistication
not only in production by also in logistics handling.
Timeliness matters, and a fast, reliable, supply chain is
essential. In East Asia, the key logistical bottlenecks
seem to be high internal land transport costs and port
logistics. This is in sharp contrast to the high
efficiency of external transport, with trans-Pacific
shipping costs declining sharply over the past decade.
The WTO framework agreement, which focuses
mainly on border issues, is narrower than the broader
trade facilitation agenda that East Asian countries are
concerned about. Yet, it can serve as an impetus to
foster their broader reform agenda.
Box 2. The End of Quotas on Garment and Textiles
Trade
New Year’s day 2005 will see the final phasing
out of the 30 year old system of quotas on world garment
and textiles trade (first under the 1974 Multifiber
Agreement and then under the transitional 1995
Agreement on Textiles and Clothing). East Asian
economies, which exported over $100 billion of the total
$226 billion world trade in garments in 2003, will be
among those most affected by the change.
China, whose exports are the most tightly restricted by
the present quota system, will be a principal gainer, due to
low unit labor costs, economies of scale (which are
especially important in textiles production), the
established finance and marketing networks of Hong
Kong-based parent companies, and vertical integration
between its garment, textiles and cotton growing sectors.
A recent study estimates that China will increase its share
of U.S. garment imports from 16 to 50 percent as a result
of quota removal, and from 20 to 29 percent in the EU
import market. (Nordas, 2004).
Vietnam is a potential winner. Its garment exports have
recently grown at a 30-40 percent annual pace to exceed
$3.5 billion in 2003. With labor costs among the lowest
in the region and productivity levels quickly rising to
those of China, Vietnam is very competitive in garments.
However, since it is not yet a member of the WTO, it may
continue to face continued volume restrictions in the US,
EU and Canadian markets while restraints are lifted on
others. If Vietnam achieves its planned accession to the
WTO in 2005 or 2006, this will be a temporary setback.
Cambodia, however, could be quite adversely affected.
Garments contribute 76 percent of exports and all of
12
K. Krumm and H. Kharas (eds.). “East Asia Integrates”.
Oxford University Press and the World Bank, 2004.
23
manufacturing employment, but are closely correlated
with those sub-categories where China is presently most
quota constrained. Productivity levels are less than in
China, offsetting lower wage levels. The industry is also
hampered by longer lead times and a limited domestic
textiles production capacity. One potential comparative
advantage however is Cambodia’s adherence to ILO-
monitored Core Labor Standards, which are viewed
favorably by some classes of buyers. Cambodia and a
number of other Least Developed Countries have also
asked for preferential duty-free access to the U.S. market,
which otherwise imposes a 15 percent duty on garment
imports from WTO members.
Even after the end of the ATC, however,
exporters are still likely to face various types of
protection, including ordinary import tariffs and so-called
safeguard or anti-dumping measures. The U.S, has
already applied one year restraints on three Chinese
knitted products, with more likely to follow, while the
E.U. is studying measures against synthetic clothing from
China.
On the whole, however, there will be a much
more fiercely competitive market place for garments and
textiles. Given the importance of economies of scale,
vertical integration and low labor costs, some speculate
that the textile and garment industry will evolve to a two-
tier structure – one, occupied by China and India, will
produce the vast majority of low-cost garments, and
another tier will be occupied by a number of producers
which serve niche markets and help firms diversify the
risk of concentration on China and India. Such niches
may be defined by brand characteristics, corporate social
responsibility, rapid turnaround or other features. Firm
location decisions will in part be determined by the pace
at which countries establish the right investment climate
for a more flexible, technology-driven sector. Success
will depend on good infrastructure and logistics, quick
turnaround times, openness to trade, efficient trade
facilitation services, low regulatory burdens, flexible
labor markets and creating a risk environment that
encourages firms to invest in skill development and
technology upgrading.
H. Nordas. (2004) The Global Textile and Clothing
Industry post the Agreement on Textiles and Clothing.
W.T.O. (September).
Capital markets and global imbalances
The second half of 2003 saw a large reflow of
private capital flows to emerging markets for the first
time since the financial crises of the late 1990s, led by
flows of portfolio and equity bond flows. International
investor demand for emerging market securities appears
to have been bolstered by growing confidence about the
global recovery and the improving environment for
East Asia Update 24

developing economies, improved perceptions of the

U.S. $ Interest Rates - Short and Long Term
general quality of policies in these economies, and by the
low level of interest rates in the developed world. Partial 5
data for 2004 suggest that flows to emerging markets
have taken a pause this year – continuing at roughly the
same levels reached in the second half of 2003, but not
4
growing as they did last year. Exhibit 19 below shows the
total of gross bond and equity issues and commercial
bank borrowings by emerging markets as a group and by
Asian emerging markets in particular. Gross flows on this
3
definition reached an annualized pace of about $250
billion in the second half of 2003 and remained at about
that level in the first three quarters of 2004. Flows to 10-Yr Treasury Note
Asian markets followed roughly the same pattern. 2 LIBOR
Exhibit 19 Spread

Gross Capital Flows to Emerging Markets

1
(US$ Bill. at annual rates)

1/ 1/04

3/ /04

04
300

1/ /04
2/ /04
3/ 04

3/ /04
4/ /04
4/ /04
5/ /04
5/ 5/04
6/ /04
6/ /04
7/ 9/04
7/ /04
8/ /04
8/ 3/04
9/ /04
9/ /04
/1 4
10 7/0
2/
/
1
16
31
15

16
31
15
30

30
14

14
29

28
12
Emerging

1/

Markets
Asia
200
100
0 billion, including significant bond issues by Malaysia and
2002 2003 H1 2003 H2 2004 H1 2004 Q3
Source: World Bank DECPG Finance Team
The leveling out or pause in emerging market
flows this year is consistent with other trends in the
international economy. As noted earlier in this report,
uncertainties about the outlook for the global economy
have tended to multiply this year. In addition, U.S.
monetary policy began tightening at mid year, with the
federal funds rate rising from 1 percent to 1.75 percent at
present, while the 6 month US dollar LIBOR, the most
commonly used benchmark for pricing commercial bank
loans, has increased by about 100 basis points. The yield
on the 10 year U.S. Treasury Note – the benchmark for
pricing bonds – also rose in the second quarter, before
falling back over the rest of the year, as concerns
increased about a slower pace of growth in the U.S.
economy going forward. (Exhibit 20. Note also the
falling spread between long and short term interest rates,
which is often viewed as a predictor of slower growth
ahead).
Exhibit 20
2
Higher U.S. interest rates can be expected to
have some dampening effect on flows to emerging
markets, while, on the other hand, the relative mildness of
the increase is consistent with the level of flows only
flattening out rather than falling this year. Indeed,
consistent with the pullback in longer term interest rates
during the third quarter, emerging market flows appeared
to be strengthening once more towards the end of the
year. Gross emerging market flows in September were
estimated to have jumped to $31 billion, up from $14
billion in August, those to Asia increasing from $3 to 7
the Philippines.
Other indicators confirm that emerging capital
markets have so far taken a relatively relaxed view of
increased global uncertainties and the tightening in U.S.
monetary policy. Spreads on some sectors of emerging
market debt – Latin America for example – did indeed
rise modestly in the first half of the year, but have fallen
back since then. Spreads on East Asian eurobonds, which
fell sharply in 2002 and 2003, have been largely stable in
2004, or seem to have been driven mainly by domestic
policy or political developments. (Exhibits 21 and 22).
Spreads for China, Korea, Malaysia and Thailand fell
below 100 basis points in mid-late 2003, and have stayed
below that level in 2004. In the Philippines spreads fell
by about 100 basis points after Mrs. Macapagal-Arroyo
won re-election in the May presidential elections. In
Indonesia spreads also spiked briefly by about 100 basis
points in July because of uncertainties about the
presidential elections there, but have fallen back since
then.
Exhibit 21
East Asia Update 25

Exhibit 23
Eurobond Spreads 1/2001 - 11/2004
900
Stock Market Indices (Jan 2003 = 1)
Korea 1.7
Philippines
Indonesia Singapore
Philippines Hong Kong
1.5
600

1.3
300

1.1

0
0.9
01

20 05

20 09

20 01

20 05

20 09

20 01

20 05

20 09

20 01

20 05
09
M

M
01

01

01

02

02

02

03

03

03

04

04

04

4
01

02

03

04
01

02

03

04
00

00

00

00
20

20

20

20

20

20
20

20

20

20
-2

-2

-2

-2
p-

p-

p-

p-
n-

n-

n-

n-
ay

ay

ay

ay
Se

Se

Se

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Ja

Ja

Ja

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M

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Exhibit 22
Exhibit 24
Eurobond Spreads 1/2001 - 11/2004
300 Stock Market Indices (Jan 2003 = 1)
China
2.1 Indonesia Malaysia
250
Malaysia Thailand Korea
(left) 1.9
200 Thailand
1.7
150
1.5

100 1.3

50 1.1

0.9
0
0.7
01

05

09

01

05

09

01

05

09

01

05

09
M

M
01

01

01

02

02

02

03

03

03

04

04

04

01

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01

02

03

04
1

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00

00

00
20

20

20

20

20

20

20

20

20

20

20

20

00
20

20

20

20

20
20

20

20
-2

-2

-2
-2
-

p-

p-

p-

p-
n-

n-

n-
ay

ay

ay

ay
n
Se

Se

Se

Se
Ja

Ja

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The recent movement of East Asian stock market

prices is also consistent with a mild pause in private
capital flows. Stock prices surged in 2003 with
strengthening growth, the improving financial health of
corporations in the region, and the return of foreign
portfolio capital inflows. Stock market prices in Thailand
doubled over the course of 2003, rose 60-70 percent in
Indonesia and by 30-40 percent in most other economies
(Exhibits 23 and 24). Prices generally peaked in January-
February this year, then pulled back by 5-10 percent in
the second quarter, before starting to move higher once
more in the third quarter.
East Asia and Global Imbalances
As was discussed in more detail in the April
2004 World Bank East Asia Regional Update, Emerging
East Asia has tended to run large overall balance of
payments surpluses in recent years, as a result of its
substantial current account surpluses since the 1997-98
financial crisis, as well as the more recent resurgence of
private capital inflows.
East Asia Update 26

Table 6. Current Account Balances (US$ Bill.) year or 13 percent of GDP by 2010.13 Non-U.S. residents
would of course become unwilling to hold ever growing
Annual Four-Quarter Sum
volumes of U.S. debt long before then. Unpredictable
2003 2003 2004 2004
changes in investor sentiment and risk appetite could then
2001 2002 2003 Q3 Q4 Q1 Q2
result at some point in a very large dollar devaluation,
USA -386 -474 -531 -530 -531 -537 -568 steep U.S. dollar interest rate hikes and a sharp
adjustment in U.S. aggregate demand and imports, a
Japan 88 112 136 124 136 154 163 severe recession in short.
Euro Area -15 52 29 26 29 42 46
Exhibit 25
East Asia 1/. 91 125 164 .. .. .. ..
East Asia 2/. 96 120 144 131 144 138 135 East Asia - Foreign Reserves
South East Asia 22 27 32 33 32 31 29 (US$ Bill.)
Indonesia 7 8 7 7 7 5 4
1,200 China Indonesia
Malaysia Philippines
Malaysia 7 8 13 13 13 14 14 Korea Taiwan (China)
Philippines 1 4 3 4 3 4 5 1,000 Singapore Thailand
Hong Kong
Thailand 6 7 8 8 8 8 7 Change in reserves from year
East Asia NIEs 52 63 86 79 86 90 92 800 ago (US$ bill.)
Hong Kong 10 13 17 17 17 15 14 2000: 47 2002: 154
Korea 8 5 12 7 12 20 25 2001: 69 2003 234
600
2004:7 251
Singapore 16 19 28 27 28 27 28
Taiwan, China 18 26 29 29 29 27 26 400
China 17 35 46 .. .. .. ..
China trade bal 23 30 25 19 25 18 14
200
Note 1/. Inclusive of China current account. 2/. Inclusive of China
trade balance.
0
Indeed, as Table 6 indicates, Emerging East Asia
Ju 996

Ju 997

Ju 998

Ju 999

Ju 000

Ju 001

Ju 002

Ju 003

Ju 004
Ja 996

Ja 997

Ja 998

Ja 999

Ja 000

Ja 001

Ja 002

Ja 003

4
00
(and Japan) are among the major suppliers of financing
1

2
l-1

l-1

l-1

l-1

l-2

l-2

l-2

l-2

l-2
n-

n-

n-

n-

n-

n-

n-

n-

n-
for the main macroeconomic imbalance in the world
Ja

economy at present, the U.S. current account deficit. The

U.S. deficit amounted to $568 billion in the year to the
second quarter of 2004, the largest part of the counterpart
to which were surpluses of around $300 billion in East
Asia and Japan. The Emerging East Asian economies
alone had current account surpluses of about $138 billion
in the year to the second quarter of 2004. Combined with
net inflows on the capital account, these economies
accumulated over $250 billion of official foreign
exchange reserves in the year to July 2004. Total reserves
of the 9 economies reached over $1.2 trillion, including
significant holdings of U.S. government debt. (Exhibit
25). According to the U.S. Treasury Department, six
Asian economies (China, Hong Kong (China), Korea,
Singapore, Taiwan (China) and Thailand) held $381
billion of U.S. government securities in August 2004,
while Japan held $722 billion. These Asian economies
thus held $1.1 trillion out of a total $1.8 trillion U.S.
official debt held by non U.S. residents, which in turn was
about one quarter of the total $7.3 trillion U.S. federal
public debt outstanding.
The recent sharp deterioration in the U.S. current
account deficit has drawn renewed attention to the need
for adjustment of global macroeconomic imbalances.
Studies suggest that on unchanged policies and with no
further dollar depreciation, the U.S. deficit would
continue to increase, reaching perhaps over $1 trillion per
To adjust global imbalances, policy makers
around the world – and, given the nature of the
imbalances, policy makers around the Pacific Rim in the
first instance – need to consider the means of achieving a
less disruptive ‘global rebalancing’ of macroeconomic
imbalances. A part of this obviously depends on U.S.
policy efforts to boost U.S. national savings by reducing
its budget deficit. But global imbalances have also
increased in recent years because of the sharp fall in
domestic investment in many East Asian economies after
the regional financial crisis, especially in the NIEs. As
Exhibit 26 shows, the ratio of investment to GDP
increased between 1997 and 2003 in only one economy,
China. It fell in every one of the other main economies of
the region, ranging from a fall of 6 percentage points of
GDP in the Philippines to one of 26 percent of GDP in
Singapore. The average change across the 9 economies
was an 11 percent fall in investment to GDP ratios.
Savings ratios also declined, but by much less, on average
falling by about 3 percent points of GDP. There was
13
Catherine L. Mann. “Managing Exchange Rates:
Achievement of Global Re-balancing or Evidence of
Global Co-dependency?” Business Economics. July
2004.
http://www.iie.com/publications/papers/mann0704.pdf
East Asia Update 27

therefore a net swing towards surplus on the external contribution to adjustment can come from further trade
current account balance of about 8 percentage points of liberalization in the region, especially in the area of
GDP, primarily due to lower investment. services, where liberalization in East Asia has tended to
lag other regions.

Exhibit 26 Exhibit 27
Changes in Savings and Investment Exchange Rates vs. US$
(1997-2003; % of GDP) (Rise=appreciation, Jan 2002=1)
1.500
Indonesia
Thailand Korea
1.400 Philippines
Taiwan, China Thailand
Yen
Singapore Euro
1.300
Taiwan, China
Philippines
1.200
Malaysia

Korea 1.100
Indonesia
1.000
Savings Hong Kong
Investment China 0.900

Ap 02

Ap 03

4
2

3
2

4
2

4
0
00

00
00

00

00
00

00

00
20

20

20
-35 -25 -15 -5 5

-2

-2
l-2

l-2

l-2
r-2

r-2

r-2
n-

n-

n-
ct

ct
Ju

Ju

Ju
Ap
Ja

Ja

Ja
O

The recent upswing in East Asian investment
therefore makes a contribution towards the global
adjustment process. As Table 6 above shows, the East
Asian current account surplus has started to fall in 2004
(although the change is disguised to some extent by the
recent sluggishness in the Korean economy, which has led
to a sharp increase in Korea’s current account surplus).
China, which has already made a contribution to
adjustment as a result of its strong recent investment and
import boom, may make less of a contribution for some
time, as it attempts to reduce the over-heated pace of
investment in the country. The issue will then become
fostering more robust and sustained investment spending
in the other Asian economies. Continued adjustment in
exchange rates is also likely to play a role in the overall
macroeconomic adjustment of the region (though not
perhaps in every individual case). While in a number of
cases such as China, Hong Kong and Malaysia, nominal
exchange rates have remained constant against the dollar
as a result of formal pegs or tight bands, in most other
cases exchange rates have generally appreciated against
the dollar over the last 2-3 years, rising by 5-10 percent in
Thailand and Taiwan, China, and 10-20 percent in
Indonesia, Korea and Japan. A third significant
O
Domestic trends and policy challenges
The preceding discussion suggests that most East
Asian economies have enjoyed an excellent economic
recovery over the past two years, supported both by the
strength of cyclical factors in the external environment, as
well as improving macroeconomic, financial and
corporate sector developments at home. This section
looks at some of the domestic trends more closely. In
addition, since the preceding discussion also suggests that
East Asian economies are slowing from their recent
cyclical peaks and external conditions are becoming more
uncertain, it also considers the policy efforts and reforms
that may be helpful to policy makers in the region as they
seek to negotiate the uncertainties and cautiously steer
economies from the sharp cyclical upswing of the last 2
years onto the path of sustained medium term expansion.
One useful focus may be to remedy domestic policy
weaknesses that are themselves sources of uncertainty,
while strengthening policies and institutions that help
alleviate risk and uncertainty.
East Asia Update
Exhibit 28
Public Sector Debt
(As % of GDP)
110
Gross Debt
90 Net of Reserves
70
50
30
10
2001 2004 2001 2004 2001 2004 2001 2004
Thailand Malaysia Indonesia
Source: National sources, IMF, World Bank. Note: Indonesia is
central government.
Fiscal Policy
The years after the 1997-98 regional financial
crisis saw substantial increases in the levels of gross
public sector debt among the five crisis affected countries,
-Indonesia, Korea, Malaysia, Philippines and Thailand.
Public debt rose as a result of governments shouldering
the cost of recapitalizing and restructuring insolvent
financial institutions, the calling of other contingent
claims on government, wider public sector deficits and
real depreciation of currencies (although, of course, the
specific contributions of these individual causes varied
widely across countries). The average of gross public
sector debt in these economies rose from about 30 percent
of GDP in 1996 – which was rather less than the average
level of public debt among all emerging market
economies at that time - to about 60 percent in 2001,
about the same as the emerging market average.
As Exhibit 28 indicates, gross public debt levels
in Malaysia have been stable in recent years at a little
over 60 percent of GDP, while falling recently to around
45 percent in Thailand and a little over 50 percent in
Indonesia.14 In recent years most East Asian economies
have also run current account surpluses and accumulated
large official foreign exchange reserves. Viewed net of
official reserves, public debt levels are estimated at a little
14
Public debt to GDP in Indonesia was previously
reported at around 70 percent. However, a recent revision
of the national income accounts has raised estimates of
GDP, reducing estimates of debt to GDP ratios.
28
less than 20 percent of GDP in Malaysia and Thailand,
and around 40 percent in Indonesia.
In Indonesia the lower trend in public debt to
GDP ratios over recent years has been supported by
generally cautious fiscal policies; the central government
overall deficit has generally been held at less than 2
percent of GDP (Exhibit 29 below), with the primary
balance running a surplus. The overall deficit for 2004 is
estimated at 1.3 percent of GDP, although both revenues
and expenditures have been boosted by higher oil prices.
Obviously, oil and gas revenues are up, but higher market
prices for fuel have also pushed the cost of fuel subsidies
sharply higher, from 1.7 percent of GDP in 2003 to an
estimated 3 percent of GDP in 2004, a hefty chunk of
total government expenditures which are 21-22 percent of
GDP. Restructuring the fuel subsidy mechanism is one of
the most important policy challenges facing the new
government. Fuel subsidies encourage inefficiently high-
energy consumption in several East Asian economies
Philippines
including Indonesia, while having a regressive effect on
income distribution. A reduction in the subsidy combined
with targeted compensation for the poor would free up
significant resources for pro-poor development spending
and for fiscal consolidation, while encouraging greater
energy conservation and efficiency.
In Malaysia fiscal policy was mildly
expansionary in 2000-03 as the government sought to
counter adverse shocks and uncertainties in the external
environment. In 2003 an Economic Stimulus Package
sought to counteract adverse shocks emanating from the
SARS epidemic and the Iraq War. Central government
deficits ran at 5-6 percent of GDP in 2000-03, although
public sector deficits were much lower, about 1 percent of
GDP or less. (Exhibit 29). With the private economy
recovering strongly, the government has aimed to achieve
substantial fiscal consolidation. The central deficit is
likely to fall to 4.5 percent in 2004, although this would
be over 1 percent larger than the original budget for 2004,
due to rising fuel subsidies. The deficit is budgeted to be
further reduced to 3 _ percent in 2005, through higher sin
taxes and curbs on current and capital spending, although
not in fuel subsidies. In Thailand the central government
and public sector balances moved into surplus in 2002/03
(October-September) with higher revenues responding to
faster growth and more efficient tax administration.
Responding to higher than expected surpluses, the
government introduced a supplementary spending
program in 2003/04, together with a temporary subsidy on
diesel and gasoline. Public investment spending will
grow for the first time since the financial crisis, and is
expected to rise significantly in 2005 and beyond, when
the government is considering a five year program of
large scale public infrastructure projects.
 East Asia Update 29

Exhibit 29 Corporate sector – recent trends and reforms 15

Public Sector Fiscal Balance The profitability and balance sheet position of
(As % of GDP) East Asian firms have continued to strengthen, providing
4
Source: National sources, IMF, World Bank. Note: a more secure foundation for the recent upswing in
Indonesia and Korea are central government investment spending observed around the region.
Ordinary income to sales ratios for listed non-financial
2 firms have risen substantially from their low points in
1998, during the financial crisis, and in cases such as
Korea and Thailand, even from levels before the financial
0 crisis. (Exhibit 30). Underlying the rise in ordinary
2000 2001 2002 2003 2004 2005 income, stronger economic activity has led to some
strengthening of profit margins at the operating income
level. At the same time there has been continued progress
-2
Indonesia
in debt restructuring, which, combined with the low
Malaysia interest rates that have prevailed over the past year and a
Philippines half, has also resulted in sharply lower interest expenses.
-4 Thailand
Korea Exhibit 30
Ordinary Income to Sales
-6 (% - Non-Financial Listed Companies)
15

Public debt issues are much more significant in 10

the Philippines. Gross public debt in the Philippines was
already over 70 percent of GDP in the mid 1990s, and,
even though the country was less affected by the regional 5
financial crisis than others, public debt has continued to
increase through an accumulation of off-budget liabilities,
significant central government deficits, deficits in public 0
enterprises and currency depreciation, reaching over 90 Indonesia Korea Malaysia Philippines Thailand USA
percent of GDP by 2001 and an estimated level over 100
-5
percent by 2004. Even viewed net of official reserves
public debt remained high. The public sector deficit
1996
remained large, at an estimated 5.7 percent of GDP for -10 Source: Worldscope: Sample of Listed
2004. In light of the weakness of the fiscal position, Non-financial companies. 2003 for 1998
President Macapagal-Arroyo announced in August that Indonesia.. 2003
the country is in a fiscal crisis. A package of fiscal -15
measures has been submitted to Congress, including
increases in excise, sin and value added taxes, a tax on
telecommunications, changes in income taxation,
rationalization of tax incentives and measures to Progress on debt restructuring, and equity
strengthen tax collection. The government estimates the infusions has also led to lower leverage ratios, which are
measures would augment revenues by 1.7 percent of now broadly in line with international norms. At the end
GDP, although congressional approval and timing of the of 2003, average debt-to-equity ratios stood at around 1.5
measures remain uncertain. An increase in electric power in Indonesia, and 1.2 in Korea and Thailand.16 However,
tariffs was also approved by the industry’s regulatory while the majority of firms have resolved debt overhangs
body, which should help reduce the public sector deficit and strengthened their financial position, there is still a
by around 0.8 percent of GDP, but will need to be segment of very weak firms across countries in the region.
complemented by other efforts to reduce the losses of the Thus while the median interest coverage ratio of firms has
national Power Company and reform the power sector.
Taken together, these measures could go some way to 15
reducing the growth of public debt, but the Philippines Discussion of corporate and financial sector trends is
would still remain an outlier in East Asia with respect to based on “East Asian Financial and Corporate Sector
the size of its public sector deficit and debt. Developments.” World Bank (2004, forthcoming).
16
Based on a sample of listed companies in Indonesia,
and Thailand. In Korea the ratio refers to the average of
manufacturing firms.
East Asia Update
improved markedly (Exhibit 31), in most countries, about
10-15 percent of total corporate debt is held by firms with
interest coverage ratios of less than 1. (The exception is
Korea, where the weaker firms are now the SMEs, which
generally have lower absolute levels of debt.)
Exhibit 31
Interest Expense to Sales
(% - Non-Financial Listed Companies)
14
Source: Worldscope: Sample of Listed
12
Non-financial companies. 2003 for
Indonesia..
10
8
6
4 control spurious bankruptcy petitions) have been
2 another important innovation, set up as a special chamber
0 complex issues raised in the implementation of the
Indonesia Korea Malaysia Philippines Thailand
Continued efforts to resolve the situation of
weak firms and deal with the remaining stock of
distressed assets can make a significant contribution to
sustaining the present economic recovery and the rebound
in investment. From the perspective of firms,
uncertainties about the conditions for resolution of their
distressed debt cast a pall over prospects for new
investment and financing. From the perspective of banks,
a relatively high continued level of Non Performing
Loans (NPLs) is costly and reduces bank profits. It can
also contribute to risk aversion, reducing banks’
willingness to lend even if they are adequately
provisioned, restricting the scope for real sector growth17.
Since the special debt workout frameworks that were
established in the aftermath of the crisis have mostly been
wound down, progress on corporate restructuring will
increasingly depend on the effective functioning of the
legal and judicial system18. Indeed, most countries in the
region are taking measures to strengthen the legal
17
Some analysis done on banks in Thailand for example,
suggests a negative relationship between banks’ NPLs
and credit growth, even after controlling for banks’
capital positions.
18
In Thailand, the CDRAC voluntary debt workout framework
closed in mid-2003, in Malaysia, the CDRC was wound
down in 2003, and in Indonesia, the JITF closed in
December 2003.
30
framework for bankruptcy, though further progress is
needed, particularly with regard to implementation.
In Korea, for instance, the unified insolvency bill,
submitted to the National Assembly in late 2002 is still
awaiting approval. In Thailand, an amendment to the
Bankruptcy Act aiming to improve the individual
bankruptcy framework was endorsed by the Cabinet, but a
specific time for submission to Parliament has not been
designated. Moreover the amendment does not cover the
1996 corporate bankruptcy framework, which retains
significant weaknesses and loopholes. Actions to lessen
1998
the case backlog in the Civil Courts (such as providing
2003 more budgetary resources and special hours for trials) are
still awaiting approval from the National Judicial
Committee.
In Indonesia, observers agree that the new
Bankruptcy Law adopted after the financial crisis is a
sound one. Amendments to help correct problems in
implementation (seeking, among other things, to better
approved in parliament. The Commercial Court was
of the existing district courts to help deal with the
USA bankruptcy law. Delays in issuing and implementing
regulations designed to insulate the commercial court
from the major problems affecting the judiciary have
meant that it too has acquired some of the same problems
as the wider judiciary, including weaknesses in
administration, and transparency and accountability, and
inadequate funding. However, an updated version of the
Commercial Court Blueprint and action plan for reform
were published in early 2004, covering administration,
transparency, funding and enforcement of court decisions,
and a number of these reforms have recently been
initiated.
In China a new draft Bankruptcy Law covering
private enterprises had its first reading in the National
People’s Congress in June. Creditors or debtors would be
empowered to petition for bankruptcy without having to
seek government approval. In contrast to existing
arrangements, the new draft law gives priority to secured
creditors over workers. While the draft law’s requirement
that any reorganization plan achieve majority approval by
each group of claimants (i.e. secured creditors, workers
and unsecured creditors) could leave reorganization plans
hostage to worker demands, the draft includes a provision
for the court to approve (“cram down”) a disputed plan as
long as specified absolute priorities are met. While
representing a major step forward, the draft law warrants
further review. One clear implication is that the new
Bankruptcy Law will require large increases in the
number and quality of insolvency judges, administrators
and other insolvency professionals.
East Asia Update 31

Financial Sector led them to reduce consumption, which has fallen in every
one of the five quarters from the second quarter of 2003
Banks have also benefited from the acceleration through the second quarter of 2004, sharply slowing GDP
of economic activity over the past one and a half years. growth.
The profitability of commercial banks—as measured by
the rates of return to assets and equity—has improved Exhibit 32
sizably in Indonesia and Thailand, and marginally in the
Philippines and Korea, and remains comfortable in Commercial Banks - Return on Assets
Malaysia. (Exhibit 32) Average risk-weighted Capital (%)
Adequacy Ratios (CAR) have also been above the 8 3
percent BIS norm in all five countries for several years 2000
now, while NPL ratios have continued to decline, 2.5
2002
reflecting, to varying degrees, continued restructuring
efforts, improved capacity of borrowers to repay, and new 2003
2
loan growth (Exhibit 33 and Appendix Tables 9).
2004
Two caveats should be noted however. First, 1.5
despite progress, NPL ratios remain in double digits in
Thailand and the Philippines. The BOT has taken several
1
measures to expedite NPL resolution by Thai banks,
including tightening provisioning requirements on long-
standing NPLs and amending laws to allow the 0.5
government assessment management company (AMC) to
acquire NPLs from private banks and AMCs. However, 0
the amendments have not yet been reviewed by Korea Indonesia Malaysia Philippines Thailand
Parliament. In the Philippines the SPV Law provides tax
breaks and other incentives to encourage financial -0.5
institutions to clear their books of bad assets, but progress
in disposing of these assets has been minimal. So far, only Exhibit 33
a handful of SPVs have been registered. There remains a Commercial Banks - Capital Adequacy
large gap between the valuations placed on these assets by Ratios (%)
banks and investors, making banks reluctant to sell the 25
assets. Strengthening the effectiveness of the SPV Act
with supporting legislation such as the Corporate 2000
Recovery Bill and the Securitization Bill is also essential 20 2002
to provide the necessary environment for distressed asset 2003
resolution.
2004
Second, these aggregate numbers mask 15
considerable differences across groups of banks, and
some segments remain vulnerable. In Indonesia for
instance, the financial position of state banks remains 10
considerably weaker. In Thailand, private banks continue
to be riddled with high NPLs.
5
Rising household debt
One trend and potential vulnerability across
countries in the region has been rising household debt and 0
with it, increases in the share of NPLs from household Korea Indonesia Malaysia Philippines Thailand
lending.
Household debt has grown the fastest in Korea,
especially between 2000 and 2002. Since 2002, the Government policies aimed at stimulating
number of people in default on their debt has risen sharply domestic demand by providing tax deductions and
to reach 3.7 million. Delinquencies on credit cards are the lotteries were a factor contributing to the growth in credit
main factor, following a more than 5 fold expansion in card use. And weakness in supervision allowed credit
credit card debts during 2000-2002. While delinquencies card companies to issue cards without requiring basic
on bank loans remain below 2 percent, delinquencies on information needed to assess credit risk, such as the
credit card debt amounted to 14 percent. Efforts by borrower’s income. Household credit extended by
indebted households to repair their balance sheets have commercial banks amounted to 35.8 percent of GDP at
East Asia Update
the end of 2003, under 60 percent of the total credit
extended to households. The financial institutions and the
government have established a number of channels for
resolving household debts, including establishing
Hanmaeum Finance (the bad bank) to restructure
individual debts, the Credit Counseling and Recovery
service (CCRS) to run an individual workout program for
personal delinquents, private workouts, a personal debtor
recovery system, where the court system will implement a
new rehabilitation procedure, and personal bankruptcies.
Nine percent of the total number of delinquent borrowers
have been resolved so far.
Household debt has also grown in Malaysia and
Thailand, without, so far running into serious difficulties.
Starting from a relatively low base, Malaysian bank loans
to households in the form of mortgages and consumer
loans almost doubled between 1998 and 2003, while
credit card use rose sharply. With the recent emergence
of alternative corporate financing instruments, and the
corresponding reduction in the corporate sector’s reliance
on bank financing, banking institutions have increasingly
focused their lending on the household sector, especially
through the expansion of their credit card business.
Whereas the total stock of banking system NPLs has
declined in recent years, to RM 58.3 billion at end-2003,
reflecting the successful asset recovery efforts of
Danaharta and corporate restructuring, NPLs to
households have risen throughout the period, to RM 19.3
billion. In particular, while NPLs on consumer loans have
declined from their peak of RM 11.2 billion in 2001 to
RM 8.4 billion in 2003, mortgage-related NPLs have risen
by 46 percent since 2001, to RM 10.1 billion. Credit card-
related NPLs have also risen sharply, but their share in
total household NPLs still remains small (3 percent).
In Thailand the share of household loans to total
credit rose to 34 percent in 2003 or by 10 percent over the
past three years, due both to strong growth in household
lending and low credit growth to corporates. This shift
towards household lending has taken place across all
institutions’ growth, although it has been particularly
strong for finance companies. Housing loans continue to
be the major component of household credit and
mortgages have the highest NPL ratio—with inflows into
the pool of NPLs in the personal consumption sector
amounting to B 34 billion in 2003, despite strong
economic growth. Credit card NPLs however, have
remained around 3 percent of credit card loans—much
lower than Korea (14 percent). The Bank of Thailand has
implemented a series of measures to curb excessive
borrowing by individuals. Banks are now required to
disclose on a consolidated basis all penalty fees charged
on missed payments on personal loans. Credit card
regulation was tightened again in April 2004 to require
that the credit be limited to five times the card holder’s
income, increasing the minimum monthly debt servicing
on a credit card balance from 5 percent to 10 percent, and
32
requiring that credit cards which are in arrears for more
than three months be revoked.
Strengthening financial supervision and regulation
Countries are also making progress in
strengthening the financial system in terms of regulation
and supervision. In Indonesia, the central bank and the
ministry of finance have signed a memorandum of
understanding on how to handle banks in financial
difficulties, covering decision-making and coordination
between the two bodies, the provision of a financing
facility; and the source of financing through the issue of
government securities. The Parliament passed a
milestone law on deposit insurance in August 2003. The
new deposit insurance program replaced the existing
blanket guarantee on all banks’ liabilities, and provided
for creating the Indonesian deposit guarantee corporation
(LPS), to insure deposits up to Rp 100 million. The MOU
and the establishment of the LPS mean that the main
elements of a financial safety net are now in place.
Finally Bank Indonesia (BI) also announced a new
regulation to improve the assessment of commercial bank
health. BI will require each bank to conduct a self-
assessment every quarter and submit it to BI for review.
Should the bank score unsatisfactorily, BI will require
bank management to provide action plans for corrective
action.
In the Philippines, legislative amendments to the
charter of PDIC – the deposit insurance agency - were
recently approved, which among other things, restored the
power of the PDIC to examine the books of member
banks and also improved the legal protection for PDIC
staff to some degree. It is also important that the BSP
charter amendments recently filed with Congress should
be enacted and put into effect promptly. The amendments
enhance the central bank BSP’s capacity to deal with
problem banks and facilitate a fast transition to
consolidated risk based supervision and international
supervision standards. The amendments are also expected
to provide better protection against lawsuits for bank
regulators. A MOU was also signed by the BSP, PDIC,
SEC and Insurance Commission (IC), creating a Financial
Sector Forum (FSF), which is expected to provide an
institutionalized regulatory framework for core
supervision and regulation of the financial system.
Another positive development is the progress made
towards establishing a centralized credit bureau, which
the BSP is currently studying in consultation with
stakeholders. The new bureau would maintain
information on both positive and negative aspects of
individual and corporate borrowers’ credit history, unlike
the existing data sharing facilities which records only
negative information.
In Thailand, the BOT has adopted a number
of measures in line with the New Basel Capital Accord,
the full implementation of which is planned for late 2008.
The supervision and examination process has shifted from
East Asia Update 33

transaction testing to reviewing a bank’s risk management

system and process. A policy statement on good
governance was issued in 2002, which requires greater
disclosure from banks, particularly with regard to their
risk profile.
East Asia Update
COUNTRY SECTIONS
Major Economies19
China
Policy measures to cool down the economy
appear to have had some success, but it is too early to call
the end of the investment boom that has become known as
“overheating”. GDP growth eased to 9.7 percent year-on-
year (y-o-y) in the first half of 2004, slightly down from
the 9.9 percent recorded in the last quarter of 2004.
Growth has still been mainly driven by investment,
although retail sales have also remained buoyant. Looking
ahead, we expect GDP growth to ease further, to 9.2
percent for 2004 as a whole, and 7.8 percent in 2005.
Debates continue on the extent and form of
“overheating”, the success of the measures to slow down
investment, as well as on the appropriateness of relying
on administrative measures instead of more market-
oriented tools. After peaking in the first quarter,
investment growth slowed down following administrative
measures that seemed targeted at limiting investments in
specific sectors where the authorities saw excess capacity
to be building up. Fiscal policy has also contributed to
limiting demand pressures, but monetary policy has
shown an ambiguous stance. Growth in monetary
aggregates and credit has slowed down considerably, in
part induced by “window guidance” of the central bank
and further tightening of reserve requirements. This
despite continued capital inflows, which the authorities
largely sterilized. On the other hand, real interest rates
have until recently continued to decline as a result of
increases in inflation. Indeed, low interest rates and the
strong incentives for local governments to boost growth in
their region, combined with their reliance on revenues
from real estate developments, continue to fuel
investment. Moreover, low or negative real deposits rates
have started to show their effects on households, who are
increasingly seeking alternative investments for deposits
in banks.
The new investment policy announced in July
aims to increase the role of the market in investment
decisions, but the key tool for this—the interest rate—is
yet to play its proper role. Banks are not yet using the
recently granted (moderate degree of) flexibility in setting
interest rates. In addition, the authorities have been
reluctant to increase interest rates significantly because of
concerns about the impact on financial fragility in the
corporate sector, banks’ balance sheets, and capital
19
More detailed individual Country Briefs for the major
economies can be found at the World Bank website:
http://www.worldbank.org/eapupdate/
34
inflows. At the same time, underlying inflation pressures
remain manageable, which provides support for the
authorities usage of measures that seemed targeted at
preventing future over-supply in certain sectors rather
than at further significantly tightening overall
macroeconomic policies. Against this background, the
modest increase in interest rates effective October 29
(around 25 basis points) serves mainly as a signal that the
authorities would be ready to use the interest rate
instrument more forcefully if required on the basis of
developments on inflation or deposits.
Nonetheless, looking ahead, with underlying
inflationary pressures projected to remain limited, drastic
macroeconomic measures to cool down the economy are
unlikely to be imminent, and if the economy lands at all,
it is likely to be a soft landing this time around. The rapid
deceleration in credit in recent months, if continued, could
already cause a larger than expected slowdown, although
it is too early to tell whether the credit growth decline is
largely due to lower demand because of the impact of the
administrative measures, or whether banks have become
more reluctant to lend. Nonetheless, fears of a hard
landing remain limited in light of continued strong
demand indicators in recent months.
Growth in agricultural production has picked up
and rural incomes increased significantly—due to grain
price increases and, to some extent, the government’s
“pro-rural” policies. Plans announced to expand the social
security system more fully to rural areas may help to
reduce the remaining large gap between rural and urban
living standards, although the feasibility of the plans at
this stage of China’s development remains to be seen.
External developments remained favorable.
Production capacity has expanded significantly due to the
recent investment boom, and this allowed exports (in
US$) to grow by 35 percent (y-o-y) in the first 9 months
of 2004. Driven by the buoyant domestic demand, imports
grew 38 percent in this period. With a small current
account surplus and a significant surplus on the capital
account, China continued to increase its foreign exchange
reserves—by US$ 80 billion to US$ 483 billion in end-
July 2004.
Indonesia
The successful and peaceful election and
political transition represent an important step in the
consolidation of Indonesia’s democracy. In the run-off
election September 20th, Susilo Bambang Yudhoyono
(SBY), former coordinating minister for security and
political affairs, was elected as the next president, with his
term extending to 2009. The next few months are crucial
to Indonesia’s medium-term economic picture. A new
East Asia Update
economic policy package and early implementation steps
by the new government would draw attention from
investors and markets. Currently there are signs of
investment recovery and the external economic
environment is supportive. Together with high capacity
utilization – serving as a proxy for investment demand - a
credible economic policy package and its implementation
are likely to be rewarded by an acceleration in investment.
The World Bank’s forecast for GDP growth is now 4.9
percent in 2004 and 5.4 percent in 200520.
During the first half of 2004, the economy grew
by 4.7 percent (yoy). The good news is that investment
grew by 8.3 percent, much higher than 0.4 percent in the
second half of 2003. Other indicators also signal a
recovery in investment. Capital goods imports for the
period January-September increased by 35.3 percent
(yoy) and the number of investment approvals is also on
the rise in 2004. However, these numbers start from a
low base in 2003 and sustained increase in investment
will require continued improvement in the investment
climate. Employment also rebounded. Recent quarterly
data indicate that the open unemployment rate declined
from 8.5 percent in August 2003 to 7.4 percent in May
2005, although a high 65 percent of the employed are in
the informal sector21. Market sentiment is strong. The
bombing at the Australian embassy in September had very
little impact on markets. The stock and foreign exchange
markets recovered to the pre-bombing level on the
following day but renewed concerns about security.
Fiscal and external risk indicators continued to improve.
The government debt to GDP ratio declined from 81
percent at end-2000 to 53 percent in June 2004. The
external debt ratio also declined from 86 percent at end-
2000 to 53 percent by June 2004. These positive political
and economic developments were reflected in rating
upgrades and Fitch recently upgraded their rating outlook
from ‘stable’ to ‘positive’.
Despite these signs of investment recovery,
Indonesia’s investment climate remains weak, especially
as compared to regional competitors. The World Bank’s
Doing Business Survey 2005 shows, for example, that it
takes 151 days in Indonesia to start a business, much
higher than regional competitors such as Thailand (33
days) and Malaysia (30 days).
On the fiscal front, the revised 2004 budget
(using 1993 base GDP) estimates that fuel subsidies will
20
Growth forecast is revised up from 4.5 percent to 4.9
percent for 2004 and 5 percent to 5.4 percent for 2005. In
addition to favorable recent political and economic
developments, change in the GDP base year affects the
revision.
21
Quarterly labor statistics are drawn from a much
smaller sample size than the annual labor force survey
and this trend will need to be confirmed from the annual
numbers from the August sample.
35
increase from a budgeted Rp.15 trillion (0.7 percent of
GDP) to Rp.59 trillion (3 percent of GDP) at $36/bbl. At
this level of expenditure the fuel subsidy is close to total
development expenditures (Rp.72 trillion or 3.2 percent of
GDP). While increased revenues will hold the overall
deficit almost unchanged (up from 1.2 to 1.3 percent of
GDP) from an efficiency point of view, reducing the fuel
subsidy is among the most important challenges for the
new government.
The White Paper package of policy measures
announced in September 2003 combined with an adequate
implementation record and monitoring mechanism
contributed to bridging the “policy credibility gap” at the
end of the IMF program. As of September 2004, the
government successfully completed most of its
commitments under the White Paper though performance
varies by area. In particular progress on ‘increasing
investment, exports and employment’ lagged behind
macroeconomic stability and financial sector
restructuring. The investment, export and employment
section included structural issues in legal reform and
employment that have proved difficult. However there
are a number of policy successes including: the enactment
of the State Audit Law and the amendment of the
Bankruptcy Law, Law No.22/1999 on decentralization
and No.25/1999 on fiscal decentralization. The new
government will need a new economic policy package
that should focus on consolidating the achievements to
date, and especially on improving the investment climate.
Korea
Buoyed by strong export demand, Korea's
economy grew 5.3 percent year-on-year in the first
quarter and 5.5 percent in the second quarter of 2004.
The economy is clearly on a rebound from last year's
underperformance and is expected to grow 4.9 percent
this year and 4.4 percent next year. Exports has been
exceptionally strong, rising 23-27 percent in real terms in
each of the past three quarters. High-tech and IT-related
products, which now account for a third of the country’s
export receipts, have generated much of the trade surplus
with cell phones and flat-panel displays gaining in
importance ahead of semiconductors. Equally strong
were shipments of steel, metals and chemicals,
particularly to China, which last year outpaced the U.S. as
Korea's main export market.
Domestic demand however has been relatively
weak and policy-makers continue to ease macroeconomic
policies with the aim of generating broader-based growth.
In August, the central bank cut interest rates by 25 basis
points to a historic low of 3.5 percent in an attempt to
encourage domestic spending. The authorities also front-
loaded fiscal expenditures into the first half of the year,
enacting a supplemental budget amounting to about 0.5
percent of GDP. For next year, the authorities are
reportedly targeting a deficit of 1.25 percent of GDP,
East Asia Update
consisting of a package of tax cuts, including a one
percentage point reduction in all income tax rates and
extra spending specially directed at social programs.
A recovery in domestic demand however will
clearly depend on whether household spending picks up.
Household spending has been depressed over the past one
and a half years, following a rapid expansion of credit
card lending during 2000-2002, which in turn resulted in a
substantial increase in household debt and household loan
delinquencies. To address the household debt problems,
the authorities and financial institutions have established a
number of channels that offer varying terms depending on
the size of debts and whether the debts are to single or
multiple creditors. The Ministry of Finance and Economy
has also announced plans to step up the financial
supervision of credit card issuers and to implement an
early warning system in the credit card loan sector.
Korea’s large corporations, which have so far
used their profits to further de-leverage their balance
sheets and to invest in abroad, particularly in China, now
appear to also be increasing their domestic investments.
Investment in machinery and equipment, which declined
for four consecutive quarters, picked up in the second
quarter. Overall, Korea’s non-financial corporate sector
remains in good health on average, having lowered
leverage ratios to international norms and strengthened
profit margins. The exception to the general pattern of
corporate health is in the SME sector. SME finances have
weakened after a period of strong credit growth, although
so far, there has been little increase in the SME
delinquency ratio.
Korea’s banking sector remains healthy. Indeed,
with the recent economic rebound banks’ net income rose
four-fold in the first half of this year. Potential bank
losses on SME loans remain limited, both because half of
the loans are collateralized and government guarantees
cover one fifth of SME credits, and because most SMEs
deal with only one or two creditors which facilitates any
debt restructuring. Following capital infusions, the
average CAR of credit card companies has also improved,
from negative last year to 7 percent this year.
Based on our expectations of the external
environment—including higher oil prices, a cooling of the
global IT sector, and a slowdown in China’s growth--we
are projecting a lower growth rate of 4.4 percent for
Korea next year. While lower than consensus forecast at
the beginning of this year, the projected growth rate is
still higher than those of most OECD countries. Over the
longer-run, initiatives to place the SME sector into a more
competitive footing will help sustain stronger growth, as
will continuing efforts to improve corporate governance
particularly in Korea’s large corporations. Equally
important will be the initiatives announced recently to
enhance productivity of the Korean economy by opening
36
up segments of the services sector to increased
international competition.
Malaysia
The Malaysian economy continued to strengthen
through the first half of 2004, and real GDP is on course
to grow by 7 percent in 2004, and 6 percent in 2005. Real
GDP increased by 8 percent in Q2 2004, driven by
sustained expansions in manufacturing output and
services, mirrored by a prolonged cyclical upswing in
both domestic private and external demand, and continued
prudent domestic financial management.
Domestic demand was driven by robust private
consumption and a sharp pick-up in private investment,
which the authorities estimate at 14_ percent. Public
consumption grew by 7.1 percent, while public
investment declined by 28 percent in line with the 2_
percentage points of GDP contraction budgeted for
2004.22
Foreign direct investment inflows were sustained
and channeled mainly to oil and gas, manufacturing, and
services sectors. External demand was boosted by the
synchronized economic recoveries in the U.S.A., Japan,
and Europe, stellar growth in China, expanding intra-
regional trade, and robust international commodity prices.
The overall global outlook for 2004 remains favorable,
but the combined effects of some moderation in China’s
growth, higher oil prices on the global economy, and the
anticipated decline in the demand for electric and
electronic (E&E) products towards the end of the year
will act to moderate growth in the second half of 2004
and in 2005.
Strong export performance marks 2004. Exports
of chemical, metal, and rubber products performed well
following higher volume sales in the region, while sales
of agricultural commodities expanded strongly from
higher earnings of palm oil and natural rubber. Crude
petroleum exports benefited from the rise in world prices,
while sales of liquefied natural gas increased sharply from
higher regional demand. Imports rose by 32 percent
through end-June, reflecting higher purchases of
intermediate and capital goods, and remained strong
through August, boosted by higher imports of consumer
goods stemming from stronger private consumption.
Tourist arrivals surged by 38.4 percent in Q1, but
declined slightly in Q2.
The overall balance of payments remained in
surplus and net international reserves rose further, to
$56.9 billion by end-September, equivalent to 7_ months
of retained imports and 5 times short-term external debt.
Total external debt rose slightly to $51 billion in Q2,
equivalent to 49 percent of GNP.
22
Gross development expenditure of the Federal Government.
East Asia Update
Consumer price inflation rose by 1.4 percent in
August, reflecting higher prices for beverages and
tobacco, rent, fuel, and power, but the overall increase
was restrained by the limited increases in Government-
controlled prices. Core inflation remained subdued.
To bolster domestic private sector-led growth,
the Government is combining gradual fiscal consolidation
with a prudent but accommodative monetary policy. The
overall budget deficit for 2004 is projected to decline to
4_ percent of GDP, from 5_ percent of GDP the year
before, and the 2005 Budget envisages a further decline to
3_ percent of GDP. The monetary stance of Bank Negara
Malaysia (BNM) remains accommodative but consistent
with the exchange rate peg to the U.S. dollar. In a further
move to liberalize lending rates, in April the BNM
introduced a new overnight policy interest rate (OPR) to
replace the three-month intervention rate. With ample
liquidity, financial institutions have been able to lower
their lending rates, and this has helped fuel consumer
spending and business investment.
The financial sector continues to be
strengthened. Around 31 of the 119 policy
recommendations of the Financial Sector Master Plan
have been fully implemented, while another 24 are being
implemented on a continuous basis. Recent measures
include strengthening guidelines for corporate
governance, improving the prudential framework by
adopting new standards on asset-backed securities and
incorporation of market risk, allowing intra-group
mergers of commercial banks and finance companies, and
improving consumer awareness and protection. The 2005
Budget also includes measures to open stock brokering
activities to foreigners, and allow the entry of global fund
managers and full foreign ownership of venture capital
companies.
The performance of commercial banks continued
to improve through mid-2004. Risk-weighted capital of
banks increased to a healthy 13.8 percent of assets, while
net non-performing loans of commercial banks declined
to 7.7 percent of total loans. Returns on equity and assets
rose steadily to 18.7 percent and 1.6 percent, respectively,
while earnings per share have increased for most banks.
The provision of Islamic banking services also continued
to expand.
In the corporate sector, recent reforms under the
Capital Markets Master Plan include the requirement that
directors report on internal controls, mandatory disclosure
of compliance with the Malaysian Code on Corporate
Governance, and the adoption of international accounting
standards and best practices on internal audit functions.
Also, the Securities Commission now has more
supervisory and enforcement capabilities, including
greater power to impose civil penalties.
Meanwhile, leverage, cash flow, and profitability
indicators of the corporate sector have improved overall.
Debt-equity ratios have declined, as companies have
37
either restructured their debts or settled them in an
environment of declining interest rates. Interest coverage
ratios, and returns on equity and assets, have improved,
although not to their pre-crisis levels. However,
performance of the Malaysian stock exchange was
disappointing. Though the exchange continued to deepen
during 2004, with the number of listed companies rising
to 946 by early October, the gains of composite index in
2003 and early 2004 were among the lowest in the
region’s top ten markets. Encouraged by the low interest
rate environment, higher funding from private debt
securities more than offset the decline in equity finance.
With regard to Government-linked companies
(GLC), thirty of the total 40 GLC are slated for
restructuring. Also, the Government has launched Key
Performance Indicators (KPI) and Performance-Linked
Compensation (PLC) programs, whereby management is
now fully accountable for performance and remunerated
accordingly. All GLC will be required to fully adopt KPI
and PLC programs by 2005, and the KPI concept is being
extended to public agencies. Further governance-related
improvements are to be implemented at the corporate
level of public agencies, including reducing the size of the
individual boards, removing regulators from the boards
and replacing them with independent directors, and
introducing new CEOs and professional management.
To guard against external vulnerabilities, the
Government is promoting domestic private sector-led
growth, while encouraging FDI in selected strategic
sectors. In addition to financial and corporate sector
reforms, and fiscal consolidation, the Government aims to
further bolster private sector development through fiscal
incentives, improved governance, sequenced
liberalization, and strengthening tertiary education to
improve educational outcomes and the technological
capacity of firms.
The Government’s reform agenda is expected to include
measures to further improve the investment climate for
domestic and foreign investors in both manufacturing and
services sectors. This will include reductions in the
regulatory burden facing firms, the strengthening of
professional and managerial skills of its workers,
promoting innovations in firms and opening up the
services sector to greater foreign investment. Greater
emphasis on total factor productivity growth is sought in
the rationalization and simplification of fiscal incentives.
Philippines
Economic growth strengthened in the first half of
2004, but the pace of growth is likely to slow given the
increase in oil prices, rising domestic interest rates and the
prospect of higher international interest rates, large public
sector deficits and external financing requirements amidst
uncertain prospects for fiscal adjustment. Risks to the
external environment add to the urgency of fiscal
adjustment.
East Asia Update
Real GDP growth increased to 6.3 percent in the
first half of 2004 from 5.3 percent in calendar 2003,
driven primarily by private consumption growth of 5.9
percent. Investment grew by 9.4 percent during the first
half, though its relatively low share in GDP (less than 20
percent) limited its contribution to overall GDP growth.
Inflation through September 2004 (y/y) jumped to 6.9
percent after averaging 3 percent in 2003 primarily
reflecting rising petroleum product prices.
Unemployment, while still high at 11.7 percent as of July
2004, fell by about a percentage point from July 2003 as
1.2 million net new jobs were generated over the period.
Most of the new jobs created were in the farm and
services sectors, whereas manufacturing jobs barely grew.
Weaknesses in public finances remain of serious
concern as public debt has grown rapidly in recent
years—nonfinancial public sector debt exceeds 100
percent of GDP and contingent liabilities are also
significant. The fiscal program for 2004 targeted the
consolidated public sector deficit (CPSD) to increase
from 5.5 percent of GDP in 2003 to 6.7 percent in 2004
reflecting a rising deficit within state-owned enterprises
(GOCCs), and notwithstanding the targeted decline in the
national government deficit to 4.2 percent of GDP from
4.6 percent in 2003. The increased GOCC deficit in turn
was expected to be driven by a sharply higher deficit
within the National Power Corporation (NPC).
Developments to date indicate that CPSD/GDP ratio may
in fact remain relatively stable in 2004 with the national
government deficit reduction on target thus far and the
GOCC deficit below target as of early 2004.
Nevertheless, it remains vital to move expeditiously to
reduce the public sector deficit given the aforementioned
risks to the external environment and the prospect of
further downgrades by international ratings agencies
absent a more vigorous effort to reduce the public sector
deficit.
The Government of President Gloria Macapagal-
Arroyo—who was reelected as President in May for a six
year term beginning in July—has proposed a series of
legislative measures to increase tax revenue, but the
extent to which these measures will be enacted, and at
what pace, remains uncertain. The Energy Regulatory
Commission (ERC) recently authorized power tariffs to
be raised by nearly one peso per kwh, which will reduce
but not eliminate the operational losses of the NPC,
whose debt and debt servicing burden remains excessive.
Philippine sovereign bond spreads have
remained relatively stable in 2004 (about 470 basis points
over ten year US Treasury bonds in mid-October); the $1
billion global bond issued by the Government on
September 9 was priced at nearly 500 basis points above
equivalent US Treasuries. Yield curves for domestic
government paper have also risen during the
year—though rate increases have lagged the rise in
inflation—and one-year T-bill rates as of mid-October
stood at nearly 10 percent. The peso depreciated in real
38
effective terms, falling to a low of P56.5/USD in mid-
October before recovering somewhat. Despite ongoing
concerns regarding the fiscal outlook, equity prices
increased by an average of about 23 percent since the
beginning of the year, underpinned by robust earnings
growth in the corporate sector through the first half of
2004. Growth in bank lending to the corporate sector
remains weak, however—loans grew by less than 1
percent in the first half of the year.
On the external front, the trade deficit narrowed
to $700 million and the current account surplus more than
doubled to $1.9 billion in the first half of 2004 as export
growth of nearly 10 percent outpaced import growth.
Philippine export growth however lagged the performance
of other major economies in the region. Notwithstanding
the current account surplus and substantial foreign
borrowing through bond issues (primarily to service
maturing debt), gross international reserves fell by nearly
$900 million in 2004 through September to $15.9 billion
in part reflecting negative net portfolio and FDI flows in
the first half.
Preliminary data from the 2003 Family Income
and Expenditure Survey (FIES) indicate that total real
family incomes decreased by 4.4 percent between 2000
and 2003 while total real expenditure declined by 1.7
percent. Average incomes and expenditure declined by
even more. These declines occurred across the span of
income categories, indicting that that poverty may have
risen during this period. There are, however,
inconsistencies between the income and expenditure
figures from the FIES and the national account data which
indicate real GDP growth of about 11 percent during the
same period.
Thailand
The Thai economy continues to perform robustly
though estimated growth of 6.4 percent this year, is lower
than last year. Higher oil prices have reduced growth but
not as much as the actual rise in world prices would
suggest; the domestic retail price of diesel has not been
raised this year. Growth of private consumption is down
relative to last year due in part to higher retail prices of
gasoline for cars, and in part to slower growth in rural
incomes. Growth of private investment has slowed too
relative to last year, especially foreign direct investment,
probably due to volatile oil prices and pre-election
uncertainties. Public investment, however, has risen
significantly this year, in sharp contrast to the previous
five years of continuous retrenchment in public capital
formation. Receipts from tourism are up strongly after
the slump last year due to Severe Acute Respiratory
Syndrome (SARS). Export earnings are growing
strongly, though growth in export volumes is down
compared to 2003, and the terms of trade will improve by
roughly 3.5 percent notwithstanding higher world oil
prices.
East Asia Update
GDP growth in 2005 is projected to be around
5.8 percent, slower than this year. This is in part due to
deferred adjustment of retail prices of diesel and lower
world demand for exports. The Government has
announced its intention to float the retail price of diesel
early next year, which would raise diesel price by more
than a third of its current price; this will affect private
consumption and private investment. Also, world
demand for exports will be lower than 2004 -- including
overall growth in import demand from China. Imports on
the other hand, are projected to continue growing more
rapidly given Government’s plans for public investment
generally and infrastructure investment particularly.
The macroeconomic situation remains robust,
though higher oil prices and rising interest rates are likely
to take their toll. Headline inflation will rise to 3 percent
in 2004, compared to 1.8 percent last year, largely due to
the increases in oil and electricity prices. Projections for
2005 indicate that inflation will rise further to around 4
percent as retail prices of diesel are adjusted fully to
reflect world prices. Real interest rates are at their lowest
level. Total investment is strong as public investment is
increasing rapidly after five-years of retrenchment;
private consumption growth, while slower than last year,
continues to be an important driver of growth.
External vulnerability to shocks has fallen
further. Total external debt has fallen to US$ 50 billion
by July this year (around 31 percent of GDP) – falling
from $52 billion in end-2003 - as the Government
continue to prepay loans, including some to the
international financial institutions. The current account
surplus, though falling will be around 4 percent of GDP in
2004, as trade surpluses narrow further with further pick-
up in import demand. External reserves now exceed
US$40 billion, around 4 times the level of short-term
external debt. Next year, the current account surplus is
expected to decline further given the projected increases
in both public and private investment and the resulting
rise in imports.
Exports earnings grew by 23 percent in the first
8 months of this year. This growth was made possible by
a 16 percent increase in world prices of exports, since
export volumes grew by only 6 percent, nearly half the
rate in 2003. Three export categories – electrical
machinery and parts, non-electrical machinery and parts,
vehicles and parts – comprised 44 percent of export
earnings this year. In terms of contribution to export
growth, the developed country markets (US, Europe &
Japan) provided most to the growth in export-earnings,
followed by ASEAN; together they accounted for two-
thirds of this growth, with China contributing a tenth,
significantly lower than last year. Exports to ASEAN
grew by 31 percent, twice the rate of last year, while
exports to China grew by 24 percent, a third of last-year’s
rate.
39
However, export volumes grew slowly at only 6
percent, half the rate in 2003. Clearly negative growth in
volumes of agricultural and fishery exports contributed,
but most of it is accounted for by a slowdown in volume-
growth of manufactured exports. Within manufactures,
volume growth of resource-based products (including
processed foods) and high technology products (like
machinery and parts) have fallen relative to last year.
With rising capacity-utilization, supply-side constraints
are becoming major influences on Thailand’s export
performance. Future private investment in manufacturing
will be a key determinant of Thailand’s ability to sustain
high export growth.
This performance should be viewed against the
remarkable Thai export performance since 1999. Exports
have grown rapidly in every year except 2001, thereby
raising the export share in Thailand’s GDP significantly
(relative to pre-crisis years) and Thailand’s export share
in world market. This success has been accompanied by a
significant shift in the composition of exports towards
higher value-added items like electrical/non-electrical
machinery and parts as well as vehicle and parts. This has
been driven in part by higher foreign direct investment
inflows in the post-crisis period, encouraged no doubt by
the liberalization of foreign entry soon after the crisis, and
by the further rationalization of the import regime.
Private investment grew by 16 percent in last 8
months, a slower rate than last year. Most of this is
probably accounted for by little or no growth in foreign
direct investment flows. This maybe due to the
uncertainties arising from higher world oil prices, the
nature of adjustment in Thai retail prices of petroleum
products and of course, the impending elections.
However, two positive aspects of this year’s growth in
private investment are worth noting. First, there is a
significant increase in Board of Investment (BOI)
approvals of private investment applications, including
FDI, suggesting that lack of FDI growth is likely to be a
‘blip” rather than a trend. Second, despite the above
uncertainties, private domestic investment growth remains
particularly robust, a good sign for the future.
Nevertheless, some private investment
characteristics suggest fragility. First, while recovery
continues, private investment as a share of GDP is still
only 17 percent, significantly lower than the annual
average of the 1980s. Second, residential construction
investment continue is still contributing around a quarter
of the annual increase in private investment; additions to
manufacturing capacity supported in part by the low real
interest rates. Third, given that capacity in manufacturing
appears to be constraining export-volume growth, even a
temporary slowdown in private investment growth is
likely to slow export volumes next year.
Banks increased corporate lending is likely to
sustain increasing private investment. There is a rise in
banks lending to businesses this year relative to last year,
East Asia Update
growing at an annualized rate of 14 percent over last year.
These loans appear to be going mainly to tradable sectors,
and relatively large firms.
Public investment will grow this year for the first
time since the crisis. After retrenchment for the past 5
years, public investment grew by more than 7 percent this
year. This growth has come mainly in the form of
investments by local governments, and to a smaller extent
by the center. With the Cabinet approval of large
infrastructure projects, growth in public investment next
year is likely to be much higher than 2004. This
continuing rise in public investment will thus become an
important driver of growth in future.
The Government is considering a large five-year
program of public infrastructure investments. The
financing mechanisms are still not clear. The final size of
the program will depend on how the financing constraint
is addressed. Nevertheless, a large investment program
will have several macroeconomic implications, one of
which relate to the evolution of current account balance; it
is very likely that Thailand will generate a current account
deficit sooner than would happen on current trends.
But will these investments “crowd-in” private
investment and promote sustained growth. This will
depend on whether public infrastructure investments will
enhance competitiveness of the Thai economy, thereby
raising rates of return on private investment. This can
happen if the Government addresses three issues. First,
public infrastructure investment program should be
embedded in an overarching strategy for delivering better
quality and more cost-effective infrastructure services
aimed at improving competitiveness. Second, these
investments will have to be accompanied by policy
changes that will promote inter-modal and logistics
efficiency and ensure better mix of public-private
investments in infrastructure and logistics. This means
that current restrictions on private entry and operation will
have to be relaxed. Third, public organizational
arrangements – in Bangkok and in the provinces – will
have to be developed in a way that increases operational
efficiency of public infrastructure investments.
Addressing the existing restrictions on the
services sector will be important in this context. In
particular this relates to the regulatory framework for
telecommunication, ports, air-travel, financial services,
logistics services and so on. Modifications in these
regulatory frameworks that help to increase competition
and improve efficiency, but also promote growth in these
sectors and enhance competitiveness of Thailand.
The 2004 Global Competitiveness Report shows
that other countries are moving ahead in competitiveness.
Thailand’s rank in overall “Growth Competitiveness” has
slipped from 32 in 2003 to 34 in 2004. This is
notwithstanding the significant improvement in ranking
on macroeconomic environment. The largest declines in
ranking are in respect of public institutions (by 7 places)
40
and in technology (by 4 places), largely because other
countries have moved ahead.
Household consumption growth slowed relative
to last year, but continues to be an important growth
driver. Household consumption in the first half of this
year grew by 5.8 percent, a slow down from 6.2 percent in
the same period last year, and will likely slow down in the
second half when oil prices has rises sharply and
consumer confidence declines. Continued growths in
consumer credits and farm incomes this year and
supportive government measures, will support
consumption growth, helping to cushion some of the
adverse impacts of the oil price rise. Consumption of
services accounts for more than half of consumption
growth, at least for the first half of the year, compared to
only a quarter last year. This is primarily because the
rebound of tourism-related services such as hotels and
restaurants and transportation services from their slump
last year.
While banks’ exposure to households have risen
further, household debts look manageable. Thailand’s
household debt to disposable income has been rising since
2002 and is close to 60 percent this year. This has been
accompanied by rising household debt for all income
groups; the lowest income group and the highest have the
highest debt as a share of household income, making them
vulnerable to a rise in interest rates.
Positive developments are seen in the financial
and corporate sector, though more remains to be done. In
the financial sector, bank supervision was strengthened by
the Bank of Thailand (BOT) and prudential regulation on
loan classification and enforcement has been tightened.
Aggressive loan expansion by a large state commercial
bank has slowed down following the BOT’s intervention.
In the corporate sector, the Parliament has passed partial
amendments to the Bankruptcy Act, which are aimed at
ameliorating the legal framework for individual
bankruptcies. Nevertheless, NPLs are still in double-digits
and measures to expedite NPL resolution has been
delayed and still awaits the enactment of amendment to
AMC law.
Implementation of reforms in 2004 continue, but at a
relatively slow pace. There has been further
rationalization of import tariffs and signing of FTAs that
are increasing competition for producers and opening up
better export opportunities. Similarly, changes in public
sector governance in respect of public financial
management and public administration streamlining
continue. There have been fewer changes in respect of
private investment regulations while the changes in legal
framework formulated for the financial sector, secured
transactions, collateral and so on, still remain to be
enacted and implemented.
East Asia Update
Vietnam
GDP growth in the third quarter, at 8.0 percent,
lifted the growth rate for the first nine months of 2004 to
7.4 percent year on year (y-o-y). Growth is expected to be
maintained at 7-7.5 percent for the rest of the year. The
main macroeconomic development in the last 9 months
has been the sharp rise in prices, generating considerable
debate among policy makers on response strategies. The
high international price of oil, which on the one hand has
been an important factor in the recent upsurge in inflation,
has on the other hand boosted export receipts and
government revenue.
The industrial sector grew by 10.6 percent in the
first 9 months of 2004 with manufacturing rising by 9.3
percent. The construction sector recorded a growth of 8.1
percent in the first nine months with a pick up in the
second and third quarters helped by demand injections
from the government’s investment program. Growth in
this sector has however been dampened by the high price
of steel. Agricultural growth stood at 2.3 percent in the
first 9 months of 2004, representing a recovery in later
months. The poultry and livestock sub-sector, which
represents around 7 percent of GDP, was impacted by the
avian influenza outbreak and witnessed a reduction in
value added of 6.1 percent y-o-y in the first quarter, and
2.2 percent y-o-y in the first six months. This represents
the net effect of a sharp reduction in poultry output being
compensated to some extent by an increase in substitute
livestock products. The impact on the tourism sector,
other than in the month of March, has not been
significant. Tourist arrivals have increased by 45 percent
in 2004 compared with the first 9 months of 2003, partly a
rebound from the effects of SARS. In recent months there
have been some new but isolated outbreaks of avian
influenza. While these have been marginal, this is an area
that would require a high level of vigilance by the
authorities.
Domestic consumption and investment have
been strong. The retail sales index rose by 18.3 percent y-
o-y in the first 9 months of 2004. Investment, in current
prices, rose 19 percent in the first 9 months of 2004
representing 36.2 percent of GDP. On the external front,
exports grew by 27 percent y-o-y in value terms during
the first 9 months of the year. Crude oil exports,
benefiting largely from high international prices, rose 43
percent in value terms. Garment exports slowed
considerably to under 18 percent (compared to 53 percent
in the same period of 2003) being constrained by quota
limits in the US market. Exports of shrimp were adversely
impacted by anti-dumping proceedings by the US. As a
result, in the first nine months, exports of sea products
remained flat overall, but declined by over 20 percent to
the US. An emerging export this year has been wood
furniture. These exports may in effect be substituting
exports from China which have been slapped with anti-
dumping proceedings. Faced with an uncertain market
situation in the US, exporters have looked to diversify
41
into the EU and Japanese markets with some initial
success. This trend will be aided by garment quota
increases in the EU market and improved food safety
standards adopted by Vietnamese exporters.
With the expiration of the MFA in 2005,
Vietnam will likely face tougher competition in
international markets. This is because Vietnam, not
currently a WTO member, will continue to face import
quotas. As a counter, the government is seeking to
negotiate garment quota increases in EU and US markets
while producers are starting to focus on non-quota
products. Another area where the government would need
to act relates to reducing the transaction costs in quota
allocation as exporters face stiffer competition from
quota-free countries. On the positive side, buyers appear
keen to have diversified sources of supply and would
retain Vietnam as an established source. A key factor
would be the signals on WTO membership: if these
remain strong then it will be a solid incentive for buyers
to not re-source away from Vietnam.
Import growth at 21 percent in the first nine
months equaled the pace in the same period last year. The
trade deficit in the first nine months is estimated at 4.3
percent of GDP compared with 6.6 percent in the same
period of 2003. With a continuation of recent trends, the
current account deficit which stood at 4.7 of GDP in 2003
will likely narrow this year as remittances have remained
strong. On the financing side ODA disbursements will
continue to be the main source. FDI disbursements,
according to official data which employ a definition
different from the balance-of-payments one, have risen 16
percent y-o-y in the first half of 2004. Gross foreign
exchange reserves stood at $6.3 billion (2.6 months of
imports of goods and services). During 2003 reserves
were boosted as commercial banks moved funds from off-
shore deposits on-shore. This trend has slowed in 2004.
Budgetary revenues remained robust in the first
9 months of 2004 fulfilling 79 percent of the annual plan
and expenditures remained on target. Government
revenues have benefited from higher non-tax sources such
as the profits of oil-producing state owned enterprises.
However, import-export revenues are reported to have
been lower than targeted. The lower than expected
collections from trade taxes can be explained in terms of
removal of tariffs on items such as oil products and steel
in order to cushion the price impact on consumers;
sharply lower imports of high tariff items such as
motorcars and their component parts; and only in part due
to the ongoing tariff reductions under the ASEAN Free
Trade Area (AFTA). The government’s target deficit of
2.2 percent of GDP for 2004 remains attainable.
By September, 2004 the CPI had increased by 10
percent y-o-y, a significant rise compared with the
January, 2004 figure of 3.4 percent. The price of food,
which accounts for nearly half the consumption basket
had risen by 19 percent y-o-y. The rise in the price of
East Asia Update
non-food items was lower, at 4 percent. This rise in
prices has been mainly supply-driven stemming from the
avian influenza outbreak, and higher international prices
of key commodities such as oil, fertilizer and steel. The
avian influenza outbreak resulted in a rise in prices of
poultry products, with knock-on effects on prices of
substitute meat products. Meanwhile, the price of
fertilizer, a major input, has risen 46 percent. However,
there are signs that a deceleration in inflation is already
underway. The average month-on-month rise in CPI
during June-September was 0.6 percent compared with
over 1.5 percent in earlier months.
Credit growth rose sharply from 25 percent in
2003 to around 35 percent y-o-y in June 2004, but this
should not be seen as the factor behind inflation as the
major rise in credit occurred after inflation had shown
signs of abating. The State Bank of Vietnam (SBV)
expects credit growth to slow in the coming months and
anticipates meeting its target of 25 percent for 2004. In
order to control credit growth SBV has increased the
reserve requirement for banks from 2 to 5 percent
(effective from July 1, 2004). Slowing credit growth at
this stage is better viewed as an attempt to control the
quality of lending rather than reducing aggregate demand.
The credit growth from commercial banks has been
somewhat offset by slower disbursements by the
Development Assistance Fund (DAF) which, in the first
six months, is reported to have met only 20 percent of its
disbursement target for 2004. This is likely related to the
new government decree regulating policy lending which
introduced stricter criteria for loan approvals.
GDP growth is expected to remain around 7-7.5
percent in 2005, with domestic demand playing a more
important role than in 2004. Export growth is likely to
slow as oil prices are expected to soften, and quota limits
constrain garment exports. Export growth would thus
depend on Vietnam’s success in negotiating quota
increases for garment exports. Investment from all
sources, state, non-state, and the foreign invested sector is
expected to remain strong. The current account deficit is
anticipated to be around 4.6 percent of GDP. Inflation is
expected to decline to 5-6 percent by the middle of next
year.
Smaller Economies
Cambodia
Cambodia’s economic growth has been slowing
starting last year. Real GDP grew by 5.2 percent in 2003,
compared to the annual average of around 7 percent in the
1999-2002 period, largely due to a jump in agricultural
growth resulting from favorable weather conditions. Real
GDP growth is projected to slow to 4.3 percent in 2004 as
agricultural slows relative to 2003 and structural
42
weaknesses constrain non-agricultural growth. Next year,
the termination of the Multi-Fiber Agreement (MFA) is
expected to lead to negative growth in the garments
sector; given the importance of garments to the
manufacturing sector, this decline will reduce real GDP
growth to around 2.4 percent in 2005. Growth in services
and construction are also expected to slow, but the impact
will likely be somewhat offset by the tourism sector,
which is expected to grow by 15 percent. Reductions in
overall incidence of poverty remain limited.
Inflation is expected to rise somewhat relative to
the low rate of 0.5 percent in 2003, but it is projected to
remain well below 5 percent in 2004 and 2005 if current
monetary and fiscal policies are maintained. Monetary
and fiscal policies have been broadly stable. Prudent
fiscal policy has been key to ensuring price stability in
Cambodia’s highly dollarized economy. Fiscal revenue is
expected to recover in 2004 after falling in 2003. The
revenue-to-GDP ratio is expected to rise to 11.9 percent in
2004 from 10.4 percent in 2003, reflecting increases in
both tax and non-tax revenues. However, Cambodia’s
revenue effort is one of the lowest in the region and
compares quite unfavorably to other low income
agricultural economies. With implementation of tax
policy and administration reform in the Tax and Customs
and Excise Departments, Cambodia’s medium term fiscal
position looks to be favorable. Expenditure will be limited
to 18.0 percent of GDP in 2004, and is projected to rise
very slowly thereafter. The projected overall budget
deficit of 6.1 percent of GDP in 2004 is expected to
decline steadily over the medium term, with the deficit
continuing to be offset by external financing. External
developments have been on track with continued
expansion of trade, a stable exchange rate, and rising
gross official reverses (equivalent to 3.0 months of
imports in 2004).
The ratification of membership to the World
Trade Organization (WTO) membership was a major
achievement for Cambodia, though overall progress on
structural reform—in particular governance reform—
remained lackluster in 2003 and in 2004, in part because
of the elections and the difficulty of forming a
government. The new government – formed in July 2004
– has announced a “Rectangular Strategy,” which puts
governance at the core and highlights the need for
creating a more favorable private sector environment.
This promising announcement has also been accompanied
by a process for formulating a comprehensive public
financial management reform program and a private
sector action plan. It is hoped that these will translate into
the implementation of reform measures soon, that will
help to increase economic confidence and begin reversing
the decline in economic growth.
Fiji
Political tensions have persisted in Fiji with
ongoing discussions between the government and
East Asia Update
opposition about the composition of the Cabinet. In mid-
2003 the Fiji Supreme Court ordered the Prime Minister
to include the Fiji Labour Party (FLP) in his Cabinet
under the power sharing provisions of the Constitution.
In response, the Prime Minister announced that Cabinet
would simply be expanded to accommodate the required
number of FLP representatives. However, disputes have
arisen as to the precise number of FLP representatives
required under the Constitution, whether the leader of the
FLP is entitled to a position in Cabinet, and whether there
is any restriction on the significance of Cabinet posts
offered to members of the FLP. This issue may not be
fully resolved until the next election due in September
2006.
Court cases in 2004 relating to the 2000 coup
resulted in Fiji’s Vice President, Ratu Jope Seniloli, along
with four other prominent Fijians, being found guilty of
taking an unlawful oath at the height of the May 2000
political uprising and sentenced to four years jail.
Agitation for pardons began almost immediately.
Despite these tensions, the economy is estimated
to have grown by 4.8 per cent in 2003; the 2004 forecast
of 4.7 per cent growth is due to continuing strength in
building and construction, wholesale and retail trade,
restaurant and hotel sectors. However, the severe floods
in April and June will have reduced output of sugar cane
and food crops. Inflation has risen marginally to 2.9 per
cent in the year to August 2004, and the year-end 2004
forecast for inflation is 3.5 per cent.
Tourism, Fiji's main foreign exchange earner,
continues to grow. Visitor arrivals rose by 17 per cent in
the year to August 2004. The garment industry, the
second biggest foreign-exchange earner, has seen a
marginal decline in the past five months, although on a
positive note Australia has extended its preferential trade
agreement for another seven years. Sugar production
through August increased by 7 per cent in 2004 over the
comparable period last season. However, problems of
expiring land leases, poor mill performance, incidences of
cane burning and cane transportation problems will need
to be resolved to prevent expected declines in future
years. Moreover, the government-owned Fiji Sugar
Corporation is alarmed about the possible ramifications of
a WTO ruling in August on the preferential treatment
given by the EU to Fiji and some other sugarcane
producing countries, but as yet it is unclear whether this
will affect Fiji’s preferential access to the EU sugar
market.
The fiscal deficit is estimated to be 6.4 per cent of GDP
for 2003, almost 1 percentage point higher than budgeted,
partly as a result of unanticipated spending pressures that
arose during the year from Cyclone Ami. The failure of
privatization receipts to materialize added to the
budgetary pressures. As a result of recent budget deficits,
total public sector debt increased to almost 50 per cent of
43
GDP in 2003, higher than the government’s medium-term
target of 40 per cent by 2005.
Lao PDR
Real GDP grew by 5.3 percent in 2003, slightly
lower than in 2001 and 2002, but is expected to reach
nearly 6 percent in 2004. This strengthening of growth
performance is due to higher private and public
investment, some recovery in tourism, and robust export
performance fuelled by growth in China, Thailand and
Vietnam. Though world growth and regional growth is
projected to slow down in 2005 relative to 2004, GDP
growth in Lao PDR is likely to exceed that of 2004,
mainly due to a projected jump in foreign investments in
mining and hydro-power, with continued good export
performance and stable agricultural and manufacturing
growth. Poverty reduction is projected to continue.
Inflation is expected to fall from the high of 12.6 percent
at end-2003 to below 10 percent in 2004 and 2005, as
long as fiscal consolidation is continued.
The fiscal situation, though improving, remains
fragile. This is largely because the share of government
revenue in GDP has been stagnating for several years,
while the pressure for increased spending continues.
These are manifest in the pressures to increase the modest
salaries and benefits of public servants, as well as to raise
non-wage recurrent expenditures. The Government has
held the line on spending increases for the last three
quarters and achieved the higher tax-collection targets.
As a result inflation has continued to fall in 2004. The
challenge is to sustain fiscal prudence and maintain
inflation at single-digit levels.
Since 2001, the Government has been
implementing a program of structural reform, together
with relatively successful macro-stabilization. The latter
has focused mainly in the areas of public expenditures,
state owned enterprises (SOEs), the financial sector,
private sector development and regional trade. These
efforts were sustained in 2004, though at an uneven pace.
On trade, annual reductions in AFTA tariffs and in
expansion of inclusion list have also continued. On SOE
reform, detailed time-bound programs of restructuring-
actions for Lao Airlines, Nam Papa Lao, Pharmaceutical
Factory No. 3 and Phudoi were adopted by the Prime
Minister in April 2004, and their implementation is
underway, albeit at a slower pace than planned. On
financial sector reform, amendments to the commercial
banking law and issuance of new regulations in respect of
concentration and foreign exchange exposure are in
process. The restructuring efforts for BCEL (the Foreign
Trade Bank) and the Lao Development Bank (latter
formed from merger of two state commercial banks) have
also been continuing in 2004 with the help of
international banking advisors, but non-performing loans
in these two banks are coming down more slowly than
envisaged, largely due to provincial government’s
East Asia Update
continuing arrears to private contractors working on
government projects. On private sector development,
incentives were recently rationalized and the process for
integrating the laws on foreign and on domestic
investment is being discussed.
Mongolia
In 2003, GDP growth in Mongolia was 5.6
percent, an increase of 1.7 percent from the 3.9 percent
growth rate in 2002. This good record resulted partly from
the strong expansion in the mining sector, and a favorable
external environment. For the first half year of 2004, the
real gross industrial output grew at 5,8 percent. This
robust growth originates mainly from the mining sector
expansion (8.8 percent growth over the first semester)
following the increase in copper and gold world market
prices and the start of mining exploitation by new foreign
investors. Given this favorable environment, GDP is
projected to reach 6 percent this year.
During the first semester, signs of inflationary
pressure were perceived. As of June 2004, CPI increased
by 5.3 percent from the corresponding period of previous
year, and by 7 percent from the beginning of the year,
respectively. This significant increase in inflation is
mainly caused by the increase in the domestic oil price
(by 23 percent since the beginning of July) which in turn
is due to the increase of prices on the world market and to
the Yukos oil company financial crisis, Mongolia’s main
oil supplier. In addition, an accommodating monetary
policy has accompanied the increase in prices. As of June
2004, M1 and M2 increased respectively by 21.9 percent
and 45.6 percent, a marked acceleration from the June
2003 figures (11.3 percent and 39 percent respectively).
At the end of 2003, public sector debt had reached 118.7
percent of GDP while external public debt was 103
percent of GDP. Most foreign loans (more than 98
percent) are concessional lending, implying a low risk and
cost on these liabilities for the Government. Overall,
Mongolia’s public debt remains manageable, despite a
significant increase following the settlement of the
Transferable Rubble Russian debt at the end of 2003.
During the first semester, export earnings
increased by 40 percent and imports by 33 percent, led by
a sustained external demand for copper, gold and textile.
Mongolia signed a trade and investment framework
agreement with the United States earlier this year, as a
first step toward a free-trade agreement. This reflects the
concern among countries that have built thriving textile
export trade regimes upon a U.S. quota system that will
expire at the end of this year. The U.S. is Mongolia's third
biggest export market, the bulk of that trade being
textiles, and textile exports contribute to 10 percent of
annual Mongolia’s GDP. Private remittances have
increased significantly over the last three years reaching
in 2003 10.8 percent of GDP. On the capital account side,
FDI and foreign aid and loan remained sustained. Overall,
net international reserves in the end of 2003 were US$
44
129 millions, a drop from the 2002 figure of US$ 225.8
millions, reflecting the use of part of the reserves for the
settlement of the Russian debt. The floating exchange rate
remained stable at the end of June 2004, at 1174 togrog
per US dollar.
In 2003, total budget revenue amounted 40.7 percent of
GDP, a 4,8 percent increase from 2002, partly due to
strong increase in corporate income tax collection (5,1
percent in 2003 versus 3.7 percent of GDP in 2002). In
2003, total budget expenditure and net lending increased
to 45.4 percent of GDP from 44.2 percent of GDP in
2002. Government overall deficit decreased in 2003 to 4.7
percent of GDP from 6 percent in 2002 and is projected to
be 4 percent in 2004. In end June 2004, total budget
revenue collection reported an increase of 43.4 percent
compared to June 2003, as a result of a good tax effort.
The corporate income tax rate was reduced by 25 percent
(from 40 percent in 2003 to 30 percent in 2004) as a step
to reduce the tax burden on private sector activities and
toward a single income tax system. As of June,
government expenditure had increased by an extra 20.1
percent compared to the corresponding period of previous
year. Overall, there are indications of a loosening of
policies in the run-up of the 2004 elections, including a
sharp increase in wages (up to 25 percent) and pensions
(up to 30 percent). The implementation of the public
expenditure management reform program has shown
progress this year, with for instance the adoption in March
2004 of a resolution on the budget planning process in
order to make it more explicit and enforceable. However,
the impact of the settlement of Russian debt were
incorporated in the Medium-Term Budget Framework in
Spring 2004, but remains to be reflected in an amended
budget for 2004 in the Fall. Finally, the June 2004
elections led to the unexpected result of no clear
parliamentary majority, opening the stage to a prolonged
period of uncertainty regarding the continuity of the
reform program, in particular in the domain of social
policies and the overall macroeconomic framework.
Papua New Guinea
Political Developments. The government
continued to face challenges in the first half of 2004,
through opposition efforts to bring about a motion of no-
confidence. In apparent response and to ward off further
challenges there have been a number of Cabinet
reshuffles. At mid-year, Parliament was adjourned until
early November 2004.
Implementation of the Enhanced Cooperation
Program between Papua New Guinea and Australia
commenced in the second half of 2004, following
Parliamentary ratification of the underlying treaty. Under
this package Australia will support PNG to respond to the
long term deterioration in the law and order situation and
to strengthen economic management through deployment
of about three dozen Australian public servants mainly
into line positions in the PNG public service and over 200
East Asia Update
police and other legal/judicial personnel to underpin
improvements in law and order as well as in areas such as
border control. Australia will provide new financing for
the police related portion of the program while the other
components will be financed out of the existing bilateral
aid program.
Economic Developments. The nascent
economic recovery of 2003, when real GDP expanded an
estimated 2.7 percent, is continuing in 2004 and GDP
growth is expected to be around 3 percent. A key factor
which has contributed to the continued improvement is a
tight fiscal stance which has underpinned the restoration
of macroeconomic stability. Buoyant global commodity
prices, particularly for a number of PNG’s key
exports—including oil, gold and some agricultural
commodities—have also contributed to increases in
production as has an improvement in business confidence.
The coffee season has commenced early but it is expected
that the bumper harvest of 2003 will not be matched in
2004. The economic recovery remains fragile not the
least because of supply constraints and resource depletion
in the mineral sector.
Expenditure control efforts have been intensified
in 2004, while an agenda for improved budget
management is being rolled out. As a result a budgetary
surplus estimated at 1.5 percent of GDP was achieved
over the first half of 2004. While the tight controls are
expected to be maintained it is expected that the overall
outcome for the year will be a deficit of around
1.5 percent of GDP, in line with the budget plan. This is
on account of seasonality in the PNG economy. In
addition to the improved expenditure controls, the budget
position has also been supported by sharply higher
revenues from the mineral sector—principally oil and
gold—combined with a sharp reduction in debt servicing
costs. Government has taken advantage of the
opportunity offered by improved macroeconomic
conditions to restructure its domestic debt obligations.
In line with these developments the current
account is expected to shift to surplus by year end. The
currency has remained stable in 2004, appreciating
slightly relative to the U.S. dollar over the first nine
months of the year.
The easing of the monetary stance which
commenced during the third quarter of 2003, has
continued through 2004 and has facilitated a reduction in
Treasury bill yields from 16 percent in January 2004 to a
little under 5 percent in September 2004. These
developments have facilitated an easing of inflation,
which was running at an annualized rate of 2 percent at
mid year. External reserves have continued to accumulate
during 2003, with gross external reserves increasing by
about US$200 million during the year to September when
they stood at just over US$600 million, equivalent to
more than 6 months of non-mineral imports.
45
Solomon Islands
The restoration of law and order, underpinned by
the intervention of the Regional Assistance Mission to
Solomon Islands in July 2003 has been effectively
maintained and permitted the scaling back of the military
component. Technical support continues, however,
through advisors and placement in-line positions, in
economic and central agencies and the legal and judicial
system. Improvements in security have boosted public
confidence and reinvigorated formal business activity,
particularly in Honiara.
The government is considering adoption of a
new constitution based on a federal system of
government, with a significant number of political,
financial and legal powers transferred to state
governments. Although a bill may be ready to be tabled
in Parliament by end-2004 or early 2005, there are
concerns regarding the high costs of establishing such a
structure, even as central government finances remain
fragile. As well, effective systems to monitor the fiscal
and economic performance of provinces are absent,
risking the sought after improvement in public service
delivery.
After four years of contraction, which saw a
cumulative decline in real GDP of 16.5 percent, the
economy expanded in the second half of 2003 due to
growth in primary production, construction and services.
Consequently GDP increased by an estimated 5.1 percent
in 2003, and is projected to expand by 4 percent in 2004.
Inflation declined substantially in 2003, to 3.8 percent on
a year-end basis compared to 15.4 percent in 2002,
although it has picked up slightly to almost 7 percent in
the year to July 2004.
The restoration of fiscal discipline was reflected
in the budget deficit of 1.4 percent of GDP in 2003, and a
surplus of 4 percent of GDP is projected for 2004.
Despite the recommencement of debt service payments,
total government debt, both domestic and external, has
only fallen marginally reflecting the large build up of
arrears. Significantly, the Government reached an
important settlement with its major domestic
bondholders—mainly the commercial banks and the
National Provident Fund—in the first half of 2004. Under
the terms of this, 60 percent of interest arrears due to the
bondholders were written-off, and the restructured bonds
were replaced with a 14 year amortizing bond, carrying an
interest rate of 21/4 percent, compared to about 9 percent
on the previous bonds. Overall the Government saved
about SI$11.8 million on the interest arrears and an
estimated SI$130 million in interest costs through the
reduction in interest rates.
The balance of payments strengthened in 2003 as
a current account surplus of almost 1.5 percent of GDP
was recorded fuelled in part by timber exports with
reserves continuing to be rebuilt, buoyed by inflows of
foreign assistance. The level of reserves has almost
East Asia Update 46

doubled in the past year, reaching SI$538.1 million in

September 2004. As a result the Central Bank of the
Solomon Islands lifted the foreign exchange controls that
had been in place since 2000.
Although the economic recovery is encouraging, the
structural reform agenda remains critical to sustaining that
recovery. This includes the cost, efficiency, reliability
and coverage of telecommunications and power service to
underpin private sector development and business
activities, as well as the resumption in inter-island
shipping services which are so important to rural
agricultural production.
 East Asia Update 47

APPENDIX TABLES

Appendix Table 1. Quarterly Real GDP Growth - % Change Year Ago

China Hong Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand East Asia
Kong (China)
Q1 1999 8.3 -2.7 -6.1 5.9 -1.0 0.7 2.1 4.1 -0.2 4.1
Q2 1999 7.0 1.9 1.8 9.7 4.8 3.8 6.6 6.4 3.4 6.3
Q3 1999 7.0 4.6 2.8 11.1 9.1 3.8 8.4 4.7 8.4 7.1
Q4 1999 6.5 9.3 5.4 10.9 11.7 5.1 8.6 6.4 6.4 7.6
Q1 2000 8.1 13.6 4.1 13.1 11.7 5.3 9.6 7.9 6.5 9.1
Q2 2000 8.3 10.1 4.5 9.4 8.5 6.1 8.2 5.1 6.2 7.7
Q3 2000 8.2 10.3 5.3 8.2 8.4 7.2 10.0 6.7 2.4 7.6
Q4 2000 7.6 7.2 7.5 4.3 7.1 5.3 9.7 3.8 4.0 6.2
Q1 2001 8.4 2.2 4.4 3.5 2.9 1.3 4.1 0.6 1.6 4.8
Q2 2001 8.0 1.4 6.1 3.7 0.2 2.0 -1.3 -3.3 2.1 4.1
Q3 2001 7.1 -0.5 3.9 3.4 -1.2 1.4 -5.6 -4.4 2.1 3.0
Q4 2001 6.9 -1.1 1.0 4.6 -0.5 2.3 -6.1 -1.6 2.6 3.3
Q1 2002 8.0 -1.0 2.7 6.5 1.0 4.0 -0.4 0.9 4.4 4.9
Q2 2002 8.4 0.4 4.0 7.0 4.1 4.2 5.0 3.7 5.5 6.1
Q3 2002 8.5 3.0 5.4 6.8 5.8 3.3 4.7 5.2 5.8 6.6
Q4 2002 8.3 4.8 4.9 7.5 5.6 5.6 4.0 4.5 6.0 6.7
Q1 2003 9.9 4.4 5.5 3.7 4.6 4.8 1.7 3.5 6.7 6.4
Q2 2003 7.9 -0.6 4.8 2.2 4.6 4.2 -3.9 -0.2 5.8 4.2
Q3 2003 9.6 4.0 3.7 2.4 5.3 4.8 1.7 4.0 6.6 5.9
Q4 2003 9.9 4.9 4.1 3.9 6.6 5.0 4.9 5.7 7.8 6.9
Q1 2004 9.8 7.0 5.0 5.3 7.6 6.5 7.5 6.7 6.6 7.5
Q2 2004 9.6 12.1 4.3 5.5 8.0 6.2 12.5 7.7 6.3 8.1
Source: Haver Analytics and national sources

Appendix Table 2: East Asia: Merchandise Export Growth

(US $; % change form a year ago)

2002 2003 Q3 2003 Q4 2003 Q1 2004 Q2 2004 Q3 2004 Apr-04 May-04 Jun-04 Jul-04 Aug-04 Sep-04

East Asia (9) 9.6 19.1 15.2 23.4 23.7 28.7 27.0 26.4 28.0 31.5 27.2 28.4 25.4
SE Asia 5.1 11.3 6.7 13.0 12.2 17.1 23.0 16.5 16.2 18.6 19.9 23.3 25.7
Indonesia 1.5 6.6 1.9 3.6 -0.9 7.1 24.7 2.9 10.8 7.5 7.7 25.6 41.4
Malaysia 5.9 12.7 7.9 15.2 17.3 22.0 26.9 23.1 20.3 22.6 28.1 23.7 28.8
Philippines 9.5 2.3 -0.8 4.8 6.3 10.8 8.4 8.9 15.3 8.2 3.2 13.7 8.4
Thailand 4.8 17.9 13.1 21.7 18.8 21.5 23.4 22.1 15.4 27.2 26.7 25.2 18.8
China 22.4 34.6 29.7 40.5 34.0 37.3 34.8 32.4 32.8 46.7 33.9 37.5 33.1
NIEs 5.7 14.2 10.6 18.0 22.9 28.0 23.5 26.4 30.0 27.7 25.8 24.7 20.2
Hong Kong 5.4 11.8 7.1 11.9 13.3 17.7 17.0 19.3 15.7 18.2 16.5 20.9 13.8
Korea 8.0 19.3 15.9 25.6 37.7 38.8 29.3 36.7 41.9 38.0 36.2 28.8 23.5
Singapore 2.8 15.2 10.9 18.9 18.7 29.0 28.5 26.6 28.5 31.9 28.2 30.5 27.0
Taiwan (China) 6.3 10.4 9.6 16.8 22.3 28.8 21.6 22.8 39.4 24.4 26.0 20.0 19.2
East Asia Update 48

Appendix Table 3. East Asia and the Pacific: GDP Growth Projections
Actual Forecast Forecast
1997 1998 1999 2000 2001 2002 2003 2004 2005
East Asia 6.4 -0.1 6.3 7.6 3.8 6.0 5.9 7.1 5.9
Developing East Asia 6.9 1.7 5.7 7.2 5.7 6.9 7.8 7.9 7.0
South East Asia 3.4 -9.3 3.3 5.9 2.5 4.6 5.3 5.8 5.5
Indonesia 4.7 -13.1 0.8 5.4 3.8 4.3 4.5 4.9 5.4
Malaysia 7.3 -7.4 6.1 8.9 0.3 4.1 5.3 7.0 6.0
Philippines 5.2 -0.6 3.4 6.0 3.0 4.4 4.7 5.4 4.5
Thailand -1.4 -10.5 4.4 4.8 2.1 5.4 6.8 6.5 5.8
Transition
China 8.8 7.8 7.1 8.0 7.5 8.3 9.3 9.2 7.8
Vietnam 8.2 5.8 4.8 6.8 6.9 7.0 7.2 7.2 7.5
Small Economies 1.8 0.4 8.1 2.6 1.7 2.6 4.2 4.1 3.4
Cambodia 6.8 3.7 10.8 7.0 5.7 5.5 5.2 4.3 2.4
East Timor -35.0 15.0 15.0 3.0 -3.0 1.0
Lao PDR 6.9 4.0 7.3 5.8 5.8 5.8 5.3 6.0 7.0
Mongolia 4.0 3.5 3.3 1.1 1.1 3.9 5.6 6.0 6.0
Fiji -0.9 1.5 9.6 -2.8 2.7 4.3 4.8 4.7 3.0
Kiribati 5.7 12.6 9.5 1.6 1.8 1.0 2.5 .. ..
Marshall Islands -9.4 2.5 0.6 0.9 -1.3 4.0 2.0 1.5 ..
Micronesia, Fed. Sts. -4.6 -2.8 0.2 4.4 1.1 0.8 2.4 2.0 ..
Palau 2.3 2.0 -5.4 0.3 4.5 1.1 1.5 2.0 ..
Papua New Guinea -3.9 -3.8 7.5 -1.2 -2.3 -0.8 2.7 2.8 2.1
Samoa 0.8 2.4 2.6 6.9 6.2 1.5 3.5 3.2 3.2
Solomon Islands -1.4 1.8 -0.5 -14.3 -9.0 -1.6 5.1 4.2 4.4
Tonga 0.1 2.4 3.1 6.6 0.3 1.6 2.5 1.0 2.0
Vanuatu 2.4 3.0 -2.1 2.5 -1.9 -0.3 2.0 2.8 3.3
East Asia NIEs 5.7 -2.7 7.1 8.1 1.0 4.7 3.0 5.9 4.4
Hong Kong (SAR) 5.1 -5.0 3.4 10.2 0.5 1.9 3.2 7.4 4.6
Korea 4.7 -6.9 9.5 8.5 3.8 7.0 3.1 4.9 4.4
Singapore 8.5 -0.9 6.8 9.7 -1.9 2.2 1.1 8.3 4.5
Taiwan (China) 6.7 4.6 5.4 5.9 -2.2 3.6 3.3 5.8 4.3
Japan 1.8 -1.2 0.2 2.8 0.4 -0.3 2.7 4.3 1.8

Sources:
World Bank data and staff estimates. East Asia is sum of Developing East Asia and Newly Industrialized Economies.
Indonesia National Accounts use base your 1993 for 1997-2000 data and base year 2000 for 2001-05 data
East Asia Update 49

Appendix Table 4: Primary Commodity Prices

(US Dollars - % change from a year ago)
Actual Projections
1980- 1991-
Commodity 90 98 1999 2000 2001 2002 2003 2004 2005

Crude oil average 0.0 -5.7 38.3 56.2 -13.7 2.4 15.9 34.9 -7.7
Non-Energy Commodities -0.8 0.4 -11.2 -1.3 -9.1 5.1 10.0 17.2 -3.1
Agriculture -1.9 0.8 -13.9 -5.5 -9.1 8.4 9.3 10.2 -3.5
Cocoa -7.3 4.0 -32.3 -20.2 18.0 66.4 -1.5 -11.5 4.5
Coffee, arabica -3.6 12.6 -23.2 20.2 18.0 66.4 -1.5 20.1 -6.6
Coconut oil -1.4 10.6 12.0 -38.9 -29.3 32.4 11.0 41.2 -9.1
Palm oil -3.0 12.3 -35.0 -28.9 -7.8 36.6 13.6 8.3 -6.3
Rice, Thai, 5% 0.8 2.1 -18.3 -18.5 -14.6 11.0 3.0 16.4 -4.3
Sugar, world 16.4 -2.8 -29.8 30.6 5.5 -20.3 3.0 -0.8 0.0
Logs, Malaysia 1.9 3.4 15.2 1.5 -16.3 2.7 14.5 6.9 2.5
Sawnwood, Malaysia 4.1 -0.1 24.1 -0.7 -19.3 9.4 4.6 4.4 4.3
Rubber, RSS1, Singapore -1.7 0.5 -12.9 6.2 -13.8 33.0 41.5 18.1 -10.3
Metals and minerals 2.9 -2.6 -2.3 12.6 -9.6 -3.1 12.7 36.8 -2.0
Tin -6.7 -0.7 -2.5 0.6 -17.5 -9.5 20.5 75.7 -12.8
Copper 4.3 -4.1 -4.9 15.3 -13.0 -1.2 14.1 58.8 -6.2
Source: World Bank DEC Prospects Group. Projections as of 10/26/04.

Appendix Table 5: East Asia: Exchange Rates (LCU/$)

Taiwan,
China Indonesia Korea Malaysia Philippines Singapore China Thailand Yen
Oct-2003 827.67 8495.00 1177.30 3.80 55.25 1.74 33.98 39.92 108.76
Nov-2003 827.72 8537.00 1202.60 3.80 55.77 1.73 34.21 39.92 109.50
Dec-2003 827.67 8465.00 1197.80 3.80 55.57 1.70 33.98 39.73 107.10
Jan-2004 827.68 8441.00 1173.60 3.80 56.09 1.70 33.39 39.26 105.97
Feb-2004 827.69 8447.00 1174.50 3.80 56.28 1.70 33.37 39.31 109.00
Mar-2004 827.70 8587.00 1153.60 3.80 56.36 1.68 33.02 39.42 104.30
Apr-2004 827.71 8661.00 1167.70 3.80 55.86 1.70 33.37 40.01 110.20
May-2004 827.68 9210.00 1165.70 3.80 55.84 1.70 33.39 40.51 110.50
Jun-2004 827.66 9415.00 1152.50 3.80 56.18 1.72 33.78 40.94 108.38
Jul-2004 827.69 9168.00 1168.30 3.80 56.01 1.72 34.14 41.35 112.08
Aug-2004 827.67 9328.00 1153.80 3.80 56.22 1.71 34.05 41.64 109.86
Sep-2004 827.66 9170.00 1147.90 3.80 56.34 1.69 33.98 41.50 110.92

Appendix Table 6: East Asia: Foreign Reserves Minus Gold (US$ Billion)
Taiwan,
China Indonesia Malaysia Philippines Korea China Singapore Thailand Total
Dec-1997 142.8 16.6 20.8 7.3 20.4 83.5 71.3 26.2 388.7
Dec-1998 149.2 22.7 25.6 9.2 52.0 90.3 74.9 28.8 452.8
Dec-1999 157.7 26.4 30.6 13.2 74.0 106.2 76.8 34.1 519.1
Dec-2000 168.3 28.5 29.5 13.0 96.1 106.7 80.1 32.0 554.4
Dec-2001 215.6 27.2 30.5 13.4 102.8 122.2 75.4 32.4 619.4
Dec-2002 291.1 31.0 34.2 13.1 121.3 161.7 82.0 38.0 772.5
Dec-2003 408.2 35.0 44.5 13.5 155.3 206.6 95.7 41.1 999.8
Aug-2004 500.6 34.8 54.2 12.6 170.4 231.6 99.9 42.8 1147.0
East Asia Update 50

Appendix Table 7: Regional Aggregates for Poverty Measures in East Asia

$1 –a-day $2-a-day

Headcount
Mean Consumption (1993 Number of Headcount Number of Population
Index
PPP$/month) Poor (mill.) Index (%) Poor (mill.) (mill.)
(%)

EAP
1990 67.95 28.9 457.9 67.0 1,059.9 1582.7
1996 99.80 14.8 253.0 49.6 850.4 1713.1
1999 101.89 15.6 276.9 50.0 885.6 1771.9
2000 113.41 14.0 250.1 45.9 820.6 1788.9
2001 121.55 13.1 235.9 43.3 781.1 1805.0
2002 134.02 11.8 214.4 39.8 725.5 1820.7
2003 143.76 10.5 193.6 36.8 676.1 1836.0
2004 154.37 9.6 178.4 34.4 636.3 1851.3
2005 164.05 8.8 164.7 32.2 601.4 1866.7
EAP less China
1990 96.33 22.1 97.3 59.3 260.3 439.4
1996 136.33 10.7 52.2 44.7 218.9 489.2
1999 123.48 11.4 58.5 51.0 262.0 514.0
2000 132.20 10.6 55.3 48.6 253.2 521.5
2001 135.79 10.0 52.9 47.6 251.5 528.7
2002 142.99 9.1 48.6 44.6 239.1 536.2
2003 145.92 7.9 43.0 41.7 226.8 543.7
2004 151.99 7.2 39.7 39.6 218.5 551.3
2005 157.72 6.6 37.0 37.6 210.3 558.8
S.E.Asia 4
1990 82.29 17.8 55.7 60.3 188.8 313.1
1996 111.29 7.8 27.2 43.6 151.6 348.0
1999 97.26 10.1 36.9 52.8 193.6 366.5
2000 102.90 9.2 34.4 49.9 185.5 372.0
2001 104.41 8.5 32.2 48.8 184.0 377.2
2002 109.82 7.3 28.0 45.3 173.5 382.8
2003 114.75 6.4 24.9 42.1 163.6 388.3
2004 119.92 5.7 22.5 39.8 156.7 393.9
2005 124.79 5.2 20.9 37.7 150.4 399.5
Lower Income EA (Cambodia, Laos, PNG, Vietnam)
1990 43.79 49.9 41.6 85.7 71.5 83.4
1996 63.62 26.1 24.9 70.3 67.2 95.7
1999 66.93 21.5 21.6 68.0 68.4 100.6
2000 70.04 20.4 20.9 66.2 67.7 102.2
2001 72.70 19.9 20.7 65.0 67.5 103.9
2002 74.17 19.5 20.6 62.2 65.6 105.5
2003 78.65 16.9 18.1 59.0 63.2 107.2
2004 81.75 15.8 17.2 56.7 61.8 108.9
2005 85.06 14.6 16.2 54.1 59.9 110.6
East Asia Update 51

Appendix Table 8: Poverty in East Asia - Country Estimates

$1 –a-day $2-a-day
Mean
Headcount Number Number
Consumption Headcount Gini Population
Index of Poor of Poor
(1993 Index (%) Coefficient (mill.)
(%) (mill.) (mill.)
PPP$/month)
Cambodia
1990 48.29 48.3 4.4 83.7 7.7 41.6 9.1
1996 57.77 36.7 4.0 76.9 8.4 41.6 10.5
1997 56.95 38.4 4.2 78.0 8.5 41.6 10.9
1998 55.97 39.4 4.4 78.6 8.8 41.4 11.2
1999 55.48 41.5 4.8 79.3 9.1 42.3 11.5
2000 55.72 43.4 5.1 79.4 9.3 43.9 11.8
2001 57.01 43.0 5.2 78.6 9.5 44.6 12.1
2002 56.68 45.5 5.6 79.0 9.8 46.2 12.4
2003 58.80 42.2 5.3 77.9 9.9 45.4 12.7
2004 59.37 42.6 5.5 77.6 10.1 46.3 13.0
2005 59.46 42.2 5.6 77.5 10.3 46.0 13.3
China
1990 57.05 31.5 360.6 69.9 799.6 36.0 1,143
1996 85.20 16.4 200.8 51.6 631.6 39.3 1,224
1998 91.32 16.1 201.2 49.8 620.8 41.0 1,248
1999 93.07 17.4 218.4 49.6 623.6 42.6 1,258
2000 105.69 15.4 194.8 44.8 567.4 43.9 1,267
2001 115.65 14.3 183.0 41.5 529.6 44.9 1,276
2002 130.27 12.9 165.9 37.9 486.3 46.1 1,285
2003 142.85 11.7 150.6 34.8 449.3 46.7 1,292
2004 155.37 10.7 138.7 32.1 417.8 47.2 1,300
2005 166.76 9.8 127.7 29.9 391.1 47.4 1,308
Indonesia
1984 49.80 36.7 58.7 80.0 128.1 30.3 160.1
1990 61.58 20.6 36.7 71.1 126.7 28.9 178.2
1996 86.62 7.8 15.4 50.5 99.4 36.5 196.8
1999 66.80 12.0 24.9 65.1 135.0 31.0 207.4
2000 72.53 9.9 20.9 59.5 125.3 32.2 210.5
2001 73.44 9.2 19.7 58.7 125.2 32.1 213.2
2002 81.72 7.2 15.5 53.5 115.6 34.3 216.2
2003 87.26 5.7 12.5 48.8 107.1 34.8 219.4
2004 91.24 5.1 11.4 46.1 102.8 35.4 222.7
2005 95.12 4.7 10.6 43.8 99.1 36.1 226.1
Laos
1990 39.16 53.0 2.2 89.6 3.7 32.7 4.2
1996 48.27 41.3 2.0 83.1 4.1 36.5 4.9
1997 50.35 38.4 1.9 81.3 4.1 36.5 5.0
1998 49.45 39.8 2.0 81.9 4.2 36.5 5.1
1999 51.55 36.6 1.9 80.5 4.2 36.5 5.3
2000 53.30 33.9 1.8 79.4 4.3 36.5 5.4
2001 55.47 31.3 1.7 77.4 4.3 36.5 5.5
2002 57.35 29.0 1.6 76.1 4.3 36.5 5.7
2003 59.01 26.9 1.6 74.9 4.3 36.5 5.8
2004 61.16 24.5 1.5 73.1 4.3 36.5 5.9
2005 63.96 21.7 1.3 70.7 4.3 36.5 6.1
East Asia Update 52

Appendix Table 8: Poverty in East Asia (Continued)

$1 –a-day $2-a-day
Mean
Headcount Number Headcount Number
Consumption Gini Population
Index of Poor Index of Poor
(1993 Coefficient (mill.)
(%) (mill.) (%) (mill.)
PPP$/month)
Malaysia
1984 172.09 8.9 1.4 29.5 4.5 50.5 15.3
1987 170.88 4.8 0.8 25.0 4.2 47.0 16.6
1989 176.21 3.2 0.6 22.4 4.0 46.2 17.7
1990 195.32 2.0 0.4 18.5 3.4 46.2 18.2
1992 219.48 1.5 0.3 17.6 3.4 47.7 19.1
1995 253.64 1.0 0.2 14.0 2.9 48.5 20.6
1996 261.87 0.8 0.2 13.1 2.8 48.5 21.1
1997 315.95 < 0.5 -- 8.8 1.9 49.1 21.7
1998 269.00 < 0.5 -- 12.9 2.9 49.1 22.2
1999 271.54 < 0.5 -- 12.6 2.9 49.1 22.7
2000 304.47 < 0.5 -- 9.7 2.3 49.1 23.3
2001 303.83 < 0.5 -- 9.7 2.3 49.1 23.8
2002 301.26 < 0.5 -- 9.9 2.4 49.1 24.3
2003 315.69 < 0.5 -- 8.8 2.2 49.1 24.7
2004 332.61 < 0.5 -- 7.6 1.9 49.1 25.1
2005 347.64 < 0.5 -- 6.6 1.7 49.1 25.5
PNG
1990 72.95 35.4 1.4 64.3 2.5 48.4 3.9
1996 93.15 24.6 1.1 54.4 2.5 48.4 4.6
1997 88.62 25.6 1.2 56.0 2.7 47.5 4.7
1998 83.15 27.8 1.4 59.0 2.9 47.7 4.9
1999 78.37 30.7 1.5 61.6 3.1 47.8 5.0
2000 71.89 35.3 1.8 65.0 3.3 47.6 5.1
2001 66.41 38.0 2.0 69.2 3.6 47.8 5.3
2002 63.41 39.2 2.1 70.4 3.8 47.5 5.4
2003 63.36 39.4 2.2 70.3 3.9 47.5 5.6
2004 63.39 40.0 2.3 70.5 4.0 47.5 5.7
2005 62.99 40.4 2.4 70.6 4.1 47.5 5.9
Philippines (* See Footnotes)
1985 74.92 22.8 12.4 61.3 33.3 41.0 54.2
1988 82.77 18.3 10.7 55.6 32.4 40.7 58.3
1990 90.32 19.1 11.7 53.5 32.6 43.8 61.0
1991 87.75 19.8 12.3 55.0 34.3 43.8 62.4
1994 89.10 18.4 12.3 53.1 35.5 42.9 66.8
1996 107.15 14.8 10.4 46.5 32.5 46.2 69.9
1997 110.21 12.1 8.6 45.2 32.3 46.0 71.5
1998 108.77 13.7 10.0 46.6 34.1 46.7 73.1
1999 107.20 13.5 10.1 46.9 35.0 46.2 74.7
2000 106.93 13.5 10.3 47.2 36.0 46.2 76.3
2001 N/A N/A N/A N/A N/A N/A N/A
2002 N/A N/A N/A N/A N/A N/A N/A
2003 N/A N/A N/A N/A N/A N/A N/A
2004 N/A N/A N/A N/A N/A N/A N/A
2005 N/A N/A N/A N/A N/A N/A N/A
East Asia Update 53

Appendix Table 8: Poverty in East Asia (Continued)

$1 –a-day $2-a-day
Mean
Headcount Number Headcount Number
Consumption Gini Population
Index of Poor Index of Poor
(1993 Coefficient (mill.)
(%) (mill.) (%) (mill.)
PPP$/month)
Korea
1990 301.09 < 0.5 -- < 0.5 -- 29.88 42.87
1991 330.38 < 0.5 -- < 0.5 -- 29.85 43.27
1992 362.09 < 0.5 -- < 0.5 -- 29.85 43.66
1993 383.03 < 0.5 -- < 0.5 -- 29.36 44.06
1994 411.09 < 0.5 -- < 0.5 -- 29.36 44.45
1995 440.03 < 0.5 -- < 0.5 -- 29.11 45.00
1996 480.46 < 0.5 -- < 0.5 -- 29.71 45.55
1997 483.84 < 0.5 -- < 0.5 -- 28.97 45.99
1998 400.86 < 0.5 -- < 0.5 -- 29.42 46.43
1999 450.06 < 0.5 -- < 0.5 -- 30.00 46.86
2000 497.15 < 0.5 -- < 0.5 -- 30.00 47.28
2001 521.82 < 0.5 -- < 0.5 -- 30.00 47.64
2002 559.06 < 0.5 -- < 0.5 -- 30.00 47.97
2003 546.35 < 0.5 -- < 0.5 -- 30.00 48.24
2004 570.39 < 0.5 -- < 0.5 -- 30.00 48.48
2005 592.64 < 0.5 -- < 0.5 -- 30.00 48.72
Thailand
1988 90.42 17.9 9.6 54.1 29.0 43.8 53.7
1990 102.88 12.5 7.0 47.0 26.1 43.8 55.6
1992 129.75 6.0 3.5 37.5 21.7 46.2 57.8
1996 143.92 2.2 1.3 28.2 17.0 43.4 60.1
1998 121.73 3.3 2.0 34.1 21.0 40.6 61.5
1999 123.50 3.1 1.9 33.6 20.7 40.7 61.7
2000 125.42 5.2 3.2 35.6 22.0 43.2 61.9
2001 131.21 3.6 2.2 32.0 19.9 42.4 62.3
2002 139.40 2.4 1.5 27.7 17.4 42.2 62.8
2003 146.80 1.6 1.0 23.8 15.0 41.4 63.1
2004 153.87 1.3 0.8 21.4 13.6 41.4 63.4
2005 161.43 1.0 0.6 18.2 11.6 40.9 63.7
Vietnam
1990 41.73 50.8 33.6 87.0 57.6 35.0 66.2
1993 48.85 39.9 28.3 80.5 57.2 35.0 71.0
1996 63.66 23.6 17.7 69.4 52.2 36.3 75.2
1998 68.54 16.4 12.8 65.4 50.9 35.4 77.7
1999 68.90 16.9 13.4 65.9 52.0 35.4 78.9
2000 73.16 15.2 12.1 63.5 50.7 35.9 79.9
2001 76.62 14.6 11.8 61.8 50.1 36.8 81.0
2002 78.67 13.6 11.2 58.2 47.8 37.5 82.1
2003 84.06 10.9 9.0 54.3 45.1 37.5 83.2
2004 87.89 9.4 7.9 51.4 43.3 37.6 84.3
2005 92.06 8.0 6.9 48.2 41.1 37.7 85.4
East Asia Update 54

Notes for Tables 7 and 8

______________________________________________________________________________________

(1) The poverty lines in Tables 8 and 9 are set at $1.08 and $2.15 per person per day (in 1993 PPP$) for all countries. For
most countries, 1993 World Bank PPP estimates are used. The PPP for the Philippines is from the Penn World Tables, while
that for PNG is the 1996 World Bank PPP. PPPs for Vietnam, Lao PDR and Cambodia have been further adjusted using a
calorie price ratio between Indonesia and Vietnam. Projections are based on World Bank growth rate forecasts for 2003-
2004. Wherever possible, the projections utilize information on sectoral GDP growth rates, changes in the food CPI relative
to the general CPI, changes in the GDP deflator relative to the CPI, and changes in the consumption-income ratio. The
projections assume that there is no change in relative inequalities within sectors. For China, the projections are done
separately for rural and urban China, and then aggregated using population shares. Estimates for all countries except
Malaysia and China are based on surveys of household consumption. The estimates for Malaysia and China use income
surveys. For China, a survey-based estimate of mean consumption is used in conjunction with the income Lorenz curves to
derive poverty estimates. These poverty estimates differ from those commonly found in national poverty assessments for two
main reasons. First, country assessments use national poverty lines that differ from the uniform international poverty lines
used here. Second, national poverty lines also typically allow for spatial cost of living differentials within countries, but such
adjustments are omitted here to maintain a consistent methodology across countries. For instance, in the case of Thailand,
these differences explain why the above estimates indicate a small increase in poverty between 1998 and 2000 (in spite of
adjusting the CPI by the change in the national poverty lines over this period), while national poverty line-based estimates
indicate a decline. Also for Thailand, the 2002 estimate is based on a longer consumption module, which could lead to a
small overestimation of consumption relative to 2000.

* Pending. Poverty estimates for Philippines are to be released shortly by Government of the Philippines.
______________________________________________________________________________________

Appendix Table 9. NPLs in the commercial banking system of the crisis-affected countries
(percent of total loans)
1997 1998 1999 2000 2001 2002 2003 2004
Dec Dec Dec Dec Dec Mar Jun Sept Dec Mar Jun Sep Dec Mar Jun

Indonesia (a) -- -- 64.0 57.1 48.8 50.3 48.5 40.7 31.1 30.3 27.7 24.4 18.1 18.9 17.9
excl. IBRA 7.2 48.6 32.9 18.8 12.1 12.8 11.8 10.5 7.5 7.6 7.1 6.7 6.8 6.3 6.2
Korea (b) 8.0 17.2 23.2 14.0 7.4 6.6 5.0 4.8 4.1 4.2 4.7 4.9 4.4
excl. KAMCO & KDIC 6.0 7.3 13.6 8.8 3.3 2.9 2.5 2.5 2.4 2.6 2.6 2.6 2.7 3.1 2.6

Malaysia - 21.1 23.4 22.5 24.4 24.6 23.7 23.1 22.4 22.1 21.9 21.1 21.2 21.0 20.1
excl. Danaharta -- 16.7 16.7 13.4 16.3 16.7 15.7 15.3 14.7 14.6 13.9 13.3 13.1 13.0 12.3
Philippines (c) 4.7 10.4 12.3 15.1 17.3 18.0 18.1 16.5 15.0 15.5 15.2 14.5 14.1 14.0 13.8
Thailand (d) -- 45.0 41.5 29.7 29.6 29.7 29.9 29.6 34.2 34.1 34.1 33.5 30.6 29.6 29.6
excl. AMCs -- 45.0 39.9 19.5 11.5 11.4 11.3 11.7 18.1 17.8 17.6 16.8 13.9 13.0 13.0
Memo: Malaysia (e) -
excl. Danaharta - 10.6 10.6 8.3 10.5 10.6 10.0 9.6 9.3 9.1 8.7 8.3 8.3 8.3 7.7

a) Only includes IBRA’s AMC; b) The NPL ratio increased in 1999 due to the introduction of stricter asset classification criteria (forward
looking criteria) ; c) From September 2002 onwards, the NPLs ratios are based on the new definition of NPLs (as per BSP Circular 351)
which allows banks to deduct bad loans with 100 percent provisioning from the NPL computations; d) Includes transfers to AMCs but
excludes write-offs. (Note that the jump in headline NPLs in December 2002 was a one-off increase, reflecting a change in definition and
did not affect provisioning requirements). The June 2003 figure is preliminary and was estimated using transfers to AMCs and lending to
AMCs as of March 2003; e) NPL series used by Bank Negara Malaysia, which is net of provisions and excludes interest in suspense.
 Special Focus: Strengthening the Investment Climate in the East Asia and Pacific Region

Reviving private investment is a critical challenge facing high investment rates suggest that capital intensity has
countries in the East Asia and Pacific region. Growth in grown rapidly there as well. .
physical capital per worker (capital intensity) contributed a
large part of East Asia’s extraordinary output growth
performance in the first part of the 1990s and before.23.
Figure 1: Growth in Physical Capital Per
Since the 1997-98 East Asian financial crisis, however,
capital per worker growth has fallen in many countries of Worker (% per year)
the region, although not in China or Vietnam (Figure 1), 12.0
running at only 1-2 percent a year in several. Private 1990-97
investment has been depressed, averaging 14 percent of
GDP in 2003 as compared to its pre-crisis average level of 1997-2003
9.0
25 percent.

This special focus paper looks at the investment climate in

East Asia, focusing in particular on those determinants of %6.0
private investment that are amenable to policy change. The
determinants of investment are wide-ranging, and a good
summary of international experience is given in the World
3.0
Bank’s World Development Report (WDR) 2005 “A Better
Investment Climate for Everyone”. This special focus
illustrates some of the global messages of the WDR with
information from Investment Climate Assessments (ICAs) 0.0
undertaken by the World Bank in five East Asian Indonesia Thailand Korea Malaysia China Philippines
economies, using data from over 6500 registered firms. 24 It
looks in particular at policies and institutional changes that Source: Bosworth and Collins (2003); World Bank calculations.
can affect the investment climate by (i) reducing policy-
related risks and uncertainties, (ii) reducing policy-related
costs of doing business, and (iii) raising investment returns. Aggregate investment patterns are mirrored by Foreign
Direct Investment (FDI) trends. FDI has played a
II. Recent trends in Investment in East Asia significant role in several East Asian economies, providing
resources and technology, both in the host industry and
G rowth in physical capital per worker has slowed through linkages with the rest of the domestic private sector.
dramatically since the 1997 financial crisis in the five However, FDI has declined substantially in most countries
crisis-hit countries, Indonesia, Korea, Malaysia, Philippines, since 1997, except in China, following global trends. (Table
Thailand (Figure 1). In the Philippines, investment has been 1). Excluding China, FDI inflows to the six largest
weak since the early 1990s and capital per worker has developing economies have been cut in half from an average
grown at barely 1 percent per year. In the four other middle- of around $16.5 billion a year in 1998-2000 to the recent
income countries of Southeast Asia, capital intensity growth trend of around $7.5 billion in 2001-2003. Indonesia and
has fallen from 4-7 percent per year to less than half that the Solomon Islands have even witnessed a consistent
rate. One exception is Korea, where investment has outflow of FDI since 1997. One exception to this trend has
recovered somewhat more robustly after the crisis. The been in resource rich economies, where FDI in mining, oil
and other natural resources has followed improvements in
third category of countries includes China and Vietnam,
legislation in Mongolia, PNG, and Vietnam.
which did not have crises and where physical capital per
worker has continued increasing very rapidly, in the case of
China of course has continued to be a magnet for FDI.
China averaging around 10 percent since 1990. While a
Indeed, China’s accession to the WTO, large domestic
detailed capital stock figure is not available for Vietnam,
market, strong growth, skilled workforce and the innovative
potential of its economy make it very attractive to FDI.
23 China received 85 percent of total FDI flows to the East
Bosworth and Collins, 2003.
24 Asia region in 2003, and became the world’s largest
Investment Climate Assessments have been completed for
recipient, attracting around US$54 billion worth of FDI.
Cambodia (2003), China (2002, 2003), Indonesia (2004),
Malaysia (2003) and the Philippines (2003). They are in
progress in Mongolia and Thailand and will soon be
launched in Lao PDR and Vietnam.
Special Focus: Strengthening the Investment Climate in East Asia 56

Table 1: Recent Trends in FDI in EAP: FDI Inflows as III. Improving the Investment Climate in East Asia
% of GDP
1994-1997 1997-2001 2002-2003 The East Asia and Pacific region generally fares well in
Cambodia 5.4 5.7 2.8 international comparisons of investment climate.
China 5.3 4.2 4.0 According to the A.T. Kearny 2003 ranking, 9 of the 25
Fiji 2.0 1.9 1.2 most preferred destinations for FDI in the world were in
Indonesia 2.1 -1.7 -0.1 East Asia. Besides China, the front-runner since 2002, Japan
Korea, Rep. 0.4 1.5 0.6 (15), Thailand (16), South Korea (18), Vietnam (21), and
Lao PDR 5.7 2.6 1.2 Malaysia (24) appear in the top 25 lists. However, results
Malaysia 6.5 3.4 2.9 from the five investment climate surveys completed in the
Mongolia 1.7 3.7 9.0 region suggest that serious impediments to private sector-led
Papua New Guinea 3.1 4.1 1.9 growth still exist. These surveys summarize the views of
Philippines 2.0 2.2 1.3 firm managers about constraints to investment and firm
Solomon Islands 3.6 -2.3 -0.6
performance, classified in terms of whether an issue is
Tonga 1.2 1.6 1.6
considered to be “serious” or “very serious”. Figure 2
Thailand 1.4 4.4 1.1
shows the most binding constraints reported in the five
Vietnam 9.1 4.9 3.6
countries. While the ranking is relative and may not be
comparable across countries, it does offer policymakers a
practical quantitative approach to prioritizing and
Services are a new engine of FDI in East Asia. One new
sequencing reform across a broad range of possible problem
phenomenon is the growing importance of services in FDI
areas. One clear result is that a single, one-size-fits-all
in the region. The share of services has increased from 43
approach would not be sensible for the region. The range of
percent of the region’s total inward FDI stock in 1995 to 50
critical issues is as diverse as the countries themselves.
percent in 2002. Growth was more pronounced in countries
like Thailand, Hong Kong (China) and Singapore, but even
in Malaysia, Philippines and Korea the share of services in
FDI is substantial (Table 2).
Fig. 2 Major investment climate constraints
Macro Instability
Table 2: Share of services in total inward FDI (Stock) 60
Policy uncertainty
1990-2002 (Percentage) Corruption
Economy 1990 2000 2002 Finance
50
Cambodiaa .. 39.7 36.4 Electricity
Skills
China .. .. 31.4a Regulation & tax admin.
40
Hong Kong, China .. 92.0 93.0
Indonesia .. .. ..
Percent

Lao PDR .. .. .. 30
Malaysia 35.4 .. ..
Mongoliaa 100.0 37.0 41.3
20
Myanmara 23.0 35.1 34.7
Papua New Guineaa 3.4 .. ..
b 10
Philippines 23.5 45.2 43.9
Republic of Korea 37.8 34.9 42.0
Singaporec 58.5 63.3 .. 0
Cambodia China Indonesia Malaysia Philippines
Thailand 47.6 62.2 56.8
Vanuatu .. .. ..
Source: Investment Climate Assessments, World Bank.
Viet Nama 20.6 .. ..
Source: UNCTAD, FDI database Macroeconomic instability continues to be a concern for a
(www.unctad.org/fdistatistics). large proportion of firms in Cambodia, Indonesia and the
a Approval data. Philippines. Uncertainty about government policies or
b Data refer only to equity. regulations is also a concern for a substantial number of
c Data for 1990-1996 refer only to equity
while data for 1997-2000 refer to total direct investment.
Special Focus: Strengthening the Investment Climate in East Asia
firms in these economies, as it is in China.25. C orruption is
also an important concern in Cambodia, Indonesia and the
Philippines.. Corruption can often increase the uncertainty
of the business environment, it also has a major impact on
inflating the cost of doing business. Finally, firms in
Malaysia and, to a certain extent, China identified skills
shortages as an obstacle to their operations. Skills shortages
are a key barrier to higher innovation and investment
returns.
a. Reducing Policy Uncertainty and Other Policy-
Related Risks.
Policy-related risks are risks stemming from policy
uncertainty, macroeconomic instability and capital markets,
and insecure property rights and arbitrary regulation.
Perhaps the most basic requirement for a strong investment
climate is to ensure a stable macroeconomic
environment. Even though macroeconomic conditions
have steadily improved since the shock of the 1997-98
financial crisis, 50 percent of firms in Indonesia still report
concerns about macroeconomic instability as a major or
severe constraint, partly because of some further volatility in
inflation, interest rates and the exchange rate during the
post-crisis period. For example, the exchange rate fell quite
sharply and inflation rose in 2000 and early 2001, when the
credibility of the administration was damaged by financial
scandals and growing political tensions between the
legislature and the President. There is a growing body of
evidence documenting the powerful negative effects on
private investment and growth of high political and
economic instability26. In a sample of 79 countries over the
period 1960-2000 Hnatkovska and Loayza (2004) find that a
one standard deviation increase in volatility reduced annual
per-capita GDP growth by 0.7 percentage points. When the
fiscal or/and external balance is unsustainable, investors
anticipate higher implicit taxation or expropriation through
seignorage, default or banking crisis and adopt a “wait and
see” attitude. In addition, the country’s risk and interest
rates rise, further depressing private investment.
The firm level surveys report uncertainty about the
content and implementation of policies as one of the
leading investment climate constraints in several economies,
including Indonesia, China, Cambodia and Philippines. In
Indonesia, 48 percent of firms are particularly concerned
about it, and in China one third of firms report the same
(although, as will be seen, they report fewer problems in
some specific areas that generate uncertainty in other
25
While the definition of policy-related risk does not
include political risk, it is important to note that political
stability is a pre-condition to a predictable policymaking.
26
Economic instability is generally proxied by volatility in
various macroeconomic variables.
57
economies). Firms’ reluctance to invest under uncertainty
stems from irreversibility effects. Once an investment is
made, firms may get stuck with excess capital or low returns
if they misjudge demand, or if their very success makes
them a target for rent-seekers – i.e. for corrupt bureaucrats
and politicians. Drilling down, policy uncertainty is often
correlated with firms’ views about stable property rights and
about stable interpretation of government regulations.
Effective property rights will tend to increase productive
investment, as investors will anticipate being able to
appropriate the returns of their activity. Poorly defined or
ill-protected property rights, judicial manipulation or
outright crime amplify risks and dampen investment. As
shown in figure 3, countries with the lowest confidence in
the legal system are also those in which the investment rates
are lowest. Less than 60 percent of firms in Indonesia are
confident that their property rights can be protected. Foreign
investment has been particularly adversely affected by well-
publicized cases of highly arbitrary rulings in commercial
cases before the courts. The rate is even lower in Cambodia
where less than 40 percent are. Importantly, even though
they report concerns about policy uncertainty in general, in
this specific area fewer Chinese firms lack confidence about
the protection of their property rights in practice. Property
rights, often used as proxy for institutions, have been shown
to be a “fundamental cause of long-run growth”(Acemoglu,
Johnson, and Robinson, 2004).
Fig. 3: Confidence that courts will uphold
property rights
(% of firms)
Philippines
Malaysia
Indonesia
China
Cambodia
0 20 40 60 80 100
Source: Investment Climate Assessments, World Bank
Consistent implementation of government regulations is
another source of policy uncertainty. In some countries, the
gap between formal policies and what happens in practice is
Special Focus: Strengthening the Investment Climate in East Asia
perceived to be large. As shown in figure 4, around 56
percent of firms surveyed in Indonesia do not believe the
interpretation of rules is predictable. This may to some
extent be an inevitable reflection of the great political
changes Indonesia has undergone in the last five years.
Policy making is now taking place in a brand new political
and institutional context, with powerful new players such as
the elected legislature and regional governments contesting
the previously almost unchecked power of the executive
over economic policy, with all players now also competing
for the favors of the electorate. The sooner policy making
and implementation settle down to predictable rules and
procedures, the better for business activity. In the
Philippines, another country where firms report high
concerns, studies often attribute policy uncertainty to
sudden changes in policies or regulations designed to
advantage a favored firm at the expense of its competitors,
as different branches or agencies of government vie for
access to bribes or to push the interests of different patrons,
or as firms seek special privileges and favors with respect to
large one-off concessions, infrastructure contracts or sales
of public assets.27 Firms are more likely to start ma king
long-term investments when they are convinced that
government policy actions will follow predictable rules of
the game.
Figure 4: Firms that believe interpretation of
regulations is unpredictable (%)
Philippines
Indonesia
China
Cambodia
0 10 20 30 40 50 60
Source: Investment Climate Assessments, World Bank
27
See, for example, Balisacan and Hill (2003) and
references therein.
58
Figure 5: Share of Management's time
spent dealing with officials (%)
Philippines
Malaysia
Indonesia
China
Cambodia
0 5 10 15 20
Source: Investment Climate Assessments, World Bank
In China, implementation effectiveness and predictability is
less of a problem, and the main source of policy uncertainty
stems from the heavy regulatory burden. As shown in
figure 5, the representative manager spends nearly 19
percent of his/her total time dealing with red tape in China.
However, the burden does not appear to be shared equally
across regions. Firms in more advanced regions appear to
have lower regulatory burdens than less advanced ones. This
might create further divergence between rich and poor
provinces, and encourage the flow of capital to regions
where there is less red tape. In Cambodia, where this ratio is
14 percent, the regulatory burden on firms is so heavy that it
overwhelms other visible deficiencies such as finance,
infrastructure, and human capital/skills.
Countries can mitigate some risks over the medium
term. Provisions to use foreign arbitration and special
commercial courts in case of conflict, for example, may
reassure a reluctant foreign investor to settle in a country
even if the efficiency of its overall judicial system is in
question. Also, developing better capital markets (bond
markets, leasing, credit rating agencies) could help diffuse
financial crisis risks. In high profile investments, such as in
infrastructure or mining, very detailed concession contracts
are one avenue to specify and allocate risk to the party best
able to mitigate it. But recent experience has shown that
even these types of contracts have their shortcomings and
are subject to re-contracting when conditions change
radically. New public-private approaches may be needed
for these types of projects.
Special Focus: Strengthening the Investment Climate in East Asia 59

b. Reducing the cost of doing business In Cambodia, firms report paying up to 6 percent of their
sales in bribes, over twice that of Bangladesh and by far the
Costs associated with weak contract enforcement, highest among all Asian comparators28. Indonesia and the
corruption, crime, unreliable infrastructure, and Philippines also report rates higher that 4 percent. Given the
burdensome regulations are powerful deterrents to fact that the average operating income is only 5-10 percent
investment. The World Development Report 2005 in most competitive environments, the impact of bribes can
estimates that these costs can amount to over 25 percent of a be very substantial. One consequence of pervasive
typical firm’s sales ---or more than three times what it pays corruption in Cambodia is little long-term investment in
in taxes. For example, the cost of dispute resolution in the productive assets outside of protected sectors. Ultimately,
Philippines is one of the highest in the world. In such legally firms prefer to remain small and informal, denying the
costly environments, firms prefer contracting and government revenues, and reinforcing low civil service
partnership arrangements that restrict exposure and lower
salaries and poor public sector regulatory performance,
the cost of exit. As a consequence there are lower levels of
which in turn contributes to weaknesses in the investment
technology transfer, lower supply of capital, and slower
climate. There is a growing body of evidence documenting
integration into production networks.
the powerful negative effects of corruption on private
investment and growth. For example, Taduran (2000)
Reducing the cost of starting and operating businesses.
estimates that a reduction in corruption in the Philippines to
The cost of registering a business is prohibitive for some
the low levels prevailing in Singapore would raise the ratio
countries, coming close to 500 percent of per capita income
of investment of GDP by 6.6 percent and the rate of annual
in Cambodia or close to 150 percent in Indonesia. Also, as
per-capita GDP growth by 1.65 percent. Also, results
shown in figure 6, the cost of registering a property can
obtained on firm-level data suggest that Chinese firms that
exceed 5 percent of the value of the property in the
report having to offer informal payments to obtain loans had
Philippines and Indonesia.
significantly lower productivity levels and labor growth
rates, see World Bank (2002, China ICA).
Curbing Corruption is also likely to be an important
element in improving the investment climate. While on a
world scale the region may not be the most corrupt ---East
Fig. 7: Bribe as Share of firm's sales (%)
Asian countries rank in the bottom half (least corrupt) of the
distribution across all countries studied by the World Bank,
the issue is serious enough to warrant analysis and scrutiny. Philippines
In Cambodia, around 55 percent of firms find corruption a
key problem, 41 percent in Indonesia, 35 percent in the
Philippines. Corruption is bad for investment and growth
because of the direct cost of bribes (Figure 7) and also Indonesia
because of the corrosive impact of corruption on
discriminatory rules and other forms of rent-seeking and
state capture.
China
Figure 6: Cost of registering a property as
% of property value
AVERAGE
Cambodia
Vietnam
Thailand
Philippines
0 2 4 6
PNG
Mongolia
Source: Investment Climate Assessments, World Bank
Malaysia
Lao PDR
Korea, Rep Better infrastructure, especially reliable power supply, is
Indonesia perceived as a major issue in the Philippines and, to a lesser
China degree in China and Indonesia. In the Philippines the costs
Cambodia

0 2 4 6 8 10 12 28
Of all countries surveyed by the World Bank, bribes
average more than six percent of sales only in Algeria and
Source: Doing Business Database, World Bank
Nicaragua.
Special Focus: Strengthening the Investment Climate in East Asia 60

associated with unreliable electricity supply alone amount to
around 10 percent of a typical firm’s sales (figure 8). This is
comparable to India and Kenya. Public investment in
infrastructure has been declining in the Philippines, and at
less than 3 percent of GNP is one of the lowest in the
region. The country ranks low for most infrastructure
indicators. The World Economic Forum ranked it 68 out of
75 countries in the overall quality and sufficiency of
infrastructure. With respect to its Asian neighbors, the
country’s rank in terms of service delivery is 8 out of 11 in
the quality of electric supply, 6 out of 12 in telephone
subscribers per 100 people, and 6 out of 12 in total road
network. Problems arising from exercise of monopoly
power also contribute to the high cost of inter-island
shipping. Increasing investments in the physical
infrastructure by revamping and rethinking Private
Participation in Infrastructure (PPI) should be considered.
Figure 8: Losses from electricity
outage as a % of sales
Philippines
Malaysia
Indonesia
Three main reasons might explain the high lending rates in
Mongolia. First, the real funding cost is high. Compared
with other East/Southeast Asian countries, Mongolia's
national savings rate is low (18 percent), and so is its
financial intermediation (financial sector assets total about
57 percent of GDP). In addition, the liberalization of the
banking system has resulted in a large number of financial
institutions (16 commercial banks, more than 100 NBFIs,
and numerous credit cooperatives, etc.), fiercely competing
for the very limited pool of savings. Financial
intermediation is not efficient. The real level of non-
performing loans (NPLs) may be much higher than what is
reported, and operating expenses are rising rapidly. Weak
banks need a large margin to survive and cover their costs.
Lending remains a high-risk business. The society's credit
culture is weak, and so is the legal and regulatory
framework that is supposed to encourage a strong credit
culture. Penalties for defaulting are low and not
systematically applied. Banks’ risk management capacity is
also weak, and the usual practice is to keep high liquidity.
In the Philippines, high public sector debt and deficits may
be generating some crowding out of the private sector.
Access to external private finance is limited by country risk
factors. High spreads on sovereign bonds—the highest in
the region—make external borrowing difficult for all but a
handful of private firms. Domestic capital markets and
nonbank financial institutions are underdeveloped and
concerns about corporate governance and sanctity of
contracts inhibit risk capital and joint ventures.

China
Fig.9: Real Interest Rate (Lending Rate, %)

Cambodia 25.0
Average 2001-2004
20.0
0 2 4 6 8 10
Source: Investment Climate Assessments, World Bank 15.0
High interest rates are a major concern in some of the
smaller countries in the region. There is ample empirical 10.0
evidence suggesting that inadequate access to finance, and
high real interest rates, are harmful for investment and 5.0
growth (Beck et al. 2004). In East Asia, Mongolia, Lao PDR
and Cambodia have the least buoyant private sectors and the
highest real domestic interest rates29 (Figure 9). Mongolia 0.0
still has the highest rate in the region, despite a noticeable
ia

d
ga
ia
na

oa
PNG
Rep
PDR

ns
Fiji

ines

tnam
ia

ilan
goli
nes
bod

ays

Ton
Chi

omo
Sam

decline from 27.4 percent in 2002 to 18.4 percent in the first

lipp

Tha
ea,

Mon
Indo

Vie
Cam

Lao

Mal

seven months of 2004.

Sol
Phi
Kor

Source: IFS (2004), IMF.

29
The interest rate is calculated from IFS (2004) as the
lending rate - CPI (inflation). The interest rate for 2004 is an
average of the first seven months of the year.
Special Focus: Strengthening the Investment Climate in East Asia
c. Reducing barriers to innovation and higher returns to
investing
In some cases, low investment rates can be explained by
policy distortions that limit the supply of complementary
production factors such as human capital or access to
technology and innovation, thereby driving down private
rates of returns on capital.
Ensuring the appropriate supply of skills that match an
employer’s desire to upgrade technology is critical to
increasing investment returns. In Malaysia one out of four
firms surveyed identify the skills and education level of
workers as a major obstacle to their activity. The ratio is
even higher at one in every three in China (Figure 10). The
complaints of firms about skills shortage are consistent with
analyses of the return to education, return to training, and
trends on unemployment (World Bank, 2003). Results
provide strong evidence that fast growing economies face
tensions at the high end of their labor markets, resulting in
high wage premiums to workers with tertiary education and
to those who have received firm-specific training, leading
correspondingly to lower returns to capital. In Malaysia, the
return for tertiary education is nearly 18 percent versus 9.5
percent for secondary education and only 4.5 percent for
primary education. This reflects the extent of skills
shortages and the high value managers’ place on skilled
workers.
Fig. 10: Managers ranking labor regulation
and skills as major constraint (%)
Philippines
Malaysia
Labor
regulation
Indonesia Skills
China
Cambodia
0 10 20 30 40
Source: Investment Climate Assessments, World Bank
For fast growing economies, potential benefits from
relaxing the skill constraints are large. Relaxing the
skills constraints can provide large benefits. In the case of
61
Malaysia, it could raise the sales of most industries by an
average of 11 percent.
Fostering a country’s innovative capacity can boost
returns on investment. An alternative way to increase
returns is to encourage innovation. There are three key
ingredients that drive a nation’s innovative capacity: ideas,
clusters and networking, and national innovation systems. In
Malaysia, while firms are technologically active in terms of
adopting and adapting new technologies, they are weak in
technology creation and innovation. Indeed, few firms
report activities to facilitate innovation. Only 20 percent of
manufacturing firms and 12 percent of services firms report
any R&D activity. Only 11 percent of manufacturing firms
file patents or copyright materials. An alternative way to
boost innovation is to encourage competition. High
competitive pressure on firms’ benefits consumers helps
drive productivity improvements, and can increase the
likelihood of innovation. The WDR 2005 estimates the
change in the likelihood of innovating at more than 50
percent. Given the complementarities between skills and
technology, further improving the quality of the educational
output in EAP countries could help reducing skills shortage
and, to a large extent, weak innovative capacity.
IV. Conclusions
This paper asks what governments in the EAP region can do
to accelerate private investment growth. Results of the
investment climate assessments conducted in the region
suggest that in Indonesia and Philippines, policy-related
risks seem to be the most binding constraint to investment.
Upholding property rights, reducing the regulatory burden,
keeping the commitment to the current rules of the game
and reducing macroeconomic instability would help. In
countries such as Philippines and Cambodia, the high cost
of doing business stemming from poor governance and
corruption, and poor physical and financial infrastructure
appear to be holding back investment. Revamping
investment growth would require curbing corruption,
ensuring a reliable supply of power, and better access to
finance. In Malaysia and, to a certain extent, in China, skills
shortages appear to be a key impediment to higher
innovation and investment returns. Further improving the
quality of the educational output could be critical in
boosting returns to investment and accelerating private
investment recovery.
These results indicate that “investment climate” issues are
diverse. Consequently, some prioritization is needed for
each country. A quantitative survey is one instrument that
can help sort out the priorities, but ultimately the quality of
a public-private dialogue is crucial to this process, and must
be followed up by a determined political commitment to
reform that might cut across several different government
Special Focus: Strengthening the Investment Climate in East Asia 62

agencies. Coordinating this change process to ensure

impact is a further challenge for governments across the
region.

This Special Focus was prepared by Albert

Zeufack, World Bank East Asia PREM, drawing
on inputs from investment climate teams
throughout the region, as well as from the World
Bank World Development Report 2005 team.
Special Focus: Strengthening the Investment Climate in East Asia 63

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