WORLD BANK EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Balancing Act WORLD BANK EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Balancing Act © 2017 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington, DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved 1 2 3 4 20 19 18 17 This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. 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Examples of components can include, but are not limited to, tables, figures, or images. All queries on rights and licenses should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; e-mail: pubrights@worldbank.org. ISBN (electronic): 978-1-4648-1209-5 DOI: 10.1596/ 978-1-4648-1209-5 Photo credits in this publication. Further permission required for reuse. •• Cover: Hong Sar / World Bank. •• Page 1: Josh Estey / World Bank •• Page 73: Bart Verweij / World Bank •• Page 107: Hong Sar / World Bank BALANCING ACT Contents List of Abbreviations xiii Preface and Acknowledgments xv Executive Summary xvii Part I. Recent Developments and Outlook 1 I.A. Recent Developments 2 A favorable global environment has contributed to improved economic performance in 2017 in developing East Asia and the Pacific 2 Domestic demand continues to drive economic performance in the region 7 Exports continue to grow across much of the region 10 Inflation remains low throughout most of the region 11 Private sector credit continues to expand in the region 13 Financial conditions and currencies stabilized during the first half of 2017 14 Recent developments in the Pacific Island Countries 20 Poverty rates have continued to fall across most of the EAP region 21 I.B. Outlook and Risks 29 Growth is expected to remain robust in the region 29 Poverty is projected to continue to fall—the pace of reduction across countries will depend on successful implementation of policies to make growth more inclusive 33 Domestic demand is expected to continue driving growth in the region 34 Continued uncertainty about global economic policies and the escalation of geopolitical tensions could jeopardize growth prospects 36 Financial sector vulnerabilities in many countries could be exacerbated by tightening in global financial markets 36 High budget deficits and rising public debt pose risks for many countries in the region 46 The Pacific Island Countries remain vulnerable to shocks, highlighting the importance of savings and stabilization mechanisms 47 I.C. Policy Considerations 48 Improving prospects for global growth provide an opportunity to address vulnerabilities 48 Accelerating reforms for sustained and inclusive growth 53 An agenda for the Pacific Island Countries 64 References69 List of Contents iii EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Contents continued Part II. Medium-Term Development Agenda 73 II.A. Raising the Bar: From Reducing Poverty to Fostering Inclusive Growth in East Asia And Pacific 74 Introduction74 Using economic classes to characterize inclusive growth 77 The three pillars of inclusive growth 80 Conclusion84 References85 II.B. Tourism in Developing East Asia: Managing Growth and Maximizing Future Benefits 87 Tourism and its economic significance in developing East Asia 87 Tourism drivers and challenges 93 Policy Priorities 98 Conclusion103 References104 Part III. Country Summaries and Key Indicators 107 Cambodia108 China111 Fiji114 Indonesia117 Lao PDR 120 Malaysia123 Mongolia126 Myanmar129 Papua New Guinea 132 Philippines135 Small Pacific Island Countries 138 Solomon Islands 145 Thailand148 Timor-Leste151 Vietnam154 iv List of Contents BALANCING ACT List of Figures Part I. Recent Developments and Outlook I.A. Recent Developments Figure I.A.1. Growth in developing EAP continued to prove resilient  5 Figure I.A.2. The region’s large economies continued to perform strongly 6 The manufacturing Purchasing Managers’ Index points toward continued expansion Figure I.A.3.  in most major countries 6 Figure I.A.4 Performance is mixed across the region’s smaller economies 7 Figure I.A.5. Domestic demand continued to drive growth in 2017 8 Figure I.A.6. Countries’ record on public investment spending is mixed 9 After widening in 2016, fiscal deficits in some of the large economies started to Figure I.A.7.  stabilize in 2017 9 Figure I.A.8. Budget deficits are large in other countries 9 Figure I.A.9. Export values continued to recover in second half of 2017… 10 Figure I.A.10. …as have export volumes 10 Figure I.A.11. Inflation is benign in the region and declined in most countries toward mid-2017 11 Figure I.A.12. Core inflation remains muted 12 Figure I.A.13. Producer prices increased rapidly in late 2016, but decelerated in 2017 12 Figure I.A.14. Most larger countries have held policy rates constant or reduced them slightly in 201713 Figure I.A.15. Real interest rates in large economies have been declining, and in most cases are significantly below their long-term average 13 Figure I.A.16. Credit growth has slowed over the past year, but remains rapid and showed signs of modest acceleration in some countries in 2017 13 Figure I.A.17. The stock of private sector debt remains elevated in several economies 14 Figure I.A.18. The increase in capital outflows experienced in late 2016 have begun to reverse 14 Figure I.A.19. Net FDI inflows increased in 2016 and 2017 in many of the larger economies 15 Figure I.A.20. Net FDI outflows from China exceeded net inflows during most of 2016, but the balance may have shifted in 2017 15 Figure I.A.21. Financial markets saw increased volatility in end-2016, but have since recovered 15 Figure I.A.22. Stock prices 19 Figure I.A.23. External corporate and sovereign bond spreads have narrowed 19 Figure I.A.24. Many major currencies have appreciated against the U.S. dollar during 2017 19 Figure I.A.25. Indonesia and Thailand show appreciation in real, trade-weighted terms 19 Figure I.A.26. Reserve coverage for the major economies in the region remains broadly adequate 20 Figure I.A.27. The prevalence of poverty has continued to decline across the region 21 List of Contents v EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 List of Figures continued I.B. Outlook and Risks Domestic demand is projected to remain the primary contributor to growth of Figure I.B.1.  regional GDP… 34 Figure I.B.2. …in most large economies 35 Figure I.B.3. …and in the smaller economies 35 Figure I.B.4. Nonperforming loans are steadily increasing across the region 41 Figure I.B.5. Debt service ratio of private nonfinancial sector 41 Figure I.B.6. Fiscal deficits are high or rising in many countries 46 Figure I.B.7. Government debt is also high or rising in many countries 46 Part II. Medium-Term Development Agenda II.A. Raising the Bar: From Reducing Poverty to Fostering Inclusive Growth in East Asia And Pacific Figure II.A.1. Poverty trends 2002–15 75 Figure II.A.2A. The evolution of poverty in EAP, 2002–15  79 Figure II.A.2B. The changing structure by economic class of EAP’s population, 2002–15 79 Figure II.A.3A. Indonesia, 2002–15 79 Figure II.A.3B. The Philippines, 2002–15 79 Figure II.A.4A. Latin America and the Caribbean: evolution of class structure 2002–13 80 Figure II.A.4B. Eastern Europe and Central Asia: evolution of class structure 2002–13 80 Figure II.A.5. Class mobility, aggregate, short run  82 II.B. Tourism in Developing East Asia: Managing Growth and Maximizing Future Benefits International arrivals to developing East Asia have grown strongly during the last Figure II.B.1.  20 years  88 Figure II.B.2. Visitor inflows and growth rates within developing East Asia vary widely  88 Figure II.B.3. Most international tourists originate from within the region 88 Domestic tourism in developing East Asia tends to dwarf international tourism in Figure II.B.4.  terms of magnitude, and the propensity for domestic travel has been rising across the region  89 Tourism spending in developing East Asia is significant and an important export Figure II.B.5.  contributor  90 The economic contribution of tourism to GDP and employment varies greatly across Figure II.B.6.  the region  91 The multiplier effect of spending on tourism tends to be stronger than for other Figure II.B.7.  sectors  92 Tourism in developing East Asia is driven by its price competitiveness but suffers Figure II.B.8.  from low environmental sustainability 94 Figure II.B.9. Developing East Asia benefits from being a price-competitive region 95 Figure II.B.10. Developing East Asia benefits from having multiple cultural heritage sites 95 vi List of Contents BALANCING ACT List of Figures continued Tourism in developing East Asia is negatively affected by pollution, threatened Figure II.B.11.  species, and limited access to improved sanitation 96 There is room to improve tourism infrastructure and use of internet for business Figure II.B.12.  transactions96 Part III. Country Summaries and Key Indicators Cambodia Figure 1. Real GDP growth, contribution to real growth 110 Figure 2. Exports of electrical machinery, equipment and parts 110 China Figure 1. Contribution to real GDP growth year-on-year 113 Figure 2. Poverty rates, estimates and projections 113 Fiji Figure 1. Real GDP growth, contribution to real growth 116 Figure 2. International and national poverty rates 116 Indonesia Figure 1. Real GDP growth and contribution to growth 119 Figure 2. Poverty rate, actuals and projections 119 Lao PDR Figure 1. Real GDP growth, contribution to real growth 122 Figure 2. Estimated and projected poverty rates 122 Malaysia Figure 1. Real GDP growth, contribution to real growth 125 Figure 2. Housing prices and median monthly household income, by income group 125 Mongolia Figure 1. Real GDP growth, contribution to real growth 128 Figure 2. Poverty rate (official poverty line): 2010–16 128 Myanmar Figure 1. Real GDP growth and sector contribution to real GDP growth 131 Figure 2. CPI inflation and food/non-food contribution to CPI inflation 131 Papua New Guinea Figure 1. Real GDP growth, contribution to real growth 134 Figure 2. Key fiscal indicators (% GDP) 134 List of Contents vii EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 List of Figures continued Philippines Figure 1. Real GDP growth, contribution to real growth 137 Figure 2. Poverty rates and GDP per capita (constant 2000 pesos) 137 Small Pacific Island Countries Figure 1. Incidence of poverty at international poverty lines (US$1.90/day and US$3.20/day) 144 Figure 2. Public and publicly guaranteed external debt (share of GDP) 144 Solomon Islands Figure 1. Trade and trade balance 147 Figure 2. Per capita GDP, growth and level of index 147 Thailand Figure 1. Contribution to annual real GDP growth 150 Figure 2. Poverty rate and GDP per capita growth 150 Timor-Leste Figure 1. Contributions to real GDP growth 153 Figure 2. Petroleum Fund wealth per capita 153 Vietnam Figure 1. Real GDP growth and contribution to Real GDP growth 156 Figure 2. Actual and projected poverty rates and private consumption per capita (constant LCU) 156 viii List of Contents BALANCING ACT List of Tables Part I. Recent Developments and Outlook I.B. Outlook and Risks Table I.B.1. East Asia and Pacific: GDP growth projections 30 Table I.B.2. Poverty will continue to decline in the EAP region 33 Table I.B.3. Nonperforming loans are elevated in Timor-Leste and many of the island economies 41 Part II. Medium-Term Development Agenda II.B. Tourism in Developing East Asia: Managing Growth and Maximizing Future Benefits Chinese travel behavior varies based on household income, with an increasing share Table II.B.1.  able to afford short- and long-haul trips  93 Developing East Asia’s economies can be grouped based on their level of tourism Table II.B.2.  development97 Part III. Country Summaries and Key Indicators Cambodia  Selected Indicators 110 China  Selected Indicators 113 Selected Indicators Fiji  116 Indonesia  Selected Indicators 119 Lao PDRSelected Indicators 122 Malaysia  Selected Indicators 125 MongoliaSelected Indicators 128 MyanmarSelected Indicators 131 Papua New Guinea  Selected Indicators 134 Philippines Selected Indicators 137 Small Pacific Island Countries  Selected Indicators 144 Solomon IslandsSelected Indicators 147 Thailand  Selected Indicators 150 Timor-Leste  Selected Indicators 153 Vietnam  Selected Indicators 156 List of Contents ix EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 List of Boxes Part I. Recent Developments and Outlook I.A. Recent Developments Box I.A.1. Recent Global Developments 3 Figure BI.A.1.1. Global GDP growth, 2007–17f 3 Figure BI.A.1.2. Regional GDP growth, 2012–17f 4 Figure BI.A.1.3. Regional GDP: Cumulative change, 2007–17f 4 Figure BI.A.1.4. Global trade growth 4 Figure BI.A.1.5. International commodity prices 5 Box I.A.2. FDI Trends in Developing EAP 16 Figure BI.A.2.1. FDI inflows across developing regions 16 Figure BI.A.2.2. Developing EAP share of global FDI flows 16 Figure BI.A.2.3. Distribution of FDI inflows in developing EAP, by destination 16 Figure BI.A.2.4a. Developing EAP inward FDI stock 17 Figure BI.A.2.4b. Developing EAP outward FDI stock 17 Figure BI.A.2.5. Developing EAP inward FDI by sector 18 Figure BI.A.2.6. Chinese FDI stock in developing EAP 18 Box I.A.3. Trends in poverty, household welfare and inequality in Myanmar 22 Figure BI.A.3.1. Trends in national poverty estimates 23 Figure BI.A.3.2. Trends in poverty in urban and rural areas 23 Box I.A.4. Has inequality in China peaked? 25 Figure BI.A.4.1. Recent evolution of income inequality in China 26 Table BI.A.4.1. Components of per capita household income in China 27 I.B. Outlook and Risks Box I.B.1. Global outlook and risks 31 Figure BI.B.1.1. Global GDP growth 31 Figure BI.B.1.2. Regional GDP growth 31 Figure BI.B.1.3. World commodity prices forecast 32 Box I.B.2. Debt dynamics in developing East Asia and Pacific 37 Figure BI.B.2.1. Fiscal positions by region 37 Figure BI.B.2.2. Private sector debt by region 38 Figure BI.B.2.3. Debt dynamics in developing EAP 38 Figure BI.B.2.4. Fiscal positions around financial stress episodes 39 Figure BI.B.2.5. Fiscal positions around natural resource price plunges 40 x List of Contents BALANCING ACT List of Boxes continued Box I.B.3. An overview of shadow banking in China 42 Table BI.B.3.1. Selected estimates of the size of the Chinese shadow banking system 42 Figure BI.B.3.1. Alternative total social financing instruments, 2005–16 44 Figure BI.B.3.2. Bank resource mobilization  44 Figure BI.B.3.3. Share of global OFI assets for selected jurisdictions 44 Figure BI.B.3.4. Evolution of OFI shares by jurisdiction over time 44 Table BI.B.3.2. Select regulatory measures aimed to reduce shadow banking risks 45 I.C. Policy Considerations Box I.C.1. Deleveraging in China 50 Figure B1.C.1.1. Credit to the nonfinancial sector in China 50 Figure B1.C.1.2. Commercial bank asset growth by bank size 51 Box I.C.2. Taxation in developing EAP: Trends, reforms, and policy implications 54 Figure BI.C.2.1. Tax collection in percent of GDP, by region, 2010–15 54 Figure BI.C.2.2. Tax collection in percent of total tax revenues, by region, 2010–15 54 Figure BI.C.2.3. Tax collection in percent of GDP, select EAP countries, 2010–15 55 Figure BI.C.2.4. Tax collection in percent of total tax revenues, select EAP countries, 2010–15 55 Table BI.C.2.1. Key challenges, objectives, and strategies for tax reforms in developing EAP 58 Box I.C.3. The effectiveness of monetary policy in developing East Asia and Pacific 59 Figure BI.C.3.1. The median impulse response of the bank lending rate to a monetary expansion is negative, but weaker for developing EAP than for advanced economies  60 Figure BI.C.3.2. The impulse responses are negative and strong for Malaysia and the Philippines, and negative but weak for Lao PDR and Fiji 60 Figure BI.C.3.3. Monetary policy is more effective when the banking system is larger … 61 Figure BI.C.3.4. …and deeper with the depth of the stock markets 61 Figure BI.C.3.5. But less effective when concentration in the banking system is higher 61 Figure BI.C.3.6. …but strengthens with the quality of the regulatory framework 61 Figure BI.C.3.7. The impulse response is enhanced by central bank transparency… 62 Figure BI.C.3.8. …but dampened by integration with international financial markets 62 Enhancing human development by spending more and spending better: What’s Box I.C.4.  possible in the Pacific? 65 Figure BI.C.4.1. Projected revenue per capita 66 Figure BI.C.4.2. Relationship between human development and public spending per capita in developing small states 66 Table BI.C.4.1. Current human development outcomes in the PICs 67 Figure BI.C.4.3. Projected expenditures as a share of GDP 68 Figure BI.C.4.4. Projected fiscal balances as a share of GDP (2021–40 average) given human development scenario expenditures 68 List of Contents xi EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 List of Boxes continued Part II. Medium-Term Development Agenda II.B. Tourism in Developing East Asia: Managing Growth and Maximizing Future Benefits Box II.B.1. The World Economic Forum Travel and Tourism Competitiveness Index (WEF TTCI) 94 Travel & Tourism Competitive Index 94 Box II.B.2. Demand assessments and integrated tourism master planning in Indonesia 99 The effectiveness of ecotourism as a means of protecting the local environment: An Box II.B.3.  example from Cambodia 100 Box II.B.4. Maximizing backward links of tourism activities in Lao PDR 101 Box II.B.5. Promoting tourism by reforming the business environment: An example from Peru 102 xii List of Contents BALANCING ACT List of Abbreviations AHDI Augmented Human Development Index PMI Purchasing Managers’ Index ASEAN Association of Southeast Asian Nations PPI Producer Price Index BRI Belt and Road Initiative PPP purchasing power parity CBRC China Banking Regulatory Commission P2P Peer-to-Peer CIT corporate income tax Q1 first quarter CSRC China Securities Regulatory Commission Q2 second quarter ECB European Central Bank Q3 third quarter EMDEs emerging market and developing Q4 fourth quarter economies q/q quarter-on-quarter eop end of period SAAR seasonally adjusted annual rate FDI foreign direct investment SOEs state-owned enterprises FSB Financial Stability Board STB Singapore Tourism Board FY fiscal year UMIC upper-middle-income country GDP gross domestic product VAR vector autoregression GEP growth elasticity of poverty VAT value-added tax IBRD International Bank for Reconstruction and WBG World Bank Group Development WEF TTCI World Economic Forum’s Travel & Tourism ICT information and communications Competitiveness Index technology WHO World Health Organization IDA International Development Association WMPs wealth management products ILHCA Integrated Household Living Conditions WTO World Trade Organization Assessment WTTC World Travel & Tourism Council IMF International Monetary Fund yoy year-over-year IPL international poverty line RERF Kiribati’s sovereign wealth fund ITMP integrated tourism master plans SAAR Seasonally Adjusted Annual Rate LCU local currency unit SEZ Special Economic Zone LMIC lower-middle-income country SOEs state-owned enterprises M&A mergers & acquisitions SPGs South Pacific Games MICE meetings incentive travel, conferences, and tCO2-e tonnes of carbon dioxide equivalents exhibitions (Singapore) TCP Tropical Cyclone Pam NBS National Bureau of Statistics (China) TFP total factor productivity NPLs nonperforming loans TTF Tuvalu Trust Fund OFIs other financial intermediaries UNFCCC United Nations Framework Convention on OPEC Organization of the Petroleum Exporting Climate Change Countries VAT value-added tax PBOC People’s Bank of China WBG World Bank Group pc per capita WTO World Trade Organization PCE per capita daily consumption expenditures yoy year-over-year List of Abbreviations xiii EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 List of Abbreviations continued Regions, World Bank Classification and Country Groups MENA Middle East and North Africa PICs Pacific Island Countries EAP East Asia and Pacific SAR South Asia ECA Eastern Europe and Central Asia SSA Sub-Saharan Africa LAC Latin America and the Caribbean Country Abbreviations MNG Mongolia MYS Malaysia CAN Canada PHL Philippines CHN China PLW Palau CYM Cayman Islands PNG Papua New Guinea FJI Fiji RMI Republic of Marshall Islands FSM Federation States of Micronesia SGP Singapore GBR United Kingdom SLB Solomon Islands IDN Indonesia THA Thailand JPN Japan TLS Timor-Leste KHM Cambodia TON Tonga KIR Kiribati TUV Tuvalu KOR Korea, Rep. USA United States LAO Laos People’s Democratic Republic VNM Vietnam MHL Marshall Islands VUT Vanuatu MMR Myanmar WSM Samoa Currency Units Kip Lao kip P Philippine peso $A Kiribati (Australian dollar) RM Malaysian ringgit $NZ New Zealand dollar RMB Chinese renminbi B Thai baht Rp Indonesian rupiah CR Cambodian riel SI$ Solomon Islands dollar D Vietnamese dong Tog Mongolian togrog F$ Fiji dollar US$ Timor-Leste (U.S. dollar) K Myanmar kyat US$ United States dollar K Papua New Guinea kina xiv List of Abbreviations BALANCING ACT Preface and Acknowledgments The East Asia and Pacific Economic Update is a joint product of the World Bank Office of the Chief Economist, East Asia and Pacific Region, and the Macroeconomic and Fiscal Management Global Practice, prepared in collaboration with the Poverty and Equity Global Practice, the Development Prospects Group, and the Finance and Markets Global Practice. The report was prepared by Congyan Tan (Task Team Leader) and Philip M. Schuler (Co-Task Team Leader), under the guidance of Sudhir Shetty (Chief Economist, East Asia and Pacific Region). Chapter I was prepared by Philip M. Schuler (lead), Ekaterine Vashakmadze, and Vera Kehayova. Contributions were received from the Chapter III team (listed below), Ana Maria Aviles, Reena Badiani-Magnusson, Monika Blaszkiewicz, Reno Dewina, Kim Alan Edwards, Samuel Freije-Rodriguez, Zhi (Ken) Gan, Raju Huidrom, Elisabeth Hyun Kim, Tuan Minh Le, John Litwack, Keita Miyaki, Antonio M. Ollero, Jose Ramon Perea, Haocong Ren, Changyi Shao, Diego M. Sourrouille, Naotaka Sugawara, Congyan Tan, Radu Tatucu, Judy Yang, Luan Zhao, and Nan Zhou. Chapter II was prepared by Caterina Ruggeri Laderchi (Chapter II.A), and Andres F. Garcia and Nikola Kojucharov (Chapter II.B). Chapter III was prepared by staff from the Macroeconomics and Fiscal Management Global Practice and Poverty and Equity Global Practice: Dwi Endah Abriningrum, Magda Adriani, Kiatipong Ariyapruchya, Reena Badiani- Magnusson, Davaadalai Batsuuri, Hans Beck, Andew Blackman, Raul Andres Castaneda Aguilar, Shaohua Chen, Derek H.C. Chen, Yew Keat Chong, Kevin Chua, Kevin Cruz, Somneuk Davading, Gabriel Demombynes, Reno Dewina, Viet Tuan Dinh, Sebastian Eckardt, Kim Alan Edwards, Samuel Freije-Rodriguez, Frederico Gil Sander, Imogen Halstead, Birgit Hansl, Indira Maulani Hapsari, Kristen Himelein, Mizuho Kida, David Knight, Chandana Kularatne, Jonathan William Lain, John Litwack, Xubei Luo, Sodeth Ly, Miguel Martin, Elitza Mileva, Shabih Ali Mohib, Jose Montes, Thi Da Myint, Laura Liliana Moreno Herrera, Evgenij Najdov, Jean-Pascal Nguessa Nganou, Minh Cong Nguyen, Yus Medina Pakpahan, Keomanivone Phimmahasay, Obert Pimhidzai, Sharon Faye Alariao Piza, Ririn Purnamasari, Habib Rab, Richard Record, Alief Aulia Rezza, Jaffar Al Rikabi, Carlos Romero, Dhruv Sharma, Altantsetseg Shiilegmaa, Kenneth Simler, Kimsun Tong, May Thet Zin, Ikuko Uochi, Robert Utz, Judy Yang, Karla Mirari Yee Amezaga, Pui Shen Yoong and Luan Zhao. The work was managed by Ndiame Diop and Deepak Mishra for the Macroeconomic and Fiscal Management Global Practice, and by Salman Zaidi for the Poverty and Equity Global Practice. Thi Thanh Than Bui, Wenxia Tang, Charl Jooste, Kristina Tan Mercado, Dave Stephan, and Sang Jin Song made substantive contributions to the model, table production and assisting staff with their forecasts. Arsianti Arsianti, Pimon Iamsripong, Angkanee Luangpenthong, and Yulita Sari Soepardjo provided technical support. Assistance with communications and outreach was provided by Alejandro Cedeno Ulloa, Diana Ya-Wai Chung, Dini Sari Djalal, Livia Pontes, and Anissa Amador Tria (External Communications, East Asia and Pacific Region). The report was edited by Diane Stamm, and designed and typeset by Budy Wirasmo. Administrative support was provided by Cecile Wodon. Preface and Acknowledgments xv EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Preface continued Throughout the report, geographic groupings are defined as follows: East Asia and Pacific comprises Developing East Asia and Pacific, and the Newly Industrialized Economies. Developing East Asia and Pacific comprises Cambodia, China, Indonesia, Lao People’s Democratic Republic (PDR), Malaysia, Mongolia, Myanmar, Papua New Guinea, the Philippines, Thailand, Timor-Leste, Vietnam, and the Pacific Island Countries. The Pacific Island Countries comprise Fiji, Kiribati, the Marshall Islands, the Federated States of Micronesia, Palau, Samoa, the Solomon Islands, Tonga, Tuvalu, and Vanuatu. The Newly Industrialized Economies comprise Hong Kong SAR, China; the Republic of Korea; Singapore; and Taiwan, China. The ASEAN member countries comprise Brunei Darussalam, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam. The ASEAN-4 comprise Indonesia, Malaysia, the Philippines, and Thailand. The ASEAN-5 comprise Indonesia, Malaysia, the Philippines, Thailand, and Vietnam. This report is based on data available through September 22, 2017, inclusive. xvi Preface and Acknowledgments BALANCING ACT Executive Summary Global economic growth has strengthened since the April 2017 East Asia and Pacific Economic Update. This improvement reflects a congruence of positive trends, with growth picking up simultaneously across country groupings. Obstacles to activity in commodity exporters have receded against a backdrop of resilient growth in major commodity importers. Growth in the Euro Area and Japan in the first half of 2017 has exceeded expectations, and U.S. growth rebounded strongly. World trade appears on track to expand at its fastest pace since 2010. Interest rates remain low as the U.S. Federal Reserve and the European Central Bank move gradually to retreat from loose monetary policy. Growth in developing East Asia and Pacific (EAP) accelerated slightly in the first half of 2017, relative to expectations six months ago. Domestic demand continues to drive the region’s performance. Consumption made the greatest contribution to growth in most large economies. Fiscal deficits have narrowed or held steady in most large countries, while remaining significant in many of the smaller economies. Consumer price inflation generally remained low and has allowed authorities to maintain generally accommodative monetary policies so far in 2017. The growth outlook for the region remains positive. With China’s growth stronger than previously expected, developing EAP as a whole is projected to grow at 6.4 percent in 2017, a modest improvement over 2016 as well as relative to expectations in the April 2017 East Asia and Pacific Economic Update. Domestic demand will remain the primary contributor to growth in most countries. Growing world trade, sustained recovery in advanced countries, and accelerating growth in emerging markets and developing economies will strengthen external demand. Commodity prices are expected to recover at a moderate pace. Global financing conditions are expected to tighten gradually. China’s growth moderation and gradual rebalancing are expected to continue despite the uptick in 2017. With more rapid growth in the first half of the year, the Chinese economy is expected to grow at 6.7 percent in 2017. Growth is projected to moderate to around 6.4 percent in 2018–19 as the economy rebalances away from investment and external demand toward domestic consumption. In most of the large Association of Southeast Asian Nations (ASEAN) economies in the region, growth is projected to increase in 2017 and 2018. Malaysia is expected to grow more rapidly, reflecting improved confidence, higher investment, and the recovery in world trade. Thailand’s growth is also expected to increase due to stronger recovery in merchandise exports and tourism. Gradual increases in growth are foreseen for Indonesia and Vietnam in 2017 and 2018. In Indonesia, private consumption is projected to strengthen in line with gains in real wages. And, in Vietnam, rebounding agricultural production and strong export-oriented manufacturing will contribute to higher growth. Growth in the Philippines is likely to expand at a slightly slower pace in 2017–18, due in part to slower-than-expected implementation of public investment projects. Nevertheless, it is expected to continue to be the fastest growing of the large ASEAN economies. The outlook for the smaller regional economies is more mixed. Several, including Mongolia, Fiji, and Myanmar are projected to grow more rapidly in 2017–18. Mongolia’s macroeconomic stabilization program is encouraging new foreign direct investment (FDI) in mining and transport. Infrastructure investment is likely to rise in Fiji and Myanmar. Implementation of new natural resource projects is expected to underpin a gradual recovery in Papua Executive Summary xvii EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 New Guinea in 2018. Cambodia and Lao People’s Democratic Republic are both expected to maintain their rapid growth, albeit at a slightly slower pace than in 2016. The power sector in Lao PDR and growth in trade and FDI in Cambodia will be the main contributors. Volatility in the pace of government spending caused by elections and the change of government in Timor-Leste will likely contribute to reduced growth in 2017, followed by a pickup in 2018. Expanding tourism, low world commodity prices, high levels of revenue from fishing fees, and rising construction activity support moderate GDP growth rates in most of the small Pacific Island Countries. Poverty has declined across most of the region and poverty rates are projected to continue falling. Projections indicate that some of the region’s larger countries (China, Vietnam) have already been successful in eliminating extreme poverty (defined as those below the international poverty line of US$1.90-a-day in 2011 purchasing power parity terms). The share of the region’s population living in moderate poverty (defined as US$3.10-a-day in 2011 purchasing power parity terms) has declined to around 10 percent and is projected to drop to around 8 percent by 2019. The pace of poverty reduction across countries depends on efforts to make growth more inclusive. In the Philippines and other countries where income inequality has limited past progress in poverty reduction, accelerating the pace of poverty reduction will require more attention to tackling inequalities of opportunity and wealth. Poverty is concentrated among ethnic minorities in some countries—in Vietnam, for example, ethnic minorities account for 15 percent of the total population, but most of the extreme poor—and inclusion should be a major focus of poverty reduction efforts. This generally positive outlook is subject to significant downside risks. First, continued uncertainty about economic policies in some advanced economies and the escalation of geopolitical tensions could jeopardize growth prospects. Rising protectionism and economic nationalism, in particular, could have a chilling effect on world trade, to which countries in the region are disproportionately vulnerable because of their integration into global value chains. Increased geopolitical tensions in the region could generate volatility in global financial markets that could cause capital outflows for developing EAP, put pressure on exchange rates, and raise world interest rates. And the region’s central role in global shipping and manufacturing supply chains means that further escalation of these tensions could disrupt global trade flows and economic activity. Second, financial sector vulnerabilities in many countries could be exacerbated by tightening in global financial markets. Private sector indebtedness has reached a level in EAP countries that is well above other regions. In China, lending to the nonfinancial sector has grown to exceptionally high levels for a middle-income country. Many banking systems in the region are already highly leveraged with deteriorating asset quality. Household indebtedness is also growing in several of the large regional economies. If world interest rates were to rise rapidly, loan defaults and capital outflows from the region could be triggered, undermining the stability of banking systems. Furthermore, particularly in China, a substantial share of new debt has involved credit intermediation through entities outside the regular banking system, that is, so-called “shadow banking.” The increased complexity of shadow banking makes supervision and risk assessment more difficult, creating additional vulnerabilities in the financial sector. Third, budget deficits remain high or are expected to rise in most countries over 2017–19. These deficits are especially worrying in countries where public debt is also high or rising, as this combination narrows governments’ policy space for responding to shocks. The deterioration of debt dynamics has been more pronounced among the region’s commodity-exporting countries, and the worsening of their fiscal positions has been substantial and xviii Executive Summary BALANCING ACT persistent since the sharp decline in oil prices in 2014. The prospect of tighter global financing conditions in the future heightens the need to improve fiscal discipline. Governments must rebuild fiscal buffers so as to be able to deploy countercyclical fiscal policy in the event of financial stress or other shocks. The improved outlook for global growth provides a window of opportunity for countries to reduce their vulnerabilities and strengthen the foundations for sustained and inclusive growth in the medium term. The favorable environment offers the space to move away from policies aimed at stimulating short-term growth toward measures that address underlying vulnerabilities. Improvements in supervision and prudential regulation can help contain risks in economies that have experienced rapid credit growth and debt accumulation. Reform of tax administration and regional tax policy cooperation can help countries address common weaknesses in their tax systems that have resulted in lower revenue collection in EAP than in other regions, including high compliance costs, aggressive incentives, and outdated tax laws and treaties. The prospects of tightening external financing and rising inflation may require monetary policy adjustment. In anticipation of the spillovers from the eventual normalization of monetary policy in advanced economies, developing EAP countries also need to further strengthen the transparency of their central banks and improve their monetary policy regimes, while refining their operational frameworks. Countries in the region should continue to pursue structural reforms that can yield long-term economic benefits. Across the region, there is still a need to strengthen competitiveness and raise productivity. Reform agendas need to be prioritized and tailored to country circumstances. In countries that are undertaking large public infrastructure programs, such as the Philippines, Thailand, Cambodia, and Lao PDR, efforts to improve public investment management systems need to be deepened. China and Vietnam have initiated measures to tackle problems in their state-owned enterprise sectors, which will need to be sustained. Recent measures to tighten regulation of shadow banking activities in China need to be continued. Developing tourism sustainably and promoting further regional integration offer opportunities for the region to offset the risk of rising protectionism. The growth in tourism that the region has seen will likely accelerate in coming years. This trend has the potential to provide substantial economic benefits to developing EAP. If this growth is not well managed, however, it could mean challenges for economic, social, and environmental sustainability. To reap the gains from tourism, countries in developing East Asia must address key market and policy failures by focusing on priorities that include a stronger emphasis on integrated investment planning, improvements in the enabling business environment for tourism, enforcement of more robust environmental quality standards, and better links with local economies. More broadly, there is a need to build on existing regional integration initiatives by further opening up markets and harmonizing standards and the business environment. ASEAN, which is celebrating its 50th anniversary in 2017, and in particular, the ASEAN Economic Community, which was launched in 2015, offer one avenue for such an effort, especially with regard to liberalizing services trade and reducing nontariff barriers. A new set of policy challenges has emerged in ensuring the continued inclusiveness of growth and development. While the policy mix aimed at achieving broad-based growth was effective in lifting most of those at the very bottom of the income distribution over the last three decades, new concerns are now emerging across the region beyond a focus on reducing poverty. Public perceptions now point to growing concerns among the regions’ citizens about high and rising inequality, falling mobility, and growing economic insecurity. And some of the long- Executive Summary xix EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 term trends that supported the region’s growth with equity model in the past—such as the demographic transition and rapid urbanization—need to be better managed. Governments in the region can adapt to these changing needs by raising the bar on policy priorities—going beyond an exclusive focus on reducing poverty to a broader emphasis on ensuring economic mobility and security for all. Such an emphasis will entail tailoring interventions to address the heterogeneity of extreme poverty at the country level, fostering mobility by closing gaps in access to jobs and services and seeking to improve the quality and productivity of those jobs, and increasing economic security by putting in place mechanisms that can help reduce households’ exposure to risks while enhancing their ability to cope with the consequences of shocks when they do occur. In the Pacific Island Countries (PICs), reforms in some areas could provide significant opportunities over the medium term. Tourism, labor mobility, fisheries, and the knowledge economy are all sectors in which policy and institutional reforms over the medium term could allow the PICs to exploit economic opportunities. In turn, these reforms could lead to significantly higher incomes and employment by 2040. The higher government revenues from increases in fishing license fees and the broadening of the tax revenue base, if combined with improvements in the quality of public spending, could help PIC governments finance significant progress in human development outcomes. xx Executive Summary WORLD BANK EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Part I. Recent Developments and Outlook  1 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 I.A. Recent Developments Developing East Asia and the Pacific has continued to perform well in the first half of 2017. The region grew more rapidly than almost all other developing regions. Improved global economic performance contributed to the region’s growing exports and favorable financing conditions. China’s economy grew more rapidly in the first half of 2017 than was anticipated. GDP growth in Thailand and Malaysia accelerated, and other large economies continued to grow rapidly. Fiji and Mongolia have seen growth pick up in the first half of 2017. Consumption and investment have remained the main drivers of growth thus far this year. Several governments have succeeded in reducing fiscal deficits in 2017, notably Mongolia and Malaysia, but deficits remain high or are on track to increase in many others. Inflation remained moderate for the most part. Several major countries that experienced net outflows of capital in 2016 have seen net inflows to date in 2017, and net outflows appear to have stabilized in China. Spreads on international sovereign bonds have been declining, and most currencies have appreciated against the U.S. dollar. With sustained growth, poverty continues to decline across the region. A favorable global environment has contributed to improved economic performance in 2017 in developing East Asia and the Pacific The world economy continued to strengthen during the first half of 2017 and high-frequency data continue to suggest an ongoing recovery in global activity(Box I.A.1). Global growth accelerated to an average of 3.1 percent (quarter-over-quarter, seasonally adjusted annual rate [q/q, saar]) during the first two quarters of 2017. Industrial production has been growing at annualized rates of 4.8 percent on average between January and July. These developments reflect an acceleration of activity in the advanced economies, improved conditions in major commodity exporters, especially in Brazil and Russia, and continued fast growth in China, India, and other major commodity importers. The global composite Purchasing Managers’ Index remained firmly expansionary, in July and August, suggesting continued momentum in Q3 2017. Global trade has regained momentum in 2017 on the strength of these developments, after two years of weak growth. Oil prices rose above US$52 per barrel in September, as international oil markets continue to slowly rebalance, metal prices have recovered some of their earlier losses in 2017 on improved demand conditions, while agricultural prices have softened on well-supplied markets. International financial conditions remained favorable. Financial market volatility has remained low in 2017 despite uncertainty over the pace of advanced countries’ monetary policy normalization and heightened geopolitical concerns. U.S. bond yields have declined in recent months as expectations of an early fiscal stimulus and rapid interest rate hikes dissipated. Meanwhile, the European Central Bank (ECB) announced in September that it was making plans to begin scaling back asset purchases. Continued low interest rates and the depreciation of the U.S. dollar against major currencies in 2017 strengthened demand for emerging market assets. During the first five months of 2017, emerging market bond issuance was 48 percent above the level during same period last year, while spreads remain near low levels not seen since 2014. 2 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT Box I.A.1. Recent Global Developments The global economy is strengthening. The recovery in global growth, which has been underway since mid- 2016, continued in the first half of 2017 (Figure BI.A.1.1). Continued positive momentum in Q3 2017 was highlighted by the July and August global manufacturing PMI surveys, which remained firmly in expansionary territory. In the first two quarters of 2017, global growth is estimated at 3.1 percent (q/q saar) on average, somewhat up from 2.9 percent (q/q saar) in the final two quarters of 2016. The expected improvement in growth this year reflects two developments against the backdrop of resilient growth in commodity-importing emerging market and developing economies (EMDEs) Figure BI.A.1.1. Global GDP growth, 2007–17f led by China and India: an investment-led recovery Percent 9 in advanced economies, and receding obstacles to 8 activity among major commodity-exporting EMDEs. 7 6 Among advanced economies, growth in the United 5 4 States in the first half of 2017 has been in line with 3 2 expectations (2.1 percent [q/q saar] on average), 1 0 while growth in the Euro Area (2.4 percent) and -1 -2 Japan (1.9 percent) has been stronger than expected -3 -4 in the April 2017 issue of the East Asia and Pacific JJWorld 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017f ▬▬Advanced economies ▬▬Emerging and developing economies Economic Update. Among the EMDEs, growth in the Sources: World Development Indicators, Haver Analytics, World Bank. first half of 2017 has been resilient in China, and Note: Data for 2017 for all regions are preliminary working assumptions to be finalized and published in the January 2018 issue of the World Bank’s Global Economic Prospects. f = forecasts. appears to have picked up in most major commodity- exporting EMDEs led by Brazil and Russia. Prospects for advanced economies are improving. In the United States, growth rebounded in Q2 2017 to 3 percent (q/q saar), following a temporary consumption-led slowdown in Q1 2017 (1.2 percent). Labor market conditions improved further in Q2 2017 and at the start of Q3 2017, but core inflation moderated up to August, and market-based inflation expectations have declined. The U.S. Federal Reserve hiked policy interest rates in June, stressing the temporary nature of the inflation slowdown. The central bank also announced that it plans to start gradually reducing the size of its balance sheet in October. In the Euro Area, growth reached 2.6 percent (q/q saar) in Q2 2017—the highest rate since Q1 2015, with high-frequency indicators suggesting continued strength in Q3 2017. Headline inflation increased to 1.5 percent in August after dropping to 1.3 percent in June and July. Core inflation also recovered slightly to 1.2 percent in July and August. The ECB left its policy stance unchanged in July, but highlighted a shifting balance of risks and signaled that the recovery might warrant further policy normalization. Growth in EMDEs is accelerating. Major commodity exporters continue to experience modest pickup in activity. Export orders in most commodity exporters continued to recover in Q3 2017, partly supported by positive momentum in global trade. GDP growth in Brazil rebounded strongly to 2.6 percent on average (q/q saar) in the first two quarters of 2017, after eight quarters of contraction. Activity in Russia accelerated sharply to more than a five-year high of 5.7 percent (q/q saar) in Q2 2017 (2.5 percent y/y). Performance (continued) I.A. Recent Developments 3 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.A.1 continued) Figure BI.A.1.2. Regional GDP growth, 2012–17f in major commodity importers has been strong, Percent 10 although activity in India in 2017 appears to have been somewhat disrupted due to the new Goods and 8 Services Tax. Commodity importers in the Eastern 6 Europe and Central Asia region continue to benefit 4 from the recovery in the Euro Area, while strong 2 domestic demand combined with an uptick in global 0 trade is helping sustain robust growth in many East -2 Asia and Pacific commodity importing economies 20 3 20 3 20 3 20 3 20 3 13 20 2 20 2 20 2 20 2 20 2 20 2 20 16 20 16 20 16 20 16 20 16 20 16 20 4 20 4 20 4 20 4 20 4 20 4 20 5 20 5 20 5 20 5 20 5 20 5 f f f f f f 17 17 17 17 17 17 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 (Figure BI.A.1.2 and Figure BI.A.1.3). 20 20 20 20 20 20 20 JJEAP JJSAR JJECA JJLAC JJMENA JJSSA Sources: World Development Indicators, Haver Analytics, World Bank. Note: Lines denote long-run precrisis (1990–2008) average growth. Data for 2017 for all regions Global trade is growing again. Global trade, are preliminary working assumptions to be finalized and published in the January 2018 issue of the World Bank’s Global Economic Prospects. f = forecasts. which regained momentum in Q1 2017, following two years of pronounced weakness, remained robust in the second quarter of 2017 (Figure BI.A.1.4). The upswing was driven by strengthening investment in advanced economies, increased trade flows to and from China, and improved import demand from commodity-exporting emerging market and developing economies. PMI surveys point to sustained gains in global export orders during Q3 2017. Trade performance so far is consistent with the 2017 growth forecast for global trade (about 4 percent), which will be the fastest pace since 2010. Although the number of newly introduced protectionist measures has declined over the course of 2017, sectors including iron and steel products are affected by more anti-dumping, anti-subsidy, and public procurement localization measures. Figure BI.A.1.3. Regional GDP: Cumulative change, Figure BI.A.1.4. Global trade growth 2007–17f Percent, PPP terms Percent 120 25 20 100 15 10 80 5 60 0 -5 40 -10 -15 20 -20 0 -25 LAC ECA MENA SSA SAR EAP 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Sources: World Development Indicators, Haver Analytics, World Bank. ▬▬Volume ▬▬Value Note: Based on the actual numbers for 1990–2016 and preliminary working assumptions for 2017 Source: Netherlands Bureau for Economic Policy Analysis, World Bank. for all regions to be finalized and published in the January 2018 issue of the World Bank’s Global Note: Last observation is June 2017. Economic Prospects. f = forecasts. Commodity prices remain generally stable. Oil prices averaged over US$52 per barrel in September, up from US$50 per barrel in August. The market continues to rebalance, with the Organization of the Petroleum Exporting Countries’ (OPEC) improved compliance in August and the implementation of previously agreed (continued) 4 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT (Box I.A.1 continued) production cuts in Libya (Figure BI.A.1.5). Inventories continued to fall from record high levels, while the Brent futures-price curve steepened, indicating a tightening market. Metal prices surged due to strong demand and tightening supply due to China’s environmental restrictions for aluminum and zinc mines and processing plants. Meanwhile agricultural prices weakened slightly on well-supplied key grain and Figure BI.A.1.5. International commodity prices Index, nominal term, 2010 = 100 oilseed markets. 180 160 Global financing conditions remain favorable. 140 120 Global financing conditions remain benign, 100 benefiting from improved global growth prospects 80 and expectations of persistently low interest rates 60 40 despite ongoing monetary policy normalization in 20 the United States. U.S. long-term yields decreased 0 7 8 9 0 11 b-0 b-0 b-0 b-1 eb- -12 eb-13 eb-14 eb-15 eb-16 eb-17 -17 Feb F Aug through much of Q2 2017, mainly reflecting ▬F▬eEnergyFe Fe Fe ▬▬FMetals F F F F ▬▬Agriculture disappointing inflation outcomes and diminished Source: World Bank. Note: Last observation is August 2017. market expectations of fiscal stimulus. As the recovery continues in the Euro Area, the European Central Bank could further reduce its asset purchase program in coming months, but the reaction of Euro Area and global bond markets has been relatively muted so far. Among emerging markets, asset prices and capital flows remained buoyant during most of Q3 2017. Net capital inflows to EMDE bond and equity mutual funds were stable in September, with the weakness in the U.S. dollar helping to sustain inflows. Growth in developing East Asia and Pacific (EAP) has accelerated slightly in the first half of 2017, relative to expectations six months ago. The region grew by 6.6 percent year-over-year (y/y) in Q2 2017, continuing a trend of small but steady increases in growth rates since Q1 2016 (Figure I.A.1). After diverging during Figure I.A.1. Growth in developing EAP continued 2016, growth accelerated in both China and in the rest to prove resilient GDP growth (year-on-year percent change) of the region. The region’s growth rate lagged slightly 8 behind South Asia’s in 2016, but continues to be higher 7 than other developing regions. Over the last decade, developing EAP’s output has grown by 90 percent, more 6 than any other developing region’s. 5 Supported by consumption and improving external 4 conditions, China’s GDP grew by 6.9 percent y/y in 3 the first half of 2017, up from 6.7 percent during 2016. Consumption contributed 4.4 percentage points 2 Q4-14 Q1-15 Q2-15 Q3-15 Q4-15 Q1-16 Q2-16 Q3-16 Q4-16 Q1-17 Q2-17 of this growth, and for the first time since mid-2015, JJDeveloping EAP ▬▬China ▬▬Developing EAP excl. China net exports contributed positively to total GDP growth. Sources: Haver Analytics; World Development Indicators. I.A. Recent Developments 5 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Output growth continues to be led by services, although the growth in real estate and finance moderated somewhat in the first half of 2017 relative to 2016. Figure I.A.2. The region’s large economies continued Figure I.A.3. The manufacturing Purchasing Managers’ to perform strongly Index points toward continued expansion in most major countries GDP growth (year-on-year percent change) Purchasing Managers’ Index (manufacturing; seasonally adjusted, 50+ = expansion) 8 56 7 54 6 52 5 50 4 48 3 46 2 1 44 0 42 Q4-14 Q1-15 Q2-15 Q3-15 Q4-15 Q1-16 Q2-16 Q3-16 Q4-16 Q1-17 Q2-17 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Aug-17 ▬▬IDN ▬▬MYS ▬▬PHL ▬▬THA ▬▬VNM ▬▬CHN ▬▬Emerging markets ▬▬CHN ▬▬IDN ▬▬MYS ▬▬VNM ▬▬THA Sources: Haver Analytics; World Development Indicators. Source: Haver Analytics. Most other major economies in the region have been growing by 5 percent or faster thus far in 2017 Figure I.A.2). The manufacturing Purchasing Managers’ Index points toward continued expansion (Figure I.A.3). ( Private consumption made the largest contribution to GDP growth during recent quarters in all but Thailand, where investment was the principal contributor. Growth in private consumption spending and rising exports of both primary commodities and manufactures contributed to Malaysia’s accelerating growth. GDP grew by 5.6 percent in Q1 2017 and 5.8 percent in Q2—its best performance since Q1 2015. Improved weather allowed the agriculture sector to rebound by a seasonally adjusted annualized rate of 24 percent in the first quarter, outperforming other productive sectors of the economy. Thailand’s economic recovery continued to broaden and gain momentum due to external demand amid global growth as well as recovery from severe drought. The economy grew by 3.3 percent in Q1 2017, exceeding market expectations, due to recovery in farm income from drought, an upturn in merchandise and tourism exports, and continued fiscal stimulus. Real GDP expanded by 5.7 percent y/y during the first half of 2017 in Vietnam (about the same pace as in the first half of 2016). Strong momentum in domestic consumption, export-oriented manufacturing, and the services sector compensated for a contraction in the oil sector. Indonesia grew by 5.0 percent in both Q1 and Q2 2017. Stronger investment offset contracting government consumption and slower net export growth. The Philippines continued to show strong growth in the first half of 2017, although its pace—6.4 and 6.5 percent in the first two quarters—lagged behind those of the first half of 2016. High consumer and business confidence, modest inflation, robust remittance growth, and improving real wages led to sustained domestic demand in the Philippines, while the recovering external environment led to an improvement in net exports. Performance has been mixed in the region’s smaller economies, reflecting their diverse circumstances. Fiji and Mongolia are rebounding from challenging conditions experienced in 2016. Construction and increased tourist arrivals in the wake of 2016’s Cyclone Winston have stimulated consumer spending, boosting Fiji’s GDP growth to a projected 3.8 percent in 2017 from 0.4 percent in 2016. Mongolia’s macroeconomic stabilization program, 6 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT foreign direct investment (FDI) flows into the mining industry, and rising coal prices sparked a recovery that began in late 2016. GDP grew by 4.1 and 6.0 percent y/y in the first two quarters of 2017, following annual growth of 1.4 percent in 2016. Although their GDP growth rates remain high, Cambodia and Myanmar are showing signs of slower growth in 2017. Cambodia’s economy is projected to grow by 6.8 percent in 2017, down slightly from 7.0 percent in 2016, as both textile and construction—the two main drivers of growth—have moderated during the first half of 2017. Investment demand decelerated in Myanmar, bringing GDP growth down to 5.9 percent in FY2016/17 from 7.0 percent the previous year, although there are signs of faster growth in FY2017/18, as illustrated in Figure I.A.4.1 The economy of the Lao People’s Democratic Republic is projected to continue to grow at 6.7 percent in 2017, supported by strong exports and investment, including additional electricity generation. GDP growth in Timor-Leste is forecast to fall to 2.4 percent in 2017 from 5.7 percent in 2016 due to reduced government spending while the government is in caretaker mode during the election period. Owing to lower than expected growth of the non-resource sector and weak commodity prices, Papua New Guinea’s GDP growth for 2017 is now forecast to be 2.1 percent (versus 2.4 percent expected earlier in the year). Finally, agriculture, fishing, transportation, and the financial sector remain important drivers of 2017 growth in the Solomon Islands, which is estimated at 3.0 percent. Figure I.A.4 Performance is mixed across the region’s smaller economies Annual real GDP growth rates Panel A Panel B 9 9 8 8 7 7 6 6 5 5 4 4 3 3 2 2 1 1 0 0 2014 2015 2016e 2017f 2014 2015 2016e 2017f ▬▬KHM ▬▬LAO ▬▬MNG ▬▬MMR ▬▬FJI ▬▬TLS ▬▬PNG ▬▬SLB Sources: National authorities through 2015. World Bank estimates for 2016 and forecasts for 2017. Note: Myanmar is presented on a fiscal year basis (for example, 2015 = FY2015/16). Domestic demand continues to drive economic performance in the region Growth in consumption spending made the largest contribution to GDP growth in China and most other large economies (  Figure I.A.5). Consumption growth accounted for most of China’s surge in second quarter GDP, and real consumption spending is on track to grow by almost 8 percent in 2017. Average disposable income has been growing more rapidly than GDP in 2017—in contrast to 2016 in China. Private consumption grew by close to 6 percent y/y during the first two quarters in the Philippines and is expected to accelerate in the second half of the year. Private consumption also grew rapidly in the first half of the year in Indonesia and Malaysia—growing at 5.0 and 5.3 percent y/y, respectively. 1 Myanmar’s fiscal year ends on March 31. I.A. Recent Developments 7 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Private investment spending has also been important. Implementation of several large-scale manufacturing projects in Malaysia and ongoing investments in the services sector boosted private investment spending to 12.9 percent y/y in the first quarter of 2017. Consequently, the contribution of investment to GDP growth also increased. Indonesian investment spending rose at its fastest pace in the first two quarters of 2017 since late 2015, in large part as a response to falling interest rates. Mongolia’s macroeconomic stabilization program restored foreign investor confidence and has been driving a rebound in investment spending that is projected to reach almost 16 percent in 2017. Investment remains high in Lao PDR, driven mainly by FDI in the power sector and public investment projects. Figure I.A.5. Domestic demand continued to drive growth in 2017 Contribution of expenditure components to change in GDP (percentage points, year-on-year) 16 14 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -14 3-14 1-15 3-15 1-16 3-16 -17 -14 -14 -15 -15 -16 -16 -17 -14 -14 -15 -15 -16 -16 -17 -14 -14 -15 -15 -16 -16 -17 -14 -14 -15 -15 -16 -16 -17 Q1 Q Q Q Q Q Q2 Q1 Q3 Q1 Q3 Q1 Q3 Q2 Q1 Q3 Q1 Q3 Q1 Q3 Q2 Q1 Q3 Q1 Q3 Q1 Q3 Q2 Q1 Q3 Q1 Q3 Q1 Q3 Q1 China Indonesia Malaysia Philippines Thailand JJConsumption JJGross capital formation JJGovernment consumption JJNet exports JJStatistical discrepancy ▬▬GDP growth Sources: Haver Analytics; World Bank staff estimates. Public investment spending is contributing to growth in Thailand and the Philippines, but has been declining in many other countries. Government investment spending in Thailand grew to 9.7 percent of GDP in Q1 2017 from 8.6 percent the previous quarter, and implementation of public infrastructure projects in Thailand has crowded in new private investment, making total investment spending the main driver of growth in the first half of 2017. Government spending on infrastructure supported investment growth in the Philippines in the first half of 2017. Figure I.A.6 shows that public investment spending has not been growing as fast as GDP in many other countries, however. Capital spending dropped sharply in Timor-Leste in 2017 due to lower budget execution during the change in government. It has also been declining gradually for several years in Indonesia, Malaysia, Cambodia and Myanmar. Cambodia's declining trend is particularly worrisome for long-term growth that as it been accompanied by a growing public sector wage bill and rising recurrent spending. Fiscal deficits narrowed or held steady in 2017 in several of the region’s large economies. Deficits narrowed in Indonesia and Malaysia, and have stabilized at around 3.1 percent of GDP in 2017 in China after widening during 2014–16 (Figure I.A.7). Vietnam has also reduced its deficit. Revenue collection surged during the first half of 2017 in Indonesia while the government constrained spending growth. Malaysia recalibrated its budget to lower world oil prices in 2016, which has brought its fiscal consolidation program back on track. In contrast, deficits are widening slightly in Thailand, which has applied fiscal stimulus to promote economic recovery. Like other countries in the region, Vietnam has been introducing measures to increase revenue mobilization and bring down its deficit. 8 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT Figure I.A.6. Countries’ record on public investment spending is mixed General government capital expenditure (percent of GDP) 12 18 40 16 35 10 14 30 8 12 25 10 6 20 8 15 4 6 10 4 2 2 5 0 0 0 2011 2012 2013 2014 2015 2016 2017 2011 2012 2013 2014 2015 2016 2017 ▬▬CHN ▬▬PHL ▬▬MYS ▬▬IDN ▬▬VNM ▬▬MNG ▬▬MMR ▬▬KHM ▬▬TLS, rhs Source: World Bank staff estimates. Note: Data for Malaysia, Myanmar, and the Philippines refer to central government capital expenditure. Data for Myanmar and the Philippines refer to the fiscal year. Data for Indonesia and Malaysia refer to the four- quarter average. rhs = right-hand side. Figure I.A.7. After widening in 2016, fiscal deficits in Figure I.A.8. Budget deficits are large in other countries some of the large economies started to stabilize in 2017 General government fiscal balance (percent of GDP), four-quarter moving averag Overall budget balance as a share of GDP 2 0 1 -2 -4 0 -6 -1 -8 -2 -10 -3 -12 -4 -14 -5 -16 -6 -18 -13 -13 -13 -13 -14 -14 -14 -14 -15 -15 -15 -15 -16 -16 -16 -16 -17 -17 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2013 2014 2015 2016 2017 ▬▬CHN ▬▬MYS ▬▬PHL ▬▬IDN ▬▬THA ▬▬KHM ▬▬FJI ▬▬LAO ▬▬MNG ▬▬MMR ▬▬VNM Sources: CEIC; World Bank staff estimates. Source: World Bank staff estimates. Note: Data refer to general government fiscal balance, except for Indonesia, where data refer to central Note: The fiscal balance for Mongolia includes commercial spending by the Development Bank of government fiscal balance; fiscal deficits do not reflect off-budget spending items. Mongolia. Budget deficits remain large in most of the smaller economies. Myanmar’s deficit is projected to rise to 4.5 percent of GDP in 2017 from 3.0 percent in 2016, although this reflects in part a greater emphasis on capital spending, and Cambodia’s deficit is projected to rise to 4.5 percent from 3.0 percent (Figure I.A.8). Low tax receipts in both resource and non-resource sectors of Papua New Guinea and increased costs of debt servicing have led the authorities to revise upward their 2017 deficit forecast in its Mid-Year Economic and Fiscal Outlook to 3.8 percent of GDP from the 2.5 percent target originally presented in the budget. The government expects to pass a supplementary budget that targets deficit reduction. Among countries where deficits are projected to fall, Mongolia has initiated fiscal consolidation as part of its stabilization program, which should bring its deficit down to 8.4 percent of GDP in 2017 from 17.0 percent in 2016. Other countries’ deficits fell for less positive reasons. Delays in reconstruction spending in Fiji brought its deficit down to 2 percent of GDP in 2016/17, and Timor-Leste’s budget deficit is also on track to fall in 2017 as the government reduces spending while it is in caretaker mode. I.A. Recent Developments 9 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Exports continue to grow across much of the region Figure I.A.9. Export values continued to recover in second Demand for the region’s exports increased in 2017 half of 2017… Export values (index of 12-month moving sum, January 2013 = 100) with the recovery in world trade growth and gradual 120 strengthening of global economic activity. Export 115 revenues increased during 2017 in all major economies 110 (Figure I.A.9). Chinese and Thai exports resumed 105 growing in volume terms, after declining during 2016, 100 95 while volume growth accelerated in Malaysia and the 90 Philippines (Figure I.A.10). Net exports made a positive 85 contribution to China’s GDP growth during the first two 80 quarters of 2017 after dragging on growth since mid- 75 2015. Commodity exporters’ performance has diverged 70 -13 Jan Jul -13 Jan -14 Jul -14 Jan -15 Jul -15 Jan -16 Jul -16 Jan -17 Jul -17 somewhat from the rest of the region since mid-2016. ▬▬CHN ▬▬THA ▬▬MYS ▬▬IDN ▬▬PHL Figure I.A.10 shows that their recovery has lagged Sources: Haver Analytics; World Bank staff estimates. behind the region’s more diversified economies. Stronger growth in advanced economies and in China stimulated demand for the region’s manufactured products. Malaysia’s electrical and electronics producers enjoyed strong export growth, for example, and the Philippines experienced real export growth of around 20 percent during the first two quarters of the year, led by electronics and semiconductors. Vietnam’s export-oriented manufacturing sector grew by 8.4 percent and 12.3 percent y/y during the first two quarters of 2017, and total exports are expected to grow by 14.6 percent in 2017. Among the smaller economies, although Cambodia’s exports are expected to grow by 7.0 percent in 2017, its textile and garment producers are facing increased competition from Myanmar and other emerging competitors in the region that have lower wages. Figure I.A.10. …as have export volumes Export volume growth (percent, 12-month growth rate) Panel A Panel B 12 12 25 10 8 8 20 6 4 15 4 0 2 10 0 -4 -2 5 -6 -4 -6 -12 0 -14 -14 -15 -15 -16 -16 -17 -17 -14 -14 c-1 4 y-1 5 -15 r-1 6 -16 -17 -17 Jan Jul Jan Jul Jan Jul Jan Jul Feb Jul De Ma Oct Ma Aug Jan Jun ▬▬CHN ▬▬EAP excl. China ▬▬Commodity exporters ▬▬THA ▬▬MYS ▬▬IDN ▬▬PHL, rhs Sources: Haver Analytics; World Bank staff estimates. Note: rhs = right-hand side. EAP commodity exporters include Indonesia, Lao PDR, Malaysia, Mongolia, Myanmar, Papua New Guinea, Timor-Leste, and Tonga. 10 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT Commodity exporters have also seen an increase in exports, helped by stronger world prices. There has been some variation across countries due to differences in products and specific national conditions. Indonesian and Malaysian natural gas exporters benefited from stronger prices in 2017. Higher world prices also contributed to growing coal exports from Indonesia and a fourfold increase in Mongolia’s coal exports during the first seven months of 2017 compared to the same period in 2016.2 Indonesia’s rubber exporters faced declining prices in 2017; Thai production bounced back after flooding at the beginning of the year and Vietnamese producers began harvesting earlier in the year than usual. Indonesian and Malaysian palm oil exports rose during the first half of 2017 as plantations recovered from last year’s El Niño conditions, pushing world prices downward since both countries supply most of the palm oil to the world market. Tourism has become an increasingly important contributor to export revenue for many countries in the region. Tourism generated US$214 billion in export revenue for developing EAP in 2015, accounting for 6.4 percent of the region’s total exports.3 Tourist receipts make up around half of total exports from the small Pacific islands (49 percent in 2015). Tourism is also a major share of exports from Cambodia (29 percent), and contributes between 15 and 20 percent to the exports from Lao PDR, Myanmar, and Thailand. In the larger and more diversified economies, such as China, Indonesia, and Malaysia, tourism is still a notable 5 to 10 percent of exports. International tourist arrivals have grown rapidly in 2017 in many countries. Arrivals to Vietnam during the first five months of 2017 were 31 percent higher than in the same period of 2016, for example. Arrivals grew by around 13 percent y/y during the first part of 2017 in Cambodia, Indonesia, and the Philippines (UNWTO 2015).4 Inflation remains low throughout most of the region Figure I.A.11. Inflation is benign in the region and declined in most countries toward mid-2017 Headline inflation (year-on-year, percent) Panel A Panel B 10 18 16 8 14 12 6 10 8 4 6 4 2 2 0 0 -2 -2 -4 -13 -13 -14 -14 -15 -15 -16 -16 -17 -17 -13 -13 -14 -14 -15 -15 -16 -16 -17 -17 Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul ▬▬CHN ▬▬IDN ▬▬MYS ▬▬PHL ▬▬THA ▬▬VNM ▬▬KHM ▬▬LAO ▬▬MMR ▬▬MNG ▬▬TLS Source: Haver Analytics. In much of the region, inflation is still muted, as in 2016. World commodity prices remain low, despite some growth in late-2016 and in 2017. This has helped to keep inflation levels relatively low, even in countries that have shown some increases in 2016 (Figure I.A.11). Changes in administered prices and monetary policy contributed 2 The United Nations’ decision in April 2017 to ban imports of coal from the Democratic People’s Republic of Korea also played a role in Mongolia’s increased coal exports. 3 Data on Cambodia are for 2014; others are for 2015. 4 Arrivals exclude cruise and other day-only tourists. I.A. Recent Developments 11 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 to some of the variation across countries. Indonesia’s hikes in administered prices pushed its inflation rate up to 4.4 percent by May 2017, whereas tapering of the effects of earlier increases in administered prices pulled Vietnam’s inflation rate down after February 2017, reaching 2.5 percent by July. Mongolia’s central bank increased its policy rate by 450 basis points (to 15 percent) in August 2016 and then cut the rate by 100 basis points in December; the inflation rate rose to 4.6 percent by April 2017 before moderating slightly. Extreme weather events also influenced inflation rates. As the shortages caused by Cyclone Winston began to ease in 2017, Fiji’s inflation rate fell to 2.0 percent y/y in June 2017 from 6.8 percent in January 2017. Consumer prices declined in Timor-Leste in 2015 and 2016 as world oil prices fell, but have since begun to rise slowly. Core inflation remains low in the large economies. It has been trending downward in Indonesia, Thailand, and Vietnam (Figure I.A.12). Core inflation in China rose during 2016 and edged above 2 percent y/y in the middle of 2017. It has also been rising in Malaysia and the Philippines since mid-2016. Figure I.A.12. Core inflation remains muted Figure I.A.13. Producer prices increased rapidly in late 2016, but decelerated in 2017 Core inflation (year-on-year, percent) Producer price index (year-on-year change, percent) 6 20 20 18 5 16 15 14 4 10 12 10 3 5 8 6 2 0 4 1 2 -5 0 0 -2 -10 -13 -14 -14 -15 -15 -16 -16 -17 -17 -13 -13 -14 -14 -15 -15 -16 -16 -17 -17 Aug Feb Aug Feb Aug Feb Aug Feb Aug Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul ▬▬CHN ▬▬IDN ▬▬MYS ▬▬PHL ▬▬THA ▬▬VNM ▬▬MNG, rhs ▬▬CHN ▬▬MYS ▬▬PHL ▬▬THA ▬▬IDN Source: Haver Analytics. Source: Haver Analytics. Note: The official PPI of the Philippines only covers the manufacturing sector. Producer price inflation decelerated in the second quarter of 2017 after rising rapidly during the second half of 2016 in the large economies  (Figure I.A.13). Producer prices in Thailand fell in July 2017. The recovery of world energy and metals prices in 2016 and their subsequent decline in Q2 2017 contributed to rising and then declining producer price inflation in China. Benign inflation allowed authorities to maintain generally accommodative monetary policies. Most large economies either cut interest rates or held them constant in 2017 (Figure I.A.14). The State Bank of Vietnam, for example, cut its key policy rate by 25 basis points in July 2017 in an effort to stabilize interest rates and boost economic growth. In contrast, China tightened monetary policy through new regulations aimed at cooling the property market and reducing risks in the banking sector. Real policy rates as of mid-2017 had declined well below their peaks in the current cycle and are now negative in Malaysia (Figure I.A.15). Only in Thailand and Vietnam are real policy rates above their long-term average. 12 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT Figure I.A.14. Most larger countries have held policy rates Figure I.A.15. Real interest rates in large economies have constant or reduced them slightly in 2017 been declining, and in most cases are significantly below their long-term average Policy rate (percentage points) Real policy rate (percentage points) 8 7 7 6 Dec-14 6 5 Jul-14 5 4 Jul-14 4 3 Sep-14 Apr-16 3 2 Dec-15 2 1 1 0 0 -1 -13 r-1 4 -14 r-1 5 -15 r-1 6 -16 r-1 7 -17 Sep Ma Sep Ma Sep Ma Sep Ma Aug China Indonesia Malaysia Philippines Thailand Vietnam ▬▬CHN ▬▬IDN ▬▬MYS ▬▬PHL ▬▬THA ▬▬VNM JJTop of current cycle JJReal policy rate as of June 2017 QQ10-year average Source: Haver Analytics. Sources: Haver Analytics; World Bank staff estimates. Private sector credit continues to expand in the region Bank lending to the private sector grew somewhat more rapidly in the first half of 2017 in many large economies. After real credit growth moderated during 2016, it accelerated in Thailand, Malaysia, and Vietnam in 2017, and remained stable in the Philippines (Figure I.A.16). As the level of nonperforming loans reached a plateau in the Philippines (hovering at around 2 percent of total loans since Q4 2016), credit growth began to accelerate slightly in early 2017. Credit has been growing at close to 20 percent y/y in nominal terms since the second half of 2015 in Vietnam and has pushed up the credit intensity of GDP, raising concerns over the productivity of new credit and mispricing of risk. Tighter monetary policy and new regulations on shadow financing in China have Figure I.A.16. Credit growth has slowed over the past year, but remains rapid and showed signs of modest acceleration in some countries in 2017 Real growth in net domestic credit (year-on-year, percent) Panel A Panel B 21 45 40 18 35 15 30 12 25 9 20 15 6 10 3 5 0 0 -13 -13 -14 -14 -15 -15 -16 -16 -17 -17 -13 -13 -14 -14 -15 -15 -16 -16 -17 -17 Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul ▬▬CHN ▬▬IDN ▬▬MYS ▬▬PHL ▬▬THA ▬▬VNM ▬▬LAO ▬▬KHM Sources: Haver Analytics; World Bank staff estimates. Note: Nominal growth in domestic credit is deflated by the CPI. I.A. Recent Developments 13 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 slowed lending to the nonfinancial sector, thus reducing Figure I.A.17. The stock of private sector debt remains macroeconomic risks somewhat. Among the smaller elevated in several economies Credit by sector (percent of GDP) economies, credit growth in Cambodia since late 2016 300 has dropped with the slight easing of economic activity, 250 while it has fluctuated around 15 percent in Lao PDR since 2015. 200 150 Private sector debt remains elevated in several economies and has grown more rapidly than 100 government debt. China’s total debt stock is well 50 above the emerging market average (Figure I.A.17), 0 and nonfinancial corporate debt has grown to over 20 10 015 016 010 015 016 010 015 016 010 015 016 010 015 016 010 015 016 010 015 016 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 CHN MYS VNM THA PHL IDN Emerging econ. 160 percent of GDP. A large share of this is concentrated Credit to general JJ JJCredit to households Credit to nonfinancial JJ government corporations in infrastructure and real estate. Household debt in Sources: Bank for International Settlements; Central Bank of the Philippines; International Financial Malaysia and Thailand exceeds 70 percent of GDP. Statistics. Note: For 2016, data refer to end-Q3, except for the Philippines, where they refer to end-2016. For the Philippines and Vietnam, disaggregated data on credit to households and nonfinancial corporations are not available. The group “emerging economies” comprises the following countries, for which data are available: Argentina, Brazil, Chile, India, Mexico, the Russian Federation, South Africa, and Turkey. Financial conditions and currencies stabilized during the first half of 2017 The large net outflows of capital experienced in Figure I.A.18. The increase in capital outflows many countries in late 2016 subsided or reversed experienced in late 2016 have begun to reverse Net capital flows (share of GDP) by mid-2017. Appreciation of the U.S. dollar in 2016, 10 intensified at the end of the year by expectations of a 5 fiscal stimulus in the United States and an accelerated return to conventional monetary policy, contributed 0 to net capital outflows from China and other large -5 economies during 2016 (Figure I.A.18). By the middle of 2017, markets came to expect a slower pace of interest -10 rate hikes by the U.S. Federal Reserve. The U.S. dollar -15 lost over 8 percent of its value against major world currencies between the beginning of 2017 and August. -20 1-12 3-12 1-13 3-13 1-14 3-14 1-15 3-15 1-16 3-16 1-17 2-17 Q Q Q Q Q Q Q Q Q Q Q Q These developments dampened the external incentives ▬▬CHN ▬▬IDN ▬▬MYS ▬▬PHL ▬▬THA for capital to flow out of the region. In addition, new Sources: Haver Analytics; IMF International Financial Statistics; World Bank staff estimates. policies and other internal developments explain some of the changes in capital flows. The Chinese authorities have introduced stricter capital controls, which helped to reduce outflows to US$42 billion in the first half of 2017 from US$268 billion during the same period of 2016.5 Net portfolio outflows from Malaysia in Q4 2016 and Q1 2017 were driven mainly by one-off events—the maturing of government securities held by foreign investors and the unwinding of nondeliverable forward positions by nonresident financial institutions—and the balance turned to a net inflow in the second quarter of 2017. 5 This includes errors and omissions. 14 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT Figure I.A.19. Net FDI inflows increased in 2016 Figure I.A.20. Net FDI outflows from China exceeded net and 2017 in many of the larger economies inflows during most of 2016, but the balance may have shifted in 2017 Net FDI flows (US$ billion, four-quarter sum) Net FDI flows (US$ billion) 20 350 300 15 250 200 10 150 5 100 50 0 0 -50 -5 -100 -10 -150 -200 -15 -250 -12 -12 -13 -13 -14 -14 -15 -15 -16 -16 -17 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 2012 2013 2014 2015 2016 Q1-16 Q2-16 Q3-16 Q4-16 Q1-17 Q2-17 ▬▬IDN ▬▬MYS ▬▬PHL ▬▬THA ▬▬VNM JJFDI net inflows JJFDI net outflows ▬▬Balance of FDI net flows Source: Haver Analytics. Source: Haver Analytics. Meanwhile, net FDI inflows have gradually increased in the large ASEAN countries, and net FDI outflows from China have stabilized. Net FDI inflows continued to rebound in Malaysia and the Philippines, reversing the pattern between 2007 and 2015 of small inflows or net outflows between 2007 and 2015, and they remained high in Indonesia and Vietnam (Figure I.A.19). Net FDI inflows into China began to exceed net outflows in Q4 2016, reflecting the new controls on outward FDI (Figure I.A.20). Inflows of Chinese FDI remained large in many of the region’s economies, even after taking into account China’s tighter restrictions on total capital outflows to the world (Box I.A.2). Thai foreign investment abroad has surged as Thai firms, taking advantage of greater economic integration, expanded their production networks and pursued resources and markets abroad. Figure I.A.21. Financial markets saw increased volatility Financial markets recovered from the volatility in end-2016, but have since recovered Total returns (index, end-2015 = 100) experienced at the end of 2016. Uncertainty about 120 Chinese growth prospects in Q3 2016 and about the 140 direction of U.S. policies after the November 2016 115 election had generated volatility in regional financial 130 markets and sparked declines in stock and bond 110 120 returns. Markets stabilized and then rallied during the 105 first half of 2017. Stock returns rose rapidly compared 110 to corporate bond returns (Figure I.A.21). Regional 100 100 stock indexes increased during 2017 after declining at 90 the end of 2016 (Figure I.A.22). Stocks in Indonesia, 95 De c-1 5 Ma r-1 6 Jun -16 Sep -16 De c-1 6 Ma r-1 7 Jun -17 Sep -17 Thailand, and Vietnam registered the largest gains, as ▬▬Sovereign (ext) ▬▬Corporate (ext) ▬▬Sovereign (local) ▬▬Stocks, rhs indexes exceeded their pre-2016 levels. Sources: J.P. Morgan; Thomson Reuters Datastream; IFC Global Macro & Market Research. Note: Data refer to the following indexes: Datastream Equity Index Asia ex-Japan (stocks), J.P. Morgan Emerging Market Bond Index (EMBI) Global Diversified Asia (external sovereign Bonds), J.P. Morgan Returns on both corporate and sovereign bonds Morgan Asia Credit Index (JACI) Corporate (external corporate bonds), and J.P. Morgan Government Bond Index-Emerging Markets (GBI-EM) Asia (local sovereign bonds). rhs = right-hand side. have increased too due to the improving external environment ( Figure I.A.21). External bond spreads declined in 2017 (Figure I.A.23). Spreads on Indonesia’s bonds fell by 200 basis points between February 2016 and July 2017. Standard and Poor’s raised its long-term sovereign credit rating for Indonesia’s external bonds I.A. Recent Developments 15 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Box I.A.2. FDI Trends in Developing EAP1 Developing East Asia and Pacific (EAP) continues to be the largest recipient of foreign direct investment (FDI) inflows among developing regions. FDI inflows into developing EAP have systematically outpaced the levels found in other developing regions since the early 2000s (Figure BI.A.2.1). Moreover, the gap with most of these regions has risen in recent years: during 2011–16, the annual average of FDI inflows to developing EAP reached US$181 billion. Among developing regions, only Latin America and the Caribbean gets close to this value, with an annual average of US$169 billion. Figure BI.A.2.1. FDI inflows across developing regions Developing EAP has experienced a strong surge Annual average; US$ billion 200 of FDI over the last decade. FDI inflows grew at 180 an annual rate of 9 percent between 2000 and 160 140 2016. This dynamism in inward FDI, which is seen 120 also in several other regions, has nevertheless 100 80 meant that developing EAP has increased its share 60 of global FDI flows, particularly after 2007 (Figure 40 20 BI.A.2.2). In 2016, the region attracted FDI inflows 0 worth US$170 billion. This value is equivalent to JJDeveloping EAP 2001–05 JJECA JJLAC 2006–10 JJMENA JJSAR 2011–16 JJSSA 9 percent of global FDI flows, up from 6 percent Source: UNCTAD. in 2007, and after an all-time high of 13 percent Note: All regions include developing countries only. in 2014. Outward FDI shows an even more robust Figure BI.A.2.2. Developing EAP share of global FDI Figure BI.A.2.3. Distribution of FDI inflows in flows developing EAP, by destination Percent Annual average, percent 16 100 14 80 12 10 60 8 6 40 4 20 2 0 0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2001–05 2006–10 2011–16 ▬▬Inflow ▬▬Outflow JJCHN JJIDN JJMYS JJVNM JJTHA JJPHL JJKHM JJMMR Source: UNCTAD. JJRest of developing EAP Source: UNCTAD. pattern: the share of global FDI flows originating in developing EAP moved from a share of 0.3 percent in 2000 to a maximum of 13 percent in 2016. In absolute terms, the outward FDI activity of developing EAP multinationals shifted from an annual average of US$16 billion during 2000–07 to US$125 billion during (continued) 1 Prepared by Jose Ramon Perea, Zhi (Ken) Gan, with useful inputs from Vera Kehayova. 16 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT (Box I.A.2 continued) 2008–16. This transition, while largely attributable to the increasing presence of China as a global investor, also points to a more complex set of FDI relationships for developing EAP, with both inward and outward investments growing across a larger number of markets and sectors. Although China accounts for the lion’s share of FDI inflows into developing EAP, other countries have experienced rapid growth. Average annual FDI inflows to China grew from US$57 billion during 2001–05, equivalent to 81 percent of total FDI to developing EAP, to US$128 billion in 2011–16, 71 percent of total FDI (Figure BI.A.2.3). Parallel to the decline in China’s share of regional FDI, other economies are playing a bigger role as FDI hosts. This is particularly the case of Indonesia and Vietnam, which went from shares of regional FDI close to 2 percent during 2001–05 to 9 percent and 5 percent, respectively, during 2011–16. Advanced economies are both the key contributors for inward FDI to developing EAP and the major recipient countries for outward FDI from the region. Advanced economies in Asia took up a major share of the FDI stocks in developing EAP—Japan, Singapore, and Korea accounted for over one-quarter of the 2015 regional FDI stock (27 percent), while the United States, the Netherlands, and Germany are the top FDI investors outside of Asia (Figure BI.A.2.4a). The majority of outward FDI flowed from developing EAP to Singapore, the Netherlands, Australia, Korea, and the United States (Figure BI.A.2.4b). Apart from advanced economies, intraregional FDI across developing EAP countries has become more prominent, with China and Indonesia also taking up a sizable share. Figure BI.A.2.4a. Developing EAP inward FDI stock Figure BI.A.2.4b. Developing EAP outward FDI stock Japan 264 Singapore 72 Singapore 217 China 42.4 United States 134 Indonesia 12.5 Netherlands 89 Netherlands 9 Germany 76 Australia 7.9 Korea, Rep. 72 Korea, Rep. 6.6 United Kingdom 53 United States 6.5 0 50 100 150 200 250 300 0 10 20 30 40 50 60 70 80 By country of origin; 2015, in US$ billions By country of destination; 2015, in US$ billions Source: International Monetary Fund, Coordinated Direct Investment Survey. Source: International Monetary Fund, Coordinated Direct Investment Survey. FDI in developing EAP is widely distributed across sectors. Statistics on the cumulative value of greenfield and mergers & acquisitions (M&A) FDI projects between 2003 and 2016 illustrate that the sector receiving the most FDI in EAP is coal, oil, and natural gas (14 percent), followed by real estate and financial services (Figure BI.A.2.5).2 In recent years, the importance of extractive industries has diminished, as Chinese investments have become more diversified across host markets and sectors. Real estate, transportation, and (continued) 2 This information is extracted from two transaction-level data sources on FDI projects. First, the fDi Markets dataset tracks media announcements of firm-level greenfield FDI projects. Second, the Thomson Reuters dataset provides the value of individual M&A transactions. The matching methodology detailed in Kierkegaard (2013) is used to merge both datasets. The information from these two datasets allows us to create a single FDI dataset covering the years 2003–15 and including both greenfield and M&A. I.A. Recent Developments 17 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.A.2 continued) automotive original equipment manufacturer are on the rise, while more investments are flowing into new sectors such as hotel and tourism, and leisure and entertainment. Figure BI.A.2.5. Developing EAP inward FDI by sector Figure BI.A.2.6. Chinese FDI stock in developing EAP Cumulative value of Greenfield and M&A FDI projects, 2003–16 Other Indonesia 4,728 32 Coal, oil & Thailand 3,179 14 natural gas Semiconductors 3 Mongolia 1,048 Electronic 4 components Food & tobacco 4 11 Malaysia 785 Real estate 4 Transportation 5 Philippines 229 Automotive OEM 9 6 8 Financial services Chemicals 0 1,000 2,000 3,000 4,000 5,000 Metals Sources: fDi Markets and Thomson Reuters. 2015, in US$ millions Note: OEM = original equipment manufacturer. Source: International Monetary Fund, Coordinated Direct Investment Survey. One notable trend is the emergence of China’s outward FDI. China has stepped up its global investment activity, reaching US$183 billion by 2016, from less than US$1 billion in 2000. In developing EAP, Chinese investment in the region reached an annual flow of US$5 billion by 2014. The main destination of Chinese outward FDI in developing EAP is Indonesia (Figure BI.A.2.6), with 47 percent of total outward FDI stocks from China, followed by Thailand (32 percent), Mongolia (10 percent), and Malaysia (8 percent). Chinese multinationals are most active in the region in metals, accounting for 30 percent of the cumulative value of the country’s outward FDI projects between 2003 and 2016. Real estate and energy extractive industries (coal, oil, and gas) also are significant, with 19 percent and 18 percent of Chinese outward FDI in the region, respectively. Looking ahead, the development of the Belt and Road Initiative (BRI), a cornerstone of China’s development strategy, will likely influence its FDI activity in developing EAP. The BRI aims to create a network of physical connectivity through a network of railways, roads, pipelines, utility grids, ports, and others that would link China with the rest of the world. This initiative involves more than 60 countries and a combined inward FDI stock of around US$6 trillion (UNCTAD 2017). While the BRI is still in its infancy, there is some evidence that it is already contributing to greater Chinese FDI into the rest of developing EAP. Following the announcement of the BRI in 2013, several countries have signed deals with China aimed at addressing infrastructure gaps within the region.3 3 These include the construction of a number of high-speed rail lines, including in Malaysia, Thailand, Lao PDR, and Indonesia. One of these would lead to a new high-speed rail line running from southern China through Lao PDR to Thailand and Malaysia. Another would be the first high-speed rail network in Indonesia, linking the cities of Jakarta and Bandung. 18 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT to investment grade for the first time since 1997.6 Spreads on Malaysian and Vietnamese external bonds fell by similar magnitudes. Figure I.A.22. Stock prices Figure I.A.23. External corporate and sovereign bond spreads have narrowed US$, index, end-2015 = 100 Emerging Market Bond Index spreads (basis points) 140 400 130 350 300 120 250 110 200 100 150 90 100 80 50 70 0 5 6 -16 -16 6 7 -17 -17 5 6 -16 -16 6 7 -17 -17 c-1 r-1 Jun Sep c-1 r-1 Jun Sep c-1 r-1 Jun Sep c-1 r-1 Jun Sep De Ma De Ma De Ma De Ma ▬▬CHN ▬▬IDN ▬▬MYS ▬▬PHL ▬▬THA ▬▬VNM ▬▬CHN ▬▬IDN ▬▬MYS ▬▬PHL ▬▬VNM Sources: Thomson Reuters; Datastream; IFC Global Macro & Market Research. Sources: J.P. Morgan; IFC Global Macro & Market Research. After falling against the U.S. dollar during the second half of 2016, most currencies in the region appreciated against it during 2017. Exchange rates for most major regional currencies reversed course during 2017 as the U.S. dollar depreciated in response to changing expectations about U.S. macroeconomic policies (Figure I.A.24). The Thai baht’s value in U.S. dollars increased by 7.5 percent between the end of 2016 and July 2017, for example, and the Malaysian ringgit gained 4.8 percent in value during this period. Only the Philippine peso has depreciated against the dollar during 2017. Nevertheless, in real, trade-weighted terms, only the Chinese renminbi and the Philippine peso have depreciated sharply since the end of 2015 (Figure I.A.25). Figure I.A.24. Many major currencies have appreciated Figure I.A.25. Indonesia and Thailand show appreciation against the U.S. dollar during 2017 in real, trade-weighted terms Index of U.S. dollar to local currency, December 2015 = 100 Real effective exchange rate index, December 2015 = 100 115 110 110 105 105 100 100 95 95 90 90 5 -16 -16 -16 -16 -16 6 -17 -17 -17 -17 5 -16 -16 -16 -16 -16 6 -17 -17 -17 l-17 c-1 Feb Apr Oct c-1 Apr c-1 Apr Oct c-1 Apr De Jun Aug De Feb Jun Aug De Feb Jun Aug De Feb Jun Ju ▬▬CHN ▬▬IDN ▬▬MYS ▬▬PHL ▬▬THA ▬▬VNM ▬▬US$ index ▬▬CHN ▬▬IDN ▬▬MYS ▬▬PHL ▬▬THA Source: Haver Analytics; U.S. Federal Reserve. Sources: Bank for International Settlements; CEIC; World Bank staff estimates. Note: Falling values denote depreciation vis-à-vis the U.S. dollar. US$ index is a weighted average of the Note: Falling values denote depreciation. The real effective exchange rate (REER) is deflated using the values of major world currencies that circulate widely outside their country of issue. consumer price index. 6 See “Upgraded,” Indonesia Economic Quarterly, World Bank, Washington DC, June 2017. I.A. Recent Developments 19 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Figure I.A.26. Reserve coverage for the major economies Reserve coverage across the region is broadly in the region remains broadly adequate adequate  (Figure I.A.26). In 2017, China halted the Selected ratios, latest and long-term average 0.6 30 slide in its foreign reserves, which had declined by around 25 percent between August 2014 and January 0.5 25 2017. The stock of reserves also increased in Indonesia, 0.4 20 Malaysia, Thailand, and Vietnam. It stabilized during early 2017 in the Philippines after a sharp drop during 0.3 15 2016. Although these reserve levels are below longer- 0.2 10 term averages for these economies, this adjustment is 0.1 5 likely appropriate given their high levels in the past. 0 0 N N S L A N N S L A N N S L A N N S L A CH ID MY PH TH CH ID MY PH TH CH ID MY PH TH CH ID MY PH TH JJReserves to M2, lhs JJReserves to short-term debt, rhs JJReserves to external financing needs, rhs JJReserves in months of imports Recent developments in the Pacific Island QQLong-term average Sources: Haver Analytics; CEIC; IMF International Financial Statistics; World Bank staff estimates. Countries Note: The long-term average denotes the 10-year average. Latest values generally refer to end-Q2 2017, except for short-term debt, where they refer to end-Q1 2016, and for external financing needs, where Most small Pacific Island Countries (PICs) they refer to expected 2017 values. External financing needs are defined as repayments on short- and long-term external debt net of the current account balance. lhs = left-hand side; M2 = broad money supply; rhs = right-hand side. experienced moderate GDP growth but remain highly vulnerable to external shocks. GDP growth rates were in the range of 2.5 to 4.0 percent in 2016–17 in most of the PICs, supported by public investment projects, fishing, agriculture, and tourism activities. Due to their small size, remoteness, and dispersion, the PICs remain vulnerable to shocks from extreme weather events, changes in donor financing and terms of trade, and the ebb and flow of construction on infrastructure projects, which can cause large swings in GDP growth. For example, GDP growth in Samoa fell to 3 percent during the first three quarters of FY2017 from 7.1 percent in FY2016, in part due to work on major construction projects winding down.7 Spending on construction to rebuild from Tropical Cyclone Pam boosted Vanuatu’s GDP growth rate to 4.0 percent in 2016, and the recovery of tourism and agriculture, along with continued reconstruction spending, are expected to support acceleration of growth to 4.7 percent in 2017. And Nauru’s GDP growth rate jumped to around 10 percent in FY2016 from 2.8 percent in FY2015, partly due to a recovery in exports after seaport repairs, but then is estimated to have slowed to around 4 percent in FY2017 as phosphate exports fell and activity associated with Australia’s Regional Processing Centre for asylum seekers moderated. Licensing fees for regional fishing continued to provide large income flows to several PICs. The introduction of the “vessel-day scheme” (a regional agreement that establishes the minimum price of a vessel day and limits the total number of vessel days sold) has substantially increased fisheries incomes for the governments of Kiribati, the Marshall Islands, the Federated States of Micronesia, Nauru, and Tuvalu, and enabled them to boost the value of their savings funds. In 2016, income from this scheme reached 53.2 percent of Tuvalu’s GDP, 68.1 percent of Kiribati’s GDP, and around 19 percent of the Federated States of Micronesia’s GDP. Kiribati’s cash reserves exceed its short-term stabilization needs, and the authorities are devoting funds to finance infrastructure investments in the outer islands and to improve connectivity and public service delivery for these populations. 7 The fiscal year in Samoa runs from July 1 through June 30. 20 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT Poverty rates have continued to fall across most of the EAP region Economic growth has contributed to the region’s success in reducing poverty. Developing EAP maintains its record of successful poverty reduction. In 2016, the share of EAP region’s population living in extreme poverty (below the international poverty line of US$1.90 a day in 2011 purchasing power parity [PPP] terms) fell to an estimated 2.2 percent, or, excluding China, to an estimated 5.2 percent (Figure I.A.27). Projections indicate that some of the region’s larger countries (for example, China and Vietnam) have already been successful in eliminating extreme poverty (that is, brought it down to 3 percent or lower), implying a moderation in the pace of poverty reduction (Box I.A.4). The share of the region’s population living in moderate poverty (below the US$3.10-a-day line in 2011 PPP terms) also fell, from 14.4 percent in 2014 to an estimated 10.9 percent in 2016. Internationally comparable poverty estimates for Myanmar are now available for the first time; household survey data indicate that poverty has declined over a decade of reforms, though relatively lower growth in agriculture implied that poverty reduction in rural areas has been more sluggish than that in urban areas (Box I.A.3). In Timor-Leste, private consumption growth—a key indicator related to the pace of poverty reduction—is forecast to be lower in 2017 than in previous years. While poverty in the EAP region has declined in the last decade, countries are not completely immune to shocks and risks, as recent household surveys have shown increased poverty rates in Mongolia and urban areas of Fiji. International poverty rates, measured at the US$1.90-a-day (2011 PPP) line, remain over 10 percent in Lao PDR and several Pacific Island Countries. Figure I.A.27. The prevalence of poverty has continued to decline across the region Poverty rate (%), number of poor (size of bubble, million), for US$1.90 a day (2011 PPP) and US$3.10 a day (2011 PPP) poverty lines 35 30 179 174 167 25 158 478 432 142 135 20 318 15 288 248 221 10 56 61 163 46 41 139 36 5 34 71 61 51 45 0 2011 2012 2013 2014 2015 2016 QQEAP: US$1.90 a day QQEAP excl. China: US$1.90 a day QQEAP: US$3.10 a day QQEAP excl. China: US$3.10 a day Sources: World Bank East Asia and Pacific Team for Statistical Development; PovCalNet. Note: The most recent household survey used for actual estimates vary from 2006 in Kiribati to 2016 in Indonesia and Mongolia. Estimates prior to 2016 are (a) derived directly from household survey data; (b) China 2013 is a survey break and data are not comparable with previous years; (c) interpolated between existing surveys; or (d) extrapolated based on per capita GDP growth and historical estimates of the growth elasticity of poverty (GEP), but China, Papua New Guinea, and Pacific Island Countries based on neutral growth distribution. For 2016 onward, estimates are projected based on projected per capita GDP growth and the GEP, and are hence preliminary and subject to revision. In China, data through 2012 are not comparable with those for subsequent years, owing to a change in the survey methodology that acted to lower reported poverty, and may account for nearly half of the reported decrease in the poverty headcount between 2012 and 2013. In late 2012, separate urban and rural household surveys were replaced with a single national household survey, which uses stratified, multistage sampling methods. There were significant changes in the collection of information from migrants (now treated as part of the urban population when measuring aggregate disposable income), and the treatment of net taxes and transfers in rural areas; and rents from home ownership are now imputed. This latter factor in particular may have had a substantial effect on reported poverty. I.A. Recent Developments 21 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Box I.A.3. Trends in poverty, household welfare and inequality in Myanmar1 The Ministry of Planning and Finance of the Government of Myanmar and the World Bank released their first joint assessment of poverty in August 2017. This report fills a pressing information gap on how the people of Myanmar have fared during a period of reform and transition. The last poverty assessment conducted in Myanmar was released in 2011, and showed multiple dimensions of change between 2004–05 and 2009–10.2 Beginning in 2011, Myanmar launched major political and economic reforms, including the removal of constraints on commerce, trade and private enterprises. Key economic reforms have included the unification of the exchange rate, the removal of a host of import and export restrictions, and new legislation that provides greater autonomy for the central bank, and increased transparency including the publication of the government budget.3 Households in Myanmar have seen substantial improvement in their wellbeing over the last decade. Poverty declined over the decade between 2005 and 2015, the latter part of which was a period of substantial reforms. The figures below present estimates of the decline in poverty over time using two methods: the first produced in the Integrated Household Living Conditions Assessment (IHLCA) reports by the Ministry of National Planning and Economic Development and development partners (MNPED et al, 2007) and the second produced by the World Bank (World Bank, 2014).4 Regardless of the method used, Myanmar has seen substantial poverty reduction over the last decade using nationally benchmarked measures of poverty. Poverty declined from 32.1 percent in 2004–05 to 25.6 percent in 2009/10 and 19.4 percent in 2015 using the method produced in the IHLCA reports. A decline of a similar magnitude was registered using the World Bank’s revised estimate: poverty went down from 44.5 percent in 2004 to 37.5 percent in 2009–10 and 26.1 percent in 2015. These improvements in well-being are also reflected in other measures of welfare. Average household expenditures have increased by 15 percent over the decade, or by 1.4 percent per year, using the IHLCA reports’ welfare aggregate. Other indicators of living standards, such as the ownership of motorcycles and televisions, have improved over time. For example, motorcycle ownership increased from just under 10 percent of households to a quarter of households in 2009–10, 39 percent in 2014 and over 42 percent of households in 2015. Urban areas have seen faster growth in household welfare, and a sharper decline in poverty in percentage point terms. Both rural and urban poverty have declined, with urban poverty falling from (continued) 1 Prepared by Reena Badiani-Magnusson. 2 Fiscal year ending on March 31. 3 For details see, World Bank (2015). 4 Both methods are based on a national definition as opposed to international definitions of poverty, and use a cost of basic minimum needs approach to set their poverty lines. Although a handful of technical choices differentiate the two methods, only a few have substantial explanatory power in explaining the differences in the poverty estimates produced. The first important difference reflects the base year for anchoring the standard of living and definition of poverty. The second difference reflects methodological choices, in particular, how household consumption was translated into individual consumption using adult equivalence scales. Due to the number of people in Myanmar living near the poverty line, small changes in assumptions can lead to large changes in poverty estimates. 22 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT (Box I.A.3 continued) 34.6 percent in 2009–10 to 19.2 percent in 2015, and rural poverty falling from 38.5 percent to 28.8 percent over the same period. The same patterns are seen using the IHLCA reports’ welfare aggregate. The more rapid decline in urban, relative to rural, poverty is mirrored in sectoral growth figures, which show a more rapid rate of growth in manufacturing and services than in the agricultural sector over the same period (World Bank, 2016). Rising welfare in urban areas has been accompanied by an expansion in asset ownership, which is strongly associated with well-being in Myanmar. Valuable assets are mostly concentrated among richer households in urban areas or in the top expenditure quintile. An increase in asset ownership over this time frame is likely a reflection of both a deepening of markets as well as of rising consumer purchasing power. Figure BI.A.3.1. Trends in national poverty estimates Figure BI.A.3.2. Trends in poverty in urban and rural areas Headcount poverty rate, percent Headcount poverty rate, percent 50 50 45.3 44.5 45 45 38.5 40 37.5 40 42.1 28.8 35 35 34.6 30 32.1 26.1 30 25 25 25.6 19.2 20 20 15 19.4 15 10 10 2004–05 2009–10 2015 2004–05 2009–10 2015 ▬▬GoM et al (2017), based in 2004–05 living conditions ▬▬World Bank (2014) - urban ▬▬World Bank (2014) - rural ▬▬World Bank (2014), based in 2009–10 living conditions Source: World Bank staff estimates. Poverty estimates were produced in collaboration with the Source: World Bank staff estimates. Poverty estimates were produced in collaboration with the Ministry of Planning and Finance. Ministry of Planning and Finance. The faster urban growth has contributed to an increase in inequality in Myanmar. Most measures of inequality have risen over the reform period, albeit from a relatively low base. Households at the top 90th percentile have seen faster consumption growth than the bottom 10th and the median household. The share of total expenditures going to the bottom 20 percent and to the bottom 40 percent has declined since 2009–10. The Gini coefficient of inequality is estimated to be 0.32 in 2015. The rise in inequality is noteworthy but unsurprising, as individuals with better education and more capital to invest benefitted more from the early liberalizations and reforms. While living standards in rural areas have seen substantial improvements, the changes have been more limited than those seen in Myanmar’s cities and towns. The rise in inequality replicates the experience of reform periods seen in other countries in the region and elsewhere. While current inequality levels in Myanmar do not stand out from a regional or global perspective, it will be important to monitor reform efforts to ensure that they result in growth that has the potential to reach the entire population. Supporting stronger growth in Myanmar’s farms and villages will be especially vital, both for reducing poverty and for keeping inequality in check. (continued) I.A. Recent Developments 23 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.A.3 continued) Despite improvements in living conditions, there are many individuals whose consumption patterns place them just above the poverty line. Individuals are considered to be near-poor or vulnerable to poverty if there is a non-negligible chance that they could fall into poverty. This is captured by looking at the population that lies within 20 percent of the poverty line. Although the fraction of poor and near-poor has declined over time, from 61.2 percent in 2004–05 to 54.7 percent in 2009–10 using the World Bank (2014) definition, 40.1 percent of the population continued to live under the near poor line in 2015. Thus, the bottom 40 percent of Myanmar’s population continues to be either poor or very vulnerable to falling into poverty. Moreover, beyond facing a substantial risk of absolute poverty, this group has limited access to basic services such as electricity, health care, and improved water and sanitation. 24 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT Box I.A.4. Has inequality in China peaked?1 China’s unprecedented success in reducing poverty since the early 1980s has coincided with possibly the most rapid growth in income inequality in the world. Between 1981 and 2013, China’s poverty rate declined from 88.3 percent to a 1.9 percent.2 At the same time, income inequality rose considerably and at a very fast pace. World Development Indicators (using tabulated income and consumption data from official Chinese sources) show that the Gini coefficient for China went from below 0.30 to 0.43 in 2010, reaching the inequality levels of countries like Russia and Turkey, but lower than in high-inequality developing countries such as Brazil, Mexico, and South Africa. Consequently, it has been claimed that although China is not the most unequal country among large developing countries, it is the one with the largest increase in inequality during this time, and that its inequality has surpassed a threshold based on country peers and income levels (Knight 2014; Xie and Zhou 2014). Given China’s size, its poverty and inequality trends have global implications. The extraordinary economic growth of China since the early 1980s has driven a reduction in worldwide poverty of historic proportions. Given the sheer size of the country, this fast poverty reduction meant that 790 million people moved out of poverty in this period, representing three-quarters of global poverty reduction. Global inequality has also declined thanks to the rise in average incomes of large emerging economies like China. According to Lakner and Milanovic (2013), global inequality, as measured by the Gini coefficient, declined from 0.722 in 1988 to 0.705 in 2008. This trend is mostly the result of narrowing differences in average incomes between countries, particularly China, which had real income growth of 228 percent, well above the world average of 24.3 percent, during 1988–2008. This reduction of between-country inequality has been accompanied by increases in within-country inequality in China, as well as in several other developed and emerging economies. Consequently, lower inequality within China would be good news both for the country and for the world by contributing to lower global inequality.3 There is growing consensus that income inequality in China seems to have peaked toward the end of the last decade. A turnaround of income inequality measured by the Gini coefficient was observed toward the turn of the last decade by a number of data sources. Official figures have recorded this decline. Estimates of the Gini coefficient (for income) by China’s National Bureau of Statistics show a rise from 0.473 in 2004 to 0.481 in 2008 and then a decline to 0.462 in 2015 (Figure BI.A.4.1). Since official microdata used by China’s National Bureau of Statistics are not publicly available, researchers have relied on other sources of data (such as tabulated data, macroeconomic aggregates, and academic surveys) to investigate these trends. For instance, Kanbur, Wang, and Zhang (2017), using six academic surveys from two different (continued) 1 Prepared by Samuel Freije-Rodriguez. 2 These figures are World Bank estimates using tabulated data of income and consumption in China, and adopting the global poverty line of US$1.90 at 2011 purchasing power parity (PPP) exchange rates. Qualitatively similar numbers are attained from the official poverty line of 2,300 yuan (at 2010 prices). 3 The net effect on global inequality of between- and within-country inequality is an empirical matter. For the period 1980 to 2010, there is consensus among economists (see, for example, Lakner and Milanovic [2013]) and noneconomists (see, for example, Hung and Kucinskas [2011]), that the between-country effect has predominated and driven global inequality down, despite growing within-country inequality. I.A. Recent Developments 25 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.A.4 continued) institutions spanning 1995 to 2015, report that the Figure BI.A.4.1. Recent evolution of income inequality Gini coefficient (for income) rose from 0.435 in in China Gini coefficient 1995 to 0.533 in 2010, before declining to 0.495 in 0.495 2014.4 World Bank staff, using 10 surveys from four 0.490 0.485 academic institutions spanning 2002–13 find that 0.480 all surveys show a declining Gini coefficient after 0.475 0.470 2010, whereas surveys before 2010 show a rising 0.465 trend in the Gini.5 0.460 0.455 0.450 This reversal in inequality is confirmed by 0.445 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 other measures of inequality. Other indicators of Source: China National Bureau of Statistics. inequality, such as the generalized entropy family, are more sensitive to trends in the extremes of the income distribution (that is, the very rich or the very poor).6 Kanbur, Wang, and Zhang (2017), using provincial average consumption data, find that generalized entropy rose from 0.16 in 1978 to 0.229 in 2005, and then declined to 0.172 in 2014. The shares of total income ascribed to specific population groups, such as the top 1 percent of the population or the bottom 50 percent, are easier to understand and have also been analyzed. Piketty, Yang, and Zucman (2017) tabulate income, tax records, and national accounts data, and document that the income share of the top 1 percent in China went from 6.3 percent of national income in 1978, to a peak of 15.6 percent in 2009, and has declined since to 14.0 percent in 2015. The income share of the bottom 50 percent, in contrast, declined from 27 percent in 1978 to14 percent in 2010 and has since remained slightly below the 15 percent mark.7 Most sources identify a closing of the income gap between rural and urban areas as the main reason behind the inequality turnaround. Again, official data report a narrowing of the rural-urban income gap. The rural-urban ratio of per capita annual income decreased from 0.50 in 2000 to 0.38 in 2008, and then increased to 0.42 in 2012. Similarly, Kanbur, Wang and Zhang (2017) indicate that the share of inequality ascribed to urban-rural differentials goes from 6.81 percent in 1984 to 14.6 percent in 2004, and declines to 8.4 percent in 2014. Piketty, Yang, and Zucman (2017) find that the ratio of urban-to-rural income per adult goes from 2.0 in 1982 to 3.70 in 2009 and stabilizes at around 3.5 between 2011 and 2015. World Bank staff decompose changes in an index of generalized entropy and find that the urban-rural (continued) 4 Data from Kanbur, Yang, and Zhang (2017). 5 Data from Freije et al. (2017). 6 The generalized entropy family is a set of indexes of inequality that rely on analogies between income distribution and information theory. The lower the probability of an event, the higher the information it conveys, and the information of a series of events is the summation of their respective probabilities. If all events have the same probability—which is akin to all individuals having the same share of income—then their information content, that is entropy, is maximal—which is akin to maximal equality. Hence, transformations of measures of entropy can be interpreted as measures of inequality. There are several indexes based on this principle, the most common of which is the mean logarithmic deviation: ∑in 1/n ln y/yi. The generalized entropy family of indexes is often used by researchers due to its decomposability property (not shared by the Gini coefficient), which allows making total inequality the exact sum of inequality between groups plus inequality within groups. 7 Data from Piketty, Yang, and Zucman (2017). 26 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT (Box I.A.4 continued) average income differential—rather than within urban or rural inequality—explains most of the upturn and downturn of income inequality.8 Table BI.A.4.1. Components of per capita household income in China Old separate surveys New integrated surveys 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Urban percapita Urban per capita annual income disposable income Total 11,320.8 12,719.2 14,908.6 17,067.8 18,858.1 21,033.4 23,979.2 26,959.0 26,467.0 28,843.9 31,194.8 wages and 7,797.5 8,767.0 10,234.8 11,299.0 12,382.1 13,707.7 15,411.9 17,335.6 16,617.4 17,936.8 19,337.0 salaries household 679.6 809.6 940.7 1,453.6 1,528.7 1,713.5 2,209.7 2,548.3 2,975.3 3,279.0 3,476.1 operations properties 192.9 244.0 348.5 387.0 431.8 520.3 649.0 707.0 2,551.5 2,812.1 3,041.9 transfers 2,650.7 2,898.7 3,384.6 3,928.2 4,515.5 5,091.9 5,708.6 6,368.1 4,322.8 4,815.9 5,339.7 Rural per capita Rural per capita annual income disposable income Total 4,631.2 5,028.1 5,791.1 6,700.7 7,115.6 8,119.5 9,833.1 10,990.7 9,429.6 10,488.9 11,421.7 wages and 1,174.5 1,374.8 1,596.2 1,853.7 2,061.3 2,431.1 2,963.4 3,447.5 3,625.5 4,152.2 4,600.3 salaries household 3,164.4 3,310.0 3,776.7 4,302.1 4,404.0 4,937.5 5,939.8 6,461.0 3,934.9 4,237.4 4,503.6 operations properties 88.5 100.5 128.2 148.1 167.2 202.3 228.6 249.5 194.7 222.1 251.5 transfers 203.8 239.8 290.0 396.8 483.1 548.7 701.4 833.2 1,647.5 1,877.2 2,066.3 rural-to-urban ratios: income (total 0.41 0.40 0.39 0.39 0.38 0.39 0.41 0.41 0.36 0.36 0.37 or disposable) wages 0.15 0.16 0.16 0.16 0.17 0.18 0.19 0.20 0.22 0.23 0.24 operations 4.66 4.09 4.01 2.96 2.88 2.88 2.69 2.54 1.32 1.29 1.30 Source: China Statistical Yearbook, several years. When looking at sources of income, wages and incomes from businesses and farms have played an important role in explaining changes in inequality over the last decade. Wages usually represent the largest income component for most people and, consequently, they also represent a large component of income inequality. Over time, however, their impact on total inequality depends on how wage inequality evolves vis-à-vis inequality in other sources of income. According to Kanbur, Wang, and Zhang (2017), the evolution of wage income represents the largest component of changes in inequality between 1995 and 2010. Since 2010, however, wages have contributed to the decline in inequality but incomes from businesses and farms (“operational incomes”) have become relatively more important in explaining this decline. This implies that not only wages, but also operational incomes, have become less unequal over time. Official data about components of income in urban and rural households seem to corroborate these (continued) 8 Freije et al. (2017) using a decomposition of income inequality changes into changes due to inequality within groups, and inequality between groups and for data using the China Household Income Project (CHIP) data for years 2002, 2007, and 2013. I.A. Recent Developments 27 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.A.4 continued) trends. The rural-urban wage ratio increased from 0.15 to 0.20 between 2005 and 2012, while the rural- urban ratio of operational income declined from 4.66 to 2.54 during the same period (Table BI.A.4.1).9 Rural wages have narrowed their gap with urban wages (although they still remain much lower), while more urban households now have business returns (which was a predominant source, in terms of farm incomes, among rural households). The deeper causes of this turnaround in inequality, however, are still unclear and need further study. Some hypotheses have been advanced. It has been argued that China has reached the “Lewis turning point,” namely the situation in which, due to rural-urban migration and modernization of agriculture, rural earnings—either wages or farm incomes —start to grow and converge toward earnings in urban areas. Others indicate minimum wage regulations, which have been in place since 2004 but have risen and are now better enforced, may be playing a role in reducing wage inequality. Yet others believe that, despite rapid expansion of the private sector in recent decades, there remains a large presence of the public sector in the Chinese economy. This aspect may put a cap on the growth of certain private sector activities, involve some forms of wage restraint in some economic activities, and result in large capital returns still going to the state rather than to the private sector. Income inequality is also connected to the distribution of productive assets and wealth, but these have been less studied due to limited data. Background work for a forthcoming World Bank report on inclusive growth in East Asia Pacific (Ruggeri Laderchi et al. 2017) collected and analyzed data from sources such as investment banking reports and stock exchanges. It shows that, as is the case in most countries, wealth inequality in China is likely to be more extreme than income inequality, but that it is comparable to, and may in fact be less extreme than, in other similar East Asian countries (Cunningham 2017; Cunningham, Huertas, and Buhler 2016; Ruggeri Laderchi et al. 2017). There are several unanswered questions about the recent decline in inequality in China. Three questions seem particularly important. First, there is a need to collect and analyze more updated data to identify whether income inequality continues to fall, levels off at current levels, or regains its previous upward trend. Second, analyses are needed of the factors that have played a role in this decline of income inequality and of the extent to which these can be expected to continue in the future. Finally, there is the question of what public policy in China should do about income inequality. There are few studies about the redistributive impact of the tax-and-transfer system in China, and the ones that exist tend to show that it has limited distributive impact, so that income inequality remains more or less the same before and after fiscal redistribution.10 This policy issue is of central importance as China advances toward its goal of becoming a modern and more prosperous society. 9 Data for 2013–15, although not strictly comparable because of use of different surveys and reference to different income concepts (that is, disposable income rather than annual income), show the same trend. 10 One study about the redistributive impact of the fiscal system in China is Solt (2016), which uses a global database of pre- and post-taxes income inequality indicators. Another study, which uses different methods but finds similar results, is by Cevic and Correa-Caro (2015). 28 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT I.B. Outlook and Risks The economic outlook for the region remains positive and will benefit from an improved external environment as well as strong domestic demand. The growth of regional GDP excluding China is projected to accelerate to 5.2 percent in 2018. China’s GDP growth is expected to decline in 2018 and 2019, although it will remain higher than most countries in the region. Poverty is projected to continue its long-term decline. Rising incomes and improved social protection programs will continue to contribute to poverty reduction. Despite the improved near-term outlook, risks arise from long-term challenges, including financial sector vulnerabilities and large fiscal imbalances that affect many countries in the region. The possible escalation of geopolitical tensions in the region could have serious economic consequences. Growth is expected to remain robust in the region Global growth and commodity prices are projected to recover, albeit slowly, while global financial conditions tighten gradually ( Box I.B.1). Global growth is projected to increase to 2.9 percent in 2017 and 2018, supported by improved performance in major commodity exporters and modest, investment-led recovery in advanced economies. World trade flows are also expected to accelerate—at a projected pace of 4.2 percent in 2017, which would be the fastest rate since 2010. Global financing conditions are expected to tighten gradually. The likely pace of tightening by monetary authorities in the advanced countries over the near term now appears to be more gradual than was anticipated in the April 2017 East Asia and Pacific Economic Update, reflecting the sluggish rise in inflation and the lower likelihood of fiscal stimulus in the near term in the United States. These conditions mean the outlook for developing EAP remains positive. With China’s growth stronger than previously expected, developing EAP as a whole is expected to grow at 6.4 percent in 2017, a modest improvement over 2016 as well as relative to projections in the April 2017 East Asia and Pacific Economic Update (Table I.B.1). Excluding China, the region is forecast to grow at around 5 percent during 2017–19, accelerating slightly over the period. The growth outlook remains more favorable than for other regions, except for South Asia. While the largest contribution to growth is expected to continue to come from private consumption, the contribution of investment—public and private—is expected to increase during 2017–19. China’s growth moderation and gradual rebalancing are expected to continue despite the uptick in 2017. With more rapid growth in the first half of the year, the Chinese economy is expected to grow at 6.7 percent in 2017. Growth is projected to moderate to around 6.4 percent in 2018–19 as the economy rebalances away from investment and external demand toward domestic consumption. This expectation also assumes that the authorities continue to implement measures aimed at bringing the growth of debt under control to reduce macroeconomic risks and imbalances. In most of the large ASEAN economies in the region, growth is projected to increase in 2017 and 2018. Malaysia is expected to grow more rapidly, reflecting improved confidence, higher investment, and the recovery in world trade. Thailand’s forecast has also been revised upward due to stronger recovery in merchandise exports I.B. Outlook and Risks 29 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Table I.B.1. East Asia and Pacific: GDP growth projections Percent change from a year earlier, unless otherwise noted Change from April 2017a forecast (percentage points) 2015 2016 2017 2018 2019 2016 2017 2018 Developing EAP 6.5 6.3 6.4 6.2 6.1 -0.1 0.2 0.1 China 6.9 6.7 6.7 6.4 6.3 0.0 0.2 0.1 Developing EAP excl. China 4.9 4.9 5.1 5.2 5.2 0.0 0.1 0.1 Developing ASEAN (ASEAN-5) 4.8 4.9 5.1 5.2 5.2 0.0 0.1 0.1 Indonesia 4.9 5.0 5.1 5.3 5.3 0.0 -0.1 0.0 Malaysia 5.0 4.2 5.2 5.0 4.8 0.0 0.9 0.5 Philippines 6.1 6.9 6.6 6.7 6.7 0.1 -0.3 -0.2 Thailand 2.9 3.2 3.5 3.6 3.5 0.0 0.3 0.3 Vietnam 6.7 6.2 6.3 6.4 6.4 0.0 0.0 0.0 Cambodia 7.0 7.0 6.8 6.9 6.7 0.1 -0.1 0.0 Lao PDR 7.4 7.0 6.7 6.6 6.9 0.0 -0.3 -0.2 Myanmar 7.0 5.9 6.4 6.7 6.9 -0.6 -0.5 -0.5 Mongolia 2.2 1.4 2.8 3.1 7.3 0.4 3.0 1.2 Fiji 3.6 0.4 3.8 3.5 3.3 -1.6 0.1 0.0 Papua New Guinea 8.0 2.4 2.1 2.5 2.4 0.0 -0.9 -0.7 Solomon Islands 2.5 3.3 3.0 3.0 2.8 0.3 -0.3 0.0 Timor-Lesteb 4.0 5.7 2.4 4.2 5.0 0.6 -1.6 -0.8 Assumptions about the external environment:c World 2.7 2.4 2.9 2.9 2.9 0.1 0.2 0.0 Advanced economies 2.2 1.6 2.1 1.9 1.7 -0.1 0.3 0.1 Emerging and developing economies 3.6 3.7 4.1 4.5 4.6 0.3 -0.1 -0.1 Crude oil (spot, US$/barrel) 51 43 53 56 59 0.0 -2.0 -4.0 Nonenergy commodities (index, 2010 = 100) 82 80 84 85 85 0.0 1.0 1.0 Food (index, 2010 = 100) 91 92 92 93 94 0.0 -1.0 -1.0 Sources: World Bank data and staff estimates. Note: a. World Bank East Asia and Pacific Economic Update, April 2017 (World Bank 2017a). b. Nonoil GDP. c. Global growth forecasts represent preliminary working assumptions. Commodity price forecast drawn from the World Bank Commodity Markets Outlook, January 2017 (World Bank 2017). Myanmar data are fiscal year growth rates (2017 = FY2017/18). Changes from April 2017 are calculated with one decimal points precision and rounded to one decimal point. and tourism. Gradual increases in growth are foreseen for Indonesia and Vietnam in 2017 and 2018. In Indonesia, private consumption is projected to strengthen in line with gains in real wages. And, in Vietnam, rebounding agricultural production and strong export-oriented manufacturing will contribute to higher growth. Although the Philippines continues to grow most rapidly among these countries (6.6 percent in 2017 compared to an average of 5.1 percent for this group), it is expected that growth in 2017 and 2018 will be lower than projected in April. The delay in the planned government infrastructure program has contributed to slower growth in investment spending, thus softening the growth prospect for the year. The outlook for the smaller regional economies is more mixed. Several, including Mongolia, Fiji, and Myanmar, are projected to grow more rapidly in 2017–18. With the introduction of a macroeconomic stabilization program and higher coal exports, Mongolia’s economy is now forecast to grow by 2.8 percent in 2017—revised upward from the April forecast of a 0.2 percent contraction—and grow even faster in 2018. The forecast for Fiji is also revised upward, albeit less dramatically, and GDP is now projected to grow by 3.8 percent in 2017, supported by 30 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT Box I.B.1. Global outlook and risks Global growth is projected to strengthen to 2.9 percent in 2017 from a postcrisis low of 2.4 percent in 2016 and remain around that rate in 2018–19(Figure BI.B.1.1). In advanced economies, a modest investment-led recovery is underway, with growth picking up to 2.1 percent in 2017, from 1.6 percent in 2016, before moderating to 1.8 percent on average in 2018–19. Figure BI.B.1.1. Global GDP growth Figure BI.B.1.2. Regional GDP growth Percent Percent 9 10 8 7 8 6 5 6 4 3 4 2 1 0 2 -1 -2 0 -3 -4 -2 20 16 20 16 20 16 20 16 20 16 20 16 2015 2015 2015 2015 2015 2015 f f f f f f 2017f 2017f 2017f 2017f 2017f 2017f 2018f 2018f 2018f 2018f 2018f 2018f 19 19 19 19 19 19 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017f 2018f 2019f 20 20 20 20 20 20 JJWorld ▬▬Advanced economies ▬▬Emerging and developing economies JJEAP JJSAS JJECA JJLAC JJMENA JJSSA Source: World Bank. Source: World Bank staff estimates. Note: Forecasts for 2017–19 reflect preliminary working assumptions to be finalized and published Notes: Lines denote long-run precrisis (1990–2008) average growth. Forecasts for 2017–19 in the January 2018 issue of the World Bank Global Economic Prospects report. reflect preliminary working assumptions to be finalized and published in the January 2018 issue of the World Bank Global Economic Prospects report. In emerging market and developing economies (EMDEs), growth is anticipated to recover to 4.1 percent in 2017, from a postcrisis low of 3.6 percent on average in 2016–17  (Figure BI.B.1.2). Growth in EMDEs is projected to further strengthen to 4.6 percent on average in 2018–19, as obstacles to growth in commodity exporters diminish, while activity in commodity importers remains robust. Following near-stagnation over the last two years, growth in commodity exporters is projected to rise to 1.7 percent in 2017 and 2.6 percent in 2018 in a broad-based recovery. However, lingering fiscal and external adjustment needs continue to dampen growth prospects in a number of countries. Longer-than-expected adjustment to low commodity prices and, to a lesser degree, lower oil price projections, have resulted in forecast downgrades for a number of exporters. Growth continues to be robust among commodity importers. Windfalls from the recent decline in commodity prices are waning, but accommodative policies are supporting domestic demand, and a recovery in global trade is fueling export growth. The forecast for growth in commodity importers remains stable, at an average of 5.7 percent during 2017–19. Global trends are supportive. Global trade is expected to grow by 4.2 percent in 2017, its fastest pace since 2010. This represents a significant upgrade from previous projections. Nevertheless, slower trade liberalization, flagging value chain integration, and elevated trade policy uncertainty continue to weigh on the medium-term outlook. Commodity prices are expected to recover at a moderate pace, reflecting (continued) I.B. Outlook and Risks 31 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.B.1 continued) the prospect of increased U.S. shale oil supplies and Figure BI.B.1.3. World commodity prices forecast Nominal U.S. dollars, 2010 = 100 evidence of sharply falling production costs (Figure 130 BI.B.1.3). Global financing conditions are expected to tighten gradually, benefiting from improving 110 market expectations about growth prospects. 90 Although there are risks to the near-term 70 global economic outlook, prospects are more positive than in the recent past. On the one 50 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 hand, stronger-than-expected growth in the largest ▬▬Energy ▬▬Agriculture ▬▬Metals and minerals advanced economies and the EMDEs—reflecting, Source: World Bank. for instance, fiscal stimulus in the United States, a more prolonged rebound in the Euro Area, or a sharper recovery in large commodity exporters—could have substantial positive spillovers, including on developing EAP. On the other hand, an abrupt tightening of global financing conditions—triggered, for example, by faster-than-expected balance sheet normalization in major central banks—or an escalation of trade restrictions or geopolitical tensions could derail the recovery. Additional downward pressure on oil prices could set back growth in oil exporters. reconstruction from Cyclone Winston, although this pace will likely slow during 2018–19. The projected 2017 and 2018 growth rates for Myanmar are revised downward by 0.5 percentage points from earlier forecasts. Businesses in Myanmar appear to have delayed investments as they wait for the government’s economic agenda to become clearer. These projections do not factor in any longer-term impact of the ongoing insecurity in Rakhine State, which if it persists could have significant adverse effects by slowing foreign investment. Forecasts for Cambodia and Lao PDR have also been revised downward, although both, along with Myanmar, will still be among the fastest growing countries in the region. The 2017 forecast for Timor-Leste has been revised downward by 1.6 percentage points (to 2.4 percent) in response to volatility in the pace of government spending caused by elections and the change of government. Growth is expected to accelerate to 4.2 percent in 2018—somewhat lower than the April projection due to uncertainty about the economic program that the incoming government will present. The 2017 forecast for the Solomon Islands has been reduced to 3.0 percent due to lower-than-expected log production and to public financial management problems that have resulted in domestic arrears and are impeding private sector activity. Most of the small Pacific Island Countries (PICs) continue to have a positive outlook. Expanding tourism, low world commodity prices, high levels of revenue from fishing fees, and rising construction activity support moderate GDP growth rates in most countries. GDP growth in Tonga is projected to pick up to around 3.4 percent in FY2018, driven by construction, a rebound in agriculture, and expanding remittances, as well as growth in the tourism sector. In Kiribati, economic growth is expected to gradually moderate toward its potential, around 2 percent per year. Vanuatu’s GDP is expected to grow by 4.5 percent in 2017, up from an estimated 4.0 percent in 2016, supported by implementation of public investment projects. Construction activity should also boost GDP growth rates in Palau and Tuvalu. In contrast, the exit of a major manufacturer of automotive wire harnesses from Samoa is forecast to subtract around 1 percentage point from GDP growth in FY2018, which is projected to be between 1 and 2 percent. 32 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT Poverty is projected to continue to fall—the pace of reduction across countries will depend on successful implementation of policies to make growth more inclusive Poverty in EAP, already at low levels compared to other regions, is expected to continue falling  (Table I.B.2). Poverty rates in the region overall and in most EAP countries are expected to continue falling. Recent evidence on the pace of poverty reduction across countries has been mixed. For example, in the Philippines, the latest Family Income and Expenditure Survey shows that poverty fell appreciably faster between 2012 and 2015 than during 2009–12; by contrast, in Indonesia, while poverty has continued to fall, the pace of reduction during the last year was slower than the rapid progress achieved during 2006–10. As most of the extreme poor in EAP continue to live in the larger countries—Indonesia, China, the Philippines, and Vietnam—the pace of poverty reduction in future years will depend crucially on their degree of success in tackling the “last mile” challenge of eliminating extreme poverty. Poverty is concentrated among ethnic minorities in some countries—in Vietnam, for example, ethnic minorities account for 15 percent of the total population but a majority of the extreme poor. These groups should be a key focus of future poverty reduction efforts. China has set the ambitious goal of eliminating extreme poverty during the 13th five-year plan period (2016–20), for which closing the rural-urban income gap by reducing barriers to internal labor mobility and strengthening agriculture will be important. In Indonesia and the Philippines, where income inequality has hampered the pace of poverty reduction, accelerating the pace of poverty reduction will require more attention to tackling its root causes, including inequalities of opportunity (for example, by tackling high child malnutrition rates) and wealth (for example, through making the overall tax system more progressive). Table I.B.2. Poverty will continue to decline in the EAP region For US$1.90-a-day (2011 PPP): estimates and projections Developing EAP Year 2016 2017 2018 2019 Poverty rate (%) 2.2 1.9 1.6 1.5 Number of poor (millions) 45 39 34 30 Developing EAP excl. China Year 2016 2017 2018 2019 Poverty rate (%) 5.2 4.6 4.2 3.7 Number of poor (millions) 34 30 28 25 For US$3.10-a-day (2011 PPP): estimates and projections Developing EAP Year 2016 2017 2018 2019 Poverty rate (%) 10.9 9.7 8.7 7.8 Number of poor (millions) 221 198 179 162 Developing EAP excl. CHINA Year 2016 2017 2018 2019 Poverty rate (%) 20.9 19.8 18.7 17.7 Number of poor (millions) 135 129 124 119 Source: World Bank East Asia and Pacific Poverty Portal. Note: The most recent household income and expenditure surveys vary from 2006 in Kiribati to 2016 in Indonesia and Mongolia. Estimates are extrapolated based on per capita GDP growth and historical estimates of the growth elasticity of poverty. PPP = purchasing power parity. I.B. Outlook and Risks 33 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Social protection programs remain important to safeguard poverty reduction against future shocks and slower growth. They will play a key role in Cambodia, where recent floods have devastated homes and the construction industry is moderating, and in Mongolia, whose economy was hit hard by the commodity price plunge and has yet to fully recover. Sustained progress in poverty reduction in China will rely on sustaining reforms in pensions and the hukou (household registration) system to provide equal access to services. Domestic demand is expected to continue driving growth in the region Private consumption is projected to remain the primary contributor to GDP growth. Its growth accounts for just under half of developing EAP’s growth in 2017 and 2018 (Figure I.B.1). For developing EAP excluding China, private consumption accounts for the majority of regional GDP growth. Private consumption is projected to grow by just under 8 percent per year in real terms in China, and between 5 and 7 percent in the larger ASEAN countries except for Thailand. Among the smaller economies, private consumption growth in Myanmar is expected to exceed 10 percent per year, as rising purchasing power and greater access to markets contribute to rising household wealth. Also notable is Mongolia, where a turnaround in consumption is expected—from a contraction of over 8 percent in 2016 to growth of about the same magnitude by 2019—as the macroeconomic stabilization program proceeds and growth resumes. Figure I.B.1. Domestic demand is projected to remain the primary contributor to growth of regional GDP… Contribution of expenditure components to GDP growth (percentage points) Panel A. Developing EAP Panel B. Developing EAP excluding China 8 6 7 5 6 4 5 4 3 3 2 2 1 1 0 0 -1 -1 2014 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019 JJPrivate consumption JJGross capital formation JJNet exports JJPrivate consumption JJGross capital formation JJNet exports JJGovernment consumption ▬▬GDP JJGovernment consumption ▬▬GDP Source: World Bank staff estimates. Investment spending will also make a significant contribution to the region’s GDP growth. In the Philippines, investment (led by public investment) is projected to grow rapidly in 2017–19 and become the largest contributor to GDP growth in 2018–19 (Figure I.B.2 and Figure I.B.3). Real investment spending is also accelerating in Thailand, albeit more modestly (to 4.1 to 4.2 percent in 2017–18 from 2.8 percent in 2016) as the government implements large infrastructure projects. In contrast, investment growth is slowing in China and Vietnam. Among the smaller economies, Mongolia stands out, with increased FDI into the mining sector contributing to the recovery of investment spending in 2017 and beyond, contrasting with its contraction by 20 to 30 percent per year in 34 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT 2014–15. Work has begun on some transport projects associated with China’s One Belt One Road Initiative, such as the high-speed railway connecting Kunming with Vientiane, which is also contributing to investment spending growth in Southeast Asia. Figure I.B.2. …in most large economies Contribution of expenditure components to GDP growth (percentage points) Panel A. China, Indonesia, and Malaysia Panel B. The Philippines, Thailand, and Vietnam 8 12 7 10 6 8 5 6 4 4 3 2 2 0 1 -2 0 -4 -1 14 15 16 17 18 19 14 15 16 17 18 19 14 15 16 17 18 19 -6 14 015 016 017 018 019 14 015 016 017 018 019 14 015 016 017 018 019 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 2 2 2 2 2 20 2 2 2 2 2 20 2 2 2 2 2 China Indonesia Malaysia Phillippines Thailand Vietnam JJPrivate consumption JJGross capital formation JJNet exports JJPrivate consumption JJGross capital formation JJNet exports JJGovernment consumption ▬▬GDP JJGovernment consumption ▬▬GDP Source: World Bank staff estimates. Source: World Bank staff estimates. Figure I.B.3. …and in the smaller economies Contribution of expenditure components to GDP growth (percentage points) Exports are expected to continue recovering in the 25 region along with the recovery of world trade. Real 20 spending on exports of goods and services is projected 15 to grow rapidly in many countries in the region—by 10 double digits each year in the Philippines and Vietnam, 5 where export-oriented manufacturing is expected to 0 benefit from continued strong growth in China and -5 the economic recovery in advanced countries. Chinese -10 exports are on track to grow by 5.8 percent in 2017, -15 up from 2.7 percent in 2016 and a small decline in 14 15 16 17 18 19 14 15 16 17 18 19 14 15 16 17 18 19 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 Cambodia Lao PDR Mongolia 2015. Exports from Cambodia and Lao PDR are forecast JJPrivate consumption JJGross capital formation JJNet exports to grow by 7.0 and 8.0 percent, respectively, in 2017, JJGovernment consumption ▬▬GDP Source: World Bank staff estimates. and accelerate in 2018 and 2019. New electricity generating capacity is coming on stream in Lao PDR. Net exports are expected to make a stronger contribution to Lao GDP growth as imports fall with the completion of those investment projects (Figure I.B.3). Reflecting their industries’ integration into international supply chains and consequently the high import content of many of their exports, real spending on imports of goods and services is also expected to continue growing rapidly in most EAP countries. This effect is pronounced in the Philippines, Vietnam, and Mongolia. I.B. Outlook and Risks 35 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Continued uncertainty about global economic policies and the escalation of geopolitical tensions could jeopardize growth prospects Rising protectionism and economic nationalism in particular could have a chilling effect on world trade. Recent pronouncements by political leaders in some advanced economies have stoked fears of a retreat from an open, rules-based world economy. Proposals have been floated to introduce discriminatory and restrictive rules of origin into the North American Free Trade Agreement, impose new restrictions on steel and aluminum imports, taxing remittances, and revise business taxation to discourage imports. The likely terms of future access to the U.K. market are becoming cloudier as Brexit negotiations proceed. Some proposed protectionist measures are aimed squarely at EAP countries. More generally, there is a risk that rising economic nationalism will have a chilling effect on world trade, to which EAP countries—especially those specializing in manufactured exports—are disproportionately vulnerable. Effects of new protectionist measures would spread from one country to another through their links in global supply chains. Geopolitical tensions in the region are rising and could escalate into armed conflict. In September, the United Nations passed additional sanctions on the Democratic People’s Republic of Korea in response to its testing of nuclear and missile technologies. Some major powers urge taking tougher measures to stop the country from developing additional nuclear capacity, including potentially military actions. Escalation of these disputes could have serious economic consequences. Because of the region’s central role in global shipping and manufacturing supply chains, escalation of these tensions could disrupt global trade flows and economic activity. The ensuing volatility in global markets would likely hamper EAP countries’ growth prospects. The “flight to safety” in financial markets that often accompanies political crises could cause capital to flow out of EAP countries, put pressure on exchange rates, and raise world interest rates. An increase in insurance costs for ships moving cargo in and out of the region would not be unexpected. Concerns about supply disruptions could lead to a spike in world commodity prices. Financial sector vulnerabilities in many countries could be exacerbated by tightening in global financial markets Private sector indebtedness has grown across much of the region since the global financial crisis. The nonfinancial sector’s borrowing from commercial banks grew to 65 percent of the region’s GDP in 2016 from an average of 52 percent during 2010–15. Both the level of private debt and the increase in debt over time in developing EAP exceed those of other regions (Box I.B.2). Many banking systems in the region face high leverage and deteriorating asset quality. Nonperforming loans have been rising steadily since 2013 in China, Indonesia, and Thailand, among the larger economies. Rapid credit growth together with a sizable stock of problem loans in Vietnam (broadly defined as reported nonperforming loans [NPLs], bad debts of banks sold to the Vietnam Asset Management Company, and other problem loans) heightens concerns about asset quality and related capital impairment risks in the banking sector. Cambodia also saw an increase in the share of nonperforming loans in 2016, although this has declined somewhat in 2017 (Figure 36 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT Box I.B.2. Debt dynamics in developing East Asia and Pacific1 Since the global financial crisis, fiscal positions in emerging market and developing economies (EMDEs) have generally deteriorated while private sector debt levels have risen. During 2007–16, government debt in EMDEs, on average, increased from 47 percent of GDP to 53 percent. The deterioration was broad-based as government debt in 2016 exceeded its 2007 level in 71 percent of EMDEs. Over the same period, fiscal balances in EMDEs worsened, on average, by 6.3 percentage points of GDP. Likewise, private sector debt—including households, nonfinancial corporates, and financial corporates—rose to 112 percent of GDP at the end of 2016 from 84 percent of GDP in 2007. Fiscal positions in developing East Asia and Pacific (EAP) have also worsened, but less than in other regions. On average, developing EAP saw a reversal of fiscal balances from 1.1 percent of GDP in surplus during 2010–15 to a fiscal deficit of 2.7 percent of GDP in 2016 (Figure BI.B.2.1, panel A). The deterioration in fiscal balance was sizable compared to other regions—the second-largest decline after Middle East and North Africa (9.6 percentage points of GDP). Despite this weakening in fiscal stance, deficits in developing EAP remained relatively low, with only the Europe and Central Asia region (2.4 percent of GDP) being lower. By the end of 2016, government debt was 42 percent of GDP in developing EAP, the only region with a decline in debt-to-GDP ratio from the 2010–15 average (Figure BI.B.2.1, panel B). Government debt in other EMDEs was, on average, 55 percent of GDP in 2016. Rapid growth in the region has helped contain the debt level, despite a deterioration of fiscal balances (World Bank 2017a). Figure BI.B.2.1. Fiscal positions by region Panel A. Overall fiscal balance Panel B. Government gross debt Percent of GDP Percent of GDP 4 100 2 0 80 -2 -4 60 -6 -8 -10 40 -12 -14 20 EAP ECA LAC MENA SAR SSA EAP ECA LAC MENA SAR SSA JJ2000–08 JJ2010–15 JJ2016 JJ2000–08 JJ2010–15 JJ2016 Source: Kose et al. 2017. Note: Simple averages. EAP refers to developing EAP. However, indebtedness of the private sector in developing EAP is now much higher than in other regions. In developing EAP, borrowing of the nonfinancial private sector from domestic commercial banks increased, on average, from 52 percent of GDP over 2010–15 to 65 percent of GDP in 2016 (Figure BI.B.2.2, panel A). This ratio varies by country, ranging from around 20 percent of GDP in Myanmar and Papua New (continued) 1 Prepared by Naotaka Sugawara with the guidance from Ekaterine Vashakmadze. I.B. Outlook and Risks 37 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.B.2 continued) Guinea to more than 150 percent of GDP in China. Total private sector debt in developing EAP was, on average, 158 percent of GDP at the end of 2016, which was higher than in other regions by 62 percentage points of GDP (Figure BI.B.2.2, panel B). Figure BI.B.2.2. Private sector debt by region Panel A. Bank credit to the private sector Panel B. Total debt Percent of GDP Percent of GDP 70 200 160 50 120 80 30 40 10 0 2000–08 2010–15 2016 2000–08 2010–15 2016 EAP ECA LAC MENA SAR SSA EAP Other EMDEs JJ2000–08 JJ2010–15 JJ2016 JJGovernment JJFinancial corporates JJNonfinancial corporates JJHouseholds Sources: Institute of International Finance; Kose et al. 2017. Note: Simple averages. EAP refers to developing EAP. Figure BI.B.2.3. Debt dynamics in developing EAP Panel A. Overall fiscal balance Panel B. Government gross debt Percent of GDP Percent of GDP 6 100 4 80 2 0 60 -2 -4 40 -6 -8 20 2000 2002 2004 2006 2008 2010 2012 2014 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016 ▬▬EAP countries ▬▬EAP commodity exporters ▬▬EAP commodity importers ▬▬EAP countries ▬▬EAP commodity exporters ▬▬EAP commodity importers Source: Kose et al. 2017. Note: Simple averages. EAP refers to developing EAP. The year of global recession (2009) is shaded in gray. Commodity exporters in developing EAP are Indonesia, Lao PDR, Malaysia, Mongolia, Myanmar, Papua New Guinea, Timor-Leste, and Tonga (based on the criteria used in World Bank [2017b]). The deterioration of debt dynamics has been more pronounced in commodity-exporting developing EAP countries. In commodity exporters, government debt peaked in 2001 as some countries, such as Myanmar, took on sizable debt. However, their debt-to-GDP ratios declined sharply until the eve of the global financial crisis, in part because of strong growth performance, shrinking fiscal deficits, and debt restructuring efforts in the late 2000s. Since the onset of the crisis, debt levels have increased once again, reaching 45 percent of GDP in 2016 (Figure BI.B.2.3, panel A). The postcrisis difference between commodity exporters and importers is highlighted in the evolution of fiscal balances. Fiscal deficits of more than 3 percent of GDP in 2009 in commodity importers turned into surpluses in 2013 and then reached around (continued) 38 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT (Box I.B.2 continued) 6 percent of GDP in 2014 (Figure BI.B.2.3, panel B). On the contrary, fiscal balances in commodity exporters have worsened year by year since 2010, especially after 2012, partly reflecting the growth slowdown in the aftermath of the commodity price plunge. In 2016, fiscal balances became negative even for commodity importers in the region as a whole. An analysis of past episodes of financial stress suggests that the postcrisis deterioration in fiscal positions during the Asian Financial Crisis was worse and more prolonged than for the global financial crisis in 2009 (Figure BI.B.2.4, panels A and B).2 In the runup to the Asian Financial Crisis, fiscal surplus declined to close to zero on the eve of crisis. Since the onset of the Asian Financial Crisis, fiscal deficits kept worsening and reached around 4 percent of GDP in a year and then remained high over the following two years. However, after the global recession in 2009, deficits shrank from 3 percent of GDP to 1 percent of GDP in two years. Government debt increased by more than 6 percentage points of GDP over three years since the Asian Financial Crisis, while debt levels stabilized over the same period after the global financial crisis in 2009. Figure BI.B.2.4. Fiscal positions around financial stress episodes Panel A. Overall fiscal balance Panel B. Government gross debt Percent of GDP Percent of GDP 2 55 1 50 0 45 -1 40 -2 35 -3 -4 30 t-3 t-2 t-1 t t+1 t+2 t+3 t-3 t-2 t-1 t t+1 t+2 t+3 ▬▬Asian financial crisis ▬▬Global recession (t = 2009) ▬▬Asian financial crisis ▬▬Global recession (t = 2009) Source: Kose et al. 2017. Note: Samples include Indonesia, Malaysia, the Philippines, and Thailand, where crisis episodes are identified in 1997–98 by Laeven and Valencia (2013). Simple averages. Year t refers to the year of onset of financial stress episodes. During past episodes of natural resource price declines, fiscal positions deteriorated significantly in resource-rich EAP but rebounded quickly as prices and resource revenues recovered. Prior to the past episodes of natural resource price drops, fiscal balances improved in most major resource-rich—energy- and metal-exporting—economies in developing EAP (Figure BI.B.2.5, panel A). In a year following these declines, fiscal balances were weakened in all countries except Indonesia. For example, a fiscal surplus in Timor-Leste was slashed by 10 percentage points of GDP from the year of natural resource price plunges. In Papua New Guinea, a surplus turned into a deficit of 3 percent of GDP. Fiscal deficits also increased in Malaysia and Mongolia. However, within three years after the price declines, fiscal balances were restored (continued) 2 Recoveries in investment, credit, and house prices were also weaker after the Asian financial crisis than those after other global recessions (Kose 2017). I.B. Outlook and Risks 39 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.B.2 continued) to or went above their pre-plunge levels. The improvement of fiscal balances was partly driven by a recovery in resource revenues (Figure BI.B.2.5, panel B). Following a decline immediately after the plunges, resource revenues rebounded to the levels prior to past plunges within three years after the decline. Figure BI.B.2.5. Fiscal positions around natural resource price plunges Panel A. Past plunges: Overall fiscal balance Panel B. Past plunges: Resource revenues Percent of GDP Percent of GDP 5 55 15 60 50 0 10 40 45 40 -5 5 20 35 -10 30 0 0 t-3 t-2 t-1 t t+1 t+2 t+3 t-3 t-2 t-1 t t+1 t+2 t+3 ▬▬IDN ▬▬MNG ▬▬MYS ▬▬PNG ▬▬TLS, rhs ▬▬IDN ▬▬MNG ▬▬MYS ▬▬PNG ▬▬TLS, rhs Panel C. Recent plunge: Overall fiscal balance Panel D. Recent plunge: Resource revenues Percent of GDP Percent of GDP 5 50 8 60 40 0 6 55 30 -5 20 4 50 -10 10 0 2 45 -15 -10 -20 -20 0 40 t-3 t-2 t-1 t t+1 t+2 t-3 t-2 t-1 t t+1 t+2 ▬▬IDN ▬▬MNG ▬▬MYS ▬▬PNG ▬▬TLS, rhs ▬▬IDN ▬▬MNG ▬▬MYS ▬▬PNG ▬▬TLS, rhs Sources: ICTD/UNU-WIDER Government Revenue Dataset (July 2017); International Monetary Fund; Kose et al. 2017. Note: Year t refers to the year of natural resource price plunges. For resource revenues, data are for central government in all countries except Mongolia (general government). The worsening of fiscal positions has been substantial and persistent during the 2014 sharp decline in natural resource prices. Unlike past price declines, the most recent natural resource price plunge has been associated with a persistent deterioration in fiscal balances. In most cases, resource-rich developing EAP saw fiscal deficits rising even two years into the plunge, while resource revenues became lower than the pre-plunge levels in all countries (Figure BI.B.2.5, panels C and D). In addition, compared to the earlier price declines, these economies entered the most recent one with weaker fiscal positions. I.B.4). IMF data reveal that the share of nonperforming loans has reached even higher levels in many of the island economies (Table I.B.3). Lending to the nonfinancial sector has grown in China. Fiscal stimulus after the global financial crisis and again in 2015 sparked rapid growth in credit, and the stock reached 236 percent of GDP by July 2017 (Box I.C.1), an exceptionally high for a midlle-income country. Credit has become more diversified, in addition to growing 40 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT in size, as new financial products are introduced outside the formal banking sector—and outside the scope of traditional prudential regulations (Box I.B.3). Figure I.B.4. Nonperforming loans are steadily increasing Figure I.B.5. Debt service ratio of private nonfinancial across the region sector Bank nonperforming loans as a percentage of total gross loans (percent) Percent of income 3.5 25 3.0 20 2.5 15 2.0 10 1.5 5 1.0 0.5 0 -12 -13 -13 -14 -14 -15 -15 -16 -16 -17 -08 -08 -09 -09 -10 l-10 -10 -11 -11 -12 -12 -13 -13 -13 -14 -14 -15 l-15 -15 -16 -16 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Jun Nov Apr Sep Feb Ju Dec May Oct Mar Aug Jan Jun Nov Apr Sep Feb Ju Dec May Oct ▬▬KHM ▬▬CHN ▬▬IDN ▬▬MYS ▬▬PHL ▬▬THA ---- EAP F&EM ▬▬CHN ▬▬MYS ▬▬THA ▬▬IDN Source: IMF Financial Soundness Indicators. Source: Bank for International Settlements. Note: “EAP F&EM” is an average across frontier and emerging markets EAP economies, including China, Indonesia, Malaysia, the Philippines, Thailand and Vietnam. Table I.B.3. Nonperforming loans are elevated in Timor-Leste and many of the island economies Bank nonperforming loans as a percentage of total gross loans (percent) 2012 2013 2014 2015 2016 Fiji 4.2 2.7 2.2 1.4 2.3 Micronesia, Fed. Sts. 2.9 2.6 2.0 Papua New Guinea 2.2 1.8 2.1 3.1 Solomon Islands 3.6 7.0 4.7 4.1 3.8 Timor-Leste 30.8 28.0 26.8 32.0 15.3 Tonga 14.4 10.6 10.5 7.6 Vanuatu 7.8 14.1 10.7 12.3 Sources: IMF, Global Financial Stability Report; Central Bank of Timor-Leste. Household indebtedness is growing in several of the large regional economies. It reached 70 percent of GDP in Malaysia and Thailand at the end of 2016, and rose to 44 percent in China from 28 percent in 2011 (Figure I.A.17). Debt service continues to grow as a share of income in the nonfinancial private sectors of China and Malaysia (Figure I.B.5). Rising world interest rates would aggravate these vulnerabilities. If world interest rates were to rise rapidly, loan defaults and capital outflows from the region could be triggered, undermining the stability of banking systems. Although the pace of interest hikes now appears likely to be more measured, particularly in the United States, than was expected at the time of the last Update, the gradual normalization of monetary policy in advanced economies will ultimately tighten conditions for EAP countries. I.B. Outlook and Risks 41 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Box I.B.3. An overview of shadow banking in China1 The People’s Bank of China (PBOC) defines shadow banking as “credit intermediation involving entities and activities outside the regular banking system, with the functions of liquidity and credit transformation, which could potentially cause systemic risks or regulatory arbitrage”  (PBOC 2013, p.203). This definition is very much along the lines of the description of shadow banking by the Financial Stability Board (FSB), which also points out that “Such intermediation, appropriately conducted, provides a valuable alternative to bank funding that supports real economic activity” (FSB 2013, p.ii). Some have argued that shadow banking in China has contributed to growth by making financial services available to customers who cannot access the formal banking system. At the same time, however, a leveraged shadow banking system can also be vulnerable to bank-like risks to financial stability. There is no consensus on how to determine the extent of shadow banking activities in China. There have been attempts to quantify these intricate financial constructions from as early as 2011/12. A range of estimates regarding the size and composition of the shadow banking system in China varies widely between 8 and 80 percent of GDP, depending on how shadow banking is defined. This broad spectrum indicates the complexity of how shadow banking activities in China are defined or accounted for (see Table BI.B.3.1). Table BI.B.3.1. Selected estimates of the size of the Chinese shadow banking system Source Date Percent of GDP International Monetary Fund March 2014 35% of 2014 GDP UBS Year end-2013 50–70% of 2013 GDP Financial Stability Board Year end-2013 31% of 2013 GDP Standard Chartered Year end-2013 8–22% of 2013 GDP J.P. Morgan Year end-2013 81% of 2013 GDP Standard &Poor’s Year end-2012 44% of 2012 GDP Source: Elliott, Kroeber, and Qiao 2015. Since the Global Financial Crisis, a large share of the new debt created in China has been bank lending converted into investment assets through innovative financial engineering or has come from nontraditional lenders, both of which have supported the recent rapid growth of shadow banking.2 Therefore, shadow banking activities in China can be executed by banks and nonbank financial institutions. The activities by banks can be classified into off and on balance sheet. On the one hand, the off-balance- sheet activities of banks include credit provided through bank-intermediated entrusted lending, off-balance- sheet bank wealth management products (WMPs), undiscounted bankers’ acceptances, and other credit guarantees. On the other hand, activities on the banks’ balance sheets include credit loans disguised under bank investment/interbank repo assets (that is, investment receivables, trust beneficiary rights, and AMPs by insurance/securities companies). In terms of the activities by nonbank financial institutions, these include (continued) 1 Written by Radu Tatucu and Ana Maria Avilés, with inputs from Nan Zhou, and comments from Haocong Ren, Luan Zhao, and Changyi Shao. 2 For more details, see Griffin and Walsh (2017). 42 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT (Box I.B.3 continued) the credit business of trust companies (trust loans); securities and fund management companies (investment products); insurance companies (nonstandard credit assets); and, to a lesser extent, leasing company/ pawnshop businesses. A typical flow involves credit assets being packaged by nonbank financial institutions into special purpose vehicles, which in turn provide financing to end borrowers, including local government financing vehicles, real estate developers, public-private partnership projects, and certain companies in unfavored/overcapacity sectors. By modifying the financing structure, these credit assets are not recognized in banks’ loan books, but are accounted as investment assets on the balance sheet or completely moved off the balance sheet. Since shadow banking activities are outside the formal banking sector, they are under less regulatory scrutiny. Indeed, shadow banking in China is generally viewed as an instrument of regulatory arbitrage that uses nonbank channels to circumvent regulatory and lending restrictions for banks (Elliott, Kroeber, and Qiao 2015). Some of these restrictions include (a) PBOC caps on bank lending volumes, (b) a 75 percent limit on the ratio of bank loans to deposits (removed in 2015), (c) concentration of lending in certain industries or sectors, and (d) costly reserve requirements imposed by PBOC on banks while capital and liquidity requirements are lower for nonbanks.3 Since the formal banking sector is required to maintain significantly higher capital and liquidity than what shadow banking chooses to carry, activities in the formal banking sector are safer though more expensive. Therefore, shadow banking can offer lower cost and higher returns to a segment of customers willing to try riskier products, for instance, by foregoing collateral protection typically required by a traditional bank. In this context, shadow banking falls outside the scope of public safety nets of deposit guarantees and lender of last resort facilities that protect banks. China’s shadow banking system has been growing rapidly in recent years. As illustrated in Figure BI.B.3.1, the three most representative shadow banking activities, entrusted loans, trust loans, and bankers’ acceptances, soared from under 7 percent of GDP in 2005 to over 31 percent of GDP in 2016. WMPs also rose significantly from 11 percent of GDP in 2013 to 31 percent of GDP in 2016, as has their importance in bank resource mobilization, as illustrated in Figure BI.B.3.2. Indeed, the ratio of WMPs to bank deposits increased from 3 to 5 percent in 2008–09, to 17 percent in 2015, confirming that WMPs are increasingly used by banks as a source of off-balance-sheet shadow credit. While China’s shadow banking sector is still small relative to the shadow banking sector in developed economies, it has been expanding much faster than in other emerging markets and differs in its composition. According to the broadest definition of shadow banking adopted by the FSB and the IMF, at the end of 2015, global assets held by other financial intermediaries (OFIs) reached a record US$92 trillion. This represents 28.8 percent of total financial assets and 150 percent of GDP. Moreover, China’s OFI assets represent 8.3 percent of global OFI assets or US$7.36 trillion (67 percent of GDP in 2015) and almost (continued) 3 Amendment to the Law of the People’s Republic of China on Commercial Banks, effective October 1, 2015, and approved by the Standing Committee of the National People’s Congress. I.B. Outlook and Risks 43 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.B.3 continued) quadrupled between 2011 and 2015—the fastest growth rate among the selected jurisdictions (Figure BI.B.3.3 and Figure BI.B.3.4). Deeper and more mature financial systems, such as the ones in the United States, the United Kingdom, and the Eurozone, have large shadow banking activities in terms of GDP. However, the diverse activities included under OFIs, such as standard collective investment funds, which provide market-based financing, are very different in nature from asset management plans in China, which mainly serve to channel bank credit. Figure BI.B.3.1. Alternative total social financing Figure BI.B.3.2. Bank resource mobilization instruments, 2005–16 Percent of GDP Percent of GDP 35 240 18 30 200 15 25 160 12 20 120 9 15 80 6 10 5 40 3 0 0 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2008 2009 2010 2011 2012 2013 2014 2015 JJEntrusted loans JJTrust loans JJBankers' acceptances JJBank deposits JJBank WMPs QQRatio: WMP-deposit, rhs Source: PBC and CBRC. Source: PBC and CBRC. Note: rhs = right-hand side. Figure BI.B.3.3. Share of global OFI assets Figure BI.B.3.4. Evolution of OFI shares by jurisdiction for selected jurisdictions over time Percent, end-2015 Percent, 2011–15 35 Euro area Others 5 33 30 EMEs 3 25 Japan 4 Canada 20 4 15 Cayman Islands 6 10 8 China 5 28 9 United States 0 United Kingdom Euro area USA GBR CHN CYM CAN JPN EMEs Others JJ2011 JJ2013 JJ2015 Source: FSB 2017. Note: (a) Also includes captive financial institutions and money lenders. Exchange rate effects have been netted out by using a constant exchange rate (from 2015). Based on time series data included in jurisdictions’ 2016 submissions. The evolution of OFI shares may also reflect improvements in the availability of data for some OFI subsectors over time at the jurisdiction level. (b) EMEs include Argentina, Brazil, Chile, India, Indonesia, Mexico, Russia, Saudi Arabia, South Africa, and Turkey. (c) Others include Australia; Hong Kong SAR, China; Korea; Singapore; and Switzerland. The increased complexity of the shadow banking system has made supervision and risk assessment more difficult, but Chinese authorities have taken steps to contain the risks stemming from these activities. The authorities have adopted several regulatory measures to try to mitigate the major risks associated with shadow banking. In recent months, there has been some indication that the enhanced regulation of shadow banking has somewhat contained the recent rapid growth of WMPs. During the latest (continued) 44 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT (Box I.B.3 continued) National Financial Work Conference (July 14–15, 2017), the authorities emphasized the need to strengthen supervision as financial services “go back to the origin” of serving the real economy.4 Thus, there is an expectation that efforts will continue in developing a cohesive regulatory framework for financial services and asset management businesses, as a way of managing the risks associated with shadow banking. A comprehensive list of the recent supervisory measures adopted by the authorities to reduce various shadow- banking-related risks is presented the Table BI.B.3.2. Table BI.B.3.2. Select regulatory measures aimed to reduce shadow banking risks5 July 2014 The China Banking Regulatory Commission (CBRC) sets tighter rules on wealth management products (WMPs); establishment of department for supervising WMPs; new rules on trading. January 2015 CBRC tightens rules on entrusted loans by disallowing firms’ lending of bank loans and prohibiting borrowers from investing in financial assets such as WMPs, bonds, and equity. September 2015 CSRC intensifies crackdown on less-regulated margin financing activities such as umbrella trusts and private financing. May 2016 CBRC issues guidance on banks’ loan-beneficiary rights transfers, to curb banks’ transferring loans off balance sheet without full risk transfer, and to enhance transparency of nonperforming loans on their books. CSRC proposes limits to fund companies in setting up subsidiaries December 2016 PBOC confirms to include banks’ off-balance sheet WMP business into the Macro Prudential Assessment (MPA) framework since 2017. January 2017 PBOC steps up regulatory oversight on the country’s fast growing third-party payment industry, effective from April 17, 2017. February 2017 PBOC circulates draft rules on taking coordinated approach to tighten supervision on broad asset business in the financial system, which aims to contain spillover risks from rising interconnectedness between formal and shadow banking system. CBRC improves its supervisory information system (namely the Project 1104) with more disclosure requirements for interbank business (e.g. issuance of negotiable certificates of deposit, issuance of WMPs). March 2017 PBOC launches a centralized clearing platform to separate the payment and clearing operations in the e-payment industry. April 2017 CBRC issues eight guidelines/opinions and vows to improve regulatory effectiveness and enhance risk control on the banking industry. Banks are required to conduct self-inspections of compliance with laws and regulations, and practices of regulatory arbitrage/improper operations. May 2017 Banking Wealth Management Product Registration & Depository Center tightens the disclosure rules on banks’ WMP asset composition and structure. June 2017 PBOC, together with other 16 Chinese government ministries and commissions, extend the expected completion day of rectification on e-finance to June 2018. July 2017 Chinese authorities deliver their refreshed commitment to remain vigilant to financial risks and facilitate reforms to curb leverage after the National Financial Work Conference. A new committee under the State Council will be established to better supervise financial stability and development. Sources: Moody’s Investors Service; Griffin and Walsh (2017). 4 The National Financial Work Conference is a major conference that has taken place every five years in China since 1997. At this flagship event, China’s top finance officials discuss ways to improve the country’s complex financial system and set future priorities for the development of the financial sector in China. 5 This is not a comprehensive list of all measures adopted by regulators to prevent and mitigate the various risks associated with shadow banking. I.B. Outlook and Risks 45 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 High budget deficits and rising public debt pose risks for many countries in the region Fiscal positions deteriorated in many EAP countries during the last decade. As in other regions, many governments in EAP ran large budget deficits to support growth in the face of collapsing world trade during the global financial crisis, reversing a trend of steady debt reduction. Box I.B.2 illustrates that the deterioration of debt dynamics was especially pronounced among commodity exporters that borrowed while world prices were rising, depleting the fiscal buffers they needed after prices plunged. Budget deficits are expected to remain high or grow larger in most countries over 2017–19. Other than in Indonesia and Malaysia, the average budget deficits of large countries during 2017–19 are forecast either to be higher than the average of the previous three years or to remain above 5 percent of GDP (Figure I.B.6). Increases are pronounced in Cambodia and the Philippines and, among the smaller economies, in the Solomon Islands. Vietnam is working to improve fiscal balances, but budget deficits are projected to average 5.5 percent over the medium term, and the composition of spending has become more tilted toward recurrent expenditure (see World Bank 2017c). Figure I.B.6. Fiscal deficits are high or rising in many Figure I.B.7. Government debt is also high or rising in countries many countries General government fiscal balance, percent of GDP General government debt, percent of GDP Average 2017–19 0 90 IDN CHN MYS PHL 80 FJI 70 -5 LAO THA SLB 60 VNM KHM MMR MNG 50 40 -10 deficits are 30 projected to increase 20 10 -15 0 -15 -10 -5 0 CHN IDN MYS PHL THA VNM KHM LAO MNG Average 2014–16 JJ2015 JJ2016 JJ2017 JJ2018 JJ2019 Source: World Bank staff estimates. Source: World Bank staff estimates. Note: Data refer to general government fiscal deficit, except for Indonesia, where they refer to central Note: Data refer to general government fiscal balance, except for Indonesia, where data refer to central government fiscal deficit, and Cambodia, where they refer to general government fiscal deficit before government debt. Data for China exclude significant off-budget debts for public investment accumulated grants. since 2015. These deficits are especially worrying in cases where public debt is also high or rising. It is the combination of the two that poses risks to fiscal sustainability, as this combination narrows governments’ policy space for responding to shocks. Mongolia’s debt approaches 90 percent of GDP (Figure I.B.7). Lao PDR's debt is projected to exceed 70 percent of GDP in 2018. Only in the Philippines is the debt-to-GDP ratio moving along a steadily declining trajectory. In Vietnam, concerns about debt are amplified by the banking sector’s unresolved impaired assets, which could eventually translate into significant public sector liabilities. The prospect of tighter global financing conditions heightens the need for fiscal discipline. Although monetary authorities in advanced countries have signaled a gradual pace for reducing their balance sheets in the 46 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT near term, they remain committed to eventually returning to conventional monetary policy. This implies higher interest rates, which will raise the cost of new borrowing and refinancing debt for countries that have not succeeded in trimming their deficits, leaving them with little fiscal space to undertake countercyclical policies in the event of shocks or to make public investments needed for long-term economic growth and poverty reduction. Some countries are already taking steps toward fiscal consolidation. Malaysia is focusing on achieving efficiency in spending. Vietnam has succeeded in mobilizing more nontax revenue while working to enhance discipline on spending. More dramatically, because more drastic action was needed, Mongolia is implementing a macroeconomic stabilization program that aims to bring the deficit down to 5 percent by 2019 from 17 percent in 2015 through a wage and hiring freeze, reprioritization of capital projects, and additional revenue measures. The Pacific Island Countries remain vulnerable to shocks, highlighting the importance of savings and stabilization mechanisms The PICs remain especially vulnerable to external shocks from extreme weather, volatile international markets, or policy changes in larger neighboring countries. Poor households in Tuvalu, Vanuatu, and other countries that depend heavily on home production of foodstuffs are particularly susceptible to weather shocks, for example. Households in countries that rely more on imported food (for example, Vanuatu and the outer islands of Tuvalu) are exposed to volatility in world commodity and currency markets. An unexpectedly rapid rise in world oil prices would undermine current account balances and increase consumer prices, given these countries’ total dependence on fuel imports and their remote locations that translate into high transport costs. Nauru’s growth outlook is particularly threatened given the uncertain future of operations at Australia’s Regional Processing Centre for asylum seekers. The long-term outlook for several PICs will be influenced by the extent to which elevated revenues from fishing license fees persist, and as importantly by how well these revenues are used. In some PICs, pressing development needs mean that there may be an argument to use part of these revenues to finance current spending on public services, or for public investments that yield a positive social return. However, excessive use of the increased revenues to finance current consumption could undermine long-term fiscal sustainability, especially in countries with already high public debt burdens. I.B. Outlook and Risks 47 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 I.C. Policy Considerations The improved outlook for global growth provides a window of opportunity for developing EAP to continue to reduce key vulnerabilities and strengthen the foundations for sustained and inclusive growth in the medium term. China should continue its policies aimed at deleveraging and strengthening fiscal discipline, including through reforms of state-owned enterprises (SOEs). In several developing EAP countries that are experiencing rapid credit growth or facing a high level of debt, improvements in supervision and prudential regulation can help safeguard economic stability. Global policy uncertainty remains high, strengthening the case for maintaining fiscal buffers sufficient for future maneuver. This need is particularly acute for commodity exporters affected by the fall in commodity prices. Meanwhile advancing tax reforms continues to be a priority to build fiscal buffers. Despite moderate inflation in many countries, most monetary authorities may need to start considering adjusting their accommodative monetary policies, as external financing tightens and inflationary pressures pick up. The improving short-term prospects for most of the region could also prove opportune for governments to accelerate structural reforms to reap the long-term economic benefits of higher productivity and improved competitiveness. Developing EAP countries could benefit significantly from further developing tourism sectors and deepening regional integration to offset the emerging global protectionism. Policies to ensure inclusive growth should involve ensuring economic mobility and security for all, going beyond an exclusive focus on reducing poverty. Improving prospects for global growth provide an opportunity to address vulnerabilities The favorable environment for developing EAP countries offers the space to move away from policies aimed at stimulating short-term growth towards measures that address underlying vulnerabilities. Over the last few years, facing weak global growth, many countries in developing EAP had strived to boost growth by loose monetary and fiscal policies, which in some cases has already led to accelerated credit expansion, diminished fiscal space, and overly accommodative monetary policies. Fortunately, firming global economic recovery and a pickup in trade activities in 2017 are likely to keep growth buoyant for developing EAP over the short to medium term. This, absent large shocks (from the realization of the risks discussed in Part I.B), can potentially alleviate the pressures to secure short-term growth, and provide a window of opportunity to tackle the economic vulnerabilities that have built up, which will pave the way for more sustained growth. ÌÌAddressing the risks posed by rapid credit growth China needs to continue its deleveraging effort to tackle rapid credit expansion and the rise of shadow banking. Fiscal stimulus and financial innovation after the global financial crisis helped offset the adverse impact of the crisis. These developments, however, led to increased indebtedness (Box I.C.1), and contributed to the expansion of a sophisticated shadow banking sector (Box I.B.3). The Chinese authorities have highlighted the importance of containing financial sector risks: the State Council Financial Stability and Development Commission was established 48 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT to coordinate financial regulatory and monetary authorities, and since late 2016, the authorities have tightened financial regulation and monetary policy to contain the growth of banking sector assets. Strengthening supervision over shadow banking activities should remain a policy priority. The authorities also need to maintain deleveraging policies, although in a measured way to avoid causing an abrupt blow to the financial sector. Improvements in supervision and prudential regulation can help contain risks in other economies that have experienced rapid credit growth and debt accumulation. Credit growth remains elevated across much of the region, as discussed in Parts I.A and I.B. Myanmar, the Philippines, and Vietnam registered rapid real credit growth and quick accumulation of debt during the last several years. Real credit growth in Cambodia has decelerated since mid-2015, when it was growing by over 30 percent y/y, but remains high. Lao PDR and Malaysia still face high levels of debt. Meanwhile, asset quality has deteriorated—the ratio of nonperforming loans to total loans have been rising steadily in China, Indonesia, Thailand, and Cambodia (Figure I.B.4).1 A sharp tightening of global financing conditions could heighten these risks. The authorities should strengthen regulation and supervision, and make use of macroprudential regulations to reduce risks to financial stability associated with leveraging (World Bank 2016).2 Several countries, including Thailand, the Philippines, Vietnam, Cambodia, and Myanmar, have strengthened such measures.3 ÌÌPersistent global uncertainty calls for continued fiscal prudence Governments in the region need to build fiscal buffers and take measures to control fiscal risks. Even though GDP growth is strong in most countries and the global environment has become more favorable during 2017, conditions could deteriorate rapidly. Public debt levels are high in many countries, and governments face considerable contingent liabilities, including corporate and financial vulnerabilities.4 Although current conditions make it possible to rebuild fiscal space, most governments are projected to increase their budget deficits. Low energy prices open a window of opportunity to reform energy pricing, including by cutting energy and fertilizer subsidies, increasing fuel taxes, and in some cases moving toward greater cost recovery in electricity (World Bank 2015). SOE reforms, including measures to enhance transparency and governance, would help reduce public financial liabilities. In particular, China needs to continue strengthening fiscal discipline. Financing investments through public-private partnerships and strengthening measures to improve fiscal sustainability for subnational governments and public-benefit SOEs would yield significant gains.5 Revenue constraints are particularly binding for commodity producers. Low commodity prices have already had a significant impact on public revenue and public finances in Indonesia, Malaysia, Mongolia, Myanmar, Papua New Guinea, and Timor-Leste. Policy makers need to streamline expenditures in line with the countries’ development priorities and undertake reforms to improve 1 For instance, Vietnam has a legacy of nonperforming assets in its banking system. 2 A list of measures includes risk-informed pricing, rigorous borrower affordability assessments, supervisory vigilance over underwriting practices and capital adequacy, elevated reserve requirements, higher liquidity ratios or loan-loss provisions, and appropriate loan-to-value and debt-to-income limits. 3 In Cambodia, minimum capital requirements for financial institutions were recently increased, and the required liquidity coverage ratio was raised to 60 percent in September 2016. In Thailand, the authorities have established a Financial Stability Committee to monitor and mitigate systemic risk, and publish financial stability reports. In Myanmar, the recent adoption of the prudential regulations is expected to help manage risks to financial sector stability. In the Philippines, the authorities have enhanced monitoring of real estate and credit conditions, and are addressing data and regulatory gaps related to the real estate sector and rising corporate leverage. In Vietnam, macroprudential regulation of credit markets was strengthened in April, with a focus on real estate. 4 Including recapitalization of banks and payout of deposit insurance funds. 5 In this regard, the adoption by the State Council of a new framework to address the current imbalance in revenues and expenditure responsibilities at different levels of government is a positive step in that direction. I.C. Policy considerations 49 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Box I.C.1. Deleveraging in China1 There is increasing concern about the pace of Figure B1.C.1.1. Credit to the nonfinancial sector in debt accumulation in the nonfinancial sector China Percent of GDP since the global financial crisis. Credit growth to 250 the nonfinancial sector averaged more than twice 200 GDP growth during 2008–16, reaching 236 percent of GDP by mid-2017.2 This increase in debt began 150 with a massive fiscal stimulus carried out in response 100 to the global financial crisis. While some measures 50 were adopted earlier in the decade to phase out this stimulus and better regulate credit growth, the pace 0 6 r-0 c-0 6 -07 -08 -09 -09 -10 -11 -12 -12 -13 -14 -15 -15 -16 -17 r c r c r c Ma De Sep Jun Ma De Sep Jun Ma De Sep Jun Ma De Sep Jun of leveraging nevertheless accelerated in 2015–16. Sources: CEIC; World Bank staff calculations. However, 2017 could potentially mark a turning point with moderating credit growth and improved financial regulation in China. The acceleration of credit growth in 2015–16 can partly be associated with a renewed fiscal stimulus aimed at sustaining strong GDP growth during a time of weak global growth. During 2015–16, public benefit SOEs (local government financing vehicles) involved in public investment projects and real estate accelerated their borrowing at a particularly high rate (over 20 percent).3 Credit growth to the nonfinancial sector surged to 14.9 and 15.9 percent in 2015 and 2016 (up from 14.2 percent in 2014), respectively. Even these numbers underestimate the actual credit growth during these two years. A significant part of the recent expansion in credit to the nonfinancial sector can be associated with shadow finance that is not fully reflected in Total Social Financing data, most notably in the form of wealth management products (WMPs) (see Box I.B.3). Much of the rapid expansion in credit, commercial bank assets, and wealth management products has been concentrated in the small- and medium-sized city and joint stock banks. These banks grew their asset and credit portfolios at over 20 percent in most years since the global financial crisis, and, since 2010, have been expanding at more than twice the pace of the Big Four national commercial banks. City and joint-stock banks are also responsible for the majority of recent shadow banking activities. Their primary exposure is to the corporate sector, including to public benefit SOEs. As deposit growth in these banks has been modest, small banks have been increasingly reliant on the Peoples’ Bank of China (PBOC) and the interbank market for liquidity to support the expansion in their credit. The volume of short-term interbank placements as negotiated certificates of deposit (NCD) mushroomed to RMB 6.3 trillion by end-2016 from (continued) 1 Prepared by John Litwack and Luan Zhao. 2 This is commonly measured in China as Total Social Financing-Equity+Government Bonds. Total Social Financing includes commercial bank credit to the nonfinancial sector, corporate bonds, and several forms of nonbank credit to the nonfinancial sector. 3 Since the Budget Reform of 2014, the government prefers to refer to former “local government finance vehicles” still involved in public investment as “public benefit SOEs.” 50 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT (Box I.C.1 continued) negligible levels in 2014.4 At the same time, PBOC claims on banks increased from around RMB 2 trillion in 2014–15 to RMB 8.5 trillion in 2016. Since late 2016, the authorities have taken several measures aimed at reducing the pace of credit growth. One aspect of this is a significant tightening of monetary policy. Net liquidity injections by the PBOC in the first half of 2017 amounted to RMB 1.7 trillion, compared to RMB 2.9 trillion in the first half of 2016. Interest rates have increased, as well. After the rapid increase in PBOC net claims on banks in 2016 described above, this increase became negligible in the first half of 2017. This policy tightening has been complemented by regulatory measures aimed at alleviating risks in the commercial banking sector. Commercial banks are now obliged by new regulations to limit the amounts of WMPs associated with so-called nonstandard products (that is, other than stocks and bonds) to below 4 percent of assets and 35 percent of outstanding WMPs. An official reclassification of NCDs as interbank liabilities should also limit commercial bank reliance on this and other interbank sources of financing, which will need to be below 33 percent of total liabilities. Other important measures include more comprehensive and frequent monitoring of risks in the banking sector, including those off balance sheet, a strengthening of bankruptcy provisions, the creation of “mutual assistance funds” to mitigate liquidity risks, and the promotion of an active role for creditor committees in restructuring existing problem debts.5 While credit to the nonfinancial sector has continued to expand at a rapid pace in 2017, Figure B1.C.1.2. Commercial bank asset growth there is evidence that the new monetary and by bank size Percent nominal growth regulatory measures are having an impact on 25 the composition of credit. Total credit to the 20 nonfinancial sector increased at a 15.1 percent annualized pace in the first seven months of 2017, 15 only slightly slower than 15.9 percent in 2016. 10 However, this aggregate measure masks the real 5 progress because it does not include a good part of shadow finance, including much of that associated 0 2015 2016 2017H1 with WMPs. More importantly, the stock of WMPs JJAll banks JJLarge commercial banks JJSmaller joint stock and city banks associated with commercial banks was 2 percent Source: China Banking Regulatory Commission. lower in mid-2017 relative to the end of 2016. This can be compared with an explosive growth of 56.5 and 23.6 percent in the stock of such WMPs in 2015 and 2016, respectively. Mirroring this change, assets in commercial banks in the first half of 2017 have been expanding only half as fast as in 2015–16. The slowdown was particularly sharp for smaller city and joint- (continued) 4 In many countries, negotiated certificates of deposit are longer-term instruments similar to bonds. Since their introduction in China in 2013, however, they have been used by banks largely for short-term (one to three month) interbank placements tied to short-term interest rates. For this reason, financial regulators in China decided in 2017 to reclassify these short-term NCDs from “bonds” to “interbank borrowing.” 5 These are funds set up at the local level that allow banks to pool funds for covering potential liquidity shortfalls in individual banks. I.C. Policy considerations 51 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.C.1 continued) stock banks, whose assets increased at a 5.3 percent annualized rate in the first half of 2017. By comparison, asset growth in large commercial banks moderated modestly from 10.5 percent in 2016 to 10.0 percent annualized in the first half of 2017. Sustaining the measures aimed at bringing credit growth under control remains challenging. Under the current circumstances, tightening both monetary policy and financial regulations simultaneously, as China did in the first half of 2017, could be associated with potential liquidity risks in the small- and medium-sized banks. As a result, the PBOC has moved to provide a bit more liquidity in the beginning of the second half of the year. Going forward, serious progress in deleveraging will likely need to involve effective resolution measures for individual cases of smaller banks that are now overextended. This is also linked to needed timely and effective restructuring, as well as to addressing insolvency and resolution in the corporate sector. The longer-term impact of the current crackdown on shadow banking and its link to commercial banking remains to be assessed. Past crackdowns on certain specific shadow banking instruments (trust loans and entrusted payments) eventually led to their substitution with new instruments, including various forms of WMPs. Despite the tighter regulatory and monetary policy environment, the incentives in commercial banks to circumvent regulations through shadow banking activities may remain strong, thereby blunting efforts to contain the pace of credit growth. spending efficiency.6 Vietnam, facing elevated levels of debt and contingent liabilities from the banking sector, also needs to implement fiscal reforms to build fiscal space.7 Similarly, Lao PDR should consolidate its spending and strengthen public debt management to address elevated debt and speed up the restructuring of state-owned banks. Advancing tax reforms will create more fiscal buffers. Growth in tax collection has been moderating in developing EAP, while revenue leakage and collection compliance costs remain high (Box I.C.2). Despite the uneven progress in tax reforms across the region, the broad thrust should continue to focus on broadening the base and reducing the rates of tax collection. Priorities for Malaysia should include broadening the base of the personal income tax, and reducing exemptions from the general sales tax. In the Philippines, the proposed tax policy reforms, with their focus on broadening the tax base, lowering tax rates, and raising excises, represent a step in the right direction.8 The government of Lao PDR has removed the fuel imports tax and is taking steps to reduce tax leakage. In addition, as e-commerce has become more prominent in a number of countries, one challenge is for the countries to design their major taxes (VAT, income taxes) to capture this potentially large but elusive base. China has put emphasis on equal treatment in taxation of electronic and traditional services. Another area of tax reforms is to consider introducing new taxes. Notably, a VAT was recently introduced in Malaysia and is being 6 In Malaysia, the civil service pension and cutting income-support measures should yield additional fiscal space. Mongolia, with large fiscal imbalances, needs to strengthen fiscal discipline to contain the imminent fiscal risks. Myanmar needs to reallocate spending across and within sectors away from low-priority to high-priority areas to accelerate the delivery of much needed public services. In Timor-Leste, the emergence of large structural deficits demands efforts to prioritize essential investments that raise domestic supply potential and support diversification efforts. 7 The costs associated with the recapitalization of state-owned commercial banks in Vietnam are estimated to be 2.5 percent of GDP. 8 Measures to expand the VAT base, increase fuel excises, tax sugary products, and reduce the elevated personal income tax rates, with an expected net positive impact on revenue, have already been submitted to the legislature. Future measures are expected to include a rationalization of fiscal incentives, a reduction in corporate income tax rates, a simplification of property taxes, and a harmonization of capital income tax rates. 52 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT planned in Timor-Leste. A number of new taxes are under discussion across the region.9 New taxes on capital gains, property, and interest income could be introduced in Vietnam. Vanuatu would benefit from introducing an income tax. Moreover, countries could establish a regional coordination mechanism to avoid harmful tax competition and to address profit shifting and erosion of the tax base. This should be accompanied by tax administration reforms focusing on enhancing efficiency, integrity, and effectiveness, and on reducing administration and compliance costs. ÌÌTightening external financing and rising inflation may accelerate monetary policy adjustment Developing EAP economies may need to tighten monetary policies as external financing conditions adjust. Despite the appreciation of major currencies against the U.S. dollar during 2017, future tightening of global financial conditions could spark capital outflows and put pressure on exchange rates in the region. In that case, the monetary authorities need to be prepared to tighten their policy stance in response. The financially integrated economies of Malaysia, and to a lesser degree Indonesia, Thailand, and the Philippines, remain relatively more exposed to exchange rate risk with sizable external debt in corporates and banks, although foreign exchange reserves currently appear adequate. In case of another wave of depreciation pressures in China, the Chinese authorities should allow greater adjustment through relative prices, and closely monitor financial sector vulnerabilities as monetary policy further tightens. Some of the smaller economies are already facing significant exchange rate pressures. In Lao PDR, Papua New Guinea, and Myanmar, the monetary authorities need to ensure exchange rate flexibility and tighten monetary policies. Macroeconomic stabilization in Mongolia requires continued tight monetary policy and exchange rate flexibility. Rising inflation may also require an adjustment in monetary policy. Although inflation remains largely muted across developing EAP, there are signs of a pickup in a few large economies in the region. In China, core inflation has been rising and edged above 2 percent y/y in the middle of 2017. Malaysia and the Philippines also saw gradual acceleration in core consumer prices since mid-2016. Monetary policy should stand ready to respond if and when inflation pressures become more pronounced. Monetary policy institutions in several smaller economies need to be strengthened ( Box I.C.3). Given the increasing short-term stabilization needs that underscore the importance of effective monetary policy going forward, countries need to improve monetary policy transmission by advancing the development of financial markets and relevant institutions. These measures may need to be supported by greater fiscal adjustment. Accelerating reforms for sustained and inclusive growth As short-term economic prospects improve, countries in the region should continue to pursue structural reforms that can yield long-term economic benefits. China needs to continue to advance market reforms to unlock its growth potential. The authorities have initiated measures to reduce overcapacity in their state-owned enterprise sectors, which will need to be sustained. Recent measures to regulate shadow banking activities need to 9 These new taxes include an environmental tax in Vietnam, taxation on passive or capital income in Mongolia, an excise on sugar beverages in the Philippines, a wealth and asset- transaction tax in Thailand, new mechanism design for an alternative minimum tax, and a tax on inheritance and gifts in Indonesia. I.C. Policy considerations 53 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Box I.C.2. Taxation in developing EAP: Trends, reforms, and policy implications1 Trends and main drivers of tax performance in EAP Tax collection in developing EAP has been trailing other developing regions. In aggregate, the region ranks fifth in total tax collection as a share of GDP (16.8 percent) out of six developing regions, only ahead of the South Asia region (12.7 percent) (Figure BI.C.2.1). The revenue intake from the value-added tax (VAT), at 25 percent of total tax revenues, is the lowest level in the region (Figure BI.C.2.2). On average, collection from trade taxes remains high, at approximately 3 percent of GDP or 16 percent of total tax intake. Figure BI.C.2.1. Tax collection in percent of GDP, Figure BI.C.2.2. Tax collection in percent of total tax by region, 2010–15 revenues, by region, 2010–15 Percent of GDP Percent total tax revenues 25 100 90 20 80 70 15 60 50 10 40 30 5 20 10 0 0 SAR EAP MENA SSA LAC ECA High income EAP ECA LAC MENA SAR SSA High income JJPIT JJCIT JJVAT JJExcise JJTrade taxes JJOthers JJPIT JJCIT JJVAT JJExcise JJTrade taxes JJOthers Source: IMF revenue database. Source: IMF revenue database. Note: CIT = corporate income tax; PIT = personal income tax; VAT = value-added tax. Note: CIT = corporate income tax; PIT = personal income tax; VAT = value-added tax. EAP is a region where tax efforts and the drivers of tax collection are highly diverse across countries. The regional averages as presented mask the vast country-specific differences in terms of total tax intake and the collection by tax type. Figures BI.C.2.3 and Figure BI.C.2.4 show the average tax effort and collection by different types of taxes in select EAP countries during 2010–15. Some contrasts are worth noting. For example, even though Cambodia’s total tax intake is low, the country manages to mobilize sizable revenues from the VAT (4.2 percent of GDP, about 35 percent of total tax revenues). The collection of the VAT in total tax intake in Cambodia is comparable to the VAT attained by the small island states of Fiji and Samoa, with the highest overall tax efforts (23.5 and 21.5 percent of GDP, respectively). Taxes on income and profits, in contrast, have been the major drivers that shape the collection pattern in the Philippines and Malaysia.2 China, Indonesia, Malaysia, and Thailand have managed to shift away from trade taxes, whereas others still rely heavily on that revenue source. (continued) 1 Prepared by Tuan Minh Le, with valuable inputs from the Bank’s country economists in EAP. 2 The analysis of the long-term revenue trend in selected Asian countries during 1990–2015 by the OECD (2017) shows similar results. The study also attributes significant improvement in tax administration to the higher tax revenues in Malaysia. (Notable improvements in tax administration include the transformation in 1996 that makes the tax administration agency a statutory authority, and the shift from administrative to self-assessment, with increased focus on performance and compliance.) 54 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT (Box I.C.2 continued) Figure BI.C.2.3. Tax collection in percent of GDP, Figure BI.C.2.4. Tax collection in percent of total tax select EAP countries, 2010–15 revenues, select EAP countries, 2010–15 Percent of GDP Percent total tax revenues 25 100 90 20 80 70 15 60 50 10 40 30 5 20 10 0 0 KHM CHN FJI IDN MYS MNG PHL WSM THA VNM KHM CHN FJI IDN MYS MNG PHL WSM THA VNM JJPIT JJCIT JJVAT JJExcise JJTrade taxes JJOthers JJPIT JJCIT JJVAT JJExcise JJTrade taxes JJOthers Source: IMF revenue database. Source: IMF revenue database. Note: CIT = corporate income tax; PIT = personal income tax; VAT = value-added tax. Note: CIT = corporate income tax; PIT = personal income tax; VAT = value-added tax. Uneven compliance costs across EAP countries Average tax compliance cost is relatively high in EAP but with much heterogeneity—both the top performers and low achievers are in the region. Data from the World Bank’s Doing Business (2017) indicate the contrast in cross-country performance. While Vietnam and Lao PDR are not the countries with the highest total tax burden (as percentage of total profits), they are ranked unfavorably in terms of ease of paying taxes: the number of hours required annually for tax compliance are 362 in Vietnam and 540 in Lao PDR. Such transaction costs are far higher than any regional average and are in sharp contrast to the best performers in the region, including Singapore, where the time required for complying with all taxes is only 67 hours.3 The distance to frontier—an aggregate indicator of the overall doing business performance— also reflects this intraregion contrast: Hong Kong SAR (China) and Singapore are the closest to the efficiency frontier (99 and 92, respectively), whereas Vietnam performs poorly (49).4 Intense tax competition and implications for tax policy and administration EAP is known as a region of aggressive tax incentives and benefits with multiple objectives. Intraregional tax competition and complex, incoherent tax policies combined make the tax system prone to abuse and lead to depletion of the tax base. In addition, EAP countries increasingly rely on tax holidays, which are regarded as the most inefficient form of tax incentives, plus an extensive list of generous fiscal benefits (for example, reduced tax rates, investment allowance, super-deduction).5 (continued) 3 The indicator for EAP is 198 hours (the regional best), while, for comparison, the regional averages are approximately 222 for Eastern Europe and Central Asia, 304 for Africa, and 343 for Latin America and the Caribbean, the highest. 4 The distance to frontier score measures the distance of each economy to the “frontier,” which represents the best performance observed on each of the indicators across all economies in the Doing Business sample since 2005. An economy’s distance to frontier is reflected on a scale from zero to 100, where zero represents the lowest performance and 100 represents the frontier (World Bank Doing Business Database 2017.) 5 In the survey of the incentive regimes in 12 countries, 92 percent of the sample have tax holidays, the most prevalent type of incentives in EAP (see World Bank 2015b). I.C. Policy considerations 55 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.C.2 continued) Globalization and regional integration have a significant impact on taxation, and the EAP region is no exception. Tax policy in other countries and international business transactions have become ever more important for policy makers in EAP in the design and implementation of country-specific tax reforms. On one side, multinational corporations increasingly engage in profit shifting through aggressive tax planning. On the other side, tax authorities in most EAP countries are generally bound by outdated tax laws and treaties, and face numerous challenges, including asymmetric information and limited data access, poor knowledge of the multinational corporations’ structure and their complex web of international transactions, and constrained administrative capacity. The fiscal cost from transfer pricing can be substantial, with the estimated revenue lost from developing countries averaging US$100 billion per year during 2002–06 (Hollingshead 2010). Trends in tax reforms and policy implications Ongoing and planned tax reforms across EAP countries aim to address the common dual objectives of raising revenues and reducing tax-induced investment hurdles. These dual objectives contain some inherent conflicts from the perspective of policy design. Vietnam and Indonesia, for example, have continued to struggle with setting straight their major objectives, recognizing the need to attain a balance of trade-offs. They are considering a substantial reduction in statutory corporate income tax (CIT) rates, yet are unsure how to design an appropriate approach to streamline the existing complex incentive system that achieves a broader tax base. In addition, policy makers face the long-standing tradeoff between efficiency and equity, and strive to enhance the efficiency of major taxes (CIT, VAT, excise), in a way that does not excessively impact the poor.6 The political reality separating tax policy and propoor expenditure consideration, commonly observed in EAP, tends to add further complexity and incoherence to the setting of individual tax regimes. Several common trends in revenue reforms can be observed in the region. Despite the differences in the breadth, depth, rationale, and timetables in country-specific tax reforms, policy makers do seem to agree on certain goals and ways to achieve them, which are reflected in the following policy trends in the region: •• Balancing between pro-growth and revenue adequacy objectives in tax policy design. The clear path to achieve the seemingly inherently conflicting objectives is to broaden the base and reduce the rates.7 Such policy choice has long been part of the overall tax policy reforms in EAP countries, in concurrence with the trend firmly established worldwide since the 1990s. The majority of EAP countries strive to link this strategic reform with the provision of a list of incentives embedded in major taxes (continued) 6 For example, extending the list of VAT exemptions or nonexport zero ratings to cover certain commodities consumed by the poor would improve the equity but lower the efficiency of the tax and create an additional burden on enforcement and compliance. 7 See, for example, OECD (2010). However the country-specific tax system setting and performance would require a specific policy strategy, as in the case of Indonesia. The country has been cutting CIT rates while at the same time adding more incentives (including extending the scope of tax holidays). As a result, total tax collection has long been stagnant. In such a context, the rate-cutting policy option should only be rationalized if coupled with other revenue-enhancing tax reforms (for example, reforming the VAT and restructuring the special tax regime for micro, small, and medium enterprises). 56 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT (Box I.C.2 continued) (CIT, PIT, VAT).8 However, this rationalizing of incentives in major taxes is not always easy, politically or economically. In addition, some countries attempt to establish direct and explicit links between fiscal incentives and targeted investments conducive to growth (such incentive regimes include upfront cost reliefs and/or reductions in the operational costs involving R&D investment). Another policy development relates to the emergence of e-commerce; countries have attempted to redesign their major taxes (VAT, income taxes) to capture this potentially large but mostly elusive base. Some countries, like China, in contrast, put emphasis on equal treatment for taxation of electronic and traditional services. •• Considering introducing new taxes. A VAT was recently introduced in Malaysia and is being planned in Timor-Leste. Some countries are planning to introduce a new environmental tax (Vietnam), to tax passive or capital income (Mongolia), to design new mechanisms for an alternative minimum tax, and to impose a tax on inheritance and gifts (Indonesia). Such consideration is gaining momentum in countries that face mounting budget pressure and receive donor technical assistance. •• Embarking on selected actions of the anti-base erosion and profit-shifting (BEPS) agenda. There is more awareness related to the BEPS-induced revenue risk, and countries in the region have started to engage in selective actions from the BEPS agenda (specifically, transfer pricing, thin capitalization, and controlled foreign company rules). These actions aim to help protect the domestic tax base and alter the behavior of taxpayers in view of increased productivity and fairness in taxation. •• Establishing regional cooperation to reverse the trend toward harmful tax competition. Without effective regional cooperation, EAP countries—acting as individual players—would be driven toward continued competition in granting increasingly excessive fiscal incentives. The ASEAN countries have attempted to reverse this trend by initiating a dialogue on improving transparency and exchange of taxation information. •• Reforming tax administration. These reforms tends to focus on enhancing efficiency, integrity, and effectiveness in tax administration with the aim of boosting revenues and reducing both administration and compliance costs. As the large tax offices are created to administer large taxpayers, who are more capable of devising and engaging in various BEPS schemes, reforms to strengthen tax offices have increasingly been conducted as an integral part of the overall strategy to address the BEPS mechanisms. A snapshot survey of 14 EAP countries reveals the most commonly perceived challenges in revenue collection and directions for reforms.9 The top challenges reflect concerns about stagnation or decline of tax revenues; administrative weaknesses and high compliance costs (both flagged by 86 percent of the survey respondents); and base erosion due to globalization and international tax matters (71 percent of the respondents). Such perception drives the way the reform strategies are being shaped, focusing on revenue (continued) 8 Some countries (for example, Fiji and Mongolia), however, strive to increase the PIT exemption threshold as an integral part of their overall reform strategy. One immediate impact of such reform is to improve equity by excluding more of the low-income earners (mostly wage earners) from a PIT regime. 9 The survey was conducted with the respective World Bank country economists. The sample consists of the following countries: Cambodia, China, Fiji, Indonesia, Lao PDR, Mongolia, Myanmar, the Philippines, Samoa, Thailand, Timor-Leste, Tonga, and Vietnam. The file is with the author. I.C. Policy considerations 57 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.C.2 continued) enhancement and improvement in efficiency and equity through restructuring the tax mix and reforming tax administration.10 Table BI.C.2.1 summarizes the key features of the ongoing and planned tax policy and administration reforms in the 14 countries surveyed. Table BI.C.2.1. Key challenges, objectives, and strategies for tax reforms in developing EAPa Objectives of Ongoing and strategic direction in tax reforms Key challenges tax reforms Tax policy Tax administration Insufficient Enhance • Develop a midterm strategy for tax policy. • Strengthen the revenue effort or stabilize • Introduce new taxes where justified (e.g., an capacity of tax or declining tax tax revenue environmental tax); introduce/revise existing administration collection. collection. efficient type of taxes (property taxes). agency (in certain Increasing risk of Improve cases, increase base erosion and efficiency INDIRECT TAXES the degree of profit shifting and equity in autonomy of the VAT/Excises administration). (BEPS) from taxation by • Introduce a VAT to replace the existing sales tax • Enhance international restructure the regime. transparency, business tax mix and transactions. enhance the • With the existing VAT regime, unify the rates integrity, and quality and while extending the scope of excise for selected efficiency in taxation Weak and integrity of tax commodities; broaden the base with rationalizing through an improved inefficient tax administration. the exemption list and/or lowering the VAT legal framework for administration threshold. tax administration. and high compliance • Reengineer costs. DIRECT TAXES business processes Personal Income Tax with central focus • Reduce or rationalize the top marginal rate with on voluntary consideration to harmonize with corporate income compliance through tax regime. enhancement of both • Simplify the rate structure and reduce exemptions. enforcement and taxpayers service. • Rationalize the exemption threshold to serve equity purpose. • Introduce internet banking and use Corporate income tax of third-party • Reduce the rate. Simplify the rate structure. information sharing • Rationalize special incentives. and cross-checking. • Review and reform the micro, small, and medium • Design and enterprise special tax regimes toward lowering the implement selected cost of compliance and making the regime more in actions with regard line with the standard income tax regime. to BEPs, especially • Increase attention to revise the tax policy and in direct links with regulations to deal with the BEPS (notably, from establishment, transfer pricing, controlled foreign company rules, restructuring, or thin capitalization, and extended definition of refunctioning of permanent establishments). large tax offices. Note: a. This table only reports the status of tax-related reforms, but does not reflect the institutional view nor the Bank’s endorsement for these reforms. 10 While most countries focus on revenue raising, there are a few exceptions in EAP countries. Some focus more on equity and efficiency of the tax system while maintaining revenue neutrality (for example, Fiji, which has retained relatively stable revenue at 32 percent of GDP). (As a side note, in reforming its tax system, Singapore focuses more on growth. Its general sales tax or the VAT was designed to achieve an overall negative tax revenue, and each general sales tax rate increase has been accompanied with a staged reduction in income tax rates.) 58 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT Box I.C.3. The effectiveness of monetary policy in developing East Asia and Pacific1 The increasing short-term stabilization needs underscore the importance of effective monetary policy in developing EAP countries. Despite the central role it plays for advanced economies in smoothing economic fluctuations, the efficacy of monetary policy in developing economies is perceived to be weaker. The world has entered a period of elevated volatility after the global financial crisis, underpinning the need for short-term stabilization. And in anticipation of the spillovers from the eventual normalization of monetary policy in advanced economies, this need will be even greater going forward. It is therefore important that the countries in developing EAP can use monetary policy effectively to respond to these volatilities. In recent years, improved policy regimes and operational frameworks, along with greater independence of central banks, have laid the groundwork for monetary policy to play a bigger role in developing EAP. Central banks in developing countries have gained greater political and economic autonomy to conduct independent monetary policy (Arnone, Laurens, and Segalotto 2006). In developing EAP, the results are reflected in improved central bank independence and governance ratings since the 1997– 98 Asian financial crisis (Ahsan, Scully, and Wickramanayake 2008). Many EAP economies have transitioned away from foreign exchange pegs allowing for independent monetary policy, and moved toward monetary regimes governed by policy rules (Stone and Bhundia 2004), either toward explicit price targets or implicit price anchors (Morgan 2013). Monetary policy operational frameworks have also improved, as central banks revised the set of instruments and procedures by which they implement, as well as communicate, monetary policy (BIS 2006). In light of the discussion on monetary policy effectiveness in the region, this box assesses quantitatively a particular channel of monetary policy transmission and identifies its main determinants. Improved policy regimes, operational frameworks, and greater independence of central bank improvements are all factors that could strengthen the monetary policy transmission mechanism.2 Ultimately, however, the effectiveness of monetary policies and the factors that contribute to it are empirical questions. Based on Mishra et al. (2014), an empirical investigation is carried out by assessing the effectiveness in a major channel of monetary transmission in developing countries—the “bank lending channel” through which monetary shocks transmit to bank lending rates. The analysis is done in two steps. In the first step, a measure for the effectiveness of monetary policy is calculated for each country, which relates to the historical response of bank lending rates to a shock to the monetary base, using a heterogeneous structural panel (continued) 1 Prepared by Antonio M. Ollero, Congyan Tan, and Raju Huidrom. The authors would like to thank Peter Pedroni for the very helpful discussion and the computer codes for the Structural Panel Vector Autoregression model. 2 The monetary policy transmission mechanism is the process by which monetary policy decisions affect the economy in general, acting on intermediate targets and operating through various channels (Mishkin 1995). I.C. Policy considerations 59 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.C.3 continued) vector autoregression model following Mishra et al. (2014).3,4 In this framework, the monetary policy is considered more effective if a favorable shock to the monetary base (that is, loosening monetary policy) can elicit a larger reduction in bank lending rates.5 In the second step, correlations between this measure and a set of contributing factors are established to assess the impact of each factor on the effectiveness of monetary policy transmission. Figure BI.C.3.1. The median impulse response of the Figure BI.C.3.2. The impulse responses are negative bank lending rate to a monetary expansion is negative, and strong for Malaysia and the Philippines, and but weaker for developing EAP than for advanced negative but weak for Lao PDR and Fiji economies Impulse response, average Q1–Q4 Impulse response, average Q1–Q4 0.005 0 -0.002 0 -0.004 -0.006 -0.005 -0.008 -0.010 -0.010 -0.012 -0.014 -0.015 -0.016 -0.018 -0.020 -0.020 Advanced Other emerging and economies EAP Developing EAP developing countries USA MYS PHL CHN IDN THA LAO FJI ▬▬75th percentile ▬▬25th percentile QQMedian Source: The impulse responses are derived from a Structural Panel Vector Autoregression analysis Source: Staff calculations. based on a sample of 132 countries with the time span from Q2 1978 to Q2 2017 (when data are available). Note: The impulse response reported (vertical axis) is the average of the responses of bank lending rates to a one standard deviation shock to the monetary base, over the first year (four quarters) following the shock. Based on this analysis, the overall strength of monetary policy effectiveness in developing EAP lies between the advanced economies and the rest of developing economies, with a predictably wide dispersion across the region. The first-stage analysis shows that a monetary expansion leads to a drop in the banking rate for most economies—a negative impulse response.6 The median response in developing EAP appears to be stronger (or more negative) than for other emerging and developing countries, but weaker (or less negative) than for the advanced economies (Figure BI.C.3.1). The dispersion across the responses (proxied by the distance between the 25th and 75th quantile) is wide compared to the quantile responses for other emerging and developing countries. The larger economies in developing EAP, many of (continued) 3 The main innovation in this framework is that it identifies both common and country-specific monetary shocks over a cross-section of countries, and permits heterogeneity in the response of model variables to those shocks. As in Mishra et al. (2014), a Structural Panel Vector Autoregression was applied on the (log) bank lending rates and the (log) monetary base (M0) of 132 countries over 39 years (Q2 1978–Q2 2017). The identification is based on the “long-run restriction” hypothesis that the M0 does not have impact on the equilibrium lending rates over the long run. The monetary policy shocks used in this analysis are the identified shocks to M0. The effectiveness of monetary transmission in an economy is proxied by the impulse response of bank lending rate to a one-standard-deviation increase in the M0 shock (monetary expansionary). 4 The advantage of a structural VAR in panels over a conventional time series structural VAR in a single country analysis is that it “takes into account responses to both idiosyncratic and common structural shocks, while permitting full cross member heterogeneity of the response dynamics” (Pedroni 2013, p180). Specifically, the technique allows for estimating both the responses of individual countries to their own independent monetary policies (in a manner that controls for common global shocks) and their responses to common international shocks that capture global events. 5 The effectiveness of monetary policy is usually assessed in terms of inflation and output outcomes. That said, the long rates determine the cost of credit for households and firms, and eventually affect inflation and output. 6 The developing EAP countries included in this analysis are China, Indonesia, Malaysia, Philippines, Thailand, Lao PDR, Mongolia, Vietnam, Fiji, Papua New Guinea, the Solomon Islands, Tonga, Vanuatu, and Samoa. 60 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT (Box I.C.3 continued) which have improved their policy regimes and operational frameworks, exhibit impulse responses that are negative and reasonably strong compared to that of an advanced economy benchmark such as the United States (Figure BI.C.3.2). Many of the smaller countries show impulse responses that are either negative but weaker or have the reverse sign. Figure BI.C.3.3. Monetary policy is more effective Figure BI.C.3.4. …and deeper with the depth of the when the banking system is larger … stock markets Impulse response, average Q1–Q4 Impulse response, average Q1–Q4 0.06 0.06 0.04 0.04 0.02 0.02 0 0 -0.02 -0.02 -0.04 -0.04 0 0.5 1.0 1.5 2.0 0 0.5 1.0 1.5 2.0 Banking assets/GDP Stock market capitalization/GDP QQAdvanced economies QQDeveloping EAP QQOther emerging and developing countries QQAdvanced economies QQDeveloping EAP QQOther emerging and developing countries Sources: Cihak et al. 2012; World Bank Global Financial Development Database. Sources: Cihak et al. 2012; World Bank Global Financial Development Database. Note: Banking assets data are annual averages, 1980–2015, for 132 countries. Note: Stock market capitalization data are annual averages, 1980–2015, for 92 countries. Figure BI.C.3.5. But less effective when concentration Figure BI.C.3.6. …but strengthens with the quality of in the banking system is higher the regulatory framework Impulse response, average Q1–Q4 Impulse response, average Q1–Q4 0.06 0.05 0.04 0.03 0.02 0.01 0 0 -0.02 -0.01 -0.04 -0.03 0.2 0.4 0.6 0.8 1.0 -2.5 -1.5 -0.5 0.5 1.5 2.5 Three largest banks’ assets/total bank assets Regulatory quality QQAdvanced economies QQDeveloping EAP QQOther emerging and developing countries QQAdvanced economies QQDeveloping EAP QQOther emerging and developing countries Sources: Cihak et al. 2012; World Bank Global Financial Development Database. Source: Kaufmann, Kraay, and Mastruzzi 2009. Note: Banking concentration data are annual averages, 1996–2015, for 120 countries. Note: Regulatory quality captures perceptions of the ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development. The data give the country’s score on the aggregate indicator, in units of a standard normal distribution, that is, ranging from approximately -2.5 to 2.5. Data are annual averages, 1996– 2015, for 132 countries. This analysis also identifies a set of contributing factors on the state of financial sectors and the quality of institutions. In countries where banking and capital markets are large and deep, such as China, Malaysia, and Thailand (Figure BI.C.3.3 and Figure BI.C.3.4), the transmission mechanism is strong. Competition in the banking sector also matters, as does the quality of the institutional and regulatory environment within which banks operate. In countries where banking competition is intense and concentration is low, as in Indonesia and Thailand, the lending channel is robust. Banks are incentivized to pass on lower policy rates to borrowers (Figure BI.C.3.5). Moreover, in countries where the operating environment is supportive of private (continued) I.C. Policy considerations 61 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.C.3 continued) activity, as in Malaysia, banks are more willing to pass on the rate effects of expansive monetary policy to the market (Figure BI.C.3.6). The transparency of the central bank also enhances the monetary transmission mechanism: frequency of communication with the public of key decisions and information, as would be the case in the Philippines and Thailand, allows banks to better interpret the monetary authority’s policy intentions and to respond to shocks that signify a change in the policy stance (Figure BI.C.3.7). Meanwhile, high degrees of integration of the economy with international financial markets, as can be observed in Mongolia and Vanuatu, tend to dampen the effect of a monetary policy shock on the lending rate (Figure BI.C.3.8). Figure BI.C.3.7. The impulse response is enhanced Figure BI.C.3.8. …but dampened by integration by central bank transparency… with international financial markets Impulse response, average Q1–Q4 Impulse response, average Q1–Q4 0.06 0.06 0.04 0.04 0.02 0.02 0 0 -0.02 -0.02 -0.04 -0.04 0 0.2 0.4 0.6 0.8 1.0 0 2 4 6 8 Central bank transparency score (International financial assets + liabilities)/GDP QQAdvanced economies QQDeveloping EAP QQOther emerging and developing countries QQAdvanced economies QQDeveloping EAP QQOther emerging and developing countries Source: Dincer and Eichengreen 2009. Sources: Dhungana 2008; IMF, International Financial Statistics; World Bank World Development Note: Central bank transparency scores are annual averages, 1998–2004, for 60 countries. Indicators; and OECD data. Note: Financial integration = international investment assets, net of foreign exchange reserves excluding gold, plus international investment liabilities, net of long-term concessional debt (debtors) or net official development assistance (creditors), in percent of GDP. Data are annual averages, 1980–2016, for 100 countries. The dispersion in the impulse responses reported for developing EAP countries can be explained by the wide variation in the development of the financial systems and the quality of institutions among EAP countries. The 25th and 75th percentiles of the impulse response function for the region are wide apart, which is mirrored by the fact that financial structures and institutional frameworks in developing EAP also vary widely. These results suggest institutional reforms in several areas for developing EAP to improve the effectiveness of monetary policy. In terms of overall macroeconomic policies, governments need to further strengthen the transparency of their central banks, improve their monetary policy regimes, and refine their policy operational frameworks. More broadly, structural reforms need to be advanced to strengthen their institutional and regulatory structures, improve competitiveness in the banking sector, and deepen their financial markets. 62 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT be maintained. Across the region, structural reforms are needed to strengthen competitiveness and productivity. These should focus on building human capital through better education and training, and on improving the institutions and business environment. Specifically, in Indonesia, the government needs to reduce the level of restrictiveness of the negative investment list. In Thailand and the Philippines, where large infrastructure projects are underway, public investment management systems need to be strengthened. Vietnam, facing a similar set of challenges as China, also should address the risks associated with its SOEs and distortions in land and capital markets. Reform agendas for the smaller economies in the region reflect their diverse development needs. Energy sector reform is an area of reform priority in Cambodia and Myanmar. Public investment management systems need to be developed in countries such as Cambodia and Lao PDR that undertake large infrastructure projects. ÌÌImproving trade to address the risks of rising protectionism Improvements in tourism competitiveness can generate large gains in trade for the region. Tourism has been growing rapidly in developing East Asia over the last two decades and has the potential to provide substantial economic benefits. However, if this growth is not well managed, it could mean challenges for economic, social, and environmental sustainability. For many of the smaller economies in the region, such as Cambodia, Lao PDR, and Myanmar, tourism is one of the main exports and sources of foreign exchange. Based on demographic, economic, and technological trends, and in particular the emergence of China as the fastest-growing tourism source market, growth will likely accelerate in the coming years. To seize this opportunity to develop tourism sustainably and enhance its economic benefits, countries need to address a range of issues, among which ensuring environmental sustainability is the most pressing one. Specifically, in countries with relatively mature tourism sectors, such as Indonesia, Malaysia, and Thailand, safety and sanitation issues are the main challenges; in countries where tourism development is relatively basic, as in the case of Lao PDR, Mongolia, and Myanmar, infrastructure development is the key issue. And for other countries in the region, tourist service infrastructure and the business environment need to be further improved. Intraregional trade could benefit significantly from deeper regional integration. Opening up markets, harmonizing standards, and streamlining the business environment would significantly boost the productivity of service industries, as well as manufacturing, which relies critically on service inputs (ASEAN Secretariat; World Bank 2015). After the United States withdrew from the proposed Trans-Pacific Partnership, alternative regional platforms have been discussed to advance developing EAP’s trade integration. In particular, faster progress on the Regional Comprehensive Economic Partnership (comprising the 10 ASEAN members, China, Japan, the Republic of Korea, Australia, New Zealand, and India) could help sustain the integration agenda, provided it addresses such issues as nontariff barriers. ASEAN is celebrating its 50-year anniversary in 2017, and, has successfully promoted integration across developing East Asia. ASEAN’s on-going integration, including the launch of the ASEAN Economic Community (AEC) in 2015, has significantly reduced tariffs on trade, boosted FDI flows, including with advanced economies in the region, and stimulated intra-regional trade. However, there remains considerable potential for broadening the scope of integration within ASEAN, particularly with regard to liberalizing services trade and reducing nontariff I.C. Policy considerations 63 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 barriers (World Bank 2015). Recognizing these possibilities, the ASEAN Economic Community (AEC) has developed the AEC Blueprint 2025 that provides the strategic direction of regional economic integration in ASEAN for the coming decade. Several initiatives have been taken recently including: adoption of an ASEAN Trade Facilitation Framework in 2016, which envisions a 10 percent reduction in trade transaction costs by 2020; the ASEAN Agreement on Movement of Natural Persons (MNP) aimed at boosting labor mobility (World Bank 2017); and the ASEAN Institutional Framework on Access to Finance for the Micro, Small and Medium Enterprises (MSMEs). ÌÌFostering inclusive growth A new set of policy challenges has emerged in ensuring the continued inclusiveness of growth and development. While the policy mix aimed at achieving broad-based growth was effective in lifting most of those at the very bottom of the income distribution over the past three decades, new concerns are now emerging across the region beyond a focus on reducing poverty. Public perceptions now point to growing concerns among the regions’ citizens about high and rising inequality, falling mobility and growing economic insecurity. And some of the long-term trends that supported the region’s growth with equity model in the past—such as the demographic transition and rapid urbanization—need to be better managed. Governments in the region can adapt to these changing needs by raising the bar on policy priorities. Policies aimed at advancing inclusive growth should involve ensuring economic mobility and security for all, going beyond the primary focus on reducing poverty. Such an emphasis will entail tailoring poverty reduction interventions to address the heterogeneity of extreme poverty at the country level, fostering mobility by closing gaps in access to jobs and services and seeking to improve the quality and productivity of those jobs, and increasing economic security by putting in place mechanisms that can help reduce households’ exposure to risks while enhancing their ability to cope with the consequences of shocks when they occur. An agenda for the Pacific Island Countries In the Pacific Island Countries (PICs), reforms in several areas could provide significant opportunities over the medium term. Tourism, labor mobility, fisheries, and the knowledge economy are all sectors in which policy and institutional reforms over the medium term could allow the PICs to exploit economic opportunities. In turn, these reforms could lead to significantly higher incomes and employment by 2040. The higher government revenues from increases in fishing license fees and the broadening of the tax revenue base, if combined with improvements in the quality of public spending, could help PIC governments finance significant improvements in human development outcomes (Box I.C.4). Tourism also holds considerable potential to raise incomes and generate employment in the PICs. Comparative advantages of resource endowments and geographical limitations make tourism development a unique opportunity for these countries. To seize this opportunity for long-term development, the PICs need to work on several fronts, including aggressively targeting the Chinese visitor market, engaging more directly in the rapidly-growing Pacific cruising product, expanding the high-end resort market, and capitalizing on the aging 64 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT population in key origin markets by developing a long-stay visitor opportunity for retirees. With appropriate reforms and additional investments, estimates from the World Bank’s Pacific Possible report indicate that the PICs could attract an additional 1 million annual arrivals to the region by 2040 above and beyond a business as usual scenario. This would generate additional annual spending of more than US$1.6 billion, and create more than 110,000 additional jobs. Box I.C.4. Enhancing human development by spending more and spending better: What’s possible in the Pacific?1 The World Bank recently launched a report, titled Pacific Possible, assessing transformative opportunities to boost economic growth in the Pacific over the next 25 years.2 Pacific Possible (PP) quantitatively assesses the extent to which exploiting available economic opportunities—in tourism, labor mobility, fisheries, and the knowledge economy—could lead to significantly higher incomes, employment, and government revenue in 2040 in each of the Pacific Island Countries (PICs).3 For each of these opportunities, an “opportunity scenario” is developed in which the PICs and their development partners intervene through policy changes to realize the potential gains. It is then possible to estimate the potential impacts on per capita incomes, employment, and government revenue by comparing the opportunity scenario with the baseline projections that typically reflect historical trends. This box focuses on how taking advantage of these opportunities could affect long-run spending and human development outcomes. PP interventions would expand PIC revenues, which could help bolster fiscal buffers while also enabling their governments to finance increased spending on public services. If spent well, these increases in public spending have the potential to significantly improve human development outcomes. Pacific Possible opportunities boost government revenues in two ways. First, PP fisheries interventions are projected to directly increase the fishing license fees accruing to PIC governments. Second, interventions in each of the four areas—tourism, labor mobility, fisheries, and the knowledge economy—are projected to boost GDP and hence the tax base in each of the PICs, which leads to higher revenues (assuming the tax share of GDP remains unchanged). In percentage terms, the largest revenue increases in 2040 are in countries that stand to gain the most from higher fisheries income, namely Kiribati, the Federated States of Micronesia, and Tuvalu (Figure BI.C.4.1). Nevertheless, the potential revenue increases (relative to current baseline projections) are also substantial in other countries—including Fiji, Samoa, Tonga, and Palau— (continued) 1 Prepared by Kim Alan Edwards. 2 The material in this box is drawn substantially from “Financing Pacific Governments for Pacific Development,” Pacific Possible Background Report No. 7, World Bank, Washington, DC, 2017d. 3 The countries included in this study are the Federated States of Micronesia, Fiji, Kiribati, the Republic of Marshall Islands, Palau, Papua New Guinea, Samoa, the Solomon Islands, Tonga, Tuvalu, and Vanuatu. For more details, see also “Box I.B.4 What is Possible in the Pacific in 2040?” in the World Bank East Asia and Pacific Economic Update April 2017, World Bank, Washington, DC, pp. 50–53. I.C. Policy considerations 65 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.C.4 continued) highlighting the role that PP interventions can potentially play as drivers of government revenues as well as economic growth. Figure BI.C.4.1. Projected revenue per capita Figure BI.C.4.2. Relationship between human development and public spending per capita in developing small states Constant 2015 US$ Augmented human development index 7,000 0.9 6,000 0.8 5,000 TON 0.7 WSM 4,000 FJI PLW Developing small states mean 0.6 FSM 3,000 RMI KIR TUV 0.5 2,000 VUT 1,000 0.4 SLB 0 0.3 FJI KIR RMI FSM PLW PNG WSM SLB TON TUV VUT 100 1,000 10,000 JJ2015 QQ2040 current projection QQ2040 opportunity projection Public expenditure per capita, average 2010–12, US$ Source: World Bank staff estimates. QQDeveloping small states QQPICs QQLandlocked countries ▬▬Developing small states trendline Source: World Bank staff estimates. By boosting government revenues, the PP interventions can potentially help PIC governments finance increases in public expenditure. According to the Augmented Human Development Index (AHDI),4 which incorporates health, education, and infrastructure provision, all the PICs apart from Fiji, Palau, Samoa, and Tonga currently have human development outcomes that are lower than expected given current per capita levels of government spending (Figure BI.C.4.2). However, after controlling for geographic constraints associated with remoteness and internal dispersion, the “efficiency” of public spending in most PICs—as measured by the development outcomes associated with a given level of public spending per capita— appears to be close to, or better than, that in other developing small states (Table BI.C.4.1, column 4).5 At the same time, human development indicators remain relatively low in several PICs due to low levels of public spending (column 5) and/or geographic constraints (column 3), implying that increasing public expenditure could help improve development outcomes. The PP interventions improve the capacity of PICs to finance such increases in public expenditure. (continued) 4 The Augmented Human Development Index is based on the United Nations Development Programme’s Human Development Index but excludes the income component and adds an infrastructure component. 5 Under this definition, spending “efficiency” will depend on factors that governments can work to improve (for example, improved public financial management or increased allocative efficiency), but also factors that may lie outside government control (for example, geographic characteristics, but also linguistic diversity, history of conflict, and social and cultural factors). 66 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT (Box I.C.4 continued) Table BI.C.4.1. Current human development outcomes in the PICs of which Index of Difference Explained by Explained by Explained human from small geography other sources by shortfall development states average of spending in public inefficiency* spending** Tonga 0.75 0.137 -0.035 0.205 -0.033 Samoa 0.704 0.091 -0.001 0.112 -0.02 Fiji 0.668 0.055 -0.008 0.091 -0.028 Palau 0.659 0.046 -0.052 -0.022 0.12 Micronesia 0.602 -0.011 -0.059 0.022 0.026 Marshall Islands 0.562 -0.051 -0.074 -0.009 0.032 Kiribati 0.534 -0.079 -0.071 0.001 -0.009 Tuvalu 0.532 -0.081 -0.126 -0.052 0.097 Vanuatu 0.457 -0.156 -0.016 -0.08 -0.06 Solomon Islands 0.368 -0.245 -0.005 -0.18 -0.06 Papua New Guinea 0.332 -0.281 0.004 -0.182 -0.103 Small states average 0.613 Source: World Bank staff estimates. Notes: * relative to the small states average. ** the deviation from the small states average index of human development that is associated with a shortfall in public spending. A negative (positive) value indicates more (less) spending would be required, assuming small states average geographic constraints and spending efficiency (i.e. assuming the PICs moved to the regression line estimated in Figure B). For many PICs, the baseline GDP projections imply that governments would find it difficult to finance the levels of public spending necessary to meet aspirational human development targets.6 These estimates of public expenditure are shown in Figure BI.C.4.3. If Pacific Possible opportunities were fully exploited, however, the public spending required in 2040 to meet these targets would fall as a proportion of GDP, due to the associated increases in national income. The direct revenue impacts of fisheries interventions will also provide more fiscal space to finance these expenditure needs in some cases. Over the next 25 years the PP interventions could potentially have a significant impact on the PICs’ ability to finance the public spending needed to achieve their human development targets. Figure BI.C.4.4 shows fiscal balances in 2040 under the human development expenditures scenario, again under both current GDP and revenue projections and PP projections. While the human development expenditures scenario would give rise to unmanageable fiscal deficits in 2040 for most of the PICs under current (baseline) growth projections, PP interventions could have a pronounced positive impact in some cases, including in Federated States of Micronesia, Vanuatu, Kiribati, and Tuvalu, as well as in Palau and Samoa. Nevertheless, budget deficits are projected to remain unsustainably large in the North Pacific countries and in Papua New Guinea, the Solomon Islands, and Vanuatu, even assuming PP growth dividends. This suggests that additional measures to increase domestic revenues and/or aid may be required to finance development- enhancing public spending in these countries over the next 25 years. (continued) 6 The target AHDI is set at the developing small states average (0.613). In those PICs where the AHDI is already above the developing small states average (Tonga, Samoa, Fiji, and Palau), the target is set equal to the current AHDI of the highest-performing PIC on this measure (0.75). I.C. Policy considerations 67 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 (Box I.C.4 continued) Figure BI.C.4.3. Projected expenditures as a share of Figure BI.C.4.4. Projected fiscal balances as a share GDP of GDP (2021–40 average) given human development scenario expenditures Percent Percent of GDP 160 24 60 140 18 45 120 12 30 100 6 15 80 0 0 60 -6 -15 40 -12 -30 20 -18 -45 0 -24 -60 FJI KIR RMI FSM PLW PNG WSM SLB TON TUV VUT FJI RMI FSM PLW PNG WSM SLB TON VUT KIR TUV JJ2040 baseline expenditure JJ2040 HDI expenditure, current GDP projection JJCurrent GDP and revenues projection JJOpportunity GDP and revenues projection JJ2040 HDI expenditure, opportunity GDP projection ▬▬2015 Source: World Bank staff estimates. Source: World Bank staff estimates. Note: The human development target is set at the developing small states average for all PICs except for Fiji, Samoa, Tonga, and Palau, where the target is higher. In addition to increasing the quantity of spending, measures to improve the quality of public spending will be of critical importance in several PICs.7 Although the estimates suggest that spending is relatively efficient in most PICs, in a number of countries—including Papua New Guinea, the Solomon Islands, and Vanuatu—failure to improve the efficiency of public spending would likely mean that the human development targets would remain well out of reach, even if spending levels were to increase significantly. 7 The above analysis assumes that between 2015 and 2040, countries in which spending is less efficient (controlling for geography), are able to boost the efficiency of their public spending to be in line with the small states average. 68 PART I. RECENT DEVELOPMENTS AND OUTLOOK BALANCING ACT References Ahsan, Amirul, Michael Scully, and J. 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Medium-Term Development Agenda  73 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 II.A. Raising the Bar: From Reducing Poverty to Fostering Inclusive Growth in East Asia And Pacific1 Developing East Asia and Pacific is now a region made up entirely of middle-income countries, thanks to rapid growth. As a result, most countries have also seen a dramatic reduction in poverty. While eliminating the remaining pockets of poverty must remain a priority, data on public perceptions point to increasing concerns among the regions’ citizens about high and rising inequality, falling mobility, and growing economic insecurity. Some of the long-term trends that had supported the region’s successful growth with equity model in the past—such as the demographic transition and rapid urbanization— also now need to be managed so as not to turn into challenges. Against this backdrop, this section explores a new characterization of inclusive growth—defined as fostering upward economic mobility (improving one’s lot in life) and economic security (being able to hold onto gains made) for all, in addition to eliminating extreme poverty—which can form the basis for a new social contract in middle-income countries such as those in East Asia and Pacific. Such a concept of inclusive growth goes beyond a binary view of societies in terms of the poor and the nonpoor, and seeks to address the needs and aspirations of all citizens. Central to this analysis is the identification of different economic classes, which can allow governments to address the concerns of their increasingly diverse populations. Introduction Developing East Asia and Pacific (EAP) is now a region of middle-income countries. This transformation has been underpinned by the rapid recovery of most economies in the region from the Asian financial crisis in the late 1990s and their resilience to the global financial crisis a decade later. While middle-income status masks the range of income levels across the region—from over US$12,000 (GDP per capita) in Malaysia to about US$1,100 in Cambodia—it also highlights the tremendous progress that has been made across the region in reducing extreme poverty. In 1990, developing EAP, with almost 1 billion poor people (that is, people living below US$1.90 a day in 2011 purchasing power parity [PPP] terms), accounted for over half of the world’s extreme poor. A quarter of a century later, this number had fallen to about 50 million and made up less than 7 percent of the world’s extreme poor (Figure II.A.1). While there remain countries such as Lao PDR, Myanmar, Papua New Guinea, and Timor- Leste, where the incidence of extreme poverty remains relatively high, it is now much less significant in much of the region. The region’s success in reducing poverty and its evolution into a middle-income region have led to the emergence of a new set of policy challenges in ensuring that growth and development remain inclusive. While the past policy mix aimed at achieving broad-based growth—the East Asian “growth with equity” development model—was effective in lifting most of those at the very bottom of the income distribution, new concerns are emerging across the region making it necessary to go beyond a focus only on reducing poverty. Inequality is high2 or rising in most countries in the region, particularly the large ones. Market-oriented reforms to take advantage of 1 Prepared by Caterina Ruggeri Laderchi, with special thanks to Sudhir Shetty, Salman Zaidi and Nikola Spatafora. 2 In line with much of the literature, inequality is defined as being high if the Gini coefficient exceeds 40 percent. 74 PART II. MEDIUM-TERM DEVELOPMENT AGENDA BALANCING ACT greater integration, and technological change, have brought prosperity to many, but also rising inequality between workers with high and low skills, between urban and rural areas, and in countries such as China and Vietnam, between coastal areas and remote inland locations (Kanbur, Rhee, and Zhuang 2014). An extreme manifestation of this trend is the sense that wealth at the top end of the distribution is becoming increasingly concentrated in many countries, and at a pace that is faster than in other regions of the developing world. Figure II.A.1. Poverty trends 2002–15 Poverty rate, percent 70 60 1004 935 281 50 274 271 262 268 875 245 40 237 806 772 219 706 674 192 30 540 621 182 176 470 168 414 557 158 131 481 122 351 141 119 434 20 115 107 97 318 341 90 288 302 76 247 284 65 10 248 58 214 52 46 41 164 36 140 71 60 50 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 QQEAP: US$1.90 a day QQEAP excl. China: US$1.90 a day QQEAP: US$3.10 a day QQEAP excl. China: US$3.10 a day Source: World Bank EAP Poverty Portal. Note: The most recent household survey used for actual estimates vary from 2006 in Kiribati to 2015 in the case of Indonesia. Estimates prior to 2015 are: (i) derived directly from household survey data; (ii) China 2013 is a survey break and data are not comparable with previous years (iii) interpolated between existing surveys; or (iv) extrapolated based on per-capita GDP growth and historical estimates of the growth elasticity of poverty (GEP), but China, Papua New Guinea and Pacific Island countries based on neutral growth distribution. For 2015 onwards, estimates are projected based on projected per-capita GDP growth and the GEP, and are hence preliminary and subject to revision. Looking ahead, some of the same factors that had supported the growth with equity model and the wave of prosperity that it brought with it could be turning into challenges. Aging and rapid urbanization are particularly important factors. An aging population could slow growth and lead to increased vulnerability for some segments of the population. From a policy point of view, the key concern is that much of the region is “getting old before getting rich”: social insurance systems have not developed enough and accumulated enough resources to cover the aged population with sufficient incomes to avoid poverty (World Bank 2016). Similarly, urbanization, which underpinned broad-based improvements in living standards for the early developers in the region, such as the Republic of Korea and Taiwan (Province of China), helped support an expansion of basic services, has now turned into a challenge for many countries. As people move to take up the opportunities and services that cities provide, and the poor are increasingly concentrated in urban areas, urbanization needs to be managed through policies and investments that ensure that cities are livable and engines of opportunity (see also World Bank, 2017). Together with an uncertain outlook for export-oriented manufacturing to be able to continue to fuel high and broad-based growth, these trends suggest that rising inequality might be more than a transitory phenomenon in the region. II.A. Raising the Bar: From Reducing Poverty to Fostering Inclusive Growth in EAP 75 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 A range of data on public perceptions point to growing concerns among the regions’ citizens about high and rising inequality, falling mobility, and growing economic insecurity. While these trends are not unique to this region, they are especially challenging because they threaten to undermine the region’s long-held belief in economic opportunities being available for all. Respondents in EAP are marginally more likely to think that “income differences are too large” than in Latin America and the Caribbean (LAC),3 another middle-income region but one long synonymous with high inequality.4 And while there is still a strong belief in EAP that high income inequality provides positive incentives to exert oneself (higher than in LAC, for example), this is much lower than in other regions such as Sub-Saharan Africa, South Asia, or the Middle East5. Perceptions of mobility (the belief that hard work will pay off) according to the Gallup poll are no higher in EAP than in LAC, despite much lower levels of inequality. In an interesting twist, while in LAC, all income groups, including the rich, appear to have similar beliefs regarding mobility, higher-income groups in EAP believe less in mobility. That the more affluent in EAP believe less in hard work paying off could reflect both their higher expectations due to the greater visibility of wealth, and a greater awareness that hard work alone might not be enough to get ahead.6 There is also a growing sense of insecurity associated with EAP’s economic success, which is consistent with the “paradox of unhappy growth” noted by Graham and Lora (2009). They highlight how in “rapidly growing middle income countries … high growth rates are, typically, associated with increasing inequality and with uncertainty as rewards to skills are changing” (Graham 2017, 27).7 “Major changes in life satisfaction in the context of record levels of economic growth in China in the 1990s [are…] a case in point” (Graham 2017, 29). While this phenomenon is observed in fast-growing economies around the world, most of EAP might be less equipped to deal with this insecurity than other middle-income regions. Indeed, most countries in LAC and in Eastern Europe and Central Asia (ECA) have in place risk management systems that help households cope with a wide variety of shocks. In EAP, despite significant innovations over the last decade, neither social assistance programs to support the most vulnerable or social insurance measures that help households deal with specific risks have sufficient coverage or provide adequate support. Not surprisingly, policy makers are taking note of these concerns and considering the need for measures that address them. A recent survey of policy makers in the region (Kanbur, Rhee, and Zhuang 2014) found that over half of them believed that high levels of inequality were not acceptable even if poverty was declining, while 95 percent thought that addressing inequality mattered to maintain stability and growth. The rest of this note discusses how to characterize inclusive growth in a way that lends itself to the concerns of policy makers in EAP countries. In doing so, it synthesizes the main elements of the approach adopted by Riding the Wave, an upcoming World Bank report about EAP (Ruggeri Laderchi et al. 2017). That report suggests defining inclusive growth in terms of the three pillars of eliminating extreme poverty, fostering upward mobility, and providing economic security for everyone. Central to the analysis in that report is a focus on economic class, which helps address societal concerns that growth is not delivering for everyone, by emphasizing the needs and aspiration of each specific segment of the population. 3 According to International Social Survey Programme (ISSP) 2009 data. 4 EAP respondents are less likely to agree with this view than respondents in Western Europe though. 5 According to World Value Survey, various waves between 2000 and 2014. 6 Relatedly, evidence from Eastern Europe and Central Asia, another middle-income region, shows that perceptions of actual mobility (and the gap between such perceptions and objective mobility) are greatly influenced by signs of growing polarization in the economy, as well as distrust of public institutions and concerns about unfair institutions (Cancho et al. 2014). 7 This paradox is apparent controlling for GDP levels (which are positively correlated with happiness), as respondents in high-growth countries are on average less happy. 76 PART II. MEDIUM-TERM DEVELOPMENT AGENDA BALANCING ACT Using economic classes to characterize inclusive growth In a middle-income East Asia and Pacific, the policy focus of countries is now less on how growth affects poverty levels and more on how growth affects the welfare of different groups in the income distribution. To capture these concerns, it is useful to look at the different segments of the income distribution. This allows a focus on inclusive growth which includes both the need to eliminate extreme poverty (especially in countries or subregions where it remains high) and concerns for the welfare and aspirations of all groups in the population. Other ways of looking at inclusiveness, such as by focusing on inequality trends (for example, a measure like the Gini index or the relative shares of labor and capital income) have a narrower focus. For example, a similar increase in the Gini index could be affecting different parts of the distribution in different ways in different contexts. To capture the needs and aspirations of different segments of the income distribution, it is useful to characterize five economic classes defined in terms of per capita daily consumption expenditures (PCE). Those classes are defined as the extreme poor, with a PCE of less than US$1.90 a day; the moderate poor, with a PCE between US$1.90 and US$3.10 a day; the economically vulnerable, with a PCE between US$3.10 and US$5.50 a day; the economically secure, with a PCE between US$5.50 and US$15.00 a day; and the middle class, with a PCE of over US$15.00 a day. ÌÌCharacterizing economic classes Partitioning the income distribution into classes has received the most attention from economists in characterizing the poor. There are now well-established extreme and moderate poverty lines that allow for comparisons across countries. After the latest update in the factor used to ensure that the dollar value of different currencies is constant across countries (the purchasing power parity factor, or PPP, last updated with 2011 values), those lines currently stand at US$1.90 and US$3.10 a day in U.S. dollar 2011 PPP terms.8 In the context of middle-income regions (and countries), a lot of attention has been given to the heterogeneity of the poor in terms of barriers that reduce their upward mobility. In Latin America, for example, these factors have been examined for particular groups of the poor, such as indigenous populations (Patrinos, Skoufias, and Lunde 2007), and more recently, the chronically poor (Vakis, Rigolini, and Lucchetti 2016). Although their emphases differ, these studies highlight the role of poor endowments (in terms of assets broadly defined, including physical, human, and social capital). The analysis of the chronically poor, defined as those who do not experience upward mobility out of poverty, in particular, adds an emphasis on the lack of economic security (uninsured risks) and the quality of institutions, especially in not delivering key services, together with the role that distress plays in driving decisions, as important factors constraining upward mobility. Identifying economic classes other than the poor is more challenging as there is no standard methodology. Economists, however, typically refer to a particular income level (Ferreira et al. 2013).9 Despite methodological differences, the literature identifies at least two features that differentiate the middle class from other segments 8 Going forward, the latter line will be specified as US$3.20 per day in U.S. dollar PPP (Joliffe and Prydz, 2016). 9 In contrast, “Sociologists and political scientists … usually define the middle class in terms of education (for example, above secondary), occupation (typically white collar), or asset ownership (including the ownership of basic consumer durables or a house)” (Ferreira et al. 2013). A similar variety of approaches has characterized economic definitions, with an emphasis on, for example, those in some predetermined section of the income distribution (for example, those between the x and the y income percentile; see, for example, Alesina and Perotti [1996]), or those above some relative consumption threshold (x percent of the median; see, for example, Birdsall et al. 1993) or absolute consumption threshold (for example, a threshold derived with reference to global comparators, or to some multiple of the poverty line; see, for example, Banerjee and Duflo [2008]). II.A. Raising the Bar: From Reducing Poverty to Fostering Inclusive Growth in EAP 77 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 of the income distribution. One is a sense of economic security which—in contrast to what happens to the poor— makes middle-class households more likely to “care about and save for the future and to have aspirations for a better life for themselves as well as their children” (Birdsall 2010, 6). Such behaviors could go a long way in explaining consumption patterns that are more skewed toward durables and investment in human capital than those of poorer groups. The other feature of the middle classes, which separates them from the rich, is being dependent primarily on their labor, rather than wealth accumulated “based on prior or current economic rents associated with monopoly or other privileges” (Birdsall 2010, 7), as would be the case for the wealthy. One can hypothesize that the latter characteristic makes the middle classes more dependent on the provision of public goods (such as good governance, including the rule of law, and high-quality provision of services such as education), which enhance the returns to their labor and human capital. In addition, being more likely to have good jobs in the formal sector, the middle classes are easier to tax than other groups, as their income flows are both easier to record than those of the rich and higher, and are generated more from formal sector activity than those of the poor. An empirically derived anchor for the definition of the middle class is provided by the concept of economic security, defined as low risk of falling into poverty. From a methodological point of view, economic security is captured by having sufficient income so as to face a very low chance of falling into poverty in a particular period (López-Calva and Ortiz-Juarez 2011). Crucial for this methodology is the identification a priori of a maximum level of risk of falling into poverty that is consistent with being in the middle class. This approach, which has been used in the case of the LAC region (Ferreira et al. 2013), set the probability of falling into poverty at 10 percent over a five-year period, approximating the average risk of falling into poverty in upper-middle-income countries such as Argentina, Colombia, and Chile. In the case of LAC, this methodology identifies as middle class slightly less than the top third of the income distribution. An important by-product of having defined an economic security line is that a new economic class—the economically vulnerable—can be characterized as those in the population whose income/consumption places them between those living in poverty and the middle class. This class, which in 2009 composed roughly 38 percent of the LAC population (against 30 percent who were poor), has graduated from poverty, but remained at high risk of falling back into it. Applying the economic security approach to EAP requires adopting some modifications to better reflect the income distribution in the region. Applying the Lopez-Calva and Ortiz-Juarez (2011) methodology in EAP leads to an economic security line of US$5.50 a day 2011 PPP.10 Since a large share of the EAP population lives above this line with a low risk of falling into poverty—almost two-thirds of the population in 2015—to add granularity to the analysis this group has been partitioned further into those who live in economic security and those who are part of a more affluent middle class. The lower bound for the middle class has been identified with reference to previous estimates in the literature, and found to be roughly equivalent to US$15 2011 PPP.11 This somewhat arbitrary line allows us to focus on the “upper tail” of those living in economic security, a practice also adopted in country work on the middle class in Indonesia.12 10 For LAC it was estimated at US$10 PPP (2005). 11 This is roughly equivalent to updating for inflation previous estimates which, with different approaches, seemed to converge to US$10 2005 PPP. For example, Kharas (2010) uses US$10 a day to US$100 a day (2005 PPP); Ferreira et al. (2013) adopt a minimum threshold of US$10 a day (2005 PPP) for LAC. And, likewise, respondents to the LatinoBarometro perception survey become more likely to self-identify as middle class than as poor at an income level of US$10 a day (2005 PPP; quoted in Ferreira et al. 2013). Note that Pritchett (2003) argues the upper bound for the global poverty line should be based on the lowest poverty line in the wealthy Organisation for Economic Co-operation and Development countries; the United States has the lowest poverty line, equivalent to US$15.8 a day (2011 PPP). 12 In Eastern Europe and Central Asia, those living in economic security (identified with the middle class) accounted for 42 percent of the population in 2012. This was based on the US$10 a day (2005 PPP) line calculated with LAC, which analysis of Russian and Moldovan panel data suggested could offer a valid “economic security line” in different contexts in the region (Cancho et al. 2014). 78 PART II. MEDIUM-TERM DEVELOPMENT AGENDA BALANCING ACT ÌÌLooking at EAP through the lens of economic class Introducing class differentiation leads to a more nuanced understanding of past trends in the region. While Figure II.A.2A shows the familiar story of the dramatic reduction of poverty in the region (from 55 to 12 percent between 2002 and 2015), Figure II.A.2B offers additional insights. In addition to the virtual elimination of extreme poverty in the region, these include the almost constant share of vulnerable individuals despite the varied events that have characterized the first 15 years of this century, and the rising wave of economic security that has swept the region. Figure II.A.2A. The evolution of poverty in EAP, 2002–15 Figure II.A.2B. The changing structure by economic class of EAP’s population, 2002–15 Percentage of the population Percentage of the population 100 100 Extreme poor 90 90 Poor 80 80 Moderate poor 70 70 60 60 50 50 Vulnerable 40 40 Nonpoor 30 30 20 20 Economically secure 10 10 Middle class 0 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 JJNonpoor (PPP US$3.10 a day and over) JJPoor (less than PPP US$3.10 a day) JJMiddle class (PPP $15 a day and over) JJEconomically secure (PPP US$5.50–US$15.00 a day) JJVulnerable (PPP US$3.10–US$5.50 a day) JJModerate poor (PPP US$1.90–US$3.10 a day) JJExtreme poor (less than PPP US$1.90 a day) Source: EAPPOV national surveys standardized. Note: Poverty rates where household surveys are unavailable have been estimated by interpolating and extrapolating based on GDP per capita growth and growth elasticities of poverty between the two closest available surveys. Figure II.A.3A. Indonesia, 2002–15 Figure II.A.3B. The Philippines, 2002–15a Percentage of the population Percentage of the population 100 100 Extreme poor 90 Extreme poor 90 80 80 Moderate poor 70 70 Moderate poor 60 60 50 50 Vulnerable 40 40 30 Vulnerable 30 20 20 Economically secure 10 10 Economically secure Middle class 0 0 Middle class 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 JJMiddle class (PPP $15 a day and over) JJEconomically secure (PPP US$5.50–US$15.00 a day) JJMiddle class (PPP $15 a day and over) JJEconomically secure (PPP US$5.50–US$15.00 a day) JJVulnerable (PPP US$3.10–US$5.50 a day) JJModerate poor (PPP US$1.90–US$3.10 a day) JJVulnerable (PPP US$3.10–US$5.50 a day) JJModerate poor (PPP US$1.90–US$3.10 a day) JJExtreme poor (less than PPP US$1.90 a day) JJExtreme poor (less than PPP US$1.90 a day) Source: EAPPOV national surveys standardized. Note: Poverty rates where household surveys are unavailable have been estimated by interpolating and extrapolating based on GDP per capita growth and growth elasticities of poverty between the two closest available surveys. (a) Based on income rather than consumption. II.A. Raising the Bar: From Reducing Poverty to Fostering Inclusive Growth in EAP 79 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Class analysis also provides interesting insights on differences among countries. Indonesia and the Philippines, for example, show very different patterns of class structure (Figure II.A.3). In Indonesia after the 2008 global financial crisis, extreme and moderate poverty seem to have started to decline more than in the past, so that developments at the low end of the distribution now follow the same pattern as the rest of the distribution. In the Philippines, despite some decline in poverty since the global financial crisis, particularly over 2014 and 2015, there appears to be significant stability in the class composition of the population, suggesting that there is limited mobility overall. Class analysis can also be useful in comparisons across world regions. In Figure II.A.4, EAP’s experience is contrasted with the other middle-income regions of the world. A note of caution is warranted, as for comparability purposes the figure adopts the same “class” cut-offs adopted for the EAP analysis, although they might not fully represent local realities.13 Nevertheless, the partition of the income distribution highlights how since 2008 there has been much more “stability” in LAC and ECA than in EAP. Whatever the extent of “churning” between segments (which cannot be detected with these data), the net effect has been that roughly the same proportion of people occupied each segment in these two regions. In contrast, in EAP, while movement into the higher segment (the middle class) appears to have slowed, the share of both extreme and moderate poverty has continued to decline in EAP, resulting in an increase in the share of households that enjoy economic security. Figure II.A.4A. Latin America and the Caribbean: Figure II.A.4B. Eastern Europe and Central Asia: evolution evolution of class structure 2002–13 of class structure 2002–13 Percentage of the population Percentage of the population 100 100 Extreme poor Extreme poor Moderate poor 90 Moderate poor 90 Vulnerable 80 80 Vulnerable 70 70 60 60 Economically secure 50 Economically secure 50 40 40 30 30 20 20 Middle class Middle class 10 10 0 0 2002 2005 2008 2010 2011 2012 2013 2002 2005 2008 2010 2011 2012 2013 JJMiddle class (PPP $15 a day and over) JJEconomically secure (PPP US$5.50–US$15.00 a day) JJMiddle class (PPP $15 a day and over) JJEconomically secure (PPP US$5.50–US$15.00 a day) JJVulnerable (PPP US$3.10–US$5.50 a day) JJModerate poor (PPP US$1.90–US$3.10 a day) JJVulnerable (PPP US$3.10–US$5.50 a day) JJModerate poor (PPP US$1.90–US$3.10 a day) JJExtreme poor (less than PPP US$1.90 a day) JJExtreme poor (less than PPP US$1.90 a day) Source: Povcalnet and linear interpolations for the inter-survey years. The three pillars of inclusive growth Riding the Wave (Ruggeri Laderchi et al. 2017) underscores how a focus on inclusive growth—defined as fostering upward economic mobility (improving one’s lot in life) and economic security (being able to hold onto gains made) for all, in addition to eliminating extreme poverty—can form the basis for a new social contract in middle-income countries such as those in East Asia and the Pacific. Such a concept of 13 Based on earlier estimates mentioned above (see footnotes 9–11), as earlier research set the “economic security line” at US$10 dollars in 2005 PPP, it can be expected that the economic security line for those regions lies closer to the “middle class line” of US$15 a day 2011 PPP than to US$5.50. 80 PART II. MEDIUM-TERM DEVELOPMENT AGENDA BALANCING ACT inclusive growth goes beyond a binary view of societies in terms of the poor and the nonpoor, and seeks to address the needs and aspirations of all citizens. ÌÌEliminating extreme poverty Eliminating extreme poverty is a key element in characterizing inclusive growth. While its incidence in the region as a whole is low, it remains high in a few countries. Extreme poverty rates, as a share of the population, are relatively high in Timor Leste, Papua New Guinea, Lao PDR, and the Pacific Island countries of Kiribati, the Federated States of Micronesia, the Solomon Islands, and Vanuatu (all above 10 percent).14 Conversely, the incidence of extreme poverty is negligible in Malaysia and Thailand, both upper-middle-income countries. Yet, most of the extreme poor are now spread across the three larger middle-income countries: Indonesia, China, and the Philippines together account for more than 80 percent of the total. Indonesia alone accounts for two-fifths of all extreme poor. The evidence on the incidence and distribution of extreme poverty across the region suggests that the “last mile” challenge of eliminating extreme poverty means very different things in different contexts. This is all the more so because, even in a given country, those living in extreme poverty can be very heterogenous—think, for example, of the differences between an ethnic minority child living in a remote rural community who cannot access schooling in his or her own language, and an elderly urban inhabitant who does not have access to jobs outside the slum in which he or she lives because of ill health. In the few countries where the incidence of extreme poverty still reaches double digits, eliminating extreme poverty at its core involves providing income generation opportunities for unskilled workers, following the path of the successful countries in the region. In this vein, for example, Lao PDR has focused on improving human capital and access to land for the poor (Pimhidzai 2015). Yet, even in these countries, specific groups may face sources of exclusion, or be located in areas too remote or underserved to benefit from such opportunities— Lao PDR again is a case in point. In countries with lower overall poverty incidence, where extreme poverty is concentrated in small pockets of the population, in contrast, identifying the exclusionary processes that perpetuate extreme poverty is key. Those are often linked to ethnicity and location.15 In Vietnam, for instance, ethnic minorities account for 15 percent of the total population but for over two-thirds of the extreme poor. Identifying, measuring, and tackling the exclusion of ethnic minorities is difficult. Vietnam is again a case in point: ethnic minorities have experienced gains in welfare since the early 1990s, but in recent years progress reducing poverty and child mortality has stalled. Poor education, malnutrition, and low access to sanitation are exerting mutually reinforcing, adverse effects on equality of opportunity for ethnic minority children. While these countries may already have the necessary resources and institutional capacity to run effective programs, the fragmentation of target groups, and their specific needs and constraints, may pose significant challenges in designing and implementing such interventions. 14 For Myanmar, for which poverty data are not available, extreme poverty is likely to be high, as well. 15 These two factors also affect the profile of the extreme poor in some countries with high poverty incidence, such as Lao PDR, though tackling them in low-incidence countries means a more deliberate focus on small subgroups of the population. II.A. Raising the Bar: From Reducing Poverty to Fostering Inclusive Growth in EAP 81 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 ÌÌFostering Upward Mobility Tracking the same households over time provides a nuanced view of mobility in a high growth-high poverty reduction region such as EAP. Country evidence shows that in each class other than the middle class, most people experienced a positive increase in consumption over a two-year period, and the increases were proportionally Figure II.A.5. Class mobility, aggregate, short run Percent of households larger for poorer classes. 16,17 However, while at least one in five people moved to a higher economic class, Vietnam 26 60 14 people from all economic classes experienced downward transitions. And despite all these movements, the Indonesia 37 45 18 largest share of households remained in the same class, even over the long term. Philippines 19 69 12 However, mobility patterns are very country specific, partly reflecting the different country Lao PDR 29 56 16 situations during the period covered. This is highlighted by Figure II.A.5, which summarizes JJClimbers0 20 JJStayers 40 60 JJSliders 80 100 movements across classes in terms of climbers (those Source: Cunningham 2017. Note: “Climbers” denotes households that moved up in economic status, “stayers” those that remained in who improve economic class), sliders (those who moved the same economic class, and “sliders” those that moved to a lower economic class. Data cover different time periods: Indonesia 2008–10; Lao PDR 2008–12/13; Philippines 2006–09; Vietnam 2010–12. to a lower economic class), and stayers (those who saw no change). The contrast between the Philippines and Indonesia is telling. In Indonesia, which experienced the highest incidence of upward moves, the chances of sliding back were also comparatively large. In the Philippines, most people did not move, but the chances of backsliding were also the least. This pattern is striking because the Philippines panel data covers a period that includes both growth and crisis (2006–09). The lack of overall economic dynamism (which can also be seen for the first part of the period shown in Figure 3.B) seems to also have implied greater resilience (lack of backsliding) during the period of economic stagnation. Looking at the characteristics of different groups helps highlight the differences in the trajectories of people over time: The “climbers,” t hose who improved their class, accounted for one-fifth (the Philippines) to one-third (Indonesia and Lao PDR) of households. Households in poorer classes were more likely to improve their class than their richer counterparts (Figure II.A.5). Country patterns differed, with the economically secure being the big winners in Indonesia, while the extreme poor experienced the largest gains in Lao PDR. Those who climbed out of (moderate) poverty and out of economic vulnerability tended to have better access to public services (education, health, and other services) and more physical and financial assets, as well as a broader social network than other households in the same economic class. Those who moved out of economic security into the middle class had more education, were living in an urban area, had access to better jobs, and recorded higher levels of female paid employment. 16 Our evidence on short-term mobility (2 to 3 years) refers to Indonesia, Lao PDR, the Philippines, and Vietnam. Long-term mobility (10 years) refers to evidence from Cambodia, Indonesia, and Vietnam. 17 Our evidence on short-term mobility (2 to 3 years) refers to Indonesia, Lao PDR, the Philippines, and Vietnam. Long-term mobility (10 years) refers to evidence from Cambodia, Indonesia, and Vietnam. 82 PART II. MEDIUM-TERM DEVELOPMENT AGENDA BALANCING ACT The “stayers,” who did not change their economic class, account for between 45 percent of the population (Indonesia) and 69 percent (the Philippines). The class composition of this group varies by country, with the extreme poor being more likely not to change class in Lao PDR and the Philippines, and the economically secure in Indonesia and Vietnam. In Vietnam, those who do not change class tend to be older, more urban, and more educated, compared with those who change class. In contrast, stayers in the Philippines tended to be younger and have greater house assets than those who move.18 The “sliders,” w  ho moved to a lower economic class, represent, on average, about a sixth of all samples. The profile of the backsliders varies by country, with less educated, those receiving less transfers, more rural, and asset- poor households being particularly likely to slide in Vietnam. In the Philippines, only 17 percent of the population moved to a lower class. In the Philippines, sliders are older, with more formal jobs. This analysis suggests that addressing the gaps in terms of access to jobs and services, improving the quality of jobs, and furthering financial inclusion to improve the productivity of micro and small enterprises, are the priorities to foster mobility. Given the country-specific nature of mobility patterns, however, the precise interventions will need to be tailored to country contexts. ÌÌEnhancing economic security Economic security, which enables individuals to hold onto their gains, is a third essential element in this concept of inclusive growth. Lack of security reflects both a high exposure to risks and a limited ability to manage adverse shocks for some. Shocks include economic shocks that affect prices and asset returns, personal shocks such as illness, and natural shocks. EAP, as other parts of the world such as LAC, seems to be very vulnerable to large-scale aggregate shocks such as natural disasters. In the last two decades, different parts of the region have been affected by two major financial crises, several spikes in food prices, natural disasters ranging from earthquakes to tsunamis, and repeated hits by massive cyclones.19 In addition, millions of the region’s inhabitants are exposed to the consequences of large natural shocks, because populations are concentrated in low-lying coastal areas or on marginal and hazardous lands within cities. In these areas, insecurity of tenure provides little incentive for households to invest in risk management, and poor provision of services such as health care compounds the effects of disasters such as flooding (Baker and Gadgil 2017). There are limited data on exposure to and impacts of shocks by class, but Vietnam’s nationally representative panel and other smaller sources offer some insights. One important aspect that emerges from the Vietnam data is that exposure to shocks as reported by households is constant across classes.20 Also, the nature of the shock is similar across class, with economic shocks being the most prevalent (for example, low income, and high 18 Receipt of transfers, degree of job formality, and household wealth (as proxied by household characteristics) do not seem to affect the likelihood of being a stayer in our samples. 19 More rigorous analysis shows how seriously EAP has been hit in the recent past. For example, in the first nine months of 2011, EAP experienced 80 percent of the global losses due to natural disasters (Jha and Stanton-Geddes 2013). 20 Note that shocks are not identified endogenously in the survey data as drops in income, but are self-reported (through questions such as “did you experience a shock” and “what kind”). Their identification, therefore, is not linked to income gains or losses, or to a specific magnitude of the shock (for example, a drop of more than 10 percent of income) or to the specific duration of the shock. II.A. Raising the Bar: From Reducing Poverty to Fostering Inclusive Growth in EAP 83 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 food prices), followed by personal shocks such as bad health or the death of a family member. Natural disasters, however, mostly affect lower-income groups. Despite similarities across classes in terms of shock exposure, negative shocks are associated with a greater probability of moving down the class ladder among the moderate poor and the economically vulnerable. However, even the middle class, despite its affluence, faces risks. Conversely, the moderate poor who do not receive a shock are 50 percent more likely than those who do to move up one class over a two-year period and 34 percent more likely to move up two classes.21 While these findings underline the significance of shocks, they also show that even the moderate poor can overcome negative circumstances if they have the appropriate asset base, as lack of assets rather than shocks appear to explain the slide into poverty. Addressing the overall risk management agenda, covering both idiosyncratic and aggregate shocks and including both ex-ante and ex-post measures, must therefore be a key element of any strategy aimed at supporting inclusive growth. Conclusion Now that developing EAP is made up of middle-income countries, policy making needs to adapt to the changing needs and aspirations of its population. While broad-based manufacturing growth has provided the key to an unprecedented path of poverty reduction, the sustainability of this model is put in question by global as well as regional developments. Factors such as aging and urbanization, which have helped support progress, could now be turning into challenges, while the economic dynamism of the region has been accompanied by high or growing inequalities, and new concerns as to whether avenues for upward economic mobility are still open to all. By raising the bar on its policy priorities—going beyond a primary focus on reducing poverty to a broader emphasis on ensuring economic mobility and security for all—governments in the region can address the needs of their diverse populations, which is highlighted by the analysis by economic class. Such an emphasis will entail tailoring poverty reduction interventions to address the heterogeneity of extreme poverty at the country level, fostering mobility by closing gaps in access to jobs and services and seeking to improve the quality and productivity of those jobs, and increasing economic security by putting in place mechanisms that can help reduce households’ exposure to risks while enhancing their ability to cope with the consequences of shocks when they do occur. 21 The qualitative results are broadly similar across countries. For instance, in rural, marginalized Cambodia, 32 percent of the moderate poor who do not receive a shock move up one or two classes over a two-year period, compared with 26 percent of those who receive a shock. Conversely, the moderate poor who do receive a shock are more likely than those who do not to become extreme poor (the probabilities are, respectively, 32 percent and 3 percent) (Ruggeri Laderchi et al. 2017). 84 PART II. 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Washington, DC: Brookings Institution Press. Jha, Abhas K., and Zuzana Stanton-Geddes, eds. 2013. Strong, Safe, and Resilient: A Strategic Policy Guide for Disaster Risk Management in East Asia and the Pacific. Directions in Development Series. Washington, DC: World Bank. doi:10.1596/978-0-8213-9805-0. Jolliffe, Dean Mitchell, and Espen Beer. 2016. “Estimating international poverty lines from comparable national thresholds.” Policy Research Working Paper No. WPS 7606, World Bank, Washington. Kanbur, R., C. Rhee, and J. Zhuang, eds. 2014. Inequality in Asia and the Pacific: trends, drivers, and policy implications. New York: Routledge and Asian Development Bank. Kharas, H. 2010. The Emerging Middle Class in Developing Countries. Paris: OECD Publishing. Lopez-Calva, Luis F., and Eduardo Ortiz-Juarez. 2011. “A Vulnerability Approach to the Definition of the Middle Class.” Policy Research Working Paper No. WPS 5902, World Bank, Washington, DC. Patrinos, Harry Anthony, Emmanuel Skoufias, and Trine Lunde. 2007. “Indigenous peoples in Latin America: economic opportunities and social networks.” Policy Research Working Paper Series 4227, World Bank, Washington, DC. Pimhidzai, Obert. 2015. “Drivers of poverty reduction in Lao PDR. LAO PDR Poverty Policy Notes.” World Bank, Washington, DC. II.A. Raising the Bar: From Reducing Poverty to Fostering Inclusive Growth in EAP 85 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Pritchett, Lant. 2003. “Who is not Poor? Proposing a Higher International Standard for Poverty.” Working Paper 33, Center for Global Development, Washington, DC. Ruggeri Laderchi, Caterina, Nikola Spatafora, Sudhir Shetty, and Salman Zaidi. 2017. Riding the Wave. An East Asia miracle for the 21st century. Washington, DC: World Bank. Vakis, Renos, Jamele Rigolini, and Leonardo Lucchetti. 2016. Left Behind: Chronic Poverty in Latin America and the Caribbean. Washington, DC: World Bank. World Bank. 2016. Live Long and Prosper: Aging in East Asia and Pacific. Washington, DC: World Bank. doi:10.1596/978-1-4648-0469-4. ———. 2017. Reducing Urban Poverty and Promoting Inclusion in East Asia and the Pacific’s cities. Washington, DC: World Bank. 86 PART II. MEDIUM-TERM DEVELOPMENT AGENDA BALANCING ACT II.B. Tourism in Developing East Asia: Managing Growth and Maximizing Future Benefits1 Tourism in developing East Asia is growing rapidly, and the region enjoys the highest level of tourism receipts among developing regions globally. For many of the smaller economies in the region, such as Cambodia, Lao PDR, and Myanmar, tourism has been one of the main exports and sources of foreign exchange. Most of the growth in international arrivals has been fueled by intraregional travel—especially from Chinese outbound tourism. China has been by far the fastest-growing source of tourism in recent years and the world’s top spender in international tourism since 2012. An additional 61 million Chinese households are expected to be able to afford long-haul international travel by 2023. Based on recent and expected demographic, economic, and technological trends, tourism growth will only accelerate in coming years. This should generate increased opportunities to develop tourism destinations in the region and capture the economic benefits of tourism. At the same time, this growth, if not properly managed, will place greater pressures on the sector’s economic, social, and environmental sustainability. Therefore, countries in developing East Asia must address key market and policy failures to properly manage and benefit from the expected growth. Priorities for action include a stronger emphasis on demand-driven integrated master planning, improvements in the enabling business environment for tourism, better environmental quality standards, the development of more eco-friendly tourism product offerings, and stronger links with the local economies. Tourism and its economic significance in developing East Asia ÌÌTrends and Profiles of Visitors Tourism activity in developing East Asia has grown significantly over the last 20 years.2 Expanding economies, a growing consumer class, and easing of travel restrictions have combined with increased capacity, infrastructure development, and air connectivity to support tourism growth. Between 1995 and 2015, international arrivals to developing East Asia grew at an average annual growth rate of 6.8 percent, the second-fastest among developing regions (behind South Asia, with 9.2 percent). By 2015, developing East Asia was receiving over 150 million international tourists annually, second only to Eastern Europe and Central Asia, which received over 160 million (Figure II.B.1). In the last five years, this visitor growth trend has begun to slow somewhat compared to earlier periods and relative to South Asia and the Latin America and the Caribbean regions—where visitor growth has been accelerating (Figure II.B.1)—but remains a robust 5 percent. 1 This chapter was prepared by Andres F. Garcia and Nikola Kojucharov of the World Bank’s Trade & Competitiveness Global Practice. The analysis is based on an extensive background report prepared by Andres F. Garcia, Kristin Lamoureaux, Hannah Messerli, Bradley Weiss, Elliot Wright, and Vera Jiazhen Zhou. It also benefited from contributions and comments by Asya Akhlaque, Antoine Coste, Paramita Dasgupta, Ahmed Eiweida, Mona Haddad, Birgit Hansl, Jessie McComb, Dina Nicholas, John Perrottet, Wouter Schalken, Sudhir Shetty, Damien Shiels, Congyan Tan and Louise Twinning-Ward. 2 Regional groupings in this report are based on International Development Association (IDA) and International Bank for Reconstruction and Development (IBRD) countries only. IDA and IBRD countries in developing East Asia include Cambodia, China, Indonesia, Lao PDR, Malaysia, Mongolia, Myanmar, the Philippines, Thailand, and Vietnam. “Developing East Asia” will be used in this report to refer to these countries. In 2015, they represented 57 percent of the East Asia and Pacific region’s international tourism arrivals and 52 percent of receipts. Countries in the Pacific are covered in the tourism chapter of Pacific Possible: Tourism (World Bank 2017). II.B. Tourism in Developing East Asia: Managing Growth and Maximizing Future Benefits 87 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Figure II.B.1. International arrivals to developing East Asia have grown strongly during the last 20 years Panel A. International visitors by region Panel B. International visitor growth rates Millions Percent 180 20 160 140 15 120 10 100 80 5 60 40 0 20 0 -5 1995 2000 2005 2010 2015 EAP ECA LAC MENA SSA SAR ▬▬EAP ▬▬ECA ▬▬LAC ▬▬MENA ▬▬SSA ▬▬SAR JJ1995–2005 JJ2006–10 JJ2011–15 Source: WDI 2017. Note: Country aggregates include IBRD and IDA countries only. Across the different countries in developing East Asia, visitor inflows and growth rates vary widely. The fastest visitor growth has come to countries newly open to tourism and transitioning to market economies: Lao PDR, Myanmar, Cambodia, Mongolia, and Vietnam (Figure II.B.2). However, as they began the period with low arrivals, they still received only small fractions of regional totals in 2015: 1.8 percent in Lao PDR, 2.4 percent in Cambodia, 2.4 percent in Myanmar, and 4 percent in Vietnam. The largest shares of tourists to the region in 2015 went to more established destinations, with China receiving 29 percent (56.9 million), Thailand 15.2 percent (29.9 million), and Malaysia 13.1 percent (25.7 million). In addition, China (4th), Thailand (11th), and Malaysia (14th) were among the top tourism destinations in the world, as measured by the total number of international visitors. Figure II.B.2. Visitor inflows and growth rates within Figure II.B.3. Most international tourists originate developing East Asia vary widely from within the region Growth (percent) Market share (percent) Percent 30 40 35 25 30 20 7.2 25 0.5 15 20 2 0.1 0.4 3.1 15 86.6 10 10 5 5 0 0 IDN CHN PHL MYS THA VNM MNG KHM MMR LAO JJ20-year average growth (1995–2015), lhs QQMarket share within EAP (2015), rhs JJAfrica JJAmericas JJEAP JJEurope JJMiddle East JJSouth Asia JJOther Source: Author’s calculations based on WDI data. Source: UNWTO. The vast majority of international visitors to developing East Asia originate from within the region  (Figure II.B.3). Over 85 percent of tourists visiting developing East Asia come from within the broader East Asia region. 88 PART II. MEDIUM-TERM DEVELOPMENT AGENDA BALANCING ACT This share has remained stable over the last 20 years. Europe has long provided the second-largest source of arrivals, maintaining a 6.4 to 8 percent share, but this share shrank by 1 percentage point from 2014 to 2015 (to 7 percent) as growth in arrivals slowed. The Americas, including the Caribbean, have generated the third- largest share historically and accounted for 3 percent in 2015. Their share has declined gradually since 1996 from 4.2 percent. While international visitors are often the focus of policy makers, the scale and pace of growth of domestic tourism in many developing East Asian countries has actually exceeded that of international tourism. As disposable incomes across the region have grown, so have the opportunities and propensities for domestic travel, which is generally more affordable than overseas travel, and in many cases also an appealing substitute, particularly in the larger countries with diverse destinations and tourism offerings (including Thailand, China, Indonesia, and the Philippines). Within the region, only Cambodia, China, Indonesia, Lao PDR, Malaysia, the Philippines, Thailand, and Vietnam report data on domestic tourism (Figure II.B.4). Within this sample, domestic tourism arrivals are 4 to 9 times greater than international arrivals in Malaysia, Vietnam, and Thailand, around 25 times greater in Indonesia, 50 times greater in the Philippines, and over 75 times greater in China.3 The volume of domestic arrivals also exceeds the total population in several of these countries, highlighting the significant scale and economic importance of this domestic market. Moreover, this domestic-arrivals-per-capita ratio has been rising steadily in almost all these countries (Indonesia being the exception), reflecting the rising domestic propensity to travel. Figure II.B.4. Domestic tourism in developing East Asia tends to dwarf international tourism in terms of magnitude, and the propensity for domestic travel has been rising across the region Panel A. Ratio of domestic to international visitor arrivals Panel B. Domestic tourism trips per capita Number of trips China 8 Philippines 7 Indonesia 6 Malaysia 5 Vietnam 4 Thailand Cambodia 3 Lao PDR 2 Korea, Rep. 1 Japan 0 0 20 40 60 80 2009 2010 2011 2012 2013 2014 2015 Ratio ▬▬CHN ▬▬KHM ▬▬IDN ▬▬MYS ▬▬VNM ▬▬PHL ▬▬THA ▬▬LAO Source: Authors’ calculations based on UNWTO and WDI data. ÌÌEconomic Impacts of Tourism The growth patterns of visitor arrivals represent only one dimension of the tourism story in developing East Asia, and the economic impact of this tourism activity must also be considered. While data to comprehensively trace the economic impact channels of tourism activity are not available for most countries in the region, two high-level indicators can provide a broad sense of the magnitude and dynamics of tourism’s economic 3 These figures include both overnight trips and same-day trips, as most countries in the sample currently do not disaggregate the data. II.B. Tourism in Developing East Asia: Managing Growth and Maximizing Future Benefits 89 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 contributions: the direct spending of visitors (tourism receipts), and the multiplier effects of this spending on employment and on activity in sectors with backward and forward links to tourism. ƒƒInternational Visitor Spending International visitor spending in developing East Asia has grown faster than arrivals over the last two decades. Developing East Asia generated a total of US$212 billion in international tourism receipts in 2015, over twice the US$91 billion earned by Eastern Europe and Central Asia, and more than the combined earnings of Latin America and the Caribbean, South Asia, the Middle East and North Africa, and Sub-Saharan Africa (Figure II.B.5). Receipts in developing East Asia have doubled since 2010, and have grown at over 11 percent on average per year since 1995. The vast majority of these regional receipts were concentrated in two countries, however—China (54 percent of the total) and Thailand (23 percent). Figure II.B.5. Tourism spending in developing East Asia is significant and an important export contributor  nnual international tourism receipts by region (IBRD & Panel A. A Panel B. Tourism share of total exports IDA countries only) US$, billions 250 Cambodia Lao PDR Thailand 200 Myanmar Philippines Malaysia 150 Indonesia Mongolia 100 China Vietnam EAP 50 Singapore Korea, Rep. Japan 0 1995 2000 2005 2010 2015 0 5 10 15 20 25 30 ▬▬EAP ▬▬ECA ▬▬LAC ▬▬MENA ▬▬SSA ▬▬SAR Tourism receipts (as % of total exports) Source: WDI 2017. For many of the smaller economies in the region, tourism is one of the main exports and sources of foreign exchange. In Cambodia, tourism income from international visitors (which is classified as a services export) accounts for 29 percent of the value of the country’s total export earnings (Figure II.B.5). This share is lower, but still significant, in some of the region’s other small economies—Lao PDR and Myanmar—ranging from 16 to 19 percent. In the larger and more sectorally diversified economies, such as China and Indonesia, tourism’s exports contribution is still a notable 5 to 10 percent. For developing East Asia as a whole, international tourism receipts represent 6.3 percent of total goods and services exports, greater than in the three largest high-income countries in the region (Japan, Singapore, and the Republic of Korea). ƒƒEmployment and Multiplier Effects The economic impact of tourism goes beyond investment and the direct spending of visitors. First, for each dollar of direct visitor spending on tourism-linked activities (travel, accommodation, tour services), a portion goes 90 PART II. MEDIUM-TERM DEVELOPMENT AGENDA BALANCING ACT toward imported goods and services (also known as spending “leakage”), meaning its direct contribution to GDP is generally less than one-for-one. The spending that does remain in the domestic economy subsequently generates additional indirect demand for other economic sectors with backward and forward links to tourism, while income earned by employees in these linked sectors induces additional spending in the economy. These combined indirect and induced impacts on output, income, and employment are known as spending “multiplier” effects, and must be factored in when estimating the overall tourism contribution to GDP. Accounting for multiplier effects, tourism’s overall contribution to GDP and employment in developing East Asia is on par with global averages, but varies widely within the region. The World Travel & Tourism Council (WTTC) provides country-specific estimates for the direct, indirect, and induced impacts of travel and tourism on the economy (Figure II.B.6). In the developing East Asia region as a whole, the overall contribution (direct plus indirect and induced) of travel and tourism to both GDP and employment was estimated at around 9 percent in 2016—roughly equal to the worldwide average, with a slightly smaller direct contribution and slightly larger indirect and induced contribution. Within the region, however, the variation is large: the largest tourism contribution to the economy is found in Cambodia, where the sector contributes 28.3 percent of GDP and nearly 25.9 percent of total employment. At the other end of the spectrum, the overall tourism contribution to GDP in Indonesia is 6.2 percent, and 5.6 percent to employment. In terms of the magnitude of the tourism multiplier (the ratio of the total tourism contribution to the direct contribution), the largest is in Mongolia, at 3.9 for both GDP and employment, and the smallest is in Vietnam (2.0). Figure II.B.6. The economic contribution of tourism to GDP and employment varies greatly across the region Panel A. Travel and tourism contributions to GDP Panel B. Travel and tourism contributions to employment World World EAP EAP Cambodia Cambodia Thailand Philippines Philippines Thailand Lao PDR Lao PDR Malaysia Malaysia Mongolia China Vietnam Mongolia China Vietnam Myanmar Myanmar Indonesia Indonesia 0 5 10 15 20 25 30 0 5 10 15 20 25 30 Percent of GDP Percent of total employment JJDirect JJIndirect + induced JJDirect JJIndirect + induced Source: WTTC 2017. The multiplier effect of spending on tourism is the highest among services sectors. The WTTC estimates the total GDP multiplier of the tourism sector to average 3.2 globally, the highest among services sectors and second only to automotive and chemicals manufacturing (Figure II.B.7). Within developing East Asia, country-specific benchmarking of the strength of the tourism multiplier relative to other sectors is constrained by data limitations, but WTTC estimates are available for Indonesia, Malaysia, Thailand, and China. For these four countries, the ratio of tourism GDP and employment multipliers to the average economy-wide multipliers is greater than 1, implying that, on balance, spending on travel and tourism delivers a stronger overall economic impact compared to other sectors. II.B. Tourism in Developing East Asia: Managing Growth and Maximizing Future Benefits 91 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Figure II.B.7. The multiplier effect of spending on tourism tends to be stronger than for other sectors Panel A. World average GDP multipliers Tourism sector multipliers (relative to economy-wide Panel B.  average) Ratio Automotive 2.5 manufacturing Chemicals manufacturing 2.0 Travel and tourism Communication 1.5 Financial services Education 1.0 Agriculture 0.5 Mining Total economy 0 0 1 2 3 4 5 6 7 Indonesia Malaysia Thailand China Ratio JJGDP JJEmployment Source: WTTC 2012. Source: Authors’ calculations based on WTTC (2017) data. ÌÌEmerging Trends ƒƒDemographic, economic, and technological shifts Demographic, economic, and technological shifts are fueling tourism growth in developing East Asia. Millennials travel more than any other generation, including baby boomers, and they will likely travel more as their income and wealth grow. Increasing urbanization and a growing middle class will raise the population’s desire and ability to engage in tourism. The spread of internet access and mobile technology has also empowered travel consumers and spawned a new sharing economy. While travel suppliers and intermediaries maintain ownership of their customers and data, they also collaborate to deliver improved travel experiences and generate new sources of revenue (McKinsey & Company 2017). For example, the Chinese e-commerce platform, Alibaba, is offering a cloud-based hotel management system to hotel brands on its platform and is planning to integrate virtual reality technology into an online hotel reservation system, enabling its users to have an immersive view of a hotel on its app. ƒƒGrowth in the Chinese outbound market China has been by far the fastest-growing tourism source market in recent years and has been the world’s top spender in international tourism since 2012. Boosted by rising disposable incomes, an appreciating currency, improved travel facilitation, and an easing of restrictions on international travel, Chinese outbound travel has been growing exceptionally over the last two decades. According to WTTC (2016), Chinese tourists spent US$215 billion outside mainland China in 2015, a 53 percent rise from the US$140 billion spent in 2014, despite the country’s economic slowdown. 92 PART II. MEDIUM-TERM DEVELOPMENT AGENDA BALANCING ACT Continued robust income growth and expansion of China’s middle class will make long-haul travel even more achievable in the coming decades. In China, the number of Chinese households earning above US$35,000 per year—a key income level at which long-haul international travel becomes affordable—rose by 21 million from 2003 to 2013 (InterContinental Hotels Group 2015). As Table 1 shows, an additional 61 million households will pass this threshold by 2023. Table II.B.1. Chinese travel behavior varies based on household income, with an increasing share able to afford short- and long-haul trips Household income level (US$) 2013 (millions of 2023 (millions of Market segments households) households) Up to US$20,000 364 312 Domestic travel US$20,000 to US$35,000 44 93 Short-haul trips and low-cost accommodations US$35,000 to US$70,000 21 63 Long-haul trips and higher-cost accommodations US$70,000 to US$150,000 5 21 Luxury accommodations and tend to spend more while on long-haul trips Over US$150,000 1 4 Customized luxury travel Source: InterContinental Hotels Group 2015. China has multiple market segments looking for new experiences. A study conducted by the Boston Consulting Group (2013) projects that, from 2012 to 2030, three segments of China’s outbound leisure market will grow the fastest: young “affluents” (ages 18 to 30), senior professionals (ages 45 to 55, traveling without an organized tour group), and small groups of families and friends (ages 30 to 45, also traveling without an organized tour group). By 2030, these segments combined will account for an additional 100 million annual trips and US$340 billion in annual spending. This trend implies significant economic opportunities for developing East Asian countries that can offer niche and higher-end products to capture this market of more experienced travelers. Tourism drivers and challenges Tourism is a complex activity that engages both public and private sectors, as well as civil society, at different points and in a multitude of ways throughout its development lifecycle. Moreover, tourism is multisectoral in nature and its successful development requires coordinated improvements along several dimensions, including infrastructure, finance, and education, among many others. Although there is no one accepted structure or model for tourism development, the World Economic Forum’s Travel & Tourism Competitiveness Index (WEF TTCI) identifies the key tourism market enablers (Box II.B.1). The results of the 2017 WEF TTCI help identify the main drivers and challenges faced by developing East Asia (Figure II.B.8). II.B. Tourism in Developing East Asia: Managing Growth and Maximizing Future Benefits 93 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Box II.B.1. The World Economic Forum Travel and Tourism Competitiveness Index (WEF TTCI)  he WEF TTCI measures countries’ tourism competitiveness across four major categories, broken down into T 14 pillars and 93 separate indicators. In the latest version, published in 2017, 136 countries are ranked, with Spain (1), France, Germany (3), Japan (4), and the United Kingdom (5) in the top five. While scores for most indicators are based on secondary data, a portion of the information comes from the Executive Opinion Survey that WEF administers annually to over 14,000 global business leaders. Travel & Tourism Competitive Index T&T policy and Natural and cultural Enabling environment Infrastructure enabling conditions resources Prioritization of Air transport Business environment Natural resources travel & tourism infrastructure Ground and port Cultural resources Safety and security International openness infrastructure and business travel Tourist service Health and hygiene Price competitiveness infrastructure Human resources Environmental and labour market sustainability ICT readiness Source: WEF 2017. Figure II.B.8. Tourism in developing East Asia is driven by its price competitiveness but suffers from low environmental sustainability WEF WTTI ranking distribution 136 119 102 85 68 51 34 17 0 nes s rce s vel ism rke t re ss ent ess ty re re ien e lity tra our ctu nne din uri ctu ctu abi ive sou dt ma tru ope nm rea sec tru tru hyg etit l re ess an or ras al nviro nd ras ras nd tain p ra bus in vel d la b rt i nf tion ss e ICT a rt i nf e in f ha us com atu tra an ety vic alt ntal s Pri ce N nd of ces nsp o ern a sin e Saf po ser He me sa our tra Int Bu and ron rce tion es Air nd ri sm i sou riti za nr rou Tou Env l re o ma G tur a Pri Hu Cul ‹‹Average SSMinimum QQMaximum Source: Author’s calculations using WEF TTCI data. 94 PART II. MEDIUM-TERM DEVELOPMENT AGENDA BALANCING ACT ÌÌDrivers One of the region’s most important drivers is its price affordability as a tourism destination. Based on the cost of living, the region includes some of the world’s most affordable destinations, with Cambodia, Indonesia, and Vietnam the most affordable.4 Moreover, the region benefits from having some of the world’s most affordable first- class hotels, which can be found in China, Indonesia, and Malaysia under US$100 a night. This compares positively with the neighboring high-income destinations of Japan, Singapore, and Korea (Figure II.B.9). Figure II.B.9. Developing East Asia benefits from being Figure II.B.10. Developing East Asia benefits from having a price-competitive region multiple cultural heritage sites Cost of living index Average daily rate (US$) Number of World Heritage Sites in developing East Asia 90 250 60 80 50 70 200 60 40 150 50 30 40 100 30 20 20 50 10 10 0 0 0 KHM CHN IDN MYS PHL THA VNM JPN SGP KOR KHM CHN IDN LAO MYS MNG MMR PHL THA VNM JJCost of living index, lhs QQAverage night rate in first class hotel, rhs JJCultural JJNatural JJMixed Sources: Numbeo (www.numbeo.com) and WEF 2017. Source: Authors’ estimations using UNESCO data (2017). Overall, the region benefits from good air transport infrastructure, but has some lagging countries. The number of takeoffs (domestic and international) per capita can be used as an estimate of the effectiveness of the country’s air transport infrastructure. In this case, Malaysia leads the region with 14 takeoffs for every 1,000 citizens, while Cambodia, Myanmar, and Lao PDR lag with around one takeoff per 1,000 citizens. Tourism in developing East Asia also benefits from its many natural and cultural attractions. The region hosts 92 World Heritage Sites, including 61 cultural, 26 natural, and 5 mixed World Heritage Sites (Figure II.B.10).5 China, with 50, has the second-largest number of World Heritage Sites (35 cultural, 11 natural, and 4 mixed) in the world, trailing only Italy, with 51. Indonesia (4 cultural and 4 natural) and Vietnam (5 cultural, 2 natural, and 1 mixed) are followed by the Philippines, which has 6 sites (3 cultural and 3 natural), and Thailand, which has 5 sites (3 cultural and 2 natural). Indonesia has a site on the List of World Heritage in Danger, meaning its World Heritage status could be removed if corrective actions are not taken (UNESCO 2017). ÌÌMarket and Policy Failures The competitiveness of the tourism sector in developing East Asia is hindered by market and policy failures. The region performs poorly on environmental sustainability, health and hygiene, tourism service infrastructure, 4 Based on Numbeo’s cost of living index, which is relative to New York City. The index is a relative indicator of consumer goods prices, including groceries, restaurants, transportation, and unitalities. 5 The number of World Heritage Sites is not entirely indicative of the economy’s cultural and natural resources. The World Heritage application process requires financial and technical resources that not all economies possess. Yet World Heritage status is probably one of the most powerful marketing labels for tourism sites. II.B. Tourism in Developing East Asia: Managing Growth and Maximizing Future Benefits 95 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 and information and communications technology (ICT) readiness. This was previously depicted in the poor WEF WTTI rankings (Figure II.B.8). The environmental sustainability of the tourism sector is affected by pollution, threatened species, and health and hygiene. In Beijing, haze pollution has an impact on the tourists’ decision-making processes, causing a portion of potential tourists to cancel tourism plans and avoid certain times of the year (Zhang et al. 2015). In the region, only Indonesia, Mongolia, and the Philippines have average pollution levels below the World Health Organization recommendations. Similarly, poor access to improved sanitation can deter tourism development. This is especially important to countries such as Cambodia, Indonesia, Lao PDR, Mongolia, and the Philippines, where less than 75 percent of the population have access to improved sanitation. In Indonesia, poor sanitation contributed to US$166 million per year in tourism loses (World Bank 2008). Finally, the region also hosts a significant share of threatened species, such as the tarsier, which draws tourists to the southeastern part of the Philippines. In the Philippines, 20 percent of total species are considered under threat, followed by Malaysia and Indonesia, with 14 percent. Figure II.B.11. Tourism in developing East Asia is negatively affected by pollution, threatened species, and limited access to improved sanitation Pollution in the region is generally above WHO guidelines Many species are threatened There are areas without access to improved sanitation Mongolia Mongolia Malaysia Philippines Lao PDR Thailand Indonesia Thailand Vietnam Cambodia Vietnam China Malaysia Cambodia Philippines Thailand China Lao PDR Vietnam Indonesia Indonesia Lao PDR Malaysia Mongolia China Philippines Cambodia 0 10 20 30 40 50 0 5 10 15 20 0 20 40 60 80 100 Particle matter (2.5) concentration Threatened species (% of total) Access to improved sanitation (% of population) Source: WEF 2017. Figure II.B.12. There is room to improve tourism infrastructure and use of internet for business transactions Quality of tourism infrastructure (out of 7) Internet use for business to consumer transactions (out of 7) 6 6 5 5 4 4 3 3 2 2 1 1 0 0 MNG VNM LAO PHL KHM CHN IDN MYS THA LAO KHM MNG PHL VNM CHN THA IDN MYS Source: WEF 2017. 96 PART II. MEDIUM-TERM DEVELOPMENT AGENDA BALANCING ACT The relatively poor quality of tourism and ICT infrastructure is also a notable problem. When asked to assess the quality of tourism infrastructure (that is, hotels, resorts, entertainment facilities), investors characterized the infrastructure in Mongolia and Vietnam as poor. Similarly, they rated the infrastructure in Lao PDR, the Philippines, Cambodia, China, and Indonesia to be just above average. Similarly, the availability of ICT infrastructure can impact tourism development. For example, the use of the internet for e-commerce can promote tourism development by creating transactions that were not possible before (inclusion), lowering the costs of existing transactions (efficiency), and giving rise to various types of scale economies (innovation) (World Bank 2016a).6 As part of 2017 WEF TTCI, investors were asked about the use of the internet for selling their goods and services to consumers. In this area, Malaysia, Indonesia, and Thailand have the greatest use of e-commerce, compared to Lao PDR, Cambodia, and Mongolia, with the lowest. ÌÌCountry Groupings Given the region’s diverse composition, countries can be grouped based on their level of tourism development. Based on the previous analyses of tourism performance and competitiveness, three country groups were identified for tourism in developing East Asia: Potential, Emerging, and Consolidating7 (Table II.B.2). •• Potential countries are working on governance issues, have shown some interest in developing their tourism sectors, have some basic infrastructure for tourism, but still face difficulties with tourism regulation, resources, and institutions. •• Emerging countries have improved their governance indicators, are prioritizing tourism sector development, and are gradually increasing their tourism flows. •• Consolidating countries have relatively mature tourism sectors, are committed to continued support for the sector, and are top performers on various economic and tourism indicators. Table II.B.2. Developing East Asia’s economies can be grouped based on their level of tourism development Group / income Lower-middle income Upper-middle income Consolidating Indonesia Malaysia, Thailand Emerging Cambodia, Philippines, Vietnam Chinaa Potential Lao PDR, Mongolia, Myanmar, — Note: a. China is categorized as Emerging based on the relative nascence of its international tourism sector, low per capita arrivals, and environmental sustainability concerns. Countries in all groups face fundamental market and policy failures that inhibit the competitiveness of their tourism markets. The most problematic issue in developing East Asia is environmental sustainability. A WEF-sponsored study examining the correlation between WEF TTCI scores and tourism performance identified environmental sustainability as the pillar that most closely correlates with tourism performance among emerging economies (WEF 2013).8 Yet, other constraints vary considerably among developing East Asia’s economies. They are summarized below for the different country groupings. 6 For example, Airbnb created competition in the lodging industry, providing more options for travelers and lowering the high rents previously enjoyed by the lodging sector. Similarly, Uber and Grab had a similar impact on the local transportation sector. 7 These categories and descriptions were developed by Trade & Competitiveness for the Tourism in Africa: Harnessing Tourism for Growth and Improved Livelihoods report (World Bank 2014). 8 To determine an economy’s “tourism performance,” the study considered its tourism arrivals (simple average growth rate of inbound tourism from 2007 to 2011) as well as its arrivals volatility rate (standard deviation of annual growth rates during the same period). II.B. Tourism in Developing East Asia: Managing Growth and Maximizing Future Benefits 97 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 The “potential” countries of Lao PDR, Mongolia, and Myanmar primarily face problems linked to the availability and quality of infrastructure. Their weakest performance is on ICT readiness (average ranking of 113), followed by ground and port infrastructure (average ranking of 111), and air transport infrastructure (average ranking of 105). Tourist service infrastructure and the business environment are the key issues among developing East Asia’s “emerging” countries of Cambodia, China, the Philippines, and Vietnam. Particularly weak pillars for these emerging economies are tourist service infrastructure (average ranking of 99) and the business environment (average ranking of 92). Among the “consolidating” countries of Indonesia, Malaysia, and Thailand, safety and sanitation issues are prominent. The “consolidating economies,” with the exception of Malaysia, struggle with the safety and security pillar (average ranking of 92) and health and hygiene (average ranking of 92). Policy Priorities Understanding the role of the public and private sectors in the development of tourism is critical to fostering its sustainable growth. Failure to properly engage stakeholders during the planning and management phases of destination development may result in lack of support for the sector or poorly implemented, ineffective, or potentially detrimental tourism. In fact, sustaining tourism growth requires continuous stakeholder engagement and adapting of policies. Based on the challenges faced by the region as a whole and specific constraints for the different country groupings identified above, the following policy priorities are key to managing growth and maximizing the future benefits of tourism in developing East Asia. ÌÌDemand-Driven Investment Planning Across all three country groupings in the region, tourism master planning is crucial for identifying and phasing public and private investments. The public sector is strategically placed to spearhead master planning initiatives that establish a common framework for the development of destinations and the management of their tourism carrying capacity. Countries can benefit from the preparation of integrated tourism master plans (ITMPs) for destination areas, based on a rigorous assessment of tourism demand and economic analysis for each destination, and prepared in close consultation with all stakeholders, including local communities and the private sector (see Indonesia example in Box II.B.2). ITMPs provide the basis for identifying and prioritizing the public investments that are most critical to unlocking the demand potential of a given destination— that is, transport infrastructure, basic services, and amenities. ITMPs are an important input into the overall strategy and vision for a destination, helping to outline the investment gaps where private investment will most likely be needed (that is, for accommodation), and thus establishing the focus areas for promotion of private investment. Finally, ITMPs provide a unified planning framework for the multitude of stakeholders engaged in the destination development process to ensure that 98 PART II. MEDIUM-TERM DEVELOPMENT AGENDA BALANCING ACT their expenditures and activities are (a) consistent with the environmental, social, and cultural opportunities and constraints of the destinations; and (b) avoid degradation of the natural and cultural assets that attract visitors. The preparation of these ITMPs is particularly important for countries in the “potential” country group, which have fewer established destinations and are more likely to embark on developing new destinations. Since a large share of up-front investment for these destinations will relate to enabling physical infrastructure—particularly to address the noted deficiencies in ICT and transport infrastructure—systematic planning and screening of these investments will be crucial to ensure scarce public resources are deployed in the most efficient manner. The “consolidating” group of countries can also benefit from strengthening systems for tourism planning and investment as their mature tourism destinations begin to reach infrastructure and service capacity limits. Lingering issues with safety and security, as well as health and hygiene in these countries partly reflect the increased strain on public services (that is, local law enforcement and tourist police) and basic sanitation Box II.B.2. Demand assessments and integrated tourism master planning in Indonesia n an effort to capitalize on the country’s diversity of natural and cultural assets and close the tourism I competitiveness gap with neighboring countries, the Government of Indonesia, in late 2015, identified 10 high-potential tourism destinations for priority development, and decided to start with three of them— Lombok, Borobudur, and Lake Toba.  t the outset of this initiative, however, coordination mechanisms for tourism development at the national A level were nascent, and those at the province and destination level were weak or absent, which was especially problematic given Indonesia’s highly decentralized governance structure. In planning their budgets for the different priority destinations, different ministries and local authorities were using different sets of assumptions about the scale of tourism activity that could be expected, and not screening their investments for tourism relevance. Growth targets for visitors, tourism GDP, and employment were being set without a comprehensive and systematic assessment of future demand and the competitiveness of each destination. This raised the risk of overly costly public spending scenarios with limited impact on tourism or local economic development.  o prepare integrated destination master plans, the government initiated market demand and investment T needs assessments for each priority destination, which provided a rigorous forecast of the magnitude and composition of future tourism demand, and the supply-side requirements to accommodate this demand. Based on the results of these assessments, integrated tourism master plans and investment budgets are being prepared for each destination. These master plans will be validated and adopted at all layers of government, to ensure that relevant agencies are working off a unified set of objectives, plans, and assumptions, thus helping to improve intragovernmental coordination and reduce the risk of duplicative public spending. Indonesia aims to strike a balance between the political temptation to rush into developing destinations and long-term comprehensive planning by starting destination development with “no regret” investments, while waiting for the master plans for those investments that need stronger planning. II.B. Tourism in Developing East Asia: Managing Growth and Maximizing Future Benefits 99 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 infrastructure to keep up with growing tourism demand. A periodic reassessment of demand trends and investment gaps is therefore an important input into ongoing destination management efforts, helping to inform and guide the planning and execution of investments needed to alleviate emerging capacity constraints and improve the overall visitor experience. ÌÌEnvironmental Sustainability While public and private sectors both have a significant role to play in improving the environmental sustainability of tourism, governments must lead. Improving environmental sustainability is a priority for all three country groupings, which perform poorly in multiple environmental sustainability areas including pollution, water and sanitation, and threatened species. Managing sustainability requires both infrastructure investments and the development and enforcement of quality standards in all countries. Developing East Asian economies across country groupings can benefit from infrastructure investments that increase access to improved sanitation, waste management, and drinking water. The private sector will have a greater incentive to connect to central systems if those systems provide the services that they demand (as identified in ITMP). Moreover, standards in the industry can hold the private sector accountable in areas such as waste management and pollution, among others. For example, the Singapore Tourism Board (STB) developed the sustainability guidelines for the Singapore meetings, incentive travel, conferences, and Box II.B.3. The effectiveness of ecotourism as a means of protecting the local environment: An example from Cambodia C  ambodia is one of the world’s conservation frontlines, with forests home to 45 species of mammals, 46 species of birds, and 17 species of reptiles on the International Conservation Union’s Red List of endangered species. To help protect bird species from mounting threats, ecotourism programs have been developed in villages such as Tmatboey. Key elements of programs include the development of community-wide awareness campaigns, creation of village committees to help manage the program, training of community members in tour guiding and hospitality training, development of birdwatching tours and local accommodations, and the marketing of ecotourism packages.  he program in Tmatboey was highly successful. From 2005 to 2008, the number of visitors increased by an T average of 36 percent per year and revenues doubled. Overall, 40 percent of the village’s families earned income from tourism services. In addition, 24 percent of revenues went to a village fund used to pay for a new school, build a road, repair water pumps, and dig new wells. This gave all villagers a strong incentive to protect their natural assets. Indeed, substantial increases of wildlife were noted. For example, the population of White-shouldered ibis, one of the rarest birds on the planet, increased from a single pair in 2002 to at least 23 individual birds in 2008. Source: Clements et al. 2010. 100 PART II. MEDIUM-TERM DEVELOPMENT AGENDA BALANCING ACT exhibitions (MICE) industry (Singapore Tourism Board 2013). These guidelines are referenced from international standards such as ISO 20121 and the APEX/ASTM Environmentally Sustainable Meeting Standards. The sustainability guidelines cover seven industry categories from across the business events ecosystem, including hotels, venues, event organizers and meeting planners, transportation, food and beverage, and audiovisual setup. Areas covered under the guidelines include advice on waste management and the efficient use of water and energy, as well as initiatives that encourage employees to develop a commitment to sustainable practices. Tourism products can be leveraged to protect the local environment, including threatened species. Studies on tourist consumer behavior indicate that there is also a growing awareness of environmental, social, and cultural impacts that tourism can generate. Tourists who seek sustainable tourism activities are sensitive to their impacts. In addition, some research indicates that the sustainable tourism market is willing to pay more to visit a destination that demonstrates responsible practices (Pulido-Fernández and López-Sánchez 2016). The combination of sustainable behavior and potential higher spending provides evidence of a market segment that can be beneficial to destinations where environmental or cultural assets may be at risk from low-yielding mass tourism. This is exemplified in the case of Cambodia, where tourism products are being used to protect the local environment (Box II.B.3). Box II.B.4. Maximizing backward links of tourism activities in Lao PDR  espite strong growth in tourism arrivals at the UNESCO World Heritage Site of Luang Prabang, poverty D levels were still high (over 30 percent) as local communities struggled to enter the tourism value chain. To improve local links and better distribute tourism spending, a cluster of UN agencies with funding from Switzerland’s State Secretariat for Economic Affairs launched the “Enhancing Sustainable Tourism, Clean Production, and Export Capacity in Lao PDR” project in 2011. The project targeted two sectors: agriculture and handicrafts (OECD, UNWTO, WTO 2013). n the agricultural sector, over 100 farmers were organized into producer groups, given technical assistance I on improving the quality and variety of their produce, and connected to hotel and restaurant owners. In addition, the fee-based “Luang Prabang Organic Agriculture” association was set up to support quality control and marketing efforts. The association is now the main supplier of fresh vegetables to high-class hotels and restaurants in the area. During July 2012 to January 2013 alone, they sold 450 tons of vegetables (30 different varieties) worth US$193,000 (ITC 2017). Members earn up to US$700 a month, compared with previous average revenues of US$300 per month (OECD, UNWTO, WTO 2013). T  he project also provided training and marketing support to over 250 cotton and silk craft artisans. The quality of their weavings was enhanced through support from an international designer. To market the products, the Luang Prabang Handicraft Association was formed, the “Handmade in Luang Prabang” label of origin was developed, and on-site weaving demonstrations were organized at hotels and museums. Over 120 producers and traders adopted the label and sales at the night market increased by 60 percent. Producers purchase each label for US$0.10, which covers LPHA’s administrative costs and thereby ensures the sustainability of the initiative (ITC 2017). II.B. Tourism in Developing East Asia: Managing Growth and Maximizing Future Benefits 101 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 ÌÌFostering Tourism Links to Local Economies Promoting the participation of local workers and firms in the tourism value chain is essential to maximizing the “multiplier” effect of tourism spending. The strongest multiplier impact comes when forward and backward tourism links to other economic sectors are maximized, and leakages (that is, need to import goods and services) are minimized. Fostering such local links involves ensuring that there is (a) a sufficient quantity of local workers and firms in the linked sectors that produce the various goods and services demanded by tourists (for example, hotels, restaurants, agriculture, transport, recreation), and (b) that these local goods and services meet the quality standards required by different tourism market segments (from low-end domestic visitors to 5-star hotels and luxury-seeking international visitors). In many cases, these skills and quality shortages can begin to be addressed through targeted training programs for tourism sector professionals, and technical assistance to firms to obtain various product and service quality certifications. A package of such assistance has been used with considerable success in Lao PDR (Box II.B.4). Box II.B.5. Promoting tourism by reforming the business environment: An example from Peru  he Cusco region received over 2.7 million tourists in 2014. Its top draw is Machu Picchu, the iconic 15th T century Incan citadel that was inducted as a World Heritage Site in 1983. While visitation to the region increased 150 percent from 2005 to 2014, excessive government red tape meant that the private sector was unable to satisfy the surging demand (DIRCETUR Cusco 2015).  or the people of Cusco to fully benefit from the tourism boom, the government had to ease its burdensome F business regulations. In fact, a 2012 study conducted by the Peru Hotel Association found that government obstacles were delaying half of the expected amount of new hotel investments in Cusco. These delayed investments were valued at approximately US$776 million. To support the government in reducing the bureaucratic barriers to opening a new business, the World Bank Group launched an advisory project in 2012. The project worked toward reducing processing time and costs by increasing administrative efficiency. This was achieved by automating some processes, elaborating clearer and specific requirements for others, and providing extensive training for public servants. B  y the end of the project, over 150 unnecessary business registration processes were eliminated. These included duplicative forms, official letters to mayors, photos of buildings in process, and copies of worker IDs. Through the elimination of so many processes and the streamlining of others, the business registration process has been reduced by an average of three years (World Bank 2016b). These reforms are also estimated to save businesses several million U.S. dollars per year—with most of the savings being experienced by small businesses (SECO 2015). 102 PART II. MEDIUM-TERM DEVELOPMENT AGENDA BALANCING ACT ÌÌConducive business environment for tourism Creating a conducive business environment for tourism investment and business entry is key for the “emerging” group of economies. As the case of Peru, which is illustrated in Box II.B.5, shows simplifying the bureaucratic burdens to business entry and investment can unlock the sector’s potential to attract more investment and for local firms to respond to and capture tourism demand. Conclusion The rapid tourism growth experienced in developing East Asia over the last decade set to continue on the back of favorable economic, demographic, and technological tailwinds, but its associated opportunities and risks must be carefully managed. Sustained or increased tourism growth from both international and domestic arrivals—supported by increasing urbanization, middle-class incomes, propensity to travel among millennials, e-enabled tourism services, and Chinese outbound tourism—will generate significant new opportunities to develop tourism destinations in the region. At the same time, this growth, if not properly managed, will place greater pressures on the sector’s economic, social, and environmental sustainability. While the public sector cannot singlehandedly steer the tourism sector on a sustainable growth path, targeted policy interventions can go a long away in facilitating stronger private investment in the sector, promoting tourism’s links with the broader economy, and ensuring that the natural and cultural assets which attract tourists in the first place are adequately protected. Depending on their stage of tourism development, different developing East Asian economies will need to prioritize certain policy initiatives over others, but the general menu of issues to be addressed is broadly similar across the region. These include a stronger policy emphasis on conducting demand-driven integrated planning, improvements in the enabling business environment for tourism, better environmental quality standards, the development of more eco-friendly tourism product offerings, and boosting the participation of local workers and firms in the economic opportunities created by tourism. II.B. 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Dang. 2015. “Tourists’ Perception of Haze Pollution and the Potential Impacts on Travel: Reshaping the Features of Tourism Seasonality in Beijing, China.” Sustainability 7: 2397–2414. II.B. Tourism in Developing East Asia: Managing Growth and Maximizing Future Benefits 105 This page intentionally blank. WORLD BANK EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Part III. Country Summaries and Key Indicators  107 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 CAMBODIA up. The share of the newly emerging exported products rose to 8.7 percent of total exports in 2016, up from less than two percent in 2010.1 Authorities’ efforts to attract international tourists seem to have paid off. Tourist arrivals accelerated to 12.8 percent growth (y/y) during the first six months of 2017, compared with 5 percent in 2016. Credit growth has slowed, decelerating to 18.2 percent y/y in mid-2017, down from 25.8 percent in 2016. Deposits growth remained strong, increasing at 20 percent, reflecting healthy capital inflows. Rising 2016 foreign currency deposits have contributed to the Population, million 15.8 expansion of broad money, which grew by 19.7 percent GDP, US$ billion 20.0 by mid-2017, compared with 17.9 percent in 2016. GDP per capita, US$ 1,265 School enrolment rate, primary (% gross)a 116.4 The current account deficit is estimated to have narrowed Life expectancy at birth, yearsa 68.2 Sources: World Bank WDI and Macro Poverty Outlook. to 10.2 percent of GDP in 2016, compared to 11.5 percent Notes: a. Most recent WDI value (2014). in 2015, given lackluster imports. Continued strong FDI inflows supported rapid accumulation of foreign reserves, reaching US$7.8 billion (or 6 months of Summary imports). Growth is projected to ease slightly to 6.8 percent in Inflation moderated to 2.3 percent at mid-2017, down 2017, from 7.0 percent in 2016. Textile exports have from 3.9 percent in 2016. Recent moderation reflects decelerated, while the exports of electrical machinery, weaker demand, and there are signs that construction equipment and parts have picked-up. Authorities’ efforts activity is slowing down. Cambodian riel (CR)/US dollar to attract international tourists also seem to have paid exchange rate depreciated to CR 4,086 in June 2017, off. Growth is projected to remain strong, expanding up from CR 4,037 in December 2016. at 6.9 percent in 2018. Downside risks to the outlook include a sharp slowdown in the Chinese economy and The fiscal position remained stable and broadly potential election-related uncertainty. supportive of growth. In 2016, strong revenue collection continued. Rising current expenditure boosted by growing wage bill was more than offset by the decline Recent Developments in capital spending. The deficit (excluding grants) is estimated to have narrowed to 3.0 percent of GDP in Growth remained strong in 2016, at 7.0 percent, while 2016, down from 3.5 percent in 2015.2 Cambodia’s there are signs of moderation (Figure 1). Owing to rising real wages and declining export prices, textile product exports growth decelerated to 5.4 percent year on year 1 The newly emerging exported products include machinery, mechanical appliances, nuclear reactors, boilers; parts thereof (Harmonized System or HS 84), electrical (y/y) in the first half of 2017, compared with 8.4 percent machinery and equipment and parts thereof; sound recorders and reproducers, television (HS 85), and vehicles other than railway or tramway rolling stock, and parts in 2016. Partly offsetting this deceleration, exports of and accessories thereof. electrical machinery, equipment and parts have picked- 2 2016 fiscal data remains preliminary. 108Cambodia BALANCING ACT debt distress level remained low as per the 2017 WB/ primarily relies on cheap labor, is gradually diminishing. IMF Debt Sustainability Analysis. It is therefore important to further improve the ease of doing business through sound regulatory environment, targeting high-value added industries as envisaged by Outlook the 2015–25 Industrial Development Policy. The growth outlook is favorable. Growth is projected to Mitigating measures are necessary to support rural expand at 6.8 percent in 2017 and 6.9 percent in 2018, households who have been hard hit by continued low underpinned by export diversification, increased public agricultural prices. In addition, the potential negative spending and recovery of the tourism sector. impacts of the slowdown of textile and construction sectors will need to be closely monitored. Successfully Downside risks to the outlook include a sharp slowdown implementing the two main pillars, social assistance in the Chinese economy and potential election-related and social security, envisaged under the 2016–25 uncertainty. The deceleration of textile and construction national social protection policy framework will help sector could affect the income earnings of the poor in prevent rural households from falling back into poverty. terms of less overtime working hours or days. The most recent preliminary quarterly survey of garment workers in Phnom Penh also confirmed that daily income earnings of garment workers declined in May 2017 compared to February 2017. Consequently, remittances originating from these sectors could possibly decline, tightening the household budget and decreasing the expenditure in education, health and investment in agricultural activities in the rural areas, too, if the trend continues. Risks and Challenges It is crucial to nurture the incipient high value-added manufacturing industries. Adopting cost-effective and competitive electricity tariffs will support high value- added manufacturing sectors that are energy-intensive. Identifying skills gaps to design courses and programs that address such gaps as targeted under the 2017– 25 National Technical and Vocational Education and Training Policy is a priority. Further facilitating investment in the manufacturing sector is needed, given the recent slowdown in foreign direct investment in the textile sector. Cambodia’s doing business ranking remains relatively low. As real wages increase, Cambodia’s external competitiveness, which Cambodia 109 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Figure 1. Real GDP growth, contribution to real growth Figure 2. Exports of electrical machinery, equipment and parts Percent Percent of total 8 10 9 8 6 7 6 4 5 4 3 2 2 1 0 0 2011 2012 2013 2014 2015 2016 2010 2011 2012 2013 2014 2015 2016 JJAgriculture JJGarment JJConstruction JJReal estate JJOther industr. JJMachinery (HS 84) JJElectrical (HS 85) JJVehicles & parts (HS 87) JJTrade JJOther services JJTaxes less subsidies ▬▬GDP growth Source: UN Comtrade; HS = Harmonized system. Sources: Cambodian authorities and World Bank staff estimates. CAMBODIA  Selected Indicators 2014 2015 2016e 2017f 2018f 2019f Real GDP growth, at constant market prices 7.1 7.0 7.0 6.8 6.9 6.7 Private Consumption 4.5 5.9 6.7 4.3 4.3 4.3 Government Consumption 2.4 4.4 5.7 7.8 10.5 10.8 Gross Fixed Capital Investment 9.1 10.6 10.1 9.7 10.4 7.8 Exports, Goods and Services 11.3 7.2 8.6 7.1 7.2 8.2 Imports, Goods and Services 10.1 6.5 8.6 6.0 6.4 7.0 Real GDP growth, at constant factor prices 6.9 6.9 6.9 6.7 6.8 6.6 Agriculture 0.3 0.2 1.4 1.2 1.1 1.0 Industry 9.8 11.7 10.5 9.2 8.3 6.8 Services 8.7 7.1 6.8 7.4 8.3 8.9 Inflation (Consumer Price Index) 1.7 1.3 3.5 2.9 3.2 3.5 Current Account Balance (% of GDP) -11.3 -11.5 -10.2 -9.6 -9.2 -8.9 Financial and Capital Account (% of GDP) 14.6 14.2 14.3 13.9 14.4 14.0 Net Foreign Direct Investment (% of GDP) 10.0 9.1 10.8 11.0 11.0 10.7 Fiscal Balance (% of GDP) -5.0 -3.5 -3.0 -4.5 -5.3 -5.1 Debt (% of GDP) 32.1 31.3 32.4 34.0 35.5 36.3 Primary Balance (% of GDP) -4.3 -3.2 -2.7 -4.2 -4.9 -4.7 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Note: e=estimate and f = forecast. 110Cambodia BALANCING ACT CHINA also been positively affected by improving global trade conditions. For the first half of the year, net exports contributed positively to growth (0.3 percentage points) as compared to a negative contribution (-0.5 percentage points) in 2016. Export growth also has important multiplier effects for China’s economy. Overall, growth continues to be led by services, although real estate and finance growth moderated somewhat in the first half of 2017 relative to 2016. In contrast to 2016, growth in average disposable income at 7.3 percent yoy in the first half of 2017 exceeded 2016 growth in GDP, thereby contributing to consumption- Population, million 1,378.7 led rebalancing. However, a decline in agricultural GDP, current US$ billion 11,227.7 prices and associated slower growth in rural business GDP per capita, current US$ 8,144 incomes appear to have moderated income growth in International poverty rate ($1.9)a 1.9 rural areas, including among poorer segments of the Lower middle-income poverty rate ($3.2)a 12.1 population. While average income growth accelerated School enrolment, primary (% gross)b 103.9 in the first half of 2017, median disposable income per Life expectancy at birth, yearsb 75.8 Source: WDI, Macro Poverty Outlook, and official data. capita (deflated by CPI) increased yoy by 5.6 percent Notes: (a) Most recent value (2013), 2011 PPPs. (b) Most recent WDI value (2014). in the first half of 2017, down from 6.2 percent and 9.2 percent in the first half of 2016 and 2015, Summary respectively. Growth in rural business incomes declined from 6.5 percent yoy in H1 2016 to 3.5 percent in Supported by consumption and improving external H1 2017. Consumer price inflation remained subdued conditions, GDP grew by 6.9 percent year on year in the in both rural and urban areas (1.0 and 1.5 percent first half of 2017. Growth is projected to moderate in monthly average yoy in the first half of 2017), with 2018–19, as the authorities continue to pursue policies food price inflation below the recent average and to constrain debt growth. Poverty reduction is expected health expenditures experiencing above average price to continue, with the extreme poverty rate projected increases (-2.1 and 5.5 percent average monthly yoy, to decline to 0.8 percent by 2019. China’s key policy respectively). World Bank estimates suggest that the challenge is managing an orderly transition to more proportion of the population consuming less than the equitable and sustainable growth through continued international poverty line ($1.9/day in 2011 PPP) fell reduction in macroeconomic imbalances and a greater from 1.4 percent in 2015 to 1.2 percent in 2016. The orientation toward domestic consumption. poverty rate calculated using the lower middle-income class poverty line (US$3.2/day in 2011 PPP) fell from 9.9 percent in 2015 to 9.1 percent in 2016. Recent Developments Tighter monetary policy and new regulations on China’s GDP grew by 6.9 percent yoy in the first half of shadow financing have slowed growth in commercial 2017, up from an average of 6.7 percent in 2016. Growth bank assets notably, consistent with the mitigation of continues to be driven primarily by consumption, which macroeconomic risks. Total credit to the non-financial contributed 4.4 percentage points of growth as opposed sector grew at an annualized rate of 15.3 percent in to 2.8 percentage points from investment. Growth has the first six months of 2016, down from 15.7 percent China 111 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 average growth in 2016. More significant signs of imbalances. Growth is projected at 6.4 percent in 2018– deleveraging are observed in bank asset data, with 19. Despite recent improvement in the international growth in total assets slowing down from 16.5 percent environment, external risks to China’s outlook remain in 2016 to an annualized rate of 9.3 percent in the first considerable. These stem from the possibility of more half of 2017. Bank assets in China partly reflect shadow restrictive trade policies and renewed strains on financing products, many of which are not included in the financial sector associated with the withdrawal the “total credit” measure cited above. of accommodative monetary policies in advanced countries. The recovery in global trade has been an important factor supporting growth so far in 2017. In the first half Given the positive medium-term growth outlook and of 2017, the US dollar value of exports and imports the recent deceleration in disposable income growth, increased by 5.3 and 18.4 percent, respectively, mainly poverty rates are expected to continue to decline but at due to higher trade volumes. This can be compared to a slightly slower pace. The share of the population living a contraction of 6.4 and 5.4 percent, respectively, in below the international poverty line would likely reach 2016. The current account balance was US$71 billion 0.8 percent, and those living below the lower middle- or 1.3 percent of GDP in the first half of 2017, down income class line would reach 7.0 percent by 2019. from 1.8 percent in 2016. Owing in part to greater market confidence and Risks and Challenges stricter capital controls, capital outflows from China stabilized considerably in the first half of 2017. The continued pursuit of policies to bring debt Gross foreign exchange reserves increased by accumulation under control is critical for China’s US$29.4 billion to US$3.1 trillion, compared to a future growth prospects. Since the start of 2017, the decline of US$163.6 billion during the same period in Government has tightened monetary policy, introduced 2016. Capital outflows, including errors and omissions, measures to strengthen financial regulation, and declined to US$42.2 billion in H1 2017, down from established a State Council Financial Stability and US$268.0 billion in H1 2016. In the context of broad Development Commission to improve regulatory US dollar depreciation, the Renminbi appreciated by coordination. Serious progress toward deleveraging is 2.3 percent against the US dollar in the first six months well worth the cost of slower GDP growth in the short of 2017. run. China’s key medium-term challenge is to manage an Outlook orderly transition to more equitable and sustainable growth through a greater orientation toward domestic GDP growth is revised upward to 6.7 percent in 2017 consumption. By ensuring that the income growth in light of better-than-expected performance in the first of the population exceeds the pace of GDP growth, half of the year. Nevertheless, growth is projected to a corresponding rise in domestic consumption can moderate in the near future as the economy rebalances potentially support relatively high growth. Many away from investment and external demand towards important reforms in areas such as pensions and the domestic consumption over the medium term. In hukou (household registration) system are key to addition, the authorities are expected to continue to creating opportunities for more rapid personal income pursue policies aimed at bringing the growth of debt growth. under control to reduce macroeconomic risks and 112China BALANCING ACT Figure 1. Contribution to real GDP growth year-on-year Figure 2. Poverty rates, estimates and projections Percentage points Poverty rate, percent 16 14 13 12 10 10 7 8 4 6 1 4 -2 2 -5 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2013 2014 2015 2016 2017 2018 2019 JJPrivate consumption JJGovernment consumption JJGross fixed investment ▬▬Poverty line $1.90 a day ▬▬Poverty line $3.20 a day JJChange in inventories JJNet exports JJStatistical discrepancy Sources: National Bureau of Statistics; World Bank estimates. Sources: National Bureau of Statistics; World Bank estimates. CHINA  Selected Indicators 2014 2015 2016e 2017f 2018f 2019f Real GDP growth, at constant market prices 7.3 6.9 6.7 6.7 6.4 6.3 Private Consumption 8.0 7.4 7.9 7.9 7.7 7.6 Government Consumption 4.1 9.9 9.5 7.8 7.6 7.4 Gross Fixed Capital Investment 7.4 7.0 6.7 5.8 5.5 5.4 Exports, Goods and Services 8.0 -0.9 2.7 5.8 4.7 4.7 Imports, Goods and Services 7.9 -0.6 5.8 6.5 5.5 5.5 Real GDP growth, at constant factor prices 7.3 6.9 6.7 6.7 6.4 6.3 Agriculture 4.1 3.9 3.3 3.3 3.3 3.3 Industry 7.4 6.2 6.1 6.1 5.7 5.5 Services 7.8 8.0 7.8 7.7 7.5 7.4 Inflation (Consumer Price Index) 2.0 1.4 2.0 2.0 2.0 2.0 Current Account Balance (% of GDP) 2.2 2.7 1.7 1.4 1.2 1.1 Financial and Capital Account (% of GDP) -1.6 -0.8 0.3 -0.2 -0.1 -0.1 Net Foreign Direct Investment (% of GDP) 1.4 0.6 -0.4 0.1 0.1 0.1 Fiscal Balance (% of GDP) -0.3 -2.3 -3.2 -3.1 -3.1 -3.0 Debt (% of GDP) 38.0 36.2 36.6 36.8 37.0 37.1 Primary Balance (% of GDP) 0.7 -1.4 -2.3 -1.9 -1.9 -1.7 International poverty rate ($1.9 in 2011 PPP)a,b 1.6 1.4 1.2 1.1 0.9 0.8 Lower middle-income poverty rate ($3.2 in 2011 PPP)a,b 10.9 9.9 9.1 8.3 7.6 7.0 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Note: f = forecast. (a) 2013 is actual based on group data provided by Povcal, 2014 onwards are projections using annual growth elasticity. (b) 2013 survey is a break and not comparable with previous surveys. China 113 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 FIJI strong consumer demand from higher incomes, lower unemployment (5.5 percent, the lowest on record in 15 years), and continued strength in remittances. The remittances make an important contribution to welfare across all income groups, and historically have been an important contributor to poverty reduction in Fiji. The annual inflation has moderated to 2.0 percent in July from a high of 6.8 percent in January this year, which also likely to have benefited the poor, as the cyclone-related supply shortages eased and the effect of higher duties on alcohol and tobacco tailed off. The Fiji 2016 dollar continues to remain stable against the basket of Population, million 0.9 currencies, appreciating modestly against the US dollar GDP, current US$ billion 4.7 and Japanese Yen (3.3 and 8.5 percent, respectively), GDP per capita, current US$ 5,247 while depreciating against the NZ dollar, the Australian Life expectancy at birth, yearsa 70.1 dollar, and the Euro (-2.5, -2.9, and -2.6 percent, Sources: WDI, Macro Poverty Outlook, and official data. Notes: a) Most recent WDI value (2014). respectively) in the year to July. The Real Effective Exchange Rate index has appreciated marginally over the same period by 0.6 percent. Summary The external deficit remains elevated at 6 percent of Growth is set to accelerate to 3.8 percent in 2017 GDP, reflecting large shortfall on the merchandise trade from 0.4 percent last year supported by the ongoing account. Import demand for raw materials and capital reconstruction work following Cyclone Winston, strong equipment continues to be strong as reconstruction visitor arrivals, and domestic consumption. Inflation activities gather pace. A large surplus in the services has moderated to 2 percent as the cyclone-related account (relating to tourism and transport) and the supply shortages eased. Growth is expected to remain continued strength in remittances are providing needed above-trend in the forecasting period on strong private offsets. Foreign reserves remain adequate, however, consumption and public investment. Downside risks which stood at F$2,349 million in end-August, sufficient include another natural disasters and acceleration in to cover 5.8 months of imports. domestic inflation. Building climate resilience is key to maintaining Fiji’s macroeconomic stability and The fiscal deficit for 2016/17 is estimated to be inclusive growth. around 2 percent of GDP—lower than the planned deficit of 7.3 percent (4.7 percent according to the national convention of counting privatization receipt Recent Developments as revenue) mainly due to delays in reconstruction activities. The 2017/18 budget remains focused on GDP growth is expected to reach 3.8 percent this completing the reconstruction projects, with a planned year, recovering from 0.4 percent last year following deficit of 7.9 percent of GDP (4.5 percent according to Cyclone Winston (Figure 1). The resurgent growth is the national convention), mainly reflecting a rollover supported by the ongoing reconstruction work, buoyant of capital expenditure from last year’s reconstruction visitor arrivals (up 5.7 percent in the year to July), and 114Fiji BALANCING ACT spending and increases in civil service wages and social only slowly in 2018–19, as several policy measures welfare payments. announced in the national budget add inflationary pressures, such as increases in the minimum wage, Government debt is expected to remain around social protection payments, and civil service wages. 50 percent of GDP. It had been falling as a share of GDP in recent years on the back of strong growth, but The fiscal deficit will likely remain elevated throughout increased last year owing to additional borrowing for the forecasting period, as the government accelerates post-Winston reconstruction. This year, F$717 million the reconstruction effort while continuing to focus on in new borrowing is expected in the budget, of which spending on priority sectors—health, education, and 74 percent is expected to be met from domestic sources infrastructure, the central elements of the previous and 26 percent from external sources. Domestic bonds three budgets—until the next election in 2018. The are issued with maturities of 1 to 15 years, and are government’s medium term fiscal projections imply mostly held by the nonbank financial institutions. This fiscal consolidation starting in 2018/19, with the year, the government is looking to issue “Green Bonds” deficit narrowing from 4.5 percent of GDP this year to denominated in local currency to attract funding for 3.0 percent and 2.5 percent in the following two years, projects to address climate change. mainly through greater revenue mobilization and moderation in capital spending from the post-Winston Poverty rates in Fiji are among the lowest in the Pacific. peaks. Based on the lower middle-income class poverty line (US$3.2/day in 2011PPP), 14.2 percent of the population live in poverty; based on the international Risks and Challenges poverty line (US$1.9/day in 2011PPP), less than two percent of the population lived in extreme poverty in There are several risks to the outlook. Another natural 2013/2014. These rates are among the lowest rates in disaster or a sharper-than-expected slowdown in growth the Pacific although they are similar to those in other in Fiji’s major export or tourism source markets— upper-middle-income countries. Although poverty including China and the United Kingdom—could rates have been falling in the last decade (Figure sidetrack the timely completion of the recovery program; 2), the averages mask divergence across regions. In divergent monetary policy among advanced economies particular, between the 2008/09 and 2013/14 surveys, could cause financial market disruptions and raise costs urban poverty has increased (from 12 to 13 percent of external borrowing; domestic inflation could re- based on the lower middle-income class poverty line) accelerate with the expansionary budget which, If not even as the aggregate poverty and rural poverty have stemmed by prompt monetary tightening, could raise declined (from 17 to 14 percent and 22 to 16 percent, inflation expectation. respectively). Building climate resilience remains a priority. Fiji is one of the most vulnerable in the world, where, each year, Outlook natural disasters cost on average 2 percent of GDP. Last year’s Cyclone Winston caused damage of F$2 billion, or GDP Growth is expected to remain above-trend, 25 percent of GDP. With climate change, the frequency moderating from 3.7 percent this year to 3.3 percent in and the cost of disasters are expected to increase. As 2019, on continued strength in consumption and public an upper middle-income country with limited access to investment in infrastructure. The year-end inflation is grants, Fiji will find it increasingly difficult to finance expected to be around 3.0 percent and to moderate the rising cost of disasters and the needed adaptation Fiji 115 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 while continuing to invest in growth- and welfare- worsening performance was due to deterioration in enhancing infrastructure, education, and health. getting credit (due to closure of the credit bureau in 2016) and lack of progress in those areas where Fiji Encouraging private sector growth by providing a had already ranked low, including starting a business, more supportive business environment also remains a getting permits, paying taxes, and registering property. priority. Fiji’s overall Doing Business ranking declined Fiji scores particularly poorly in starting a business— to 97 in 2017, down from 84 in 2016, and its “distance 159th of 190 countries—with 40 days required to start to frontier” score declined to 60.7 from 62.5. Fiji’s one. Figure 1. Real GDP growth Figure 2. International and national poverty rates Percent Percent 10 40 8 30 6 4 20 2 0 10 -2 -4 0 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2002/3 2008/9 2013/14 ▬▬Real GDP growth ▬▬5 period moving average ▬▬$3.20/day ▬▬$1.90/day ▬▬Consumption basic needs poverty ▬▬Income basic needs poverty Source: World Development Indicators and staff estimates. Sources: Fiji Bureau of Statistics, WB staff calculations. Selected Indicators FIJI  2014 2015 2016e 2017f 2018f 2019f Real gross domestic product 5.6 3.6 0.4 3.8 3.5 3.3 Agriculture 1.9 6.3 -9.7 3.8 2.1 2.3 Industry 0.4 1.1 -0.7 4.7 3.5 3.1 Services 7.2 3.7 4.1 3.7 3.1 3.0 Inflation (Consumer Price Index) 1.4 1.6 3.7 3.5 2.7 2.9 Current Account Balance (% of GDP) -7.6 -1.5 -3.4 -5.8 -6.2 -6.0 Fiscal Balance (% of GDP)a -4.2 -2.3 -4.7 -2.0 -4.5 -2.4 Debt (% of GDP) 48.4 45.9 46.2 47.8 50.4 51.6 Primary Balance (% of GDP) -1.0 -0.6 -1.9 -0.8 -1.7 -0.4 Sources: Fiji Bureau of Statistics, Reserve Bank of Fiji, World Development Indicators, and staff estimates. Note: (a) Fiji changed the government fiscal year from the calendar to the August-July fiscal year starting 2016. 116Fiji BALANCING ACT INDONESIA net export growth. Growth rates have been around 5 percent since Q1 2014, significantly lower than those recorded at the beginning of the decade, as the economy continues to adjust to lower global commodity prices. Despite strong real wage growth and the unemployment rate hitting a record low, private consumption growth remained tepid due to administrative price hikes and the side-effects of measures to improve tax compliance. Government consumption saw a notable contraction, partly reflecting base effects of a surge in Q2 last year 2016 and the shift in the Hari Raya Idul Fitri holidays to Q2 Population, million 260.6 this year. GDP, current US$ billion 932.8 GDP per capita, current US$ 3580 Investment growth rose to the highest since Q4 2015, International poverty rate ($1.9)a 6.8 partly due to lower lending rates for investment loans, Lower middle-income poverty rate ($3.2)a 31.6 in line with the 150-basis point reduction in the policy Upper middle-income poverty rate ($5.5)a 63.3 rate last year. After surging in Q1, export and import Gini coefficienta 38.4 School enrolment, primary (% gross)b 105.7 growth both slowed significantly, in part reflecting Life expectancy at birth, yearsb 68.9 weakening commodity prices in Q2, despite a stronger Sources: WDI, Macro Poverty Outlook, and official data. economic growth. The current account deficit to Notes: (a) Most recent value (2016), 2011 PPPs; (b) Most recent WDI value (2014). doubled to 2.0 percent of GDP in Q2. A seasonal rise in the primary income deficit and a widening of the Summary services trade deficit, as transport and travel imports jumped during Idul Fitri, also contributed to the larger The Indonesian economy continues to enjoy robust current account deficit. economic growth and macroeconomic stability, with low inflation, a widening but still benign current After climbing in H1 2017 due to administrative price account deficit, a conservative fiscal budget deficit and hikes, inflation has begun to ease. Bank Indonesia a supportive external environment. Amid pockets of recently cut the policy rate by 25 basis points, to support softness, the economic outlook is moderately positive, growth, after keeping it unchanged for nine months. with strengthening domestic demand, in light of the upcoming elections and accommodative monetary Revenue collections surged in H1 2017, while conditions. Political and policy uncertainty, and expenditure growth was weak. The revised 2017 Budget elevated inflation pose downside risks. sets out a higher fiscal deficit of 2.9 percent, up from 2.4 percent of GDP in the original 2017 Budget, due to both a reduction in revenue targets and an increase in Recent Developments expenditure. Indonesia’s real GDP growth was 5.0 percent yoy in Q2, Reflecting enhanced fiscal credibility, Standard and unchanged from Q1 as stronger investment was offset Poor’s upgraded Indonesia’s sovereign bond rating to by contracting government consumption and slower an investment grade in May. Since then, capital flows Indonesia 117 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 saw some strengthening with net FDI in Q2 at a near With stronger economic growth and lower inflation, three-year high. The banking sector continues to be the extreme poverty rate, based on the international well capitalized. Against the U.S. dollar, the Rupiah has poverty line of US$1.90 per day, is anticipated to been remarkably stable. In real trade weighted terms, fall by 0.9 percentage points in 2017, then a further the Rupiah depreciated slightly. 0.8 percentage points in 2018 and 0.7 percentage points in 2019. This corresponds to an average annual In the year to March 2017, the official poverty rate, decline of 0.8 percentage points between 2014 and fell by 0.2 percentage points to 10.6 percent, partly 2019, substantially less than the annual average reflecting a surge in real wages, broad unemployment decline of 2.9 percentage points witnessed between falling to its lowest recorded levels, and a contained 2006 and 2010. inflation rate. However, the decline in poverty is still lower than those achieved between 2006 and 2010, which averaged 1.1 percentage points annually. Risks and Challenges Global policy uncertainty, especially the threat of Outlook increased international protectionism, continue to pose substantial downside risks to the nascent recovery Real GDP growth is expected at 5.1 percent in 2017, in global trade. Geopolitical risks within the region climbing to 5.3 percent in 2018–19 on a stronger global and across the world are also substantial. Remaining growth and domestic demand. Private consumption uncertainties over the pace of monetary tightening by is projected to climb in line with gains in real wages. the U.S. Federal Reserve and the continued divergence Private investment faces headwinds of global and from the accommodative policies of the ECB and Bank domestic uncertainty and soft global commodity prices, of Japan, also pose risks. but tailwinds of lower borrowing costs and robust domestic demand. The external sector is expected to Domestic risks are also substantial. Political and policy contribute positively given stronger global growth, uncertainty remain heightened with the looming partially offset by easing coal prices and a deteriorating regional and presidential elections. Meanwhile, terms-of-trade. The current account deficit is projected both expansionary monetary and fiscal policy with to gradually widen from 1.7 percent in 2017 to a tight labor market could lead to a bout of elevated 1.9 percent in 2019. inflationary pressures, which would have a dampening effect on private consumption growth, and hence GDP Government consumption is forecast to rise in 2018 growth. and 2019 supported by enhanced revenue performance linked to stronger economic growth and tax reforms. Poverty is becoming an increasingly urban phenomenon In a signal of its commitment to fiscal discipline, the in Indonesia. In March 2017, the proportion of Government’s proposed 2018 budget implies a of Indonesia’s poor in urban areas was 38.4 percent, up deficit at 2.2 percent of GDP. 1.5 percentage points from March 2016. Back in the year 2000, urban dwellers comprised just 31.8 percent Consumer price inflation is expected to average at of Indonesia’s poor. This trend presents policy makers 4.0 percent this year as the effects of the electricity with a fresh set of challenges, as poor urban dwellers price hikes dissipate and food inflation remains low. may face certain non-monetary deprivations—including Assuming the current weather conditions persist and lack of access to healthcare, education, transportation, further fuel and energy hikes remain on pause, inflation good housing, and clean water—while issues like will ease to 3.5 percent in 2018–19. crime, congestion, and pollution are likely to be more prevalent in cities than in rural areas. 118 Indonesia BALANCING ACT Figure 1. Real GDP growth and contribution to growth Figure 2. Poverty rate, actuals and projections Percent Percent 8 90 80 6 70 60 4 50 40 2 30 0 20 10 -2 0 2012 2013 2014 2015 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 JJPrivate consumption JJGovernment consumption JJGross fixed capital formation ▬▬PPP US$1.90 poverty rate, percent ▬▬PPP US$3.20 poverty rate, percent JJNet exports JJStatistical discrepancy ▬▬GDP Sources: National Socioeconomic Survey (SUSENAS); World Bank staff calculations. Sources: National Statistics Agency (BPS); World Bank staff calculations. INDONESIA  Selected Indicators 2014 2015 2016e 2017f 2018f 2019f Real GDP growth, at constant market prices 5.0 4.9 5.0 5.1 5.3 5.3 Private Consumption 5.3 4.8 5.0 5.0 5.2 5.2 Government Consumption 1.2 5.3 -0.1 3.5 5.0 6.0 Gross Fixed Capital Investment 4.4 5.0 4.5 5.0 5.1 5.2 Exports, Goods and Services 1.1 -2.1 -1.7 5.0 4.8 4.8 Imports, Goods and Services 2.1 -6.4 -2.3 3.2 3.8 4.0 Real GDP growth, at constant factor prices 5.2 4.1 5.2 5.1 5.3 5.3 Agriculture 4.6 3.5 3.4 3.8 4.2 4.6 Industry 4.4 2.8 4.1 4.2 4.4 4.7 Services 6.1 5.5 6.8 6.4 6.3 6.0 Inflation (Consumer Price Index) 6.4 6.4 3.5 4.0 3.5 3.5 Current Account Balance (% of GDP) -3.1 -2.0 -1.8 -1.7 -1.8 -1.9 Financial and Capital Account (% of GDP) 3.3 2.1 1.7 3.3 3.4 3.5 Net Foreign Direct Investment (% of GDP) 1.7 1.2 1.7 1.9 3.0 3.6 Fiscal Balance (% of GDP) -2.1 -2.6 -2.5 -2.7 -2.2 -2.1 Debt (% of GDP) 24.7 27.4 27.9 29.1 29.1 29.2 Primary Balance (% of GDP) -0.9 -1.2 -1.0 -1.1 -0.5 -0.4 International poverty rate ($1.9 in 2011 PPP)a,b 8.3 7.5 6.8 5.9 5.1 4.4 Lower middle-income poverty rate ($3.2 in 2011 PPP)a,b 38.6 34.0 31.6 29.6 27.6 25.6 Upper middle-income poverty rate ($5.5 in 2011 PPP)a,b 69.9 68.0 63.3 61.8 60.4 58.9 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: e = estimate, f = forecast. (a) Calculations based on EAPPOV harmonization, using 2010-SUSENAS, 2015-SUSENAS, and 2016-SUSENAS. Actual data: 2016. Forecast are from 2017 to 2019. (b) Projection using annualized elasticity (2010-2015). Indonesia 119 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 LAO PDR over government spending. An additional 250MW of power generation is expected to come on stream in 2017, bringing total installed capacity to around 6,600 MW, most of which is exported. Manufacturing exports continued to expand as new companies entered the two special economic zones while a good harvest and some recovery in commodity prices gave a boost to agriculture and mining exports. On the other hand, delays on some power projects as well as a tighter fiscal stance resulted in slower investment activity. Output in mining stagnated due to lower grade ores at one of the mines. The trend of declining number of tourist arrivals 2016 during 2016 continued in the first half of 2017. Weak Population, million 6.9 oil prices, well-stocked food markets and moderating GDP, current US$ billion 13.5 demand kept inflation pressures subdued. GDP per capita, current US$ 1,957 International poverty rate ($1.9)a 22.1 The growth in agriculture exports, in part reflects a Lower middle-income poverty rate ($3.2)a 57.8 restructuring in the agriculture sector, characterized Upper middle-income poverty rate ($5.5)a 84.7 by increased participation of traditionally small scale Gini coefficienta 36.4 School enrolment, primary (% gross)b 116.3 farming households in the production of export linked Life expectancy at birth, yearsb 66.1 commodities. Taken together with continued expansion Source: WDI, Macro Poverty Outlook, and official data. in the special export zones, this points to better economic Notes: (a) Most recent value (2012), 2011 PPPs. (b) Most recent WDI value (2014) opportunities and improvements in household welfare in both rural and urban areas. Poverty reduction is thus Summary expected to have continued. Economic growth decelerated in 2017 compared The fiscal deficit is projected to reach 6.2% of GDP in to earlier years. An expansion in power generation, FY2017. The removal of exemptions on fuel imports manufacturing and agriculture is offset by slight in 2016, recovering commodity prices (resulting in deceleration in investment and a drop in tourism. The higher royalties and import duties) as well as efforts to recent growth in agriculture and manufacturing, albeit expand tax base and improve compliance is helping off- from a low base, created more jobs and contributed set the impact of moderating economic growth. Still, to poverty reduction. The fiscal deficit remains elevated revenues are likely to remain below ambitious target keeping public debt high. The external balance will levels triggering an adjustment in spending, including narrow slightly in 2017. Fiscal and external buffers stronger control on purchase of goods and services and remain thin, signaling remaining vulnerabilities of the lower transfers. Public debt is expected to edge towards economy. 70 percent of GDP by the end of 2017. The current account balance is expected to narrow Recent Developments this year. Exports of electricity, manufactures and agriculture products continue to perform well, while Growth is projected to further moderate to 6.7 percent in recovering copper prices supported mining exports. 2017 as strong exports are weighed down by slowdown Imports increased at a slower pace reflecting the slow in investment, weaker tourism and stronger controls recovery in oil prices, completion of some power project 120 Lao PDR BALANCING ACT construction and gradual launch of the construction a declining trend. Revenues are expected to increase works on the Kunming—Vientiane railway line. Imports due to planned hike in excise tax rates, strengthened are expected to pick-up in the second half of the year revenue administration, improved tax-payer services as the project construction picks up. Net services will and the launch of modern revenue management decline as tourism activities slow. Reserves are expected information system. At the same time, spending growth to increase only slightly this year, but remain at around will be controlled through strong check over the wage 2 months of imports and less than 25 percent of foreign bill and public recruitment, cancelation of some of currency deposits. the public investment projects as well as cuts on non- essential spending. Improved public spending efficiency In response to the large current account deficit and and service delivery can improve living conditions and limited reserves, the kip depreciated by 2.1 percent help lower poverty. and almost 7 percent, against the US dollar and the Thai baht, respectively since the start of 2017, helping The external account is expected to widen in 2018 reverse some of the strong appreciation in recent years. reflecting the large import content of the infrastructure Consequently, the gap between the official and parallel projects, including the railway, but enter a declining market rate narrowed to 1.5 percent compared to above trend as the power generation capacity comes on 3 percent at the start of the year. stream and increases exports. The current account will continue to be financed by FDI and external borrowing, While monetary conditions remain unchanged, credit increasingly on less concessional terms. growth decelerated to 17 percent yoy in June this year compared to 22 percent a year ago due to slight weakening in the loan portfolio, more modest deposit Risks and Challenges growth as well as tighter fiscal space. Risks in the financial sector persist as some banks remain undercapitalized There are significant risks to this outlook. and overall profitability, while recovering, remains Opportunities outside of the power sector are likely to low. The authorities are in the process of restructuring materialize only if challenges related to the business two state-owned banks and revising the regulatory environment (creating level playing field, simplifying framework. tax administration, building human resources) are gradually addressed. Failure to create jobs will keep the link between economic growth and poverty reduction Outlook relatively weak. The medium term outlook remains broadly favorable. Furthermore, reversal of commodity prices, particularly Growth will continue to be driven by the power sector, metals and some agriculture products can affect Lao while greater ASEAN integration opens opportunities, exports and livelihoods. Weaker oil and metal prices especially in agriculture, tourism, retail trade as well will also affect government revenues, putting further as some manufacturing as part of regional value chain. pressure on the fiscal position. These sectors have significant potential to create jobs and lower poverty further. Fiscal slippage, continued low external buffers and failure to deal with weaknesses in the financial The five-year fiscal plan envisaged a narrowing of the sector could threaten macroeconomic stability, with fiscal deficit over the medium term helping, to stabilize a disproportionate impact over the poor and future and eventually put public debt as a share of GDP on growth prospects. Lao PDR 121 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Figure 1. Real GDP growth, contribution to real growth Figure 2. Estimated and projected poverty rates Percent and percentage point contributions Percent 10 60 8 50 6 40 4 30 2 20 0 10 -2 0 2013 2014 2015 2016 2017 2014 2015 2016 2017 2018 2019 JJPublic consumption JJPrivate consumption JJInvestment ▬▬US$3.2 PPP ▬▬US$3.2 PPP - proj. ▬▬US$1.9 PPP ▬▬US$1.9 PPP - proj. JJNet exports ▬▬Real GDP growth Source: Staff calculations based on LECS 4-5. Source: Staff estimate and based on national statistics. LAO PDRSelected Indicators 2014 2015 2016e 2017f 2018f 2019f Real GDP growth, at constant market prices 7.5 7.4 7.0 6.7 6.6 6.9 Private Consumption 8.0 5.2 4.5 4.5 4.6 4.6 Government Consumption 3.7 -0.4 7.4 4.5 4.5 4.7 Gross Fixed Capital Investment 9.9 17.3 6.1 5.5 10.5 8.1 Exports, Goods and Services 16.6 -6.5 7.2 8.0 9.0 10.5 Imports, Goods and Services 15.8 -3.0 3.0 3.0 8.0 7.0 Real GDP growth, at constant factor prices 7.5 7.4 7.0 6.8 6.6 6.9 Agriculture 8.0 1.4 0.5 2.8 3.2 3.2 Industry 7.2 11.1 11.3 9.2 8.5 9.2 Services 7.5 8.1 7.2 6.8 6.9 6.6 Inflation (Consumer Price Index) 4.1 1.3 1.5 2.0 3.0 3.0 Current Account Balance (% of GDP) -17.7 -17.3 -14.2 -14.0 -17.0 -16.6 Fiscal Balance (% of GDP) -4.4 -3.7 -5.6 -6.2 -4.8 -3.5 Debt (% of GDP) 63.0 64.8 68.1 70.5 70.4 68.5 Primary Balance (% of GDP) -3.5 -2.5 -4.1 -4.7 -3.2 -1.8 International poverty rate ($1.9 in 2011 PPP)a,b 17.5 15.8 13.9 12.7 11.3 9.9 Lower middle-income poverty rate ($3.2 in 2011 PPP)a,b 51.5 48.9 46.3 43.7 41.2 38.5 Upper middle-income poverty rate ($5.5 in 2011 PPP)a,b 82.0 80.6 79.0 77.6 76.0 74.5 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: f = forecast. (a) Calculations based on EAPPOV harmonization, using 2012-LECS. Nowcast: 2014-2016. Forecast are from 2017 to 2019. (b) Projection using neutral distribution (2012) with pass-through = 0.7 based on GDP per capita in constant LCU. 122 Lao PDR BALANCING ACT MALAYSIA conditions, and improved consumer confidence. Private investment also sustained rapid growth rates during the period, reflecting mainly continued capital spending in the manufacturing and services sectors. The higher public sector expenditures seen in Q1 2017 moderated in the subsequent quarter, following lower spending on emoluments, and supplies and services, as well as fixed assets by public corporations. On the external front, gross exports rebounded strongly from the subdued growth experienced in 2016, in line with the ongoing improvement in global demand. 2016 The positive external performance was broad-based, Population, million 30.8 underpinned by double-digit growth in commodity and GDP, current US$ billion 290.5 manufactured exports. Continued strength in global GDP per capita, current US$ 9,445 demand for Malaysia’s Electrical and Electronic (E&E) School enrolment, primary (% gross)a 102.8 products, particularly for semiconductors, remained the Life expectancy at birth, yearsa 74.7 Source: WDI, Macro Poverty Outlook, and official data. main driver of growth in gross exports. Gross imports Notes: (a) Most recent WDI value (2014). also registered a robust expansion during the period on account of higher intermediate imports and capital imports, particularly in Q1 2017. Summary Labor market conditions remained favorable during the GDP growth in Malaysia accelerated during the first period. The unemployment rate stood at 3.4 percent of half of 2017 to 5.7 percent (y-on-y), supported by the labor force, while the labor force participation rate strengthening domestic and external demand. As a was sustained, in Q2 2017, at 67.8 percent of the total result, Malaysia’s economy is expected to grow at working-age population. Private sector wage growth was 5.2 percent in 2017. The outlook remains positive as sustained, supported by broad-based wage expansion the Malaysian economy continues to experience broad- in domestic- and export-oriented manufacturing and based growth across a range of diversified sectors. services industries. Nevertheless, as an open economy, risks relating to changes in the global economic outlook weigh on Headline inflation was higher at 4.1 percent in the first Malaysia’s growth as the economy is vulnerable to half of 2017, driven mainly by cost factors. In particular, shifts in external demand and market sentiment. higher domestic petrol prices during the period resulted in higher inflation in the transport category. Prices of food, which accounts for nearly 40 percent of low- Recent Developments income households’ budgets, were also significantly higher (4.2 percent y/y to July 2017) following The Malaysian economy experienced robust growth reductions in cooking oil subsidies and disruptions in of 5.7 percent in the first half of 2017, underpinned fresh food supplies due to adverse weather conditions. by strong private sector expenditure with additional Housing continues to be a significant contributor to cost impetus from an improvement in external demand. of living pressures, with growth in mean housing prices Private consumption expanded firmly, supported by outpacing mean income growth and continued decline favorable income growth amid stable labor market Malaysia 123 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 in new construction at the lower end of the housing going forward. The improvement in export performance market. is expected to continue into the second half of 2017, in tandem with the ongoing expansion in global demand. The financial account recorded a reduced net outflow of Meanwhile, the government remains committed to RM8.8 billion in Q1 2017, followed by a net inflow of fiscal reforms amid a continued expectation of the fiscal RM7.3 billion in Q2 2017. The reversal of capital flows deficit target of 3.0 percent of GDP being achieved in was due mainly to a resumption of portfolio investment 2017. The Malaysian economy is expected to sustain its by non-residents, amid improved market sentiment current growth momentum into 2018 and 2019, albeit and confidence against the backdrop of a positive at a more moderate pace amid expectation of lower domestic growth outlook. The renewed non-resident capital expenditure growth. investor interest in the domestic financial market also contributed to the strengthening of the ringgit amid a broad weakening of the US dollar. Risks and Challenges Domestic monetary and financial conditions remained Notwithstanding the better-than-expected growth supportive of economic activity throughout the first performance, the Malaysian economy continues to face half of 2017. Bond yields declined during Q2 2017 uncertainties and risks emanating mainly from the on account of non-resident inflows and continued external environment. The main risks to growth arise demand from domestic institutional investors. Stable from the policy uncertainty in the major economies, retail funding costs continued to support financing to geopolitical developments and commodity price the private sector, which reflected in an improvement in volatility. Ongoing adjustments to the rising cost of the growth of net financing consistent with the pace of living amid continued fiscal consolidation and elevated the economic activity. Banking system liquidity remains household indebtedness could also weigh on the sufficient for financial intermediation with most banks strength of private sector demand. Monetary policy continuing to maintain surplus liquidity positions. will continue to operate in a complex environment, characterized by robust domestic demand and higher prices amid continued uncertainty in the global economic Outlook and financial market developments. Exchange rate flexibility and responsive macroeconomic management Economic activity in Malaysia is projected to expand by are therefore crucial in absorbing negative shocks from 5.2 percent in 2017, in line with continued favorable the external environment. leading indicators of near-term private sector activity and confidence. Domestic demand is expected to The favorable domestic environment provides a crucial remain the primary anchor of growth, underpinned opportunity for the Federal Government to further by robust growth in private sector expenditure. strengthen its finances towards a more sustainable Stable labor market conditions, sustained consumer debt path. Broadening of revenue sources and reducing confidence and ongoing income-support measures exemptions on Goods and Services Tax (GST) could would continue to lend support to private consumption. further enhance revenue collection, while addressing Private investment activity is expected to be sustained the rising civil servants’ salaries and pensions could by the implementation of existing and new investment contain the expansion in operating expenditures. projects, especially in the manufacturing and services Accelerating structural reforms to improve both private- sector. Continued public infrastructure investments sector productivity and public-sector efficiency should would also lend support to domestic growth and be accorded significant priority for Malaysia to sustain contribute towards sustained demand for capital imports its current growth momentum in the medium term. 124Malaysia BALANCING ACT Figure 1. Real GDP growth, contribution to real growth Figure 2. Housing prices and median monthly household income, by income group Percent, percentage points Constant 2010 RM, in thousands 9 11 10 9 6 8 7 6 3 5 4 0 3 2 1 -3 0 -13 2-13 3-13 4-13 1-14 2-14 3-14 4-14 1-15 2-15 3-15 4-15 1-16 2-16 3-16 4-16 1-17 2-17 Q1 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q 2009 2010 2011 2012 2013 2014 2015 2016 2017 JJConsumption JJInvestment JJInventory JJTop 20% JJMiddle 40% JJBottom 40% ▬▬Average house price ('000) JJGovernment JJExternal ▬▬Annual GDP growth Sources: World Bank staff calculations based on Department of Statistics data. Source: World Bank staff calculations based on Department of Statistics data. MALAYSIA  Selected Indicators 2014 2015 2016e 2017f 2018f 2019f Real GDP growth, at constant market prices 6.0 5.0 4.2 5.2 5.0 4.8 Private Consumption 7.0 6.0 6.1 6.6 6.5 5.9 Government Consumption 4.3 4.4 1.0 4.4 3.3 2.8 Gross Fixed Capital Investment 4.8 3.7 2.5 6.1 3.2 4.2 Exports, Goods and Services 5.0 0.6 0.1 7.3 0.8 0.6 Imports, Goods and Services 4.0 1.2 0.4 8.9 0.5 0.0 Real GDP growth, at constant factor prices 6.0 5.0 4.2 5.2 5.0 4.8 Agriculture 2.0 1.2 -5.1 7.1 2.1 1.1 Industry 6.1 5.2 4.8 4.1 4.0 4.2 Services 6.6 5.4 5.3 5.7 6.1 5.7 Inflation (Consumer Price Index) 3.2 2.1 2.1 2.2 2.3 2.3 Current Account Balance (% of GDP) 4.2 3.0 2.6 2.6 3.0 3.6 Fiscal Balance (% of GDP) -3.6 -3.2 -3.1 -3.0 -2.8 -2.7 Debt (% of GDP) 55.6 57.7 57.9 55.2 56.0 55.5 Primary Balance (% of GDP) -1.4 -1.0 -0.8 -0.7 -0.6 -1.4 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: e = estimate; f = forecast. Malaysia 125 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 MONGOLIA private investment following substantial FDI inflows in the mineral sector. Private consumption is also expected to recover by 2.9 percentage points in 2017 from a negative growth in 2016 following positive developments on the labor market. Unemployment rates declined to 8.6 percent in 2017H1 from about 10 percent in 2016. Real household income per capita increased by 2.6 percent (y/y) in the 2017H1, up from the 11.3 percent decline in 2016H1. Largely driven by a reduction in non-food inflation, headline inflation slightly dropped below 3.5 percent (y/y) in July 2017. It will remain at moderate level and below the Central 2016 Bank target of 8 percent for the rest of 2017. Population, million 3.0 GDP, current US$ billion 11.4 The fiscal stance will improve in 2017 as deficit will GDP per capita, current US$ 3,809 decrease by almost half from 17 percent of GDP in 2016 School enrolment, primary (% gross)a 101.7 following better than expected revenue performance in Life expectancy at birth, yearsa 69.5 Source: WDI, Macro Poverty Outlook, and official data. a context of a fiscal adjustment program agreed with Notes: (a) Most recent WDI value (2014). the Fund, the Bank and other development partners. This program includes eliminating capital expenditures financed by the Development Bank of Mongolia (DBM), Summary and the net financing by Bank of Mongolia (BOM) of the Housing Mortgage program. It also focuses on Following positive developments in the mineral sector, strengthening revenue mobilization while improving real GDP growth is expected to improve to 2.8 percent efficiency of public investment. Current account balance in 2017 compared to -0.2 percent initially projected. will improve on account of positive developments on Growth outlook remains positive in 2018 and beyond the trade and services accounts during the 2017H1. mainly on account of increased private investment Total exports will likely rise by 15 percent in 2017 from in the mining sector and new impetus in trade and 3 percent during the previous year. Mongolia’s buffers transport services. Early signs of improvements in to external shocks are improving as gross international household incomes in 2017 augur a decline in poverty reserves are estimated to substantially increase. after sharp increase between 2014 and 2016. Risks to the outlook include political uncertainty, climate shocks, commodity shocks, and regional instability. Outlook Economic growth is projected to further improve Recent Developments modestly to 3.1 percent in 2018 from about 2.8 percent in 2017, and to accelerate to over 7 percent in 2019 Following the 2016 economic slowdown, recovery and beyond. Private investment will remain a key has been modest as growth is estimated to increase driver for the medium-term growth, especially in to 2.8 percent in 2017. This performance is largely mining, and trade and transport services. Inflation will driven by positive developments in the mineral sector remain modest and below the central bank medium (mainly coal) as well as stronger performance in term target of 8 percent. Therefore, the BOM is likely 126Mongolia BALANCING ACT to pursue an accommodating monetary policy, which The recent dismissal by Parliament of the cabinet raises should stimulate growth. Private consumption is also uncertainty about the government's commitment to projected to further improve over the medium term. implementation of the fiscal consolidation program, Consequently, the poverty rates are expected to decline. as well as commitment to a positive environment for FDI, both critical for Mongolia’s medium term Agriculture is projected to grow at about 4 percent over growth. Moreover, the political changes will complicate the medium term. This is below the sector’s 2014–15 government efforts to refinance outstanding sovereign performance, mainly as climate change continues to bonds; given Mongolia's weak external position, if adversely affect Mongolia through drought, and harsh such risks should materialize this would slow down the winter. Industry is projected to grow at 7.5 percent in recovery process. Efforts to reduce poverty and promote 2018–19, following substantial developments expected shared prosperity sustainably may also be affected, as in the mining sector. Services sector would also grow a result. In fact, fiscally sustainable labor and social strongly over the same period on account of strong protection policies will be key to reducing poverty in the backward linkages between mining and transport coming years. In contrast, if the new cabinet maintains services. Moreover, trade and transport sectors may also fiscal discipline and an open stance toward FDI, benefit from the recent intensification of relations with Mongolia's prospects for growth and poverty reduction Russia, especially in the transit for the China-Russia in the medium term are more positive. trade. Weather-related shocks will remain an important The fiscal deficit is projected to further decline challenge to Mongolia’s economy and meeting food substantially in the medium term, as government security needs to the rural population. Adaptation to remains committed to implement its fiscal consolidation climate change should therefore be prioritized to help program. The balance of payments will continue to face mitigate food production shocks. structural vulnerabilities exacerbated by developments on the country’s debt situation. Construction-related Commodity market volatility is likely to affect imports over the next two years are expected to outpace Mongolia’s growth prospects. Improving government’s export growth, and put upward pressure on the current management of proceeds from minerals is therefore account balance. Exchange rate volatility will subside critical. Recent efforts by the government to promote following the disbursement of donors’ support and export diversification through improved trade further FDI inflows. Moreover, gross international cooperation is also a positive step. reserves would significantly improve to 6.5 months of imports in 2019 from 3.2 months in 2017. Risks and Challenges While growth has been better than expected in 2017 due to coal prices, underlying structural issues remain. There are substantial domestic and external exogenous risks to the outlook. These risks include persistent political uncertainty, climate shocks, commodity market volatility, and regional instability. Mongolia 127 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Figure 1. Real GDP growth, contribution to real growth Figure 2. Poverty rate (official poverty line): 2010–16 Percent, percentage points Percent of total population 35 50 30 25 40 20 15 10 30 5 0 20 -5 -10 10 -15 -20 -25 0 Q1-13 Q3-13 Q1-14 Q3-14 Q1-15 Q3-15 Q1-16 Q3-16 Q1-17 2010 2011 2012 2014 2016 JJFinal consumption JJGross capital formation JJNet exports ▬▬GDP JJNational average JJUrban JJRural Source: National Statistics Office. Source: National Statistics Office. MONGOLIASelected Indicators 2014 2015 2016e 2017f 2018f 2019f Real GDP growth, at constant market prices 6.9 2.2 1.4 2.8 3.1 7.3 Private Consumption 6.3 7.2 -8.2 2.9 8.0 10.0 Government Consumption 3.4 -4.5 11.0 -7.1 -3.4 -0.9 Gross Fixed Capital Investment -21.7 -34.4 7.8 18.7 35.0 25.0 Exports, Goods and Services 53.2 1.2 12.6 15.2 6.0 8.1 Imports, Goods and Services 6.8 -11.5 12.4 19.1 17.5 14.0 Real GDP growth, at constant factor prices 9.2 5.4 1.5 2.0 3.1 7.3 Agriculture 13.7 10.7 6.2 3.0 3.5 4.0 Industry 12.7 9.9 -0.6 1.7 4.0 11.0 Services 5.4 0.4 1.9 2.0 2.2 5.2 Inflation (Private Consumption Deflator) 10.7 1.1 0.9 8.0 6.5 6.9 Current Account Balance (% of GDP) -11.5 -4.8 -6.3 -5.3 -9.1 -12.4 Financial and Capital Account (% of GDP) 8.3 3.5 7.9 7.0 15.2 20.8 Net Foreign Direct Investment (% of GDP) 2.1 1.5 1.1 8.5 13.9 19.8 Fiscal Balance (% of GDP) -10.5 -8.5 -17.0 -8.4 -7.1 -4.6 Debt (% of GDP) 58.4 60.4 87.3 84.8 88.9 85.5 Primary Balance (% of GDP) -8.4 -5.2 -13.3 -4.0 -2.2 -0.3 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: e = estimate; f = forecast. 128Mongolia BALANCING ACT MYANMAR lower than the 7 percent of the previous year (Figure 1). Despite notable reforms and strong foreign investment commitments, investment demand decelerated as private investors bided their time pending greater clarity in the government’s economic agenda. Public investments declined from 6.2 percent of GDP in 2015/16 to 5 percent in 2016/17 in response to fiscal constraints. Private consumption, which accounts for close to 50 percent of GDP, has remained strong particularly in urban areas. Rising consumer purchasing power 2016 and greater access to markets have contributed to Population, million 54.4 substantial growth in household asset ownership. Using GDP, current US$ billion 73.7 the international poverty line (US$1.9/day in 2011PPP), GDP per capita, current US$ 1355 poverty is estimated to be 6.5 percent in 2015 and International poverty rate ($1.9)a 6.5 93 percent of the extreme poor are estimated to live in Lower middle-income poverty rate ($3.2)a 30.2 rural areas. Although historical trends in global poverty Upper middle-income poverty rate ($5.5)a 67.9 measures are not available, trends in national estimates School enrolment, primary (% gross)a 99.7 Life expectancy at birth, yearsa 65.9 of poverty point to a decline in poverty between 2004/05 Source: WDI, Macro Poverty Outlook, and official data. and 2015. Poverty is estimated to have declined from Notes: (a) Most recent value (2015), 2011 PPPs. (a) Most recent WDI value (2014). 32.1 percent in 2004/05 to 25.6 percent in 2009/10 and to 19.4 percent in 2015. Urban areas have seen Summary faster growth in household welfare and a sharper decline in poverty in percentage point terms. Myanmar’s macroeconomic environment remains stable, though economic growth is slowing to 5.9 percent Inflation pressures abated over the course of 2016/17, in 2016/17 compared to 7 percent in 2015/16, weighed averaging 6.8 percent compared to 10 percent the down by slower investment demand. Growth is projected previous year (Figure 2). Food price inflation moderated to recover to 6.4 percent in 2017/18. Near term macro- throughout the year, except for a short spike in late 2016 economic vulnerabilities from the projected decline in coinciding with a sharp depreciation in the kyat making global gas prices call for continued fiscal and monetary imports more expensive. The Real Effective Exchange discipline. The economic impact of recent insecurity in Rate depreciated by 9 percent between August 2016 Rakhine State may be substantial. Accelerating private and March 2017. and public investment are high priorities. Consistent with falling inflation, annual growth in money stock moderated from 26 percent in 2015/16 Recent Developments to 19 percent in 2016/17. This is in part thanks to a policy on limiting Central Bank financing of the Union Myanmar’s macroeconomic environment over the Budget following a spike the previous year. Growth in course of 2016/17 has remained relatively stable credit to the private sector remained high at 33 percent following a challenging 2015/2016. Economic growth in 2016/17. moderated to 5.9 percent, below expectations and Myanmar 129 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 The current account and fiscal deficits have narrowed Risks and Challenges from 7.2 percent of GDP in 2015/16 to 5.3 percent in 2016/17, and from 4.4 percent of GDP to 3 percent Low gas prices could impact significantly on fiscal and over the same period, respectively. The trade deficit external balances, and exacerbate financing pressures. has remained large (8.5 percent of GDP) as gas export A recent import ban by India on pulses and beans may receipts have continued to decline. The demand affect Myanmar’s exports and the incomes of farmers for merchandise imports is picking while demand reliant on these key imports. The 2017/18 Union Budget for investment goods has contracted sharply. Fiscal proposes continued rebalancing of expenditure towards adjustment was driven more by cuts to public higher quality public investments and services that investment than improvements in general government benefit notably the poor but, unless revenue efforts and revenue collection, which, at 11 percent of GDP, remain cash management reforms accelerate, it will be difficult significantly below potential and regional peers. to eliminate central bank financing of the deficit and related pressure on inflation. Outlook Continued monetary discipline and exchange rate flexibility are important for containing external Economic growth is projected to recover to 6.4 percent pressures, as consumer imports continue to grow in 2017/18 and average 6.9 percent per year over fast. The economic impacts of recent insecurity in the medium-term. An expected bounce in agriculture Rakhine State may be substantial if it deters investors. activity is likely to support stronger growth in rural Appropriate implementation of recently adopted incomes and to contribute to declining poverty. Poverty prudential regulations are critical for financial sector is projected to decline from 6.5 percent in 2015 to stability. Lending to agriculture, manufacturing, and 4 percent in 2020, in particular if agricultural growth construction—all sectors that have faced a relatively and higher agricultural incomes translate into higher difficult year—have increased sharply, reiterating rural labor demand and wages, but productivity concerns over credit concentration and asset quality, bottlenecks remain. Other areas with potential which are not reflected in official figures. include construction of infrastructure including power, telecommunications and housing, as well as hospitality Whilst Myanmar’s recent consumption boom is services, and financial services. associated with improved household welfare, accelerating investments in productive capital is critical Inflation is projected to decline to 5.2 percent by to long-term growth and job creation. Structural reform year end 2017/18, thanks to a continued pick up in is important for domestic value addition, job creation agriculture output. A gradual reprioritization of public and managing import demand, as well as capturing investments, government revenue reforms, and higher foreign investment flows to emerging and developing concessional loan disbursements are expected to economies. help ease fiscal constraints. The public sector deficit is projected at 4.3 percent of GDP, lower than the The government has indicated that it is developing an 5.9 percent in the 2017/18 Budget. The current account economic strategy, which is expected to build investor deficit is projected to increase to 6.8 percent of GDP confidence and accelerate the implementation of due to a continued decline in gas sector receipts and a investment commitments. Policy priorities should pick-up in investment related imports. include, among other things: cost reflective electricity tariff policy with protection of vulnerable groups to promote financial viability of the power sector; 130Myanmar BALANCING ACT implementation of the Regulation on Credit Information Reporting Systems to improve lending decisions; and adoption and implementation of the Companies Act. Figure 1. Real GDP growth and sector contribution to real Figure 2. CPI inflation and food/non-food contribution GDP growth to CPI inflation Growth and contribution in percentage points yoy change and component contribution, percent 9 16 8 14 7 12 6 10 5 4 8 3 6 2 4 1 2 0 -1 0 -14 -14 c-1 4 -15 -15 c-1 5 -16 -16 c-1 6 -17 2013 2014 2015 2016 2017f 2018f 2019f 2020f Apr Aug De Apr Aug De Apr Aug De Apr JJAgriculture JJIndustry JJServices JJCPI food JJCPI nonfood ▬▬CPI headline Sources: MOPF, WB Staff estimates. Sources: CSO, WB Staff estimates. MYANMARSelected Indicators 2014 2015 2016e 2017f 2018f 2019f Real GDP growth, at constant market prices 8.0 7.0 5.9 6.4 6.7 6.9 Real GDP growth, at constant prices 8.0 7.0 5.9 6.4 6.7 6.9 Agriculture 2.8 3.4 -0.4 3.5 4.0 4.1 Industry 12.1 8.7 8.9 8.0 8.3 8.5 Services 9.1 8.4 8.0 7.2 7.3 7.4 Inflation (Consumer Price Index) 6.1 8.4 7.0 5.2 4.9 5.3 Current Account Balance (% of GDP) -2.9 -7.2 -5.3 -4.7 -4.7 -4.1 Fiscal Balance (% of GDP) -0.9 -4.4 -3.0 -4.5 -4.6 -4.4 Primary Balance (% of GDP) 0.4 -2.6 -1.4 -3.2 -3.2 -3.4 International poverty rate ($1.9 in 2011 PPP)a,b .. 6.5 5.8 5.1 4.4 4.0 Lower middle-income poverty rate ($3.2 in 2011 PPP)a,b .. 30.2 28.1 25.4 22.9 20.1 Upper middle-income poverty rate ($5.5 in 2011 PPP)a,b .. 67.9 65.6 63.1 60.5 57.8 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: f = forecast. (a) Calculations based on EAPPOV harmonization, using 2015-MPLCS. Actual data: 2015. Nowcast: 2016 - 2016. Forecast are from 2017 to 2019. (b) Projection using neutral distribution (2015) with pass-through = 0.3 based on GDP per capita in constant LCU. Myanmar 131 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 PAPUA NEW GUINEA and a shortage of foreign currency coupled with an overvaluation of the Kina. Growth in the non-resource sector has also been adversely affected by lower commodity prices due to a curtailing of public and private expenditure given lower revenue receipts and disposable income, respectively. The cash flow shortage in the public sector coupled with the shortage of foreign currency has contributed to fewer construction projects completed. Additionally, lower than expected log production has also negatively impacted growth in the non-resource sector. Therefore, 2016 overall economic growth is expected to decline to Population, million 7.9 2.1 percent of GDP in 2017 from 2.4 percent a year GDP, US$, billion 22.1 earlier. GDP per capita, US$ 2,787 GDP per capita, US$, PPP 3,541 Consequently, employment in the non-resource sector National poverty rate, percenta 39.9 contracted by 2.5 percent through-the-year to March Gini coefficient, consumptiona 0.4 quarter 2017, reflecting sluggish performance from School enrolment, primary (% gross)b 114 Life expectancy at birth, years 62.3 the non-resource sector. Non-resource employment Source: WDI, Macro Poverty Outlook, and official data. contracted in a number of sectors including building Notes: (a) 2009/10. (b) 2012 and construction (down 13.6 percent), transport (down 10.0 percent), retail (down 5.6 percent), wholesale Summary (down 3.1 percent), and finance and other services (down 1.3 percent). On the other hand, the manufacturing Following the 2017 National Elections, the relatively sector and the agriculture, forestry and fishery sector low global commodity price environment continues recorded growth in employment by 1.9 percent and to place limits on GDP growth, revenue receipts and 0.6 percent respectively. foreign exchange inflows. Based on the latest household survey data, the national poverty rate in 2010 is 39.9  percent. The Recent Developments level of consumption inequality, measured by the Gini coefficient, is 0.41 in 2010. In late August, the elected government released the 100-Day Economic Stimulus Plan to address the fiscal Following the aftermath of the elections in June stress and structural measures to strengthen growth. 2017, the Mid-Year Economic and Fiscal Outlook (MYEFO) revises the expected budget deficit in 2017 to Notwithstanding the higher growth in the agriculture 3.8 percent of GDP (or PGK 2.8 billion). This is higher and mining sector in the first half of 2017 owing to the than the deficit projected in the original 2017 Budget end of the drought in 2016, GDP growth is projected of 2.5 percent of GDP (or PGK 1.9 billion). to remain sluggish due to the ongoing weakness in commodity prices, further fiscal consolidation The reason for the upward revision in the deficit is the lower corporate tax revenue and higher expenditure 132 Papua New Guinea BALANCING ACT driven by higher than expected debt servicing costs and Headline inflation is projected to ease significantly to expenditure on wages and salaries. The higher deficit 4.1 percent in 2017, from 6.7 percent in 2016, owing is projected to increase debt-to-GDP to 35 percent of the slowdown in the economy, fiscal consolidation and GDP from 32.2 percent in 2016. This increase in debt, the stability of the currency. In PNG, the exchange rate further pushes the debt level above the debt threshold is the primary anchor of inflation expectations. of 30 percent of GDP. In response, the recently elected government is Outlook preparing a supplementary budget. The latter undertakes fiscal consolidation which is estimated to At least till 2020, growth in the resource sector lead to a fiscal deficit of 3.2 percent of GDP and public is expected to remain subdued reflecting the low debt to slightly under 35 percent of GDP in 2017. commodity-price environment coupled with the lack of any new resource projects expected before then. Notwithstanding the lower commodity prices, on the back of LNG exports, relatively sluggish GDP growth In the non-resource sector, growth is expected to remain and significant import compression due to the limited moderate due to the expected on-going shortage of FX availability of foreign exchange, the current account and continued fiscal consolidation. is expected to be in surplus (12.1 percent of GDP) in 2017. The surplus in the current account is largely In the medium to longer-term, outlook for growth is offset by financial account outflows due to a build-up in relatively more sanguine with the establishment of foreign currency account balances of resident mineral more resource projects post-2020. GDP growth is companies coupled with net loan repayments by the expected to edge towards trend in the longer term, government. which is estimated at 4 percent. The preliminary balance of payments (BoP) data for the five months to May 2017 showed an overall Risks and Challenges surplus of PGK113.5 million, compared to a deficit of K88.0 million in the corresponding period of 2016. In In the near term, risks are weighted to the downside. Fiscal 2017, the BoP is expected to show an overall surplus of stress and limited foreign currency inflows is expected 0.6 percent of GDP, marginally higher than 2016. to continue given the expected low commodity price environment in 2017 and 2018. Fiscal consolidation, The low commodity-price environment and pressure while necessary in the face of lower commodity prices, on the currency (Kina) prompted the central bank to runs the risk of further moderating growth while the intervene to slow the rate of Kina/USD depreciation to foreign exchange shortage would continue to dampen limit pass-through to inflation. Central bank intervention necessary imports. in the foreign exchange (FX) market has resulted in the shortage forex liquidity. The latter continues to be a There are a number of challenges both in the near-term constraint to business activity. The central bank needs and the medium to longer-term. Firstly, maintaining to improve the FX allocation mechanism, in concert macroeconomic stability and government’s ability to with strengthening the effectiveness of monetary policy maintain a prudent fiscal stance and ensure public by mopping up excess Kina liquidity. service delivery (particularly infrastructure) in the face of limited revenue receipts. Second, there is a growing Papua New Guinea 133 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 risk that longer the FX shortage continue, a more active shadow FX market may emerge. Possible upside risks: (i) new major resource project(s) commencing earlier than expected; and (ii) fiscal position improves with tax administration and policy measures are more successful than expected. Figure 1. Real GDP growth, contribution to real growth Figure 2. Key fiscal indicators (% GDP) Percent, percentage points Percent of GDP Percent of GDP 14 50 29 12 40 27 10 25 8 30 6 23 20 4 21 2 10 19 0 0 17 -2 -4 -10 15 2013 2014 2015 2016 2017 2018 2019 2020 2013 2014 2015 2016 2017e 2018f 2019f 2020f JJAgriculture, forestry & fishing JJOil & gas extraction JJMining & quarrying JJOverall budget balance, lhs JJDebt, lhs JJConstruction JJOther ▬▬Total ▬▬Total expenditure & net lending, rhs ▬▬Revenue incl. grants, rhs Sources: PNG Treasury, Bank of Papua New Guinea, IMF and WB staff calculations. Sources: PNG Treasury, Bank of Papua New Guinea, IMF and WB staff calculations. PAPUA NEW GUINEA S  elected Indicators 2015 2016 2017e 2018f 2019f 2020f GDP, at market prices 8.0 2.4 2.1 2.5 2.4 3.0 Mining and Petroleum 8.9 1.8 1.0 1.1 1.1 1.1 Non-mining and non-petroleum -1.0 0.6 1.1 1.4 1.3 1.9 CPI inflation, period average 6.0 6.7 4.1 4.5 4.3 5.1 Fiscal Revenue 18.8 15.4 15.0 15.0 15.0 15.0 Expenditure 23.1 19.9 18.2 18.1 18.5 18.5 Balance -4.3 -4.5 -3.2 -3.1 -3.5 -3.5 Debt 30.9 32.2 34.8 36.8 39.0 40.5 External Current account balance 13.5 12.0 12.1 11.4 10.9 11.1 Resource 13.9 11.5 11.1 10.4 10.4 10.0 Non-resource -0.4 0.5 1.0 1.0 0.5 1.1 Debt -0.7 -0.7 -0.7 -0.7 -0.7 -0.7 Sources: PNG Treasury, Bank of Papua New Guinea, IMF and WB Staff calculations. Notes: e = estimate; f = forecast. 134 Papua New Guinea BALANCING ACT PHILIPPINES in July 2016. This pattern reflects the evolution of capital formation, which eased to 9.7 percent in H1 2017, following its outstanding performance of 30.9 percent in H1 2016 when rapid economic expansion was spurred by a stimulus from election-related spending and investment (Figure 1). In contrast, positive consumer sentiment, coupled with modest inflation and robust remittance growth boosted domestic consumption. Further, net exports improved as the Philippines’ main exports, electronics, significantly rebounded. On the production side, the services sector remained the principal growth engine, while the agriculture sector 2016 recovered strongly, benefitting from favorable weather Population, million 102.3 conditions. GDP, current US$ billion 304.9 GDP per capita, current US$ 2982 The fiscal sector was supportive of growth at the International poverty rate ($1.9)a 6.6 expense of a widening deficit. Fiscal policy continued Lower middle-income poverty rate ($3.2)a 27.0 an expansionary path, leading to an increase in the Upper middle-income poverty rate ($5.5)a 56.1 deficit to 2.1 percent of GDP in H1 2017 compared Gini coefficienta 44.4 Life expectancy at birth, yearsb 68.3 to 1.7 percent of GDP in H1 2016. Total revenues Sources: World Bank WDI and Macro Poverty Outlook. expanded by 6.8 percent year-on-year in nominal Notes: (a) Most recent value (2015). (b) Most recent WDI value (2014). terms to reach 15.6 percent of GDP in H1 2017, but fell short of the 16.0 percent of GDP in H1 2016, Summary in large part due to a decline in non-tax revenues. Government expenditures increased, on the other hand, The Philippine economy had a slower start in 2017 by 9.0 percent year-on-year in nominal terms in H1 compared to 2016, when government’s election- 2017, reaching 17.7 percent of GDP, the same level related spending and front-loaded private investment as in H1 2016. The increase in spending was driven fueled growth in the first half of the year. Besides solid by both higher capital outlays and current operating consumption growth, a favorable external environment expenditures, such as personnel services and subsidies was the bright spot, pushing export growth to to government corporations. Subsidies are a relative 20.0 percent year-on-year in H1 2017. Fiscal and small expenditure item, however, they increased by monetary policies remained supportive of growth with nearly sixty percent. The government relied primarily on-target budget execution and successful inflation on domestic sources to finance the larger deficit while targeting which also makes it likely that poverty the total debt to GDP ratio declined to 42.5 percent in reduction has continued. H1 2017 from 42.9 percent in H1 2016. The central bank kept the key policy rate unchanged at Recent Developments 3.0 percent since June 2016 as inflation remained within its target range of 2–4 percent. In the earlier months The Philippines grew by 6.4 percent year-on-year in H1 of 2017, higher food and energy prices drove headline 2017, following strong growth of 6.8 percent year-on- inflation up. But inflationary pressures subsided year in H2 2016 after the new administration took over recently. Headline inflation peaked at 3.4 percent in Philippines 135 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 April and has since then decelerated to 3.1 percent in main trading partners which would lead to higher August. Ample liquidity allowed for credit expansion, external demand, while imports would remain elevated with commercial bank loans expanding by 19.0 percent due to necessary imports of intermediate and capital year-on-year in June. Key banking system indicators goods, including for the infrastructure program. As the point to continued stability: nonperforming loans public infrastructure program gains traction, capital declined from 2.1 percent of the total loan portfolio in outlays and construction activities are expected to June 2016 to 1.9 percent in June 2017, and the banks’ rise. Consumption growth is expected to remain firm capital adequacy ratio stood at 15.3 percent as of March, contingent on sustained remittances and expanding well above the 10.0 percent regulatory minimum. credit contributing to improving income levels. Local elections in 2019 will likely boost domestic activities The balance of payments turned into deficit in H1 2017, as early as the latter half of 2018. Growth in 2018 and driven by the higher capital outflows unmatched by 2019 is projected at 6.7 percent. the modest improvement in the current account. The capital and financial accounts reversed to net outflows Poverty based on the lower middle-income class line in H1 2017 at US$81.9 million (0.1 percent of GDP), is projected to decline to 22.9 percent in 2018 (Figure from US$1.5 billion (1.0 percent of GDP) net inflows in 2). The pace of poverty reduction may drop slightly in H1 2016. the face of slightly lower overall growth, but poverty is expected to continue to fall as the economy continues Official poverty figures based on the most recent its structural transformation. Increased spending in household survey data—from 2015—show an infrastructure would generate construction jobs that are acceleration of poverty reduction. Sustained economic expected to boost poverty reduction. growth since 2015 make it likely that the poverty rate has continued to decline. Based on the lower middle- income class poverty line (US$3.2/day in 2011 PPP), Risks and Challenges poverty in 2015 is estimated at 27.0 and projected to be 24.2 percent in 2017, implying that 1 million Sustained investment in physical infrastructure and Filipinos have exited poverty each year since 2015. human capital development could create quality Contributing factors to poverty reduction include a employment needed to safeguard the country’s conditional cash transfer program that reaches one- progress on delivering inclusive growth. To this end, the fifth of the population and the ongoing transition of government has continued to expand its proposed 2018 workers out of agriculture. budget, prioritizing such investments. More inclusive growth also requires government’s commitment to structural reforms that promote competition in key Outlook sectors, secure property rights, and improve the investment climate. In 2017, the economy is projected to expand at a slightly slower pace than 2016, at 6.6 percent. The delay in A faster-than-expected increase in interest rates in the anticipated push of the planned government advanced economies remains a source of external risk. infrastructure program has been contributing to Expectations of international interest rate tightening the moderation of fixed capital formation growth, may lead to renewed capital outflows and volatility in softening the growth prospect for the year. However, the foreign exchange market. Meanwhile, the pace of the medium-term growth outlook remains positive, and economic growth could be slower if the government is is expected to be anchored in growth in the Philippines’ unable to timely deliver on its planned infrastructure 136 Philippines BALANCING ACT program. Complementary reforms to address budget sustainability over the medium-term will also depend execution and implementation bottlenecks and to ensure on the success of the priority tax reforms. high quality of spending are needed. Maintaining fiscal Figure 1. Real GDP growth, contribution to real growth Figure 2. Poverty rates and GDP per capita (constant 2000 pesos) Percent, percentage points Poverty rate, percent GDP per capita, pesos 15 60 2,500 50 10 2,000 40 5 1,500 30 0 1,000 20 -5 500 10 -10 0 0 -14 -14 -14 -14 -15 -15 -15 -15 -16 -16 -16 -16 -17 -17 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 JJPrivate consumption JJGovernment consumption JJInvestments ▬▬International ▬▬LMIC ▬▬GDP per capita JJDiscrepancy JJNet exports ▬▬GDP growth Sources: Source: Philippine Statistics Authority. Sources: Source: Philippine Statistics Authority. PHILIPPINES  Selected Indicators 2014 2015 2016 2017f 2018f 2019f Real GDP growth, at constant market prices 6.1 6.1 6.9 6.6 6.7 6.7 Private Consumption 5.6 6.3 7.0 6.0 6.1 6.3 Government Consumption 3.3 7.6 8.4 3.8 6.0 8.7 Gross Fixed Capital Investment 7.2 16.9 25.2 12.2 14.7 16.1 Exports, Goods and Services 12.6 8.5 10.7 17.1 12.2 12.4 Imports, Goods and Services 9.9 14.6 18.5 17.0 14.3 15.5 Real GDP growth, at constant factor prices 6.2 5.9 6.8 6.6 6.7 6.8 Agriculture 1.7 0.1 -1.3 4.2 4.0 3.5 Industry 7.8 6.0 8.0 6.8 6.8 7.0 Services 6.2 6.8 7.5 6.8 7.0 7.1 Inflation (Consumer Price Index) 4.1 1.4 1.8 3.0 2.6 2.8 Current Account Balance (% of GDP) 3.8 2.5 0.8 -0.2 -0.3 -0.5 Financial and Capital Account (% of GDP) 3.4 1.1 0.3 0.3 0.1 0.1 Net Foreign Direct Investment (% of GDP) 2.0 2.0 2.6 2.6 2.6 2.7 Fiscal Balance (% of GDP) -0.6 -0.9 -2.4 -2.4 -2.5 -2.8 Debt (% of GDP) 45.4 44.8 42.0 41.8 41.2 40.8 Primary Balance (% of GDP) 1.7 1.4 -0.3 -0.1 -0.2 -0.4 International poverty rate ($1.9 in 2011 PPP)a,b .. 6.6 5.8 5.1 4.5 4.0 Lower middle-income poverty rate ($3.2 in 2011 PPP)a,b .. 27.0 25.6 24.2 22.9 21.7 Upper middle-income poverty rate ($5.5 in 2011 PPP)a,b .. 56.1 55.2 54.3 53.5 52.6 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: f = forecast. (a) Calculations based on EAPPOV harmonization, using 2006-FIES and 2015-FIES. Actual data: 2015. Nowcast: 2016 - 2016. Forecast are from 2017 to 2019. (b) Projection using annualized elasticity (2006-2015) with pass-through = 1 based on GDP per capita in constant LCU. Philippines 137 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 SMALL PACIFIC ISLAND COUNTRIES slower pace. The recovery is expected to have supported increased formal sector employment, which contracted for four consecutive years during FY2012–FY2015, for a cumulative decline of 6.8 percent. Consumer prices fell in FY2016 and are expected to have remained flat in FY2017, due to lower domestic fuel prices and a stronger US dollar (the official currency of the FSM) holding down prices for some imports. After traditionally running large deficits, the current account moved into surplus in FY2014 and FY2015, and is expected to have registered surpluses again in FY 2016 and FY2017, reflecting higher fishing licence receipts. 2015 Population, million 0.88 FSM’s macro-fiscal performance has improved GDP, US$ billion 3.01 significantly over the past three years, resulting in GDP per capita, current US$ 4,406 large fiscal surpluses of 6–12 percent of GDP during Sources: WDI, World Bank staff estimates. FY2014–FY2016. While general tax revenue has remained steady at around 12 percent of GDP, which Summary is low relative to other countries in the Pacific, non- tax revenue (excluding grants) have almost tripled Most Small Pacific Island Countries (PICs) are since 2011 to over 20 percent of GDP, reflecting higher experiencing moderate to strong growth, driven by fishing license fees resulting from the introduction of stimulus from public and donor-funded investments, the Vessel Day Scheme (a regional agreement that which has also supported job creation. Inflation remains establishes the minimum price of a vessel day and modest due to relatively stable global commodity limits the total number of vessel days sold). Another prices. Continued strong fishing license revenues have large fiscal surplus is expected in FY2017. Along with supported large fiscal and current account surpluses. increased Compact grants, higher revenues have been Nevertheless, medium-term fiscal sustainability used to increase capital expenditure. The government remains a challenge for most PICs, with both revenue has also prudently transferred fiscal surpluses to the and expenditure subject to large and frequent shocks. FSM Trust Fund aimed at mitigating external shocks and potential future shortfall from the scheduled end of Compact grants from 2024. Recent Developments In Kiribati, growth is expected to have been about The economy of the Federated States of Micronesia 4.2 percent in 2016, representing Kiribati’s sixth (FSM) is expected to have grown 3.0 percent in FY2016 consecutive year of economic expansion. Growth is (ending September 30), continuing the recovery expected to moderate to about 2.8 percent this year, with commenced in FY2015 (3.7 percent growth), after three the winding down of major donor-financed infrastructure years of contraction during FY2012–14. Recent growth projects. Inflation has remained around 2 percent, with has been driven by higher production in the fisheries the relative stability of food and commodity prices and sector and increased construction activity related to the relative stability of the Australian dollar (which infrastructure projects. In FY2017, growth is expected Kiribati uses as its currency). Despite large trade deficits, to moderate to 2 percent, as the recovery continues at a the current account balance has remained in surplus in 138 Small Pacific Island Countries BALANCING ACT recent years due to high levels of fishing license fee phosphate exports and a moderation in RPC-related revenue paid by foreign companies to fish in Kiribati’s activity. vast Exclusive Economic Zone and, to a lesser degree, solid investment incomes from the Revenue Equalization Government revenue has increased substantially since Reserve Fund (RERF), Kiribati’s sovereign wealth fund, FY2012 due to RPC-related revenues and fishing and stronger remittance inflows. Fishing license fee license fees, as well as increased tax collection from revenue in 2016 was equivalent to about 68 percent of the implementation of employment and services taxes GDP, down from the record 93 percent of GDP received and improvements in tax administration. However, in 2015, but still very strong by historical standards, government spending has also increased rapidly, driven by the effects of the Vessel Day Scheme and particularly on the wage bill (in an effort to retain key continued favorable weather conditions. The continued public employees), but also on goods, services, and strong fishing license fee revenue supported a budget social benefits. After accounting for a contribution to surplus in 2016, estimated at about 3.9 percent of GDP. the Nauru trust fund, estimates suggest a small fiscal deficit of around 1 percent of GDP in FY2017. The strength of fishing license fee revenues in recent years and has resulted in the accumulation of substantial The Palauan economy grew by 1.9 percent in FY2016, cash reserves. In 2015, the government made a net following growth of 11.4 percent in FY2015. The strong transfer of AUD 50 million to the RERF, and in 2016, the growth in FY2015 was driven by tourist arrivals (which government made another transfer of AUD 70 million increased by 34 percent) and construction activity. to the RERF. Cash reserves have now accumulated above However, the rapid rise in tourism activity strained the buffer required to deal with general volatility and infrastructure, prompting the authorities to limit the shocks, and the government plans to use these funds to number of charter flights in FY2016, resulting in a finance infrastructure investments in the outer islands, 13 percent fall in annual tourist arrivals. Lower tourism to improve connectivity and service delivery for remote receipts, combined with higher imports for transport populations. and medical equipment, also weakened the external position, with the current account deficit reaching Nauru grew by more than 20 percent annually on 10.3 percent of GDP in FY2016. Despite slowing growth, average from FY2011–FY2014 (year ending June) the economy continued to create jobs (up 4.4 percent due in part to the reopening of Australia’s Regional in FY2016), meaning formal employment has now Processing Centre (RPC) for asylum-seekers in 2012, increased by 16 percent since FY2012. Consumer prices which is currently the main driver of economic activity fell by 1.3 percent in FY2016, as the stronger US dollar in Nauru. The resumption of phosphate mining in 2011 (the official currency of Palau) held down local prices and an increase in fishing license fees also spurred for food and transport services. Economic growth is economic activity. However, growth in more recent years expected to rebound to around 5 percent in FY2017 as has been much slower on average and remains volatile, tourism activity recovers with the entry of new hotels, with Nauru’s undiversified economy making it highly and construction picks up. vulnerable to external shocks. After damage to seaport facilities, FY2015 saw only modest growth of around Palau’s fiscal position has strengthened in recent years, 3 percent, but the economy rebounded in FY2016, with FY2016 registering a fiscal surplus (including growing by about 10 percent due to seaport repairs, grants) of 4.3 percent of GDP, the sixth consecutive strong activity in the service sector, and a large increase annual surplus, underpinned by increased collections of in government spending. Growth is estimated to have income tax and import duties, and higher capital grants. slowed to 4 percent in FY2017 due to a slowdown in Small Pacific Island Countries 139 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 These were partially offset by increased SOE subsidies disaster-recovery and other construction activities and higher contributions to public sector pensions. pushed up the import bill. Economic growth is expected to remain steady in the Comprehensive revenue policy and administrative Republic of Marshall Islands (MHL). Following reforms have led to significant increases in domestic growth of 0.4 percent in FY2015, the MHL economy is revenue collection over the last five years. Combined expected to expand by around 1.4 percent in FY2016 with tighter controls on operating expenditure, these and 1.7 percent in FY2017, reflecting the recovery of increases in revenue helped reduced the budget deficit agriculture production following the drought in early to 0.4 percent of GDP in FY2016, from 3.9 percent in FY2016, and the resumption of delayed Compact-grant FY15 and 5.3 percent in FY2014, despite a pronounced infrastructure projects. Increased capital spending decline in grants over the same period. Budgetary data is expected to increase imports, pushing the current for the first three quarters of FY2017 suggest that this account back into deficit following a large one-off solid revenue performance has been maintained, while surplus in FY2015. Inflation is expected to be around operating expenditures of most ministries (apart from 1 percent in FY2016 and FY2017, and continued high education and health) have been reduced by 10 percent fishing license fees are expected to underpin a continued from the previous year. While Samoa’s external public small fiscal surplus in both years. However, larger fiscal debt remains high compared with most other small surpluses will be required to build adequate buffers to PICs, as a proportion of GDP it has declined to around sustain government spending following the scheduled the government’s target of 50 percent, down from its end of Compact grants from 2024. peak of 55 percent in FY2015. Economic growth in Samoa accelerated to around Growth has been relatively strong in Tonga in 7 percent in FY2016 (year ending June), much faster recent years. Growth in FY2016 (year ending June) than originally forecast and a significant acceleration is estimated at 3.4 percent, supported by one-off from growth of between 1 and 2 percent in the previous events, including the King’s Coronation; post-cyclone two years. Growth in FY2016 was driven by tourism reconstruction; private sector investment, including the arrivals, lower fuel prices, and new fish processing re-development of the International Dateline Hotel; and facilities, as well as two major sporting events. In the a recovery in agricultural production following a severe first three quarters of FY2017, the pace of growth drought in 2015. Growth in FY2017 is projected to have has moderated to around 3 percent, due to slowing moderated to around 2.7 percent, due mainly to a delay activity in the construction sector (reflecting the in implementation of various construction projects. In completion of major infrastructure works in 2016) May 2017, Tonga withdrew from hosting the 2019 and in the fishing industry. Average annual inflation Pacific Games. Nevertheless, the government continues was very subdued at 0.1 percent in FY2016, with to prioritize sports development, and the large majority declines in the prices of imported goods (particularly of planned donor-funded construction related to the fuel) continuing to offset increases in domestic prices. Games will go ahead as planned. While inflation has In FY2017, inflation is expected to have remained been very subdued in recent years, it spiked to around contained at around 1.3 percent. Although the trade 9 percent in year-on-year terms in February 2017, balance improved in FY16, the current account deficit due in large part to policy-driven increases in import widened to 6.1 percent of GDP (from 3.0 percent in duties and excise taxes on fuel, alcohol, tobacco, and FY15) due mainly to a reduction in remittances related less healthy foods and drinks. However, inflation should to charities. Nevertheless, the current account deficit return to more modest rates as these one-off effects remains below levels observed in previous years, when pass through. The current account deficit is estimated to 140 Small Pacific Island Countries BALANCING ACT have narrowed to around 3 percent of GDP in FY2016, in 2017) to finance ongoing climate change mitigation while official foreign exchange reserves stood at around efforts, as well as to finance recovery and rehabilitation 10 months of import cover in early 2017. from climate change impacts and natural disasters. The government continues to focus on increasing The current account moved from a net surplus of around domestic revenues, which have increased by over 7.6 percent of GDP in 2015 to a deficit of around 4 percent 5 percentage points of GDP over the last five years, of GDP in 2016, owing to a widening of the trade supported by a series of policy and administration deficit, reflecting increased imports for government and reforms. At the same time, total public expenditure donor-funded investment projects. The labour market has also increased, mostly in response to cyclone for Tuvalu’s seafarers has collapsed in recent years reconstruction needs and increases in wages for (owing to increased international competition), limiting civil servants. The deficit is estimated to have risen income from remittances—estimated at 0.5 percent of to 2 percent of GDP in FY2016, from 1.1 percent in GDP in 2016. Record fishing license revenues in 2015 FY2015, with lower grants from development partners and 2016 resulted in substantially higher income flows, also affecting the bottom line. The government has and continued to finance a significant portion of the successfully maintained a stance of avoiding any new goods and services deficit (estimated at 81.5 percent of non-concessional borrowing. GDP in 2016). Gross reserves have remained adequate, covering around just over 6 months of imports in 2016. Economic growth has picked up in Tuvalu in recent years, with GDP growth estimated at 3 percent in 2016 (up In 2016, economic growth for Vanuatu is estimated from 2.6 percent in 2015) and is expected to rise further at 4 percent, driven primarily by government and to 3.2 percent in 2017 due to continued government donor funded reconstruction activities following TCP expenditure on capital projects. Government and donor in 2015. GDP growth is expected to remain strong funded investments, including outer-island school and in 2017 (projected at 4.6 percent), on the back of clinic projects have also contributed to the pick-up in continued reconstruction activity and the recovery of growth over recent years. Inflation was moderate at the agricultural and tourism sectors. The agricultural 2.6 percent in 2016 (down from 3.2 percent in 2015) sector recovered in the second half of 2016, following and is expected to rise to 2.9 percent in 2017 as unusually dry conditions triggered by El Niño throughout economic activity picks up. 2015 and early 2016, while tourism arrivals for the year surpassed 2015 arrivals by 19 percent. Inflation The fiscal position, which improved significantly remained moderate at 2.2 percent in the last quarter over recent years, returned to a deficit estimated at of 2016, and is expected to increase to 2.5 percent in 2.6 percent of GDP in 2016—largely due to Tropical 2017. On the back of stronger-than-expected revenue Cyclone Pam (TCP) recovery and reconstruction performance (driven by VAT collections and excise expenditures and one-off spending on infrastructure taxes) and under-implementation of the development investments. Non-tax revenues such as fishing license budget, the pre-grant fiscal balance recorded a surplus fees and dot.tv internet domain leases finance the bulk of 2.3 percent of GDP. In 2017, the government has of spending needs. Notably, fish license fees increased targeted a balanced budget, with both revenue and from 38.6 percent of GDP in 2014 to 53.2 percent in expenditure estimates projected at 25 percent of GDP. 2016. Supplementary to the Tuvalu Trust Fund (TTF) and its auxiliary fund—the Consolidated Investment Overall, economic growth is estimated at 4.6 percent in Fund (CIF)—the government established the Tuvalu 2017, driven by ongoing large infrastructure projects, Survival Fund (TSF) in 2016 (capitalized at A$7 million the continuation of post-cyclone reconstruction and Small Pacific Island Countries 141 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 rehabilitation activities, the gradual recovery of reforms to boost medium-term growth and revenues agricultural production, and overall growth in visitor are essential, particularly for the Compact of Free arrivals. The current account deficit is estimated at Association countries (FSM, RMI and Palau), as the 21 percent of GDP in 2017, reflecting the continued asset base of government-managed trust funds is not increase in imports associated with post-cyclone projected to provide sufficient returns to offset the recovery efforts. Inflation for 2017 is estimated at effect of expiring U.S. grants after FY2023. Without 2.5 percent—an increase on the previous quarter— these reforms, the fiscal surpluses in these nations are driven by transport and food prices. expected to turn into a deficit beyond FY2023. In terms of the incidence of poverty in the region, none The outlook for Kiribati remains positive. Growth is of the PICs conduct regular household income and expected to gradually moderate toward its potential, expenditure surveys, and thus, do not produce regular around 2 to 2.5 percent per year, but if planned major statistics on poverty. Based on the most recent statistics donor-financed infrastructure projects and government- available for each country, in the past, Vanuatu, Kiribati financed outer island infrastructure investments are and the north Pacific (FSM and MHL) have had the implemented, the medium-term growth forecast will highest incidence of poverty based on the international shift up. Maintaining fiscal sustainability remains a poverty line (US$1.9/day in 2011PPP) and lower challenge despite large fiscal surpluses in recent years, middle-income class poverty line (US$3.2/day in 2011 as expenditure pressures remain and fisheries revenues PPP) (Figure 1). In recent years, poverty is likely to come off their peak. A deficit of 0.7 percent of GDP have increased in both Vanuatu and Tuvalu due to the is projected for the current year. Both revenue and impacts of TCP and El Nino weather patterns. Vanuatu expenditure are subject to large and frequent shocks. is particularly susceptible to adverse weather due to the The main sources of income—fishing license fee relatively high dependence on home produced food revenue, investment income from the RERF, and foreign compared to regional neighbors. In Tuvalu, adverse aid—will continue to be volatile, while disaster-related weather conditions disproportionately impact the outer expenditure shocks—particularly from storm surges and islands, where 99 percent of households depend at least king tides—could increase in frequency and severity partially on home production of food items, compared with climate change. The country’s large infrastructure to 74 percent in Funafuti. and essential services deficit, widespread poverty, and young and growing population also require increased and more effective spending on physical and human Outlook and Emerging Challenges capital. Ongoing efforts to improve the performance of state owned enterprises also need to be maintained, to The outlook, particularly for FSM, MHL, Palau and continue to improve access to basic public services and Tuvalu, is subject to substantial risks due to their reduce fiscal risk. reliance on tourism, external grants, and commodity imports. A slowdown in key trading partners, a further In Nauru, the economy is projected to contract in FY18, U.S. dollar appreciation, and natural disasters could with only modest economic growth expected over the impact negatively on tourism activity. Higher commodity medium term. Growth remains dependent on the very prices could make food and fuel imports costlier. Global uncertain outlook for the RPC, which in turn is contingent financial sector volatility could also affect returns on on the extent to which asylum seekers in Nauru are the various trust funds held by these countries, and resettled in other countries and the potential additional their ability to provide fiscal space for priority spending donor support that Nauru may receive to compensate for or buttress against future shocks. Structural and fiscal revenue shortfalls. Nevertheless, the central case is for a 142 Small Pacific Island Countries BALANCING ACT substantial decline in RPC revenue, beginning in FY18. For Vanuatu, if current and planned public investments Nauru’s biggest challenge is to diversify its economy are undertaken efficiently, and with due regard to beyond reliance on the RPC and phosphate mining, domestic capacity constraints, they should boost neither of which is a sustainable source of income in Vanuatu’s potential growth rate and ensure that services the longer term. To ensure fiscal sustainability, it will are available to the poorest and most vulnerable. Given be important for the revenue reforms now underway the government’s conservative fiscal stance in recent to be complemented with systematic efforts to contain years, it now has some fiscal space to take on moderate the wage bill and recurrent spending, while preserving levels of concessional debt to meet its post-cyclone critical expenditures on health and education. recovery and broader development needs. Further, throughout 2016 the government made progress in In Samoa, the exit of a major manufacturer of addressing deficiencies in controls on anti-money automotive wire harnesses in the second half of 2017 laundering and combating the financing of terrorism, is likely to temporarily reduce growth by around which will see Vanuatu withdrawn from the Financial 1 percentage point, with growth in FY18 projected to Action Task Force money laundering ‘grey list’, and may slow to between 1 and 2 percent. Growth is expected impact positively on new foreign business investment. to return to an annual rate of around 2 percent over the medium term, supported by construction of public infrastructure and increased productive capacity in the tourism and agriculture sectors. Nevertheless, as public debt remains high, it is important that fiscal restraint is maintained, consistent with recent government efforts to increase domestic revenues, control recurrent spending (while protecting critical social expenditures), and pursue only high-priority and concessionally- funded capital investments. In FY2018, growth in Tonga is projected to pick up to around 3.4 percent, driven by construction, a rebound in agriculture, and expanding remittances, as well as growth in the tourism sector. The key challenge facing Tonga in coming years is to maintain its prudent fiscal stance. This should be aided by the recent introduction of fiscal anchors which set medium-term targets for domestic revenue, the wage bill, and external debt. Management of the government wage bill should also be strengthened by the recent implementation of a new remuneration framework and performance management system. To the extent that Tonga manages its government spending prudently, it will retain the fiscal space necessary to meet pressing service delivery needs and respond quickly and effectively to the frequent shocks (particularly natural disasters) that it faces. Small Pacific Island Countries 143 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Figure 1. Incidence of poverty at international poverty Figure 2. Public and publicly guaranteed external debt lines (US$1.90/day and US$3.20/day) (share of GDP) Percent of the population Percent of GDP 40 70 35 60 30 50 25 40 20 30 15 20 10 5 10 0 0 TON WSM TUV KIR FSM VUT 2009 2008 2010 2006 2013/14 2010 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016e JJExtreme poverty (US$1.90/day) JJPoverty (US$3.20/day) ▬▬Kiribati ▬▬Republic of Marshall Islands ▬▬Federated States of Micronesia Sources: Latest available joint World Bank and IMF DSAs. ▬▬Samoa ▬▬Tonga ▬▬Tuvalu ▬▬Vanuatu Sources: Latest available joint World Bank and IMF DSAs. SMALL PACIFIC ISLAND COUNTRIES  Selected Indicators 2014 2015 2016e 2017f Real GDP growth, at constant market prices Kiribati 0.4 7.5 4.2 2.8 Marshall Islands -1.1 0.4 1.4 1.7 Micronesia, Federated States -2.4 3.7 3.0 2.0 Nauru 36.5 2.8 10.4 4.0 Palau 5.8 11.4 1.9 5.0 Samoa 1.2 1.6 7.1 2.5 Tonga 2.1 3.7 3.4 2.7 Tuvalu 2.2 2.6 3.0 3.2 Vanuatu 2.3 -0.8 4.0 4.5 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: Financial Years in the Small PICs are as follows: Tuvalu and Vanuatu (Jan – Dec); Nauru, Samoa and Tonga (Jul – Jun); MHL, FSM and Palau (Oct – Sept); e = estimate; f = forecast. 144 Small Pacific Island Countries BALANCING ACT SOLOMON ISLANDS and a large influx of donor financing. The national basic-needs poverty rate, estimated in 2012/13, is 12.7 percent, while the gini coefficient is 37.1. Economic growth for 2016 is estimated at 3.3 percent, driven by higher output in the logging and agricultural sectors, and investments in construction, communications and manufacturing. In 2017, the infrastructure push is continuing, but growth is forecast at 3.0 percent, with the marginal slowdown driven by continued public financial management problems which have resulted in domestic arrears and are impeding private sector 2016 activity. Agriculture, fishing, transportation and the Population, million 0.6 financial sector remain important drivers of growth in GDP, current US$ billion 1.2 2017. Domestic economic activity, as measured by the GDP per capita, current US$ 1,997 Central Bank’s production index, increased in the first School enrolment, primary (% gross)a 113.9 five months of 2017 supported by strong log output Life expectancy at birth, yearsa 67.9 Source: WDI, Macro Poverty Outlook, and official data. and fish catch. Production declined in June, reflecting a Note: (a) Most recent WDI value (2014). month-on-month decline in log output (18 percent), fish catch (8 percent) and cocoa (35 percent). International Summary prices for key export commodities recovered throughout 2016, and remained relatively stable in H1 2017—with The Solomon Islands Government prioritizes the exception of palm oil, declining by 13 percent. infrastructure and development in rural areas—where most of the population reside. Growth is expected to Since 2015, the government has pursued expansionary remain at trend of around 3 percent. In the medium- fiscal policy with targeted investments towards rural term, emerging challenges include a sharper than infrastructure and development, and the health and expected downturn in the Chinese economy, and education sectors—potentially important and direct ongoing uncertainties, particularly in the logging and investments in improving the well-being of Solomon mining sectors. Continued strong and coordinated Islands’ poor. The 2016 budget resulted in a deficit of government action coupled with greater private sector 3.1 percent of GDP, financed through a draw-down of investment to promote inclusive economic growth will the government’s cash reserves. Similarly, the 2017 be necessary to ensure broad-based improvements in budget targets a deficit of 4.3 percent of GDP, although living standards. the actual deficit could increase substantially, should optimistic revenue estimates not be met. Overall, this increase in expenditures has resulted in cash reserves Recent Developments declining from SI$880 million at the end of 2015 to SI$179 million at the end of 2016, significantly eroding Solomon Islands remains dependent on foreign aid the government’s ability to absorb future exogenous flows and natural resource extraction, and is heavily shocks. exposed to natural disasters and exogenous shocks. Following the cessation of civil strife in 2003, economic Total PPG external debt stood at 7.6 percent of GDP at growth has depended primarily on the logging sector end-2016. As such, Solomon Islands continues to enjoy Solomon Islands 145 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 one of the lowest debt-to-GDP ratios in the region, and Index is expected to remain at around 3 percent over globally. The most recent debt sustainability analysis the medium term. (2016) classifies Solomon Islands at a moderate risk of debt distress with the baseline scenario subject to significant risks, resulting from a lower-than-expected Risks and Challenges growth path and a shock to financing terms. With logging sources expected to be fully depleted in International reserves stood at US$513 million at end- the long run and uncertainty around the exploitation of 2016, equivalent to 9.4 months of imports. The current the country’s mining potential, Solomon Islands faces account is projected to have widened from 3.0 percent the challenge of developing new sources of growth. of GDP in 2015 to 3.9 percent in 2016, to support In the near term, growth will be supported by major imports related to large infrastructure projects. infrastructure projects and logging may not decline significantly. This outlook is subject to considerable Inflation fell throughout 2016 from 2.9 percent in risks, particularly from any contraction in log demand in January to negative 2.2 percent in December, driven by China (the main export destination for logs), or delays price falls in food, transport and communications. in infrastructure projects. Thereafter, the impending decline of the logging industry is likely to significantly reduce growth and a vital source of government Outlook revenue. Economic growth is projected to average 3 percent per Future developments in the mining sector hinge on year over the medium-term, driven by infrastructure the development of a legal and regulatory framework investments in the road transport, telecommunications conducive to mining, and on clear procedures for the and energy sectors. This baseline scenario also assumes acquisition of land for exploration and exploitation. resumed gold-mining activity, the exploitation of large Such frameworks and procedures will also ultimately nickel deposits, and sustained levels of foreign direct impact the extent to which forthcoming benefits from investment averaging 3.3 percent of GDP. mining are shared across the population. The government has targeted a budget deficit for the A number of challenges remain in the fisheries third consecutive year, estimated at 4.3 percent of GDP. sector, including licensing, monitoring, and enforcing The 2017 budget optimistically projects domestically- compliance in offshore fisheries. If sustainably managed, sourced revenues to increase by 19.4 percent against fisheries offer the potential to contribute to growth and the revised 2016 budget, which could widen the government export earnings over the medium term. planned deficit further, should this target not be met. A second supplementary appropriation bill for the year, Tourism could also make an important contribution to due for passage in Q3, poses additional fiscal pressure broad-based, and potentially more inclusive growth on the deficit. in the longer-term, although at this stage it is not very developed. Challenges include limited to limited The current account deficit is expected to widen to market exposure, domestic transport infrastructure and 5.0 percent of GDP by end-2017, reflecting an increase services, and access to finance for small-and-medium in imports related to much needed infrastructure and enterprises operating in the sector. energy projects, and the underlying long-run decline in logging exports; while the Honiara Consumer Price 146 Solomon Islands BALANCING ACT Further, should future formal employment opportunities continue to remain concentrated in Honiara and the immediate surroundings, this might exacerbate challenges associated with rapid population growth, rural-to-urban migration, and the growth of urban squatter settlements. Figure 1. Trade and trade balance Figure 2. Per capita GDP, growth and level of index US$, thousands Percent of GDP Percent growth Index 800 40 12 160 10 700 30 140 8 600 20 120 6 500 10 100 4 400 0 2 80 -10 0 300 60 -2 200 -20 40 -4 100 -30 20 -6 0 -40 -8 0 05 006 007 008 009 010 011 012 013 014 015 016 017 018 019 020 05 006 007 008 009 010 011 012 013 014 015 016 017 018 019 020 20 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 20 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 JJTrade balance as % GDP, rhs ▬▬Imports ▬▬Exports JJReal GDP per capita, percent change ▬▬Real GDP per capita index (2003=100), rhs Sources: Central Bank of the Solomon Islands, World Bank staff estimates, IMF. Sources: World Bank staff estimates, IMF. Note: rhs= right-hand side. Note: rhs= right-hand side. SOLOMON ISLANDSSelected Indicators 2015 2016e 2017e 2018f 2019f 2020f Real economy Real GDP 2.5 3.3 3.0 3.0 2.8 2.7 Per capita real GDP 0.3 1.0 0.8 0.8 0.6 0.5 GDP deflator 1.7 1.6 1.6 1.6 1.6 1.6 CPI (eop) 3.5 -2.2 1.9 1.8 2.9 3.4 Fiscal accounts (% of GDP) Expenditures 48.2 44.4 45.5 46.9 44.5 43.9 Revenues 47.9 41.3 41.3 42.2 41.5 41.0 General government balance -0.2 -3.1 -4.3 -4.7 -3.0 -2.9 Balance of Payments (% of GDP) Current account balance -3.0 -3.9 -5.0 -5.0 -5.6 -5.8 Imports (goods and services) 53.5 50.8 51.6 51.2 51.7 51.2 Exports (goods and services) 45.5 45.0 44.3 42.9 42.5 41.9 Foreign direct investment 2.4 2.9 3.9 3.6 3.6 3.7 Gross reserves (in US$ millions, eop) 519.6 513.6 519.9 542.0 561.2 594.2 In months of next year’s imports 10.0 9.4 8.9 8.6 8.5 8.4 External debt 10.6 7.6 8.5 12.5 14.0 16.0 Exchange rate to US$ (average) 7.9 7.9 8.1 7.9 7.9 7.9 Nominal GDP (US$ millions) 1,158.4 1,232.9 1,272.4 1,372.2 1,456.9 1,548.0 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: e = estimate; f = forecast. Solomon Islands 147 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 THAILAND Credit issuance remained subdued as lending standards tightened while loans to large corporates turned positive in 2017Q1 for the first time since 2015. Loans to SMEs and households continued their deceleration trend. The recent improvement in economic performance builds on the gradual recovery of the past two years. Private consumption expanded by 3.1 percent in 2016, compared to 2.2 percent in 2015, largely driven by improved farm income and stimulus measures. Both public consumption and public investment continued to expand by 1.7 percent and 9.9 percent during the 2016 year, respectively. Services and merchandise exports Population, million 68.1 grew substantially in 2016Q4 . GDP, current US$ billion 407.0 GDP per capita, current US$ 5,973 Agriculture showed signs of recovery from a contraction School enrolment, primary (% gross)a 103.7 caused by a severe drought in 2015, as output expanded Life expectancy at birth, yearsa 74.4 Source: WDI, Macro Poverty Outlook, and official data. by 15.8 percent in 2017Q2. Higher output and Notes: (a) Most recent WDI value (2014). commodity prices, as well as higher yields, supported farm income. In the long-run, managing the impact brought about by cycles of flood and drought through Summary improved water management is a key priority. The Thai economic recovery has continued to broaden Manufacturing growth decelerated to 1.0 percent in and gain momentum, reflecting an increase in external 2017Q2 and remained at relatively low levels similar demand and recovery from severe drought. The economy to previous quarters. Growth was stronger in export- grew by 3.7 percent in 2017Q2, exceeding market oriented industries in 2017H2 as merchandise exports expectations. Merchandise exports recorded 8.0 percent increased in line with higher demand from main trading growth, due to global commodity prices and trading partners. However, capacity utilization remained low at partner growth. The agricultural sector expanded by 59 percent. 15.8 percent due to rising prices and recovery from severe drought. Poverty rates are expected to fall at a Thailand’s external position strengthened further. slower rate  in the medium term  due to low agricultural Combined with a slight strengthening in the terms of prices. trade, higher net exports contributed to an increase in the trade surplus to US$ 35.8 billion in 2016 and US$ 6.6 billion in 2017Q2. The current account surplus Recent Developments totaled 11.4 percent of GDP. Foreign reserves increased by 3.2 percent to US$ 197.6 billion end-2016, or Domestic demand remained lackluster. Both private 3.8 times short-term foreign debt. Total external debt investment and private consumption growth remained remained stable at 32.5 percent of GDP. moderate. Private investment expanded by 3.2 percent in 2017Q2 after contracting by 1.1 percent in 2017Q1, The fiscal stance remained expansionary to support reflecting spare production capacity in manufacturing. economic recovery. The fiscal deficit is expected to widen 148Thailand BALANCING ACT to 3.7 percent of GDP in FY2017, up from 2.6 percent of peaking in FY2020. However, weaknesses in the public GDP in FY2016. However, public investment contracted infrastructure management framework and historical by 7.0 percent in 2017Q2 after significant expansion in performance suggest a more prolonged expansionary public investment. The annual budget disbursement in fiscal stance that will extend beyond FY2022. 2017Q2 fell to 18.5 percent of the 2017 budget. The implementation of public infrastructure projects Despite low inflation, the Bank of Thailand has in 2017 would help improve investor sentiment. The maintained the policy rate at 1.5 percent since April Transportation Action Plan covers 36 infrastructure 2015. Headline inflation decelerated to 0.1 percent in projects worth 896 billion baht for investment in 2017Q2 due to food prices. The Thai Baht averaged 2017. Five projects began construction in 2017H1. 35.3 per USD in 2016, a slight 2.9 percent depreciation Key projects include the Chinese high-speed rail, dual compared to the previous year. However, strong tracking, and new mass transit lines in Bangkok. The fundamentals and an improved external position led first phase of the Chinese high-speed rail project has to steady appreciation pressure in 2017, with the baht been recently approved by the cabinet. appreciating by 7.8 percent by end-August. Normalization of agricultural prices following a decline Thailand continued to make progress in reducing in the global commodity price cycle will limit agricultural poverty. Based on the national poverty line, the poverty income growth and declines in rural poverty. Rising rate fell from 12 percent in 2011 to 7 percent in 2015. agricultural income in the recent years mainly reflected Poverty rates are expected to fall at a slower rate in a global commodity price cycle and not long-term the medium term, with poor rural households affected productivity increases in agriculture. As agricultural by cycles of drought and historically low agricultural prices fall back to more normal levels, growth could prices. Nevertheless, farm income growth turned become less inclusive, with the rural poor negatively positive beginning in 2016H2 following recovery from affected. Poverty is therefore expected to decline at a drought. slower rate in rural areas in the medium term. Outlook Risks and Challenges The broadening export upturn and public infrastructure The first risk is a deterioration in global economic plans are contributing to an improvement in Thailand’s prospects, particularly trade protectionism, which will economic outlook. Economic growth is projected to weigh on Thai exports and economic recovery. Trade reach 3.5 percent in 2017 and 3.6 percent in 2018, as protectionism and the implementation of the Brexit inflation is expected to return gradually to the inflation vote reflect a significant rise in economic uncertainty, target range. Continued agricultural recovery and which is expected to adversely affect global growth. strengthened household balance sheets will support Such an outcome would hamper economic recovery and private consumption while the export upswing will spur increase the need for more stimulus. Thailand has ample manufacturing and private investment. However, a monetary and fiscal buffers but timely implementation broad-based recovery will hinge on domestic demand. of public infrastructure projects may prove challenging. Ambitious public infrastructure projects will result A second risk is a rise in Thailand’s political uncertainty if in expansionary fiscal policy well into FY2022. The ongoing political reforms fail to satisfy broad segments Transportation Action Plan shows public investment of society. In such a scenario, political uncertainty could Thailand 149 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 delay public spending, planned public infrastructure projects and economic reforms and weigh on investor conference. However, the accession of Crown Prince Maha Vajiralongkorn and royal approval of the new constitution help mitigate this risk. Figure 1. Contribution to annual real GDP growth Figure 2. Poverty rate and GDP per capita growth Percent, percentage points Percent 8 25 6 20 4 15 2 10 0 5 -2 0 -4 -5 2012 2013 2014 2015 2016 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 JJTotal consumption JJGross fixed capital formation JJInventory change ▬▬Poverty rate (national) ▬▬GDP per capita growth JJNet foreign demand JJResidual Sources: World Bank; National Economic and Social Development Board. Sources: World Bank; National Economic and Social Development Board. THAILAND  Selected Indicators 2014 2015 2016e 2017f 2018f 2019f Real GDP growth, at constant market prices 0.9 2.9 3.2 3.5 3.6 3.5 Private Consumption 0.9 2.2 3.1 3.1 3.1 3.0 Government Consumption 2.8 3.0 1.7 3.1 3.1 3.1 Gross Fixed Capital Investment -2.2 4.4 2.8 4.0 4.2 3.7 Exports, Goods and Services 0.2 0.7 2.1 2.3 2.4 3.0 Imports, Goods and Services -5.3 0.0 -1.4 -1.4 2.6 2.9 Real GDP growth, at constant factor prices 0.8 2.8 3.4 3.5 3.6 3.5 Agriculture 0.7 -3.8 0.6 3.0 1.3 1.3 Industry -0.3 2.2 2.0 2.0 2.1 2.2 Services 1.6 4.1 4.7 4.6 4.8 4.5 Inflation (Consumer Price Index) 1.9 -0.9 0.2 0.7 1.6 2.0 Current Account Balance (% of GDP) 3.8 8.1 10.6 10.9 10.4 10.2 Financial and Capital Account (% of GDP) -3.6 -7.9 -11.2 -11.5 -11.1 -10.9 Net Foreign Direct Investment (% of GDP) -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 Fiscal Balance (% of GDP) -0.8 -1.9 -2.6 -3.6 -3.7 -3.6 Debt (% of GDP) 43.1 45.0 45.1 45.9 47.3 48.3 Primary Balance (% of GDP) 0.3 -0.8 -1.5 -2.4 -2.4 -2.3 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty and Equity Global Practice. Notes: e = estimate; f = forecast. 150Thailand BALANCING ACT TIMOR-LESTE private consumption were strong in 2016, with car registrations 8 percent higher, international visitor arrivals 6.6 percent up and consumer imports buoyant. Private consumption is projected to have grown by 4.2 percent in 2016. Investment-related imports such as iron, steel and cement imports were 70 percent higher in 2016, and with government investment sharply higher, total investment growth is projected at 50 percent for 2016. The offshore petroleum sector, not part of GDP presented here, continues to decline with production falling by 8 percent in 2016 and 16 percent further in H1 2017 year-on-year. 2016 Population, million 1.3 While most consumption proxies continued to show GDP, current US$ billion 1.8 strength in 2017—international visitors up 40 percent GDP per capita, current US$ 1,458 in Q1 2017 year-on-year, car registrations 12 percent International poverty rate ($1.9)a 30.3 higher—government expenditure has weakened which Basic Needs Poverty Ratea 41.8 is expected to drag growth down. School enrolment, primary (% gross)b 136.8 Life expectancy at birth, yearsb 68.3 Source: WDI, Macro Poverty Outlook, and official data. The government budget position has moved from a Notes: (a) Most recent value (2014), 2011 PPPs. (b) Most recent WDI value (2014). large surplus in 2014 and previous years to a deficit of 14.7 percent in 2015 and 29.8 percent of non-oil Summary GDP in 2016. Petroleum revenues have declined, with total government receipts falling from 190 percent The current year has seen both Presidential and of GDP in 2014 to 80 percent in 2015 and further to Parliamentary elections, with a hiatus in public spending 72 percent in 2016. Over the three years, expenditure growth over the course of the elections. While there are has remained around 100 percent of GDP. The balance some signs of growth in the private sector, particularly in of the Petroleum Fund stood at US$16.5 billion at end the non-tradable and tourism sectors, but it remains to 2014, and by end 2015 has declined to US$16.2bn and be seen whether this growth can be sustained, and may further to US$15.8 billion by end 2016. Public debt depend on effectiveness of the incoming government’s outstanding is relatively low, at 3.9 percent of GDP, or economic program. Growth for 2017 is forecast to be around US$66 million, at end 2016. In 2016, domestic 2.4 percent, on lower government expenditure with the revenues were slightly stronger than the previous government in caretaker mode over the election period. year, at 11.9 percent of non-oil GDP, but now look to have subsided again, with first half 2017 domestic revenues 4 percent lower year-on-year. Government Recent Developments expenditure slowed to date in 2017 and is 12 percent lower in the first half year-on-year. Overall the first-half Gross domestic product is expected to have grown by 2017 government accounts were in surplus of around 5.7 percent in 2016, but slowed significantly in 2017 36 percent of GDP, although this is likely to deteriorate to date. Government spending was 20 percent higher as expenditure nearly always accelerates rapidly in the over 2016 and government consumption is expected second half of the year. to have grown by 7 percent in real terms. Proxies for Timor-Leste 151 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Coffee exports continued to recover in 2016, with export this forecast, which will be affected by the program of volumes reaching 29,000 tonnes, 20 percent higher the incoming government. than in 2015. Petroleum tax receipts and investment returns have continued to more than offset a large The outlook for private investment in the coming years deficit in goods and services trade to produce current looks to be gradually strengthening and there are a account surpluses, although falling petroleum earnings small number of sizeable private investment projects means the surplus is declining, from US$ 1.1. billion in underway. Construction commenced in mid-2017 on a 2015 to a projected US$300 million in 2016. new container port, with an initial private investment of US$150m and government contribution of US$129m. Annual average CPI continues to be subdued with Hilton recently announced a partnership with a local deflation of 1.3 percent in 2016, but positive inflation company to develop a new 150 room hotel in Dili, with of 1.0 in 2017 to July. Recent inflation trends have been construction already underway. Business and adventure largely driven by prices in the tradable sector. While tourism is anticipated to be a source of increased Timor-Leste’s REER remains heightened, it depreciated demand in the coming years and also in 2017 Citilink just over 2 percent in 2016 and a further 2 percent launched a new, price-competitive daily flight service in the first half of 2017. Credit to the private sector via Bali to Jakarta. has been stagnant for the last two years, contracting by 1.8 percent in 2016, with a slight recovery of The current account is not forecast to fall into deficit 2.8 percent Q-on-Q in the first quarter of 2017, with over the forecast period while there continues to be an absence of basic domestic financial frameworks both significant overseas earnings from the Petroleum constraining domestic credit growth. Fund and further petroleum receipts for the next three years. Poverty in Timor-Leste has declined since 2007. The latest survey estimates that the basic needs poverty rate declined from about 50 percent in 2007 to nearly Risks and Challenges 42 percent in 2014. Measured using the international poverty line (US$1.9/day in 2011 PPP), poverty The petroleum fields that have fueled government declined even more rapidly, from 46.8 percent in 2007 spending to date are fast-depleting, and the uncertain to 30.3 percent in 2014. These reductions in monetary prospect of new revenues will only offer, at best, poverty have been accompanied by other improvements temporary respite from the difficult tasks of diversifying in living standards, including increased electricity the economy and improving public services that are access, dwelling quality and asset ownership. needed in order to bring down the alarmingly high levels of poverty. While some of the conditions for private sector led-growth seem to be improving, the Outlook private sector remains very small and to build on the modest gains in private sector development made Growth for 2017 is forecast to be 2.4 percent, on so far, the government could take a leading role in lower government expenditure with the government in addressing binding constraints in the public sphere. caretaker mode over the election period. Based on first- Major weaknesses exist in the legislative frameworks half execution levels, it is unlikely that spending will and institutional capacity in areas of economic property reach the same level as 2016. Growth is then forecast and commercial justice—such as contract enforcement, to pick up, to 4.2 percent in 2018 and 5.0 percent in secure land leasing, national payments systems, and 2019, although there is significant uncertainty around bankruptcy legislation. At the same time, the public 152 Timor-Leste BALANCING ACT sector lacks the basis for domestic revenue mobilization While over 2007 to 2014 there has been noticeable in a post-oil environment, and would need to develop reduction in poverty, consumption inequality has new frameworks, such as the planned value-added tax, remained largely unchanged within the same period, as in the near-term. It is unlikely that domestic taxation, presented by the Gini index of 0.28 in 2007 and 0.29 levied at a level competitive with ASEAN peers and in in 2014. This signifies the need for continued efforts an efficient manner, would be a significant deterrent in poverty and inequality reduction to continue apace to new business development when coupled with efforts to strengthen overall economic growth. a commitment to improving the institutional and operating environment for business. Figure 1. Contributions to real GDP growth Figure 2. Petroleum Fund wealth per capita Constant price, percent Current prices, US$ billion ('000) 14 16 12 14 10 12 8 10 6 8 4 6 2 4 0 -2 2 -4 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 JJAgriculture, etc. JJPublic-led sectors JJPrivate sector services, etc. Sources: Government of Timor-Leste and World Bank staff estimates. Sources: Government of Timor-Leste and World Bank staff estimates. TIMOR-LESTE S  elected Indicators 2014 2015 2016e 2017f 2018f 2019f Real GDP growth, at constant market prices 4.2 4.0 5.7 2.4 4.2 5.0 Private Consumption 5.6 1.6 4.2 2.9 5.1 4.3 Government Consumption 12.3 3.7 7.4 -5.6 -0.1 2.9 Gross Fixed Capital Investment 6.1 -4.1 39.2 -38.6 34.4 8.8 Exports, Goods and Services -20.1 -5.3 16.3 16.0 15.4 20.0 Imports, Goods and Services 11.5 -4.8 25.0 -29.2 18.8 5.9 Real GDP growth, at constant factor prices 4.4 6.0 5.3 2.2 4.2 5.0 Agriculture -0.5 0.3 0.0 0.5 0.6 0.8 Industry -9.9 24.4 14.8 -6.6 4.5 3.0 Services 10.3 3.1 4.0 5.6 5.0 6.6 Inflation (Consumer Price Index) 0.7 0.6 -1.3 0.8 1.5 2.5 Current Account Balance (% of GDP) 137.7 67.7 12.8 44.5 35.6 21.4 Fiscal Balance (% of GDP) 78.1 -14.7 -29.9 -12.1 -20.7 -23.3 Debt (% of GDP) 2.0 4.6 5.7 7.5 9.6 12.8 Primary Balance (% of GDP) 78.1 -14.7 -29.9 -12.1 -20.7 -23.3 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: e = estimate, f = forecast. Timor-Leste 153 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 VIETNAM expanded by 5.7 percent (y/y) during the first half 2017 (about the same pace the first half of 2016). Mining output contracted by 8.2 percent y/y), largely reflecting increasingly constrained marginal production capacity of Vietnam’s aging oil fields. This was offset by strong momentum of Vietnam’s fundamental growth drivers— domestic demand and export-oriented manufacturing. The service sector accelerated to 6.9 percent, driven by buoyant retail trade growth, which benefited from sustained strength of domestic consumption. Industrial production outside of the mining sector also remains robust with manufacturing output accelerating to 2016 10.5 percent in the first of half of 2017, driven in large Population, million 92.7 part by the export oriented FDI sector. Growth has also GDP, current US$ billion 203.8 gradually recovered to 2.7 percent in agriculture from GDP per capita, current US$ 2,199 last year’s drought, though the recovery is still fragile. International poverty rate ($1.9)a 2.8 Lower middle-income poverty rate ($3.2)a 11.6 Labor market conditions consequently improved, with Upper middle-income poverty rate ($5.5)a 36.3 more than 270,000 wage jobs created in the first Gini coefficienta 34.8 School enrollment, primary (% gross)b 109.4 quarter of 2017. Most of these were created in the Life expectancy at birth, yearsb 75.6 FDI sector, particularly in rural based manufacturing Source: WDI, Macro Poverty Outlook, and official data. firms. Real wages increased by 4.5 percent in that Notes: (a) Most recent value (2014), 2011 PPPs. (b) Most recent WDI value (2014). quarter and by more than 20 percent y/y -a pattern seen across sectors and especially benefited rural low Summary skilled workers. Poverty is expected to have significantly reduced, especially in rural areas. Growth is projected to remain resilient at 6.3 percent this year driven by export-oriented manufacturing Monetary policy continues to balance growth and and robust domestic demand. Broad macroeconomic stability objectives. Inflationary pressures remain stability is being maintained, but delays in fiscal moderate. Headline inflation softened in the first consolidation and elevated credit growth may months of 2017 and underlying core inflation remains exacerbate risks to long-term stability. Acceleration of well below 2 percent. Reflecting decreasing food prices structural reforms would help raise potential growth. and still low energy prices, the year-on-year CPI increase Externally, strong trade linkages expose Vietnam to a moderated to 2.5 percent in July, down significantly from potential weakening of external demand in case the 5.2 percent in January 2017. Amid moderate inflation, ongoing global recovery loses momentum. the State Bank of Vietnam (SBV) cut its key policy rates by 0.25 percentage points in July to boost economic activity to help achieve the official GDP growth target Recent Developments of 6.7 percent. Meanwhile, credit continues to expand rapidly, at about 20 percent year-on-year during the Despite some moderation in economic activity, especially first six months of the year—a pace more than double during the first quarter of 2017, Vietnam’s economy nominal GDP growth. While supporting investment continues to show fundamental strength. Real GDP growth, the credit intensity of growth is rising, and 154 Vietnam BALANCING ACT sustained acceleration of credit may raise concerns over Outlook asset quality, particularly given the unsolved balance sheet risks related to past bad debts. Vietnam’s medium-term outlook remains positive. Real GDP growth is projected to accelerate slightly After a large surplus in 2016, Vietnam’s external to 6.3 percent in 2017, underpinned by buoyant current account balance started to decline in early domestic demand, rebounding agricultural production, 2017. Robust growth in exports, tourism receipts, and and strong export-oriented manufacturing, aided private remittances led to a current account surplus by a recovery in external demand, which will be only of about 4 percent of GDP in 2016, marking the sixth partially offset by declining oil production. Inflationary consecutive year of a widening current account surplus. pressures will remain moderate, reflecting stable core The financial account also continued to see large net inflation and tapering of administrative price hikes. The inflows of foreign direct investment (about 6 percent current account is expected to remain in surplus, albeit of GDP) and long-term loans, allowing the SBV to at a lower level as stronger import growth resumes. Over gradually rebuild foreign reserves. The current account the medium term, growth is projected to stabilize at surplus started to decline in the first half of 2017 as around 6.4 percent in 2018–19, accompanied by broad import growth recovered strongly to 23.6 percent macroeconomic stability. Barring extreme weather (from -0.6 percent during the same period last year). related shocks, poverty is expected to fall further. Bolstered by the strong external position, the nominal exchange rate has been relatively stable. Risks and Challenges Fiscal consolidation is underway. The fiscal deficit (including off-budget items) is estimated to have widened Domestic and external risks call for continued to about 6.5 percent of GDP in 2016 from 6.2 percent macroeconomic prudence. In view of resilient growth in 2015. As a result, Vietnam’s total outstanding public momentum, solidifying macroeconomic stability and debt (government, government-guaranteed, and local rebuilding policy buffers should remain the foremost government) was estimated at about 63 percent of GDP priority. Lowering the fiscal deficit will help to contain at the end of 2016, inching quickly toward the legally rising risks to fiscal sustainability and provide fiscal mandated ceiling of 65 percent of GDP. space to accommodate potential future shocks. Containing risks from rapid credit growth requires Fiscal outturns in the first half of 2017 suggest stronger continued improvements in supervision and prudential revenue performance (mostly of non-tax revenue) and regulation. The longer-term challenge for the Vietnam greater spending discipline, which helped contain is to sustain rapid growth and poverty reduction. the budget deficit and rising public debt. But the Considerable gains are possible from structural reforms adjustment has so far largely resorted to ad-hoc, one- that alleviate constraints on productivity growth, off measures. For a high-quality fiscal consolidation to including through SOE reforms, further improvements be sustained over the medium term, further structural in the business environment and more efficient factor measures are needed to boost revenue potential and markets for land and capital. The gender wage gap spending efficiency while protecting growth-enhancing remains a concern, particularly in the urban FDI sector investments in infrastructure and human capital. where the average wage for males rose even as that for females marginally declined unlike in rural areas where the increase was proportionate. Vietnam 155 EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017 Figure 1. Real GDP growth and contribution to Figure 2. Actual and projected poverty rates and private Real GDP growth consumption per capita (constant LCU) Percent, percentage points Poverty rate, percent Private consumption per capita, constant LCU, in million 30.1 100 30 90 20.1 25 80 70 10.1 20 60 0.1 50 15 40 -10.1 10 30 20 -20.1 5 10 -30.1 0 0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2002 2004 2006 2008 2010 2012 2014 2016 2018 JJGovernment consumption JJExports JJGross fixed capital formation JJInventories ▬▬Intenational poverty rate ▬▬Lower middle-income poverty rate JJPrivate consumption JJImports JJStatistical discrepancy ▬▬GDP ▬▬Upper middle-income poverty rate ▬▬Consumption per capita Sources: Official data and Macro Poverty Outlook. Source: World Bank. VIETNAM S  elected Indicators 2014 2015 2016e 2017f 2018f 2019f Real GDP growth, at constant market prices 6.0 6.7 6.2 6.3 6.4 6.4 Private Consumption 6.1 9.3 7.4 7.5 7.2 7.0 Government Consumption 7.0 7.0 8.8 4.9 6.7 8.5 Gross Fixed Capital Investment 9.3 9.4 9.3 9.0 8.8 8.4 Exports, Goods and Services 11.6 12.6 17.9 14.6 13.6 13.5 Imports, Goods and Services 12.8 18.1 19.2 15.3 14.0 13.8 Real GDP growth, at constant factor prices 5.7 6.8 6.1 6.4 6.5 6.5 Agriculture 3.4 2.4 1.4 1.9 2.0 2.0 Industry 6.4 9.6 7.6 7.6 8.2 8.3 Services 6.2 6.3 6.9 7.0 6.6 6.5 Inflation (Consumer Price Index) 4.1 0.9 2.7 4.0 4.5 4.5 Current Account Balance (% of GDP) 5.0 0.1 4.0 2.5 1.8 1.5 Fiscal Balance (% of GDP) -6.3 -6.2 -6.5 -5.7 -5.5 -5.4 Debt (% of GDP) 55.1 58.4 62.6 63.3 63.9 64.6 Primary Balance (% of GDP) -4.6 -4.2 -4.4 -3.6 -3.5 -3.2 International poverty rate ($1.9 in 2011 PPP)a,b 2.8 2.2 1.8 1.4 1.1 0.9 Lower middle-income poverty rate ($3.2 in 2011 PPP)a,b 11.6 9.5 8.1 6.9 5.9 5.1 Upper middle-income poverty rate ($5.5 in 2011 PPP)a,b 36.3 31.7 28.1 24.7 22.0 19.0 Sources: World Bank, Macroeconomics and Fiscal Management Global Practice, and Poverty Global Practice. Notes: f = forecast. (a) Calculations based on EAPPOV harmonization, using 2014-VHLSS. Actual data: 2014. Nowcast: 2015 - 2016. Forecast are from 2017 to 2019. (b) Projection using neutral distribution (2014) with pass-through = 0.87 based on private consumption per capita in constant LCU. 156 Vietnam WORLD BANK EAST ASIA AND PACIFIC ECONOMIC UPDATE OCTOBER 2017