REGIONAL OVERVIEW

Recent performance

The story of recent economic developments in the ESCAP region is one of resurgence of economic growth in an environment of substantially improved macroeconomic stability. Several factors contributed to stable consumer prices. Exchange rates appreciated considerably in the countries hit by the crisis by the early part of 1999 and then stabilized. Domestic supply conditions improved as a result of falling interest rates, the easing of the credit crunch and rising imports. In several countries, better weather conditions led to higher agricultural output. Private consumption demand tended to remain muted, and particularly so in the countries which had fallen victim to the 1997 crisis.

A noteworthy aspect was that the substantial reduction in inflation, averaging only 4 per cent for developing economies of the region in 1999, was shared by all subregions. In East and North-East Asia, inflation turned negative owing to deflationary forces in China and Hong Kong, China. Such was also the case for the developed economies of the region because of the influence of the Japanese economy, which continued to experience a mild deflation. Among the 25 developing economies of the region, as many as 19 recorded lower inflation rates. There were only five countries with double-digit inflation rates in 1999 as against eight in the previous year. Most of those which continued to have double-digit rates were able to bring down the rates very substantially.

The improved growth performance was also reasonably broad-based, cutting across all the subregions, with the exception of South and South-West Asia. The broad-based nature of improved growth pulled up the average growth rate of the developing economies of the ESCAP region to 5.6 per cent in 1999 in sharp contrast to the figure of 0.1 per cent in the preceding year. Fourteen out of 25 developing economies for which data are presented in table II.1 achieved a higher growth rate in 1999; only two registered negative growth as against eight in 1998.

The slight deceleration in South and South-West Asia has to be read against the fact that this subregion recorded the highest growth rate among all subregions in 1998. However, the majority of countries in this subregion, including the largest, India, experienced lower growth for a variety of country-specific factors. Particularly noteworthy was the debilitating impact of a devastating flood in Bangladesh, and of a colossal earthquake in Turkey, which caused a contraction of GDP in that country.

The major contribution to the dramatic upturn in GDP growth for developing economies of the region as a group came from the economies of East and South-East Asia which had been hit by the crisis in 1997. In 1998, as many as eight economies in the ESCAP region suffered a decline in output; six of them were in East and South-East Asia. All of them turned around and recorded large gains in output in 1999. The two exceptions were Hong Kong, China and Indonesia, where there was marginally positive growth. The Republic of Korea witnessed a stunning growth rate of 9.0 per cent, the highest in the region. The largest economy, China, maintained a high growth rate, although slightly lower than in the past few years.

The Pacific island economies averaged a much higher growth rate in 1999 because of significantly improved performance in the larger economies of the subregion. The highest rate within this group and the second highest in the entire ESCAP region was attained by Fiji. In contrast, there was negative growth in Tonga largely due to an exogenous shock in the form of a highly damaging cyclone.

Of the eight economies in North and Central Asia for which data are presented in the present Survey, five registered the same or a higher growth rate in 1999 compared to the previous year. None had negative growth. The turnaround in the Russian Federation from the deep contraction of output in 1998 deserves special mention.

Towards an explanation

In the vast ESCAP region, the performance of individual countries is determined by the confluence of an array of country-specific as well as global forces. Nevertheless, it is possible to discern a number of common elements which contributed to the bright landscape depicted above. The following paragraphs briefly analyse some of these elements.

Fiscal stimulus provided a significant boost to growth in many economies, especially so in the economies of East and South-East Asia hit by the crisis. Several economies which had not been directly affected by the crisis also resorted to increased public expenditure as a means of stimulating growth or containing the damage inflicted by natural calamities. The budget deficit as a proportion of GDP increased in as many as 15 developing economies of the region out of a total of 25 for which full-year data are available for 1999. This was particularly pronounced in some economies of East and South-East Asia, including China. The only exception was the Republic of Korea, where there was a small decline in budget deficit as a proportion of GDP from an uncharacteristically high level of 4.2 per cent in 1998 to 3.9 per cent in 1999.

Export performance was another major source of boost to economic growth for the majority of countries. In this case, the distribution among subregions was relatively more uneven. All the economies in South-East Asia recorded a substantially higher growth rate of merchandise exports, with the exception of Indonesia where the growth rate remained negative, albeit of a much lower magnitude than in the previous year. In the other subregions, the picture was rather mixed. Overall, out of 25 economies in the various subregions (excluding North and Central Asia), 16 recorded a higher growth rate of merchandise exports. Among the factors which caused improvement in the export performance were increased global demand against the backdrop of strong economic performance in the United States and the recovery in Japan, better world prices for many of the primary commodity exports from the region and enhanced domestic supply capacities resulting from a relaxation of the liquidity crunch and weather-induced improvements in agricultural production.

The combination of fiscal stimulus and better export performance created certain other conditions favourable for improved growth performance. These two elements together helped to increase capacity utilization and contained a rise in unemployment. In consequence, greater optimism was generated, leading to some recovery in domestic private consumption. In part, domestic consumption was fostered by the wealth effect of rising stock market indices as well as relatively greater stability in currency exchange rates.

Several economies in the region also benefited from external capital inflows. In addition to official flows to which many of the economies in East and South-East Asia gained access in the aftermath of the crisis, there has been a return of some private flows as well. As noted in chapter I, the volume of private financial flows to Asia in the first eight months of 1999 exceeded the amount channelled to the region during the whole of 1998.

Near-term prospects

Current indications suggest reasonably optimistic prospects for further strengthening of regional growth in the immediate future. It is projected that developing economies of the region will reach an average growth rate of slightly over 6 per cent in the year 2000, about half a percentage point above the rate achieved in 1999. There are a number of elements underlying this optimistic projection.

As detailed in the subsequent analysis, the restructuring of the financial sector is proceeding apace. Non-performing loans in the financial system have started declining. These developments should help a further easing of monetary policy stance and reduce interest rates. Private consumption and investment are thus expected to gain stronger momentum.

Many of the economies in East and South-East Asia still have considerable excess capacity in their manufacturing sectors. Falling interest rates, the easing credit crunch and the restoration of export finance facilities should help the utilization of the prevailing capacity for both domestic consumption and production for export. Another reason for expecting continued strong performance in exports is that demand conditions in the developed market economies are likely to remain favourable. Even though the United States economy may decelerate somewhat in 2000, the European Union is expected to register a higher growth performance. A slightly better performance in Japan cannot be ruled out. In addition, the current phase of recovery should boost intraregional trade and investment. Export growth, in turn, will help to finance the import of raw materials and intermediate inputs needed to utilize prevailing excess capacity, as well as of capital equipment for new investment.

Further progress in corporate debt restructuring is also anticipated. Exchange rate stability coupled with strong export performance will help to ease the debt-servicing burden and should encourage domestic investors to undertake more investment activities. In addition, it may be easier for corporate entities to raise investment finance from the domestic capital market with continuing improvement in stock market indices.

As already indicated, there are signs of the return of private capital inflows into the region. The current recovery and the accompanying policy changes, many of which are even more favourable to FDI than in the past, are likely to sustain this momentum. However, as in the past, private capital inflows will benefit only a small number of economies.

Downside risks and policy challenges

Despite the above optimistic scenario, the region is not free from some downside risks which pose a number of policy challenges. One of the risk factors lies in the short-term negative effects of the structural reforms. Many of the countries in the region are taking initiatives to restructure their corporate entities. The measures initiated in this regard include efforts aimed at strengthening, and implementing more forcefully, bankruptcy legislation, privatizing state enterprises, opening up both private and state enterprises to acquisition by transnational corporations, and encouraging corporate entities to consolidate their operations, shed some lines of business and focus on core areas of business. These measures may generate a sense of uncertainty with respect to employment prospects and thus dampen the pickup in domestic demand. The policy challenge is to ensure that the momentum of efficiency-enhancing restructuring measures is retained or even intensified, while avoiding loss of consumer confidence and its adverse ripple effects.

The financial sectors of many countries remain plagued by serious problems. The overhang of non-performing debt remains huge in those countries of East and South-East Asia affected by the crisis despite the progress achieved so far. But even outside these subregions, the non-performing loan problem is significant in several countries. In many countries, commercial banks are under pressure to consolidate and restructure, capital adequacy requirements are yet to be fully met and loan loss provisions remain insufficient. Financial institutions may therefore continue to adopt a cautious lending stance which may restrain growth. Countries are thus confronted with the dilemma of encouraging financial institutions to lend in order to meet the credit needs for sustained growth or minimizing the risks of further accumulation of bad debt.

As has already been noted, a major source of recovery in the region has been the export momentum. It will be recalled that one of the crucial factors which caused the 1997 crisis was the dramatic deceleration in export growth suffered by the countries of East and South-East Asia in 1996. The reliance on external demand as a primary stimulus for growth is always fraught with some degree of risk.

In the above context, enhancing export competitiveness assumes critical significance. The recent recovery in export growth was facilitated by the presence of excess capacity and a major depreciation in exchange rates. Once the excess capacity reaches a point of exhaustion and exchange rates appreciate further, fundamental competitiveness will determine export performance. Enhancing such competitiveness will require technological upgrading of existing lines of business, as well as progressive diversification and a shift into more knowledge-based and technology-based activities. Typically, there is stiffer competition in these activities from both developed countries and advanced developing countries outside the region. It is also worth mentioning here that a number of low-income developing countries in the region have succeeded in diversifying into low-end, labour-intensive manufactured exports, particularly textiles. To a great extent, this success has been underpinned by the global trade regime, including country-specific export quotas. With the envisaged abolition of quotas under WTO agreements, those countries will face stronger competition from other developing countries within and outside the region. They will have to improve their cost competitiveness significantly and develop new niche export products.

The agricultural sector continues to be a significant source of value added, employment, raw materials and exports for many economies in the region. For them, the agricultural sector is the major determinant of overall economic performance. The crisis in East and South-East Asia also highlighted the importance of this sector as a social safety net mechanism. Most countries of the region will therefore have to pay greater attention to improvements in agricultural productivity.

Fiscal stimulus played a significant role in improved economic performance in 1999, but there are obvious limits to the degree of reliance that can be placed on this source. Beyond a certain point, persistently large fiscal deficits are bound to affect macroeconomic stability. There is also a risk that the continuation of large fiscal deficits may crowd out private investment. In addition, they impose contractual debt-servicing obligations for governments which may pre-empt development expenditure in such areas as infrastructure, health, education and other essential public services. It is therefore imperative that alternative sources of stimulus are found to drive the future growth process. A stronger recovery of private consumption, as well as investment, is thus crucial.

Finally, it should be noted that there are some downside risks in the external environment. In this context, a particular concern relates to the performance of the United States economy. As explained in chapter I, this economy remains somewhat vulnerable to a potentially abrupt decline, especially because of a record level of deficit in the private sector financial balance. There are also concerns about the strength of recovery in Japan. Another external risk arises from the recent hike in oil prices. Most of the countries in the ESCAP region are net importers of oil. So far, the increase in oil prices has not constrained the process of recovery in the region but, if the current level of prices continues for a substantial period of time, an adverse impact on balance of payments, production costs, competitiveness and eventually growth cannot be lightly dismissed.