Chapter

I. Recent Developments and Outlook

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
May 2006
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Asia’s growth has garnered strong momentum in recent quarters, with the region benefiting from a surge in external demand for electronic products, which has stimulated investment, employment, and consumption in most economies. While high oil prices remain a threat, the risks going forward are now more balanced than at the time of the August 2005 Regional Economic Outlook, notably because world growth has become more balanced and less dependent on the United States. Inflation remains a concern in some ASEAN-4 countries following increases in domestic fuel prices, but prompt monetary policy action has limited second-round effects so far.

Growth

The year 2006 is expected to be another good one for Asia. Growth for the region is forecast at 7 percent, the same as in 2005 but higher than the 6 percent expected at the time of the August Regional Economic Outlook. Japan’s strong recovery continues apace, with the country expected once again to grow faster than its estimated long-run potential (Box 1). While growth is likely to moderate in China and India, this merely signals a return to more sustainable—but still very robust—levels.

Real GDP Growth(Year-on-year percent change)
2004200520062007
Proj.Proj.
Industrial Asia2.52.72.82.2
Japan2.32.72.82.1
Australia3.62.52.93.2
New Zealand4.32.00.92.1
Emerging Asia8.48.38.07.7
China10.19.99.59.0
India7.48.07.37.0
NIEs5.94.55.24.5
ASEN-45.85.25.15.7
Asia7.17.16.96.6
Sources: IMF, APDCORE database; and staff estimates.

The region is benefiting from the strong momentum garnered in recent quarters. Growth in the second half of 2005 in China and the NIEs was over 2¼ percentage points higher than expected in August, with India and Japan providing positive surprises as well. Fourth quarter growth was strong in two ways, extending across the region and across sectors, with both exports and domestic demand gaining traction. Australia and New Zealand, though, were important exceptions (Box 2).

GDP Growth(In percent)
RO Proj.1
2004200520052005
Q42Q42
Industrial Asia2.52.72.52.8
Japan2.32.72.53.1
Australia3.62.52.91.5
New Zealand4.32.03.40.6
Emerging Asia8.48.36.58.9
China10.19.98.010.6
India7.48.06.27.2
NIEs5.94.54.77.0
ASEN-45.85.26.66.4
Asia-137.17.15.77.6
Sources: IMF, APDCORE database; and staff estimates.

Asia: GDP Growth

(Year-on-year percent change)

Sources: IMF, APDCORE database; and staff calculations.

The strong growth momentum derives in large part from a booming demand for electronics, which account for one-third of the region’s exports. Global demand for all lines of electronics surged in the summer of 2005 and has remained buoyant since then, helped by a confluence of factors: a wider offering of high definition TV programming by cable companies helped boost sales of flat screen TVs and other ancillary products; phone companies improved network coverage for 3G Wireless, releasing pent up demand;1 MP3 players became the mainstream choice for music replay, both portably and at home; and major companies switched to digital as photography’s technology of choice. Equally important, better inventory management in the industry now means stronger contemporaneous correspondence between demand and production: for instance, while excess inventories in the chip industry amounted to $15 billion or one full month of revenues in late 2000, they only amounted to one-tenth of that amount in late 2004.

The NIEs have capitalized on this upswing, but the performance in the ASEAN-4 has been mixed. Growth in electronics exports has accelerated sharply since last summer in the NIEs, explaining why second-half growth in these economies surprised on the upside. Electronics exports have also been robust in Malaysia and Thailand (although they seem to be decelerating in the latter). But export performance has disappointed in the Philippines, and electronic shipments have plunged in Indonesia. The implications of this underperformance are not clear, since electronics exports from the Philippines and Indonesia are traditionally less correlated with the global cycle. However, there are signs that some ASEAN-4 economies could face medium-term challenges in electronics, stemming from underinvestment in the sector and the effective transfer of productive capacity to China (Box 3).

ASEAN-4 Versus NIEs: Electronic Export Growth

(y/y percent change, 3mma)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

Looking forward, external demand looks set to remain strong. The U.S. economy retains strong momentum despite a soft patch in the fourth quarter, and is projected to grow at a healthy 3 ¼ percent in 2006. Prospects have also improved in Europe, despite similarly disappointing fourth quarter figures. Of direct relevance for electronics exports, investment is growing briskly especially in the United States, with orders and shipments of capital goods now exceeding levels last seen at the peak of the IT boom. The Semiconductor Industry Association (SIA) expects global semiconductor sales to grow by 7.9 percent in 2006, higher than the 6.8 percent growth estimated for 2005. Admittedly, some widely- watched electronics indicators such as the U.S. book-to-bill ratio and U.S. new orders have declined, but this can be explained by the transfer of manufacturing capacity out of the U.S. and by anticipated price declines in semiconductors, respectively. More pertinently for Asia, regional chip makers are reporting healthy growth in orders and the global book-to-bill ratio is at a historically high level.

OECD Leading Indicators

(6-month percent change, annualized)

Sources: OECD; and CEIC Data Company Ltd.

1Manufacturing.

Tech Sector Indicators1

Sources: CEIC Data Company Ltd; and VLSI Research Inc.

1 Three-month moving average.

Shifts within the electronics sector could have within-region implications for growth. The SIA estimates flash memory sales to have grown by 58 percent in 2005 and expects a further 24 percent growth in 2006, while the figures for global DRAM sales are minus 5 percent and minus 10 percent, respectively.2 (These figures do not take into account recent falls in flash memory prices, though, reflecting concerns about launch delays of some key products that use flash.) In the longer term, however, there is no doubt that flash will progressively replace DRAM and hard drives, as flash memory capacity increases and prices fall. Korean firms would benefit the most if these trends are confirmed, thanks to their superior competitiveness in flash memory products, while Japanese and Taiwanese firms also have the technology to shift production from DRAM to flash. ASEAN-4 producers, however, would be negatively affected if DRAM and hard disk production were to cede market share to flash.

Emerging Asia’s exports will also benefit from developments within Asia. In particular, Japan’s recovery has deepened and broadened, with fourth quarter growth reaching an impressive 5½ percent (q/q, SAAR) and the contribution of domestic demand rising throughout the year. The yen’s depreciation vis-à-vis regional currencies may have dampened imports from the region, but as the yen stabilizes and the expansion continues, these imports are likely to pick up further. In the meantime, China’s imports are gaining momentum, growing at an annual rate of 25 percent in the first quarter of 2006 relative to the same period last year, compared with 22 percent in the fourth quarter of 2005. While a large part of these imports are processed and then rexported to third markets such as the U.S., China’s role as a source of final import demand is growing. Handset-maker Nokia expects China to add 250 million mobile-phone subscribers by 2010, while sales of flat-screen TVs—many of them made outside of China—are estimated to have risen by close to 200 percent in 2005. China has now surpassed Japan as the third largest market for this product.

The region’s export boom is lifting corporate profits and stimulating employment, income, and consumption. In some economies this process has been going on for some time. In Japan, for example, profits have been steadily rising since 2002 and are now at levels last seen in the late 1980s, leading to vigorous hiring and wage growth. In other countries, this process is in the early stages. In Korea, the export boom in the second half of last year has contributed to an increase in employment (seasonally adjusted) of about 240,000 between September 2005 and March 2006, versus a loss of 70,000 jobs during the third quarter of 2005. And as employment and household incomes have increased across emerging Asia—including on farms, thanks to high commodity prices—consumption has accelerated, with annualized growth reaching 7 percent in the fourth quarter.3 Even in the ASEAN-4, consumption has been remarkably resilient despite increases in fuel prices, rising inflation, and higher interest rates.

NIEs: Contributions to GDP Growth

(Year-on-year change in percent of previous year’s GDP)

Sources: IMF, APDCORE database; and staff calculations.

ASEAN-4: Contributions to GDP Growth

(Year-on-year change in percent of previous year’s GDP)

Sources: IMF, APDCORE database; and staff calculations.

Prospects for investment are generally improving in the NIEs but not in the ASEAN-4, where higher uncertainty following recent fuel price increases has led firms to be more cautious. After a slump, investment’s contribution to growth has generally been rising in the NIEs, as high corporate profits have allowed firms to expand capacity and profit from good economic conditions. Residential investment is not faring as well as equipment investment in these economies, but this is due to very specific factors: land sales have been slow in Hong Kong SAR, and Korea recently passed measures to rein in increases in housing prices. The situation in Taiwan Province of China is more worrisome, though, as the fall in investment there has been large and broad-based—and has occurred despite a strong export performance. Meanwhile, in the ASEAN-4, investment was undermined initially by the uncertainty ahead of recent increases in fuel prices, and then by the subsequent inflation and rising interest rates, particularly in Indonesia. There was also a sharp fall in public investment in the fourth quarter in Malaysia. But looking ahead, investment in the ASEAN-4 is likely to rebound as public investment revives and these economies adjust to the fuel price increases.

Economic risks to Asia’s outlook are more balanced than at the time of the August Regional Outlook. On the positive side, the rise in U.S. corporate investment is lifting some weight off the shoulders of American consumers. At the same time, global demand is becoming less dependent on the United States, with activity picking up in Europe—albeit after a soft fourth quarter—and the recovery in Japan proving stronger than expected.

High oil prices, however, remain a threat to the outlook (Box 4). While rising oil bills have so far had only a moderate effect on global economic activity in general and on Asia’s growth in particular, this may change going forward, as recent oil price increases have mostly been due to concerns about future supply rather than unexpected increases in demand.

Oil Prices

(U.S. dollars per barrel)

Sources: Bloomberg LP; and IMF, Commodities Price System database.

1Futures price series are calculated using the current spread between Brent and Dubai forwards, Tokyo Commodity Exchange’s Middle East crude oil futures, and IPE Brent.

In addition, financial markets in the region will likely be tested as global liquidity conditions tighten (Chapter II). Although banking soundness has improved, in some countries banks have experienced rapid growth of credit to households, and close supervision is needed (Box 5). Asia has also benefited from the run-up in emerging market equity prices and like other regions, could see equity market declines if foreign investors were to pull back amid a rise in global risk aversion. But, these risks should generally be manageable, owing to the improvements in the region’s economic fundamentals.

Global imbalances pose another risk, but probably not in the short term. The U.S. current account deficit is projected at 6½ percent of GDP in 2006, about the same as last year. While a disorderly adjustment to global imbalances seems unlikely in the immediate future, a sharp slowdown in U.S. demand would have significant consequences for Asia, which remains highly dependent on external demand.

The risk of an avian flu pandemic is the hardest to quantify but potentially the most devastating. The deadly H5N1 virus has now spread to Africa and to continental Europe. While the human death toll so far has been contained, a mutation of the gene that would lead to human-to-human transmission—and hence to much higher infection rates among humans—cannot be ruled out. The effects of such a pandemic on Asia’s economy are very hard to estimate and depend partly on the quality of contingency plans, which remain largely untested, but they could potentially amount to several percentage points of GDP (Box 6).

Inflation

Inflation has risen to double-digit levels in the ASEAN-4 due to fuel price increases, but second-round effects so far have been modest. Headline inflation now stands at the 10¼ percent mark in the ASEAN-4 because of the 15¾ percent rate in Indonesia, but inflation in the Philippines is also significant at 7½ percent. Core inflation in ASEAN-4 accelerated with the fuel price increases, but this was almost entirely driven by developments in Indonesia. Even in Indonesia, core and headline inflation have remained subdued lately on a month-to-month basis. Looking forward, average headline inflation in the ASEAN-4 is projected to come down to 9 percent in 2006 as the effect of fuel price increases wanes. However, much depends on the path of world oil prices, and on future decisions to reduce oil price subsidies, which remain significant in Indonesia and Malaysia despite recent domestic price increases. Meanwhile, inflation may rise this year in India, perhaps by half a percentage point to 5 percent, on account of strong domestic demand.

CPI Inflation(Year-on-year percent change, average)
20042005200620062007
LatestProj.Proj.
Industrial Asia0.40.20.80.70.9
Japan0.0-0.30.40.20.6
Australia2.32.72.82.92.7
New Zealand2.33.03.22.72.4
Emerging Asia4.43.22.83.53.2
China3.91.80.92.02.2
India16.64.74.05.15.5
NIEs2.42.31.42.12.3
ASEN-44.67.510.38.94.6
Asia3.52.62.42.92.8
Sources: IMF, APDCORE database; and staff estimates.

ASEAN4: Consumer Prices

(12-month percent change)

Sources: CEIC Data Company Ltd; IMF, APDCORE database; and staff estimates.

In the rest of emerging Asia, inflation is expected to rise slightly, to around 2 percent. In China, higher inflation is expected to come from planned reforms of energy and utility prices, although overcapacity in other sectors will put a lid on price pressures. Food price inflation, an important determinant of overall inflation in China, is expected to stabilize at current levels after falling for much of 2005.4 Meanwhile, vigorous exports and domestic demand recoveries should help close the output gap in the NIEs, but even so inflationary expectations remain well contained.

NIEs: Consumer Prices

(12-month percent change)

Sources: CEIC Data Company Ltd; IMF, APDCORE database; and staff estimates.

China: Consumer Prices

(12-month percent change)

Sources: CEIC Data Company Ltd; IMF, APDCORE database; and staff estimates.

External Sector

Excluding China, Asia’s current account surplus has been shrinking. High oil prices are estimated to have added some $30 billion to imports in emerging Asia excluding China between 2003 and 2005, and to have accounted for one-third of total import growth in Japan in 2005. And further pressure on imports has come from domestic demand, notably in Japan and India. As a result, imports grew much faster than booming exports, reducing the current account surplus of emerging Asia excluding China by an estimated $23 billion or 1½ percentage point of GDP in 2005, while Japan’s surplus fell by $8 billion or ¼ percentage point of GDP. Looking forward, strong domestic demand will lead to a further deterioration of the current account balance in Japan and India, while vigorous exports will help stabilize the balance in the ASEAN-4 and boost it slightly in the NIEs.

Current Account Balances(In billions of U.S. dollars)
2004200520062007
Proj.Proj.
Industrial Asia125.4112.389.983.4
Japan172.1163.9140.2133.6
Australia-40.2-42.0-40.8-41.8
New Zealand-6.5-9.6-9.5-8.4
Emerging Asia185.7253.0257.2275.4
China68.7158.6173.3189.6
India1.4-12.9-26.1-28.7
NIEs88.785.888.693.9
ASEN-426.921.521.520.6
Asia311.1365.3347.2358.8
Emerging Asia excl. China117.194.483.985.8
Sources: IMF, APDCORE database; and staff estimates.
Current Account Balances(Percent of GDP)
Current accountNon-oil current account
20042005200620072004200520062007
Proj.Proj.Est.Proj.Proj.
Industrial Asia2.42.11.71.53.84.04.14.0
Japan3.83.63.22.95.35.85.85.7
Australia-6.3-5.9-5.6-5.5-5.9-5.5-5.0-4.8
New Zealand-6.7-8.9-8.9-7.6-4.3-6.1-6.0-4.8
Emerging Asia4.25.04.54.47.79.810.210.5
China3.67.16.96.77.312.914.014.7
India0.2-1.8-3.1-3.1-3.41.41.00.8
NIEs7.06.05.75.610.810.710.710.7
ASEAN-44.43.12.82.57.07.27.06.4
Asia3.23.53.23.15.66.87.37.5
Emerging Asia excl. China4.73.42.72.58.07.47.27.2
Sources: IMF, World Economic Outlook; APDCORE database; and staff estimates.

By contrast, China’s current account surplus more than doubled in 2005, but is now projected to stabilize. The current account surplus grew from $69 billion in 2004 to close to $160 billion in 2005, an increase of 3½ percentage points of GDP. However, on a sequential basis, Chinese export volume growth has softened, while imports have risen rapidly since August after four months of virtual stagnation, reflecting higher domestic spending. As a result, China’s trade surplus has stabilized somewhat in recent months, a trend that is expected to continue in the rest of 2006. For the year as a whole, the current account surplus is forecast to remain at 7 percent of GDP.

China: Twelve-Month Trade Surplus

(In billions of U.S. dollars)

Source: CEIC Data Company Ltd.

These are wideband mobile services that allow users to, among other things, access the internet or TV on their cell phones.

DRAM and flash are two different types of memory chips. In DRAM, any byte of memory can be accessed directly without proceeding sequentially through the preceding bytes, making information retrieval fast. However, DRAM chips are volatile, meaning that any information stored is lost when the power is turned off. Flash is gaining market share over DRAM because it is nonvolatile, a very convenient feature for popular items such as handsets and MP3 players. Flash remains slower and more expensive to produce than DRAM, but the gap is closing.

Emerging Asia here excludes China and India, for which quarterly data on expenditure components are not available.

Food items account for some 50 percent of China’s CPI basket. Food price inflation in 2005 was partly distorted by an exceptionally poor harvest in 2004.

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