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Regional focus: Asia’s economic outlook is bright, but risks loom

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
May 2005
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Decades of rapid growth have made Asia’s economies a vitally important part of the world economy. Three out of the world’s 10 largest economies are in Asia: Japan, China, and Korea. Asia accounts for about one-fifth of global output and nearly half of recent world economic growth. Global growth in the coming years thus depends, in no small measure, on what happens in Asia. This article examines Asia’s economic outlook and shifts in production patterns that are occurring with the recent end of the system of global textile quotas. It is the first in a series of quarterly articles that the IMF Survey plans to run on Asia, which will look at economic trends in the region and topical policy issues.

This year is shaping up to be another good one for the region, with GDP expected to grow by 5¼ percent. This is somewhat slower than last year’s rate of 6¼ percent, but last year’s growth was the best in almost a decade, partly due to a surge in the region’s exports (see chart). In particular, demand for electronics exports boomed as the sector finally recovered from its post-2000 slump, resulting in a 41 percent increase in Asian sales of semiconductors. Export growth in 2005 should subside to more normal rates as the electronics expansion matures, slowing GDP growth to a more sustainable rate. Emerging Asia—China, India, the NIEs (Newly Industrialized Economies—Hong Kong SAR, Singapore, and Taiwan Province of China), and the ASEAN4 (Indonesia, Malaysia, the Philippines, and Thailand)—is projected to grow by 6½ percent, compared with 7½ percent in 2004.

The outlook for other economic indicators is generally favorable. The region’s current account surplus is forecast to narrow modestly to 2¾ percent of GDP from 3¼ percent of GDP, reflecting the export slowdown. Meanwhile, regional inflation is projected to remain at 3 percent.

Three major risks loom, however. First, world oil prices have increased again this year, and as of mid-May are around 20 percent higher than they were in December 2004, hurting regional incomes and putting upward pressure on inflation. So, the possibility of further oil price increases is one downside risk. Second, global current account imbalances have continued to widen, threatening to trigger a disorderly adjustment of world currencies and interest rates. The IMF has emphasized that addressing global imbalances is a shared responsibility of countries, requiring more flexible exchange rates in emerging Asia where appropriate, as well as policies to increase national savings in the United States, and further structural reforms in Europe and Japan to boost their growth. Third, as indicated in the IMF’s April 2005 World Economic Outlook, the risks to growth in the advanced economies outside Asia are predominantly on the downside, which points to a risk that demand for Asian exports may decelerate by more than projected in the second half of the year.

Spectacular economic growth …

Last year’ growth was the best in almost a decade, well above that of the European Union and the UnitedStates.

(Percent)

… partly thanks to booming exports

Exports growth reached 18 percent in 2004 but is expected to subside to more normal rates in 2005 as the recent electronice expansion matures.

(Percent)

Data: IMF, World Economic Outlook.

This situation presents some difficulties for the region’s policymakers. On the one hand, they need to be prepared for a slowdown in growth, which might warrant some compensating macroeconomic stimulus. But they also need to guard against a rise in inflation, requiring some policy tightening. In such circumstances, policymakers will need to remain vigilant, carefully sifting the evidence before deciding which way to adjust macroeconomic policy. They will need to take into account the fact that the monetary stance in most cases is already highly accommodative, with policy interest rates at historically low levels—around 3½ percent in emerging Asia—roughly the same as forecast inflation. For countries with pegged exchange rates, an advantage of moving to increased exchange rate flexibility would be a greater ability to use monetary policy to adjust demand conditions and control inflation. For example, in Korea, the exchange rate appreciated by 17½ percent against the U.S. dollar in the year to mid-May, helping to offset the impact of higher world oil prices.

The end of textile quotas

The expiration of global textile and clothing quotas at the end of 2004 is having important effects on the region, especially China and the low-income countries in Asia: Bangladesh, Cambodia, Lao P.D.R., Mongolia, Nepal, Sri Lanka, and Vietnam. This complex system of quotas had distorted global textile trade for decades, and its abolition holds out the promise that export orders will finally go to the most competitive firms, resulting in substantial savings benefiting the world’s consumers. But for this to occur, protectionist pressures need to be kept at bay.

So far, available information suggests that China, as expected, has been the major beneficiary. Data for the first three months, for example, indicate that China’s textile and clothing exports to the United States have jumped sharply—by nearly 60 percent, and by around 180 percent in newly liberalized product lines—although the growth in China’s total textile exports in the first quarter of 2005 has remained largely the same as last year. India’s exports have also grown rapidly.

These developments, however, have already produced a protectionist response. In mid-May, the United States decided to reimpose quotas on seven categories of clothing imports from China, limiting their growth to no more than 7½ percent over a 12-month period. The European Commission is conducting its own investigation into several textile product categories and, on May 17, announced that it would seek emergency safeguards for two categories of products (T-shirts and flax yarns). China announced on May 20 that it would raise export taxes substantially on 74 products, effective June 1.

Meanwhile, the Asian low-income countries have been doing reasonably well. China’s increase in market share has so far come mainly at the expense of middle-income countries, rather than low-income countries, partly because importers have been maintaining diverse low-cost suppliers in case the United States or the European Union imposed bilateral quotas on China. Thus, textile exports of Bangladesh, Cambodia, Sri Lanka, and Vietnam to the United States have actually increased—by 17 percent on average during the first quarter.

At the same time, there are some ominous signs for the Asian low-income countries. Prices are falling, by almost 12 percent on all apparel imports from China into the United States and by more than 50 percent in certain categories. Over time, this will squeeze the profit margins of Asia’s low-income country exporters and erode their overseas orders. If the same geographical shifts in production that took place during the first year of an earlier round of liberalization occur again, an IMF staff study suggests that the textile exports of Asian low-income countries could fall significantly. The decline could range from 8-18 percent, depending on the country, reducing GDP growth for about one year by ½-2¾ percentage points.

As this process occurs, the IMF will be aiding the adjustment process through its Trade Integration Mechanism, which was introduced in April 2004 to help member countries meet balance of payments shortfalls that might result from multilateral trade liberalization. Bangladesh has made use of this mechanism. The shift in textile production will play out over the coming years, and the ultimate pattern remains uncertain.

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