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ASIAN DEVELOPMENT

Outlook2007

Asian Development Bank

Update


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All rights reserved. Published .

Printed in the Philippines.

ISSN: -

Publication Stock No.


Te annual Asian Development Outlook provides a comprehensive economic analysis o economies in

developing Asia and the Pacic.

Te views expressed in this book are those o the authors and do not necessarily reect the views and policies o

the Asian Development Bank or its Board o Governors or the governments they represent.

Te Asian Development Bank does not guarantee the accuracy o the data included in this publication and

accepts no responsibility or any consequence o their use.

Use o the term country does not imply any judgment by the authors or the Asian Development Bank as to the

legal or other status o any territorial entity.


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Foreword

TisAsian Development Outlook (ADO)2007Update revises upward the

orecast or growth in developing Asia or 2007 to 8.3% rom the 7.6%

orecast earlier this year, inADO. Tis reassessment stems rom the

exceptionally strong perormance o Asias giantsthe Peoples Republic

o China (PRC) and India.

Buoyed by exports, investment, and consumption, the PRC posted

its astest growth rate since 1994 at 11.5% in the rst hal o the year.

India, on the back o its quickest expansion in 18 years, grew by 9.3% in

the rst quarter o FY2007 (AprilJune). Te headline number or 2007

has also been lied by aster than expected growth in Indonesia and the

Philippines.

Te Update anticipates a gentle slowing o growth through 2008, butcautions that the outlook is highly uncertain. Unolding events make

predictions at this juncture particularly hazardous. It is clear, however,

that developing Asia would not be immune rom processes that erode

consumer and investor condence in the wider, global economy. A

steep downturn in the United States, with knock-on eects in Japan and

the euro zone, would mark a signicant deterioration in the external

environment and would undoubtedly cut into regional growth going into

2008. Negative impacts would be transmitted through both trade and

nancial channels.

At the same time, however, developing Asia is in a much better

position to cope with adverse external developments: it has stout nancial

deenses and some scope or policy adjustments. A key message o theUpdate is that, beyond the gyrations in the global economy, developing

Asias growth prospects will continue to depend on how well economies

cope with their own domestic challenges.

Te Update also presents an analysis o export perormance in East

and Southeast Asia. Tis examines the inuence o real exchange rate

changes on export perormance during 19902006, a period in which

intermediate goods trade burgeoned. Te results suggest that supply-

side actorsincluding the quality o inrastructure and the business

investment climateplay a very important role in regional export

perormance. Tis is particularly true or manuactured products and or

some o the astest-growing industries in global trade, such as electrical

and nonelectrical machinery, as well as transport equipment.

Te Update was prepared by the sta o the Asian Development Bank

rom the ollowing departments: Central and West Asia, East Asia, South

Asia, Southeast Asia, Pacic, and Economics and Research, as well as the

resident missions o the Asian Development Bank. Te economists who

contributed the country chapters are: Mohammad Zahid Hossain and

Rezaul Khan (Bangladesh); Jian Zhuang (Peoples Republic o China);

Narhari Rao and Hiranya Mukhopadhyay (India); Purnima Rajapakse

(Indonesia); Hiroki Kasahara (Malaysia); Jesus Felipe and Sadar

Parvez (Pakistan); omomi amaki and Joven Balbosa (Philippines);

Luxmon Attapich (Tailand); and Dao Viet Dung and Omkar Shrestha


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iv Asian Development Outlook 2007Update

(Viet Nam). Subregional summaries were provided by Padmini

Desikachar or Central Asia (with the text box on resource windalls

prepared by Norio Usui), adateru Hayashi or South Asia, Sharad

Bhandari or Southeast Asia, and Bruce Knapman and Craig Sugden

or the Pacic. Te subregional coordinators were Padmini Desikacharor Central and West Asia, Klaus Gerhaeusser or East Asia, adateru

Hayashi or South Asia, Sharad Bhandari or Southeast Asia, and Craig

Sugden or the Pacic.

Frank Harrigan, Assistant Chie Economist, Macroeconomics and

Finance Research Division, assisted by Cyn-Young Park and Edith Lavia,

coordinated the overall production o the publication. Part 1, Developing

Asia and the world, was prepared by Frank Harrigan, Cyn-Young Park,

and Lea Sumulong. Juthatip Jongwanich provided the section on export

dynamics in East Asia, with input rom ed James. Paolo Hernando

contributed a box on oil subsidies, Gemma Estrada and Pilipinas Quising

provided an analysis oADOs orecasting perormance, and Shiela

Camingue authored a section on estimating regional and subregionalgrowth.

echnical and research support was provided by Shiela Camingue,

Gemma Estrada, Paolo Hernando, Pilipinas Quising, Nedelyn Ramos, Lea

Sumulong, and Rashiel Velarde.

Richard Niebuhr and Anthony Patrick as the economic editors made

substantive contributions to the country chapters, subregional summaries,

and other parts o the publication. Jonathan Aspin did the style and copy

editing. Elizabeth E. Leuterio was responsible or typesetting and data

linking, as well as graphics generation, assisted by Maria Susan orres.

Artwork and cover design were rendered by Mike Cortes o /Doubleslash/

Media Inc. Maria Susan orres, Zenaida Acacio, and Pats Baysa provided

administrative and secretarial support. Te publication would not havebeen possible without the cooperation o the Printing Unit under the

supervision o Raveendranath Rajan.

Ann Quon and Saby Mitra o the Department o External Relations

planned and coordinated the dissemination o the Update.

IFZAL ALI

Chie Economist

Economics and Research Department


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Contents

ADO 2007 UpdateHighlights

Part Developing Asia and the world Developing Asia World economy Subregional summaries

Part Export dynamics in East Asia

Part Economic trends and prospects in developing Asia

Bangladesh Peoples Republic o China India Indonesia Malaysia Pakistan Philippines Tailand Viet Nam

Part Technical notes GDP growth and ination orecasting perormance oAsian Development Outlook Estimating subregional and regional growth or developing Asia

Statistical appendix Statistical notes and tables


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Denitions

Te economies discussed inAsian Development Outlook 2007Update are classied by major analytic or

geographic groupings. For this publication, the ollowing apply: Association o Southeast Asian Nations (ASEAN) comprises Brunei Darussalam, Cambodia, Indonesia,

Lao Peoples Democratic Republic, Malaysia, Myanmar, Philippines, Singapore, Tailand, and Viet Nam.

Developing Asia reers to 43 developing member countries o the Asian Development Bank.

Central Asia comprises Armenia, Azerbaijan, Kazakhstan, Kyrgyz Republic, ajikistan, urkmenistan,

and Uzbekistan.

East Asia comprises Peoples Republic o China; Hong Kong, China; Republic o Korea; Mongolia; and

aipei,China.

South Asia comprises Islamic Republic o Aghanistan, Bangladesh, Bhutan, India, Maldives, Nepal,

Pakistan, and Sri Lanka.

Southeast Asia comprises Cambodia, Indonesia, Lao Peoples Democratic Republic, Malaysia, Myanmar,

Philippines, Singapore, Tailand, and Viet Nam.

Te Pacifc comprises Cook Islands, Fiji Islands, Kiribati, Republic o the Marshall Islands, FederatedStates o Micronesia, Nauru, Papua New Guinea, Republic o Palau, Samoa, Solomon Islands, Democratic

Republic o imor-Leste, onga, uvalu, and Vanuatu.

Unless otherwise specied, the symbol $ and the word dollar reer to US dollars.

Te Statistical Notes give a detailed explanation o how data are derived.

Te Update is generally based on data available up to 31 August 2007.

Acronyms and abbreviations

ASEAN Association o Southeast Asian Nations

CDO collateralized debt obligation

CPI consumer price index

EU European Union

FDI oreign direct investment

FPE raction o positive errors

FY scal year

GDP gross domestic product

GNI gross national income

IMF International Monetary Fund

MAE mean absolute error

MNE multinational enterprise

NIE newly industrialized economy

PPP purchasing power parity

PRC Peoples Republic o China

RMSE root-mean-square error

US United States

VA value-added tax

WO World rade Organization


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With growth o 8.3%, 2007 is likely to be another bumper year or

developing Asia. This estimate has been revised up rom the 7.6%

orecast in March made by Asian Development Outlook 2007.

Strong growth in the Peoples Republic o China (PRC) (now put at

11.2%) and India (8.5%) will spearhead expansion, but there is a more

general pattern o high and, in some countries, accelerating growth.

In the rst hal o 2007, the Philippines grew by 7.3%, the highest rate

in almost 20 years, and the country is expected to post growth o 6.6%

or the ull year. In Indonesia, growth continues to edge up and is now

expected to nish the year above 6%.

The outlook or 2008 remains avorable, and the baseline orecast

points to only a marginal slowing o growth to 8.2%. Momentum in the

PRC and India is seen staying robust. In the PRC, double-digit growth

o 10.8% is expected, and the pace o expansion in India should remain

at 8.5%. Indonesias prospects continue to brighten, with growth o

6.4% penciled in.

Symptoms o overheating suggest that output is growing at close to

its potential in the PRC and India. Stoked by rising ood prices, infation

pressures are building in the PRC. Credit is expanding, and equity andproperty markets have posted strong gains. In India, even though

infation has cooled, the central bank remains vigilant and shows no

signs yet o easing interest rates.

Recent convulsions in credit markets and the possibility o spillovers

into the real economy heighten uncertainty about the uture. Events

are still unolding and predictions at this time are unusually uzzy, with

the chances o downward revisions becoming more likely.

ADO 2007 UpdateHighlights
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Asian Development Outlook 2007Update

I growth in the United States (US) lurches down, developing Asia would

not be immune. But the tremors rom a downturn in the US are likely

to be modest and short-lived even i it alls into recession. Available

evidence suggests that, depending on timing, severity, and duration,

a US recession could clip growth in developing Asia by 12 percentage

points. I a synchronous steep downturn in the US, euro zone, and

Japan were to occuran event that currently seems improbable

growth in developing Asia would be at greater risk. But stout reserves,

improved nancial systems, and scope or policy adjustments put the

region in a better position to weather any storm.

A special chapter in this Updatelooks at the dynamics o East Asias

export perormance over the past quarter century. Exports have been

an important part o its growth story. The analysis reveals important

changes over the years in the pattern and direction o exports and

traces the emergence o sophisticated supply chains in the region.East Asia has shown itsel to be particularly adept at positioning itsel

in the astest-growing global export markets.

As organizational and technological innovations have spurred the

separation and reinement o tasks, their geographic dispersal,

stimulated by the search or scale and cost advantages, has created

trade. The chapter shows that this burgeoning trade in tasks is,

in the short run, less sensitive to real exchange rate movements

than are exports o primary commodities or nished manuactured

goods. Supply-side actors, such as good inrastructure, a welcoming

investment climate, and services and logistics support, play animportant role in explaining export perormance. The chapter nds,

too, that demand external to Asia remains an important infuence on

regional exports. The parts and components that are traded within East

Asia and that account or much o the growing regional integration

are usually assembled in nal products, which are shipped to external

markets.

Technical notes look at Asian Development Outlooks orecasting

perormance and how the choice o aggregation weights infuences

estimates o regional and subregional growth.
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Part 1Developing Asia and the world


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Developing Asia and the world

Developing Asia

OverviewDeveloping Asias prodigious growth continued through the rst halo 2007, setting the scene or another bumper year. Te region is now

expected to expand by 8.3%, revised up rom 7.6% projected in Marchs

Asian Development Outlook 2007(Figure 1.1.1). Growth in 2008 is

currently anticipated to slow gently to 8.2%. But this Update cautions that

the outlook or 2008 is now hazy. Te likelihood o growth slowing more

abruptly than this Updates central projections suggest is rising.

Revisions to 2007s growth projections are again heavily inuenced

by exceptionally strong perormance in both the Peoples Republic o

China (PRC) and India. In the rst hal o 2007, the PRC grew at 11.5%,

aster than at any time since 1994. India, building on its astest growth

in 18 years in FY2006 (which ended in March 2007), registered growth o9.3% in the rst quarter o FY2007. ogether, the PRC and India account

or 55.3% o total gross domestic product (GDP) in developing Asia and so

exert a powerul inuence on regional trends (Figure 1.1.2). Teir impact

on aggregate projections and outcomes would be greater still i weights

were calibrated in purchasing power parity terms rather than by the

Atlas method (see the technical note, Estimating subregional and regional

growth or developing Asia, in Part 4). Te momentum o the PRC and

India is expected to sustain solid regional perormance through 2008.

Tough these two countries imprint dominates, a more general

pattern o ast and, in places, accelerating growth is evident. Te

Philippines enjoyed its astest growth in almost 20 years in the rst hal

o 2007, and Indonesias trend growth rate is steadily edging up. Central

Asia, with oil and gas prices remaining high, continues to expand at a

double-digit pace. So ar, downside surprises have been ew, though the

process o healing Nepals economy is slow and the Fiji Islands is now

expected to contract more sharply in 2007 than previously thought.

So ar, the storm in global credit markets has created only some

turbulence in developing Asiaequity markets ell by an average o just

6% in August (Figure 1.1.3). Yet it is not clear whether the storm has blown

itsel out or merely paused. Financial innovation in global credit markets

has succeeded in dispersing risks but this has created opacity about these

risks true magnitude and location. Increasing wariness about trading

1.1.1 GDP growth, developing Asia

0

2

4

6

8

10

BABABA

%

2006 2007 2008

A = ADO 2007; B = ADO 2007 Update.

Note: Full-year data have led to upward revisions or 2006.

Source: Asian Development Outlookdatabase.

Click here or fgure data

1.1.2 Weights in regional aggregate

0

20

40

60

80

100

Rest of developing Asia

India

China, People's Rep. of

0605040302012000

%

Source: World Bank, World Development Indicators onlinedatabase, downloaded 16 February 2007.

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Developing Asia and the world Developing Asia

Global risks to the outlook now appear accentuated. Te possible

implications o a US slowdown or developing Asia are assessed

below. But other risks remain. Avian u is still a signicant source o

uncertainty with potentially devastating consequences, and concerns

remain about growing trade protectionism. Geopolitical and securityrisks are heightened in some parts o the region, and political

uncertainties, with important elections coming up, obscure the outlook

or some countries.

Can developing Asia weather a US slowdown?Te odds are still against a recession in the US, but they are narrowing.

Te baseline orecast in this Update is that the US will experience a

slowdown in 2007 and that growth will then pick up in 2008. It is

expected that any acceleration in 2008 will be gentle and that output

will remain below its potential level. Yet there is now much greater

uncertainty around this baseline projection, with the tails on theprobability o bad outcomes getting atter. One measure now puts the

chances o a US recession at over 1 in 4, its highest value since the last

quarter o 2001 (Figure 1.1.5). Te question is whether developing Asia

could weather a much sharper slowdown than is currently anticipated.

Despite rapid expansion in developing Asia and other parts o the

world, the US remains the dominant economy globally in terms o its

weight in GDP and in global nancial market transactions. Te US

share o world exports is second only to that o the euro zone, and the

country is the worlds top importer. Tough it is true that the weight o

other regions, including developing Asia, is rising, and that their internal

markets are becoming more closely integrated, it does not automatically

ollow that they have become impervious to the ortunes o the worldslargest economy.

Other than economic size, there are several other reasons why the

US is still likely to exercise a noticeable pull on other regions, and

particularly on developing Asia. Te rst is that tighter regional trade ties

are largely complementary to external trade linkages with the US. Indeed,

in East and Southeast Asia, closer trade integration emerges largely as

a result o back and orth trade in intermediate goods and parts, much

o which is assembled in nal goods or export to the US and other

industrial countries.Asian Development Outlook2007(Figure 1.5.5, p. 69)

estimates that just under 79% o the merchandise that leaves Asias ports

eventually ends up in external markets. A chill in the US is thereore

likely to send a downdra along the regions supply chains. In a recent

study at the European Central Bank, Dees and Vansteenkiste (2007)

estimate that working back along the chain o direct and indirect demand

or the regions exports, a 1% reduction in US GDP could instigate a

contraction o 0.37 percentage points in developing Asias GDP, having

allowed or inuences transmitted through adjustments to demand in

other regions.

Te explosive growth and integration o global nancial markets

constitute a second reason why signicant uncoupling seems unlikely.

Home bias in international nancial markets is waning and investors

increasingly have a global reach. Tere is compelling evidence not just o

1.1.5 Recession probability index

-25

0

25

50

75

100

125

042000969288848076721968 07

Note: The chart was prepared using US GDP growth dataor the second quarter, released on 27 July 2007.

Source: http://www.econbrowser.com/archives/2007/07/

recession_proba_2.html, downloaded 31 August 2007.
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Te global economy has been experiencingrising uel costs, with the price o crude oil

nudging per barrel in early September. Rising global consumption, coupledwith supply restraint rom the Organizationo the Petroleum Exporting Countries(OPEC) and sluggish growth in non-OPECoil production, has led to a tight market.Demand is expected to outrun supply in, resulting in a drawdown o oil stocks.

In this context o rising and high uelprices, some governments have sought tomoderate the pass-through to consumers. oassess the extent o their interventions, retailprices in developing Asia were surveyed

by Asian Development Bank residentmissions in August . Te results o theirsurvey update earlier exercises describedin Asian Development Outlook (ADO) (published in April) and the ADO Updateso and . (As or those publications,the basic methodology is that developedby the German echnical Cooperation,which runs similar surveys, the last being inNovember .)

Retail uel prices rom the various surveyswere compared against three benchmark

prices and classied into our price bands.Te rst benchmark is Brent crude. Retailprices below this benchmark are subsidizedand all in the rst price band, BC. Tesecond benchmark is retail uel prices in theUnited States (US). Prices above crude butbelow the US benchmark all in the secondprice band, AC. Te US uel price is usedas the cost recovery price; however, a rangeo actors, such as local processing anddistribution costs, determines actual costrecovery or specic countries.

Te third benchmark is retail uel prices

in Luxembourg, assigned as the EuropeanUnion (EU) benchmark. Luxembourg uel prices reectEU-wide taxes, and allow or environmental costs. Fuelcosts above US prices but below Luxembourg prices allin the third price band, AUS, and suggest greater costrecovery, but are unlikely to mean that the consumerpays or environmental costs. Retail prices above the EUbenchmark are put in the ourth price band, AEU.

Te le panel o able presents data or retail dieselprices drawing on our surveys rom to (ADO Update, ADO ,ADO Update, and the latestsurvey). It shows that over the months between August

and August , diesel prices have generally movedto higher price bands. In act there is only one economythat has dropped to a lower-priced band. Nine economieshave moved to the next highest price band. Out o economies in the August survey, charged retailprices above the US benchmark. But only one o these(Republic o Korea) had prices above the EU benchmark.

Comparisons o surveyed prices with gasolinebenchmarks are shown in the right panel. Tere hasbeen some back and orth movement o gasoline pricesin Asia relative to the US benchmark. As reported in

ADO Update, o economies priced above the

.. Evolution o retail uel prices in Asia

Movement o prices in terms o our price bands, diesel and gasoline

Economy Diesel Gasoline

Update5

ADO

Update

Update

Update5

ADO

Update

Update

Turkmenistan BC BC BC BC BC BC BC BCMalaysia BC BC BC BC AC AC AC ACIndonesia BC AC AC AC AC AC AC ACKazakhstan AC BC BC AC AC AC AC ACMyanmar BC BC AUS AC BC BC AC BCAzerbaijan BC BC BC AC AC BC BC ACPakistan AC AC AC AC AUS AUS AUS AUSViet Nam AC AC AC AC AC AC AC ACKyrgyz Republic AC AC AC AC AC AC AC ACUzbekistan AC BC BC AC AC AC AC ACBangladesh AC AC BC AC AUS AC AC AUSChina, Peoples Rep. o AC AC AC AC AC AC AC ACMaldives - - AC AC - - AC AC

Sri Lanka AC AC AC AC AUS AUS AUS AUSAghanistan AUS AC AC AC AC AC AC AUSIndia AUS AC AC AC AUS AUS AUS AUSTajikistan AUS AC AC AC AUS AC AC AUSThailand AC AC AC AC AUS AC AC AUSPhilippines AC AC AC AC AC AC AC AUSCambodia AUS AC AUS AUS AUS AUS AUS AUSTaipei,China AC AC AC AUS AUS AC AUS AUSBhutan AUS AC AC AUS AUS AUS AUS AUSPapua New Guinea AUS AUS AUS AUS AUS AUS AUS AUSLao Peoples Dem. Rep. AC AC AC AUS AUS AUS AUS AUSMongolia AUS AC AUS AUS AUS AC AC AUSNepal AC AC AC AUS AUS AUS AUS AUSSingapore AC AC AUS AUS AUS AUS AUS AUSArmenia - AC AC AUS - AUS AUS AUS

Timor-Leste, Dem. Rep. AUS AUS AUS AUS AUS AUS AUS AUSHong Kong, China AEU AEU AUS AUS AEU AEU AEU AEUFiji Islands AUS AUS AUS AUS AUS AUS AUS AUSKorea, Rep. o AUS AEU AEU AEU AEU AEU AEU AEU

Memorandum items (prices in US cents per liter)Brent crude oil 9 9 US retail Luxembourg retail 9 9

- = data not available; BC = below crude price; AC = above crude price but below US price;AUS = above US price but below Luxembourg price; AEU = above Luxembourg price.

Note: Economies arranged according to diesel prices in August 2007 (ascending order).

Sources: Surveys by ADB resident missions; national press reports; Bloomberg; Energy InormationAdministration, available: www.eia.doe.gov, downloaded 10 August 2007; German TechnicalCooperation, International Fuel Prices, available: www.gtz.de/uelprices.


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Developing Asia and the world Developing Asia 7

US benchmark. At publication oADO this was nolonger true, as the US had racked up retail prices more

quickly than the Asian economies in the sample, but byAugust , some lagging economies in Asia had caughtup with US price adjustments, so that two thirds oeconomies in the sample surpassed the US benchmark.

In terms o pricing regimes, able summarizes theAugust survey data on retail uel price policies. Atthat date, uel prices were still government controlled inmore than hal the economies in the sample. In limitingthe pass-through eects o high crude prices to consumers,governments have resorted to direct and indirect means ocontrolling retail uel prices.

Direct subsidies to lower retail prices or the wholepopulation were used by o the economies or

gasoline and or diesel. Direct subsidies or tax breaksor targeted industries, such as arming, shing, andtransportation, and or selected uses, such as cooking andelectricity, were used by o the economies.

Indirect methods o lowering uel prices or the wholepopulation, such as regulated pricing, compensatory taxchanges, and use o state-owned petroleum companies toabsorb losses, were used by o the economies.

Whether directly or indirectly controlled, in over halthe economies, regulated prices were raised as world

prices rose.o nance direct and indirect subsidies, governments

primarily relied on budgetary provisions, with halthe economies that administered uel prices nancingtheir subsidies through the budget. One third usedcompensating changes in taxes to soen the impact o uelprice increases. Others () nanced subsidies throughstate-owned enterprises, use o bank loans, issuance obonds, or cross-subsidies.

Te survey data suggest a slowly changing paradigmin uel price policy in developing Asia. Tere has been agreater tolerance o the need to pass through rising uelprices to consumers, even in economies where prices

remain administered, suggesting some rebalancing o scalpriorities. Nevertheless, subsidies and controlled pricespersist, and prevail in a majority o economies.

Some governments view price controls and subsidiesas an important way o providing support to those onlow income, but poor targeting oen means that thesesubsidies are captured by other groups. Te opportunitycost o subsidizing uel remains high.

.. Evolution o retail uel prices in Asia (continued)

Survey o retail uel price policy in developing Asia, August

Economy Fuel price controlled or Fuel price subsidized or Change in

administeredprice or

subsidy in

Direct subsidies

or tax breaksor certain uses

or targetedconsumers

Subsidy nanced through

A B C D A B C D Govt.budget

Changein tax

Obudget

Other

Turkmenistan Malaysia Indonesia Kazakhstan Myanmar Azerbaijan Pakistan Viet Nam Bangladesh China, Peoples Rep. o Maldives Sri Lanka Aghanistan India Thailand

Philippines Cambodia Taipei,China Bhutan Papua New Guinea Lao Peoples Dem. Rep. Nepal Armenia Samoa Timor-Leste, Dem. Rep. o Fiji Islands

A = gasoline; B = diesel; C = kerosene; D = LPG/uel oil/gas.

Note: At the time o the survey, the ollowing economies neither provided uel subsidies nor controlled uel prices: Hong Kong, China; Republic o Korea; KyrgyzRepublic; Mongolia; Singapore; and Tajikistan.

Sources: ADB resident missions; national energy agencies; international press reports.


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strong comovement o prices or similar assets but also comovement o

asset price volatility across markets. IMF (2007) observes that contagion

through nancial channels, in terms o both prices and volatility, is a

particularly potent orce or spillovers during asset market retreats. As

the US is the global nancial center, disturbances there almost inevitablyreverberate in other regions.

More traditional transmission channels are also likely to be still in

play. For example, a dip in global growth will probably inuence the

trajectory o primary commodity prices and thereore terms o trade.

Exchange rate and interest rate changes may also have wealth eects

and inuence scal positions. But disentangling these and other possible

sources o spillovers and making conjectures about their impact i growth

in the US lunges downward is ar rom easy.

The evidence

One approach is to si or clues rom past episodes o US slowdowns.

According to the National Bureau o Economic Research (NBER), theUS has experienced only seven slowdowns since 1970 (ve classied as

recessions). Small-sample problems in the historical data are exacerbated

by the act that only a handul o countries in developing Asia actually

have quarterly measurements o output that span these events. Annual

data or East and Southeast Asia are shown in Figure 1.1.6.

IMF (2007) calculates that or the ve US recessions between 1974

and 2001, developing Asias growth ell by about 0.28 percentage points

or each percentage point decline in US growth. But this average masks

a wide range. As a broad observation, US recessions that were triggered

by wider global shocks (such as the oil price rises o the 1970s) were more

closely associated with downturns in other regions. Tose recessions

incubated domestically (such as the aermath o the savings and loancrisis o the early 1990s), had more limited spillovers. As the current

problems in credit markets bear some supercial resemblance to those

that suraced aer that crisis, it might be tempting to conclude that

the threat rom current ructions is not great. But in the early 1990s,

global nancial markets were much smaller than now, and not nearly so

integrated.

Te most recent recession, which started with the dot-com

meltdown in 2000 and was propagated by a cyclical downturn in the

electronics industry, presents a somewhat more arresting picture. During

this recession, IMF (2007) estimates that growth in the US declined

by 2.9 percentage points with growth in developing Asia alling by

1.1 percentage points. Only the oil price shocks o the early 1970s show

more pronounced synchronization o growth decelerations.

Recessions and slowdowns appear to be quite dierent creatures rom

the perspective o their potential or spillover eects. NBER identies

two (non-recession) growth slowdowns in the US, in 1986 and 1995. In

1986, developing Asia was rebounding rom a homegrown slowdown in

growth that occurred in the rst hal o the 1980s. In the mid-1990s, the

regions growth was high and stayed unrufed by slowing in the US. And

again, during the course o the current slowdown in the US, growth has

accelerated in developing Asia.

Averaging out across dierent phases o the US business cycle allows

1.1.8 Share in overall balance o payments

-50

0

50

100

150

2000 01 02 03 04 05 06

%

Current account

Capital and financial account

Net errors and omissions

Note: Data reer to Bangladesh; Peoples Republic o China;Hong Kong, China; India; Indonesia; Republic o Korea;Malaysia; Pakistan; Philippines; Singapore; Taipei,China;and Thailand.

Sources: CEIC Data Company Ltd.; International MonetaryFund, International Financial Statistics online database; bothdownloaded 10 September 2007.


1.1.7 Average interregional business cycle

correlations

-1.0

-0.5

0.0

0.5

1.0

Asia excluding PRC-G3Asia-G3

Q2

07

Q1

06

Q1

04

Q1

02

Q1

2000

Q1

98

Q1

96

Q1

94

Q1

92

Q1

1990

Correlation

Note: Asia comprises Peoples Republic o China; HongKong, China; Indonesia; Republic o Korea; Malaysia;Philippines; Singapore; Taipei,China; and Thailand. G3comprises United States, Japan, and euro zone.

Source: Oxord Economics, Quarterly Model, August 2007.


1.1.6 GDP growth and US recessions

-5

0

5

10

15

20

AsiaUnited States

05200095908580751970

%

Note: Quarterly periods o US recessions, as dened bythe National Bureau o Economic Research (NBER), areidentied by the shaded areas. Annual growth rates arecentered across the x-axis labels. Asia comprises PeoplesRepublic o China; Hong Kong, China; Indonesia; Republico Korea; Malaysia; Philippines; Singapore; Taipei,China;and Thailand.

Sources: World Bank, World Development Indicators onlinedatabase; Directorate-General o Budget, Accounting andStatistics, available: eng.stat.gov.tw; NBER, Business CycleExpansions and Contractions, available: www.nber.org; alldownloaded 10 September 2007.

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Developing Asia and the world Developing Asia

or more data to be brought to bear on the analysis. But the striking

dierences in apparent spillovers over these phases caution against

drawing simple inerences. Looking or regularities in the time series data

or the US and developing Asia, IMF (2007) concludes that disturbances

to US growth have had signicant eects on the newly industrializedeconomies and the ASEAN-4; but also that impacts have been

comparatively short-lived. Dees and Vansteenkiste (2007) conclude that

the US and Asian business cycles are largelyindependent o one another.Given the presence o the PRC in their sample, and its uninterrupted

growth over the past 25 years, as well as the violent eects o the Asian

crisis on regional growth in the second hal o the 1990s, this nding is

perhaps not so surprising. But i spillovers really do behave dierently

between upturns and downturns, and are particularly potent during

recessions, it is not clear what can be inerred rom averages culled rom

expansions, contractions, and tranquil periods.

Asian Development Outlook 2007(in the chapter, Uncoupling Asia:

Myth and reality), provides another perspective on business-cyclesynchronization. It observes that the early 1990s presents strong evidence

o detachment o developing Asia rom the G3 (US, Japan, and euro zone).

But there is also evidence o a pronounced structural break ollowing

on the heels o the Asian crisis. Since the crisis, it would seem that there

has been much closer synchronization o the Asian and G3 business

cycles (Figure 1.1.7). Correlations between PRC and G3 business cycles

are weaker. Te postcrisis data conrm that the G3 business cycle leads

movements in output in developing Asia at intervals o 1 to 3 years. Lying

behind these ndings might be the strong dependence on export-led

growth in the postcrisis period, deepening nancial market integration,

and indeed, improved policies that have helped promote greater stability.

However, intriguing as these ndings may be, they do not provide a basisor robust prediction.

Another way o trying to understand how growth in developing Asia

might respond to shocks in the US is to apply simulation techniques

using models o the global economy. IMF (2007) reports exercises using

its global economic model. It nds impacts that are not very dierent

rom the numbers calibrated rom event studies. In a recent ADB study,

Park (2007) uses Oxord Economics global economic model to examine

scenarios in which there is a hypothetical US slowdown, and traces

possible impacts on developing Asia. (Tese scenarios are illustrative and

should not be regarded as orecasts.)

Tree hypothetical situations are considered in the ADB study. It is

assumed, rst, that a contraction in US demand leads to a 1 percentage

point all in US output growth and that this downturn endures or

2 years. Tis lowers output growth in developing Asia by 0.45 percentage

points in the rst year and by 0.75 percentage points in the second.

Second, a 10% depreciation o the US dollar (against all currencies other

than the Hong Kong dollar, which is linked to the US dollar) is assumed

to occur in tandem with the assumed deceleration in US growth. Now

growth in developing Asia slows by close to 2% in each year. In such

an event, a depreciation o the US dollar might be needed to stimulate

growth in a context o weaker domestic demand in the US. Tird, the

hypothetical shock to US growth occurs together with an assumed 10%

1.1.11 Real equity prices

0

100

200

300

0

200

400

600

Taipei,China

Korea, Rep. of

Singapore

Hong Kong, China

0604022000989694921990

Index, 1990 = 100Index, 1990 = 100

0

100

200

300

Thailand

Philippines

Malaysia

Indonesia

0604022000989694921990

Index, 1990 = 100

Sources: CEIC Data Company Ltd.; International MonetaryFund, International Financial Statistics online database;both downloaded 8 September 2007.


1.1.10 Growth in private sector bank credit

-10

0

10

20

-15

0

15

30

Thailand

Singapore

Philippines

Malaysia

Korea, Rep. of

Indonesia

AprJan

07

OctJulAprJan

06

OctJulAprJan

2005

% %

Sources: CEIC Data Company Ltd.; International MonetaryFund, International Financial Statistics online database;both downloaded 8 September 2007.


1.1.9 Nonperorming loan ratio

0

5

10

15

20

25

Thailand

Philippines

Pakistan

Malaysia

Korea, Rep. of

Indonesia

0605040302012000

%

Sources: CEIC Data Company Ltd.; Bank Negara Malaysia,available: www.bnm.gov.my; State Bank o Pakistan,available: www.sbp.org.pk; all downloaded 8 September2007.

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10 Asian Development Outlook 2007Update

decline in investment in the PRC. With deteriorating prospects or

growth and trade, there could be cuts in investment spending in the

PRC both by domestic and by oreign investors. In the remainder o

developing Asia, GDP growth now slows by 0.8 percentage points in year

one and by 0.9 percentage points in year two.

Downside risks

ogether the evidence rom past slowdowns, available statistical ndings,

and the results o modeling simulation exercises suggests that developing

Asia would certainly eel the tremors rom a US recession, though these

are likely to be modest and short-lived. Even i the worst experiences o the

past 35 years were replayed, the attrition o growth is unlikely to be severe.

I a recession o recent median depth and duration occurred in the

USan event that has a low but rising probabilitya deceleration o

growth in developing Asia by 2 percentage points would be at the upper

end o plausible estimates or eects o the spillover, with a central

prediction closer to 1 percentage point. Depending on timing, this couldpossibly prune growth to a range o 67% rom the baseline prediction o

8.2% in 2008.

o the extent that past events provide a reliable guide, they suggest that

the magnitude and speed o impacts will be critically aected by exchange

rate adjustments (as illustrated in Parks [2007] simulations), by impacts on

primary commodity prices, and by any spillovers rom the US to the wider

global economy. I evidence o a synchronized and sharp slowdown across

the G3 were to appearagain, something considered unlikelythis could

make a signicant dent on growth in developing Asia.

Country-level impacts

At a country level, susceptibility to spillovers rom a sharp US downturnwould depend on a variety o actors. Te buildup o reserves that has

occurred across the region certainly provides a strong buer against

external shocks (see Box 1.1.2, Developing Asias oreign exchange reserves

and the United States merchandise trade decit). However, those economies

that have built reserves through current account surpluses are in a

stronger position than those that have experienced reserve growth through

capital inows. Any capital ight could deplete reserves as investors

leave or saer havens. Fortunately, or most economies in developing

Asia, current account surpluses have been the primary driver o reserves,

though or India (where cover is still ample), and periodically or some

other economies, capital inows have been important (Figure 1.1.8).

Likewise, vulnerabilities have retreated with improved health o

domestic nancial systems. Te quality o banks assets and their capital

strength have been boosted (Figure 1.1.9). Te corporate sector too has

reduced its exposure to debt (Figure 1.1.10).

Asset valuations generally are in line with undamentals. It is true

that equity prices in developing Asia have enjoyed strong growth since

2004, but this should be seen in the context o quite modest perormance

over a longer stretch o time (Figure 1.1.11). Property markets are also

making a comeback, but valuations have not soared as in some industrial

countries, nor have credit risks become elevated in the way that they have

in the US (Figure 1.1.12).

1.1.13 Public sector debt

30

40

50

60

20

24

28

32

ThailandMalaysia

India

Bangladesh

0605040302012000

% of GDP % of GDP

40

55

70

85

PhilippinesPakistanIndonesia

0605040302012000

% of GDP

Sources: Bangladesh Bank, available www.bangladesh-bank.org; Government o India, Ministry o Finance,available: nmin.nic.in; Bank Indonesia, available:www.bi.go.id/web/en; Government o Indonesia, DebtManagement Oce, available: dmo.or.id; SingaporeMinistry o Trade and Industry, available: app.miti.gov.sg/; Bank o Thailand, available: www.bot.or.th; CEIC DataCompany Ltd; International Monetary Fund, Pakistan: 2006

Article IV Consultation, Sta Report, available: w ww.im.org;all downloaded 10 September 2007.


1.1.12 Selected residential propert y prices

50

100

150

200

United States

Hong Kong, China

Korea, Rep. of

Malaysia Singapore

Thailand

Q1

07

Q1

06

Q1

05

Q1

04

Q1

03

Q1

02

Q1

01

Q1

2000

Index, 2000 = 100

Source: CEIC Data Company Ltd., downloaded 8 September2007; www.realtor.org/Research.ns/Pages/MetroPrice,downloaded 15 September 2007.

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Developing Asias oreign exchange reserves rose by about billionin the rst hal o to . trillion, according to preliminary

data (box table). Tis advance was about two-thirds larger than the billion increase in the same period o the previous year.

Tis continues a pattern o large gains made by the region since (Box gure ), and developments through June suggest that will see the largest increase to date. All but one o the economies in theregion made reserve gains, with the Peoples Republic o China (PRC)accounting or about o the rise as its current account surplusstrengthened. India accounted or about o the increase, reectingits larger capital account surplus.

With ,. billion as o end-June , the PRC holds about o developing Asias oreign exchange reserves. Te next ve largestholders (in descending order, aipei,China; Republic o Korea; India;Singapore; and Hong Kong, China) together hold ,. billion, or

about o the regional total.Box gure indicates that developing Asias share in the United

States (US) merchandise trade decit (census basis, not seasonallyadjusted), which had been essentially stable since , increased at

a aster pace in the rsthal o . Te US tradedecit with developing Asiaamounted to . billion,or . o the US total(. billion), up by. percentage points romthe rst hal o .

Te US trade decit withthe PRC widened by about in JanuaryJune rom the prior-year period,to . billion, whileother developing Asianeconomies trade surpluswith the US ell by . to. billion.

Te PRC has expandedits share o the regionalsurplus over the years(about in versus

in ), reectingboth its emergence asa low-cost producer omanuactured goods, andthe growth o intraregionaltrade (the latter eaturesexports o components andsupplies to the PRC orassembly into goods orexport, including to the US).

.. Developing Asias oreign exchange reserves and the United States merchandise trade decit

2 Developing Asias share in the US

merchandise trade decit

0

15

30

45

60

South AsiaSoutheast AsiaEast Asia

H1

07

06H1

06

0503200199971995

%

Note: Shares o Central Asia and the Pacic are negligible.

Source: US Census Bureau, available: www.census.gov,downloaded 3 September 2007.


Developing Asias oreign exchange reserves

($ billion)

StockJune

Change in rst halo year

Central Asia . . .

Armenia . . .

Azerbaijan . . .

Kazakhstan .9 . .

Kyrgyz Republic .9 . .

Tajikistan . . .

East Asia ,9. . .

China, People's Rep. o ,. . .

Hong Kong, China . . .

Korea, Rep. o . . .Mongolia . . .

Taipei,China . -. .

South Asia . . .

Bangladesh . . .

Bhutan . . .

India . .9 .

Maldives . . .

Nepal . . .

Pakistan . . .

Sri Lanka . . .

Southeast Asia 9. . .9

Cambodia . . .Indonesia 9. . .

Lao People's Dem. Rep. . . .

Malaysia 9. 9. .

Myanmar . . .

Philippines . . .

Singapore . . .

Thailand . . .

Viet Nam . . .

The Pacic . . .

Fiji Islands . . -.

Micronesia, Fed. States o . . .

Papua New Guinea . . .

Samoa . . .Solomon Islands . . .

Tonga . . .

Vanuatu . . .

Developing Asia ,9. . .

Sources: International Monetary Fund, International FinancialStatistics online database; www.cbc.gov.tw; Bank o Korea,available: www.bok.or.kr; all downloaded 3 September 2007.

1 Developing Asias oreign exchange

reserves

-150

0

150

300

450

1996 98 2000 02 04 06 07a

Annual change, $ billion

-1

0

1

2

3

Stock, $ trillion

Stock, end of period

China, Peoples Rep. of

Rest of developing Asia

a First hal.

Sources: International Monetary Fund, InternationalFinancial Statistics online database; ww w.cbc.gov.tw;Bank o Korea, available: www.bok.or.kr; all downloaded3 September 2007.

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Responses

Public sector debt levels remain high in some countries, but have been

coming down (Figure 1.1.13). Te costs o servicing debt are likely to rise

as increased volatility eeds through to the repricing o risks. Indeed

this is already happening. During July and August, spreads on Asiansovereigns increased across the board (Figure 1.1.14) though in some

cases a reassessment o domestic circumstances also played a part. Rising

costs o debt servicing will hurt most where debts are already substantial.

Tose countries where debt levels are low and decits are small have

greater latitude to use scal measures to counteract any weakness coming

through other channels. However, long lags in spending could mean

that support kicks in just as economies are healing naturally. And i an

economic slowdown led to US dollar weakening, this would ease scal

pressures as the size o US dollar-denominated debts would shrink in

local currency terms.

I unolding evidence suggests that there are threats to growth, the

scope or monetary policy adjustments will depend on circumstances. Ineconomies where real interest rates are already very low (Figure 1.1.15),

cuts may not have much impact. And in countries where there is

overheating, slower growth may help reduce ination risks. Monetary

easing would make most sense where growth may slip below potential

and where real interest rates are moderate. Easing would be consistent

with ination (and output) objectives provided that it is appropriately

calibrated on the deationary impulse coming rom weakening external

demand, and on any induced eects on domestic consumption and

investment that could occur through credit and wealth channels.

Growth prospectsGrowth o 8.3% is now expected in 2007, easing gently to 8.2% in 2008

(Figure 1.1.16 and able 1.1.1). Momentum in the PRC and India supports

ast growth at the regional level. I these two countries are removed rom

the averages, the other economies are expected to grow by more modest

averages o 5.7% in 2007 and 5.6% in 2008.

Te baseline orecasts or 2007 anticipate some modest slowing in the

global economy, and a mild recovery in the US through 2008. Stabilizing

monetary responses seem likely. But the downside risks to growth in 2008

are elevated, and much will depend on whether distress in credit markets

deepens and spills over into the wider nancial system and real economy

(see above).

In the rst hal o 2007, growth in East Asia quickened, lied by

ast expansion in the PRC. Growth in the rst hal in the PRC was

11.5%, trending up through the second quarter. Te now amiliar

pattern o vigorous investment spending and rapid expansion o exports

underpinned growth in the PRC. Eorts by the authorities to rein back

investment and export demand growth have, as yet, had limited impact.

Investment administered by local governments is again growing at a ast

clip, and the withdrawal in midyear o export-supportive measures may

have brought orward export deliveries. Private consumption demand,

as measured by retail sales, is also growing briskly, bolstered by rapidly

expanding incomes in rural as well as urban areas.

1.1.15 Real lending rate

0

2

4

6

8

Korea, Rep. of

Hong Kong, China


JulAprJan07OctJulAprJan06OctJulAprJan2005

%

-4

0

4

8

12

Thailand

Singapore

Philippines

Malaysia

Indonesia

JulAprJan

07

OctJulAprJan

06

OctJulAprJan

2005

%

3

5

7

9

11

IndiaBangladesh

JulAprJan

07

OctJulAprJan

06

OctJulAprJan

2005

%

Source: International Monetary Fund, International FinancialStatistics online database; downloaded 8 September 2007.


1.1.14 S elected sovereign spreads

0

100

200

300

100

250

400

550

Viet Nam

Philippines

Pakistan

Malaysia

Indonesia


AugJulJunMayAprMarFebJan

2007

Basis points Basis points

Source: Bloomberg, downloaded 10 September 2007.
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Growth in Hong Kong, China continues to benet rom the bristling

economic activity in the PRC. In the rst hal, growth was 6.3% and

this Updates prediction is that growth in ull-year 2007 will be about

6%. Tough this is a little slower than recent outcomes, it is an upward

revision on the March orecast oADO 2007. In the Republic o Korea(hereaer Korea), underlying demand pressures have been building,

prompting the authorities to unexpectedly raise interest rates in July

and August. Reecting stronger than expected exports and a pickup

in consumption, estimated growth or Korea is revised up to 4.6%.

In aipei,China as well, the growth orecast is revised marginally up,

mainly on the back o an increase in investment in the rst hal o 2007.

Mongolia is beneting rom strong prices or copper and gold, warranting

an upward revision o the growth projection or 2007. It is now expected

that Mongolia will grow by 8%, capping 4 straight years o growth in

excess o 7%. East Asia is now projected to expand by 8.9% in 2007

(Figure 1.1.17).

South Asia continues to build on the progress o recent years. Growth

o 8.1% is expected in 2007 (Figure 1.1.18). Potential growth rates in

Bangladesh, India, and Pakistan, the subregions largest countries, all

appear to have risen and growth is also on a more stable trajectory. India

enjoyed its quickest expansion in 18 years in FY2006 (ended March 2007)

and industry is now spearheading growth. In the rst quarter o FY2007

(i.e., AprilJune 2007), growth showed little let-up despite higher interest

rates and a sharp appreciation o the rupee. Still, tighter monetary

conditions or the rest o FY2007 will lead to some soening. It is now

oreseen that India will grow by 8.5% in 2007, an upward revision to the

estimate o 8.0% made in March in ADO 2007.

.. Selected economic indicators, developing Asia,

ADO Update ADO Update

Gross domestic product (annual change)

Developing Asia . . . . .Central Asia . . . 9. .East Asia 9. . .9 . .South Asia . . . . .Southeast Asia . . . .9 .The Pacic . . . . .

Consumer price index (annual change)

Developing Asia . . . . .Central Asia .9 . 9. .9 9.East Asia . .9 . . .South Asia a .9 . . . .Southeast Asia . . . . .The Pacic . . . . .

Current account balance ( o GDP)

Developing Asia . . . . .Central Asia . . . . .East Asia . . . .9 .9South Asia -. -. -.9 -. -.Southeast Asia . . . . .The Pacic .9 -. . . .

a India reports on a wholesale price index basis.

Sources: Asian Development Outlookdatabase; sta estimates.

1.1.17 GDP growth, East Asia

0

2

4

6

8

10

080706050403022001

%5-year moving average

Forecast

Sources: Asian Development Outlookdatabase; staestimates.


1.1.16 GDP growth, developing Asia

0

2

4

6

8

10

080706050403022001

%

Forecast

5-year moving average




22/158


In Bangladesh, political developments continue to dominate, though

on the economic ront, there has been little change. Te textile industry

is doing well in the post-quota world and private remittances provide an

important source o support or consumption and investment. However,

recent measures against corruption and hoarding have added to businesssector uncertainty. In Pakistan, growth is put at 6.5% in FY2008 (ending

June 2008), but any adverse developments on the political and security

ront could have a crucial bearing on the economy. Growth o 7.0% in

FY2007 (ended June 2007) was largely underpinned by expansion in

large-scale manuacturing industry and in services. Remittances rom

Pakistans oreign-based workers continue to provide substantial support

to domestic demand.

Hopes or improvement in Nepals economic circumstances and

perormance have so ar not been met. Indeed, this Update revises down

the estimate or growth in FY2007 (ended 15 July 2007), to 2.5%. In Sri

Lanka, real economic growth is expected to hold its course, though the

macroeconomic situation continues to give cause or concern. In theMaldives, economic rhythm will return to a more settled pace ollowing

the spike in 2006 that reected tsunami-related reconstruction activities.

Te completion o a large hydro-project will give a boost to the income

growth o Bhutans small economy. In Aghanistan, growth has been

revised up due to a stronger than expected recovery in agriculture.

Growth in Indonesia continues to edge up and the outcome in 2007

is now expected to exceed 6%. In the rst hal, growth o 6.1% added to

the evidence o a strengthening economy, with growth accelerating in the

second quarter to 6.3%. As ination has come down, private consumption

and investment have led the way, and strength should build in the

second hal o the year. In the Philippines, rst-hal growth o 7.3% was

the highest in almost 20 years. Growth was propelled by net exports,consumption spending, and by higher levels o government expenditure.

On the supply side o the economy, services activity is enjoying vigorous

growth but manuacturing growth and investment spending continue

to lag. Tere has been brisk expansion in the mining sector, but rom a

low base. For 2007, this Update revises up its projection to 6.6%, on the

assumption that growth in the second hal will moderate rom the ast

pace o the rst 6 months.

In Malaysia, domestic demand is supporting growth. Private

consumption has grown vigorously and public sector investments in

inrastructure projects added to growth in the rst hal o 2007. Te

contribution o net exports to growth in Malaysia is ebbing, and is

expected to be negative this year. Viet Nams private sector shows ever-

increasing dynamism. Improvements in the business investment climate

and World rade Organization (WO) entry have added to condence.

On the supply side, growth was almost entirely attributable to industry

and services. Tis Updates orecast or growth o 8.3% in 2007 is

unchanged romADO 2007.

In Tailand, political uncertainty continues to sap consumer and

private investment condence. Still, in the rst hal o 2007 better

than expected net export perormance helped support growth, as did

government investment spending. It is expected that Tailands growth in

2007 will stay unchanged rom the original ADO 2007projection o 4%.

1.1.18 GDP growth, South Asia

02

4

6

8


080706050403022001

%

Forecast



1.1.19 GDP growth, Southeast Asia

0

2

4

6

8

080706050403022001

%5-year moving average

Forecast




23/158


Cambodia sees a marginal downward revision to its growth orecast, but

the Lao Peoples Democratic Republic registers no change. For Southeast

Asia as a whole, this Update uprates the projection o growth rom 5.6%

to 6.1% or 2007 (Figure 1.1.19).

Growth in Central Asia has again been underpinned by high pricesor oil and mineral exports. Higher production and exports are adding

directly to growth, but earnings are supporting domestic demand and

the expansion o services. Tis Update revises up its projection or GDP

growth in 2007 to 11.1% (Figure 1.1.20).

Azerbaijan and Kazakhstan are now set to grow more quickly as

a consequence o larger than expected increases in oil production and

exports, and stronger domestic demand. In urkmenistan, growth is

supported by larger exports o natural gas. Economic perormance in

Uzbekistan is improving, with higher investment and exports, and

growth has steadily climbed. In the rst hal, it grew at 9.7% and ull-

year 2007 growth should be 8.0%, a signicant upward revision rom

the estimate inADO 2007. Growth in both the Kyrgyz Republic and inajikistan was strong in the rst hal o 2007. In the Kyrgyz Republic,

the industry sector has bounced back rom the disruptions o 2006 and

2005, and investment- and remittance-uelled consumption has supported

strong expansion in ajikistan.

For the Pacic Islands, this Update downgrades the projection o

growth or 2007 rom 4.5% inADO 2007to 3.5% (Figure 1.1.21). In large

measure, this is because an expected rebound in imor-Leste has not

been as strong as had been anticipated. Te economic allout in the Fiji

Islands rom political events has also been more accentuated than was

earlier oreseen. However, Papua New Guinea, the largest economy in the

Pacic, is expected to do better.

Looking ahead to 2008, this Update orecasts regionwide growth o8.2%, marginally lower than the revised orecast or 2007. Nevertheless,

the central orecast o 8.2% is a substantial upward revision o the

March orecast o 7.7% inADO 2007. Tough growth is revised up or

all subregions, most o the increase is due to the upward revision or

East Asia, with nearly all o that being attributed to a ull 1 percentage

point rise in the projection or the PRC. Tis Update now projects

growth o 10.8% or the PRC in 2008, up rom the 9.8% oADO 2007.

Te reassessment o prospects or the PRC recognizes that momentum

has continued to accelerate through 2007, and that it may be dicult to

reverse quickly. Tough measures taken to slow the economy have had

limited eect so ar, they should have greater purchase going orward.

Elsewhere in East Asia, growth in Korea is expected to accelerate in 2008

as private consumption strengthens.

In India, growth is expected to hold steady in 2008 at or about its

potential level. Tis projected so landing assumes that the authorities

successully contain ination pressures, without crimping either investment

or export demand. Te outlook or growth in Bangladesh, Pakistan, and Sri

Lanka through 2008 is also steady, though these economies ace ongoing

and signicant macroeconomic stabilization challenges.

In Southeast Asia, prospects may brighten or Tailand, provided that

new elections deliver a government that has a credible economic program.

Malaysias growth may pick up a little rom that seen in 2007, but i the

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electronics slump continues this will trim its prospects. I Indonesia can

continue to make headway on restoring investor and broader economic

condence, its growth could climb urther in 2008. For Southeast Asia

as a whole, growth o 6.1% is expected or 2008, a slight upward revision

rom the March orecast oADO 2007.Prices o oil and minerals are expected to moderate in 2008, shaving

growth a little in Central Asia. In 2008, growth o 10.1% is now expected.

Growth projections have been revised up or the Pacic Islands. By 2008,

the Fiji Islands should be expanding, i only slowly, and Papua New

Guinea is expected to grow at 4.5%, boosted by earlier investments in

high-grade mining activities.

As explained above, the outlook or 2008 is subject to an unusually

large degree o uncertainty, with the possibility that unavorable external

developments could cause growth to slide. For the PRC, the most

probable channel o transmission would be through the demand or its

exports. Slower export growth would then cascade back down through

regional supply chains, hitting other countries in East and Southeast Asia.Despite the limited degree o integration o the PRCs nancial markets

with the wider international economy, nancial market contagion cannot

be ruled out. Stresses might then leach into other parts o the economy.

In the PRC and in some other countries, scal positions would provide

room or stabilizing responses.

Domestic rather than external demand has been the main driving

orce behind Indias spurt in growth. Nevertheless, industrial exports

have been rising quickly and trade in services has been a mainstay o the

current account earnings or some years now. Both would be negatively

inuenced i the temperature o the global economy were to drop.

Finally, i a slowing global economy were to cause commodity prices

to soen, this would trim prospects in Central Asia, and would have aneect on other economies that have enjoyed the benets o high prices in

past years.

Ination prospectsInation in the PRC, which has or long been tame, picked up in the rst

hal and by August 2007 had risen to 6.5%. Much o the ination strain

is coming rom rises in ood prices. Tough some o these rises reect

temporary actors, ood is such a big component o the consumption

basket that there is a risk o rising prices spilling over into broader

cost pressures. Further interest rate rises look possible as do delays in

adjustments to controlled prices o uels and other commodities.

Te PRCs considerable current account surplus and strong capital

inows continue to seep into domestic liquidity, complicating monetary

policy. Eorts to contain the growth o liquidity and credit continue, but

so ar, have had only limited impact. Te PRCs equity markets surged

again in the rst hal o 2007, largely impervious to the spasms in global

markets. House prices also continued to make steady gains in many

cities. Credit demand in the PRC is driven partly by the expectation o

urther gains in asset markets. Forecast ination in the PRC is revised up

to 4.2% rom the March prediction o 1.8% made inADO 2007. In Korea,

concerns about rising ination expectations prompted the authorities to

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raise interest rates in the last couple o months. For East Asia as whole,

the ination orecast or 2007 is revised up to 3.5% (Figure 1.1.22), rom

the March orecast o 1.9%.

Monthly wholesale price ination in India has come o the earlier

peaks seen in the rst 3 months o 2007, and since June has been withinthe Reserve Bank o Indias target range. A combination o higher policy

rates, targeted lending restrictions, appreciation o the rupee, some

easing o supply-side pressures on ood, and controls on the prices o

uels helped bring down wholesale price ination to 4.5% at end-July

2007. Elsewhere in South Asia, ination pressures are not ar rom the

surace. Tough central banks are taking tightening measures, ination

rates remain uncomortably high in Bangladesh, Pakistan, and Sri

Lanka. Credit expansion to nance government spending is making

the control o ination more dicult, particularly in Pakistan and Sri

Lanka. In Nepal, a poor harvest has added to ination. Tese have raised

South Asias ination orecast or 2007 to 5.7% rom 5.5% inADO 2007

(Figure 1.1.23).In Southeast Asia, ination is expected to moderate urther in 2007.

Aggregate ination is now seen coming down to 3.8% in 2007 rom over

7% in 2006 (Figure 1.1.24). Indonesia accounts or much o this reduction.

Te authorities there undertook aggressive monetary tightening in late

2005 and 2006 to combat ination pressures arising rom sharp uel

price increases. But the downward revision to the subregional ination

orecast (rom 4.2% inADO 2007) is primarily a result o ination alling

more quickly than anticipated in Malaysia, Philippines, Tailand, and

Singapore. Ination is expected to accelerate a little in Viet Nam relative

to the 2006 outcome. Buoyant demand in Viet Nam and high levels o

liquidity have contributed to high and rising ination.

Ination is now expected to accelerate more quickly in CentralAsia. TeADO 2007orecast o 8.6% or 2007 is revised up to 9.7%

(Figure 1.1.25). A major contributor to this pickup is Azerbaijan, where

oil revenues are boosting spending. However, a more general pattern o

modest upward revisions is discernible. Strong oreign exchange inows

and higher public spending are liing ination rates.

In the Pacic Islands, ination orecasts are revised up. Tis is

largely due to higher orecast ination or Papua New Guinea. Te local

currency, the kina, has depreciated and pass-through o earlier oil price

rises continues. Ination in the Pacic Islands is now expected to average

4.7% in 2007, up rom the orecast o 3.5% in ADO 2007(Figure 1.1.26).

Developing Asias prospects or ination (Figure 1.1.27) as well as or

output growth in 2008 are complicated by the uncertainty shrouding the

global economy. In the baseline, it is expected that ination will moderate

a little over 2007 levels. I growth turns out to be slower than anticipated,

ination could come down more quickly. On a subregional basis,

reductions in ination are expected in East Asia, South Asia, Central Asia,

and in the Pacic; but in Southeast Asia, ination will remain steady.

Balance-o-payments prospectsAs a percentage o GDP, developing Asias current account balance is

expected to show little change on 2006s outcome. Te revised estimate

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o this Update is that the current account surplus in 2007 will be 6.1% o

regional GDP, compared with 5.8% in 2006 (Figure 1.1.28).

In 2007, only South Asia is expected to have a current account decit

(Figure 1.1.29). Indias decit will probably be larger than in 2006, but has

been revised down rom the estimate in ADO2007s March orecast. Awidening decit in merchandise goods trade is being partially oset by

signicant earnings on the services account rom soware exports, back-

oce services, and remittance income.

Pakistans decit, which is now estimated to expand to 5.2% o GDP,

reects its widening trade gap, as exports rom its textiles and clothing

sector are pressured by more intense global competition. Tough

remittance income remains strong, it is insucient to oset Pakistans

trade decit. Growing remittances more than nance Bangladeshs trade

decit, and it is now estimated to post a current account surplus o 1.4%

o GDP in 2007. In Sri Lanka, the current account decit is expected to

narrow, ollowing the jump in 2006 as rapid growth in imports sparked

by tsunami reconstruction eorts have moderated.Te current account surplus in East Asia or 2007 is now projected

at 8.2% o GDP, an increase over the surplus in 2006 (Figure 1.1.30).

All economies in East Asia are in surplus. Te surplus in the PRC is

expected to widen to 10.9% o GDP in 2007 as exports continue to outrun

imports. Likewise, Hong Kong, China and aipei,China are also expected

to post large surpluses in 2007. In Hong Kong, China, strong services

perormance, linked to continued expansion in the PRC, underpins the

current account surplus. In aipei,China, export perormance has been

strong in the rst 6 months, validating theADO 2007projection. For

Korea, the narrow current account surplus predicted inADO 2007has been

revised up, reecting stronger exports. A small surplus o 0.6% o GDP is

now predicted. Mongolias expected surplus holds rm at 2% o GDP.Te consolidated current account surplus or Southeast Asia is

expected to come o its recent peak. Compared to a surplus o 7.8% o

GDP in 2006, the surplus in 2007 is now predicted at 7% (Figure 1.1.31).

Surpluses or Indonesia and Malaysia are both expected to shrink, and in

the case o Malaysia by more than 4 percentage points o GDP (though

rom a very high base). Nevertheless, there have been general upward

revisions to the orecasts made in ADO 2007in March. Tailands strong

export perormance is expected to li its surplus to 3% o GDP in 2007

and Singapores strong surplus is expected to continue its upward dri.

Viet Nams current account decit is expected to widen sharply in 2007

as a result o rapid growth in imports o raw materials, and intermediate

and capital goods, and a decline in oil exports.

Tere is little change in the projection o the current account

position o Central Asia. Tis Update projects a surplus o 3.5% o GDP

(Figure 1.1.32) as against 3.2% in the March estimate oADO 2007. It is

expected that a larger projected decit or ajikistan, reecting increased

spending on capital imports coupled with sluggish aluminum exports,

will be more than counterbalanced by a larger surplus or urkmenistan

driven by strong exports o gas.

For the Pacic, this Update incorporates an estimate or imor-Lestes

current account position in 2007. Te large surplus reects a surge in oil

and gas revenues as production rom existing elds increases. Compared

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with 2006, the Pacics current account surplus is estimated to rise to

7.3% o GDP (Figure 1.1.33). Excluding imor-Leste, the orecast or the

Pacics current account decit is revised upward to 5.2% o GDP rom

1.2% inADO 2007, mainly resulting rom a larger projected decit or the

Fiji Islands, where political and security concerns are expected to reduceocial transers and tourism receipts.

Te outlook or the current account o the balance o payments

in 2008 is or an aggregate surplus o 5.7%. At a subregional level, the

surpluses in East Asia and Southeast Asia are projected to decline. Faster

economic growth and stronger demand should reduce the surplus in

Indonesia and Tailand. Malaysias surplus may track down i the price

o its primary commodity exports soen and the recovery in electronics

activity is slow. In East Asia, it is expected that the PRCs surplus will

decline slightly to 10.5% o GDP in 2008. Finally, i slower growth in the

global economy were to occur in tandem with an appreciation o regional

currencies, this would tend to erode the regions current account surplus

moving into 2008. Soer prices or oil and minerals would trim exportearnings, particularly in Central Asia but also in some other countries.

Reerences

Dees, S. and I. Vansteenkiste. . Te ransmission o US CyclicalDevelopments to the Rest o the World. European Central Bank WorkingPaper Series No. . Frankurt.

International Monetary Fund (IMF). . Decoupling the rain? Spilloversand Cycles in the Global Economy. Chapter in World Economic Outlook(April). Washington, DC.

Park, C.-Y. . Can East Asia Weather a US Slowdown? ERD WorkingPaper Series No. . Economics and Research Department. AsianDevelopment Bank. Manila.

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World economy

United StatesBoosted by strong expansion in business investment, public spending,

and net exports, growth in the second quarter o 2007 accelerated to 4.0%

(quarter on quarter, seasonally adjusted annualized rate) rom a tepid

0.6% in the rst (Figure 1.2.1). But the persistent housing slump remains

a major risk to economic perormance. For the sixth consecutive quarter,

private residential investment contracted. On a 12-month moving average

basis, housing starts have been declining since April 2006 (Figure 1.2.2),

but the inventory o unsold homes is still high. With this overhang,

and rising deaults and oreclosures among subprime mortgage-holderscontinuing to depress the housing market, house prices are likely to drop

urther (Box 1.2.1).

Facing subprime mortgage anxieties, many US consumers have lost

condence: the August consumer condence reading dipped to its lowest

in a year. Personal consumption expenditures grew by only 1.4% in the

second quarter, slowing sharply rom 3.7% in the rst. Real disposable

personal income, too, barely increased in the second quarter, and a

pickup in gasoline and ood prices depressed spending on nondurable

goods. Consumers also ace increasing headwinds rom alling home

prices, rising interest burdens, and slowing employment opportunities. In

addition, recent weakness in equity markets associat