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11Asian Development Outlook 2010 UpdateThe Future of Growth in AsiaDonghyun ParkPrincipal EconomistEconomics and Research DepartmentAsian Development Bank

National Asset-Liability Management ConferenceSingapore29 September 2010Good morning,I will be presenting the Asian Development Outlook (ADO) 2010 Update to you today.ADO is ADBs major annual publication providing a comprehensive economic analysis of 45 economies in developing Asia and the Pacific.The ADO is hot off the press and in fact, it was officially launched in Hong Kong yesterday.2OutlineEconomic prospectsFragile global recoveryVibrant regional outlook

Special chapter:The future of growth in Asia33My presentation today will focus on economic prospects, first for the global economy, and then for developing Asia. After that, I will discuss issues related to The future of growth in Asia, which is the special theme of this ADO 2010 Update.After my presentation, I will be happy to take any questions that you may have.Key messagesDeveloping Asia is rebounding solidly with growth expected to reach 8.2% in 2010Growth momentum is slowing in major industrial economies and significant downside risks remainDeveloping Asia must again focus on long-term growthStructural policies are needed to promote productive capacity via 4 core elements trade, human capital, infrastructure, and financial development44Let me run you through the key messages of my presentation:Developing Asia is rebounding solidly from the global economic downturn. Growth is expected to reach 8.2% in 2010, underpinned by a rapid turnaround in exports, healthy private demand, and the lingering effects of expansionary fiscal and monetary policy measures.In contrast, the major industrial economiesthe United States (US), eurozone, and Japanseem to be losing steam and are forecast to grow by only 2.2% this year. Weakness in US housing markets, the specter of eurozone sovereign debt default, and risks of commodity price spikes are clouding global prospects. A second contraction in the major industrial economies is unlikely, but cannot be ruled out.As developing Asias recovery progresses, policy makers must turn their focus from managing short-term macroeconomic fluctuations to ensuring strong and sustained medium- and long-term growth. This will require policies that expand the regions productive capacity through both factor accumulation and rising productivity. Trade, human capital, infrastructure, and financial development will be key elements of that growth.Beyond the crisis, beyond the recovery, developing Asia must reset its priorities toward achieving strong and sustainable long-run growth.Economic prospectsI will now begin with the global and regional outlook.5Global conditions improved, but still fragile6saar: seasonally adjusted annualized rate6Encouraging macroeconomic developments in the first quarter of 2010 for the major industrial economies will boost the annual growth rate beyond what was projected in ADO 2010, and this Update revises the 2010 GDP growth projection for these economies to 2.2% from Aprils 1.7%. However, the recovery that looked promising early this year is starting to run out of steam, and moderation in growth is now seen for the remainder of this year. As the effects of the economic stimulus packages fade, uncertainty about the ability to sustain growth picks up. Growth in 2011 in the major industrial economies is thus expected to be more anemic than in 2010 and the forecast is maintained at 2.0%.Inflation remains subdued in the major industrial economies as restrained growth in oil prices and muted domestic demand keep inflation in check. Consumer price inflation in these economies is expected to average 1.2% in 2010 and 1.3% in 2011.United StatesEurozoneJapanMajor industrial economiesQ12008-0.72.80.91.0Q20.6-1.7-2.6-0.8Q3-4.0-2.1-4.8-3.3Q4-6.8-7.1-10.3-7.5Q109-4.9-9.6-16.4-8.6Q2-0.7-0.59.71.0Q31.61.7-0.31.3Q45.00.73.43.0Q1103.71.35.03.0Q21.63.91.52.4

Risks to the global outlookThreat of another contractionContinued weakness of the US housing marketRisk of insolvency and default in eurozoneSpikes in commodity prices77Downside risks to the wobbly industrial-country recovery remain. Slower second-quarter growth and signs of continued weaknesses in the US and Japan mean that their economic recovery is still frail. Shifting too quickly to fiscal and monetary tightening could heighten the risk of another contraction. There is also the danger that the eurozone will be unable to avoid eventual default or debt restructuring by one or more of its member economies. The lingering sovereign debt concerns have seen bond spreads widening in the blocs peripheral economies. Spikes in commodity prices remain a downside risk.Developing Asia recovered with speed and vigorForecast8In contrast to the frail recovery in advanced economies, developing Asia recovered with speed and vigor. GDP growth is now projected to rebound to 8.2% in 2010, revised up from the earlier forecast of 7.5% in April. However, with growing concerns over the strength of the global economy, the sustainability of private domestic demand, and the challenge of managing capital inflows and exchange rates, the 2011 growth forecast is maintained, at a still robust 7.3%.8due to a favorable mix of factorsStrong export recoveryRobust private demandSustained effects of stimulus policies9SIN=Singapore; MAL=Malaysia; THA=Thailand; INO=Indonesia; PHI=Philippines; KOR=Republic of Korea; HKG=Hong Kong, China; IND=India; TAP=Taipei,ChinaDriven by buoyant exports, strong private demand, and the sustained effects of stimulus policy, economies in the region performed better than expected in the first half of 2010. While the strengthening of the recovery is being felt across the region, the driving forces differ among economies. In India, growth has continued to benefit from forceful expansion of domestic demand, corporate profits, and favorable financing conditions that have stimulated investment. In tandem with the recovery in global trade, a sharp upturn in exports sparked growth in the larger ASEAN economies and the newly industrialized economies, fuelling recoveries in consumption and private investment.9But variations remain across subregionsf: forecast10The improved outlook is broad-based with projections for 2010 lifted in all subregions. Aggregate growth in the five economies of East Asia is now projected to rise to 8.6% in 2010, largely owing to recoveries in the regions open economies. In 2011, the impact of the phasing out of economic stimulus policies, slower growth in world trade, and the end of the low-base effect due to the slump indicate that East Asian GDP will increase at a more moderate 7.7%.South Asias growth prospects for 2010 have been lifted to 7.8% from Aprils forecast, mainly owing to stronger domestic demand conditions as consumer and business confidence is on the rise. For 2011, South Asias growth forecast has been cut to 7.8%. Southeast Asias bigger economies have rebounded from last years weakness at a much stronger pace than was foreseen in April. The pace of growth in several Southeast Asian economies will decelerate in 2011, due in part to the end of the low-base effect and moderation in the expansion of world trade. Aggregate growth is forecast at 5.4%, slightly better than foreseen earlier.Growth across Central Asia has revived because of higher oil prices and economic recovery in the Russian Federation, the regions major trade and financial partner. Subregional growth is now nudged up to 5.1% in 2010. At 5.7%, the forecast for Central Asia in 2011 is essentially unchanged from that made in April.The Pacific aggregate growth projection has been upgraded to 4.3% for 2010. Aggregate growth in the Pacific is seen picking up to 5.1% in 2011, slightly above the earlier forecast. 10as well as across economiesSubregion/Economy200920102011ADO 2010UpdateADO 2010UpdateCentral Asia2.74.75.15.95.7East Asia6.18.38.67.77.7 China, Peoples Rep. of9.19.69.69.19.1 Hong Kong, China-2.85.25.84.34.3 Korea, Rep. of0.25.26.04.64.6 Taipei,China-1.94.97.74.04.0South Asia6.77.47.88.07.8 India7.48.28.58.78.7 Pakistan1.2-4.1-2.5Southeast Asia1.35.17.45.35.4 Indonesia4.55.56.16.06.3 Malaysia-1.75.36.85.05.0 Philippines1.13.86.24.64.6 Singapore-1.36.314.05.05.0 Thailand-2.24.07.04.54.5 Viet Nam5.36.56.76.87.0The Pacific3.73.74.35.05.1Developing Asia5.47.58.27.37.311Prospects are bright for most regional economies.The PRC, as expected, grew at a double-digit rate in the first half of 2010. While that pace will ease in the second half, the PRC is still forecast to expand by 9.6% over the full year. Growth is projected to moderate to 9.1% in 2011.India is experiencing a surge in economic activity, prompting the central bank to tighten its monetary stance in a series of policy rate adjustments starting in January to forestall overheating. Indias growth projection is raised to 8.5% in 2010 and retained at 8.7% in 2011. 11Inflation remained stableForecast12Despite recent upward movements in food prices, inflation in developing Asia is generally within central banks comfort zones. It is expected to be subdued at 4.1% and 3.9% in 2010 and 2011, respectively. But monetary authorities will need to guard against spikes in global oil or food prices. 12Yet uneven across subregionsf: forecast13Price pressures in the PRC this year have been milder than anticipated, so that the subregional inflation forecast for East Asia is lowered a touch to 3.0%. It is maintained at this rate for 2011. South Asias inflation forecast has been increased to 7.9% for 2010. This adjustment is entirely due to very high inflation in India, where food inflation soared after poor monsoon rains in 2009 stunted agricultural output. For 2011 this Update retains the earlier projections for relative price stability to prevail in most economies, though the subregional projection has been raised to 6.5%, owing to upward adjustments in Nepal and Pakistan.Forecasts for subregional inflation in Southeast Asia are edged down to just over 4% for both 2010 and 2011, given moderate price pressures so far this year. Inflation pressures in Central Asia have been kept in check by a strengthened watch on the part of policy makers as well as by adequate food supplies. As a result, this Update marginally lowers the inflation forecast to 6.6% in 2010 and 6.4% in 2011.The subregional inflation forecast for the Pacific is raised to 5.9% for this year, with price pressures expected to ease a bit in 2011.13Current account surplus decliningf: forecast14The continued strength of domestic demand in the region will keep the overall current account surplus in the next 2 years to an average of around 4% of GDP.Current account surpluses equivalent to about 5% of East Asian GDP are still expected for this year and next.The projection of the 2010 current account deficit in South Asia is increased to 2.2% of GDP. The change is mainly due to a revision for India to 2.7% of GDP, reflecting strengthened growth and investment. The projection of South Asias current account deficit in 2011 has been increased to 2.5% of GDP. Again, the change mostly reflects reworked estimates for India.Current account surpluses of 5.7% are projected for Southeast Asia in both years.The overall Central Asian current account position is now forecast to strengthen to a surplus of 8.4% of GDP in 2010 from the earlier estimate of 7.0%, mainly due to a better outcome for oil exporters Azerbaijan and Kazakhstan. For 2011, an 8.3% of GDP current account surplus is forecast.14Strong rebound in capital flows 15Refers to aggregate data for the Peoples Republic of China; Hong Kong, China; Indonesia; Republic of Korea; Philippines; Singapore; Taipei,China; and Thailand.The strong economic recovery and the return of investors risk appetite for emerging market assets have combined to bring a surge in capital flows to developing Asia. Following a dip in late 2008 and early 2009, capital inflows to the region have since recovered. The strong rebound in capital inflows has been driven by portfolio equity flows spurred by strong economic fundamentals. The region continues to attract sizeable foreign direct investment on the back of sound long-term growth potential, improved business environment, the strength of economic reforms, and commitment to macroeconomic discipline. Other investment flows have been persistently more volatile and tend to be more susceptible to external shocks and currency instability compared to FDI and foreign portfolio investment flows. With ample local funding available, banks and nonbank corporations have shied away from foreign borrowing, thereby limiting net debt inflows. 15Exchange rates under appreciation pressure16% change from Sep2008-Sep2010% Depreciation% AppreciationNote: Based on monthly average of $ value of local currency as of 15 September 2010.1 PRC=People's Republic of China.1While capital inflows bring benefits to recipient economies, spurring investment and economic growth, their gush can also carry significant risks and challenges. By adding to reserves, significant flows to Asia are creating excessive liquidity and putting pressure on real exchange rates to appreciate. All this is complicating macroeconomic management by exacerbating trade and current account imbalances. Given their rapidly growing reserves, attention has now shifted from reserve management to reform of the global reserve system, in which developing Asias policymakers need to take their part.16Foreign exchange holdings rising17ASEAN4=Indonesia, Malaysia, Philippines, and Thailand.The regions sizable foreign exchange reserves holdings were more than adequate to cover the rollover of short-term foreign currency debt as developing Asia headed into the recent crisis. These reserves have helped to maintain investor confidence and enhance regional economies capacity to respond to external shocks. They also provided alternative policy options to stabilize currency and financial markets in the face of large swings in exchange rates.The PRCs reserves increased from $1.1 trillion in January 2007 to $2.4 trillion in June 2010.17The future of growth in AsiaOverall, developing Asias recovery seems to have taken firm hold. As the global crisis recedes, medium- and long-run growth will reassert itself as the regions top macroeconomic priority. Aggressive fiscal and monetary expansion limited the depth of the slowdown, and laid the foundation for a V-shaped recovery. The central challenge now facing the region is to transform this foundation into sustained medium- and long-run growth.18Sustaining growth in the medium- to long-term mattersLiving standards in the region remain below those of the industrialized countriesNo guarantee that developing Asias stellar growth record will carry over into the post-crisis periodThe regions long-term growth potential is not pre-defined19Medium- and long-term growth matters hugely to developing Asia. Despite its rapid precrisis growth and resilience during the crisis, the region lags far behind the industrial economies in per capita income and remains home to two-thirds of the worlds poor. Therefore, sustaining growth matters both for lifting the regions general living standards and making a further dent on its poverty.There is no guarantee that the regions stellar growth record will carry over into the post-crisis period.Indeed, the post-crisis global economy may prove to be a less benign environment for the regions export-led growth paradigm. Weaker demand from industrialized countries implies that export-dependent developing Asia cannot rely on its traditional markets at least over the medium-term. In turn, this means that a key challenge for the region will be to find new growth drivers.The regions long-term growth potential is not pre-defined. The important question now is whether the regions rapid historical economic growth can continue in the next two decades. Standard growth models predict the conditional convergence of income, implying that faster growing Asian economies will tend to grow slower as they are likely to have already achieved faster rates of factor accumulation and greater technological progress, leaving them with little room for further growth.19Its time to improve Asias long-term productive capacity Four core elements of Asias future growthTradeHuman capitalInfrastructureFinancial development20The return of long-run growth means that the regions policy makers must give higher priority to structural supply-side policies that improve the economys productive capacity by fostering factor accumulation and productivity growth. While countercyclical fiscal and monetary policies can smooth temporary output fluctuations, they cannot sustain growth over a longer time horizon. Above all, developing Asias continued transformation from a low-income capital-scarce region to a middle-income capital-abundant region may significantly affect the profile of its future growth. This growth is likely to be more balanced, where both factor accumulation and productivity growth are major contributors. Elements such as trade, human capital, infrastructure, and financial development are likely to be especially important for growth.20TradePromotes exploitation of economies of scale and better resource allocation through specialization21Central Asia=Armenia, Azerbaijan, Georgia, Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan.Southeast Asia=Brunei Darussalam, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Viet Nam.South Asia=Afghanistan, Bangladesh, India, Maldives, Pakistan, and Sri Lanka.Northeast Asia=Hong Kong, China; Peoples Republic of China; Japan; Republic of Korea; Mongolia; and Taipei,China.The Pacific=Fiji Islands, Papua New Guinea, Samoa, Solomon Islands, Tonga, and Vanuatu.East Asia=Northeast and Southeast Asia.Trade has been a core ingredient of the regions past success and will remain beneficial for both factor accumulation and productivity growth. Given their different levels of development and integration into the world economy, various parts of developing Asia need to pursue a range of strategies in order to leverage trade for growth.Compared to East Asia, however, South Asia as well as Central Asia trade less, receive less investment, and are less integrated with other countries in and outside the region. Trade costs, including tariff and non-tariff protection, are well above the regional average. The intraregional trade share is but a fraction of East Asias. And the extent of network trade is negligible.

21Trade policy should:Take full advantage of potentially large domestic consumption and intraregional trade

Expand the base of domestic production and diversify exports for Asias weaker economies22The key challenge is for production and trade networks to take full advantage of potentially large domestic consumption and intraregional trade. For South Asia, the top priorities are trade facilitation and regional integration. For Asias weaker economies, the urgent need is to expand the base of domestic production and diversify exports.

22Human capitalImproves labor productivity and facilitates technology adoption and innovation23Educational Attainment(average years of schooling)PrimarySecondaryTertiaryHuman capital promotes growth through improving labor productivity and facilitating technology adoption and innovation. Developing Asia has made significant progress in educational outcomes. The regional average, however, still falls below that of the industrial economies and masks considerable variations. Therefore, the region should continue to prioritize investments in human capital.

23Education reform agenda should:Increase investment to improve enrollment (especially secondary and tertiary) and ensure quality education

Take account of how educational systems can produce outcomes that meet the standards and skill sets required by the labor market24However, simply raising average educational outcomes may not automatically translate into higher growth rates. For investments to be effective, the design of the education reform agenda will need to take account of how the educational system is able to produce outcomes that meet the standards and skill sets required by the labor market.

24InfrastructureProvides key intermediate inputs for production and final consumption services to households25SIN=Singapore; HKG=Hong Kong, China; TAP=Taipei,China; KOR=Republic of Korea; MAL=Malaysia; THA=Thailand; AZE=Azerbaijan; SRI=Sri Lanka; PRC=Peoples Republic of China; KAZ=Kazakhstan; CAM=Cambodia; TAJ=Tajikistan; PAK=Pakistan; IND=India; INO=Indonesia; PHI=Philippines; VIE=Viet Nam; BAN=Bangladesh; NEP=Nepal; MON=Mongolia; JPN=Japan; USA=United StatesOverall, physical infrastructure stocks in developing Asia have been growing fast. However, they remain well below world-class standards in both quantity and quality. But as the substantial infrastructure investments needed may be beyond the financial capacity of governments alone, facilitating arrangements, such as publicprivate partnerships, are likely to be required.

25Infrastructure investment should:Address congestion, environmental degradation, and other costs associated with urban agglomeration

Close the wide urban-rural infrastructure divide26Demand for infrastructure services is expected to soar in developing Asias cities due to rapid urbanization. In order to keep cities competitive, investments in infrastructure need to be designed to address congestion, environmental degradation, and other costs associated with urban agglomeration. In addition, closing the wide urbanrural infrastructure divide requires improving access to basic infrastructure services, such as the provision of potable water and sanitation, in rural areas.

26Financial developmentFosters efficient allocation of resources, speeds up accumulation of physical capital, and promotes dynamic efficiency27PRC=Peoples Republic of China; BAN=Bangladesh; IND=India; INO=Indonesia; PAK=Pakistan; PHI=Philippines; THA=Thailand; OECD=high-income economies of the Organisation for Economic Co-operation and DevelopmentA widespread perception is that developing Asias financial systems substantially lag its real economy, despite a great deal of progress in the former in recent years. An equally popular perception is that the region remains financially underdeveloped relative to the industrialized countries. Comparing financial developmentas measured by total liquid liabilities, bank credit, stock market capitalization, and bond market capitalizationof some major developing Asian countries with that of OECD confirms that the region is still financially underdeveloped relative to the industrialized countries. In particular, the regions bond markets remain the least developed. Only recently have bond markets expanded rapidly, and these are due to official measures undertaken to develop local currency bond markets, including regional efforts such as the Asian Bond Markets Initiatives and the Asian Bond Funds. 27Financial reforms should:Deepen and broaden financial systems

Safeguard financial stability through strong prudential regulation and bond market development

Increase accessibility of financial services28As the relative weight of productivity growth in developing Asias growth gradually rises, its financial systems will have to evolve accordingly. The role of these systems must no longer be limited to boosting the quantity of investment but must enhance the efficiency of investment and thus contribute to productivity growth. Such an evolution requires deeper, broader, and more liquid financial systems.As the global crisis showed, financial instability can have huge consequences for growth. Therefore, it is critical that the region safeguard financial stability through strong prudential regulation and bond market development. Another priority is to make financial services more accessible to small and medium-sized enterprises and poorer households, so as to promote entrepreneurship and equality of opportunity.

28291980-20072011-2030Baseline2011-2030ReformCHINA9.35.56.6INDIA5.54.56.0KOREA6.33.94.2INDONESIA4.84.46.0THAILAND5.43.84.5MALAYSIA6.25.25.9SINGAPORE6.84.34.3Asias Actual Growth and Future Growth ProjectionsSOURCE: LEE AND HONG (2010)As the relative weight of productivity growth in developing Asias growth gradually rises, its financial systems will have to evolve accordingly. The role of these systems must no longer be limited to boosting the quantity of investment but must enhance the efficiency of investment and thus contribute to productivity growth. Such an evolution requires deeper, broader, and more liquid financial systems.As the global crisis showed, financial instability can have huge consequences for growth. Therefore, it is critical that the region safeguard financial stability through strong prudential regulation and bond market development. Another priority is to make financial services more accessible to small and medium-sized enterprises and poorer households, so as to promote entrepreneurship and equality of opportunity.

29Key messagesDeveloping Asia is rebounding solidly with growth expected to reach 8.2% in 2010Growth momentum is slowing in major industrial economies and significant downside risks remainDeveloping Asia must again focus on long-term growthStructural policies are needed to promote productive capacity via 4 core elements trade, human capital, infrastructure, and financial development3030To recap, the key messages of my presentation are:Developing Asia is rebounding solidly from the global economic downturn. Growth is expected to reach 8.2% in 2010, underpinned by a rapid turnaround in exports, healthy private demand, and the lingering effects of expansionary fiscal and monetary policy measures.In contrast, the major industrial economiesthe United States (US), eurozone, and Japanseem to be losing steam and are forecast to grow by only 2.2% this year. Weakness in US housing markets, the specter of eurozone sovereign debt default, and risks of commodity price spikes are clouding global prospects. A second contraction in the major industrial economies is unlikely, but cannot be ruled out.As developing Asias recovery progresses, policy makers must turn their focus from managing short-term macroeconomic fluctuations to ensuring strong and sustained medium- and long-term growth. This will require policies that expand the regions productive capacity through both factoraccumulation and rising productivity. Trade, human capital, infrastructure, and financial development will be key elements of that growth.Beyond the crisis, beyond the recovery, developing Asia must reset its priorities toward achieving strong and sustainable long-run growth.