East Asia Update: Testing Times Ahead

Dear Roy

From a global trade perspective, the United States clearly matters more to the world economy than China – but its pre-eminence in world markets is gradually declining.
The US share of world imports has shrunk from 19 percent in 2000 to below 15 percent in 2007, while the share of East Asia (excluding Japan) is now 19 percent — of which China is over 6 percent — and that of other developing countries is around 22 percent.

Note that there is a lot of trade of intermediate and semi-finished products within East Asia which is ultimately destined for US markets – so a slowdown in US imports is usually accompanied by a slow down in trade within East Asia. If we assume East Asia is one country (economists are used to assuming anything to make a point!), then the United States imports about imports about 29 percent of East Asia’s final exports – compared to about 26 percent for other developing countries and 45 percent for other industrial countries (that is Europe, Japan, Australia, Canada and so on).

In short, the US is an important player in the world market (it accounts for roughly a fifth of the world’s GDP), but its role has been shrinking slowly.

Best regards

Vikram

Dear Roy

I am not an expert on the international rice market, and a lot of analysis is underway to try to explain why the rice prices have suddenly exploded (and there is no better term to describe what has happened). For what its worth, my sense is that that part of the striy can be explained by two long term trends – rapidly growing global demand for rice driven in part by rapid growth in incomes in the developing world, especially China and India; and slowing growth in rice production as yield increases have slowed and land used for rice cultivation has been lost to urbanization and industrialization in key producing countries – again in countries like China and India, but also in Indonesia and Thailand among others.

But the above explanation suggests that the relative price of rice would increase relatively gradually – although, as we have seen, the price of rice suddenly began to climb rapidly around the middle of last year. My hunch is that the long-term trends have been overlaid by three relatively short-term factors that explain the sudden spike in recent months. First, rice stocks have gradually declined in the rice surplus countries and the markets did not react until they reached critically low levels; second, the crisis in the US financial markets have driven investors – always in search of high returns – away from the stock and bond markets and toward commodities (which also partly explains, incidentally, why there has been a spike recently in other food prices, as well as fuel, and metal prices). Finally, the worlds major exporters are relatively few – Thailand, Egypt, India, Vietnam, China, and so on – and many of these countries have either banned rice exports or placed tough export restrictions in a bid to keep domestic prices affordable for their own populations.

But as I said, these are just my own “theories” without any real evidence to back them up, so let’s wait and see what the real "gurus" have to say once they have analyzed the data.

Best regards

Vikram

Dear Mr. Windfield

East Asia's (and China's) export growth rate has been declining since 2004 even as its GDP growth rate has been rising. It follows that domestic demand has become a more important driver of growth over the last few years.

Looking to the future, the deceleration in global growth stemming from the slowdown in the United States will mean that export markets are unlikely to grow as rapidly in 2008 as they did in 2007 – which suggests that exports from East Asia (and China) will grow even more slowly. And while GDP growth is also expected to slow, it will not slow as rapidly as export growth – thanks to continued robust domestic demand.

Best regards

Vikram

Dear Sokheang

The US slowdown – which is likely to spread to other industrial and developing countries -- will obviously have a dampening effect on Cambodia’s export prospects, particularly in garments. But we don’t believe this will too pronounced because the US slowdown is not the only global factor that will affect Cambodia. Another factor is high global food prices which we hope will spur agricultural production in Cambodia (a primarily agricultural economy where agricultural growth in the past contributed about a quarter of the growth rate of GDP). In addition, while the slowdown in the world economy may dampen the growth of tourist arrivals in the country (many of whom come to see the world-famous Angkor Wat temple complex in Siem Reap), it is important to remember that Cambodia is a largely dollarized economy, and the declining value of the US dollar has made tourism to Cambodia very cheap for Asian and European tourists. So its quite possible that the price effect may trump the income effect, and Cambodia’s tourist industry may actually benefit overall.

Inflation has been rising in Cambodia just as it has in other East Asian economies (or for that matter, around the world). Cost-push pressure is being exerted by higher food, fuel, and metals prices, but this is being more than accommodated by rising money supply which is being driven by substantial capital inflows. Here the situation is rather the same as in Vietnam.

Best regards

Vikram

Dear Eddy

The technology you suggest, if it works, could be invaluable to governments who are keen to target subsidies to specific individuals or households. Such forms of “smart” conditional cash transfers could significantly reduce costs of administering such subsidy schemes. The challenge will remain, however, of how to identify the individuals and households who should receive such cards. In Indonesia, they have a terrific family planning survey which they used to identify poor households during the crisis so they could give each such household 20kgs of rice each month. But updating such survey information is costly -- and therein lies the rub. Once you have a technology that is able to do that frequently, accurately, and cost-effectively, then you could have a real winning combination.

Best regards

Vikram

Dear Imran

I am not sure what you mean by your first question, but its interesting to note that a strong and resilient Chinese economy (which is the third largest in the world in PPP terms) works strongly in favor of the United States – especially now that its economy is slowing so quickly – because China has become an important market for US exports. The decline in the US dollar should assist the United States in becoming more competitive in external markets and allow exports to become an engine of growth and reverse – or at least ameliorate -- its economic slowdown. And indeed there are indications that this is already happening – the US trade deficit (that is, imports less exports) is shrinking rapidly. But this process will be helped enormously if US export markets are strong and growing healthily. And that not only means China but other developing and developed economies as well.

A strong and resilient Chinese economy is even more helpful to Asia – especially East Asia. Trade within East Asia has been growing particularly rapidly over the last three decades, and China has been at the center of such growth in the last two of them. Apart from being a part of an East Asian production network, China is also an independent source of demand for raw materials as well as finished goods. Slower growth in China has important ramifications for export growth in the rest of East Asia.

Best regards

Vikram

Dear Luong (I hope I have your first name right!)

Allow me to rephrase your question if I may. I think you mean to ask whether it is possible for Vietnam to reduce the growth rate of credit from 50 percent a year (which was the case in 2007) to 30 per cent a year (the recently announced target for 2008) while still maintaining GDP growth at around 8 percent.

If that is your question, then it’s a terrific one!

I think there is no doubt that the Vietnamese authorities are quite right in being concerned about the inflation rate – which was above 16 percent as of February 2008. Rising food prices, and the desire to maintain a fixed exchange rate that, in turn, fueled rapid credit growth, were the most important underlying reasons. Lowering the pace of domestic credit expansion to around 30 percent in 2008 is, therefore, an important element in the country’s anti-inflationary policy – but it’s not the only one. The authorities are also looking to see if their fiscal stance can also be less expansionary and are re-examining their policies toward exchange rate flexibility (to allow the nominal exchange rate to appreciate somewhat as a way of reducing imported inflation).

Will the reduction in the credit expansion rate from 50 percent to 30 percent be so drastic as to affect the growth rate? We believe that a slowdown in the growth rate is probably inevitable, but it should not be too significant. Indeed, the Vietnamese have done this once before – in 2004, when the authorities reduced the growth rate of credit from 46 percent to 25 percent (although admittedly they did it over two years), and the impact on the growth rate was not an issue. But more important is the point that economic policymaking involves balancing many different objectives, and this requires that adjustments in key macroeconomic policy parameters are done gradually. Thus, the authorities need to gradually reduce domestic credit expansion over 2008 so as not to “shock” the economy and avoid any sharp contraction in economic activity. And if it turns out that the eventual outcome is a higher pace of credit expansion than the target 30 percent, then so be it – so long as they don’t deviate from their eventual objective of lowering the core inflation rate (that is, excluding food and fuel) to a level that is below the real growth rate.

Now, some people could argue that the target credit growth rate of 30 percent for 2008 is too “expansionary” and would continue to fuel inflation. While this is certainly possible – in which case monetary policy may need to be tightened further – its important to remember that Vietnam ‘s economy is still being monetized, so an expansion in broad money at a rate significantly higher than the growth of nominal GDP is possible while still being consistent with decelerating inflation.

Best regards

Vikram

Dear Nasrudin

The Indonesian economy has been recovering well since the 1997 crisis. Last year it reached its highest growth rate since the crisis, the government’s debt burden has declined considerably (as has the external debt burden of the country), and the banks and corporations are in much better financial shape today (thanks to more careful lending and borrowing decisions). All of this while the country has gone through two transformations -- the first is its transformation into a vibrant democracy and the second is its transformation into a highly decentralized economy. These are remarkable accomplishments.

But to be honest, there are other features that worry me – some of which are short term and others are long term.

Among the short term issues, I worry about the high and rising oil subsidy that is a huge burden on the budget (it costs over 100 trillion rupiah a year at the current high price of oil in world markets!). What is more, this subsidy helps the rich more than it helps the poor. One estimate shows that something like 45 percent of the subsidy benefits people at the top 10 percent of the income distribution. At this level the subsidy is also equal to the government’s entire social spending plus its capital spending. Wouldn’t it be better if this subsidy were reduced somewhat and the savings be used to help the genuinely poor –so that they can better afford to pay for the rising cost of food?

A second concern I have is the so-called “jobless’ nature of the growth in much of this decade. Usually, growth leads to more employment and poverty reduction – but in Indonesia the employment generation and poverty reduction in recent years has been disappointing, although I’m glad to say that employment did show strong growth in 2007. I am not sure why the trend of employment growth has been slow – it could be that much of the growth is coming from plantations and capital intensive industries that do not employ a lot of people; or it could be that industries are loathe to employ additional staff as they grow because restrictive labor regulations will not allow them to be shed in the event of a downturn. What is needed is a careful examination of the causes – something that the World Bank is doing jointly with the government – so that corrective measures can be taken. And this is where your second point comes in –rapidly growing and healthy small and medium enterprises (SMEs) usually helps boost employment and productivity (and hence wages) and also creates skills in the informal sector. But promoting a vibrant SME sector is easier said than done – may countries have tried and failed. At the same time some have succeeded and it is worth seeing what lessons Indonesia can learn from these examples. I would suggest that you take a look at the World Bank’s excellent Private Sector Development Blog to learn more: http://psdblog.worldbank.org, as well as the following IFC-World Bank website specifically devoted to SME development: http://ifchq14.ifc.org/ifcext/sme.nsf/Content/Home.

A third concern I have (and I promise I will stop here!) is to do with Indonesia’s long term prospects – which depends a great deal on its ability to develop world class competitive "knowledge intensive industries". Experience shows that successful middle income countries have been able to become competitive in areas that have traditionally been the preserve of industrial economies – areas that require knowledge and skills, such as electronics, finance, medicine, genetics, ICT, and so on. But there is little sign of such industries developing in Indonesia – and at the same time, it is not clear what the government needs to do promote their growth (introducing the wrong policies could do more damage than good!). So this is clearly an area for further investigation and debate.

Best regards

Vikram

Dear Saadi

Unfortunately, our analysis focuses on East Asia – and therefore, I cannot say much about Pakistan which is part of South Asia. But you can always contact my colleague, Shanta Devarajan, the World Bank’s Chief Economist for the South Asia Region and ask him your question at his excellent blog: End Poverty in South Asia. (http://endpovertyinsouthasia.worldbank.org/).

Good luck.

Vikram

Dear Bruno

You raise a very interesting question. My sense is that the Chinese authorities are probably hoping that the slowdown in the global economy will help their own efforts in cooling the Chinese economy. That may explain the pause in the gradual appreciation of the nominal exchange rate that had been taking place earlier. At the same time, the authorities have been steadily tightening monetary policy (domestic interest rates have been rising steadily). I suspect that unless inflation actually comes down, the authorities will continue to adopt a fairly restrictive monetary stance.

At the same time, the authorities have imposed a few price controls and export quotas of foodstuffs and this has probably suppressed the headline inflation rate somewhat – although to what extent is not known.

Finally, let me add that there is a debate in China on the effectiveness of monetary policies and whether tightening monetary policy can actually slow investment and growth. Those who believe monetary policy is largely ineffective argue that much public and private investment is driven by local authorities who sell or lease land to finance their investments – and this activity is independent of the interest rate. In addition, despite monetary tightening, the real lending rate in China is still marginally negative, so the incentive to borrow continues to be strong.

Best regards

Vikram

Dear Ben

The growth rate of China’s exports more than halved between 2004 and 2007 (from 40 percent to 20 percent) while GDP growth increased from slightly around 9 percent to over 11 percent. That means domestic demand became a more important driver of growth during that period.

Best regards

Vikram

Dear Dr, van Gessel

Thank you for your very kind words. Your proposal on tempe processing appears quite intriguing, so may I suggest you contact our Sector Manager for Rural Development in East Asia – Mr. Rahul Raturi – and seek his advice on the matter. We'll send you his contact details separately after the chat.

Best regards

Vikram

Dear Banjoko

I am not sure I fully follow the logic behind your question, but let me use this opportunity to make one point. China’s rapid growth over the last three decades has been far higher than the growth rate of the United States – so by simple arithmetic, China’s importance in the world economy has grown relative to that of the US. Yet, the GDP of the US is still about four times that of China ($13 trillion compared to $3 trillion) while China has a population that is four times that of the US. That means the average per capita income in the US is about sixteen times that of China. Of course, if the two countries continue to grow at their current pace (say 10 percent a year for China compared to about 3 percent a year for the US), then China’s per capita income will equal that of the US in about 40 years. But a lot of things can happen in 40 years!

Best regards

Vikram

Dear Deborah

I agree with you that price controls dampen incentives to produce. But I am not sure I agree with you when you suggest that distribution channels are to blame for high prices or that "middlemen" are the culprits. I know that this is a popular view in many countries, but there is little evidence to support it. Its quite possible that this may be true in a particular locality in a particular country, but I don’t believe one can generalize from a few instances.

The reality is that foodgrain – such as rice or wheat or corn – is a fairly homogenous commodity (at least the different strains are homogenous). And it would take an astonishingly capable trader to corner the market in a country. In some countries, however, the government may by law grant a public sector company monopoly control over foodgrain trade, but I don’t believe you are referring to such cases.

Best regards

Vikram

Dear Djarot,

My earlier answer to Nasrudin Arief might be helpful. The Indonesian economy is growing strongly recently and we are expecting around a 6% growth rate in 2008. However the ‘jobless’ nature of growth is a concern - although employment did grow strongly in 2007 - and this problem needs more analysis and attention. Sustained poverty reduction will be helped by continued strong growth and be further assisted by the government’s growing focus on targeted programs for the poor and on social spending for health and education.

Best regards

Vikram

Dear Nkoulou

Good question – but I am not competent to answer it! But do keep an eye on the World Bank’s Africa Region website at http://www.worldbank.org/afr for information.

Best wishes

Vikram

Dear Marina

Your projections are based on current trends continuing into the not-too-distant future – and I daresay you are probably right (although I have not done the numbers myself). But China has enormous opportunities to improve the energy efficiency of its economy for the simple reason that it invests about half its GDP – and this allows it to replace old capital stock (machines, buildings, cars, buses, and so on) fairly quickly with new capital stock that could embody new technologies that use less energy. It also has the opportunity to develop new transport systems and plan its rapidly growing urban areas in ways that make them far more energy efficient than the United States. But to do this, there not only need to be strong price incentives to shape consumer choice and encourage energy efficient investment, but also strong urban and other public policies that ensure sound environmental standards and efficient energy use.

Of course, with oil at above $100 per barrel, not only has the incentive to increase energy efficiency increased, but the incentive to find substitutes has also increased substantially. There is renewed interest in wind and solar energy and there has been a substantial increase in the production of bio-fuels (although with the painful side effect of increasing the demand for corn and contributing significantly to its recent price increases).

Incidentally, most of China’s energy does not come from oil but from coal – and if oil-based technologies can be converted to electricity-based technologies, then China’s reliance on oil will be significantly reduced (and it has abundant coal). But coal has its own environmental problems, although in electricity generation China uses the latest technology in its new electricity generation plants that ensure they do not pollute the environment. On average, China puts up four 500 MW electricity generation plants a week (most of them coal-based) – that’s one every two days or so! Unfortunately, I understand that these new environmentally-friendly technologies are sometimes not used because not using them saves more money than paying the fines for polluting the environment!

Best regards

Vikram

Dear Qiwen
As I said in my responses to some other questioners, the Chinese authorities are keen to prevent a situation of significant excess demand which could threaten a more general inflation, and have therefore already been tightening monetary policy in various ways. A moderate slowdown due to weaker export growth would likely be welcome to policy makers, as it would help prevent the emergence of excess demand, while also reducing the trade surplus (which has been a source of trade friction with countries like the US). As you note, the government does have significant room to use more expansionary fiscal policy, should the slowdown in the economy turn out to be more than desirable. However you probably want to keep separate the question of the desirable rate of growth from that of energy efficiency and pollution. The aim should be to maintain high growth that generates new jobs and continues to reduce poverty rapidly, while at the same time applying policies that help firms and individuals change their production and consumption patterns towards more energy efficiency and less pollution.

Best regards

Vikram

Dear Seii,

I’m afraid I’m probably not qualified to give you specific investment advice! But let me suggest that further development of domestic capital markets is going to be one of the most important and exciting economic developments in East Asia in coming years. Most companies in the developing countries of the region still derive the bulk of their financing from banks or internally generated profits. However stock markets and domestic bond markets, while still relatively small, are growing fast, especially as governments make strong efforts to improve the legal, regulatory and technical underpinnings needed. The development of such markets will in turn boost development by providing firms and individuals access to more diversified forms of financing and new ways to diversify risk.

Best regards

Vikram

Dear Mr. Lutfi

I know Mr. Boediono well and I would certainly not presume to give him any advice – and I think his move to Bank Indonesia augurs well for the country. Right now Indonesia is facing the same concerns and problems that are confronting all the other countries of the East Asia region – namely cost push pressures that are leading to rising headline inflation. Bank Indonesia’s primary objective is to ensure that this one-off increase in food prices does not trigger higher core inflation – but that’s not an easy task!

Best regards

Vikram

Dear Show

The reason we do not include Myanmar in our analysis is because Bank activities are limited and no financing is provided to the Government. In line with the Bank’s practice of engagement in fragile and prolonged crisis situations, we continue to conduct analytical and monitoring activities, including providing technical support to IMF Article IV missions and missions led by other donors, and a small amount of trust-funded grant support for global public goods through non-government arrangements (in particular, to FAO for avian and human influenza-related issues). As with other countries in non-accrual status, the Bank’s limited activities with respect to Myanmar aim to maintain the World Bank’s analytical and operational readiness to assist, when circumstances warrant, as part of an international re-engagement effort that would include progress towards arrears clearance. Furthermore, data are often so scarce that it prevents us from doing analytical work with much depth.

Best regards

Vikram

Dear Rae

This is a really good question for which the answer would vary depending on the country concerned. As the East Asia Update noted, one set of effects of further “aftershocks” from the financial crisis in the US will be felt through either the stock and bond markets, or more directly through the balance sheets of banks. As far as stock and bond markets are concerned, they have already experienced – and absorbed – the initial shocks, but countries need to be concerned that further shocks do not lead to significant capital outflows. But even if this were to happen, most if not all countries of the region have significant reserves to deal with the situation – or they could allow greater flexibility in the exchange rate if necessary. Most corporations rely on banks for their financing – and from what we can discern the banks seem to be in good shape to continue providing loans to them.

There is a possibility that the aftershocks will also lead to a deeper and longer slowdown in the US – in which case the impact on East Asia will be through even slower growth in exports that will then feed through into slower growth in incomes. Here again, given their already rapid growth, East Asian economies could potentially slow further and still be growing reasonably fast. At some point however, if growth slows to the point that it leads to concerns about the impact on the poor or perhaps to social tensions, East Asian economies have the fiscal space to introduce expansionary fiscal policies to stimulate the economy and substitute domestic demand growth or export growth. I should note, though, that this fiscal space may not be all that large, given that the countries in the region are already facing rising inflation and expansionary fiscal policies could potentially add to those pressures.

Best regards

Vikram

Dear Zulgerel

China has become a key engine of growth through trade and financial flows – and its rapid growth has promoted exports and investments in the rest of East Asia. Increasingly, the countries of East Asia are being connected through production and financing networks – and China is a key part of this structure in large part because if its enormous size, but also because of its rapid growth and high investment levels.

As far as analysis of these structures are concerned, you may wish to look at the World Bank’s report entitled: "An East Asian Renaissance: Ideas for Economic Growth" – published last year - on the web http://go.worldbank.org/E3DKQVL300.

Best regards

Vikram

Dear Sarah

You have presented well the challenges of conveying policy recommendations that cut across sectors and ministries. Some countries have already set up inter-ministerial committees to deal with the problem of rising food prices – which include the central bank, the Ministry of Finance, the Agricultural Ministry, the Ministry of Industry, and so on. In others, decisions are being coordinated by offices of coordinating ministers or the prime minister. So it all depends on what the specific decision making structures are in each country – but without doubt, it is important that such policies be supported from the very top of the government hierarchy.

Best regards

Vikram

Dear Ramon

You may want to look at an earlier question on rice that I think should answer your question.

Best regards

Vikram

Dear Show,

Sovereign wealth funds are of two kinds – either they come from the reserves of the central bank or they are financed from the accumulated savings from government fiscal surpluses. In either case, the ownership is with the sovereign authority of the country – hence the name “sovereign wealth fund”. That is why the Myanmar government cannot have any claims on the Singapore sovereign wealth fund (actually Singapore has two: Temasek and the Government Investment Corporation).

But that does not preclude the Government of Myanmar having resources invested outside the country – as many governments and central banks, and indeed sovereign wealth funds, do.

Best regards

Vikram

Dear Richard

First of all, let me thank you for performing such an important service as the disabled are often a forgotten group in developing countries.

Coming to your question – to the extent that programs for the disabled are dependent on government budgets or voluntary contributions from the private sector or households, any broad economic slowdown is likely to also lead to some erosion in financial support. This is something that we need to keep a close eye on. I also worry that were the slowdown in East Asia to accelerate and lead to lay-offs and more unemployment, then the disabled could be affected disproportionately. In such circumstances, there is a strong case for governments to consider programs to protect the disabled as well as ensuring that the disabled are not discriminated against in the workplace.

Good luck with your work.

Best regards

Vikram