EAST ASIA UPDATE From Cyclical Recovery to Long Run Growth REGIONAL OVERVIEW Special Focus: Making Services Work in East Asia October 2003 East Asia and Pacific Region The World Bank CONTENTS East Asia and Pacific regional overview ................................................1 1. Introduction............................................................................................1 2. An improving cyclical outlook...............................................................5 Diverse growth outcomes in the wake of SARS................................6 Box 1 Health Policy Responses to SARS.................................8 Poverty continues to move lower ­ but is it getting harder?..............8 3. International environment ­ better but still uncertain.....................10 World recovery gathers strength ­ again ........................................10 Booming China trade and regional integration................................13 Trade policy challenges after Cancun..............................................14 International capital markets and exchange rates ............................17 4. Domestic trends and policy challenges ...............................................21 Financial sector trends and reforms..................................... ............22 Corporate performance and policy issues........................................24 The political season and public governance trends..........................26 Appendix Tables........................................................................41 Special Focus: Making Services Work in East Asia ...............................49 Key Indicators Tables .................................................................................63 EAST ASIA AND PACIFIC REGIONAL OVERVIEW Introduction are improving. Poverty is falling in most countries, consumer spending has burgeoned in South East Asia and Economic activity in East Asia should strengthen in more recently investment has also strengthened in Thailand, coming months.1 The region had already begun a cyclical with more modest pickups in some other countries. Partly as recovery in 2002, but this was partially side-tracked by a result of restructuring efforts, profitability and balance SARS and other shocks in early 2003. East Asian growth sheets of banks and corporations are healthier in several fell to only 3 percent in the second quarter of 2003 from near post-crisis countries, capital inflows are up, bank lending is 6 in the first. On balance, though, the impact of SARS was rising and financial markets are higher ­ a better climate for less than first feared, and growth projections for the full year more investment. Finally, the region is becoming more 2003 remain unchanged compared with six months ago. comfortable with representative forms of governance. Information on performance in the third quarter is Instead of creating major tensions, the many elections and incomplete, and also mixed, because of conflicting signals political transitions in the region over the next 18 months from different indicators and differences across countries. will tend to strengthen overall political legitimacy and The quick passing of SARS ­ at least for the time being ­ stability. Experiments with decentralization have also given has been accompanied by a sharp rebound in tourist arrivals the public more voice, a trend that can be leveraged to and retail sales. Far from too little growth, China is in the improve the delivery of key services like health and midst of a powerful boom that has policy makers looking for education ­ the subject of the accompanying Special Focus ways to cool the pace of expansion in some sectors. On the on "Making Service Delivery Work in East Asia" other hand, export growth in most countries slowed in the summer and in some has yet to revive. Text Table 1. East Asia Economic Growth These conflicting signals obscure the near term 2001 2002 2003 2004 outlook a little, but, on balance, we think prospects for East East Asia 3.5 5.8 5.0 5.7 Asia are getting brighter. If the momentum of reform can be Develop. E. Asia 5.5 6.6 6.5 6.5 maintained, the region should be well placed to convert S.E. Asia 2.4 4.4 4.5 4.9 Indonesia 3.4 3.7 3.5 4.0 cyclical recovery into more sustained long run growth. Malaysia 0.4 4.2 4.6 5.4 There are at least four sets of reasons for this Philippines 3.2 4.6 4.0 4.2 optimism. First, the global economy is improving, led by Thailand 1.9 5.2 5.8 6.0 Transition Econ. stronger growth in the US and Japan (although there is still China 7.3 8.0 7.8 7.4 uncertainty about the durability of the recovery), which Vietnam 5.2 6.0 7.0 7.0 should lead to higher world trade growth. After a deep three- Small Countries 1.4 1.5 3.7 4.1 year recession the world high tech industry seems to be Newly Ind. Econ. 0.7 4.5 2.6 4.6 moving forward, if still by fits and starts. While foreign Korea 3.0 6.3 3.0 5.1 direct investment flows to developing countries are still 3 other NIEs -1.3 2.9 2.2 4.3 modest compared to pre-recession levels, portfolio equity Japan 0.4 0.2 1.9 1.2 and bond market flows to emerging markets including East World Bank East Asia Region; October 2003. Asia have revived this year. Stock and high yield debt markets have mounted strong advances around the world, especially in emerging markets, including those in East Asia. Two dangers deserve special attention. First, Second, continued strong growth in China is propelling a international trade is the life blood of East Asia. The setback vast expansion in its imports from the rest of East Asia, at the Cancun trade talks might allow protectionist interests which is gradually balancing fears about the competitive worldwide to go on the offensive, causing long term damage threat from China. The emergence of China as a major to the world trading system. Second, within East Asia global production base for high tech multinationals is progress on institutional and governance reforms has been energizing intra-regional production networks and trade. slow and there is evidence this is hurting its competitive position in the world. Third, post-financial crisis "fire-fighting" finally seems to be behind us and domestic conditions in the region There are several priorities for policy. Prudent macroeconomic policy will, if anything, become even more complex, needing not only to keep public debt on a 1 East Asia comprises Developing East Asia (China, sustainable track without slowing growth, but also to better Indonesia, Malaysia, Philippines, Thailand and some smaller manage exchange rates and credit policy in the face of economies) and four Newly Industrialized Economies or renewed capital inflows, so as to prevent the potential NIEs (Hong Kong, Korea, Singapore and Taiwan, China). emergence of new financial euphoria. The situation East Asia Update 2 similarly requires continued emphasis on strengthening the total numbers of poor in the region at the $2 level financial sector supervision and regulation, corporate are estimated to have fallen by over 60 million. These governance and the supporting legal and judicial framework stem from strong gains in rural incomes in countries like for the financial and corporate sectors, as well as fostering China, Thailand and Vietnam. However there is some the development of more diversified capital markets to better evidence that while progress in poverty reduction in handle different kinds of risks. A period of cyclical upturn East Asia over the last decade has been impressive, even and the post-election honeymoon period in some countries despite the impact of the financial crisis, future progress may also be a good time to move aggressively on the may be more difficult as poverty becomes more governance agenda, to improve public financial management concentrated in remote areas and among ethnic and accountability, undertake civil service reforms, extend minorities or other socially disadvantaged groups. This anti-corruption efforts and so on. A focus on improving will put a premium on developing more detailed delivery of services like education and health can exploit the information about poverty, to help develop more advantages of decentralization, make a direct contribution to carefully targeted and cost-effective poverty reduction reducing poverty and build up human capital for long run strategies. Poverty is a multi-faceted concept that growth. Finally, governments must be wary of domestic includes not just lack of income but also deficiencies of protectionist pressures ­ especially seductive in an election specific attributes such as education, health and access period - and look for ways to continue to make progress on to services like water and sanitation. This report's the trade agenda. Properly designed regional trade opening Special Focus on "Making Service Delivery Work in can facilitate cooperation on reducing regulatory barriers to East Asia" discusses recent experiences with trade while providing stepping stones to broader multilateral institutional reforms to improve access by the poor to liberalization, but measures that add to the complexity and these key services. costs of trade need to be avoided (for example creating a messy "spaghetti bowl" of rules of origin in bilateral trade International environment more supportive agreements). · Developed country growth: After a six month `soft Improving cyclical outlook in East Asia spot' in the last quarter of 2002 and the first quarter of · Economic growth in East Asia is likely to have 2003, when growth slowed sharply all over the experienced only a mild setback this year, dipping from developed world, recent data point once more to close to 6 percent in 2002 to around 5 percent, before improving confidence, demand and activity, notably in being forecast to pick up to near 6 percent once more in the United States and Japan, underpinned by the very 2004. (Text Table 1 and Appendix Table 3). These supportive monetary and fiscal policies adopted by projections for overall regional growth are in fact many governments. Overall OECD growth is expected identical to those we made six months ago. However, to pick up mildly to about 1.8 percent in 2003, still well with the playing out of the SARS crisis and the Iraq below its longer run 2.5 percent trend. If, as expected, War, and with more evidence of recovery in the business investment spending continues to revive, developed world, uncertainty about the outlook is overall OECD growth should also continue to perhaps less now than it was then. In addition, growth in strengthen, reaching a forecast growth of about 3 the low and middle income countries or developing percent in 2004. Stronger machinery and equipment economies of the region has turned out stronger than we investment should also provide the missing driver for expected, with solid 7-8 percent growth in China and recovery in global high tech demand, a key issue for Vietnam, and near 6 percent growth in Thailand. East Asia, where so much of manufacturing exports are Overall growth in developing Asian countries is now in the high tech sector. World semiconductor expected to run around 6.5 percent in both 2003 and sales in dollar terms have already been moving ahead 2004. Growth in the NIEs is however expected to fall to since the middle of 2002. less than 3 percent this year, before rebounding to 4-5 · US dollar prices for non-oil primary commodities are percent in 2004. enjoying a mild revival after having slumped a · Poverty is unlikely to have been negatively affected by cumulative 33 percent between 1997 and 2001. Prices this year's mild downturn in regional growth, since rose 5.1 percent in 2002 and are expected to increase most of the slowdown was concentrated in the Newly another 7 percent in 2003, underpinned by the recent Industrialized Economies, which contain virtually no fall in the US dollar, specific supply conditions in people living at the $1 or $2 a day income levels. The individual commodities and the improving outlook for number of poor in East Asia at the $2 a day level is stronger world growth. Commodity exporting expected to fall by 30 million to around 680 million in economies in South East Asia and the Pacific Islands 2003, while the poverty rate (or headcount index) at the have enjoyed terms of trade based income gains from $2 a day level would fall to about 37 percent, its lowest higher prices over the course of 2002 for agricultural ever level, down from 39 percent in 2002. This would food and beverage commodities like rice, palm oil, follow an especially strong performance in 2002, when coconut oil and coffee, agricultural raw materials like East Asia Update 3 rubber and logs, and minerals like gold, copper and tin. Domestic trends and policy challenges Oil prices have remained stubbornly high in the upper $20 a barrel range this year, but are expected to be · In addition to better international conditions, a number moving lower in 2004 due to higher non-OPEC of domestic trends are also falling into place that could production and reviving Iraqi production. This will help the region finally put the remains of the financial benefit East Asia which is overall a net oil importing crisis behind it and move into a sustained period of region. economic growth and poverty reduction. One broadly · The boom in China trade has continued in 2003, positive trend already apparent over the last couple of although at a more moderate pace than in 2002. In the years has been stronger consumer spending by first five months of this year, exports to China and Hong households, supported by lower real interest rates and Kong from the rest of East Asia grew by about one third more consumer credit and housing finance lending by and contributed about one third of their overall export banks. Apart from continued strong investment growth, while exports to other East Asian economies spending in China and Vietnam, there are indications contributed another 18 percent. Thus about 50 percent that investment spending was either stabilizing or of these economies' export growth this year has been showing signs of pickup in some post-crisis countries in contributed by growth in intra-regional trade. China's the latter part of 2002 and the first half of 2003, most imports from and its trade deficits with the rest of East notably in Thailand, where it was growing at 7-9 Asia have also been soaring, in an almost mirror image percent from year earlier levels in real terms. of its surplus with the US. Thus China's combined Banks in most of the trade deficit with Korea, Singapore and Taiwan (China) · Financial sector trends: previously crisis affected East Asian economies jumped from around $36 billion in mid 2002 to $53 continue to experience gradual improvements in billion in mid 2003, and its trade balances with Japan profitability, capital adequacy and asset quality. Non and South East Asia have also moved into growing performing loans (NPLs) as a share of total commercial deficits. bank loans are now generally much lower than in the · International capital markets saw a marked immediate aftermath of the financial crisis, reflecting improvement in sentiment over the course of 2003, improvements in the balance sheets of borrowers due to especially with respect to emerging markets, which ­ higher growth and lower interest rates, a pickup in new after a long hiatus ­ have once more begun to attract loan demand and continued restructuring of bad debts. significant portfolio bond and equity market inflows. Progress also continues at varying rates on restructuring The median eurobond spread among six East Asian of NPLs, privatization of banks nationalized during the economies fell around 70 basis points in the first 8 crisis, strategic consolidation of financial systems and months of the year. East Asian stock markets surged strengthening of financial sector supervision and between 20 and 50 percent between April lows and the regulation. end of September. With the exception of the Philippines, most East Asian economies with more · Capital Market Development: In addition to more active banks, an array of new capital markets are also playing flexibly managed exchange rates also saw appreciations an increasingly important role in financial against the US dollar of 5-7 percent between the start of intermediation in the region. The proportion of the 2003 and the end of September. More broadly defined financing needs of all Asian entities supplied by local indexes of exchange rate market pressure also show bond markets surged from 3 percent in 1997 to nearly persistent upward pressure on most East Asian 40 percent in 2001, and markets for Asset Backed currencies, reflecting in particular the continued build Securities and venture capital have also grown strongly. up of foreign exchange reserves in the region. China Reforms to foster capital market development are now a fits the same pattern as other East Asian economies in prominent element on the regional reform agenda, this regard. Analysis in this report indicates that, at least including proposals to strengthen market infrastructure, over the last 1-2 years, the rapid buildup of reserves in develop relevant legal frameworks, foster a broader East Asia has been due more to swings on the capital investor base and achieve greater harmonization of account of the balance of payments than to trade or relevant regulations at the regional level. current account trends. In China, where this trend is most clearly defined, the reserves buildup has · Corporate performance has also continued to improve contributed to domestic credit expansion and has tended in most of the previously crisis-affected countries. The to complicate monetary policy. These kinds of ratio of ordinary income to sales for listed non-financial pressures and complications can lead governments in companies rose in 2002 in Indonesia, Korea, Malaysia, East Asia to view greater exchange rate flexibility as an and Thailand. Higher earnings and lower interest potentially useful tool for better domestic payments have reduced the short-term financial macroeconomic management, vulnerability of firms as measured by the interest coverage ratio. Median interest coverage ratios rose between 2001 and 2002 in all five crisis countries, and, East Asia Update 4 except in the Philippines, are also estimated to be higher The coming 18 months will also see important political than in 1996. The improved financial health of banks transitions in several main countries of the region. There and corporates should now support stronger business will be legislative and/or presidential elections in Indonesia, investment going forward. Korea, Malaysia, the Philippines and Thailand. In addition · Governance: the policy tasks facing countries in the Prime Minister Mahathir of Malaysia will step down from office this October. Cambodia also recently conducted region constantly lead on to questions of governance successful elections, and is in the process of forming a new and institutions. For example, strengthening insolvency government. From a broad, long-term perspective these systems and legal and judicial systems more broadly is events reflect the region's substantial achievement in seen as crucial for corporate restructuring and strengthening consensual or representative institutions over improving the investment climate in East Asia. Good the last 10-20 years, and should mark a further advance in progress appears to have been made on corporate that direction. governance in the region, although enforcement of those principles remains an issue. The report reviews recent World Bank data on perceptions of public sector governance around the world. Among the results is that, generally speaking, governance in East Asia is rated as rather better than in Latin America but significantly poorer than in Central and Eastern Europe. Viewed over time, the quality of governance in East Asia is assessed as having remained fairly constant over the last 6-7 years, while that in emerging Europe ­ which now attracts much more FDI (as a share of GDP) than East Asia - has improved substantially. But one needs to be careful about how to interpret such perceptions based indicators. For example it could be that the greater openness and voice in the region allows people to learn more about and more harshly criticize an underlying reality that may in fact be improving. The Regional Update was prepared by Milan Brahmbhatt, Lead Economist, East Asia PREM, with the assistance of Antonio Ollero, and Nancy Mensah, drawing on inputs from country economists and sector specialists throughout the East Asia and Pacific Region. The report was prepared under the general guidance of Homi Kharas, Chief Economist, and Jemal-ud-din Kassum, Regional Vice President, East Asia and Pacific Region. East Asia Update 5 EAST ASIA AND PACIFIC REGIONAL OVERVIEW An improving cyclical outlook also improved in several of the post-crisis countries, which Economic activity in East Asia2 is expected to should further help foster a recovery in business investment. strengthen in coming months. Growth dipped in the second Not that the outlook is entirely sunny, of course, quarter of 2003, principally because of the shock to and the report also discusses a number of concerns or risks consumer and business confidence from the unexpected that will need to be addressed if the prospective cyclical SARS crisis. However, although growth outcomes in the recovery is to mature into a long period of sustained second quarter were quite diverse, on balance the impact of expansion. There are well known macroeconomic SARS seems to have been more modest than previously imbalances and structural weaknesses among developed feared. Readings on how the regional economy did in the countries that could yet frustrate the global recovery. The third quarter are not yet clear cut because of conflicting breakdown of the global trade talks at Cancun needs to be signals from different indicators and differences across overcome. China's economy faces new problems for countries. On the one hand, the quick passing of SARS ­ at economic management, in part as speculative capital inflows least for the time being ­ has been accompanied by sharp put upward pressure on the country's exchange rate peg and rebounds in tourist arrivals and retail sales. Far from add to rapid growth in foreign reserves, domestic money concerns about too little growth, China is in the midst of supply and bank credit. Large foreign exchange reserve such a strong boom in investment that policy makers are accumulations in several other countries, while reducing focusing on preventing overheating in some sectors, thereby vulnerability to external shocks, can also complicate avoiding a `hard landing' for the economy in 2004 or macroeconomic management. a topic discussed in more beyond. On the other hand, export growth in the majority of detail later in this report. More broadly, long run growth countries slowed during the summer and in some has yet to may be constrained by institutional weaknesses in the recover. investment climate and governance. An assessment of governance outcomes suggests the region has made little Developing a firm view on the near term outlook is progress in this area over the last 6-7 years, a time when difficult in the face of these conflicting signals. However, emerging economies in Central and Eastern Europe have on balance we think the prospects for a stronger cyclical made dramatic progress on governance. A higher and more recovery in East Asia are now good, on the basis of a sustained pace of FDI inflows to emerging Europe suggests number of supportive global and domestic conditions that that governance issues may be having direct implications for are discussed in more detail in the rest of this report. The the region's competitiveness. recovery in the developed world is picking up, led by stronger growth in the US and Japan, and the pace of world Exhibit 1 trade growth will likely follow, helped also by the roaring pace of domestic demand and import growth in China. With East Asia: Quarterly Real GDP investment spending in the developed world starting to (1999 Q1 - 2003 Q2. % Change Year Ago) revive, even the long depressed world high tech industry 12.0 seems to be advancing, if in fits and starts. East Asia seems set to emerge as an even more important global production base for high tech MNCs, centered in China but drawing on 9.0 many countries in the region. Looking forward to better times, world stock markets have mounted a strong advance, 6.0 while global investors' appetite for riskier higher return assets has grown keener, leading to reviving portfolio flows to developing countries and especially strong rallies in 3.0 emerging market stock and debt markets, including in East Asia. Domestic interest rates are low and, partly as a result of restructuring efforts, the profitability and asset quality of 0.0 East Asian banks has improved in most of the post-financial crisis countries, supporting a marked revival in new bank credit flows. Corporate profitability and balance sheets have -3.0 E.Asia NIEs SE Asia China -6.0 2 East Asia comprises Developing East Asia (China, Indonesia, Malaysia, Philippines, Thailand and some smaller economies) and four Newly Industrialized Economies or NIEs (Hong Kong, Korea, Singapore and Taiwan, China). East Asia Update 6 Diverse growth outcomes in the wake of SARS new lending as well as to slow speculative short term capital inflows. Thus, while growth in the rest of the region is Aggregate East Asian GDP growth in the second expected to be accelerating into 2004, it is expected to be quarter of 2003 fell to a year on year (y-o-y) rate of a little slowing in China, easing from near 8 percent in 2003 to over 3 percent, down from almost 6 percent in the first quarter of the year.3 around 7.4 percent next year. (Exhibit 1). One adverse factor affecting several economies was the renewed and rather The other fast growing transition economy of the unexpected slowdown in the developed world in late 2002 region, Vietnam, experienced just over 60 SARS cases, a and early 2003, which contributed to a slower pace of export significant number. Tourist arrivals in May were down growth in several economies. More important, however, around 50 percent on a year earlier but have rebounded was the impact of public concern about the SARS virus, since, with little apparent effect on overall economic growth, which took off in the second half of March and reached its which is expected to reach around 7 percent this year, peak in May, before tailing off as strong public health support by healthy broad-based expansion in exports, measures around the region took hold and the number of consumption and investment. new cases fell to zero by mid-June. Exhibit 2 But, while second quarter growth slowed almost everywhere, there was still a great diversity of outcomes. In Tourist Arrivals (1/02 to 8/03; Jan.02=1) China, growth, while decelerating from an exceptionally 1.40 high pace in the first quarter, remained robust by ordinary standards, and appears to have resurged in the third quarter. Strong growth in Vietnam also seems to have been little affected. At the other extreme, there was a sharp slowdown in the Newly Industrializing Economies, while, in between, 1.00 the SARS impact on the middle income economies of South East Asia seems to have been less than initially feared. China, which is otherwise in the midst of an exceptionally powerful expansion, saw growth dip from 9.9 China percent on a year ago in the first quarter to a (still strong) 6.7 0.60 Thailand percent pace in the second as a result of SARS. Although Singapore China was the center of the epidemic, with over 5000 cases, Vietnam its impact on the economy was cushioned by the size and Indonesia diversity of the country and the underlying momentum of growth. Tourist arrivals fell by around 30 percent from a 0.20 year earlier in May, the peak of the crisis, but began 2 2 2 2 2 2 2 2 2 3 3 3 3 3 3 rebounding in June. (Exhibit 2). The economic impact of Jan-0Feb-0Mar-0Apr-0May-0Jun-02Jul-0Aug-0Sep-0Oct-No 02v-02c-0Jan-0Feb-0Mar-0Apr-0May-0Jun-03Jul-0Aug-03 De the tourism decline was also limited by the fact that tourism comprises a much smaller part of the economy than in many The middle income economies in South East Asia other countries of the region. Retail sales slid to a still had fewer SARS cases ­ the highest was 14 cases in the positive year on year pace of 4-5 percent in May but have Philippines ­ and experienced only relatively mild effects on since bounced back to near 10 percent by August. Fears that growth in the second quarter. Thailand, where tourism plays SARS would disrupt cross-border business contacts and a larger than average role in other East Asian economies, exports appear to have been overstated, since exports have also experienced a significant 50 percent fall in arrivals by continued to grow by around a 30 percent pace through May, but this was offset by continued growth in goods August in nominal dollar terms. Indeed the attention of exports, consumption and investment. The year on year policy makers is now focused on moderating the pace of pace of GDP in the second quarter only dipped to a still high expansion in sectors such as real estate and other areas of 5.8 percent from 6.7 percent in the first. SARS also seemed infrastructure at the level of sub-national governments, to have limited impact on underlying trends in the other which is fueled by credit expansion, and which is raising South East Asian economies. Second quarter growth concerns about potential adverse effects on the quality of continued at a 4-5 percent year on year rate in Malaysia. and investment, the fiscal position and the health of the banking at 3­4 percent in Indonesia, slowing most in the Philippines, system. The authorities have taken steps to better control although this seems to have had less to do with SARS than with weak goods export growth and cuts in public spending aimed at reversing a large fiscal deficit. 3 Quarterly growth figures for East Asia refer to a GDP weighted average of 9 economies: China, four South East Monthly indicators for the third quarter suggest the Asian economies (Indonesia, Malaysia, Philippines and softer tone for growth could continue a little longer. In Thailand) and four Newly Industrialized Economies or NIEs particular, as discussed in the next section, year on year (Hong Kong, Korea, Singapore and Taiwan (China) ). export growth in South East Asia continued to slow through East Asia Update 7 August. However, in contrast to the Newly Industrializing other more purely domestic factors. High consumer debt Economies, private consumption growth in particular has levels and new credit restrictions have led to retrenchment in remained strong in South East Asia, while more recently consumer spending and housing construction. Confidence investment growth has also strengthened to a robust 7-9 has also been hurt by labor unrest and the North Korean percent year on year rate in Thailand, with more modest crisis. GDP contracted from the preceding quarter by 1.6 signs of revival in some other countries. With prospects for percent in the first quarter and 2.9 percent in the second world recovery improving, consensus forecasts for most of (seasonally adjusted annual rate). Revival of activity in the these countries have also turned up recently, after having third quarter was dampened by a serious typhoon hitting the been pared lower over much of the past year. (Exhibit 3) southern part of the country, but should strengthen with the completion of adjustment in household balance sheets, Exhibit 3 supportive fiscal policy and further recovery in the world Change in Consensus Forecasts for 2003 economy. Growth between 1/02 and 9/03 8 Prospects have also turned modestly higher in the Pacific Island economies. Growth in Fiji is projected around 5 percent as a result of higher tourism and garment and sugar exports. Papua New Guinea is expected to see its first 6 positive growth since 1999 as a result of higher prices for its ) commodity exports such as gold, oil and traditional %( htwo agricultural products. The outlook is even greatly improved in the Solomon Islands, where a regional assistance mission 4 Gr led by Australia has succeeded in reestablishing law and P order after a long period of ethnic strife that led to massive GD declines in economic activity. Source: Consensus Forecasts, various issues. 2 Regional totals are simple averages. All told, this year's cross-cutting or divergent trends add up to an aggregate regional downturn that may be milder than previously expected, with growth dipping to Forecast Date 0 around 5 percent from 5.8 percent in 2002, almost entirely Jan-02 Mar-02 Jun-02 Oct-02 Feb-03 May-03 Sep-03 due to the weakness in the Newly Industrializing Economies. China Japan USA (Exhibit 4). But with stronger world growth and supportive EAP NIEs (4) SE Asia (4) domestic conditions discussed in the rest of this report, regional growth is expected to recover to a little under 6 Among the Newly Industrialized Economies percent in 2004. Leaving out the NIEs, growth in (NIES), second quarter growth fell to a negative year on year Developing East Asia is expected to reach 6.5 percent this pace in Hong Kong (China), Singapore and Taiwan (China), year - the highest among all developing regions, and little which were among the economies with significant numbers changed from 2002 ­ and to continue at about the same rate of SARS cases. By May tourist arrivals were down by in 2004. around 70 percent from year earlier levels in Singapore and Exhibit 4 Hong Kong. Retail sales fell as cautious consumers stayed away from markets, shops, restaurants and other places East Asia: Real GDP Growth 1990-04 15.0 where SARS could be transmitted, adding to the effects of S. E. Asia already low consumer confidence pre-SARS. The prevailing NIEs China uncertainty also contributed to further declines in already East Asia 10.0 weak fixed investment. The outlook for these economies improved with the steep fall in SARS cases in late May and early June. Tourist arrivals are rebounding, returning to near 5.0 year earlier levels by August, and retail sales are also recovering. In contrast to South East Asia, there are indications of a pick up in export growth, led by a strong 0.0 rebound in electronics and other high tech exports. In 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Singapore, GDP, which had fallen by 11 percent in the second quarter (at a seasonally adjusted annual rate from the -5.0 S.E.Asia: Indonesia, Malaysia, Philippines, Thailand. first quarter), rebounded by 15 percent in the third. NIEs: Hong Kong (SAR), Korea, Singapore, Taiwan (China). Among NIEs, Korea was much less directly -10.0 affected by SARS, experiencing only 3 cases as compared to over 1700 in Hong Kong, over 200 in Singapore and over Concerns remain however that SARS may have 300 in Taiwan (China). Growth was however depressed by become endemic and that ­ like other influenza like diseases East Asia Update 8 ­ it may return with the lower temperatures of winter. This Poverty continues to move lower ­ but is it getting possibility underlines the importance of policy makers harder? drawing appropriate lessons from their responses to this spring's SARS outbreak and further strengthen the This year's mild downturn in regional growth is preparedness of public health systems to deal with cross- unlikely to have much of a negative impact on income border epidemics. Box 1 on Policy Responses to SARS poverty, since most of the slowdown was concentrated in the discusses the recent experience and its lessons further. Newly Industrializing Economies, which contain virtually no people living at the $1 or $2 a day level. The number of Box 1 ­ Health Policy Responses to SARS poor in East Asia at the $2 a day level is expected to have The responses to the SARS epidemic, although varied across fallen by around [30] million to around 680 million in 2003. countries, highlight the importance as well as vulnerability The poverty rate (or headcount index) at the $2 a day level of public health infrastructure in the region. Several lessons would then fall to about 37 percent, its lowest ever level, can be drawn from these experiences. Vietnam showed how down from 39 percent in 2002. (Exhibit 5 and Appendix to decisively contain an epidemic, quickly and at relatively Tables 6 and 7). modest cost. The government facilitated prompt and open Exhibit 5 reporting, requested immediate assistance from the World Health Organization (WHO), initiated rapid case detection, Poverty - Headcount Index and performed vigorous contact tracing. Political 90 ($2 a day poverty line. Percent) commitment at the highest level was a key factor. In Vietnam S.E. Asia (4) Singapore action was also swift, comprehensive and on a East Asia China large scale. The government mobilized many sectors of the Other Small * community, not just the medical profession; cooperated with neighboring countries to restrict travel; and promoted 75 individual social responsibility. In China, the reaction varied over the duration of the outbreak. After an initial delay in recognizing the scope of the issues and problems with data sharing, China became fully committed to fighting 60 the disease, and, additionally, expanded capacity to be better prepared for a renewed outbreak or other similar events. The Government launched a program to address SARS- related diagnosis and clinical management, with assistance 45 from WHO, the World Bank and bilaterals (UK, Canada, Japan). The program also aims to strengthen the capacity of the public health system for infectious disease prevention * Cambodia, Lao PDR, Papua New Guinea and control more generally. It has also renewed 30 commitment to improving health care services. 1990 1996 1999 2000 2001 2002 2003 2004 These examples highlight some main lessons learned in About two thirds of the East Asian poor at the $2 a combating the SARS epidemic: the need for government commitment at the highest levels, improved surveillance and day level live in China, and of those about 90 percent live in reporting, transparency of information, involvement of the China's rural areas. Although the pace of rural poverty media to build support and share knowledge, strengthened reduction in China slowed during the 1990s, the poverty rate overall capacity in the health system, and in particular at the $2 a day level is estimated to have fallen to 37 percent strengthened capacity for infectious disease prevention and in 2002 from 42 percent in 2001, a notable advance, control, together with better global preparedness and supported by rural real income growth of about 5 percent. collaboration and the need to stimulate rapid, high level Poverty reduction is likely to have been slower in the first research for recommending sound control interventions. half of 2003 compared to 2002. In rural areas, the growth rate of agricultural value-added was under 3 percent in the Looking forward, the region faces the challenge of ensuring first half of 2003, mainly because of weak sales of animal that SARS or other infectious diseases do not evolve into husbandry products, fruits and vegetables. Cash income of serious epidemics. This will be a fight against complacency. rural residents was also negatively affected as migrants to There is a need to strengthen the overall public health infrastructure while also addressing broader issues of health the cities returned home during the SARS crisis and have sector reform and development. Cross-sectoral interventions only partly reclaimed their urban jobs since. In the first half in the infrastructure and environmental sectors to ensure of this year, per capita cash income of rural residents was clean water supply also need tackling. Information, RMB 1,158, a real increase of 2.5 percent, only half the monitoring and surveillance systems need improvement. 2002 pace. Unemployment is up in urban areas, partly a The World Bank stands ready to continue supporting these result of SARS-induced problems in the services sector, and efforts. partly a result of continued enterprise restructuring. East Asia Update 9 However, per capita disposable income of urban residents in in this period. Given this year's acceleration in growth and the first half of this year reached RMB 4,301, a real increase with commodity prices remaining at higher levels, progress of 8.4 percent. Poverty alleviation policies continued to on poverty reduction in Thailand is expected to continue. focus on targeted support to poor counties and on regional Exhibit 7 development in the lagging provinces. In addition, new initiatives (tax credits and subsidies) have been launched to promote job creation and to establish some rural health insurance and a public health crisis response system. The other main concentrations of poor people are among the low and middle income countries in South East Asia, in particular Indonesia (around 115 million people below the $2 a day line in 2002), Vietnam (48 million), Philippines (36 million) and Thailand (17 million). Here poverty rates have generally been trending lower in the years since the financial crisis, although at varying rates. Exhibit 6 Thailand - Poverty Rate 2000 and 2002 (National Poverty Line) 30 2000 2002 20 Source: Socioeconomic Survey 2002 10 0 Vietnam completed an extensive new household Rest of Country Northeast living standards survey (VHLSS) in 2002, allowing a more accurate monitoring of poverty trends at national and regional levels. The proportion of the population with per According to Thailand's recently released capita expenditures under the national poverty line dropped "Socioeconomic Survey 2002", poverty at the national dramatically during the last decade from 58 percent in 1993 poverty line4 rose from 11.4 percent in 1996 to 14.2 percent to preliminary estimates of around 29 percent in 2002. As in 2000, but then fell rapidly to only 9.8 percent in 2002, less would be expected in a country rapidly expanding than pre-financial crisis levels. Poverty reduction has been manufactured exports into world markets, urban poverty fell especially strong in the backward North-East, where two sharply from 29 to 6 percent, but ­ more impressively ­ rural thirds of Thailand's poor are concentrated. The pace of poverty also fell sharply, from 66 to 34 percent. However, poverty reduction was twice as fast as in the rest of the while progress in poverty reduction over the last decade has country. (Exhibit 6). Farm households benefited from been impressive, recent data suggests a slowdown in the substantial price increases in 2001-02 for important crops pace in the last five years. The rapid gains in productivity like paddy rice, rubber, tapioca, palm, and oilseeds, generated by rural reforms may have run their course in reflecting both higher world prices and domestic conditions. boosting rural incomes, and reducing poverty further in In addition strong economic growth has fueled labor Vietnam may become increasingly difficult as poverty demand, drawing labor out of agriculture into higher paying becomes concentrated in remote areas and among ethnic jobs in industry and services. The share of workers minorities. Regional disparities in poverty and the rate of employed in agriculture declined from 44.2 to 42.5 percent reduction are large and reflect both geographic/ethnic factors and the extent of integration with national and international 4 markets. The information in VHLSS is being combined The poverty line equals to 30 Baht per person per day, or with data available from the population census to make US$0.70, or about US$1.5 in Purchasing Power Parity East Asia Update 10 detailed studies of the geographical distribution of poverty, production systems, a higher share of livestock production the main correlates of poverty and how market opportunities, and continuing regional specialization have led to a pick up public policies and participation affect the well-being of in agricultural growth since 1997/98 (5.3 percent). There poor households. Exhibit 7 shows preliminary results from has been also continuing improvement in value added per ongoing work to develop detailed poverty maps for Vietnam. worker in the sector, although productivity levels continue to Poverty in the Philippines is also likely to have lag behind those of neighboring countries. Attainment of fallen in the last couple of years, but at a slower pace than in the Millennium Development Goal of halving poverty by Thailand and Vietnam, falling at the $2 level from an 2015 seems to be well within Lao PDR's reach. estimated 47 percent in 2000 to about 45 percent in 2002. Finally, it is important to remember that poverty is However disparities in poverty incidence across sectors a multi-faceted concept that includes not just lack of income remain significant. While urban poverty has declined, but also deficiencies of specific attributes such as education, poverty in the rural areas remains obstinately high, with health and access to services like water and sanitation. three-quarters of poor families still residing in the provinces. Making progress on these dimensions cannot rely entirely on Poverty incidence among the ten poorest provinces ranges income growth. As the accompanying Special Focus on from 53-63 percent. These provinces are mostly found in "Making Services Work in East Asia" in this report Mindanao, Cordillera, and the Bicol region. In comparison, observes, a one percent increase in per-capita income among the least poor provinces had poverty incidence ranging from low income countries is associated with only about a 0.5 5-12 percent. Mostly, these are cities and provinces located percent decline in under-five infant mortality, and, more in the NCR and the CALABAR zone area. Economic importantly, there is a very wide range in how far an extra isolation is an important correlate of poverty incidence at the dollar of income is associated with better health outcomes. regional level. While East Asia has in general enjoyed spectacular income East Asia also contains small low income growth over the decades, its progress in specific areas of economies like Cambodia, Laos and Papua New Guinea, health care, access to water and sanitation has often been where the absolute numbers of poor are fewer than much slower. As the Special Focus observes, there may elsewhere, but where the incidence of poverty in the many valuable cross-country experiences as to how public population is much higher, generally above 70 percent at the policy can foster better service delivery poor in an $2 a day level. In Cambodia, for example, quite rapid per- economically efficient manner. capita GDP growth has been concentrated in the garment and tourism sectors, which employ only a small part of the International environment ­ better but still labor force. On the other hand agricultural output growth uncertain has averaged only 1-2 percent a year, holding back income gains for rural households, which comprise 90 percent of the A slowdown in the developed world in late 2002 poor. Poverty at the $2 level is estimated to have hardly and early 2003 contributed to slower export and overall GDP fallen from 80 to 79 percent between 2000 and 2003. In growth in East Asia in the second quarter of the year. terms of geographic breakdown, the Poverty Map in the Exhibit 8 shows that, while China's export growth was little National Poverty Reduction Strategy shows pockets of deep affected by the global slowdown, export growth in other poverty spread throughout the country. economies fell through the first half of the year. The export slowdown was especially severe for South East Asian By contrast, there has been considerable progress in economies, where it continued into the third quarter. In reducing poverty in Lao PDR. While Lao PDR remains a some of these countries a downshift in electronics exports desperately poor country with more that three-quarters of led the overall slowdown. This may be partly a matter of population living on less than US$2 a day (the highest time lags, so that continued recovery in the developed world incidence of poverty in the region), poverty levels have should be reflected in East Asian export numbers in due fallen rapidly in the last decade. Based on the preliminary course. There could also be a lagged effect of disruptions to results of the 2002/03 LECS III survey and using the import orders from China because of SARS. national poverty line, the poverty headcount rate fell to 31 percent from 39 percent in the last survey in 1997/98. World recovery gathers strength - again Progress in national poverty reduction was driven largely by After a six month `soft spot' in the last quarter of declining numbers of rural poor while poverty seems to have 2002 and the first quarter of 2003, when growth slowed slightly edged up in urban areas since 1997/98. Five years sharply all over the developed world, recent data point once ago poverty in rural areas was twice as high as in urban more to improving confidence, demand and activity, notably areas but the recent data shows that this gap has now in the United States and Japan, underpinned by the very declined to 30 percent. Lower inequality also contributed to supportive monetary and fiscal policies adopted by many reduced poverty ­ the Gini coefficient declined from 0.35 to governments to offset the global slowdown. 0.33 - suggesting that economic growth has become more pro-poor. The continuing decline in rural poverty reflects a gradual improvement in the agricultural policy environment through greater market orientation. Diversification of East Asia Update 11 US and Japan lead developed country recovery exports are now in the high tech sector. Exhibit 9 shows In the United States second quarter 2003 growth picked up that world semiconductor sales in dollar terms have already to 3.1 percent at an annual rate from 1.4 percent in the two been moving ahead since the middle of 2002, and were preceding quarters. Most importantly, U.S. business fixed running at 12-13 percent higher than year earlier levels by investment, which had plunged after the bursting of the high August. tech equity bubble in 2000, showed its first robust growth in more than two years, increasing by 7.7 percent at an annual Text Table 2. International Economic Environment rate. Second quarter growth was also fueled by stronger 2001 2002 2003 2004 consumer spending and a surge in defense spending. % Change from previous year, except interest rates Monthly data for retail sales, durable goods orders, GDP Growth purchasing intentions and housing sector indicators suggest World 1.3 1.9 2.2 3.0 continued strengthening of activity in the third quarter. OECD 1.0 1.6 1.8 2.5 Labor market data for September gave the first evidence that United States 0.3 2.4 2.6 3.9 the gloomy jobs situation could be starting to turn around. Japan 0.4 0.2 1.9 1.2 Euro Area 1.6 0.9 0.5 1.7 Exhibit 8 World Trade (Volume) -0.7 3.0 4.6 7.9 CPI Inflation - G7 a/ 1.7 1.0 1.4 0.9 East Asia - Export Growth Oil Price - $/bbl 24.4 24.9 26.5 22 (US$ - % Change Year Ago) - % Change -13.7 2.4 6.3 -17.0 40.0 Non-oil Commodity -9.1 5.1 6.9 1.1 China Prices LIBOR (US$. 6 Mo.) 3.5 1.8 1.0 2.0 30.0 Source: World Bank DEC Prospects Group update September E.Asia 2003. a/ In local currency, aggregated using 1995 weights. 20.0 Overall growth in the developed world will however tend to be held back by still generally weak 10.0 conditions in Europe. GDP in the Euro Area contracted by 0.3 percent at an annual rate in the second quarter of 2003 SE Asia (after stagnation in the first quarter), weighed down by broad 0.0 contraction in private consumption, investment and net exports. Even here, though, glimmerings of better times have appeared, with some pick up in late summer and -10.0 Oct-00Jan-01Apr-01Jul-01Oct-01Jan-02Apr-02 Jul-02Oct-02Jan-03Apr-03 Jul-03 September in business sentiments, purchasing manager surveys and new orders. However Euro Area growth for NIEs 2003 as a whole is still only expected to reach around 0.5 -20.0 percent, a third successive year in which European growth has fallen. (Text Table 2). Remarkably it is semiconductor sales within East Second quarter growth jumped to an unexpectedly Asia (excluding Japan) that have been the fastest growing high 3.9 percent in Japan., helped by stronger growth in element of world sales, so the region is now the largest exports and in non-residential investment. Although there is regional semiconductor market in the world ­ approaching some uneasiness that a good part of this real investment 40 percent of world sales in August 2003. (Exhibit 9). These growth was due to lower measured price deflators rather data tend to support the idea that an accelerated restructuring than more nominal spending, the prospect for a continued and relocation of the global electronics industry towards pickup in investment is supported by rising business China and East Asia has been underway in recent years sentiment and machinery order indicators, as well as .by because of severe competitive pressures during the long 2-3 improving profitability in the corporate sector. year recession in global high tech. However, all these semiconductors being sold in East Asia are used as Overall OECD growth is expected to pick up components for finished high tech products, and since a mildly to about 1.8 percent in 2003, still well below its substantial part of the final markets for these finished longer run 2.5 percent trend. (Text Table 2). If, as expected, products lie outside East Asia, the region's high tech business investment spending continues to revive, overall producers still continue to rely significantly on market OECD growth should also continue to strengthen, reaching a conditions in the rest of the world. forecast growth of about 3 percent in 2004. Stronger machinery and equipment investment should also provide the missing driver for recovery in global high tech demand, a key issue for East Asia, where so much of manufacturing East Asia Update 12 Exhibit 9 However, it would probably not be prudent for countries to assume that prices will continue to strengthen, World Semiconductor Sales (Bill US$. 3 Mo.Mov.Averages. 1/95-8/03) or even that they will necessarily maintain their recent gains. 20 As Exhibit 10 indicates, prices for some food commodities Asia Ex. Japan: Asia ex. Jp started to soften in the first part of 2003 as the supply % of World Sales Japan Europe disruptions that had supported higher prices began to pass. 16 Dec. 1998 23.4 Oct. 2000 24.7 Americas Agricultural raw materials and minerals will likely have Dec. 2001 33.3 stronger near term prospects because of strengthening Aug. 2003 38.2 industrial demand with the world recovery. Metals prices 12 are expected to rise 6 percent in both 2003 and 2004. However prices will tend to be kept in check by high inventories and available idle capacity for many metals. 8 Oil prices surged to average over $30a barrel in the first quarter of 2003 because of fears of supply disruptions because of the Iraq war, low world stocks, high demand due 4 to weather, and reduced production due to labor and political troubles in Nigeria and Venezuela. Prices fell quite sharply with the onset of the war and its rapid conclusion, but then, 0 somewhat unexpectedly moved higher again in the second Feb-95Aug-95Feb-96Aug-96Feb-97Aug-97Feb-98Aug Feb-99Aug Feb-00Aug-00Feb-01Aug-01Feb-02Aug-02Feb-03Aug-03 -98 -99 and third quarters, though not to the pre-war highs above $30. The recent strength in oil prices appears to reflect a better appreciation of the difficulties involved in refurbishing Iraqi oil production, persistent tightness in Risks to the recovery in the developed world global inventories and continued cohesion in OPEC's This discussion has set out the baseline view for a management of its production and marketing. Prices are moderate recovery in the developed world over the coming expected to average around $26-27 in 2003. However prices year. This recovery is however subject to significant should begin moving lower in 2004 as non-OPEC macroeconomic imbalances and structural weaknesses. A production continues to rise in response to the high prices of world recovery once more led by the United States will tend recent years as well as gradually rising Iraqi production. to further widen the already large US current account deficit, which could precipitate severe exchange rate instability at Exhibit 10 some point in the future. Japan has experienced a number of `false dawn' economic recoveries over the last decade, and East Asia: Commodity Prices more evidence will be needed to assess if the present (US$ - Index 2000 Q1=1) recovery will be sustained over time. Significant structural LogsMeranti Rice reforms are also needed to revitalize growth in Europe. 1.40 Coconut Oil Interest rates have already been pushed to or near zero. Palm Oil Rubber Sharply higher fiscal deficits will likely constrain the ability 1.20 Crude Oil of governments to continue to the expansive counter-cyclical Copper fiscal policies of recent years. 1.00 Commodity price recovery and stubbornly high oil prices US dollar prices for non-oil primary commodities 0.80 are enjoying a mild revival after having slumped a cumulative 33 percent between 1997 and 2001. Prices rose 5.1 percent in 2002 and are expected to increase another 7 0.60 percent in 2003, underpinned by the recent fall in the US dollar, specific supply conditions in individual commodities 0.40 and the improving outlook for stronger world growth. Commodity exporting economies in South East Asia and the 00 Q1 00 Q3 01 Q1 01 Q3 02 Q1 02 Q3 03 Q1 July 03 Pacific Islands have enjoyed terms of trade based income gains from higher prices over the course of 2002 for This year's high oil prices and higher non-oil agricultural food and beverage commodities like rice, palm commodity prices will tend to erode incomes in countries oil, coconut oil and coffee, agricultural raw materials like like China and Korea that are net importers of both, while, at rubber and logs, and minerals like gold, copper and tin. the other extreme, boosting incomes in countries like Indonesia and Malaysia that export both. Oil importers and East Asia Update 13 non-oil commodity exporters like Thailand and the exports to China and Hong Kong). The boom in China trade Philippines will tend to see the effects offset each other to has continued in 2003, although at a somewhat more some extent. If, as expected, oil prices weaken in the longer moderate pace. In the first five months of this year, exports term, these effects will tend to be reversed. to China and Hong Kong from the rest of East Asia grew by about one third and contributed about one third of their Booming China trade and regional integration overall export growth, while exports to other East Asian economies contributed another 18 percent. Thus about 50 The last two years have seen an extraordinary surge percent of these economies' export growth this year has been in economic integration between China and other East Asian contributed by growth in intra-regional trade. After falling economies. Till recently assessments of trade with China in in 2002, East Asian exports to Japan have also been growing other East Asian economies have tended to focus on this year. Adding in Japan increases the proportion of trade concerns about growing import competition from China in growth this year contributed by intra-regional to 60 percent. their home or third country export markets. Recent experience has perforce turned attention to another aspect of As noted, the ongoing boom in China trade in part the matter ­ China's rapid emergence as a center for regional reflects a restructuring of the regional and global division of production networks and a market for exports of specialized labor, with China emerging as a global base for final components and other intermediate inputs from elsewhere in production and assembly, and other East Asian economies East Asia, which are assembled in China for export to the developing more specialized roles as suppliers of key inputs rest of the world, or for consumption within China. and components. Last April's East Asia Regional Brief documented these trends by looking at changes in the Exhibit 11 product composition of intra-Asian trade in more detail, Contributions to Export Growth in 8 E Asian noting how even South East Asian economies that Economies * traditionally exported natural resource based products to (Percent of total export grow th. 2002 and 2003 Jan-May) China now focus increasingly on exporting it `high tech' manufactures. Here we look a little further at how the China Share of foreign market in To China+HK boom is affecting the bilateral pattern of trade balances. As 70 8 economies' total 2002 Exhibit 12 shows, China's long standing trade surplus with exports: To Other E.Asia the United States has risen quite sharply of late. Using China+HK - 18.8% To USA Chinese statistics, the surplus on China's direct trade with 50 Other E.Asia - 23% To Japan the US (i.e. excluding that routed through Hong Kong) USA - 19% increased from a 12-month total of a little over $30 billion in Japan - 10.8% mid-2002 to nearly $50 billion in June 2003. However, with China's exports incorporating large volumes of components 30 imported from the rest of Asia, its imports from and trade deficits with the rest of East Asia have also been soaring, in an almost mirror image of its surplus with the US. Thus 10 China's combined trade deficit with Korea, Singapore and Taiwan (China) jumped from around $36 billion in mid 2002 to $53 billion in mid 2003, and its trade balances with Japan 2002 2003 M 1-5 -10 and South East Asia have also moved into growing deficits. * See text for countries. Source: IMF DOT. The net result is that China's trade surplus is actually trending lower this year, even in nominal dollar terms. This Last year so powerful was this trend that exports point is clearly relevant for an assessment of recent from eight other emerging Asian economies to China and exchange rate trends in East Asia, and is taken up further in Hong Kong (taken together) grew by around 40 percent, a subsequent section. while the rest of their exports grew by only 6 percent.5 As a Trade with China and East Asian intra-regional result exports to China and Hong Kong alone contributed trade in general will likely continue to grow at high rates for about 60 percent of overall export growth in the rest of East an extended period because of the large unexhausted gains Asia. (Exhibit 11). Growth in exports among themselves from trade available to participants. But, as in any trading contributed another 21 percent of these economies total relationship, market growth could be quite uneven from one export growth. (Astonishingly more than 80 percent of year to the next. For example, one of the aims of Japan's overall export growth was also contributed by macroeconomic policy in China at present is to prevent overheating in some sectors so as to avoid a "hard-landing" for the economy in the future, and - other things equal - this 5 In this discussion the "rest of East Asia" comprises three will contribute to a slower growth in demand for imports Newly Industrialized Economies (Korea, Singapore and from the rest of East Asia. A marked slowdown in China's Taiwan (China)), four South East Asia middle income exports to the rest of the world ­ for example because of economies (Indonesia, Malaysia, Philippines and Thailand), escalating trade tensions and protectionism ­ would also and Vietnam. East Asia Update 14 damage East Asia's exports to China, by reducing demand After Cancun - complementarity of multilateral and regional for component imports used to produce exports to the rest of approaches the world. The failure to find agreement at Cancun is a setback Exhibit 12 for the cause of global economic development and poverty China - Trade Balances Jan-97 to Jul-03 reduction, but, with strong leadership from the leading developed and developing economies, it need not be more (US$ Mill. 12 month moving totals) than a temporary one. The negotiations will now be taken 60000 up by senior officials at Geneva, who will be able to draw on Total considerable progress that was made in many specific areas in the run-up to Cancun, and the considerable information 40000 that Cancun provided about what a more balanced and mutually acceptable set of negotiating options would look 20000 like. Developing East Asian countries played a leading part USA in the negotiations for the Doha Round so far, and have both Indonesia+Philippines+Thailand an important role and a major interest in seeing it through to 0 a successful conclusion. An early opportunity to take up trade issues occurs at the meeting of APEC Leaders in Thailand later in October, where it is one of the main items -20000 Japan on the agenda. On the other hand, it also appears that protectionist -40000 special interests in many developed and developing Korea+Singapore+Taiw an (China) countries have intensified opposition to a new global trade deal. The fact that a number of countries ­ including several -60000 East Asian countries - are holding elections over the next 12- 18 months may add to the protectionist momentum as incumbent governments (or opposition parties) are tempted Trade policy challenges after Cancun 6 to promise favors to influential special interest groups for electoral reasons. A particular element of danger here is that On September 10-14 WTO members met in Cancun the existing or applied tariff rates in many East Asian for a mid term review of the Doha Round of trade talks, but countries are well below the rates that have been bound with were unable to arrive at a consensus on how to advance the the WTO, so that a significant increase in protectionism negotiations. Members were divided on several issues, could occur while remaining consistent with WTO especially on agriculture and the so-called Singapore issues - obligations.7 Resisting protectionist pressure and successful behind-the-border regulations on investment, competition, conclusion of the Doha Round will therefore ultimately trade facilitation and transparency in government depend on a political judgment by leaders that the gains to procurement - whose inclusion in the talks was opposed by their general public and to the internationally competitive many developing countries. On agriculture in particular an sectors of their economies far outweigh losses to the unprecedented coalition of developing countries (the G21, interests demanding protection. This likelihood of this which included China Indonesia, Philippines and Thailand) outcome can be bolstered by the adoption of complementary challenged the joint US-EU position on agriculture for not policies that seek to enhance competitiveness by fostering going far enough on market access, domestic subsidies and higher domestic productivity, as well as targeted policies to export subsidies. On the Singapore issues, the EU ­ one of help adjustment by especially vulnerable groups that may be their strongest proponents ­ ultimately signaled a adversely affected. willingness to take investment and competition issues off the table, but other positions remained too far apart to achieve The likely gains from a successful Doha Round are consensus in the time available. One positive development in fact very large both for the world as a whole and for East was that Cambodia (together with Nepal) is now set to Asia in particular. As documented in much recent research, become among the first of the first of the Least Developed agricultural protection, high tariff peaks, tariff escalation and Countries (LDCs) to join the WTO. closed services markets in high-income countries discriminate against developing countries. High trade barriers in developing countries themselves further reduce trade opportunities and impose high costs on their own consumers. World Bank studies indicate that a multilateral trade agreement that comprehensively reduced barriers to 6This section draws on "East Asia Integrates: A Trade Policy Agenda for Shared Growth", eds. K. Krumm and H. Kharas, forthcoming 2004. See www.worldbank/eaptrade 7 For example Indonesia's applied rate of around 7 percent for advance edition. compares to a WTO bound rate of around 37 percent. East Asia Update 15 trade in agriculture, manufactures and services could Services liberalization the key for East Asia increase the income of developing countries by one trillion dollars (or over 9 percent) by 2015, as compared to a The biggest gains for East Asia are likely to come baseline without such an agreement.8 (This estimate is only from the services sector, an area which saw more progress of so-called static gains, based on the conservative than others in the WTO negotiations. East Asia has in fact assumption that productivity is left unchanged despite lagged behind other developing regions in liberalizing trade greater opportunities for global specialization and trade. in services, even though greater the evidence suggests that Estimates of dynamic gains that include higher productivity more competition in services can generate higher are typically substantially larger). A 9 percent gain in productivity throughout the economy. Estimates suggest developing country incomes would make a substantial that, after controlling for other determinants of growth, contribution to achieving the Millennium Development countries that fully liberalized trade in services grew on Goals for poverty reduction. The proportionate gains for average 1.5 percentage points faster than other countries East Asia are even larger. It is estimated that static income over the past decade.9 Competitiveness in high-value, gains from a successful Doha Round for developing East differentiated agriculture and in manufacturing would Asian economies could be $270 billion or more than 10 especially benefit from more efficient business services. percent of baseline income. Services is a sector where liberalization in a In recent years East Asian countries have also put regional setting could help lay the ground for multilateral emphasis on developing regional approaches to trade liberalization. Services barriers are often prohibitive and not liberalization, with the ASEAN Free Trade Area launched in revenue generating, so the liberalization on a preferential 2002 and a large number of potential new Regional Trading basis will likely have few costs of trade diversion. A Arrangements (RTAs) under discussion. On October 8, regional approach may be easier to negotiate and would 2003 the leaders of ASEAN, China, Japan and India agreed create an opportunity for countries to strengthen necessary the Bali Concord II as a platform to achieve a broader regulatory capacities such as the harmonization and mutual ASEAN community. In parallel, India and ASEAN members recognition of domestic regulations in financial, signed a Framework Agreement on Comprehensive professional, and a range of other services. Since the Economic Cooperation, including a free trade area covering liberalization of services may be necessary for industries to substantially all trade in goods by 2016--sooner for some of benefit fully from the removal of regional barriers to goods the partners, with provisions for an Early Harvest Program. trade, it may be preferable to give the service sector a high China and ASEAN agreed to speed up talks on the FTA they priority from the start of any negotiations. A regional agreed last year. services liberalization should be fairly promptly followed by a mover to a fuller multilateral services liberalization, which It may therefore be more useful for policymakers would generate further gains, by allowing purchases from in the region to approach multilateral and regional the most competitive suppliers worldwide.10 approaches as strategic complements rather than substitutes. The World Bank's forthcoming study "East Asia Integrates: Substantial gains from agricultural liberalization A Trade Policy Agenda for Shared Growth" argues that Gains from multilateral agricultural liberalization regionalism needs to be viewed as means of fostering greater by high-income countries are estimated at well over $10 regional cooperation over a broad array of development billion for developing East Asia, and triple that once issues, and as a means of furthering progress on "deep dynamic productivity gains are taken into account.11 integration." The rapid growth in intra-regional production However, the direct impact of agricultural subsidies and networks, trade and investment of recent years has brought domestic support programs in Europe and the United States to the forefront new issues, such as potential gains from on farmers in East Asia is limited because they heavily services liberalization, greater harmonization of national concentrated on meat, dairy products and cereals. With the regulations (including, for example, investment regulations, intellectual property issues, product standards, health and 9 safety standards and testing requirements), logistics and the A. Mattoo, A. Subramanian and R. Rathindran. (2000). tackling of various other "behind-the-border" issues that "Measuring Services Trade Liberalization and its Impact on might otherwise hamper the continued expansion of intra- Economic Growth: An Illustration". World Bank Working regional business. Regionalism is looked to as a means of Paper 2655. 10 tacking this new, more complex agenda. But, properly A multilateral liberalization would also avoid the risk of handled, the institutional development needed for deeper giving first mover advantages to inefficient regional integration at the regional level can also greatly strengthen producers. 11 the East Asia region's ability to capitalize on the World Bank Global Economics Prospects, 2003. Real opportunities that multilateral liberalization will create. income gains for Korea and developing East Asia are estimated at US$11 billion, assuming fixed productivity and US$32 billion with endogenous productivity, excluding production subsidies, compared to baseline income in 2015. 8 World Bank Global Economic Prospects, 2003. In 1997 China would account for one-third of static gains and two- US dollars. thirds of dynamic gains. East Asia Update 16 notable exception of rice, East Asian farmers are not directly coverage. Leaving out so-called sensitive sectors may engaged in these distorted world markets. Products such as politically be the course of least resistance, but it has fruits, vegetables, and spices together account for only 7 significant costs. As Exhibit 13 indicates, the gains for percent of the developed countries' total domestic support ASEAN countries from an ASEAN+3 RTA which left out payments. agriculture would only be 40 percent of the gains if Instead, other barriers in international agricultural agriculture was included. For China leaving out agriculture markets are more important for East Asia. There are four could turn a small gain into a loss. Policy makers in the practices of the developed countries, which are especially region tend to worry that agricultural trade opening might harmful. First, the use of specific rather than ad valorem reduce the reliability and stability of key consumer staples tariffs often leads to very high effective protection, like rice. However analysis suggests that because of the particularly on low quality goods produced by the poorest dominance of East Asia in rice production and trade, a countries. Products such as palm oil, rice, and sugar, as well coordinated regional approach could contribute to an as fish, crustaceans, and fruits and vegetables are most increase in the share of rice that is traded and thereby to an affected here. Second, developed countries use tariffs that increase in reliability and stability of rice markets, thereby cascade upwards on goods such as coffee and vegetables, as addressing the core concern of East Asian policymakers. protective devices for their agro-processing industries. Preferential access and rules of origin Third, conformance with health and safety regulations, notably maximum pesticide residue levels and difficulties Poorly designed preferential trading arrangements with understanding and administering standards, are costly often fail to meet their stated objectives because of the ways for many exporting countries. Fourth, complex rules of in which they raise the costs of doing business for affected origin make it hard for countries to avail of all the incentives firms. This often occurs under the preferential access theoretically made available to them. The gains from arrangements that rich countries offer to developing removal of these barriers are substantial, albeit more difficult countries, as well as under regional or bilateral trading to measure. agreements. Developed economies like the European Union and the United States provide preferential access to a variety Exhibit 13 of exports from developing economies, especially the least developed countries, including various East Asian Static gains from ASEAN+3 goods trade economies. However evidence suggests that limited liberalization (As % of GDP) 1.6 coverage and rules of origin limit the value of these schemes With Agri. in reducing barriers to products important to the poor in East Asia. The U.S. Generalized System of Preferences (GSP) Without Agri. scheme effectively excludes most poor East Asian countries' 1.2 agricultural exports, so most of their exports enter the U.S. market at MFN rates. The least developed countries' access to the EU market for agricultural products is formally more 0.8 open, since under the Everything but Arms agreement these countries have duty- and quota-free access. However, their access to the EU market appears to be constrained by 0.4 restrictive rules of origin. These rules are imposed to prevent transshipment that is re-export of products produced in non-eligible countries. The related administrative costs are often so great that exporters in developing countries, 0.0 who prefer to pay the ordinary MFN tariffs, do not take up ASEAN China Korea Japan many preferences. For example, about 480 million euros of Cambodia's exports to the EU are eligible for Generalized -0.4 System of Preferences (GSP) benefits, but only 36 percent of Gilbert & Scollay, 2001, 2002. actually enter under the GSP. This proportion is also only in 30-40 percent range in the Philippines, 40-50 percent in Malaysia and Mongolia, and 50-60 percent in China, There is also considerable scope for gains from Indonesia, Lao PDR, Thailand and Vietnam. action by East Asian economies to reduce their own agricultural trade barriers. Agricultural exporters in East However problems with rules of origins extend well Asia pay one third of all tariff duties paid to foreign beyond preferential access to developed countries. The governments to enter other East Asian markets. Static gains recent trend towards a proliferation of bilateral trading from agricultural liberalization in East Asia could total over arrangements in East Asia could also create a mass of $70 billion, or over $200 billion when dynamic gains are complex and inconsistent regulations, for example as regards included. This point is also true for proposed RTAs in East rules of origin. This is the danger of creating a so-called Asia, which are moiré valuable the wider is their sectoral spaghetti-bowl of regulations which significantly raises the cost of doing business for firms ­ which could reduce the East Asia Update 17 ability of the region to benefit from broader global trade Philippines, where spreads have remained high, in a 300-500 liberalization, rather than being as at present one of its basis points range over the past year, due to concerns about principal beneficiaries. Some of these problems could be the difficult fiscal position, the slowdown in export growth mitigated by better design of regional or bilateral trading this year and political tensions. arrangements, for example by allowing for cumulation under rules of origin and allowing for multiple rules for conferring Exhibit 14 origin. However, many of the bilateral arrangements being Eurobond Spreads 1/99 - 9/03 negotiated at present are missing these features. There is 400 therefore a danger that these agreements may actually hurt the competitiveness of East Asian firms in the global market.12 China Malaysia Thailand In conclusion, East Asia has been one of the 300 principal beneficiaries of multilateral trade liberalization over the past decades and it is likely to be one in the next multilateral round. Efforts at regional trade liberalization face many of the same issues as multilateral liberalization, 200 and need to be viewed as a complement rather than an alternative to the multilateral approach. A properly designed "open" approach to regionalism can help provide stepping- 100 stones to broader multilateral opening. International capital markets and exchange rates 0 International capital markets saw a marked improvement in sentiment over the course of 2003, Jul-99 ct-99 Jul-00 ct-00 Jul-01 ct-01 Jul-02 ct-02 Jul-03 especially with respect to emerging markets, which ­ after a Jan-99 Apr-99 O Jan-00 Apr-00 O Jan-01 Apr-01 O Jan-02 Apr-02 O Jan-03 Apr-03 long hiatus ­ have once more begun to attract significant inflows of portfolio bond and equity market inflows. This Exhibit 15 development augurs well for the strengthening of recovery Eurobond Spreads 1/99 - 9/03 in the developing world, including in East Asia, although, as 1200 will be seen, and as China is experiencing, it may also Indonesia Philippines Korea complicate problems of macroeconomic management. Emerging boom in emerging markets 900 This is apparent in many indicators. Spreads on emerging market debt and developed country high yield debt began falling in the last quarter of 2002 and continued to fall 600 through much of 2003, despite other concerns about the world recovery, the Iraq war and other uncertainties. The rally in high yield debt has been driven by rising demand, 300 because of the extraordinary 45 year lows in developed country interest rates, as well as by restricted new supply of this type of debt, because of many developing countries, 0 notably those in East Asia, running sustained current account surpluses in recent years. Jan-99Ma y-99 p-99Jan-00May-00Sep-00Jan-01May-01Sep-01Jan-02May-02Sep-02Jan-03May-03Sep-03 Se Emerging market spreads overall have fallen to their lowest levels since just before the Russian crisis of Exceptionally low interest rates and expectations of early 1998, and spreads in East Asia have generally followed a global economic recovery have also encouraged a this pattern, with a few deviations. (Exhibits 14 and 15). worldwide rally in equity markets since the end of the first Spreads for China did reverse to some extent in the first quarter. Emerging stock markets have been among the quarter and April, related perhaps to SARS concerns, but leaders in this rally, with substantial increases across the they fell back even more steeply, dropping below 30 basis board, in Latin America, Russia, Eastern Europe, Asia. In points in September. The other more exception is the East Asia the strongest gains between the April lows and late September were in Indonesia and Thailand, where equities 12 P. Brenton (2003). "Notes on Rules of Origin with rose by 40-50 percent. Stock prices were up 30-40 percent Implications for Regional Integration in South East Asia." in Hong Kong and Korea, and by roughly 20-25 percent in World Bank. Malaysia, Philippines and Singapore. (Exhibits 16 and 17) East Asia Update 18 Exhibit 16 Foreign exchange reserves have in fact been rising Stock Market Indices in several East Asian countries ever since the aftermath of the 1997-98 financial crisis. Reserves held by eight leading 1.5 (28 Dec.2002=1) Japan East Asian economies other than Japan rose from around Philippines $400 billion in January 1997 to approaching $900 billion by Singapore mid-2003. Interestingly, the pace of reserve accumulation Hong Kong (SAR) accelerated after mid 2001 in most economies. So rapid has 1.3 this pace become that n the first half of 2003 the acquisition of US Treasuries by Asian economies including Japan was sufficient to cover 90 percent of the increase in the financing requirement for the US balance of payments. 1.1 A broader composite index of underlying speculative pressure has been proposed which takes into account not only explicit exchange rate movements but also interest rate changes and reserve changes.13 For example, an 0.9 actual currency appreciation, a fall in interest rates and a rise Dec-01 Feb-02Apr-02 Jun-02Aug-02Oct-02Dec-02 Feb-03Apr-03 Jun-03Aug-03 in reserves are all taken as indicators of underlying market pressure for a currency appreciation. As conventionally measured, this underlying pressure is shown by a negative Exhibit 17 value of the composite index. Stock Market Indices Exhibit 18 (28 Dec.2002=1) 1.6 Exchange Rates vs. US$ Indonesia (Rise=depreciation. Jan.2001=1) 1.2 Korea Thailand 1.4 Malaysia 1.1 1.2 1.0 1.0 0.9 Indonesia Korea Philippines Thailand 0.8 0.8 Dec-01 Feb-02 r-02 Ap Jun-02 Aug-02Oct-02Dec-02 Feb-03 r-03 Ap Jun-03 Aug-03 Jan-200Apr-2001Jul-200Oct-200Jan-200Apr-2002Jul-200Oct-200Jan-200Apr-2003Jul-2003 1 1 1 2 2 2 3 Foreign reserves and exchange rate trends Exhibit 19 graphs Exchange Rate Market Pressure Another key reflection of rising net international Indices for several of the main East Asian economies demand for East Asian financial assets is the upward between the start of 2000 and mid 2003. It is notable that pressure on most East Asian currencies. With the exception since late 2001 the indexes for China, Indonesia, Korea and of the Philippines, most East Asian economies with more Thailand have trended significantly to the negative region, flexibly managed exchange rates saw appreciations against indicating currencies that were under pressure to appreciate. the US dollar of 5-7 percent between the start of 2003 and the end of September. (Exhibit 18). Explicit exchange rate movements may not however be the best measure of underlying pressures on currencies, because policy makers may be taking actions to 13 See for example Eichengreen, B., A. K. Rose, and C. prevent them from appreciating, for example by cutting local Wyplosz (1996): `Contagious Currency Crises', interest rates, so as to make local assets less attractive, or by Scandinavian Journal of Economics; and Kaminsky, G. and selling local currency to buy foreign currency, preventing C. M. Reinhart (1996), `The Twin Crises: The Causes of the local currency from appreciating and accumulating Banking and Balance of Payments Problems', International foreign exchange reserves in the process. Finance Discussion Paper 544, Board of Governors of the Federal Reserve Board, Washington D.C. East Asia Update 19 Exhibit 19. East Asia ­ Exchange Rate Market Pressure Indices (January 2001 ­ July/August 2003) China: Exchange Rate Market Indonesia: Exchange Rate Pressure Index Market Pressure Index 2.0 6.0 0.0 3.0 -2.0 -4.0 0.0 -6.0 -3.0 -8.0 -10.0 -6.0 0001 0006 0011 0104 0109 0202 0207 0212 0305 0001 0006 0011 0104 0109 0202 0207 0212 0305 Korea: Exchange Rate Market Malaysia: Exchange Rate Pressure Index Market Pressure Index 4.0 6.0 2.0 4.0 0.0 2.0 -2.0 0.0 -4.0 -2.0 -6.0 -4.0 01 06 11 04 09 02 07 12 05 0001 0006 0011 0104 0109 0202 0207 0212 0305 00 00 00 01 01 02 02 02 03 Philippines: Exchange Rate Thailand: Exchange Rate Market Pressure Index Market Pressure Index 4.0 8.0 2.0 4.0 0.0 0.0 -2.0 -4.0 -4.0 1 6 1 4 9 2 7 2 5 000 000 001 010 010 020 020 021 030 0001 0006 0011 0104 0109 0202 0207 0212 0305 East Asia Update 20 Following Eichengreen, Rose and Wyplosz (1996), the chart Exhibit 21 also shows a solid horizontal line indicating 1.5 standard deviations below the average value of the index as a Current Account Balances conventional threshold for a speculative attack on the (US$ Bill. 12 Month Moving Totals) currency.14 The indexes for the four countries mentioned 50 have touched or breached that threshold three or four times times since the start of 2001. 40 If East Asian currencies are under pressure to appreciate, what is the source of this pressure? One China (trade balance) suggestion is that it is the large current account surpluses 30 that East Asian economies have run since the financial crisis of 1997-98, which, it is sometimes suggested, nowadays Korea themselves reflect efforts by policy makers to maintain the 20 currencies at artificially low levels. Thailand Exhibit 20 10 Current and Capital Account* Balances Philippines (As % GDP. 2001-02 versus 1999-00.) 0 10.0 China Thailand Korea Philippines 99 99 9 00 00 0 01 01 1 02 02 2 03 8.0 Jan-19May-19Sep-199Jan-20May-20Sep-200Jan-20May-20Sep-200Jan-20May-20Sep-200Jan-20May-2003 6.0 A more plausible source for the recent acceleration in reserve accumulation is the capital account. This is 4.0 clearest for China. The current account surplus has stayed stable at around 2 percent of GDP in both 1999-00 and 2.0 2001-02. But the capital account, which has usually run a deficit, swung round to a large surplus of about 3 percent of 0.0 GDP in 2001-02, largely due to a swing in short term capital and errors and omissions. This accords well with anecdotal -2.0 -00 information on growing speculative inflows into China, which are thought to have increased in 2003. In other cases -4.0 1999-00 2001-02 1999-00 2001-02 1999-00 2001-02 1999 2001-02 like Thailand, earlier large current account surpluses were Capital A/C used to pay off foreign debt, reflected as large capital -6.0 account deficits. More recently, these capital outflows have Change in Current A/C become much smaller, and may even become positive -8.0 Reserves = because of short term inflows of late. 0.9 5.0 -0.2 3.3 6.7 2.8 2.1 0.3 -10.0 What of the potential costs of large reserve * Capital Account includes errors and omissions.. Source: IMF IFS. accumulation? It is certainly true that in the wake of the financial crisis the buildup of reserves provided an Exhibit 20 suggests that current accounts did important prudential buffer against the risk of further indeed surge in the years after the crisis, in particular as balance of payments shocks, and thus helped reestablish domestic investment and demand in the crisis countries macroeconomic stability in the crisis countries. From the collapsed, averaging around 8 percent of GDP in Thailand viewpoint of crisis prevention the most relevant indicator is in 1999 and 2000, for example. However current accounts the ratio of international reserves to short term external debt have generally fallen since then, in the period 2001-02, by remaining maturity (the so-called "Greenspan ratio"). It especially in relation to GDP. As the subsequent Exhibit 21 is sometimes suggested that a ratio of one can provide a shows, current accounts have continued to fall in 2003, even simple benchmark for a country with a balanced current in nominal dollar terms. account and no capital flight.15 However, as Text Table 3 indicates, the reserves to short term debt ration in most of the larger East Asian economies now far exceeds this benchmark. 14 Eichengreen et al refer to the 1.5 standard deviation 15 See for example, International Monetary Fund (2000): threshold in terms of a speculative attack to devalue a "Issues in Reserves Adequacy and Management", which currency. Here we use it to refer to a speculative attack to however cautions that the simple benchmark should only be revalue or appreciate a currency. used as a starting point for deeper analysis. East Asia Update 21 Text Table 3. East Asia: Foreign Exchange Reserves Domestic trends and policy challenges and Measures of Reserve Adequacy For the last five years many countries in East Asia Foreign Reserves Ratio of have been struggling through two sets of adverse events ­ Reserves In Months Reserves to the aftermath of the 1997-98 regional financial crisis and the (Bill.US$) of Imports Short term Debt loss of confidence, collapse in asset values and mass of bad Dec. June debts that came in its wake; and the world economic 1996 2003 1996 2002 1996 2002 slowdown that began in late 2000 and has continued till the China 16 107.0 351.4 8.4 10.7 3.36 11.23 middle of 2003, centered on an unprecedented recession in Indonesia 18.3 33.0 3.7 7.4 0.49 2.05 the global high technology industry and the bursting of a Korea 34.0 131.7 2.3 7.9 0.46 2.59 global equity price bubble. The preceding section looked at Malaysia 27.0 36.8 3.6 4.6 2.03 3.56 evidence that the global environment for East Asia has Philippines 10.0 12.7 3.0 4.2 1.13 1.67 finally turned for the better. This section looks at the Thailand 37.7 38.5 5.4 6.2 0.76 3.43 evidence that domestic trends are also falling into place that Source: IMF IFS; BIS-IMF-OECD-World Bank Joint Debt Stats. could help the region finally put the remains of the financial crisis behind it and move into another long cycle of economic growth and poverty reduction, as well as some of Such high reserve accumulations can be costly, reforms that can help this process along. especially at present when the returns they earn are so low because of low international interest rates. Perhaps more One positive trend already apparent over the last importantly, a policy of maintaining the country's exchange couple of years has been stronger consumer spending by rate at a fixed or stable level against some other currency households, supported by lower real interest rates and a will lead to some loss of independent control over the substantial increase in consumer credit and housing finance country's monetary policy, which can lead to significant lending by banks. (Text Table 4). In 2002 and the first half complications of macroeconomic management. At present, of 2003, growth in consumer spending contributed 70 for example, the United States is maintaining a strongly percent or more of growth in GDP in Indonesia and the expansive monetary policy to support its recovery from Philippines, and more than 50 percent in Thailand. The recession, but Asian economies that maintain a stable recent development of new consumer lending instruments exchange rate against the dollar also have to `import' this and markets by banks reflects to some extent the success of expansive monetary policy, even though it may be efforts to recapitalize and restructure financial systems after inappropriate to the cyclical position of their own economy, the crisis and the improvement in the financial health of which may be one of strong growth. In this situation Asian regional banks. These improvements are discussed in the economies experience a buildup of reserves, which is next sub-section, which also notes a marked pickup in the matched by an increase in high-powered money and rate of overall commercial bank lending to the private sector subsequently in credit expansion by the financial system. from the end of 2001 onwards. Naturally, bank This may then stimulate a boom in domestic investment, management and regulators will need to ensure that the new consumer durables spending and asset prices, which, if left credit expansion is undertaken prudently and does not unchecked, can encourage yet more credit expansion and so become a new source of vulnerability. Korea is already become self-fueling, somewhat in the way that the experiencing a recession this year with GDP falling in both conditions were laid for the 1997 financial crisis in some the first and second quarters as consumers cut spending and East Asian countries. The ongoing credit, investment and adjust their balance sheets in the wake of excessive growth asset price boom in China raises concerns of this sort, which in consumer credit. is one reason why the authorities are taking steps to curb certain types of credit expansion and speculative capital Text Table 4. Real Private Consumption inflows. In some cases government interventions to mop up (% change from year ago) excess liquidity by issuing government bonds can push up Indonesia Korea Malaysia Philipp. Thailand domestic interest rates, attracting yet more speculative capital inflows, another potential vicious circle. It is these 1997 7.8 3.5 4.3 5.0 -1.4 kinds of risks and complications that can lead governments 1998 -6.2 -11.7 -10.2 3.4 -11.5 to view greater exchange rate flexibility as an additional 1999 4.6 11.0 2.9 2.6 4.3 useful tool for domestic macroeconomic management. 2000 3.6 7.9 13.0 3.5 4.9 2001 2.3 4.7 2.4 3.6 3.7 2002 4.7 6.8 4.4 4.1 4.7 2003 * 4.3 -0.7 3.9 5.0 6.3 First half of 2003 - % change from first half of 2002. Until recently the piece of the recovery missing in 16 Note that in 2002 China changed its classification of the post-financial crisis countries was fixed investment, short-term debt from original maturity to remaining maturity which apart from an initial rebound in 2000, from extremely basis, which led to a sharp increase in the reported figure. East Asia Update 22 depressed crisis levels, has tended to show only weak and several countries. (Text Table 6). Bank income has erratic growth. But there are indications that investment benefited from somewhat higher interest margins in several spending could be starting to respond to more favorable countries, higher non-interest income due to the macroeconomic conditions, most notably in Thailand, where improvement in overall economic conditions, better-cost it was growing by around 8 percent from year earlier levels control and lower provisioning expenses. In Korea, in real terms in the first half of 2003, and was contributing however, rates of return on equity and assets declined in 20-25 percent of GDP growth. (Text Table 5). Firms face a 2002 through to the first quarter of 2003. Higher provisions better market outlook because of stronger domestic on account of the loans to SK Global and households, and consumption and prospects for a pickup in export market, valuation losses on securities of Hynix and Hyundai while, as noted, real interest rates are low and availability of Engineering contributed to lower net income. In Malaysia, credit is improving. As discussed in following sections, East too, there was some decline in the rates of return to assets Asia firms' profitability and balance sheets are improving, and equity during the first half of 2003. with income to sales and interest coverage ratios trending higher, while debt-equity rations have fallen, all of which should be supportive of new investment activity. Text Table 6. Commercial Banks. Efforts at financial and corporate restructuring Rate of Return on Assets since the crisis have contributed to the improved financial 2000 2001 2002 2003 * health of the corporate and banking sectors, and it is Korea -0.5 0.8 0.6 0.7 important that restructuring efforts be continued to deal with Indonesia 0.6 1.5 2.0 2.2 the remaining core of distressed firms and financial Malaysia -- 1.4 1.8 1.0 institutions. Structural and institutional reform efforts to Philippines 0.4 0.5 0.8 0.9 improve the investment climate will also be important. Thailand -0.2 1.5 0.2 1.0 These include further improvements in financial supervision * Latest available. and regulation, corporate governance., business regulation, debtor-creditor regimes and the legal and judicial Exhibit 21 framework more generally, as well as reducing barriers to Non-performing loans in Commercial Banks foreign direct investment in services and strengthening (% of total loans) infrastructure and the provision of other public services important for business. Thailand Text Table 5. Real Gross Fixed Investment Dec-98 Philippines (% change from year ago) Dec-00 Indonesia Korea Malaysia Philipp.. Thailand Dec-01 Malaysia 1997 8.6 -2.2 9.2 11.5 -20.5 Dec-02 1998 -33.0 -21.2 -43.0 -11.2 -44.3 Jun-03 1999 -18.7 3.7 -6.5 -2.0 -3.2 Korea 2000 22.6 11.4 25.7 2.8 5.3 2001 3.1 -1.8 -2.8 12.0 0.9 Indonesia 2002 -0.2 4.8 0.3 2.4 6.3 2003 * 5.9 4.1 2.0 0.5 7.7 0 10 20 30 40 50 60 First half of 2003 - % change from first half of 2002. Asset quality has also generally continued to Financial sector trends and reforms 17 improve. Non-performing loans (NPLs) as a share of total Financial sector trends commercial bank loans are now generally much lower than in the immediate aftermath of the financial crisis. The NPL Banks in most of the previously crisis affected East ratio continued to fall during 2002 in most countries, though Asian economies continue to experience gradual there was little further change in the first half of 2003.18 improvements in profitability, capital adequacy and asset (Exhibit 21). This broad trend towards lower NPLs reflects quality. Bank return on assets are generally positive and a number of factors, including improvements in the balance significantly higher than in 1998-2000, the immediate sheets of borrowers due to higher growth and lower interest aftermath of the financial crisis, although absolute levels of rates, a pickup in new loan demand (in some cases for the returns on assets are still quite low ­ one percent or less ­ in first since the financial crisis ­ Text Table 7), and continued 17 Discussion of financial and corporate sector trends draws 18The rise in Thailand's NPL ratio in 2002 shown in Exhibit on "East Asia Update: Progress on Financial and Corporate 21 was due to a change in definition, which did not affect Restructuring". World Bank, 2003. Forthcoming. provisioning requirements. East Asia Update 23 restructuring of bad debts. Improving asset quality and Exchange Banks. Disclosure requirements for unlisted bank profitability have helped strengthen capital adequacy. financial institutions were recently strengthened. Capital adequacy ratios are well above the 8 percent guideline in all countries, although there is concern that In the Philippines, the Philippine Deposit Insurance capital may tend to be overstated in some cases where Corporation (PDIC) agreed to a P20 billion financial problems with asset quality are understated. assistance package for the government-sequestered United Coconut Planters Bank (UCPB). The NPL ratio of the bank Text Table 7: Commercial bank claims on private sector was estimated at nearly 40 percent at the end of 2002 and (% change from year ago) the slow progress in its resolution was raising the costs daily. The regulatory authority of the central bank 1999 2000 2001 2003* continues to be compromised by lack of legal protection China 11.5 11.5 9.5 20.8 from court challenges. In August the Appeal Court moved Indonesia -55.5 22.2 10.3 16.8 to suspend the central bank governor and other officials for Korea 19.0 18.2 13.7 19.3 the closure of Urban Bank in 2000, though this ruling was later appealed and reversed. Legislation to strengthen legal Malaysia 3.8 7.8 3.6 6.0 protection for bank regulators and to clarify rules for bank Philippines -2.3 5.4 -1.8 0.5 closures and rescues continues to face delays in Congress.. Thailand -5.4 -16.0 -10.4 12.4 *Growth between end 2001 and 2003 Q2 at annualized rate Capital market development In the past commercial banks have played a Some qualifications should be noted, however. dominant role in the financial systems of East Asian NPL ratios remain above 10 percent in several countries, countries. Since the 1997-98 financial crisis, there has been change in the first half of 2003 has been sluggish and there a growing consensus on the need to foster more diversified are often concerns about the quality of restructured assets. or balanced financial systems that combine a variety of In Thailand NPLs remained a relatively high 17.6 percent in capital markets with traditional banking structures. The mid 2003. Moreover, a rise in re-entry NPLs led to an goals are to enable more efficient pricing and management increase in private banks' NPLs in the first half of 2003. So of risks while avoiding a too great concentration of risk in far about two thirds of private banks' NPLs have reverted any one set of institutions provide access to a wide range of back to NPL status. In the Philippines commercial bank financial services, facilitate efficient management of private NPLs were around 15 percent in mid 2003, or around 24 and public savings; and enable rationalization of corporate percent if real and other properties owned and acquired balance sheets. (ROPOA) are factored in. Reserves for bad debts are less than one third of non-performing assets, which may be Capital markets do indeed appear to be taking off. inadequate, since discounts during workouts are likely to be Bond markets have become important sources of financing high. As Text Table 7 indicates, new lending growth has in East Asia. In 1997, local bond markets supplied less than been very slow, pointing to a dearth of credible borrowers. 3 percent of the funds raised by Asian entities in all local In Korea, following a steady decline until the end of 2002, and international loan, bond and equity markets. In 2001, the NPL ratio rose to 3.2 percent in June 2003, as a result of the share of local bond markets rose to 38 percent of total loan defaults by SK Global Company and increases in financing. While still not as large as equity markets, bond overdue consumer loans and credit card defaults. markets - at about 40 percent of GDP - have more than Nonetheless, at 3.2 percent of total loans, Korea's doubled in size since the crisis. A securitization market is commercial bank NPL ratio remains significantly below that also emerging led by Korea with Thailand, Malaysia and of the other crisis-affected countries. China taking measures to expand this market. Issuance of Asset Backed Securities (ABS) in 2002 was around Financial sector restructuring and reforms US$3.8bn. About US$1bn worth of rated securitizations Progress on asset restructuring is reviewed in the took place in the year to August 2003. discussion of corporate restructuring below. Progress also Venture capital is also becoming an important continues on other important aspects of financial sector source of finance in East Asia. Corporate venture capital restructuring and reform including privatization of banks grew at a 35 percent average annual rate between 1996 and nationalized during the crisis, strategic consolidation of 2001. Private equity capital-under-management reached financial systems and strengthening of financial sector about $89 billion in 2002. In Thailand venture capital raised supervision and regulation. In Indonesia stakes in Banks increased 366 percent in the period 1998-2001 relative to Mandiri and Danamon were recently sold and the authorities 1995-1997; the corresponding increase for Malaysia was plan to sell stakes in four more banks in 2003 and 2004. 246 percent. However, Asian venture capital firms differ bank Indonesia continues an ongoing effort to strengthen from their US counterparts in three ways: - their sources of prudential regulations, recently in areas such as risk financing are banks and governments rather than individuals management. In Korea agreements have reached allowing or institutions; the uses of financing tend to be for disposal of government stakes in Chohung and Korea established firms in the financial and manufacturing sectors East Asia Update 24 rather than early stage financing in start ups; and their exit channels to retail investors and corporate governance in strategies (tend to be through trade and negotiated sales brokerage firms. rather than IPOs. · Legal Infrastructure. Improvements are needed in Countries are undertaking important measures to accounting and auditing standards; standardization of strengthen capital markets. Korea, Malaysia and Thailand bond contracts, underwriting standards, clearing and have undertaken reforms of government bond markets with settlement procedures; the definition of "true sale" of regard to frequency and issue size, primary dealer systems, assets and clear legal status of Special Purpose better auction procedures and issuance of longer maturity Vehicles; better bankruptcy law and foreclosure paper to strengthen the benchmark yield curve. In Thailand, practice; credit information agencies and clarification of the Bond Dealing Centre (BDC) was upgraded to an data privacy and bankers' confidentiality. organized exchange to facilitate secondary market activities. In Philippines the Bankers Association has developed a · Harmonization at regional level. In developing a detailed proposal for establishing a Fixed Income Exchange. regional bond market key issues to be addressed: Thailand and Malaysia have developed ten year Capital include: development of regional credit rating agencies, Market Development plans to strengthen the legal and regional level clearing and settlement systems; and regulatory framework for issuance of a wide range of debt cross-border securities borrowing and lending and equity instruments. mechanisms. A special emphasis is being placed on developing Corporate performance and policy issues securitization markets because this form of financing could be a very useful option for rationalizing corporate and Corporate Trends banking balance sheet structures, linking small firms to Corporate performance in 2002 continued to capital markets and enabling greater infrastructure improve in most of the previously crisis-affected countries. financing. Korea, Taiwan (China), Malaysia, Thailand and The ratio of ordinary income to sales for listed non-financial China have or are putting into place legislation that would companies rose from 2001 to 2002 in Indonesia, Korea, enable issuance of asset-backed securities. At the regional Malaysia, and Thailand.19 (Exhibit 22). Much of the rise in level, under an APEC initiative, the Hong Kong Monetary profits resulted from lower interest charges, which in turn Authority and the Ministries of Finance in Thailand and reflected the fall in interest rates through much of the Korea are co-chairing an initiative to assist APEC region, as well as lower levels of corporate debt. economies develop securitization and credit guarantee markets. Exhibit 22 At the regional level, the ASEAN+3 countries have Listed Non-financial companies: established a regional bond fund to support uptake of Ordinary Income to Sales (%) sovereign and corporate debt issues by regional investors, Thailand including domestic currency issues. This initiative is also supported by policy dialog on developing a policy, legal and Philippines regulatory framework and the trading infrastructure for a 2002 regional bond market. Malaysia 2001 Further progress on capital market development 2000 can be helped by reforms in a number of areas. Korea · Broaden demand: The investor base and demand for corporate bonds can be broadened by reducing Indonesia restrictions on contractual savings institutions. The lack of a diversified investor base makes bond markets less -5 0 5 10 15 liquid, resulting in price inefficiencies. · Increase supply of quality bond issues: The supply of Higher earnings and lower interest payments have quality debt instruments can be encouraged by reducing reduced the short-term financial vulnerability of firms as statutory restrictions on the issuance of fixed-income measured by the interest coverage ratio (ICR).20 Median securities and other repressive regulations; as well as, interest coverage ratios rose between 2001 and 2002 in all more broadly, by corporate restructuring that improves the credit standing of issuing corporations. 19 Calculated using the Worldscope database. The 2002 · Strengthen Market Infrastructure: The network of estimate for Indonesia is based on a small sample of 55 primary dealers to make markets needs strengthening, companies and so should be treated with caution. as do settlement systems for government bonds, 20 The interest coverage ratio is the ratio of earnings to authorization and registration procedures, distribution interest payments. A ratio less than 1 indicates a firm unable to even meets its current interest charges. East Asia Update 25 five countries, and, except in the Philippines, are also from further progress in corporate restructuring during estimated to be higher than in 1996, before the financial 2001 and 2002. Other than the Philippines, most countries crisis. In Indonesia, Korea, Malaysia and Thailand there have adopted a similar approach to restructuring, including was a decline between 2001 and 2002 in the proportion of the use of a centralized asset management company (AMC), firms whose interest coverage was less than 1, and an out-of-court workouts under some version of the `London increase in the proportion of firms with interest coverage of approach' and court supervised workouts. The extent of at least 2. Corporate debt-equity ratios have also come progress on implementing corporate restructuring using down substantially in all five countries and are now closer these tools has varied a good deal across countries, however, to international norms. depending on factors such as the level of top political Nonetheless, vulnerability remains, since the support for restructuring, the level of legal protection proportion of firms with interest coverage less than 1 available to creditors and the general efficiency of judicial remains high relative both to benchmark developed systems. Over and above the immediate restructuring task, countries like the US, and to these economies' own situation the circumstances increasingly demand policy makers' in 1996, before the financial crisis. (Exhibit 23) In the attention to deeper institutional reforms in such areas as Philippines, in particular, the sample indicates that almost insolvency law, the efficiency of legal and judicial systems 40 percent of listed firms had interest coverage of less than and corporate governance, which will improve the ability of 1 at end-2002. 21 In the other countries the apparently markets themselves to monitor and, where necessary, contradictory fact that the median ICR has risen since 1996 penalize and restructure inefficient firms. and that there is also a larger proportion of firms with ICRs Corporate restructuring and reforms have made less than one might indicate the emergence of a dualistic most progress in Korea and Malaysia. In Korea, KAMCO corporate economy, where the financial health of one large had resolved 59 percent of its portfolio by the end of 2002. group of firms has improved a lot due to natural growth and Some 1246 firms were selected in the first half of 2003 restructuring efforts (pulling up the median ICR), while under the Continuous Credit Risk Assessment System, another group of "hard core" distressed firms are failing to which obliges by creditor banks to scrutinize and reorganize improve through either channel. high-risk borrowers. The government is further strengthening the bankruptcy code and corporate Exhibit 23 governance requirements with new bills before the National Proportion of firms in different Interest Assembly. In Malaysia the Danaharta AMC is due to Coverage Ratio (ICR) classes (%) implement recovery strategies for its entire portfolio and to close shop by 2005. The CDRC, which oversaw, voluntary 2002 out-of-court workouts, was able to close in 2002. Creditor USA 1996 rights are being further strengthened with new legislation to facilitate the appointment of special administrators for 2002 distressed firms. The government has also moved more Korea aggressively to address restructuring at some of the largest 1996 groups, including Renong and Pernas. New stock market regulations for distressed firms have also encouraged a 2002 Malaysia wave of M&A activity. 1996 Arguably, restructuring in Indonesia and Thailand 2002 has tended to lag because a credible threat of foreclosure Philippines and insolvency has been lacking. In Indonesia progress on 1996 AMC restructuring was slower than in Korea and Malaysia, IBRA having disposed of 20 percent of assets. Several 0 20 40 60 80 100 initiatives were undertaken during 2002 and 2003 to address ICR <1 ICR: 1 to 2 ICR >2 some of the perceived weaknesses of the insolvency system and courts, including measures to improve the training of judges, increase the transparency of the commercial court decisions, and to strengthen the accountability of judges and Corporate restructuring trends the internal court process. In Thailand the TAMC has The previous section noted that the recent approved resolution of about 70 percent of its portfolio as of improvement in financial health of East Asian corporation June 2003, and is expecting a recovery rate of 46 percent on reflects not only better growth and lower interest rates, but this. However, despite reforms of the judicial process, civil also reductions in corporate debt, which resulted in part courts remain subject to large backlogs and long delays. Proposed legislation on the insolvency regime, corporate governance and the Securities and Exchange Commission 21 Moreover, the Worldscope sample is based on large listed remains in the legislative pipeline. However, significant companies that are of interest to foreign investors. It is therefore efforts have been expended in 2003 to improve financial likely to be a biased towards the better performing firms. East Asia Update 26 reporting and disclosure of listed companies. The SEC has can provide insight and helpful benchmarks for other intensified its enforcement capacity and effort on violations countries in East Asia to accelerate their reforms. of disclosures and insider trading which has led to the criminal prosecution of company officials. The Philippines Exhibit 24 did not adopt a centralized arrangement for dealing with CLSA Corporate Governance Index - NPLs. Despite the 2002 Special Purpose Vehicle Act (SPV) 2003 which allows banks to sell assets to a specially designed 8 private sector AMC, corporate restructuring is still sporadic and infrequent. If enacted the Securitization Bill currently before parliament could have a positive impact on corporate restructuring by allowing SPVs more flexibility in 6 managing acquired assets. Corporate governance trends 4 Recent surveys suggest that most countries in East Asia are making progress on strengthening corporate governance, especially the middle income countries, although prevailing levels still vary a good deal. These is a 2 general recognition of the importance of corporate re governance for improving their business environment, IndiaKorea enhancing their competitiveness, and attracting investment, SingapoHoSource: ng Kong MalaysiaThailand CLSA Emerging Markets, 2003China ilippinesIndonesia Ph particularly FDI. Research confirms that companies with high quality corporate governance are rewarded with a lower weighted average cost of capital and with higher market valuation of the company. Increasingly, the link The political season and public governance trends between corporate governance and good governance is being recognized by policy makers and business leaders as a At numerous points the policy tasks facing critical issue. countries in the region lead on to questions of governance and institutions. Improving fiscal positions often requires Broadly speaking, corporate governance challenges strengthening public sector financial management and in East Asia can be defined as less than desirable accountability. Effective delivery of key services like enforcement, inadequate financial reporting and disclosure education, health, water and sanitation plays a key role in practices, prevalence of informal norms over formal rules, poverty reduction, as well as in development more broadly, and ineffective implementation of the rule of law. A recent and. relies crucially on institutional mechanisms that allow survey of corporate governance in Asia by CLSA Emerging consumers of services to demand accountability from Markets ranks markets in the region according to the quality service providers and policy makers. (The Special Focus in of rules and regulations, the enforcement of rules, the this report on "Making Service Delivery Work in East Asia" political and regulatory environment affecting corporate discusses the institutional challenges of service delivery in governance and the ability of firms to maximize value more detail). Strengthening insolvency systems and legal without arbitrary restrictions, the adoption of International and judicial systems more broadly is seen as crucial for Generally Accepted Accounting Standards (IGAAP), and corporate restructuring and improving the investment the presence of institutional mechanisms to promote climate in East Asia. Civil service reform can underpin awareness and a culture of good corporate governance. greater government effectiveness generally. Exhibit 24 indicates the overall ranking of The coming 18 months will also see important countries for corporate governance quality in 2003, political transitions in several main countries of the region. indicating that among middle income East Asia economies, There will be legislative and/or presidential elections in Korea and Malaysia have done more to strengthen corporate Indonesia, Korea, Malaysia, the Philippines and Thailand. governance than others. An interesting observation is that In addition Prime Minister Mahathir of Malaysia will step some of the weaker economies actually had rules and down from office this October. Cambodia also recently regulations on the books and adoption of accounting conducted successful elections, and is in the process of standards equal to those in the better performing economies. forming a new government. From a broad, long-term Where they fell behind was in terms of enforcement of the perspective these events reflect the region's substantial rules, the broad political and regulatory environment achievement in strengthening consensual or representative affecting corporate governance and the presence of institutions over the last 10-20 years, and should mark a institutional mechanisms to promote good corporate further advance in that direction. But in the near term they governance. However, the success of countries such as may also distract policy makers' attention from governing, Korea and Malaysia in improving their governance systems or, cause reforms to be delayed or reversed, or lead to the East Asia Update 27 adoption of policies that favor special interests but harm the than Latin America, but well below Central and Eastern broader national interest. Europe. Indeed one of the most striking features of the Given these governance challenges and transitions governance dataset (not shown in the exhibit) is a very large it may be useful to take stock of where governance in East improvement in the rating of governance in Central and Asia stands now and how it compares to other developing Eastern Europe between 1996 and 2002. Governance regions. A recently updated World Bank database of indicators over this period in East Asia have, if anything governance indicators facilitates this comparison. 22 The deteriorated on average. (Exhibit 26). However, given the study draws on surveys of the perceptions of citizens, fairly large standard errors in the estimates of governance, businessmen, foreign investors and civil society as to the the safest conclusion is probably that the average quality of quality of governance in a country and aggregates them six governance across the region has not changed much since composite measures of governance, covering voice and the financial crisis. accountability, political stability, government effectiveness, Exhibit 26 regulatory quality, the rule of law and control of corruption. East Asia - Governance Over Time Exhibit 25 (1996 and 2002) Governance Indicators across Regions 2002 (2002) 1.00 0.30 East Asia (15) 1996 Latin America (18) CEE (13) 0.50 0.10 0.00 -0.10ice &Accn. Stability Rule of Law of Corruption Accn. ess Vo ofLaw Political Control Voice& Political -0.50 GovernmentEffectivenRegulatory Quality Stability Rule Government EffectivenessRegulatoryQuality ControlofCorruption -0.30 Exhibit 25 compares averages of governance indicators in 2002 for 15 East Asian economies with Does it really matter that East Asian governance regional averages for Latin America and Central and indicators have been flat over the last 6-7 years, but have Eastern Europe.23 East Asia is rated significantly lower than fallen well below those in Central and Eastern Europe? the other two regions for voice and accountability, as Studies accompanying this World Bank governance measured by an index, which incorporates assessments of research project find that better governance as measured by civil liberties, political rights and independence of the these indicators has a strong positive causal relationship media. For the other five indicators East Asia rates higher with better development outcomes across countries, for example higher per-capita incomes, lower infant mortality rates and higher adult literacy rates. The point can also be 22 The research project, its methodology and data sources made in a more impressionistic way by looking at the trend are described in D. Kaufmann, A. Kraay and M. Mastruzzi of foreign direct inflows to East Asia Central and Eastern (2003): "Governance Matters III: Governance Indicators for Europe in recent years. FDI inflows averaged 2.8 percent of 1996-2002" This and other papers as well as the underlying GDP for six leading East Asian economies in 1996-97, but database are available at this simple average fell to 1.7 percent in 2000-01. For the http://www.worldbank.org/wbi/governance/pubs/govmatters European countries, on the other hand, FDI to GDP ratios 3.html rose from a simple average 3.4 to 5.4 percent over this 23 The 15 economies are Cambodia, China, Fiji, Hong Kong, period. Obviously one cannot draw simple causal Indonesia, Korea, Lao PDR, Malaysia, Mongolia, inferences from the gap in governance outcomes to the gap Philippines, Papua New Guinea, Singapore, Thailand, in FDI outcomes: many other macroeconomic, regional and Taiwan (China) and Vietnam. The paper by Kaufman et al sectoral factors are also likely to be in play. But the outlines numerous methodological pitfalls and cautions in governance gap certainly is not helping. This example comparing the governance indicators across countries or underlines the importance of making progress on across time. Taking into account the standard errors of the governance challenges as an element in maintaining or estimates, it is sensible to only pay attention to quite large improving East Asia's international competitiveness. rather than small differences or changes. East Asia Update 28 Looking within the regional averages also suggests some interesting patterns. Voice and accountability are seen Exhibit 27 as having risen markedly in Indonesia after the passing of the Suharto regime, but this is accompanied by a significant Governance: Voice & Accountability versus fall in the ratings for the other governance indicators. Here Government Effectiveness (2002) the challenge in coming years will be to show that greater 2.50 Singapore voice can indeed be combined with higher levels of political stability and government effectiveness, as they are in a 2.00 USA numbers of other East Asian economies and other developing economies around the world. Another feature of s 1.50 the data is that, more often than not it is the smaller, low- es Hong Kong France en income economies that have seen significant deterioration in Taiwan governance, while the high income economies have tended ivtceff Malaysia 1.00 (China to see improvement. This raises the worrying potential for a E Korea vicious circle, where small low income countries that nte 0.50 already have poor governance (Exhibit 27), experience China Thailand further worsening in governance, which renders them even mnrevo 0.00 Fiji less able to achieve fast economic development, while high G-2.00 -1.50 -1.00 -0.50 0.00 0.50 1.00 1.50 income countries with good governance tend to improve it Vietnam Mongolia even further. The danger of such a potential vicious circle -0.50 Indonesia Philippines adds to the case for deliberate policy efforts to improve Lao PDR Cambodia PNG governance from a development and poverty reduction -1.00 perspective. Voice & Accountability East Asia Update 29 COUNTRY SECTIONS Major Economies24 The Government has taken several steps in recent months to ensure greater prudence in credit support to risky China and potentially risky investment, and to the residential real Despite SARS and relatively slow growth in world estate market. It is likely, however, that stronger fiscal and trade, China's economic performance in the first half of quasi-fiscal curbs (in particular on local government 2003 was surprisingly good--GDP expanded by 8.2 percent investment behavior) are required to maintain the stable (y-y). Official projections suggest that the growth rate for economic conditions required to support completion of the all of 2003 will be about 8 percent. However, SARS and post-WTO structural adjustment. associated low growth in the services sector affected job creation adversely. Two events have dominated the strategic reform agenda since our economic update of April 2003. The first is Growth was driven by exceptionally high the creation of two institutions--China Bank Regulatory investment and credit expansion. The share of capital Commission (CBRC) and State Assets Supervision and formation in GDP is estimated to be above the levels Administration Commission of the State Council (central reached during the economic over-heating of the early SASAC), which signaled the commitment of the new 1990s. Although capacity utilization remains low in many administration to address long-standing issues in the state- industrial sub-sectors, rapid additions to production capacity owned banking and corporate sectors. The second is the are being made, and not just in new product lines. Much of national campaign against SARS, and the focus of the this investment is taking place with the direct or indirect Government on better crisis recognition and mitigation support of sub-national entities, who are poorly-monitored. mechanisms. China's response to SARS demonstrated that There is need for concern about its relative economic the country has an enormous capacity to address and solve efficiency and the risks this level and pattern of investment issues if there is a national will and strong leadership. poses to future fiscal management and the health of the financial sector. Taking such factors into consideration, a Indonesia debate is raging about whether investment is over-heated in Macroeconomic stability in Indonesia has China today, and what would be an appropriate policy continued to improve, while the external environment is response. likely to be supportive. As a result, growth is expected to China's external position is strong, but the external accelerate in the medium-term. However, the investment current account surplus has fallen. Although merchandise climate remains weak and some indicators raise concern export growth was a strong 32.5 percent in January-August about macroeconomic prospects going forward. A stable (y-y), measured in nominal dollar terms, the sharper increase political situation and implementation of policies in the of 40.6 percent in imports and the estimated fall in service economic policy package are key for improving the exports have meant that, during the first half, the net effect investment climate. On balance, our projections envisage of external sector developments on total demand has been real growth of 3.5 percent in 2003 and 4 percent in 2004. contractionary. During the first half of 2003, the economy Speculation on the future value of the Renminbi, performed well despite external shocks such as the Iraq together with strong net FDI inflows, have led to large crisis and SARS. The economy grew by 3.6 percent (yoy), capital inflows into China. The central bank has purchased although that was lower than the government's annual target about US$70 billion in foreign exchange in the first 7 of 4 percent. Private consumption remains the main source months of 2003. By end-July, reserves amounted to of growth. CPI inflation further decelerated to 6.2 percent US$356.5 billion, equivalent to 11.5 months imports of (yoy) in September. The fall in inflation rates has enabled goods and services. the central bank to reduce key interest rates to below 9 percent. On the external side, vulnerability has been The role of credit expansion--an increase of 23.2 reduced. Gross reserves reached US$34 billion as of percent by end-July 2003--has received a lot of attention, as September. Private capital flows were almost balanced in many analysts and officials regarded it as a factor Q1 2003. The short-term debt to reserve ratio declined to contributing to unsustainable growth in certain sectors, and below 50 percent by end-2002. On the budget side, fiscal in risky investment. The major driving force for credit consolidation is on-track. In the draft 2004 budget, the expansion is the central bank's interventions to manage budget deficit is projected at 1.2 percent of GDP or 0.6 pressures on the exchange rate in the face of surging capital percentage points lower than the 2003 budget. Market inflows. sentiment has been favorable despite the Marriott bombing on August 5. The declines in the rupiah exchange rate and share prices were temporary and markets recovered quickly. 24More detailed individual Country Briefs for the major Share prices reached an index level of 600, the highest since economies can be found at the World Bank website: early 2000. http://www.worldbank.org/eapupdate/ East Asia Update 30 On the other hand, there are a few worrying signs. decelerated sharply. Korea is now technically in recession The pace of investment (measured by permanent investment with negative quarter-on-quarter growth in the first two licenses issued by the investment coordinating board) in quarters of 2003. Much of the slowdown reflects weak 2003 is worse than 2002. Oil and gas manufacturing private consumption, which had been the mainstay of declined sharply on a constant price basis in the first half of economic growth in 2002. Following quarter-on-quarter 2003, in accordance with the decline in oil production. growth of 0.75 percent in the last quarter of 2002, private Employment has shown little progress. The unemployment consumption declined by 2.0 and 1.4 percent respectively in rate has been gradually increasing even in the official the first two quarters of 2003. The growing credit card statistics. This suggests that the current moderate economic delinquencies, stagnation in credit to households and very growth rate is not enough to improve employment. On the recently, a decline in property prices (which had risen by external sector, non-oil and gas exports and imports growth over 20 percent in one and a half years from 2001) have rates slowed down in July. Machinery exports and imports, dampened consumer confidence and spending. one of the main trading items, contributed to the slow down. Fixed investment growth slowed in the first quarter The implementation of policies in the government's on weaker domestic consumption and export prospects, then recent economic policy White Paper will have an important contracted by 1.9 percent in the second quarter, reflecting a influence on the macroeconomic situation going forward. In 1.1 percent decline in construction and a 2.5 percent fall in July, the government decided not to extend its existing IMF plant and equipment investment. Exports of goods and program beyond the end of 2003. Afterwards, the services grew 0.2 percent on a quarterly basis in the first government issued its new economic policy package on quarter and declined by 0.9 percent in the second. Strong September 15 as an attachment to the presidential growth in exports to China was not enough to offset instruction. The package comprises measures related to: (i) sluggish growth in the US market. macroeconomic stability, (ii) financial sector reform and (iii) increase in investment, exports and employment. The Unemployment increased to 3.4 percent in July economic package lays out an impressive time-bound from 2.8 percent a year ago. Weaknesses in the labor market program of economic reforms that, if implemented, would notwithstanding, Korea continues to be beset with labor contribute to strengthening macroeconomic stability, strife. There have been 263 strikes in January to July and lowering risk premiums, and fostering higher investment and there are no indications that the current wave of militant growth. Assuming that there is no major disturbance in the industrial action will soon moderate. 2004 elections and a gradual improvement in the investment climate, real growth could reach around 5 percent in 2006. Despite a deficit of 1.4 percent of GDP in the first quarter, Korea recorded a positive current account balance of As regards corporate restructuring, total distressed 0.3 percent of GDP in the first half of 2003. The slower debt amounted to $55.9 billion or 43 percent of all corporate growth in export volumes relative to the pace in the second debt at the end of 2002, which, while high, was down from half of last year was matched by an even slower growth in 55 percent at the end of 2001. Progress on AMC import volumes. Following the domestic slowdown, import restructuring was slower than in Korea and Malaysia, IBRA volume growth decelerated to 8.1percent in the first quarter having disposed of 20 percent of assets under its and 4.1 percent in the second, compared to the average 14.5 management, with another 19 percent at the state of signing percent volume growth in the second to fourth quarters last a memorandum of understanding or implementing year. Korea also suffered from a 15 percent year-on-year restructuring proposals. The recovery rate on IBRA's sales deterioration of its terms of trade in the first quarter, and a has so far has amounted to about 27 percent. The JITF had further deterioration of 6.8 percent year-on-year in the also cumulatively completed 96 debt-restructuring cases second quarter. worth $20.5 billion as of July 2003. A fundamental hindrance to restructuring, however, is the lack of credible FDI inflows of $650 million through July suggests mechanisms to force equity owners to surrender control, that FDI inflows for the year will likely be much lower than leading to a stalemate where creditors refuse to write-off the total inflows of $2.0 billion last year. However, portfolio debt while owners refuse to surrender control. Several investment has strengthened--portfolio investment in debt initiatives were undertaken during 2002 and 2003 to address securities have kept up to last year's pace and investments in some of the perceived weaknesses of the courts. These Korean equity securities may have finally turned around involve measures to improve the training of judges, increase during the second quarter. With portfolio inflows the transparency of the commercial court decisions, and to strengthening, reserves (excluding gold) reached $ 136.1 strengthen the accountability of judges and the internal court billion in end-August from $ 121.3 billion at the end of last process. year. Korea now holds the fourth largest reserves globally after Japan, China and Taiwan (China). Net external assets Korea stood at $ 56.7 billion at the end of June, compared to $ 54.3 billion at the end of last year and $ 46.6 billion at the end of Macroeconomic developments: After robust GDP 2001. growth of 7 percent in 2002, the Korean economy has East Asia Update 31 Monetary and fiscal policies: In response to the National Assembly would consolidate and strengthen three downturn, the authorities have introduced a set of fiscal and separate bankruptcy codes. A draft bill on class action monetary measures, including cuts in income and sales suits--which is expected to boost the rights of minority taxes, accelerated government spending and spending on shareholders and transparency in the management of infrastructure projects, tax incentives for facilities companies--is pending in the Korean legislature. investment, and a cumulative 50 basis point cut in the overnight rate (to 3.75 percent). The success of earlier fiscal Macroeconomic Outlook and Policy Issues: The consolidation efforts gives Korea ample flexibility to outlook for domestic demand over the short term is mixed, respond to the current weakness in domestic demand as reflected in the consumer and business confidence through fiscal action. The consolidated fiscal surplus, indices, which continued to fall in the third quarter. including social security funds, was 3.8 percent of GDP last Nonetheless the fiscal and monetary measures introduced year and 6.9 percent of GDP for the first quarter of 2003. should help boost weak domestic demand in the short-term. Front loading of government expenditures resulted in a We expect growth to average 3.0 percent in 2003 and pick deficit of 4.4 percent of GDP in the second quarter. up during the course of 2004 to average 5.1 percent, as domestic demand stabilizes and as export growth Financial sector performance: Having declined to strengthens, reflecting a continued expansion of exports to 2.4 percent at end the of 2002, the NPL ratio of commercial China, and a recovery of the important US market. banks rose to 3.2 percent in June 2003, primarily due to loan However, much will depend on Korea's success in defaults by SK Global Company and increases in overdue resolving the consumer debt overhang and the remaining consumer loans and credit card debt. These developments segment of weak corporates. Passing the consolidated also led to a decline in commercial banks' rates of return on insolvency law that has been submitted to the National equity, assets and capital adequacy ratios in the first half of Assembly, and is currently being reviewed in the related 2003--although at 10.4 percent at the end June 2003, the committees--will be an important step. Beyond this, there is latter remains comfortably above the BIS recommended need to further improve corporate governance (strengthening ratio of 8 percent of risk-weighted assets. Performance in the of shareholder rights, a clearer role for outside directors), non-banking sector, however, continued to improve through disclosure--particularly with regard to related party the first quarter of 2003--important since segments of the transactions, and continued reforms in accounting and non-banking sector in Korea are still quite vulnerable. auditing to align Korea with evolving international best practice. Corporate sector restructuring and performance: The corporate sector's performance improved considerably Malaysia during 2002 as a result of relatively low interest rates and A broad based recovery gained momentum in 2002 progress in restructuring: thus average income to sales rose and continues in 2003. In 2002, real GDP grew by 4.2%, up from 0.4 percent at the end of 2001 to 4.7 percent at the end from 0.4% in 2001. From the supply side, growth was of 2002. The median interest coverage ratio also rose from supported by the rapid expansion in the services and mining 195.9 percent in 2001 to 269.2 percent in 2002. However, sectors and the favorable expansion in the manufacturing while average performance improved during 2002, the sector. The services sector grew by 4.5% in 2002, supported differentiation among firms became even more marked by the recovery in domestic demand, the expansion in trade during 2002. Indeed, Korea continues to have a sizable related activity and the growth in tourist arrivals. The proportion of corporates--23.6 percent--whose interest manufacturing sector turned around with an expansion of coverage is less than 1. 4.1% in 2002 compared to the 6.2% contraction in 2001. Further progress in corporate restructuring was seen Mining sector grew by 4.5% thanks to increased production during 2002, which helped in the improvement in corporate from new oil and gas fields, the increase in demand and performance. KAMCO had resolved 59 percent of its favorable prices. From the demand side, growth was also portfolio by the end of 2002, with a recovery rate so far of broad-based helped by an expansionary fiscal policy, 61 percent. The government undertook to force the pace in favorable export performance, and increased private 2001 by passing the Continuous Credit Risk Assessment consumption. Private consumption was helped by favorable System and the Corporate Restructuring Promotion Law, labor market conditions (unemployment rate fell to 3.5% in which increased the obligation of banks to scrutinize and 2002), the reduction in income taxes, low interest rates, rise reorganize high-risk borrowers. Some 1246 firms were in disposable incomes in the urban areas, rise in rural income selected for scrutiny in the Assessment in the first half of as a result of the sharp increase in agricultural commodity 2003, of which 149 will be dissolved or restructured, and prices, and increased access to credit as a result of the another 274 will undertake recommended changes. improved banking sector. Higher commodities prices Restructuring is also becoming a more market driven brought benefit to about half a million small holder families process, with the stock market and banks becoming more in the rubber, palm, and cocoa sectors. selective in access to finance. To facilitate this shift, the In 2003, the economy expanded at 4.4% in the 2nd government is further strengthening the bankruptcy code and quarter (4.6% in the 1st quarter). For the first half of the year, corporate governance requirements. A new bill before the the GDP growth rate reached 4.5% (compared with 2.6% for East Asia Update 32 the same period in 2002) despite the impact of Severe Acute the goods account was more than sufficient to offset the Respiratory Syndrome (SARS) on the regional economy and deficit in the services account. the uncertain global situation. (Malaysia itself only experienced 5 cases according to WHO). Both fiscal and Outstanding loans by the banking sector increased monetary expansion contributed to stimulate domestic in the fourth quarter of 2002, with loans to small borrowers demand. Private consumption remained resilient with 3% increasing more rapidly. Lending by financial institutions to growth in the 2nd quarter, and 4.4% for the first half of the purchase residential property has steadily increased over year (compared with same period in 2002). Manufacturing time, rising from 13.4% of total lending in 1998 to 18.5% in performed well at 6.5% compared with 5.2% for the 1st 2001, while lending for consumption credit increased from quarter, driven by growth in the resource-based industries. 11.5% to 14.8% during the same period. Another indicator Manufacturing growth rates were positive since the 2nd of consumption spending, spending through credit cards, quarter of 2002. Construction activities increased, stimulated increased by 25.8%, continuing the high rate recorded in by higher public expenditure in infrastructure projects. 2001 (22.3%). Growth was higher in both the number of Other sectors show improvement as well: agriculture at credit cards in circulation as well as the value of 10.4% and mining at 10.5%. The services sector sustained transactions. This high growth notwithstanding, credit card more moderate growth of 2.8% due perhaps to the SARS balances have been settled thanks to higher disposable impact after a broad-based growth of 4.5% in the 1st quarter. income. NPLs of credit card transactions, about 0.7% of total NPLs of the banking system, declined to 4.1% of total Aggregate domestic demand expanded by 3%, outstanding loans at end-2002 from a peak of 17.4% at end- reinforced by exports (5.8%). Public sector consumption 1998. NPLs (6 months) in the banking system have declined remained strong at 7.2% from expenditures on salaries, further to 6.8% at end-June 2003 (compared with 7% at end- defense and goods purchases. Inflation recorded a 1.1% March). The risk weighted capital ratio of the banking increase for the first seven months of 2003 compared with system was at 13.1% at end June and decreasing slightly same period in 2002. The exchange rate remains fixed to the since December 2002 (13.2%). US dollar. The government argues that the exchange rate should remain fixed in the interest of stability and because a As regards corporate restructuring, the Danaharta high portion of exports are made to the US. Net AMC is due to implement recovery strategies for its entire international reserves increased further to $38.6 billion as of portfolio and to close shop by 2005. The CDRC, which mid-August 2003, adequate to finance 6 months of imports oversaw, voluntary out-of-court workouts, had its powers and 4.3 times the short-term external debt. Total external strengthened in 2001 and was able to resolve most of the debt increased modestly from US$ 45.7 billion in 2001 to debt entrusted to it and to close down in 2002. Malaysia has US$ 48.8 billion, equivalent to 55% of GNP in 2002, but traditionally had quite strong creditor rights under its 1965 remains manageable. There are no arrears. Companies Act, and these are being further strengthened with new legislation to facilitate the appointment of special Exports grew by 6% in 2002 and continue to administrators for distressed firms. Recently the expand in 2003, compared to sharp contraction in 2001 (by government has also moved more aggressively and directly 10% in 2001 in US$ terms). Export growth has been helped to address the restructuring problems of some of the largest by the increased intra-regional trade and the accession of groups, including Renong and Pernas. New stock market China into WTO. China' share in Malaysia's trade, while regulations for distressed firms to improve their financial small (4.7% of total trade in 2001) has been rising. position by end 2002 have also encouraged a wave of M&A Although competition between Malaysian and Chinese activity exports in third country markets is likely to intensify, an IMF analysis of US import data shows that, since 1998, Fiscal policy has been the main counter-cyclical Malaysia has sustained increasing competitiveness in key instrument of the Government. Fiscal policy played a segments of electronics exports such as office/data central role in mitigating global uncertainties in 2002 with processing machines, relative to the reference economies-- the Government's overall financial position registering a China, Singapore, South Korea and Taiwan (China), all of deficit of 5.6% in 2002 compared to 5.5% in 2001. The high which are Malaysia's close rivals in electronics exports. The savings rate (gross national savings was 34 % of GNP in terms of trade effect of China's accession into WTO is likely 2002) and ample liquidity in the banking system made it to be positive for Malaysia, given that China's demand for possible for the fiscal deficit to be largely financed food and energy imports is expected to rise significantly and domestically. Fiscal policy measures included increased Malaysia is a net exporter of these products. While Malaysia development expenditures for projects with high seems to be coping well against increasing competition, employment potential, low import content, and a short China's entry into the WTO places a premium on the gestation period; a 2 percentage point reduction in pension competitiveness of Malaysian firms and Malaysia's contributions to the Employee's Provident Fund and higher attractiveness as a destination for FDI. The overall balance individual tax rebates. of payments improved thanks to the sustained large surplus Private investment remains sluggish. Following the in the current account, larger inflows of long term capital crisis, private gross fixed capital formation fell sharply from and a lower net outflow of short term capital. The surplus in 38% of GDP in 1997 to around 10% in 2001. Net foreign East Asia Update 33 direct investment also fell from around 4% in 1997 to less Such a positive trend could, however, be than 0.5% in 2001. Although there is a slight recovery in undermined if the jolts to investor confidence witnessed in 2002, Malaysia is still far from pre-crisis investment levels. recent months were to persist. These include a military There is room for improving private investment to 20% of `mutiny' in late July, subsequent coup rumors, and the GDP by improving the investment climate. The main suspension of top central bank officials including the challenge is to address the skills shortage facing firms both governor for having closed a failing bank The persistent in manufacturing and service sectors. weak investor confidence associated with perceived risks has Despite the continued geopolitical uncertainties, the delayed a recovery in investment and constrains future restoration of macroeconomic stability, and the progress growth. achieved in the restructuring of financial and corporate The National Government's fiscal position sectors provide the policy makers with greater policy improved through August 2003 as expenditure was flexibility to sustain economic recovery. The structure of contained in real terms despite higher interest payments and the Malaysian economy is diversified with a strong revenue was up by over 12 percent through August as a traditional sector--petroleum, gas, palm oil, and other result of sustained efforts to improve tax administration; and commodities--that will act as a buffer against uncertainty in the National Government deficit had fallen by 21 percent the other modern sectors of the economy. A modest world compared to the first eight months of 2002. If this fiscal recovery, some pick-up in the global electronics industry, performance can be maintained for the rest of the year, the firm commodity prices, and further expansion in intra- Government's targeted deficit reduction to P202 billion (4.7 regional trade will help sustain economic growth in percent of GDP) should be attainable, and the five year Malaysia. deterioration in tax revenue/GDP would also be broken. To continue the vital recovery in tax revenue beyond 2003--tax revenue/GDP is still more than four Philippines percentage points below its 1997 level--the stronger tax administration effort will have to be maintained, and Economic growth slowed to 3.9 percent (GDP) in supported by policy actions. This needs to include restoring the first half of 2003 from the 4.5 percent pace established in the real value of excise tax revenues on alcohol, tobacco and 2002 reflecting slower agricultural growth, weaker exports, petroleum products and avoiding future erosion through the impact of the war in Iraq, SARS, and a cutback in inflation. And there is a need to review the system of government spending designed to reduce the budget deficit. investment incentives to examine whether more effective GNP continued to grow more strongly though at 4.8 percent incentives can be designed at less cost to government on the strength of rapidly expanding net factor income finances. On the expenditure side, the wage bill needs to be flows, mainly from overseas Filipino workers. Exports only contained in the context of civil service reforms that promote grew by 0.7 percent through the first 7 months of 2003 a more professional meritocratic bureaucracy, and compared with the same period of last year and actually fell discretionary spending needs to be closely monitored and by 8 percent in July. contained. Such measures are essential to achieve the Inflation has remained subdued at 3 percent through significant reductions in the deficit that are still targeted and September 2003. Nominal interest rates have maintained needed without further damaging cuts in vital maintenance their lower levels (e.g., 91 day T-bill rate at 5.3 percent) and or capital spending. the spreads on dollar denominated bonds maturing in 2008 The improvement in National Government finances have narrowed to about 320 basis points. But perceived is very welcome but is being undermined by developments risks have weighed on the Peso, which fell to all time lows outside the central government. In particular, the deficit and of over PHP55 per USD in late September, even as other financing requirements of the National Power Corporation currencies in the region have strengthened against the dollar, have increased significantly in 2003 reflecting one-off and the Philippine Stock Market is up by about 30 percent factors as well as prior actions to limit price adjustments. since the start of 2003. This underlines the importance of pressing ahead Government forecasts anticipate an increase in expeditiously on the ambitious privatization agenda within growth in the second half of 2003 predicated on firmer the power sector, closely monitoring costs in government- recoveries in the U.S. and Japan and the ongoing recovery in owned corporations in the interim period, and allowing the East Asia. Stronger export growth would be driven by the Energy Regulatory Commission to establish tariff structures electronics sector and increasing regional demand. free from political interference. Agricultural production is also expected to record higher As regards corporate restructuring, the Philippines growth rates on the strength of anticipated recovery in rice did not adopt a centralized arrangement for dealing with and corn production. Meanwhile, personal consumption, NPLs and repossessed assets on the books of the banks. which grew at a 5 percent pace in the first half, does not Although the Special Purpose Vehicle Act (SPV)--which show signs of decelerating in the short term. allows banks to sell assets to a specially designed private sector AMC or special purpose asset vehicles--was passed East Asia Update 34 last year, and was expected to provide the impetus for growth in the first half of 2003. Manufactured exports systematic corporate restructuring, this has yet to occur. At accounted for four-fifths of that growth; three two digit HS present, corporate restructuring is still sporadic and products like electronics, computers & parts and automobile infrequent. On the regulatory and legislative front, there and parts ­ involving assembly of labor-intensive have been no major developments since the passage of the components ­ topped the export-growth list in all markets. SPV Act. There is some expectation that the Securitization This movement up the ladder to technologically more Bill may be approved by Parliament before the end of the sophisticated products began in Thailand before the crisis, year. If enacted, this could have a positive impact in and was sustained after the crisis by the large real facilitating corporate restructuring and distressed asset depreciation of the baht and the WTO accession of China. resolution by allowing SPVs more flexibility in managing Manufactures that depend on many components/processes and disposing of acquired assets. On the governance front, benefit from splitting production across countries, with the SEC continues to use its regulatory powers to improve China as a low-cost assembler helping to reduce East Asia's standards of corporate governance. cost of production of these assembled products. In fact electrical machinery, non-electric machinery, and transport Thailand equipment also dominate intra-regional exports, accounting for nearly half of East Asia's exports to the region. Thailand's recovery has strengthened further. GDP Private investment grew by more than 17 percent, growth is expected to reach 5.8 percent in 2003, following a much faster than last year. No doubt this is prompted in part 6.2 percent rate of growth in the first half and 5.2 percent in by rising utilization of existing capacity, led by both 2002. The SARS impact on second quarter growth was less consumption and export growth. Nevertheless, recovery of than expected, shaving a mere 0.3 percent of its GDP growth private investment during 1999-2003 period is much slower this year because of reductions in tourist arrivals. Growth, than in the previous four Thai recoveries. The share of over the last eight months, in private consumption, private private investment in GDP has risen to only 15.5 percent in investment and exports, which exceeded last year's rate, 2003, five years after the crisis, much lower rate than the made this possible. Higher private consumption growth, average of 22 percent in the 1980s. This is not only because dominated by automobiles, motorbikes and mobile phones, many firms' balance sheets remain fragile but also because was sustained by rising farm incomes, double digit growth in many investors have become more cautious following the consumer credit, and tax breaks for low income earners. crisis. Also, rates of return to investment in Thailand have Given the projected improvements in the global economy, been falling for some time now. The implementation of Thailand's GDP growth is expected to be higher next year. structural reforms in terms of deregulation in various sectors As a result, poverty has fallen significantly below and promotion of skills-development and firm-level R&D to the level in 1996. The latest survey for 2002 shows that the enhanced productivity growth has not progressed much. In poverty headcount fell to 9.8 percent last year, below the addition, growth in bank credit to the corporate sector level of 11.4 percent in 1996 and the peak level of 13.8 remains constrained, in part because expected reforms in percent in 2000. Survey data also shows that this decline secured transactions and creditor rights have not between 2000 and 2002 was driven mainly by substantial materialized. The resulting credit constraint has affected declines in poverty in the poorest Northeastern region, where adversely the small and medium service sector firms, which two-thirds (or 67 percent) of Thailand's poor lived. The have experienced disproportionate reductions in access to Northeast's poor benefited from the large increases in real bank credit; the more competitive tradable sectors were able farm incomes, the movement of labor out of agriculture into to generate a good deal of internal finance while large firms better-paying off-farm employment and probably the tapped the bond market. increases in public spending that were directed at the region Fiscal consolidation continues. Rising revenue since the crisis. resulting from higher growth and restrained expenditures Sustained macroeconomic adjustment continues to have advanced the date for reaching a balanced budget. reduce external vulnerability. The generation of current Public debt has fallen to below 50 percent of GDP. Most of account surplus of around $6.5 billion a year has kept the stimulus measures have been credit-based with the foreign exchange reserves high at around $39 billion, exception of tax cut for low-income groups, advance equivalent to three times Thailand's short-term debt and to retirement benefits and tax breaks for housing. Initiatives six months of its imports.. This has permitted the country to that continued from last year include credit extension to make pre-payments and reduce external debt to around $56 SMEs, the Village Fund, the People's Bank, and debt billion by June 2003, a reduction of nearly $4 billion relative suspension for farmers, funded mainly by SFIs and state- to December 2002. owned banks. Exports are expected to grow by around 12 percent Progress in implementing structural reforms is this year, much higher than last year. This is supported by mixed. There continues to be progress in public sector faster growth in both regional markets as well as developed governance ­ especially public administration and the country markets. In contrast to last year, Japan, USA and budget ­ and some new measures in trade. There is also Europe contributed slightly less than a third of the export recent movement in financial and corporate sector East Asia Update 35 restructuring and in corporate governance. However, there done better than others in terms of poverty reduction, there has been no progress since 2000 in the area of business has been progress in all of them. climate (i.e. private investment regime). While the National Competitiveness Committee continues to develop a In April, Vietnam became the first country in the comprehensive strategy, implementation of specific actions world to successfully contain the SARS-outbreak. Resolute have not taken place. and decisive action by the Government with support from the World Health Organization and other international As regards financial and corporate sector partners was instrumental in containing the disease. Vietnam restructuring, financial institutions had restructured a appears to have weathered the epidemic, without any cumulative total of Baht 2.9 trillion (US$ 67 billion) of noticeable impact on growth, or slowdown in aggregate NPLs by June 2003. This compares to US$61 billion at the domestic demand. In the first 8 months of 2003, retail sales end of June 2002, and represents some slowdown in the pace maintained their 2002-growth rate, while exports and of restructuring. One reason is that it is the more industrial production have continued to expand at robust complicated cases that remain. In a recent change of rates. The temporary effects of SARS were mainly felt in the approach the voluntary out-of-court workout framework led tourism and travel industry, which account for around 3.5 by the Corporate Debt Restructuring Advisory Committee percent of GDP. As early as June, a rebound in hotel (CDRAC) was wound down in March 2003, with its bookings was evident, and as of August, major hotels report remaining portfolio transferred to the TAMC and the civil occupancy rates at the pre-SARS levels. courts. The TAMC has approved resolution of about 70 percent of its portfolio as of June 2003, and is expecting a The sustained economic expansion is driven by recovery rate of 46 percent on this. However, despite export growth and domestic activity and investment. From a reforms of the judicial process, civil courts remain subject to sectoral perspective, the domestic private sector has been large backlogs and long delays. Progress in legal and tax growing fastest. On average, each month for the past 3 years, reform to strengthen corporate restructuring has been slow. almost 1,600 new enterprises have been registered. This Reforms to the insolvency and bankruptcy regime are still trend has continued in 2003. under review by the Legal Reform Committee for Eight-month figures show overall exports Development of Thailand (LRC). Other pieces of legislation increasing by 28 percent. In spite of the quotas and special such as the Draft Secured Transactions Act, the revised draft taxes introduced by the US to shield itself from Vietnamese Security and Exchange Commission Act and legislation on competition, demand from this market continues to swell the corporate governance remain at various points in the order books of Vietnamese exporters. Sales to the US legislative pipeline. However, significant efforts have been increased 180 percent on a year earlier, making this the most expended in 2003 to improve financial reporting and important export destination for Vietnam. The EU, Japan disclosure of listed companies. The SEC has intensified its and China are the next most important markets. Rising enforcement capacity and effort on violations of disclosures prices for key export commodities, notably crude oil and and insider trading which has led to the criminal prosecution rubber have also helped secure a higher dollar value of of company officials. exports so far in 2003. In 2003 measures were taken to reduce tariffs. Imports have been growing faster than exports and More than a third of the tariff lines had their rates reduced to a trade deficit of US$ 4.5 billion, around 10 percent of GDP, three lower bands: namely raw materials (1 percent), semi- is expected for the year. The main import categories behind finished goods(5 percent) and finished goods (15 percent). the rising import bill were machinery and spare parts, As a result average tariff fell to around 15 percent, though petroleum products, and other production inputs needed for average tariff on agricultural products remain at the high rate the fast expanding export industries. At this juncture a trade of 25 percent. In July and September 2003, the remaining deficit of this magnitude should not be cause of concern for 61 percent of total tariff lines, including live animals, wheat, Vietnam -- it would actually be expected, given the need for peas, chemical products, base metal, clock parts, petroleum investments in new production capacity. Indeed, many of the products, textiles, iron and steel, machinery and electronic foreign direct investments that have come on-line take the appliances, received approvals from the Cabinet to form of machinery and large equipment components, which sequentially adjust to the three-band tariff structure by 2008, show up on the import side of the trade balance rather than of which a fifth was to be immediately implemented. as financial inflows. Vietnam Recent analyses of debt sustainability indicate that the external position is solid, even under pessimistic Vietnam continues its strong growth and poverty assumptions. Standard & Poors, Fitch Ratings, and Moodys reduction performance. In 2003 growth is projected at have all assigned sovereign ratings of BB- and B1 to around 7 percent, making it the fastest growing economy Vietnam. Remittances from abroad are in the range of two to after China. At the same time, poverty headcount rate (using three US$ billion annually (almost 20 percent of exports and the national poverty line) has been reduced form 58 percent more than annual FDI and ODA disbursements combined). in 1993 to 29 percent in 2002. While some regions have This high level is probably sustained by the confidence the East Asia Update 36 US-Vietnam Bilateral Trade Agreement has instilled in the Smaller Economies overseas Vietnamese community. In 2003, FDI commitments have started growing Cambodia again, after last year's decline. A record US$ 300 million of FDI were committed in August of this year, the highest Cambodia's economy grew by 5.5 percent in 2002, lower amount ever in a single month. FDI commitments were 37 than the growth rate in 2001 (6.3 percent). Economic percent higher in the first eight months of 2003 compared to expansion in 2002 was driven by robust construction the same time last year. Actual inflows of FDI continue to activities in Phnom Penh and strong rebound in exports increase at around 10 percent per year. (mainly in garments and footwear) and tourism receipts in the last quarter. The economy is expected to slow down The Ministry of Planning and Investment expects further in 2003 (4.8 percent growth projected) due to the domestic and foreign investments to increase by a combined adverse effects of the anti-Thai riots and the SARS outbreak 18 percent this year, to total 36 percent of annual GDP. With in the region. Uncertainties in the run-up to the national the capital formation of the increasing number of registered election held in July and the subsequent delay in forming a enterprises, the private share of domestic investment jumped new government exacerbated the growth prospect. The fiscal 20 percent in 2002 to reach a level of around 10 percent of deficit is projected to widen in 2003 compared with the GDP. Preliminary estimates for this year show that private target due mainly to the revenue shortfall. To contain the domestic investment has continued to rise as a share of GDP. fiscal deficit, it is important to collect domestic arrears and Higher farm gate prices for non-food crops, as well implement key provisions in the Law on Taxation as higher labor earnings, have buttressed demand. Retail decisively. Monetary policy continued to be prudent. sales increased 11 percent in the first eight months of the Inflation remained low (1.7 percent as of June 2003). year, and sales of new cars surged 39 percent. Part of the External developments were broadly on track with continued increase in car sales can be ascribed to recently introduced expansion of exports, largely stable exchange rate, and rising and announced future tax hikes on imported cars and locally gross official reverses (3.0 months of imports). Progress in assembled ones, causing consumers to bring forward their implementing structural reforms has been uneven. car purchase to avoid the new taxes. Significant progress has been made in some areas, including promulgation of the revised Law on Investment and the Headline inflation slowed to 2.7 percent, year-on- revised Law on Taxation, and complying with required laws year in September, from 4 percent in 2002. Although and regulations for WTO accession (Cambodia was admitted housing and construction materials prices surged 9 percent, to WTO membership in September, 2003). In contrast, reflecting strong activity in the real estate market, the overall implementation of other key structural reform areas has been index was held back by stagnant food prices. Prices of delayed, particularly for legal and judicial reform, anti- pharmaceuticals shot up 18 percent on year. corruption, forestry crime monitoring and forestry Budget revenue was up 11 percent in the January to concession restructuring. Due to the delay in forestry August period, essentially due to rising corporate tax management reform, the second tranche disbursement of collection. Tax payments from the private domestic sector Structural Adjustment Credits (SAC) has been being led the increase, followed by the foreign invested sector. delayed. This pattern mirrors growth in industrial output, where the private sector leads, just ahead of the foreign-owned sector, During 2003-2004, GDP growth is expected to continue to and the state-owned sector lagging behind. The resilient be led by the garment, construction, and tourism sectors. In revenue performance means that the budget deficit will be its Poverty Reduction Strategy Paper (PRSP), the lower than projected earlier this year. Government aims for the achievement of annual GDP growth rates of 6-7 percent over the medium term. The agricultural sector has faced severe challenges Nevertheless, despite recent years' favorable growth in the form of alternating droughts and floods in the past performance, the foundations for future growth remain year. On this backdrop, the aggregate increase in the 2003 fragile: (i) growth has been narrowly based on the garment winter-spring crop of 1.4 percent is quite remarkable. sector, which employs only a small fraction of the labor Notwithstanding the temporary setback that the SARS force; (ii) the industrial base other than garments is almost outbreak afflicted upon the tourism and travel industries, the nonexistent; (iii) agricultural output, which accounts for service sector as a whole appears to uphold the growth about 40 percent of GDP, has expanded only at a slow pace, momentum of the past two years, with value-added partly owing to drought and flooding and the lack of an increasing by 6.4 percent in the first half of the year. adequate irrigation system; and (iv) the private sector is not competitive because of relatively high wages and an opaque business environment. In addition, the scheduled phasing out of the textile and apparel quotas under the Agreement in Textile and Clothing in 2005 poses a significant risk to Cambodia's growth prospects. This risk can be managed only if the Government takes decisive actions, including in East Asia Update 37 the areas of governance, to improve the investment climate of the December 2002 riots, focuses on three areas of the and flexibility in the labor market, which would be needed to longer-term program where Government intends to have boost Cambodia's competitiveness and yield the high growth immediate impact: governance, job-creation and service- rates projected in the PRSP. delivery for poverty reduction, particularly in education and health. Democratic Republic of Timor Leste Fiji Timor-Leste became independent on May 20, 2002, following 25 years of conflict, a violent transition from Political Developments. The Fiji Supreme Court Indonesian rule in September 1999 and two and half years of handed down its much awaited verdict on the legality of the United Nations administration. The country now faces the Qarase government in July 2003. The Court ruled in favor challenges of nation-building with very limited human of the Indo-Fijian dominated Fiji Labor Party (FLP) and resources, embryonic institutions, a stagnant economy, high ordered Prime Minister Qarase to include the party in its levels of poverty and unemployment, aggravated by Cabinet. Under the power sharing provisions of the unrealistic expectations about what can be achieved. Constitution the FLP which won 27 out of 71 seats should Inevitably this has contributed to social and political have been included in the Cabinet, but had thus far been tensions, as reflected in the December 2002 Dili riots. excluded. The PM in response announced an increase in Cabinet members from 22 to 36 to accommodate the FLP, The gradual winding down of the international rather than asking current members to step down. presence following independence and slow-down in reconstruction programs has led to contraction in economic This issue has yet to be resolved, with the parties activity, particularly in urban areas and in services that going back to the Supreme Court to arbitrate over the exact catered to expatriates. Data deficiencies preclude number of seats to which the FLP is entitled. In addition, quantification of the decline in output. However, non-oil there have been claims of tokenism in regard to offered exports, amounting to just $5 million in 2002, mostly coffee, appointments; FLP claims it will have responsibility for only have shown little improvement and there has been a 2.5 percent of the total budgeted expenditure for 2003. significant drop in imports, from around $212 million in Economic Update. On the economic front, the 2001 to $187 million in 2002. As a result the current government downgraded its forecasts for GDP growth in account deficit, financed from official transfers, has 2003 from 5.7 to 5.1 percent, citing the effects of SARS, the narrowed from $277 in 2001 to $239 million in 2002. conflict in Iraq and the adverse impact of Cyclone Ami. The Inflation fell to 1% by October 2002 (on a year-on- authorities also revised downward GDP growth estimates for year basis), but it had since risen to around 7% by April 2002 from 4.4 to 3.8 percent, and for 2001 from 4.3 to 4.0 2003. Private sector wages have started to fall--one of the percent. largest employers recently reduced pay for unskilled workers Growth in 2003 has received a strong contribution by 25% to $80 dollars a month. Nevertheless, the overall from tourism, boosted by visitors associated with the South wage level remains relatively high in comparison with Pacific Games in June. In contrast, the sugar industry has neighboring countries, undermining competitiveness. A shown continuing weakness, with milling problems and low fifth of the working age population in Dili/Baucau was cane quality in the initial weeks of crushing producing lower unemployed in late 2001. output in the season to June. Cane sugar, traditionally a key While some interest has been shown in concessions industry, has suffered a severe decline in recent years. Since for exploitation of natural resources, such as fisheries and its peak in 1994, when the industry generated 13.5 percent of forestry so far there has been little new investment. Bank GDP, it has fallen by 40 percent in real dollar terms to now deposits increased to $55 million by end of 2002, but account for only 6.8 percent of GDP. The decline is closely domestic bank lending was less than 10% of deposits linked to problems of land tenure, as well as inefficient primarily for commercial activities and housing loans. The production arrangements. External assistance is being bulk of bank deposits continue to be invested abroad. sought both for restructuring the sugar industry, and for planning alternative livelihood opportunities for farmers and Ratification of the Timor Sea Treaty in March 2003 workers who would move out of the sugar sector. provides assurance that the planned development of the Bayu-Undan oil and gas field will proceed. Although there Recent data indicate that production in the gold and may be some opportunities for service activities in Timor, garments sectors during the first six months of 2003 has also the principal benefit will be from the $3 billion in revenues been lower on an annualized basis. Declines in garments that the project is expected to generate over a twenty-year have been attributed to the stiff competition faced by period from 2004. manufacturers from their Asian counterparts. Inflation in June was 4.3 percent and current forecasts are for year-end The National Development Plan, prepared shortly inflation remain of about 5 percent. before Independence, outlines Government's development and poverty reduction objectives. A Stability Program Revised fiscal statistics indicate that the announced by Government in January 2003, in the aftermath Government recorded a surplus of 0.5 percent of GDP, in the East Asia Update 38 four months to April. This was higher than forecast, and Structural reform has been sustained over the last was partly the result of buoyant VAT collections which were 12 months. The Government has hired external consultants up 47 percent on the same period in 2002 due to the to restructure SOEs and to strengthen the monitoring of SOE combination of an increase in the VAT rate and growth in performance. Restructuring of state-owned banks has consumer spending. The total deficit forecast for 2003 is continued with the help of international banking advisors,. equivalent to 4.6 percent of GDP, with estimates for 2004 A rural micro-finance policy statement and action plan has and 2005 currently at 3.5 and 3.0 percent, respectively. Total been prepared through a consultative process in the public sector debt stood at 46 percent of GDP in June 2003, provinces, for the prime minister's approval. The budget and current trends imply that the government will be unable outcome and plan is being published annually starting in to meet its debt target for 2005 set at 40 percent of GDP. 2002, and several measures aimed at improving public On the external front, merchandise exports to May financial management have been implemented. Trade is rose by about 8 percent, compared to a fall of 7 percent being opened up and special efforts are being made to during the same period in 2002. This increase was attributed promote trade with its fast-growing neighbors. to increases in garments and sugar exports (despite weaker overall production figures), which offset negative Mongolia contributions from fish and timber. Over the same period imports rose by 15 percent in response to stronger growth. In 2002, Mongolia's GDP growth was 3.9 percent, At the end of June foreign reserves were US$372 million, a vast improvement from 1.0 in 2001, reflecting a strong which is equivalent to 2.9 months of imports of goods and growth of non-agricultural GDP of 10.8 percent on average. non-factor services. GDP growth is projected to continue to increase in 2003 at 5 rate. Labor market conditions showed some improvement in the first half of 2003 relative to the same Exports earnings stagnated in 2002 reflecting weak period last year. There was a 10 percent increase in new external demand and low world copper and cashmere prices, taxpayers, and the Reserve Bank's June survey of job despite higher copper volumes and higher gold prices. As advertisements reported a 2 percent increase, with firms import growth remained strong, trade deficit widened from expecting increases in both permanent and temporary 15 percent in 2000 to 20 percent of GDP in 2002. However, employment over the next 12 months. Emigration, however, buoyant emigrants' remittances, sustained donor support and continued to rise, with figures for May 2003 up 6 percent private capital inflows led to an overall surplus of the over the previous year's results. Much of this outflow is balance of payments in 2002, with an increase of official concentrated in professional and technical workers, which is reserves to US$238.2 million, or 17 weeks of imports. The putting additional strains on the ability of both the public togrog/US dollar exchange rate remained stable in 2002 and private sectors to attract suitably skilled workers. compared to 2001. The real effective exchange rate depreciated slightly in 2002 following the decrease in Lao PDR inflation. The overall government deficit was 5 percent of In 2003 real GDP is expected to grow by around GDP in 2002 and is expected to remain at the same level in 5.5 percent, lower than last year, as a result of a slowdown in 2003, thanks to the government decision to freeze civil credit growth and private investment, and the SARS-induced service wages. Revenues as a proportion of GDP continued fall-off in tourist receipts. Agricultural growth will also be to increase in 2002 to 38.5 of GDP (from 34.5 in 2000), lower largely because of a shortfall in coffee production due more than offsetting the increase in current expenditures to bad weather, though prospects for dry season rice look from 30.8 in 2000 to 33.7 percent in 2002. However, there good. Industrial sector shows robust growth as does services are concerns about the sustainability of revenue and the and should help to sustain the overall real GDP growth rate. impact of high level of taxation on the private sector The Government has taken steps recently to reduce activities. The post -1991 external debt remains manageable inflation and to restore macroeconomic stability. After at a level of 89 percent of GDP in 2002 (59.4 percent of reducing inflation sharply between 1998 and 2002, money- GDP in Net Present Value) and a service ratio at 29 of financing of a growing budget deficit in 2001/02 caused by GDP, given the high degree of concessionality of falling revenue and rising capital spending, led to a pick-up Mongolia's external debt. Mongolia and Russia are in inflation to double-digits, peaking in June at around 17 discussing a settlement of the Transferable Ruble pre-1991 percent. The exchange rate also depreciated rapidly, pushing debt. The agreement on the terms and conditions could have up prices. The Government adopted additional revenue significant implications for Mongolia's future debt service measures, mainly in the form of higher taxes on petroleum burden. and strengthening of tax administration. This has helped to Inflation was 0.9 percent in 2002 and is expected to reduce the deficit and lower the inflation-rate since July remain low in 2003, despite a surge in June 2003 (6.5 2003. Increasing and sustaining revenue mobilization of percent) due to large seasonal increases in food prices. about 13-14 percent of GDP will be critical to continued Keeping inflation under control was helped by the reversion macro-stability. of domestic food supplies to a normal level following the East Asia Update 39 drought and dzud of 2001, the stability of the Togrog vis a privatization efforts are not well resourced and if not vis the U.S. dollar and a monetization process. Indeed, managed and discharged well could impair the longer-term Monetary and credit aggregates have risen sharply over the prospects for privatization in PNG. Budget difficulties have last two years, on average of 32 percent and 107 percent been exacerbated by the non-disbursement of the Asian respectively, reflecting the combined effects of an increase Development Bank's second tranche of a Public Sector in real money demand and a reintermediation process Reform Loan (US$35 million) due to specific governance following structural reforms in the banking system. related concerns. Because of these unforeseen events On the structural front, the Government completed domestic borrowing has been greater-than-targeted in the its Poverty Reduction Strategy in July 2003. The strategy is year to date. based on macro stability and public sector reforms, private- With net external financing flows negative, the sector-led growth, balanced and sustainable development burden of financing has fallen on the domestic side, with with a focus on environment, human development /gender potential adverse consequences on credit to the private and governance. While it is difficult to asses any poverty sector. As Treasury bills are the primary government trend in Mongolia given the lack of data comparable over security, concerns have also arisen over the maturity time, general perceptions suggest that inequality is structure of domestic debt as maturities have shortened. increasing. Upcoming results from a new LSMS will provide This has the potential to complicate budget financing. a more objective assessment of poverty in 2004. Important Meanwhile Treasury bill yields have risen from 13.5% at progress was made in 2003 in fiscal and public expenditure end 2002 to just over 20%. management, including using a Treasury Fiscal Account, starting the installation of a Government Financial The kina has appreciated by approximately 18 Management Information System, and the implementation of percent against the U.S. dollar in the year to the beginning of the Medium term Budget Framework following the adoption September 2003, reflecting tight monetary policy, growing of the Public Sector Management and Finance law last year. exports, flat imports and the strong relationship between the More transparency in public expenditures is still needed kina and the Australian dollar, which has also appreciated particularly in the area of public investment. In the area of against the U.S. dollar during the same period. These public enterprise reform and bank restructuring, the developments have allowed the Central Bank to rebuild authorities have made good progress, but important gross international reserves which currently stand at around challenges remain. The privatization of the Trade and US$400 million in gross terms, equivalent to nearly 61/4 Development Bank (TDB) and the Agricultural Bank were months of imports. finalized in December, 2002 and January, 2003 respectively. First half announcements of the go-ahead for the The petroleum import company NIC was privatized in Timor Sea gas project have temporarily dampened PNG's August. However, the privatization of other large enterprises pipeline aspirations which would have seen development of such as the Gobi cashmere factory which are still carrying its vast gas resources and construction of a US$3 billion out loss-making activities has been delayed, while the pipeline to Australia. energy sector's persistent financial imbalances continue to pose a threat to medium-term fiscal and external Solomon Islands sustainability. The long awaited economic and social turnaround Papua New Guinea in the Solomon Islands appears to have been set in motion-- this follows an extended period of ethnic strife and a Papua New Guinea is expected to see its first massive decline in economic activity. A regional assistance increase in real GDP since 1999 this year, forecast at about 2 mission was dispatched to the country in July 2003 percent, due mainly to higher international prices for gold following an appeal by the Prime Minister for external and oil during the first half of the year which spurred assistance to help end the ethnic conflict of the past three production increases. The non-mineral economy has also years. This assistance, provided largely by Australia, shown some improvement in traditional agricultural areas-- includes military support, a police presence, technical covering coffee, copra, cocoa and vanilla. However, the assistance for public finance administration, development medium-term output trend is expected to remain weak assistance to underpin peace and reconciliation, and reflecting the ongoing problems in the mineral economy financial support. The status and functions of the regional arising from a lack of investment and resource depletion. assistance mission were established through an Act of Budget management concerns continue to weaken Parliament, the Facilitation of International Assistance Act, confidence in the Government and impair prospects for the 2003. Law and order was swiftly restored following the non-mineral economy. deployment of some 2,500 troops and 250 police to the Implementation of the 2003 budget has been Solomon Islands in July. Rebuilding the confidence of the challenging, due in part to optimistic financing assumptions business community and general public will be essential (including significant unidentified external financing and factors in restarting sustainable economic growth, but this asset sales--approximately US$45 million in external may take time. financing and US$58 million in asset sales). The East Asia Update 40 During the first half of 2003, there was a pick up in The fiscal excesses which characterized budgetary economic activity principally due to the forestry and management since 2000, continued in the first seven months fisheries sectors. But the growth attributed to these activities of 2003 even in the face of an improvement in revenue cannot be considered sustainable. Timber production performance. Revenues were 28 percent higher than increased some 70 percent compared to the same period last budgeted over the first half of the year due to--increased year due both to the resumption of production by some administrative effort by the authorities, rising revenues in companies and the commencement of new operations. Some response to the increased production in selected areas timber companies have recently begun to harvest around- highlighted above and coordination efforts between the the-clock, reportedly out of concern that the regional mission customs service and the central bank to prevent double may curtail their activity. If logging continues at the rates invoicing of imports. observed in the first six months, production this year is expected to equal the peak of the environmentally disastrous Expenditures continued to diverge significantly logging boom of the mid-1990s with total output estimated from budgeted amounts with the three largest violators being to reach 800-900,000 cubic meters. Fisheries production is the Police Department which saw expenditure exceed the up by an estimated 71 percent in the first half of 2003 budgeted amount by over 280 percent, the Office of Prime compared to the same period in 2002. There are, however, Minister and Cabinet and the National Parliament. These some unresolved concerns regarding the commercial overruns were offset by under-spending in other areas, of viability of the government owned operations, which have which the largest ones were in the Ministry of Health and relied on donor support. Medical Services, and debt servicing. Following the advent of the regional assistance During the second half of August 2003, a promising mission and the restoration of law and order, there has been start was made to enhance budget execution with the support a spurt of economic activity, especially in Honiara, largely a of the regional assistance mission: with physical and result of the influx of associated personnel and modest personal safety assured, staff have returned to work at the capital inflows. This could form the basis of a more Ministry of Finance (and other ministries). Tight controls sustained, long term recovery, underpinned by a resumption have been instituted over all spending, and payments are of aid flows. being scrutinized. Early improvements have been the near In the first half of 2003 the Solomon Island dollar elimination of payroll arrears and the generation of savings declined by 10.7 percent against the U.S. dollar and 33.2 from greater scrutiny. For example, the Police payroll, which percent against the Australian dollar. Given the import had swelled to SI $1.4-1.5 million per pay period, has been intensity of the economy this has fuelled inflationary reduced to approximately SI$900,000. Cash reserves are pressures: inflation averaged 15.4 percent in 2002 and 14 also being built up to modest levels. percent in the first half of 2003. International reserves rose during the first half of 2003 to US$28 million (around 3 months of currently depressed imports) from US$16 million at end-2002. This increase was due in part to an increase in exports coming mainly from the forestry and fisheries sectors, but was aided by the maintenance of exchange controls. Reserves have remained stable in July and August at around US$25-28 million, following the arrival of the regional assistance mission. East Asia Update 41 APPENDIX TABLES Appendix Table 1. Quarterly Real GDP Growth - % Change Year Ago China Hong Kong Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand (China) Q4 1998 7.8 -5.3 -18.3 -5.9 -11.2 -2.4 -2.9 3.4 -7.2 Q1 1999 8.3 -2.7 -5.9 5.8 -1.0 0.7 2.1 4.1 -0.2 Q2 1999 7.6 1.9 2.0 11.2 4.8 3.8 6.6 6.4 3.4 Q3 1999 7.8 4.6 2.3 13.0 9.1 3.8 8.4 4.7 8.4 Q4 1999 6.8 9.3 5.4 13.0 11.7 5.1 8.6 6.4 6.4 Q1 2000 8.1 13.6 3.4 13.1 11.5 5.3 9.6 7.9 6.5 Q2 2000 8.3 10.1 4.7 10.2 8.3 6.1 8.2 5.1 6.1 Q3 2000 8.2 10.3 4.7 10.0 8.1 7.2 10.0 6.7 2.3 Q4 2000 7.3 7.2 6.9 5.0 6.7 5.3 9.7 3.8 3.8 Q1 2001 8.1 2.3 4.5 3.8 2.9 2.3 4.1 0.6 1.6 Q2 2001 7.8 1.5 4.4 3.0 0.4 3.1 -1.3 -3.3 1.9 Q3 2001 7 -0.5 3.8 2.1 -1.0 2.5 -5.6 -4.4 1.8 Q4 2001 6.6 -1.1 1.2 3.5 -0.8 3.8 -6.1 -1.6 2.5 Q1 2002 7.6 -0.6 2.7 6.2 1.3 3.8 -1.5 1.2 3.9 Q2 2002 8 0.8 3.9 6.6 4.0 4.1 3.8 4.0 5.1 Q3 2002 8.1 3.4 4.3 5.8 5.8 3.8 3.8 4.8 5.8 Q4 2002 8.1 5.1 3.8 6.8 5.4 5.8 3.0 4.2 6.2 Q1 2003 9.9 4.5 3.4 3.7 4.6 4.5 1.6 3.2 6.7 Q2 2003 6.7 -0.5 3.8 1.9 4.5 3.2 -4.3 -0.1 5.8 Source: Haver Analytics and national sources. Appendix Table 2. East Asia: Merchandise Export Growth (US $; % change from year ago) 2001 2002 2002 Q32002 Q42003 Q1 2003 Q2 Apr-03May-03Jun-03 Jul-03 Aug-03Sep-03 East Asia (9) -7.4 9.6 16.7 27.5 6.2 5.8 16.3 14.8 17.3 13.3 12.1 #N/A SE Asia -8.9 5.1 14.6 14.0 4.7 0.3 8.4 6.5 9.4 2.6 0.1 #N/A Indonesia -8.8 1.4 19.3 13.5 1.7 0.9 4.2 4.2 3.7 5.0 0.9 #N/A Malaysia -9.7 6.1 12.6 11.6 1.2 -1.5 5.7 5.8 6.0 -1.1 -4.4 #N/A Philippines -14.8 7.8 14.9 11.6 5.5 -9.3 -1.8 -4.0 27.7 -7.9 -2.2 #N/A Thailand -5.3 5.7 13.5 19.0 11.6 7.2 22.4 14.3 11.3 11.5 6.8 #N/A China 7.3 22.3 27.0 43.9 11.7 14.8 33.2 37.3 32.6 30.5 27.2 #N/A NIEs -11.5 5.7 12.6 25.4 3.9 3.0 10.5 7.5 12.8 8.5 8.8 #N/A Hong Kong -5.3 5.4 17.9 31.0 2.5 -3.7 9.0 13.6 14.0 7.6 7.0 #N/A Korea -12.1 8.0 13.5 27.1 6.9 11.7 19.3 3.6 21.5 15.3 10.4 23.9 Singapore -9.9 2.8 11.7 20.6 8.5 3.6 6.8 9.0 10.5 5.6 5.7 #N/A Taiwan (China)-22.3 6.3 4.4 20.1 -1.9 3.1 5.5 2.0 3.3 4.5 13.0 11.6 East Asia Update 42 Appendix Table 3. East Asia and the Pacific: GDP Growth Projections Actual Forecast Forecast 1996 1997 1998 1999 2000 2001 2002 2003 2004 East Asia 7.8 6.4 -0.1 6.5 7.6 3.6 5.8 5.0 5.7 Developing E. Asia 8.8 6.9 1.7 5.7 7.0 5.6 6.6 6.6 6.5 South East Asia 7.3 3.4 -9.3 3.3 5.4 2.4 4.3 4.5 4.9 Indonesia 7.8 4.7 -13.1 0.8 4.9 3.5 3.7 3.5 4.0 Malaysia 10.0 7.3 -7.4 6.1 8.5 0.3 4.1 4.6 5.4 Philippines 5.8 5.2 -0.6 3.4 4.4 3.0 4.4 4.0 4.2 Thailand 5.9 -1.4 -10.5 4.5 4.7 1.9 5.3 5.8 6.0 Transition China 9.6 8.8 7.8 7.1 8.0 7.5 8.0 7.8 7.4 Vietnam 9.3 8.2 4.0 4.5 5.5 5.0 6.0 7.0 7.0 Small Economies 6.8 0.5 0.3 6.3 2.8 1.4 1.5 3.7 4.1 Cambodia 7.0 3.7 1.8 5.0 7.7 6.3 5.5 4.8 5.8 East Timor Lao PDR 6.8 7.0 4.0 7.3 5.8 5.7 5.7 5.5 5.9 Mongolia 2.4 4.0 3.5 3.3 1.1 1.1 3.0 5.0 5.3 Fiji 3.1 -0.9 1.4 9.6 -3.2 4.0 3.8 5.0 3.0 Marshall Islands -16.6 -10.1 0.8 -0.2 0.7 2.1 .. .. .. Micronesia, Fed. Sts. -2.4 -5.2 -2.3 1.1 2.5 1.1 0.8 2.4 2.0 Papua New Guinea 7.7 -4.9 -2.8 7.6 -1.3 -3.5 -3.1 2.0 2.0 Solomon Islands 3.5 -2.3 1.1 -1.3 -13.3 -10.1 -4.0 1.0 1.5 Tonga -0.4 0.2 1.6 3.1 6.2 0.5 1.6 1.8 1.8 Vanuatu 2.5 1.5 2.2 -2.5 3.7 -1.9 -0.3 2.0 2.0 East Asia NIEs 6.3 5.8 -2.6 7.7 8.5 0.6 4.5 2.6 4.6 Hong Kong (SAR) 4.3 5.1 -5.0 3.4 10.2 0.5 2.3 2.1 4.3 Korea 6.8 5.0 -6.7 10.9 9.3 3.0 6.3 3.0 5.1 Singapore 8.2 8.5 -0.9 6.4 9.4 -2.4 2.3 1.0 4.7 Taiwan (China) 6.1 6.7 4.6 5.4 5.9 -2.2 3.6 2.7 4.1 Japan 3.6 1.8 -1.2 0.2 2.8 0.4 0.3 0.6 1.6 Source: World Bank data and staff estimates. East Asia is sum of Developing East Asia and Newly Industrialized Economies. East Asia Update 43 Appendix Table 4. East Asia: Exchange Rates (LCU/$) China Indonesia Korea Malaysia Philippines Singapore Taiwan, Thailand Yen China Oct-2002 8.28 9233 1241.13 3.8 52.91 1.786 34.95 43.66 123.9 Nov-2002 8.28 8976 1211.91 3.8 53.31 1.765 34.71 43.32 121.5 Dec-2002 8.28 8940 1208.91 3.8 53.52 1.753 34.85 43.28 121.9 Jan-2003 8.28 8876 1179.27 3.8 53.56 1.736 34.61 42.77 118.8 Feb-2003 8.28 8905 1191.19 3.8 54.07 1.746 34.79 42.88 119.2 Mar-2003 8.28 8908 1232.40 3.8 54.59 1.753 34.72 42.75 118.6 Apr-2003 8.28 8675 1232.82 3.8 52.81 1.777 34.82 42.88 119.8 May-2003 8.28 8279 1199.80 3.8 52.51 1.734 34.72 42.15 117.4 Jun-2003 8.28 8326 1194.00 3.8 53.40 1.734 34.62 41.65 118.3 Jul-2003 8.28 8548 1181.60 3.8 53.71 1.755 34.42 41.78 118.7 Aug-2003 8.28 8578 1178.40 3.8 54.99 1.754 34.00 41.67 118.8 Sep-2003 8.28 8442 1153.00 3.8 55.20 1.746 34.00 40.11 115.0 Table 5. Foreign Reserves Minus Gold (US$ Billion) China Indonesia Malaysia Philippines Korea Taiwan, Singapore Thailand Total China Dec-1996 107.0 18.3 27.0 10.0 34.0 88.0 76.8 37.7 398.9 Dec-1997 142.8 16.6 20.8 7.3 20.4 83.5 71.3 26.2 388.8 Dec-1998 149.2 22.7 25.6 9.2 52.0 90.3 74.9 28.8 452.8 Dec-1999 157.7 26.4 30.6 13.2 74.0 106.2 76.8 34.1 519.1 Dec-2000 168.3 28.5 29.5 13.1 96.1 106.7 80.1 32.0 554.4 Dec-2001 215.6 27.2 30.5 13.4 102.8 122.2 75.4 32.4 619.5 Dec-2002 291.1 30.5 34.2 13.1 121.3 161.7 82.0 38.0 772.1 Jul-2003 361.3 32.6 37.9 12.9 132.9 182.2 86.9 36.7 883.3 Aug-2003 #N/A 32.3 36.7 12.8 136.2 185.7 #N/A 37.4 Sep-2003 #N/A #N/A #N/A 12.7 141.5 190.6 38.6 Source: Haver Analytics East Asia Update 44 Appendix Table 6 : Regional Aggregates for Poverty Measures in East Asia $1 ­a-day $2-a-day Mean Consumption HeadcountNumber of HeadcountNumber ofPopulation (1993 Index Poor Index Poor (mill.) PPP$/month) (%) (mill.) (%) (mill.) EAP 1990 67.95 28.9 457.9 67.0 1,059.9 1582.7 1996 99.80 14.8 253.0 49.6 850.4 1713.1 1999 104.88 15.9 282.2 50.1 887.4 1771.9 2000 112.89 14.0 250.3 45.9 820.7 1788.9 2001 120.93 13.0 235.1 43.2 780.0 1805.0 2002 134.45 11.5 209.5 39.3 716.1 1821.4 2003 143.76 10.7 196.6 37.2 683.6 1837.9 2004 152.11 10.0 185.2 35.3 654.0 1854.4 EAP less China 1990 96.33 22.1 97.3 59.3 260.3 439.4 1996 136.33 10.7 52.2 44.7 218.9 489.2 1999 123.34 11.4 58.5 51.0 262.0 514.0 2000 130.38 10.6 55.4 48.6 253.3 521.5 2001 133.66 9.9 52.1 47.4 250.4 528.7 2002 140.54 8.7 46.8 44.1 236.6 536.2 2003 144.08 8.2 44.6 42.7 232.4 543.7 2004 149.03 7.7 42.4 41.4 228.0 551.3 S.E.Asia 4 1990 82.29 17.8 55.7 60.3 188.8 313.1 1996 111.29 7.8 27.2 43.6 151.6 348.0 1999 97.27 10.1 36.9 52.8 193.6 366.5 2000 102.79 9.2 34.3 49.9 185.5 372.0 2001 105.14 8.3 31.2 48.4 182.7 377.2 2002 111.70 6.8 26.2 44.6 170.9 382.8 2003 114.65 6.5 25.1 43.2 167.7 388.3 2004 117.98 6.1 24.0 41.7 164.4 393.9 Note: The poverty lines in Tables 6 and 7 are set at $1.08 and $2.15 per person per day (in 1993 PPP$) for all countries. For most countries, 1993 World Bank PPP estimates are used. The PPP for the Philippines is from the Penn World Tables, while that for PNG is the 1996 World Bank PPP. PPPs for Vietnam, Lao PDR and Cambodia have been further adjusted using a calorie price ratio between Indonesia and Vietnam. Projections are based on World Bank growth rate forecasts for 2003-2004. Wherever possible, the projections utilize information on sectoral GDP growth rates, changes in the food CPI relative to the general CPI, changes in the GDP deflator relative to the CPI, and changes in the consumption-income ratio. The projections assume that there is no change in relative inequalities within sectors. For China, the projections are done separately for rural and urban China, and then aggregated using population shares. Estimates for all countries except Malaysia and China are based on surveys of household consumption. The estimates for Malaysia and China use income surveys. For China, a survey-based estimate of mean consumption is used in conjunction with the income Lorenz curves to derive poverty estimates. These poverty estimates differ from those commonly found in national poverty assessments for two main reasons. First, country assessments use national poverty lines that differ from the uniform international poverty lines used here. Second, national poverty lines also typically allow for spatial cost of living differentials within countries, but such adjustments are omitted here to maintain a consistent methodology across countries. For instance, in the case of Thailand, these differences explain why the above estimates indicate a small increase in poverty between 1998 and 2000 (in spite of adjusting the CPI by the change in the national poverty lines over this period), while national poverty line-based estimates indicate a decline. Also for Thailand, the 2002 estimate is based on a longer consumption module, which could lead to a small overestimation of consumption relative to 2000. East Asia Update 45 Appendix Table 7: Poverty in East Asia ­ Country Estimates $1 ­a-day $2-a-day Mean ConsumptionHeadcountNumber of HeadcountNumber of Gini Population (1993 Index Poor Index Poor Coefficient (mill.) PPP$/month) (%) (mill.) (%) (mill.) Cambodia 1990 48.29 48.3 4.4 83.7 7.7 41.6 9.1 1996 57.77 36.7 4.0 76.9 8.4 41.6 10.5 1997 56.95 38.4 4.2 78.0 8.5 41.6 10.9 1998 57.31 37.7 4.2 77.7 8.7 41.4 11.2 1999 55.27 41.7 4.8 79.4 9.1 42.3 11.5 2000 54.67 44.6 5.3 80.0 9.4 43.9 11.8 2001 54.84 45.0 5.4 80.1 9.7 44.3 12.1 2002 57.27 44.2 5.5 78.7 9.7 45.7 12.4 2003 57.98 44.1 5.6 78.4 9.9 46.3 12.7 2004 59.63 42.9 5.6 77.6 10.1 46.6 13.0 China 1990 57.05 31.5 360.6 69.9 799.6 36.0 1,143 1993 67.24 29.0 343.9 65.0 769.8 41.2 1,185 1996 85.20 16.4 200.8 51.6 631.6 39.3 1,224 1998 91.32 16.1 201.2 49.8 620.8 41.0 1,248 1999 97.33 17.8 223.7 49.7 625.3 43.4 1,258 2000 105.69 15.4 194.8 44.8 567.4 43.9 1,267 2001 115.65 14.3 183.0 41.5 529.6 44.9 1,276 2002 131.91 12.7 162.6 37.3 479.6 46.1 1,285 2003 143.63 11.7 151.9 34.9 451.1 46.9 1,294 2004 153.41 11.0 142.8 32.7 426.0 47.1 1,303 Indonesia 1984 49.80 36.7 58.7 80.0 128.1 30.3 160.1 1987 55.63 25.7 43.4 74.2 125.4 33.1 169.0 1990 61.58 20.6 36.7 71.1 126.7 28.9 178.2 1993 68.54 14.8 27.8 61.6 115.5 31.7 187.6 1996 86.62 7.8 15.4 50.5 99.4 36.5 196.8 1999 66.80 12.0 24.9 65.1 135.0 31.0 207.4 2000 72.53 9.9 20.9 59.5 125.3 32.2 210.5 2001 73.44 9.2 19.7 58.7 125.2 32.1 213.2 2002 81.72 7.2 15.5 53.5 115.6 34.3 216.2 2003 83.27 7.0 15.3 52.3 114.7 34.7 219.4 2004 84.96 6.8 15.1 51.0 113.7 35.1 222.7 Laos 1990 39.16 53.0 2.2 89.6 3.7 32.7 4.2 1992 41.35 48.8 2.1 88.1 3.9 32.7 4.4 1996 48.27 41.3 2.0 83.1 4.1 36.5 4.9 1997 50.35 38.4 1.9 81.3 4.1 36.5 5.0 1998 49.53 39.6 2.0 81.8 4.2 36.5 5.1 1999 51.49 36.7 1.9 80.5 4.2 36.5 5.3 2000 52.66 35.1 1.9 79.8 4.3 36.5 5.4 2001 55.46 31.3 1.7 77.4 4.3 36.5 5.5 2002 56.56 30.0 1.7 76.6 4.3 36.5 5.7 2003 58.32 27.9 1.6 75.3 4.4 36.5 5.8 2004 60.38 25.4 1.5 73.8 4.4 36.5 5.9 East Asia Update 46 Appendix Table 7: Poverty in East Asia (Continued) $1 ­a-day $2-a-day Mean ConsumptionHeadcountNumber of HeadcountNumber of Gini Population (1993 Index Poor Index Poor Coefficient (mill.) PPP$/month) (%) (mill.) (%) (mill.) Malaysia 1984 172.09 8.9 1.4 29.5 4.5 50.5 15.3 1987 170.88 4.8 0.8 25.0 4.2 47.0 16.6 1989 176.21 3.2 0.6 22.4 4.0 46.2 17.7 1990 195.32 1.96 0.4 18.5 3.4 46.2 18.2 1992 219.48 1.53 0.3 17.6 3.4 47.7 19.1 1995 253.64 1.02 0.2 14.0 2.9 48.5 20.6 1996 261.87 0.81 0.2 13.1 2.8 48.5 21.1 1997 315.95 < 0.5 -- 8.8 1.9 49.1 21.7 1998 269.00 < 0.5 -- 12.9 2.9 49.1 22.2 1999 271.62 < 0.5 -- 12.6 2.9 49.1 22.7 2000 302.42 < 0.5 -- 9.8 2.3 49.1 23.3 2001 303.24 < 0.5 -- 9.8 2.3 49.1 23.8 2002 305.70 < 0.5 -- 9.6 2.3 49.1 24.3 2003 313.19 < 0.5 -- 9.0 2.2 49.1 24.7 2004 323.71 < 0.5 -- 8.2 2.1 49.1 25.1 PNG 1990 72.95 35.4 1.4 64.3 2.5 48.4 3.9 1996 93.15 24.6 1.1 54.4 2.5 48.4 4.6 1997 88.62 25.6 1.2 56.0 2.7 47.5 4.7 1998 83.15 27.8 1.4 59.0 2.9 47.7 4.9 1999 78.37 30.7 1.5 61.6 3.1 47.8 5.0 2000 71.88 35.3 1.8 65.0 3.3 47.6 5.1 2001 65.68 38.2 2.0 69.7 3.7 47.7 5.3 2002 61.17 42.8 2.3 71.5 3.9 47.5 5.4 2003 61.00 42.2 2.3 71.4 4.0 47.5 5.6 2004 60.88 42.8 2.4 71.7 4.1 47.5 5.7 Philippines 1985 74.92 22.8 12.4 61.3 33.3 41.0 54.2 1988 82.77 18.3 10.7 55.6 32.4 40.7 58.3 1990 90.32 19.1 11.7 53.5 32.6 43.8 61.0 1991 87.75 19.8 12.3 55.0 34.3 43.8 62.4 1994 89.10 18.4 12.3 53.1 35.5 42.9 66.8 1996 107.15 14.8 10.4 46.5 32.5 46.2 69.9 1997 110.21 12.1 8.6 45.2 32.3 46.0 71.5 1998 108.77 13.7 10.0 46.6 34.1 46.7 73.1 1999 107.20 13.5 10.1 46.9 35.0 46.2 74.7 2000 107.03 13.5 10.3 47.1 35.9 46.2 76.3 2001 110.57 11.9 9.3 45.3 35.3 46.0 77.9 2002 112.10 11.5 9.1 44.7 35.5 45.9 79.5 2003 114.45 10.8 8.7 43.5 35.3 45.9 81.1 2004 117.17 9.8 8.1 42.2 34.9 45.9 82.6 East Asia Update 47 Appendix Table 7: Poverty in East Asia (Continued) $1 ­a-day $2-a-day Mean Consumption HeadcountNumber of HeadcountNumber of Gini Population (1993 Index Poor Index Poor Coefficient (mill.) PPP$/month) (%) (mill.) (%) (mill.) Korea 1990 301.09 < 0.5 -- < 0.5 -- 29.88 42.87 1991 330.38 < 0.5 -- < 0.5 -- 29.85 43.27 1992 362.09 < 0.5 -- < 0.5 -- 29.85 43.66 1993 383.03 < 0.5 -- < 0.5 -- 29.36 44.06 1994 411.09 < 0.5 -- < 0.5 -- 29.36 44.45 1995 440.03 < 0.5 -- < 0.5 -- 29.11 45.00 1996 480.46 < 0.5 -- < 0.5 -- 29.71 45.55 1997 483.84 < 0.5 -- < 0.5 -- 28.97 45.99 1998 400.86 < 0.5 -- < 0.5 -- 29.42 46.43 1999 450.06 < 0.5 -- < 0.5 -- 30.00 46.86 2000 481.54 < 0.5 -- < 0.5 -- 30.00 47.28 2001 497.66 < 0.5 -- < 0.5 -- 30.00 47.64 2002 516.81 < 0.5 -- < 0.5 -- 30.00 47.97 2003 530.41 < 0.5 -- < 0.5 -- 30.00 48.24 2004 556.93 < 0.5 -- < 0.5 -- 30.00 48.48 Thailand 1988 90.42 17.9 9.6 54.1 29.0 43.8 53.7 1990 102.88 12.5 7.0 47.0 26.1 43.8 55.6 1992 129.75 6.0 3.5 37.5 21.7 46.2 57.8 1996 143.92 2.2 1.3 28.2 17.0 43.4 60.1 1998 121.73 3.3 2.0 34.1 21.0 40.6 61.5 1999 123.50 3.1 1.9 33.6 20.7 40.7 61.7 2000 125.42 5.2 3.2 35.6 22.0 43.2 61.9 2001 131.21 3.6 2.2 32.0 19.9 42.4 62.3 2002 139.40 2.4 1.5 27.7 17.4 42.2 62.8 2003 146.22 1.7 1.1 24.6 15.5 41.8 63.1 2004 153.46 1.3 0.8 21.7 13.8 41.6 63.4 Vietnam 1990 41.73 50.8 33.6 87.0 57.6 35.0 66.2 1993 48.85 39.9 28.3 80.5 57.2 35.0 71.0 1996 63.66 23.6 17.7 69.4 52.2 36.3 75.2 1998 68.54 16.4 12.8 65.4 50.9 35.4 77.7 1999 67.96 16.9 13.4 65.9 52.0 35.4 78.9 2000 71.26 15.2 12.1 63.5 50.7 35.9 79.9 2001 73.84 14.6 11.8 61.8 50.1 36.8 81.0 2002 78.67 13.6 11.2 58.2 47.8 37.5 82.1 2003 82.01 12.0 10.0 55.8 46.4 37.6 83.2 2004 85.50 10.6 8.9 53.4 45.0 37.7 84.3 Notes: See Notes to Table 7. East Asia Update 48 Appendix Table 8. NPLs in the commercial banking system of the crisis-affected countries (percent of total loans) 1997 1998 1999 2000 2001 2002 2003 Dec Dec Dec Dec Mar Jun Sept Dec Mar Jun Sept Dec Mar Jun Indonesia (a) -- -- 64.0 57.1 54.4 52.6 50.5 48.8 50.3 48.5 40.7 31.1 30.3 27.7 excl. IBRA 7.2 48.6 32.9 18.8 18.1 17.6 14.7 12.1 12.8 11.8 10.5 7.5 7.6 7.1 Korea (b) 8.0 17.2 23.2 14.0 12.9 10.5 9.6 7.4 6.6 5.0 4.8 4.1 4.2 4.7 excl. KAMCO & KDIC 6.0 7.3 13.6 8.8 7.6 5.6 5.1 3.3 2.9 2.5 2.5 2.4 2.6 3.2 Malaysia - excl. Danaharta -- 16.7 16.7 13.4 14.3 15.5 16.5 16.3 16.7 15.7 15.3 14.7 14.6 13.9 Philippines (c) 4.7 10.4 12.3 15.1 16.6 17.0 17.9 17.3 18.0 18.1 16.5 15.0 15.5 15.2 Thailand (d) -- 45.0 41.5 29.7 29.3 28.9 29.3 29.6 29.7 29.9 29.6 34.2 34.1 34.1 excl. AMCs -- 45.0 39.9 19.5 19.2 13.9 14.1 11.5 11.4 11.3 11.7 18.1 17.8 17.6 Memo: Malaysia (e) - excl. Danaharta - 10.6 10.6 8.3 9.3 10.3 10.7 10.5 10.6 10.0 9.6 9.3 9.1 8.8 a) Only includes IBRA's AMC; b) The NPL ratio increased in 1999 due to the introduction of stricter asset classification criteria (forward looking criteria) ; c) From September 2002 onwards, the NPLs ratios are based on the new definition of NPLs (as per BSP Circular 351) which allows banks to deduct bad loans with 100 percent provisioning from the NPL computations; d) Includes transfers to AMCs but excludes write-offs. (Note that the jump in headline NPLs in December 2002 was a one-off increase, reflecting a change in definition and did not affect provisioning requirements). The June 2003 figure is preliminary and was estimated using transfers to AMCs and lending to AMCs as of March 2003; e) NPL series used by Bank Negara Malaysia, which is net of provisions and excludes interest in suspense. MAKING SERVICES WORK IN EAST ASIA AND THE PACIFIC accountable through the power of the purse ­ by paying for Introduction 25 satisfactory service or taking his or her business elsewhere. However for the services considered here--such as health, Since education and health are key dimensions of well education, water, electricity, and sanitation--there is often being, it is now widely accepted that, in addition to higher no direct accountability of the provider to the client, for incomes, reducing poverty also means more and better example when service providers are financed by the education and improved health. As a result the Millennium government out of tax revenues. There is then a "long Development Goals (MDGs) adopted by the United Nations route" of accountability--by clients as citizens influencing in 2000 set goals for universal completion of primary school policymakers, and policymakers influencing providers. and substantial reductions in child and maternal mortality by When the relationships along this long route break down, 2015. service delivery fails. This Special Focus asks what public policy can do to Sections 2 to 4 take on each of these relationships in improve the delivery of key services such as education, turn to show how: healthcare, water and sanitation in East Asia, drawing on · increasing clients' choice and participation in approaches and analysis in the World Bank's recently service delivery can help them monitor and released World Development Report 2004: Making Services discipline service providers; Work for Poor People and on experience in a variety of countries in East Asia over the last decade. · strengthening accountability of service providers to policy makers can be achieved through a variety of Section 1 below briefly reviews recent trends in service approaches; delivery in East Asia. Sections 2 to 4 then consider approaches to strengthening service delivery. At a broad · making relevant information more widely available level policy that strengthen economic growth and make and developing mechanisms for citizens to voice available more resources for health and education are of their views and hold policy makers accountable can course important. But, as Box 1 shows, they may not be increase their influence over service delivery enough on their own to achieve desired outcomes. outcomes. Therefore, in addition to promoting growth and mobilizing resources, governments need to find more specific or precise Section 5 below discusses how governments ways to improve the way services work. should innovate to find the appropriate arrangements for service delivery, using systematic evaluation and There is no single `right' model for service delivery. dissemination about what works and what doesn't. Different societies employ a wide variety of methods for delivering services--government provision, private sector delivery, non-profits or community participation for example ­ and all approaches have seen successes and Figure 1 A framework of accountability relationships failures. Finding what arrangement works for a particular service in a particular setting is the key. The World Development Report 2004 develops a simple framework to help understand the variety of experiences. The service delivery chain can be unbundled into the relationships between three sets of actors. (Figure 1). Clients--as patients in clinics, students in schools, travelers on buses, and consumers of water--are the ultimate beneficiaries of services. They have a relationship with the frontline providers, with schoolteachers, doctors, bus drivers, and water companies. In a competitive-market transaction the consumer holds the service provider 25This Special Focus on Making Services Work in East Asia and the Pacific was prepared by Philippe Auffret (EASPR), Deon Filmer (DECRG), Elizabeth King (EASHD), and Rekha Menon (EASHD) with a contribution from Bruce Harris (EASES). Unless otherwise specified, examples and data are drawn from World Development Report 2004: Making Services Work for Poor People. http://econ.worldbank.org/wdr/wdr2004/. Making Services Work in East Asia and the Pacific 50 Box 1 Growth, public spending and outcomes The association between outcomes and public Cross-country evidence shows that economic growth is an spending--after controlling for national income--is important determinant of improved health and education weak outcomes, but alone it may not be enough to reach the Public spending and child mortality, percent deviations from amounts predicted by GDP per capita goals countries set. In general growth would need to be extraordinarily high to reach the MDGs though this route alone. One estimate finds that average GDP per capita growth would need to be 6.7 percent per year to reduce 150 under-5 mortality by two thirds between 1990 and 2015 ) (the MDG target)--a growth rate that only China met pc 100 between 1990 and 2000. And there is great variation in the PDG service outcomes achieved for any given GDP growth rate. 0002 yb 50 More public spending can contribute to improving tear edtci ed outcomes, but by itself it is also not enough. The cross- tylatro pr 0 country association between public spending on health and m etar child mortality is insignificantly different from zero. (Box omrf -50 figure). At the level of the individual country too, more 5-rednU onitai spending is not always associated with better outcomes. In dev -100 Thailand average per-child public spending on education %( increased several-fold between the 1980s and the 1990s -150 but the primary completion rate remained almost constant -150 -100 -50 0 50 100 150 between 1990 and 2000. But spending more can be part of Per capita public spending - health 1990s average an overall strategy to improve outcomes. Thailand (% deviation from expenditures predicted by GDP pc) doubled per capita public spending on health between the mid-1970s and the mid-1980s while also substantially changing the way services were targeted, personnel managed, and authority delegated. Infant mortality fell from 74 per 1,000 births in 1970 to 42 by 1985. Today it is 28 per 1,000. Table 1. Prospects for reaching the Millennium Development Goals Primary Gender Child school equality in Child Births Immunization Access to safe malnutrition completion school mortality attended for measles water Cambodia .. .. .. China Fiji .. .. .. .. Indonesia Lao PDR .. Malaysia .. .. .. Mongolia .. .. PNG .. .. Philippines Thailand .. Vietnam - .. Seriously off Insufficient track Off track On track Achieved data Legend .. Source: www.developmentgoals.org Making Services Work in East Asia and the Pacific 51 I. The status of outcomes and services in East Asia minority children did.26 In China differences along ethnic lines are pronounced as well. In some countries inequalities emerge along regional lines. For example in the Philippines Many countries in East Asia and the Pacific have made people in the Autonomous Region of Muslim Mindanao substantial progress in improving development outcomes. have substantially higher under-5 mortality, even controlling For example Vietnam has reduced under-5 mortality to for household wealth (Table 2).27 under 50 per thousand live births, substantially below the average of 121 for low income countries. But there is substantial variation across countries. A compact way of Table 2. Under-5 mortality by region in the richest and assessing prospects is to ask whether current trends are poorest fifth of the population, Philippines 1998 sufficient for the country to reach the different Millennium Average Poorest Richest Development Goals by 2015. Table 1 indicates quite a quintile quintile number of East Asian countries are "off track" or "seriously Overall 52.1 74.2 25.2 off track" in terms of goals for child and maternal health. In Autonomous Region of some cases, such as under-5 mortality in Vietnam, the goal Muslim Mindanao 96.5 106.6 45.5 is unlikely to be met because it will be hard to sustain past Rest of country gains. But in most cases it reflects some combination of 50.3 70.8 25.1 low economic growth, inadequate spending, and services Source: Analysis of Demographic and Health Survey data. Quintiles based on index of household assets and dwelling that are failing. Reaching the goals on access to clean water characteristics. is also proving a challenge for many countries in the region. The broad aggregates used to determine Table 1 can There are several dimensions along which services fail, mask substantial variation within countries, for example contributing to poor outcomes. In some settings there is a between different income groups or geographical regions. lack of access--for instance many still lack access to safe In Cambodia under-five mortality in 2000 was almost 150 water or improved toilet facilities, especially among the per 1,000 births among the poorest fifth of the population, poor. But low access can be overcome. Indonesia but only 57 in the richest fifth (Figure 2). In all the expanded access to primary education in the mid-1970s by countries for which there are data, child mortality is using its oil windfall to build new schools and hire more substantially lower for the rich than for the poor. teachers. Primary enrollment doubled between 1973 and 1986, reaching 90 percent--though the story on quality is less positive.28 Access can become the first hurdle in post- Figure 2. Under-5 mortality in the richest and conflict environments such as Aceh and Maluku in poorest quintiles (Deaths per 1,000 live births) Indonesia, Timor Leste and Cambodia. At independence, schools and health facilities in Timor Leste were all but 160 destroyed and restoring the availability of these services 140 formed a cornerstone of the recovery efforts. 120 But physical access to services is only part of the story. 100 Indeed, while public production of services increased access to services in many countries in East Asia, this often 80 Poorest happened at the expense of quality, or at least happened at 60 quintile low quality. Difficulties in recruiting and maintaining Average qualified personnel at peripheral facilities, low pay and 40 demoralized staff led to poor quality services. Lack of 20 Richest quintile necessary supplies (books, drugs, equipment) and 0 maintenance of buildings further undermined staff Cambodia Indonesia PNG 1996 Philippines Vietnam motivation and lowered the quality of these services. 2000 1997 1998 1997 Services must meet at least minimal quality standards before Sources: Analysis of Demographic and Health Survey data. Vietnam from Gwatkin and others (2000). Quintiles based on they can be expected to contribute to improving outcomes. index of household assets and dwelling characteristics. At a minimum, staff must reliably report for work. A recent multi-country study found high staff absence rates in many People of particular ethnicity, religion, or who live in 26 Vietnam Delivering on its Promise: Vietnam particular regions sometimes face specific problems that Development Report 2003. p. 54. result in worse service delivery outcomes than the rest of the 27 See also a recent report, World Bank, Human population. In Vietnam while over 80 percent of children Development for Peace and Prosperity in the Autonomous from the majority Kinh ethnic group entered lower Region in Muslim Mindanao. (2003a). secondary school in 1998, less than two-thirds of ethnic 28 Filmer, Lieberman, and Ariasingam (2002). An evaluation of the enrollment and labor market outcomes of the program are in Duflo (2001). Making Services Work in East Asia and the Pacific 52 countries: in Indonesia as many as 42 percent of staff in largely unregulated private health sector. In many primary health facilities were not present on the day of an countries, especially transition economies such as unannounced visit. In Papua New Guinea 15 percent of Cambodia, Vietnam, China and Mongolia, private facilities teachers were absent. (See data annex). offer services similar to those the public sector is supposed When staff report for work--as many do, even in to be providing,. Studies find that clients of all income extremely difficult conditions--complementary inputs such levels seek private care, although the type of facility might as textbooks in schools, medicines in clinics, and adequate vary by income. For example, informal drug vendors and and safe facilities are needed. Textbook distribution is private pharmacies are often the first points of contact for frequently subject to fraud. Medicines are often diverted self-treatment and account for the majority of health service from public clinics where they are supposed to be "free" for utilizations in Vietnam and Cambodia, particularly among sale on illegal markets. And last, when little is available for the poor, primarily because they tend to be cheap (Lonnroth, upgrading and maintaining facilities they can become unsafe 2000; World Bank 1999b). Fifty five percent of clinics in and non-conducive to the delivery of effective services. China are now privately owned. Another indicator of systemic failure is the fact that In education, the private sector tends to be more funds allocated for health or education are often not spent prominent at post-basic levels. In general, however, the on services that actually reach the poor. Studies typically number of private schools is growing rapidly. As in public find that less than 20 percent of public spending on health or facilities, the technical quality of services at private facilities education goes to the poorest 20 percent of the population. can be low, highlighting the need for effective regulation For example in 1996 in Cambodia only 15 percent of public (perhaps through accreditation or licensing) or performance- spending on education went to the poorest 20 percent while based incentives (see discussion below on contracting with 29 percent of that spending went to the richest 20 percent NGOs in Cambodia). (see Data Annex). But some countries have managed to Figure 3. Sources of financing for health services allocate resources to reach the poor. In Malaysia in 1989, 29 percent of public spending on health went to the poorest 20 percent of the population. That services often fail should not be cause for pessimism. There are many examples of innovations and interventions that have led to improved outcomes. The next three sections contain examples from East Asia (and other regions) of ways that changes in relationships of accountability between clients, providers, and policymakers have made services work better. II. Improving service delivery by promoting the power of clients over providers In the 1960s and 1970s, most governments in the East Asia and Pacific region developed elaborate and expensive public infrastructures to deliver health and education Source: World Health Organization, data for 2000 services, financed largely through general tax revenues. This approach helped increase coverage but was less successful By spending their own money on services, clients are at creating quality and financial sustainability. A feature of already playing a role. Private expenditures on health these experiences was the lack of involvement of clients. account for well over 70 percent of total health expenditures This section discusses the increasing role of the private in Indonesia, Cambodia, and Vietnam (Figure 3). The use sector in East Asia--a sector where clients with financial of private health insurance is low, although this form of resources typically have more power. Approaches to financial protection is growing in countries such as China, promoting client power over public providers are then Indonesia, and the Philippines. In most countries primary discussed, including such interventions as cash transfers to education is officially free of charge but official fees are families or information dissemination. required at post-primary levels. This has changed in some countries as a way of increasing resources. For example, Private provision and private financing the Vietnamese government permits public institutions to charge fees at all levels of education except at the primary The private sector provides a substantial share of health level. Where data are available, private financing is services in East Asia, and its role in education is also typically a substantial share of total education spending (see increasing. Demand for convenient hours, closer facilities Data Annex). and a better quality service has led to rapid growth of a Making Services Work in East Asia and the Pacific 53 charges for public health services. These reforms Figure 4 When to charge user fees? improved the productivity of public health institutions, but led to under-provision of some services. Immunization coverage dropped from 75 percent in 1979 to 39 percent by the mid 1980s. The incidence of measles and polio rose. In response, the Chinese Government introduced a program of immunization insurance where households pay 2-4 Yuan (0.25-0.5 US$) per child per year for defined immunization services. By 1994, immunization rates increased to 85 percent in areas with the insurance program but remained low in those areas without it. The Ministry of Health increased efforts to improve insurance coverage and by 1997 immunization coverage exceeded 85 percent. (Liu and Mills, 2002). · Vietnam introduced fees for hospital services in 1989. By 1998 fees accounted for 30 percent of hospital revenue, while state hospital subsidies fell over the same period (World Bank, 2001b). However 45 percent of households with sick members reported they could not afford user fees (Hien 1999). Local leaders reported that poor people chose not to use or left health facilities without care (Hoang et al, 2003). The government responded in 2002 by establishing provincial "Health Care Funds for the Poor (HCFP)" to subsidize out-of-pocket costs of eligible individuals. Information dissemination Generating and disseminating information can be a Source: World Development Report 2004 useful tool to increase the power of clients as well. One approach is government accreditation of providers and User-fees and demand-side interventions facilities to signal high quality. One example is the Sentrong Sigla ("Center of Vitality") Movement in the Policymakers in the region have sometimes considered Philippines, which publicly recognizes and certifies user charges as a way to promote oversight by clients and government health facilities that meet quality standards. In increase resources for quality services. There is no single Thailand many hospitals have independently sought right policy on user fees. Their appropriateness depends on international accreditation by the International Organization the characteristics of the service and the ability of for Standardization (ISO), a global standards body. governments to identify the poor, as shown in Figure 4. A Increasing transparency is another way to use particular concern with user fees is their impact on use by information to empower poor people. For example in the poor. One study found that a one percent increase in Cambodia, block grants to schools are allocated, delivered prices at public hospitals reduced utilization among the and used in a public way so that the community can hold poorest quintile by 26 percent in Philippines (Tan, 2001, schools accountable for how the money is spent. Funds are Solon et al 2003). But another study based on an disbursed by the Provincial Office of Education in see- experiment with higher fees in public facilities in Indonesia through plastic bags at public ceremonies at provincial found only small effects on health outcomes as the number centers. The money is collected by four delegations--the and use of private facilities increased in response to the Cluster School Director, a Deputy Director of the cluster, a change in the public sector (Gertler and Molyneaux, 1995). teacher representative and a community representative. Demand-side subsidies--that is cash transfers to Each Cluster Director publicly counts the money and households to let them buy more services--are sometimes announces the amount. School directors' report on grant used to offset the potential negative impacts of user-charges. expenditures to community representatives and parents and By putting money in the hands of clients, these subsidies display records in the school office for all to see. increase the power of clients. Some examples: Information transparency in Uganda is credited with increasing the amount of money intended for schools that · In China, financing reforms in the 1990s resulted in actually reaching them from 13 to over 80 percent. less government spending and the introduction of user (Reinikka and Svensson 2001). Making Services Work in East Asia and the Pacific 54 provides an example of making great effort to integrate its III. Ensuring that the public sector is geared towards poverty reduction strategy to its newly established budget serving poor people process. The second accountability relationship that needs to be Contracting with non-government providers strong for services to work is that between policymakers and Some governments contract education and health service providers. In some cases this relationship can take services to the private sector, NGOs, or even other public the form of an explicit contract. More often it is a more agencies. general and less explicit relationship. Improving this "compact" can be a way to improve services. This section · Civil war left Cambodia with little health infrastructure first discusses some broad public expenditure underpinnings and among the worst health indicators in East Asia. In for effective services, then looks at three approaches that 1998 the government contracted with nongovernmental have been used in East Asia and the Pacific: (i) entities to provide health services in 12 randomly Performance-based contracts that explicitly link outcomes selected rural districts. Contractors were chosen with financial incentives to providers--which could be non- competitively on the quality of technical proposals and government providers; (ii) privatization with explicit price. Agreements were made about deliverables, contracts for service performance; (iii) increasing the targets for 13 health indicators, an enforceable contract involvement of local communities by transferring control and a performance verification system. Progress was over the financing and management of services from a measured through independent household surveys and distant national agency to local government spot checks. Payments were linked to achieving (decentralization), or community groups (Community targets, with bonuses for above-target performance. The Driven Development) or even facilities (facility autonomy). contracting approach was associated with substantially improved health facility utilization as well as improved health outcomes (Bhushan, Keller, and Schwartz 2002). Public expenditure underpinnings of effective While there was some question if public spending in services different types of districts was equal (which would be necessary to ensure proper evaluation), the example The issue of public financial discipline came to the fore nonetheless illustrates how contracting can be after the 1997 financial crisis, which sharply raised public implemented (and that governments might be willing to debt and interest burdens while reducing the share of spend more when spending is linked to outcomes). discretionary expenditure.29 A variety of instruments are · Another example of contracting is a pilot initiative in being used to promote fiscal discipline. Some countries are privatized hospital management in Mongolia. In the developing a modern "Medium-Term Expenditure late 1990s management of the Bayanzurkh district Framework" (MTEF), which includes rigorous fiscal hospital was put up for bid. Assessments found that forecasts and spending plans, though these initiatives are compared with the traditional managers, contract generally at early stages. Countries are also moving away managers paid more attention to building human from micro-management of inputs to performance resources, providing client-oriented medical service, management. Outcome performance indicators are used in upgrading quality measures at the hospital, creating a Malaysia's "Modified Budgeting System" with similar but sustainable business environment, and using profit- more limited use in the Philippines, Thailand and Indonesia. sharing, salary and incentive mechanisms to improve However, some countries have been less successful at services. There are indications that outcomes such as maintaining financial discipline: despite restrictive control outpatient mortality improved. Sadly, the impact of the mechanisms, Indonesia, Cambodia and China have less initiative was not rigorously evaluated, suggesting a lost successful at keeping sectoral spending within budget, opportunity for learning. which reduced responsiveness, quantity and quality of East Asian countries have some evidence that using service delivery (World Bank, 2001a). contracted firms and giving them clear and measurable An additional approach to organizing public spending objectives and adequate resources can improve the coverage has been the use of Poverty Reduction Strategy Papers and quality of service delivery. There are risks, however. (PRSPs) which explicitly link public expenditures to service Measurable and meaningful objectives are not always easy delivery for the poor. Vietnam, Cambodia and Mongolia to define. Sometimes, as with the Mongolia pilot, the status already have a PRSP while one is under preparation in Lao of the contracting firm was left murky, next steps after the PDR. Papua New Guinea and Timor-Leste may prepare one contract was implemented were undefined, and whether the by next year. However, in both Vietnam and Cambodia asset would eventually be transferred to the contractor if much remains to be done to link the PRSP to the budget performance was satisfactory was unclear. Moreover, the process (World Bank, 2003b) although Timor-Leste government itself did not know how to view such a contracting arrangement within the larger hospital system. 29 See for example the East Asia Regional Update Special Focus of October 2001, Word Bank (2001a). Making Services Work in East Asia and the Pacific 55 Privatization or district. How to resolve disparate goals such as these is a permanent issue under decentralization. Governments are Privatization is sometimes advocated as a way of faced with the challenge of designing contracts and incentive improving access and quality, especially in water provision. systems that minimize these divergent interests.30 Political goals sometimes influence management decisions in large state-owned enterprises such as utilities, hampering Indonesia's decentralization reform, which began in the efficiency and quality of services while doing little to earnest in 2001, is changing approaches to improving promote equity. Especially after the financial crisis of the educational quality, with less focus on inputs for schools late 1990s, some governments looked to privatization as a and more on building stronger governance and management way of improving efficiency and accessing private systems at the school, district, and higher levels. This shift investment and management expertise. Importantly, in focus should allow local governments and schools to privatization contracts often explicitly defined the make more informed choices about appropriate responsibilities of the service provider, the policy maker, the interventions and allocating scarce resources to support regulatory and tariff parameters and issues of access by poor those choices (Box 2). households in order to improve accountability. One example was the privatization of the Metropolitan Waterworks and Community Driven Development Sewerage Systems in Greater Manila, Philippines. Two private consortia were given the responsibility under long Another way of increasing the accountability of term concession contracts to expand water and wastewater providers is to give control of resources and decisions to services (Dumol, 2000). Despite continuing problems with community groups, an approach called Community Driven the West consortia, the approach has succeeded in Development (CDD), which has attracted particular increasing service coverage especially among the urban attention in Indonesia, Timor Leste, Cambodia and the poor, increasing water pressure in the overall Metro Manila Philippines. CDD investments are usually for multi-sectoral area, and substantially improving water quality and reducing projects, allowing communities to decide on investments water losses through leaks in the East consortia service area. from an open menu but about 40 percent remain sector specific. Decentralization to lower levels of government Many of the region's CDD operations are based on Although the rationale for decentralization is often experience gained in one of the original, and by far the political, well-managed decentralization has the potential to largest, CDD operations in the region, KDP (Kecamatan expand and improve public services. Its promise lies in Development Project). KDP transfers resources to empowering frontline providers who are closer to clients-- collective bank accounts held by village representatives. heads of schools and teachers, or doctors and nurses--as Villagers can select from an open menu of projects, well as district and community leaders, all of whom are allowing them to determine their own priorities. Projects likely to know more about local problems and needs than receive technical assistance and support for village level officials of the national government. These people are management of procurement, finance, and project possibly better at finding ways to improve operations. They implementation. Importantly, there is full transparency have an incentive to lobby for more resources and better through a program of disclosure and independent civil staff, and to experiment with new ways of doing things. In society monitoring. KDP has now reached almost half of countries as large and diverse as China and Indonesia, for the 65,000 villages in Indonesia and is generally example, greater opportunities to seek local solutions can institutionalizing a participatory and sustainable approach to yield many benefits. There are sufficiently different local local development. conditions to make innovation and experimentation CDD approaches are not without risks. Three main rewarding, even necessary, and to the extent that a region issues emerge: potential undermining of local government; can learn from the experience of others, locally generated the sustainability of CDD, especially in heterogeneous innovations can stimulate continuing improvements in communities; and the potential capture of benefits by elites. service delivery. The risks associated with giving districts These issues are not necessarily unique to CDD but the more autonomy to choose modes of service delivery can be approach brings them to the fore. Balancing these risks with mitigated by holding local decision-makers accountable for the potential benefits of having strong accountability at the delivering what they promise. very local level will likely be key to the long-run success of But decentralization also has its problems. Different CDD. Rigorous evaluation of impact will be important to levels of government can have opposing or misaligned assess that success. goals. For example, national government may want to use education to foster a clear national identity, while local governments and communities may care more about preserving local customs and norms. The national 30 For more extensive discussion of the impact of government may want to allocate public funds so as to help decentralization in the health sector in Indonesia and the equalize development indicators across the country, an Philippines see the April 2002 East Asia Regional Update action that might be deemed undesirable by a wealthy state (World Bank 2002). Making Services Work in East Asia and the Pacific 56 Box 2 Managing Indonesia's decentralization In education, Indonesia's recent "big bang" decentralization takes two forms: the transfer of principal responsibilities, authority and resources for the delivery of services to district governments, and the transfer of some decision-making power to individual schools. But important issues about governance and management of the sector remain to be resolved. The basic decentralization laws are vague, related regulations tend to be contradictory, governance and management functions often seem to have been inappropriately assigned, and the Education Law, which takes decentralization a step further from the district to the school level, does not resolve all these issues. For example, there remain ambiguities about teacher management: The district government is responsible for hiring and paying teachers in public schools, with the exception of madrasah teachers, but compensation systems for civil servants are set centrally--with many districts also using their prerogative to provide supplementary benefits and incentives. And while initial teacher preparation remains the function of accredited universities, it is not clear who is responsible for the continuing professional development needs of teachers. In addition, some functions may have been decentralized too far, with consequent loss of economies of scale, ability to solve inter-district problems, and loss of technical capacity. It is possible for districts to collaborate with each other in trying to remedy this, and some are doing precisely that--but there are few guidelines to inform this type of collaboration. The vagueness and uncertainty leave lower levels of government to wrestle with difficult conceptual tasks that may be beyond their capacity, while taking away from them management tasks, such as teacher management, that they are capable of handling. Likewise, data collection and information exchange systems that existed in the past are no longer giving even fundamental data, such as enrollments, to the national authority. In 2000 the annual census of secondary schools yielded only a 30-percent response rate as compared with 80 percent in previous years. Using their new independence, some districts are conducting experiments to upgrade their schools, but the lessons are not systematically documented or analyzed to see how broadly applicable they might be. Personnel, financial, procurement, and information management systems are among those that form the complex architecture that support the operation of the education system in Indonesia. Unless they are rebuilt or replaced, other types of education expenditures and capital investments will not yield their potential returns. Source: World Bank and partners (forthcoming), Education in Indonesia: Managing the Transition to Decentralization Autonomy at the facility level A remaining role for the central government Another approach to promoting accountability is Whatever the level of devolution chosen, there remain ceding substantial autonomy to facilities such as schools, strategic roles for the national government to perform. hospitals, and clinics, and encouraging more participation These include actions that lower levels of governments do by citizens through parent-teacher associations and health not have an incentive to take individually because they committees. Behind these measures is the belief that cannot fully capture returns, are less able to perform frontline providers who are able to act with professional because of economies of scale, or do not have sufficient autonomy and initiative will be able and willing to use their resources to undertake. Prime among these are setting goals technical knowledge and information to improve services. and standards of service provision, engaging in There are some examples of this form of extreme experimentation when needed or rewarding innovations decentralization. For example Thailand experimented with from other parts of the system, establishing a transparent an "autonomous public hospital model" in response to the regulatory framework and enforcing it, and ensuring economic crisis of 1997 (Jongudomsuk. et al. 2003). The equitable delivery. In addition, there is a question of which Ministry of Public Health contracted with individual functions within a delivery system to decentralize. Some hospitals to deliver a package of care based on a fixed argue that there is no such thing as a really decentralized amount of funding per capita. The autonomous hospital system of provision because almost all decisions (e.g., behaved as a provider of some services, as well as a finance, staffing) retain degrees of centralization and purchaser of services that it could not offer directly. decentralization. The issue then becomes one of finding the Payment was retrospective and monthly, with hospitals appropriate balance, given the objectives of the system. required to absorb the cost of overruns. Unlike the experience in other regions, however, these reforms IV. Ensuring that citizen voice is reflected in (including autonomous hospitals in Thailand) have not been setting policy priorities extensively evaluated as yet. The third accountability relationship (illustrated in Figure 1) that needs to be strong for services to be effective is that between policymakers to citizens. This relationship includes formal political mechanisms--political parties and Making Services Work in East Asia and the Pacific 57 elections--and informal ones--advocacy groups and public groups and eventually engaged the managers of public information campaigns. Citizens need information about agencies. A follow-up report card rated some services how actions of the state have promoted their well being. substantially higher, though scores on corruption and access They also need mechanisms to make sure that politicians to grievance systems remained low. Nevertheless the and policymakers are rewarded for good actions and initiative was deemed successful at focusing on remedying penalized for bad ones. these problems and the Public Affairs Centre (which A recent study finds that many East Asian countries conducted the survey) collaborated with local partners to rate relatively poorly in terms of voice and accountability-- prepare similar studies in other Indian cities. Other a measure of how well the population's voice is reflected in countries, including the Philippines and Vietnam, have the political system (Kaufmann et al 2003). Correcting for adopted localized versions of the approach. countries' level of economic development does not affect Other ways of using information technologies can also this ranking (Kaufmann et al 1999). be helpful. Electronically publicizing the prices of How can increasing voice and accountability lead to common-use goods and services led to convergence of improved services for the poor? First, it can lead to less prices and helped procuring agencies to get value for money corruption--the abuse of public office for private gain. in the Philippines (OECD, 2003, p.24). In South Korea the There is a strong negative correlation between voice and results of public tender are published in the Official Gazette accountability and corruption (Kaufmann et al 2003). for all to see. In the Philippines the award of public Corruption, in turn, is associated with lower growth and at procurement decisions and their rationale are posted in a least one study finds that corruption is associated with less centralized Electronic Bulletin Board (OECD, 2003, p.28). public spending on health, education and welfare transfers Figure 5 Newspaper announcement of textbook (Mauro, 1997). Second, without voice there is little check distribution schedule in the Philippines on policymakers to ensure that the demands of poor and marginalized groups are reflected in the design of policies-- pro-poor policies that in turn improve service delivery for the poor. Third, an increase in voice and accountability is associated with the use of information technologies, which enhance the overall efficiency of public sector delivery with benefits for all including the poor. There is no magic bullet to improve the accountability of politicians to citizens. Information, however, can be a powerful tool. For example, tracer studies of textbook delivery to schools in the Philippines used to reveal high leakages. In response, the government recently created the National Textbook Delivery Program. A total of 35 million textbooks are currently being delivered to schools throughout the country. By engaging a variety of organizations such as parent-teacher associations and NGOs and--importantly--publishing a detailed list of when textbooks are going to be delivered in each province (Figure 5), the government hopes to use the power of information to ensure that textbooks make it on time to schools and students (Transparency Accountable Governance, 2003). Another way of using information has been to use "citizen report cards". Producing information through report cards provides a way to aggregate and give expression to the voices of the poor, which can then feed into the design of new policies. Citizen report cards were developed by a civil society NGO in Bangalore, India in 1993 to galvanize action to improve the quality of public services in that city (Paul 2002). Surveys of users rating their experiences with public services were organized and publicized as "report cards". The survey results--revealing poor quality, petty corruption, lack of access for slum dwellers, and the hidden costs of outwardly cheap services--were widely publicized by an active press. The report cards opened a dialogue between providers and user Making Services Work in East Asia and the Pacific 58 V. Evaluation: a role for national governments and the country. These evaluations inform policymakers donors throughout the world of the potential for innovations to be successful. They therefore have a large element of being This Special Focus has discussed a variety of global public goods--which helps explain why they are so approaches to making services work--building the power of scarce. If they are global public goods, then the clients, ensuring that providers serve poor people, international community--donors--should subsidize them. promoting the ability of clients to hold policymakers accountable. A variety of policy instruments can be used but no one approach fits all countries or all services. Conclusions Innovation and experimentation coupled with rigorous Reaching the MDGs in all countries in the East Asia evaluation--finding out what works and what doesn't--is and Pacific region will rest on faster economic growth and required to improve services in a sustainable way. adequate public spending on the services that contribute to Governments are constantly trying out new approaches better health and learning--but making services work for but without evaluations they will not know whether poor people will also be required if these goals are to be outcomes changed because of the change in policy or met. In some countries the main challenge is to improve because of other reasons. Often, unfortunately, reforms are outcomes for the population as a whole. These tend to be undertaken on such a large scale as to make evaluation the poorer countries for which the goals present a reasonable extremely difficult (for example Thailand's 30 Baht health challenge. But for all countries, including those that have reform or Indonesia's "big-bang" decentralization). But set goals going beyond the MDGs, ensuring that outcomes even in cases where new policies can be phased in gradually for the poor and disadvantaged are not significantly worse there is a lack of systematic evaluation of the impacts of than the majority of the population is a priority. new policies. The example of contracting delivery of health Making services work will take different forms in services in Cambodia discussed above is a relatively rare different countries for different services. The experience case of randomized evaluation in the region. from around the world--including in the East Asia and The example of Mexico's Education, Health, and Pacific region--suggests that putting clients at the center of Nutrition Program (Progresa) shows the potential benefits the service delivery process is key to improving services for that can come from evaluation: improving program design, everyone. scaling up, and mobilizing domestic and international · This means ensuring that clients have power--financial support. The program gives cash to families if their children and informational--as in the demand-side financing are enrolled in school and mothers regularly visit health interventions in China, Vietnam, and Indonesia or the clinics for checkups, information sessions, and nutritional health facility certification scheme in Philippines. supplements for infants. Phasing in communities--a · It means ensuring that providers have the incentive to process required for budgetary purposes--in a random serve the poor as in the contracting for health service fashion allowed the construction of "control" and delivery in Cambodia, or in some decentralization "treatment" groups that could be exploited in program efforts. evaluations. The fact that these evaluations showed · It means ensuring that clients have the means to have increased school enrollment and better child health led to their demands reflected in policymaking, as in citizen popular and political support for the program. By learning report cards. what worked and what didn't the program could confidently expand into urban areas and secure international donor Finding out what instruments work to promote each of support (from the Inter-American Development Bank) to these channels should be a priority, and one that donors finance that expansion. Moreover, the program was not should support financially. Rigorous impact evaluation of abandoned after a change in government, unlike previous reforms helps learn about how to improve interventions-- programs, and clear and credible evidence of benefits but it does more than that. By producing clear and credible contributed to maintaining the integrity of the program's evidence of success, it helps consolidate reforms and design (albeit with a name change to Oportunidades). facilitates scaling up. While countries can and should innovate and evaluate in order to improve service delivery, the benefits of systematic program evaluation go beyond the program and Making Services Work in East Asia and the Pacific 59 Data Annex Annex Table 1 Absence rates among teachers and health care workers in public facilities (percent). Surveys carried out in 2002. Primary schools Primary health facilities East Asian countries in study Indonesia 18 42 Papua New Guinea 15 19 Countries in other regions Ecuador 16 - India 23* 43 Peru 13 26 Zambia 17 - Uganda 26 35 Notes: The absence rate is the percentage of staff who are supposed to be present but are not on the day of an unannounced visit. It includes staff whose absence is "excused" and "not excused" and so includes, for example, staff in training, performing nonteaching "government" duties, as well as shirking. *Average for 14 states. ­ indicates data not available. Sources: Chaudhury and others (2003), Habyarimana and others (2003), and NRI and World Bank (2003). Data should be considered preliminary. Annex Table 2: Percent of public expenditures on health and education that accrue to the poorest and richest 20 percent of the population Country Year Type of spending Poorest Richest Poorest Richest quintile quintile Country Year Type of spending quintile quintile Educatio n Health Cambodia 1996 All levels 15 29 (f) Indonesia 1987 All 12 29 (a) 1996 Primary 21 17 (f) 1987 Public health center 18 17 (a) 1996 Lower-secondary 8 38 (f) 1987 Hospital 8 35 (a) 1996 Upper-secondary 4 56 (f) 1990 All Public expenditure on health 12 29 (b) 1996 Postsecondary 2 76 (f) 1998 Primary Health Care 21 18 (c) Indonesia 1989 All levels 15 29 (g) 1998 Hospitals 10 40 (c) 1989 Primary 22 14 (g) Malaysia 1989 All Public health spending 29 11 (d) 1989 Junior Secondary 7 34 (g) Vietnam 1993 All 12 29 (e) 1989 Senior Secondary 3 56 (g) 1993 Commune health centers 20 10 (e) 1989 Tertiary 0 92 (g) 1993 Hospital inpatients 13 24 (e) 1998 All levels na na 1993 Hospital outpatients 9 39 (e) 1998 Primary 25 13 (c) 1998 Junior Secondary 16 21 (c) 1998 Senior Secondary 10 34 (c) Lao PDR 1993 All levels 12 34 (h) Vietnam 1991 All levels 12 35 (I) 1993 All levels 17 23 (j) 1993 Primary 20 17 (j) 1993 Lower-secondary 7 34 (j) 1993 Upper Secondary 2 60 (j) 1998 All levels 18 21 (j) 1998 Primary 26 13 (j) 1998 Lower-secondary 12 22 (j) 1998 Upper Secondary 4 41 (j) Sources: (a) Van de Walle, Dominique, "The Distribution of Subsidies through Public Health Services in Indonesia, 1978-87," The World Bank Economic Review, 8(2):279-309; (b) Birdsall, Nancy and Robert Hecht. 1995. 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