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Navigating Turbulence,

Sustaining Growth

WORLD BANK EAST ASIA AND PACIFIC ECONOMIC UPDATE 2011, VOLUME 2


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WORLD BANK EAST ASIA AND PACIFIC ECONOMIC UPDATE 2011, VOLUME 2

Navigating Turbulence,Sustaining Growth


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November 2011 The International Bank or Reconstruction and Development / The World Bank

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1 2 3 4 13 12 11 10

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ISSN: 2079-5874

Key title: World Bank East Asia and Pacic Economic Update (Print)

Abbreviated key title: World Bank East Asia Pac. Econ. Update (Print)

Cover photo: Mr. You Ji, The World Bank.

WORLD BANK EAST ASIA AND PACIFIC ECONOMIC UPDATE 2011, VOL. 2


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Preface and acknowledgments

The East Asia and Pacifc Economic Updatewas prepared by a team led by Ekaterina Vostroknutova with guidance

rom Bert Homan (East Asia and Pacic Regional Chie Economist) and Ahmad Ahsan (Acting Sector Director,

Poverty Reduction and Economic Management, East Asia and Pacic Department). Team members were Antonio

Ollero, Douglas Addison, Marek Hanusch, Tehmina Khan, Manohar Sharma, Juan Feng, Trang Van Nguyen, and

Chul Ju Kim. Inputs were also provided by Ivailo Izvorski, Ashley Taylor, Frederico Gil Sander, Aira Maria Htenas, andHironori Kawauchi. World Bank country economists throughout East Asia and Pacic region provided country write-

ups and data, and assisted with the analysis.

Developing East Asia as used in this report includes China, Indonesia, Malaysia, Philippines, Thailand, Cambodia, Lao

Peoples Democratic Republic, Mongolia, Papua New Guinea, Timor-Leste, Vietnam, and the island economies in the

Pacic. The Newly-Industrialized Economies (NIEs) include Hong Kong SAR, China; the Republic o Korea; Singapore;

and Taiwan, China. Middle-income countries, as used in this report, reer to China, Indonesia, Malaysia, Philippines,

and Thailand. Low-income countries as used in this report include Cambodia and Lao PDR. The ASEAN member

countries are Brunei Darussalam, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Singapore,

Thailand, and Vietnam.

NAVIGATING TURBULENCE, SUSTAINING GROWTH


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contents

Preace and Acknowledgments....................................................................................................................................iii

Abbreviations ............................................................................................................................................................... vi

Summary 1

I Weak External Demand Slows Growth 3

Growth moderated, driven by weak eternal demand, especially in manuacturing ....................................4

Manuacturing employment ollowed output ................................................................................................ 8

Poverty is epected to decline urther ..........................................................................................................9

East Asian eports were supported by Chinas domestic demand ...............................................................9

Foreign investors sold regional equities and bonds as market volatility was rising globally........................ 12

II Policies Reocus on Sustaining Growth 15

Monetary policy: waiting to ease? .............................................................................................................. 16

Currencies under pressure, central banks losing reserves .......................................................................... 20

Fiscal policy: ne-tuning needed? ............................................................................................................... 21

III New Risks Add to Old Challenges 25

A challenging global environment ...............................................................................................................26

Increased uncertainty highlights vulnerabilities ........................................................................................... 27

Poverty reduction eorts could be hampered by ood price shocks i incomes stagnate ..........................33

Focusing on long-term growth ....................................................................................................................37

Country Pages and Key Indicators 42

Cambodia ....................................................................................................................................................42

China ...........................................................................................................................................................45

Fiji ................................................................................................................................................................48

Indonesia ..................................................................................................................................................... 51

Lao PDR ......................................................................................................................................................55

Malaysia ......................................................................................................................................................58

Mongolia .....................................................................................................................................................61

Papua New Guinea ......................................................................................................................................64

Philippines ...................................................................................................................................................67

Small Pacic Islands .................................................................................................................................... 70

Solomon Islands ..........................................................................................................................................73Thailand .......................................................................................................................................................77

Timor-Leste .................................................................................................................................................80

Vietnam .......................................................................................................................................................82

Appendi Tables .........................................................................................................................................................85

Appendi Table 1. Real GDP Growth .......................................................................................................... 85

Appendi Table 2. Real GDP and Components o Aggregate Demand ...................................................... 86

Appendi Table 3. East Asia: Merchandise Eport Growth ........................................................................ 87


iv


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Appendi Table 4. East Asia and the Pacic: GDP Growth Projections ......................................................87

Appendi Table 5. Regional Aggregates or Poverty Measures in East Asia ............................................. 88

Appendi Table 6. East Asia: Echange Rates ............................................................................................89

Appendi Table 7. East Asia: Foreign Echange Reserves Ecluding Gold ................................................. 90

Appendi Table 8a. East Asia: Balance o Payments .................................................................................. 91Appendi Table 8b. East Asia: Capital Account Components .....................................................................91

Appendi Table 9. East Asia: Nonperorming Loans ...................................................................................92

Appendi Table 10. East Asia: Financial Market Indicators ......................................................................... 93

Appendi Charts .........................................................................................................................................................94

Appendi Chart 1. East Asia: Stock Market Price Indices ...........................................................................94

Appendi Chart 2. East Asia: Local-Currency 10-Year Government Bond Yields .......................................95

Appendi Chart 3. East Asia: Foreign-Currency Government Bond Spreads..............................................96

Appendi Chart 4. East Asia: Sovereign Credit Deault Swap (CDS) Spreads ............................................97

Appendi Chart 5. East Asia: Foreign Echange Reserves and Echange Rates .......................................98

Appendi Chart 6. East Asia: Real and Nominal Echange Rates* .............................................................99


CONTENTS


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abbreviations

APEC Asia-Pacic Economic Cooperation

ASEAN Association o Southeast Asian

Nations

ASEAN+3 Association o Southeast Asian

Nations plus China, Japan, andRepublic o Korea

BAAC Bank or Agriculture and AgriculturalCooperatives (Thailand)

BI Bank Indonesia

BIS Bank or International Settlements

BOP Balance o payments

CBOE Chicago Board o Options Echange

CEIC CEIC Data Company Ltd.

CPI Consumer price inde

DOTS Direction o Trade Statistics

EAP East Asia and Pacic Region, WorldBank classication

ECA Eastern Europe and Central Asia

Region, World Bank classication

EFSF European Financial Stability Facility

EPFR Emerging Portolio Funds Research

ETFs Echange traded unds

FDI Foreign direct investment

GDP Gross domestic product

GFSR Global Financial Stability Report

IDR Indonesian Rupiah

IMF International Monetary Fund

KSEI Indonesian Central SecuritiesDepository

LAC Latin America and the CaribbeanRegion, World Bank classication

LICs Low-income Countries

MENA Middle East and North Arica Region,World Bank classication

MICs Middle-income countries

MSCI Morgan Stanley Capital International

NIEs Newly-industrialized economiesOECD Organization or Economic

Cooperation and Development

PMI Purchasing manager indices

SAS South Asia Region, World Bankclassication

SBIs Indonesia central bank bills

SOE State-owned enterprise

SSA Sub-Saharan Arica Region, World

Bank classication

SUNs Indonesia local currency bonds

TFP Total actor productivity

UN COMTRADE United Nations Commodity Trade

statisticsWB World Bank

WDI World Development Indicators

WEO World Economic Outlook

Y-o-y Year-on-year changes are changes

in levels epressed over thecorresponding period (month orquarter in relation to the requency o

the data) o the previous year

Countries

CHN China

HKG Hong Kong SAR, China

IDN Indonesia

KHM Cambodia

KOR Republic o Korea

LAO Lao Peoples Democratic Republic(PDR)

MNG Mongolia

MYS Malaysia

PHL The Philippines

PNG Papua New Guinea

SLB Solomon Islands

SGP Singapore

THA Thailand

TMP Timor Leste

TWN Taiwan, China

VNM Vietnam


vi


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Summary

Growth in developing East Asia in the rst hal o 2011 remained strong, but continued to moderate, mainly due to

weakening eternal demand. Global growth was also aected by supply shocks rom geopolitical disturbances in the

Middle East, supply chain disruptions ollowing the earthquake and tsunami in Japan, and a slower-than-epectedrecovery o private demand in crisis-aected countries. More recently, uncertainties over scal sustainability in the U.S.

and sovereign debt in the Eurozone ed nancial volatility and aected investor and consumer sentiment. Domestic

demand in East Asian economies has also been sotening, driven by the normalization o scal and monetary policy,

although it remained robust and the largest contributor to growth. We project that real GDP in developing East Asia

will increase by 8.2 percent in 2011 (4.7 percent ecluding China), while growth will slow to 7.8 percent in 2012. Risks

are on the downside, however.

Based on the still robust current growth projections, the proportion o people living on less than US$2 a day in

developing East Asia is epected to decrease to about 24 percent in 2011, down two percentage points rom 2010,

and an estimated 38 million people are projected to move out o poverty. However, poverty reduction eorts would

be hampered in the event o another sudden increase in ood prices against a backdrop o slowing income growth.

The growth slowdown was particularly pronounced in industrial production. Eports o major regional industrial supply

chains, especially electronics, have started to decline. Demand or commodities and raw materials remained strong,

helping resource-rich economies maintain high levels o eport and GDP growth. East Asia, and China in particular,

is gaining importance as a source o global demand, while rising consumer goods imports in China are beneting the

regions manuacturing eporters.

In the short- to medium-term, East Asias growth prospects are constrained by global uncertainty and by the impact

o natural disasters. The slow progress towards resolution o debt problems in the Eurozone intensied investors

concerns over global growth and stability. As capital fowed out o emerging markets into relatively saer havens,

portolio investments reversed and stock markets lost value in East Asia. Markets remain jittery, even ater the

Eurozone countries agreed on a solution or the sovereign debt and banking problems. Fiscal and nancial consolidation

in the Eurozone is likely to reduce growth in Europe, and could lead to renewed nancial outfows rom East Asia

as banks shore up their capital coverage. Credit outstanding rom European banks to developing East Asia amounts

to US$427 billion, or si percent o GDP. But high reserves and current account surpluses protect most East Asian

countries against the impact o possible renewed nancial stress.

The eects o fooding in several countries are likely to take a toll on growth this year. Because o widespread fooding,

Thailands GDP growth or 2011 was revised down to 2.4 percent, although the nal tally o the damage done is yet

to be made. Losses in production are being elt in the entire region, as the impact o the disaster is spreading through

the industrial supply chains. While reconstruction ater the food in 2012 is likely to contribute to growth, the resilienceo East Asias production networks is being tested once more. Earlier in the year, ater the March 11 earthquake and

tsunami in Japan, East Asian countries suered production losses rom disrupted supply chains in electronics and

automotive industries. However, these returned to their pre-disaster growth rates and production levels shortly ater

Japanese industry recovered in June. This time, recovery o production to pre-disaster levels in the region will also

depend on the strength o global demand or electronics and cars.

With growing recognition that the current global economic slowdown could continue into the long-term, policymakers

in East Asia are rethinking their policy options. With a ew eceptions, notably Vietnam and Mongolia, the emphasis



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has shited rom ghting infation and dealing with ecess capital infows to sustaining growth, now the dominant

concern.

In the short-term, striking a balance between stimulating growth and ghting the eects o global uncertainty is the

primary challenge. Policymakers are likely to hold o urther policy tightening and stand ready to act should urthernegative shocks to growth occur or in the etreme case o a disorderly resolution o the Eurozone debt problem.

Monetary policy normalization has already been on hold in most countries in recent months and some central banks

have started to cut ocial interest rates. In countries where the recent nancial turbulence resulted in signicant

pressures on echange rates, policymakers have also intervened in the currency markets. In this scenario it will also

be important to take precautionary steps against nancial risks arising rom sudden downward movements in asset

prices. Fiscal positions, while not as strong as beore the 2008 crisis, leave sucient space or scal stimulus in most

middle-income countries should this become necessary.

Stimulus alone will not be enough to address the likely prolonged weakness in the global economy. Slow global growth

presents an opportunity or East Asian governments to reocus on reorms that will enhance growth in the medium-

and long-term. Increasing productivity and moving toward higher value-added production can be achieved through

higher investment, including in productive inrastructure, education, and in building social security systems in most

countries. Where levels o investments are already high, increasing the quality and eciency o these investments

should be the rst priority alongside rebalancing growth towards domestic consumption. Improvements in public

investment programs and regulatory rameworks will improve the quality o investments and increase investment

rates. Further investment in disaster management and prevention is also becoming increasingly important or the

region. Any scal stimulus should promote these structural reorms that support rebalancing and domestic sources

o growth.

Once volatility in global nancial markets recedes, capital fows are likely to return to East Asia. When that happens,

a concerted eort in the region to use echange rate feibility to gain more independence in monetary policy, as

well as to shit demand towards domestic sources, could become an option yet again. Eorts to deepen regional

integration through eisting regional initiatives can boost regional trade and demand and help establish the East Asia

and Pacic regions new role in leading the global economy.


2 SUMMARY


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I. Weak External Demand Slows Growth

Developing East Asia continued to grow strongly, but economic growth

slowed in 2011 due to lower demand or its exports rom the developed

economies, and scal retrenchment and monetary tightening in the East Asian

Economies. Industrial production, notably in the electronics sector o the

middle-income countries, has been aected more severely than other sectors,

and manuacturing employment growth has slowed too. The slow progresstowards resolution o the debt situation in Europe intensied investors

concerns over growth and stability, while recent market volatility triggered

capital outfows as investors focked to saer havens, including U.S. treasury

bonds. Portolio investments in East Asia have started to reverse and stock

markets have lost value. Bank fows kept up well, but could yet turn lower as

European banks will need to absorb losses and increase capital coverage in

the wake o any denitive Eurozone settlement. At this critical juncture, Chinas

robust domestic demand is supporting growth in the region, particularly

through imports o manuactured goods as well as commodities. China is also

importing more consumer goods, which presents a new opportunity or the

regions exporters.



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Growth moderated, driven by weak external demand, especially in manuacturing

Slower expansion in demand in developed countries, the withdrawal o scal stimulus in the region, and

tighter monetary policy combined to put a brake on growth in developing East Asia in 2011. Real GDP growth

in the developing economies in the region, ecluding China, slowed to 4.5 percent in the second quarter o 2011, rom5.7 percent in the ourth quarter o 2010 (Figure 1). For developing East Asia as a whole, growth ell rom 9.1 percent

in the last quarter o 2010 to 8.5 percent in the second quarter o 2011. Where third quarter data became available,

the same trend as in the rst hal o 2011 persisted. In China, growth slowed to 9.6 percent in the rst hal and even

urther to 9.1 percent in the third quarter o 2011, down rom 9.8 percent in the last quarter o 2010. In Indonesia,

the year-on-year growth rate in the third quarter was the same as in the rst hal o 2011. Growth in resource-rich

economies was more robust than in those that eport manuacturing products (Figure 2).

Slower growth refects weakening external demand. Growth in the Association o Southeast Asian Nations

(ASEAN) countries was constrained by weak eternal demand (Figure 3). For China, eternal demand growth slowed

down rom nearly 40 percent in early 2010 to 10 percent in the third quarter o 2011 (Figure 4). Driven by the same

actors, Hong Kong SAR, China, has narrowly missed a recession in the third quarter, contracting in the second and

barely growing in the third quarter.

While weakening recently, domestic demand in the middle-income countries was still the largest contributor

to growth. Growth in domestic demand also slowed, but remained more robust than eternal demand in 2011. Thiswas especially true in China, where domestic demand grew by 10.7 percent in the third quarter, slightly higher than

9.7 percent growth in the same quarter o 2010 (Figure 4, Figure 5).1 Chinas investment growth has returned to

its pre-crisis level, as stimulus was withdrawn. Real consumption growth also was waning, most notably in 2011,

reaching pre-2008 crisis growth rates (Figure 5). Domestic demand in ASEAN has been slowing gradually ater

reaching a peak o 12 percent in rst quarter o 2010, easing to just under ve percent in the second quarter o 2011.

1 Domestic demand was calculated as GDP less net trade and is defated by the GDP defator.

Fi 1. Real GDP growth moderated in most o developing EastAsia...

Real GDP growth, in percent, year on year

Developing East Asia excluding China China

Sources: Haver Analytics and World Bank sta calculations.Note: The developing countries included the gure are Indonesia, Malaysia, Philippines,Thailand and Vietnam. Not seasonally adjusted.

Fi 2. ...especially, among manuacturing exporters

Real growth rates, in percent

Manuacturing Resource rich.

Sources: World Development Indicators (WDI) and World Bank sta.Notes: 2011 data are rom World Bank projections. Manuactures include Cambodia,Malaysia, Thailand, Philippines, and Thailand. Resource rich countries include Indonesia,Laos, Mongolia, PNG, Timor-Leste, and Vietnam.

16

14

12

10

8

6

4

2

0

-2

Q1-07 Q3-07 Q1-08 Q3-08 Q1-09 Q3-09 Q1-10 Q3-10 Q1-11 Q3-11

n/a

2000

8

7

6

5

4

3

2

1

0

-1

-2

2 00 1 2 00 2 2 00 3 2 00 4 2 00 5 2 00 6 2 00 7 2 00 8 2 00 9 2 01 0 2 01 1


4


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Nevertheless, domestic demand was the key driver o growth, more than osetting the negative contribution rom

net eports in Malaysia and the Philippines in the rst hal o 2011 (Figure 6).

The growth slowdown was more pronounced in the industrial sector o the middle-income countries,excluding China. Output among the low-income countries is responding to the global malaise with a lag (Figure

7). Real growth in industrial value-added goods produced by the middle-income countries in East Asia (ecluding

China), slowed by 1.9 percentage points in the rst quarter o 2011, and by another 2.7 percentage points in the

second quarter (Figure 8). Some o this sotening was due to supply chain disruption ater the devastating earthquake

and tsunami that hit Japan in March. For eample, production o small cars ell by seven percent between April and

August 2011 due to these disruptions (see Bo 1). Industry growth remained relatively stable in China during the rst

hal o this year.

Fi 3. Domestic and external demand in ASEAN moderatedater peaking in 2010...

Percent change, constant prices, year-on-year

Developing East Asia excluding China China

Sources: Haver Analytics and World Bank sta calculations.

Fi 4. ...but growth in external demand or Chinas exportshas slowed even aster

Percent change, constant prices, year-on-year

Manuacturing Resource rich.

Sources: Haver Analytics and World Bank sta calculations.

40

30

20

10

0

-10

-20

Q1-07 Q3-07 Q1-08 Q3-08 Q1-09 Q3-09 Q1-10 Q3-10 Q1-11 Q3-11 Q1- 07 Q3- 07 Q1- 08 Q3- 08 Q1- 09 Q3- 09 Q1- 10 Q3- 10 Q1- 11 Q3- 11

40

30

20

10

0

-10

-20

Fi 5. Real growth in consumption and investment has beenslowing in the middle-income countries...

Real real growth, rom indices, year-on-year, in percent

Consumption, China Consumption, Other MICs

Investment, China Investment, Other MICs

Sources: Haver Analytics and World Bank sta calculations. MICs include Indonesia,Malaysia, the Philippines, and Thailand.Note: Chinas consumption is retail sales (NSA, 100 Mln Yuan) defated by the CPI(NSA). Chinas investment is rom nominal, cumulative NSA, 100 Mln Yuan, convertedto incremental, and defated by the GDP price inde (NSA).

Fi 6. ...but still drove growth in the rst hal o 2011

Real growth contributions, year-on-year, in percent o GDP

Consumption Gross Fixed Captial Form. Incr. in Stocks

Net Exports GDP

Sources: Haver Analytics, IMF, and World Bank sta calculations.

40

30

20

10

0

-10

Q 1- 07 Q 3- 07 Q 1-08 Q 3- 08 Q 1- 09 Q 3- 09 Q 1-1 0 Q3 -1 0 Q 1- 11

8

4

6

2

0

-2

-4

Indonesia MalaysiaPhilippinesThailand


I. WEAK ExTERNAL DEMAND SLOWS GROWTH


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Growth in the second hal o 2011 is expected to be

more modest than earlier in the year, especially in

the manuacturing sector. Manuacturers sentiment

remains weak and refects lingering uncertainty about

nancial problems and slow economic recovery in

the developed economies, and the impact o natural

disasters on economic prospects domestically. Output

in the Eurozone contracted by 2 percent in September,

and the purchasing manager indices (PMI) declined in

October indicating that a stronger contraction could

ollow in the ourth quarter. PMIs in China, newly-

industrialized economies, and the U.S. (each major

eport markets or East Asia countries), dropped

through the 50 percent threshold in the third quarter,

indicating that a contraction in the near uture is possible

(Figure 9).2 In addition, capacity utilization was close to

its pre-crisis peak in most middle-income countries, and may act as a brake on epansion as well. As predicted in

the previous issue3 o the Regional Update, the economic impacts o the Tohoku earthquake in Japan have mostly

dissipated (see Bo 1) but the lingering eects o fooding will take a toll on growth this year. In Thailand, eceptionally

strong fooding is epected to reduce growth by one percent o GDP in 2011 (see Bo 1). However, reconstruction in

2012 is likely to contribute to growth (see Chapter III or growth projections).

2 Preliminary monthly data indicate that in October 2011 Chinas PMI has increased to just above 50.

3 Securing the Present, Shaping the Future, EAP Economic Update, March 2011, World Bank, Washington DC.

Fi 7. The slowdown in the middle-income countries,excluding China, is more pronounced...

Real GDP growth, in percent, year on year

MICs excluding China 4 LICs Pacic Islands

Sources: Haver Analytics and World Bank sta calculations.Note: Low-income countries are: Cambodia, Laos, Mongolia, and East Timor. MiddleIncome countries are: Indonesia, Malaysia, Philippines, Thailand and Vietnam.

Fi 8. ...because o weakening industrial production

Industrial production growth, in percent, year on year

Middle Income and Vietnam, exclud ing China China

Sources: Haver Analytics and World Bank sta calculations.Note: The developing countries included the gure are Indonesia, Malaysia, Philippines,Thailand and Vietnam. For China, gross industrial value added inde is used, 2005=100.

2000

12

10

8

6

4

2

0

-2

-4

2 00 1 2 00 2 2 00 3 2 00 4 2 00 5 2 00 6 2 00 7 2 00 8 2 00 9 2 01 0 2 01 1

20

10

0

-10

Q1 -0 7 Q3 -0 7 Q 1-0 8 Q3 -0 8 Q1 -0 9 Q3 -0 9 Q 1-1 0 Q 3-10 Q1 -1 1

Fi 9. Manuacturers sentiment deteriorated in the thirdquarter

Purchasing Manager Indices

China Hong Kong SAR, China Korea, Rep.

Singapore Taiwan, China

Source: Markit.

65

60

55

50

45

40

35

30

3/07 9/07 3/08 3/09 3/10 3/119/08 9/09 9/10 9/11

below 50indicatescontraction


6 I. WEAK ExTERNAL DEMAND SLOWS GROWTH


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Box 1 Natural disasters are aecting growth and regional production networks

In Thailand, widespread fooding has reached Bangkok and surrounding provinces, which together produce close to

40 percent o Thailands GDP. As a result o the food, GDP growth in 2011 was revised down rom an earlier orecast

o 3.4 percent to 2.4 percent. The damages are estimated to be up to our percent o GDP, including two percent

in industrial estates that are part o the regional supply chains, 0.4 percent in agriculture, and 0.6 percent in retailindustry and tourism.

As this report is going to print in mid-November, the fooding has aected over 1,000 manuacturing plants in si

industrial estates. Several international rms have warned that they will have to increase prices as a result o anticipated

shortages. Several actories have closed, and Western Digital Corporation (a major producer o hard drives, with

60 percent o its production situated in Thailand) has warned that current supplies will last or only one month. The

food is also aecting automotive supply chains. Plant shutdowns had already cut carmaker Hondas world output by

ve percent and halted its production in Malaysia, due to lack o parts.

It is not the rst time this year that the resilience o East Asian supply chains has been tested by natural disaster.

Japan was struck by a magnitude 9.0 undersea earthquake on March 11, 2011. It was the most powerul earthquake

to have hit Japan, and one o the ve most powerul earthquakes in history. The earthquake was accompanied by

etremely powerul tsunami waves that devastated many low-lying areas in Japan and resulted in tremendous human

loss (15,824 dead and 3,824 missing, as o October 18, 2011). Many adverse economic consequences ollowed,

including the loss o some power generating capacity and concern over nuclear contamination. Consumer condence

and several sectors o production have suered as a consequence. The automotive industry was hit particularly hard

when the Renesas plant in Tohoku, which produced 40 percent o the worlds microcontrollers, was destroyed,

halting car production around the world. Other East Asian countries suered economic loss rom the disrupted supply

chains in electronics and automotive industries. In Thailand, or eample, small car manuacturing swung rom growth

at 46 percent in February 2011 to a 40 percent decline in April. Some other industries were similarly aected, such as

the manuacture o galvanized metal sheets.

By June 2011, however, the aected industries in Japan had recovered to their pre-disaster levels o output (Bo

Figure 1). Shortly ater that, the aected sectors in other countries returned to their pre-disaster growth rates and

production levels (Bo Figure 2). Whether the levels o production in Thailand can recover in the coming months

remains to be seen, and will depend on demand or electronics and cars, which in turn is linked the global growth.

Like in the case o Tohoku, reconstruction ater the Thai food is likely to be benecial or growth in 2012.

Production networks are serving the region well, as they reduce costs o production through diversication and

specialization. But their resilience has been tested by a series o natural disasters, eposing the vulnerability o these

comple production processes to eternal shocks. As the reconstruction ater the Tohoku earthquake is ongoing,

international companies are developing strategies to make their operations more resilient to catastrophes. They are

planning to increase inventories, develop technologies that are easier to substitute in case o a disaster, andmost

importantlyintensiy their connections to other economies in the region to diversiy supplies.

Bx Fi 1. Production recovered in Japan

2011 Volumes change, as percent o 2010 volumes

Semiconductor or devices Passenger cars Chemicals Manuacturing, total

Source: Ministry o Economy, Trade and Industry o Japan.

Bx Fi 2. Six months ater the Japan disaster, Thaiautomotive industry was growing at pre-disaster ratesGrowth (percent)

Manuacturing o small cars (


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Manuacturing employment ollowed output

Growth in manuacturing employment began slowing, ollowing dissipation o stimulus eects and global

easing o manuacturing trade.4 Ecepting Malaysia, growth in manuacturing employment has started to slow,

which is also a natural consequence o capacity utilization that is reaching pre-crisis levels. However, employmentgrowth remained below pre-crisis levels in the low-income countries (Figure 10, Figure 11). In the Philippines, this

was due to the act that the electronics sector, which contributes over a hal o gross eports, has not recovered

rom the recent crisis, and workers moved into service sector jobs, which serve as a saety net during downturns.5

Contraction in manuacturing employment in Thailand was due to a shit o unskilled workers toward the agriculture

4 See Chapter II or scal policy analysis.

5 See Securing the Present, Shaping the Future, EAP Economic Update, April 2011, World Bank, Washington DC.

Fi 10. Manuacturing employment growth is slowing, andwas negative in Thailand in the rst hal o 2011...

Annual employment growth by sector, percent

Agriculture Industry Services

Source: CEIC.

Fi 11. ...and is still below pre-2008 crisis levels in manycountries

Inde, 2007=100

2008 2009 2010 H1 2011

Sources: CEIC, Cambodia Ministry o Commerce, and Cambodia National Institute oStatistics.Note: Cambodias manuacturing employment is measured as employment in thegarment industry.

20

15

10

5

0

-5

-10

-15

China09'H1

Malaysia Philippines Thailand10' 11' 09' 10' 11' 09' 10' 11' 09' 10' 11'H1 H1 H1 H1 H1 H1 H1 H1 H1 H1 H1

115

110

105

100

95

90

85

80

Cambodia China Indonesia Malaysia Mongolia Philippines Thailand

Fi 12. Unemployment rates continued to decline across themiddle-income countries...

Unemployment rate (percent)

2008 2009 2010 H1 2011

Sources: World Bank sta calculations using data rom CEIC, Haver Analytics, andThailand National Statistical Oce.Note: Mongolias unemployment rate is the annual average rom the Labor ForceSurveys by the National Statistical Oce o Mongolia.

China Indonesia Malaysia Mongolia Philippines Thailand

12

10

8

6

4

2

0

Fi 13. ...while real wages continued to trend up

Inde, Q1 2007=100

Cambodia China Indonesia

Malaysia Mongolia Thailand

Sources: World Bank sta calculations using data rom CEIC, Haver Analytics,Cambodia Ministry o Commerce, and Cambodia National Institute o Statistics.Note: Only garment workers wages or Cambodia.

160

150

140

130

120

110

100

90

80

70

60

Q1 -0 7 Q3 -0 7 Q 1-0 8 Q3 -0 8 Q1 -0 9 Q3 -0 9 Q 1-1 0 Q 3-10 Q1 -1 1




17/110

sector, which has been eperiencing strong growth ater the crisis. Total employment continued to grow, however,

perorming best in Indonesia, Malaysia, and Thailand (Figure 12).

Real manuacturing wages kept growing, albeit at slower rates than in 2010. Wages in most countries in the

region have recovered to their pre-crisis levels and have continued on an upward trend (Figure 13). In China, realmanuacturing wages trended up, although there was some cyclical slowdown in the second quarter o 2011. In

Mongolia, however, surveys o inormal sector workers show that their real wages stagnated ater the crisis, so that

earnings were insucient to meet basic needs.

Poverty is expected to decline urther

Based on the projected GDP growth, the proportion o the population living on less than US$2 a day in

developing East Asia in 2011 is expected to decrease by 2.2 percentage points to 24.3 percent rom 26.5 percent

in 2010. Based on current growth orecasts (see Chapter III), it is estimated that 38 million people in developing East

Asia will emerge out o poverty by the end o 2011 (Figure 14, Figure 15). However, poverty reduction eorts would

be hampered in the event o another increase in ood prices, i incomes stagnate.

East Asian exports were supported by Chinas domestic demand

As a result o sluggish external demand or their nal products, exports o the three major regional industrialsupply chains, especially electronics, have experienced a severe slowdown. Advanced economies imports

have grown by just two-to-our percent a year, while European imports contracted in the third quarter o 2011 (Figure

16). As these major sources o global demand are slowing, they particularly aect eports o the main production

networks in East Asia, most importantly electronics eports which ell in September, ollowing contractions in apparel

and oce machines earlier in the year (Figure 17). Monthly eports o electronics rom the Philippines contracted by

40 percent on average (compared to a year earlier) since the start o 2011; eports o telecommunications equipment

rom Thailand ell by 30 percent in September, and eports o oce machines and computers in Malaysia and

Indonesia contracted by over 20 percent during some months in 2011 compared to a year earlier.

Fi 14. Poverty is projected to urther decline, despite slowinggrowth...

Poverty headcount ratio (percent o population)

East Asia East Asia excluding China

Source: PovcalNet and World Bank sta calculations.

Fi 15. ...and 38 million people will escape pover ty in 2011

Millions o persons living on less than US$2 a day

East Asia Developing China

Source: PovcalNet and World Bank sta calculations.

60

55

50

40

45

35

30

25

20

2 00 2 2 00 3 2 00 4 20 05 20 06 2 00 7 2 00 8 2 00 9 2 01 0 20 11 2 01 2

54.1

50.7

47.9

46.1 46.8

41.8

39.738.4

36.3 3533.4

52

47.1

42.7

39.1

34.3

32.1

29.4

26.5

24.322.4

37.4

2007 2008 2009 2010 2011 2012

633

412

597

551

499

461428

384

342

300

268242




18/110

Demand or commodities and raw materials remained strong, however, helping resource-rich economies

achieve high levels o export growth. While combined East Asian eports grew on average by 20 percent in 2010,

there has been variation across countries (Figure 18). Commodity eporters registered higher eport growth rates

than other countries, most notably Mongolia which eports nearly all its commodities to China (mostly coal and

copper, Figure 19).

East Asia, and China in particular, continued to grow in importance as a source o global demand. Since the

nancial crisis battered developed economies, Chinas share in world imports has consistently grown, approaching

its share o 10 percent in global GDP (Figure 20). It now imports almost as much as the European Union, the worlds

largest single market. Chinas trade surplus also dropped by about 30 percent between 2007 and 2010 (Figure 21).

Chinas growing demand or imports, especially o consumer goods, presents a new opportunity or the

regions exporters. As its trade surplus declined, Chinas imports or domestic needs grew aster than imports

Fi 19. ...driven by strong perormance in the ore, metal, andenergy sectors

Resource eports, growth rate and resource eports to China, in percentage ototal resource eports

Ore, metal and uel exports, growth rate, 2010/2009 Total exports, growth rate, 2010/2009

Ore, metal and uel exports t o China, % o ore, metal and uel exports (R HS)

Source: U.N. COMTRADE.

Fi 16. External demand is barely growing...

Imports, US$ terms, change, in percent, year-on-year

United States European Union Japan

Source: Haver.

Fi 17. ...and it is dragging down exports o electronics

Eports, US$ terms, change, in percent, year-on-year

Oce machines and computers (SITC 75) Telecommunications equipment (SITC 76)

Electrical machinery and apparatus (SITC 77) Road vehicles and parts (SITC 78)

Apparel and clothing accessories (SITC 84)

Source: CEIC.

8

6

4

-2

-4

2

0

-6

-8

-10

-12

-14

1/08 8/08 3/09 5/1010/09 12/10 7/11 1/08 7/08 1/09 7/09 1/10 7/117/10 1/11

80

60

40

20

0

-20

-40

-60

Fi 18. Commodity exporters recovered aster to their pre-crisis export growth rates than other countries...

Average year-on-year monthly growth in eports

200608 H1 2009 H1 2010 H1 2011 H1

Source: CEIC.

100

80

60

40

20

0

-20

-40

-60

KHM MYS VNM THA CHN IDN MNGPHL

120

100

80

60

40

20

0

-20

-40

MNG MYS PHL IDN LAO THA VNM




19/110

or processing and re-eport (Figure 22). Its imports

o consumer goods have also been growing rapidly,

with emerging East Asian countries currently holding

18 percent o this market (Figure 23, Figure 24).

Chinas growing consumer goods market represents a

potentially signicant new opportunity or East Asian

eporters, i it continues to epand rom its low base o

just two percent o the world consumer goods market.

Raising Chinas private consumption by ve percentage

points o GDP is estimated to be associated with an

improvement in the trade balance o Chinas regional

trading partners by between 0.1 percentage points

o GDP (in Indonesia) and 0.5 percentage points (in

Malaysia).6 Highlighting Chinas importance to the

region, its trade balance with developing East Asia

improved in East Asias avor during the recovery

(Figure 21).

Regional domestic demand is expected to support export growth going orward, but it cannot ully

compensate or the eects o global slowdown and uncertainty. Even though broad trade indicators have been

upbeat in the rst hal o 2011, some worrisome signs have emerged. In September, eports rom Hong Kong SAR tomainland China contracted by 7.3 percent, compared to a year earlier. Due to its position at the center o production

chains, this could be an indication o rockier times ahead or regional trade.

Remittances into developing East Asia have remained resilient at mid-year, helping recipient countries

maintain current account surpluses. However, economic weakness in the U.S. and in the Eurozone, which are

6 IMF, 2011, China: Spillover Report or the 2011 Article IV Consultation and Selected Issues, Washington DC.

Fi 20. Chinas rising share in worlds imports puts it oncourse to surpass Europe as the second largest importer...

Percent

China impor ts, % world impor ts China impor ts, % o EU impor ts (R HS)

Source: CEIC.

Fi 21. ...and Chinas imports rom developing East Asia havealmost recovered to pre-crisis levels

Merchandise trade, US$ billions

Chinas tr ade balanc e wit h world Dev. EAs trade balance wit h wor ld

Dev. EAs trade balance with China (RHS)


12

10

8

6

4

2

0

90

80

70

60

50

40

30

20

10

0

2007 2008 2009 2010 JanAug 2011

350

300

250

200

150

100

50

0

30

25

20

15

10

5

0

2004 2006 2008 201020022000

Fi 22. Chinas imports or domestic needs grew aster thanthose or processing and re-export

Imports, US$ billions per month

Ordinary trade Processing trade

Source: Haver.

100

90

80

70

60

50

40

30

20

10

0

1/08 8/08 3/09 10/09 12/105/10 7/11




20/110

the biggest hosts to migrant workers rom developing economies, may depress remittance fows this year. In the

Philippines, the worlds ourth-largest remittance recipient ater India, China, and Meico, remittances stood at

US$13 billion through August, growing by 6.9 percent compared to a year earlier. Healthier fows rom Asia and the

core Eurozone countries compensated or weaker fows rom the U.S. However, remittances growth in the region is

projected to settle at around si-to-seven percent this year, below its historical average, with lower fows rom the

Middle East also playing a part.

Foreign investors sold regional equities and bonds as market volatility was rising globally

Portolio investment in East Asia continued to grow

through the rst hal o 2011, but in August and

September, international equity and bond unds

sold o an estimated three percent o their portolio

positions in emerging East Asia. Risk aversion grew,

driven by the debt crisis in the Eurozone, and the stock

market slide in September triggered a rush by investors

to relatively sae assets, notably U.S. government

bonds (Figure 25). East Asian markets were recently

dealing with high infows o hot capital (Figure 26).

But they also were among the most aected by thisfight to saety, and the subsequent outfow o these

short-term unds highlighted the vulnerability o the

region to the events in Europe. During August and

September, international mutual unds and echange

traded unds (ETFs) unloaded around US$13.1 billion o

their holdings o emerging East Asian equities and bonds, equal to about three percent o their holdings in the region

(Figure 27). Fund fows rom mutual and ETFs represent, on average, about one-third o equity fows and one-th o

bond fows reported on balance o payments basis.

Fi 23. Chinas imports o consumption goods grew at anaverage annual rate o 14 percent in the past 15 years, comparedwith the world average o 6 percent...Imports o consumption goods, percent change year-on-year

World China


Fi 24. ...and most countries in the region have at least a onepercent share o this market

Chinas imports o consumer goods rom selected sources, in US$ billions, and inpercent o Chinas total consumer goods imports

In US $ billions (L HS) In per cent o C hines e c onsump tion goods impor ts (R HS)


40

30

20

10

0

-10

-20

2001 2004 2007 201019981995

6

5

4

3

2

1

0

14

10

12

8

6

4

2

0

USA DEU KOR THA HKG VNM SGP IDN M YS P HLJPN

Fi 25. As market volatility increased ater an escalationo the Greek debt crisis in May, investors rushed to the relativesaety o U.S.Treasury bondsMarket volatility inde and bond yields

Market volatil ity index (CBOE VIX) (LHS) U.S. Treas., 10-yr, y ie ld (RHS)

German govt., 10-yr, yield (RHS)

Source: Chicago Board o Options Echange (CBOE) and Thomson Datastream.

60

50

40

30

20

10

0

4

2.5

3

3.5

2

1.5

1

0.5

0

1/3/11 6/3/11 11/3/11




21/110

Capital market indices in the region dropped sharply. While capital fows to the region had helped deepen and

broaden some o the local equity markets, they also increased the sensitivity o the regions equities to global events

(see Chapter III). Share prices have become more volatile, and some East Asian markets ell more sharply than those

in the advanced economies (Figure 28, Figure 29). Since the Greek crisis intensied in May this year, the losses in

the region varied, alling by between 21 percent (Hang Seng in Hong Kong SAR, China) and three percent (Philippine

PSEi) between May and November.

Foreign direct investments (FDI) remained strong in the rst hal o the year. These are driven by structural,

rather than cyclical, actors and are thereore the least volatile o all investment fows. FDI infows increased in

the second quarter and outward FDI fows have also held relatively steady as residents in Malaysia, Thailand, and

Indonesia invested abroad earlier in the year. Chinas outward investments are still remarkably small relative to its

Fi 26. Ater buoyant portolio infows during the rst hal othe year...

Net capital infows, BOP terms, US$ billions

FDI, net Portolio investment, net Other investment, net

Source: IMF.

Fi 27. ...oreign investors withdrew at least 3 percent o totalportolio investment in August and September

Net equity and bond purchases by international mutual and ETF unds, weekly, inUS$ millions

Indonesia Malaysia Korea Philippines China

Thailand Singapore Hong Kong SAR, China Vietnam Taiwan, China

Source: Emerging Portolio Fund Research (EPFR).

2003 2005 2007 20091 99 9 20 011 99 5 19 97

300

250

200

150

100

50

0

-50

-100

-150

-200

H1-

2011

H1-

2010

4,000

3,000

2,000

1,000

0

-1,000

-2,000

-3,000

-4,000

-5,000

1/5/11 3/9/11 5/11/11 7/13/11 9/14/11

Fi 28. The regions equity prices dropped by more than aquarter rom their May high...

Equity price indices, in U.S. dollar terms

MSCI Far East excluding Japan MSCI All-country world

Source: Morgan Stanley Capital International (MSCI), via Thomson Datastream.

Fi 29. ...as more volatile emerging markets ell sharper thanthose in the advanced economies

Stock price indices, percent change

Years peak-to-date (Apr/MayNov)

Source: Thomson Datastream.

1,600

1,400

1,200

1,000

800

600

400

200

0

1/00 9/01 5/03 1/05 5/089/06 1/10 9/11

0

-5

-10

-15

-20

-25

HKG TWN KOREUROPE

(STOXX 600) THAJPN

(NIKKEI 225) SGPUSA

(S&P500) MYS IDNCHN PHL




22/110

GDP and are concentrated in the natural resource sector.7 However, the projected US$8 billion o outfows in 2011

include investments in high-tech rms in Europe, most recently in Swedens Volvo Group.

Bank credit fows remained stable through the rst hal o 2011 but represent an important risk, should

European banks start deleveraging. As discussed in Chapter III, even i a denitive Eurozone settlement isimplemented successully, European banks would likely need to deleverage and could reduce eposure to emerging

markets. During the 2008 crisis, international banks reduced their eposure to developing East Asias non-bank private

sector by US$36 billion between mid-2008 and the rst quarter o 2009 (Figure 31). An impact o similar proportions

now could mean that over US$30 billion dollars fow out, constraining credit available to the private sector.

7 See Robust Recovery, Rising Risks, East Asia and Pacic Economic Update, November 2010, World Bank, Washington DC.

Fi 30. Inward FDI fows were robust in the rst hal o 2011

Inward and outward FDI fows, balance o payments basis, in US$ billions

Indonesia Malaysia Philippines Thailand China (RHS)

Source: Haver Analytics.

Fi 31. International bank fows to East Asia are vulnerable topotential reversals should European banks start deleveraging

Changes in eternal claims o BIS reporting banks on non-bank private sector,echange rate adjusted, in US$ billions

China Indonesia Malaysia Philippines Thailand Vietnam

Source: BIS, Locational Banking Statistics.

15

10

5

0

-10

-5

-15

80

40

60

20

0

-20

-40

Q4-09 Q2-10 Q4-10 Q2-11

Inward FDI

Outward FDI

30

20

10

0

-20

-10

-30

3/07 9/07 9/08 3/09 9/09 9/10 3/113/103/08




23/110

II. Policies Reocus on Sustaining Growth

The global economic malaise has led policymakers to rethink their policies

during the last six months. Fighting infation and dealing with excess capital

infows that drove currency appreciation was a key priority beore. Now

the emphasis is on supporting growth. Monetary tightening is on hold, and

currencies have weakened in nominal terms. A tapering in capital infows

will initially help central banks manage infation. While real interest rates arenegative in nearly all East Asian countries, some are preparing or a round o

monetary easing to cushion the impact o global weakness. Others will likely

balance global risks against those rom easing too soon and will be reluctant

to cut interest rates unless there is an abrupt deterioration in growth. When

capital fows return, however, a concerted eort in the region to use exchange

rate fexibility to gain more independence in monetary policy and shit

demand more towards domestic sources could be an option o choice. The

current global slowdown could continue into the long- term, and as such, the

case or a stimulus is weaker this time around. Should the need arise, however,

scal space is available to promote the structural transormation needed

to sustain more domestically-driven growth. With or without the stimulus,

policymakers will need to sharpen their ocus on addressing the challenges o

long-term growth.



24/110

Monetary policy: waiting to ease?

Ater months o tightening, central banks in the region have halted interest rate hikes. During the last si

months, infation was accelerating rapidly, orcing authorities to raise interest rates and cash reserve requirements

(Figure 32, Figure 34). Curbing credit growth, an eective instrument o monetary policy in many countries, hasalso been employed to ease infationary pressures (Figure 33). Some space or monetary tightening still remains, as

nominal rates are below their peaks and real rates are negative (Figure 35). But sustaining growth seems to be the

dominant concern among policy makers at this time.

Indonesia was the rst country to cut interest rates as it moved to protect growth in the ace o a weakening

external environment. The authorities cut interest rates both in October and November, by 75 basis points in total,

to si percent. The move was somewhat ahead o market epectations, especially because Indonesia was aected

by outfows o portolio investments in August and September (see Chapter I), but infation has been trending

Fi 32. Monetary tightening has not reached pre-crisis levels(except in Vietnam)...

Nominal policy rates

Vietnam Indonesia China Philippines

Thailand Korea Malaysia

Source: Haver.

Fi 33. ...but authorities were able to slow credit growth, akey instrument in controlling infation

3-month moving average y-o-y growth, percent

China Indonesia Malaysia Philippines

Sources: Finstats, World Bank, and Datastream.

16

14

12

10

8

6

4

2

0

1/07 9/07 5/08 1/09 5/109/09 9/111/11

40

35

30

25

20

15

10

5

0

1/07 10/07 7/08 4/09 10/101/10 7/11

Fi 34. Infation is rebounding...

Infation, in percent p.a.

2008 max 2009 min Sep-11

Source: Haver Analytics.Note: August data or Malaysia. 2008 ma is the highest value in 2008, and 2009 min isthe lowest value in 2009.

Fi 35. ...and real policy rates dropped and became negative

in most countriesPolicy rates, infation-adjusted, average in percent p.a.

Jan-10 Sep-11

Source: CEIC.

30

25

20

15

10

5

0

-5

Vietnam China Philippines MalaysiaIndonesia Thailand

6

4

2

0

-2

-4

-6

-8

China Indonesia Malaysia VietnamPhilippines Thailand


16


25/110

downwards and Indonesia has the highest real policy rates among the middle-income countries in the region (Figure

35). Although infation appears to have peaked in the region, negative real interest rates mean some countries will

likely remain reluctant to use interest rate cuts to pre-empt the impact o a global slowdown (Figure 34, Figure 35).

In Mongolia, which grew by 20.8 percent in the third quarter compared to a year earlier, overheating concerns still

dominate, with the central bank increasing interest rates in October, the third hike this year.

Food prices were the main driver o infation in

many countries, and remain a risk. International

ood prices were stuck near their 2008 peaks this

year, and rice prices were a particular concern earlier in

the year. Domestically-produced oods, such as meat

and vegetables, were also increasingly strong drivers

o infation due to supply disruptions rom foods and

animal disease. In China, monthly pork price infation

grew rom 20 percent to nearly 60 percent compared

to a year earlier since January 2011, due to the above

actors, as well as because o temporary decits

resulting rom a supply-demand mismatch and high

prices o eed (Figure 36). Chapter III o this report

takes an in-depth look at ood prices and their impact

on the poor during the 2008 crisis.

New risks have emerged as capital fows adjust to continuing uncertainty in Europe. These include increased

risks o capital fow reversals, more volatility in the equity and bond markets, as well as a possible reversal in bank

fows, should the European banking sector start deleveraging. These potential risks are discussed in more detail in

Chapter III. So ar, measures to reduce liquidity included raising reserve requirements (oten to their pre-crisis levels,

like in Malaysia) and emphasizing the use o macro-prudential measures. For eample, Indonesia earlier in the year

etended the holding period on short-term Central Bank debt instruments. It also introduced mechanisms to support

the domestic government bond market in case o a shock and in September reduced the lower band o the interest

rate corridor or monetary operations to stimulate

transactions in the domestic money market (see Bo

2). Countries have also allowed their currencies to

depreciate somewhat.

A slowing or reversal in capital infows will initially

help central banks manage monetary policy. Earlier

this year, authorities aced a challenge o maintainingstability without losing competitiveness. With capital

infows surging, high asset prices and credit growth

raised overheating concerns in some countries. In the

open economies, the reversal in fows will help. In

China, housing markets have already cooled somewhat,

driven by decisive policy interventions. But the share o

real estate loans in total bank lending is high (especially

i inormal lending is included) and a sharp all in house

Fi 36. Food prices are a large part o CPI

Shares o ood in CPI, percent

Food Energy

Source: WDI.

50

40

30

20

10

0Philippines Indonesia Thailand U.S.Malays ia China

Fi 37. Banks in Indonesia and the Philippines have limitedexposure to the housing markets

US$ billions

Real estate loans as % o total loans, 2010 Households mortgage debt as % o GDP, 2008

Total households debt as % o GDP, 2009

Sources: ADB Asian Economic Monitors, Dec 2010 and July 2009. Household debt dataor Thailand is rom the Bank o Thailand and is or 2009.

80

70

60

50

40

30

20

10

0

KOR IDN PHL CHN THA HKG MYS TWN SGP


II. POLICIES REFOCUS ON SUPPORTING GROWTH


26/110

Box 2 Capital outows during periods o international market turbulence: Indonesias recentexperience

As has been the case or many emerging economies, Indonesias eposure to global risk sentiment has risen in recent

years as oreign investors have taken on increasing holdings o domestic portolio assets (Bo Figure 1). Non-resident

investors hold roughly one-third o Rupiah government bonds (SUNs) and central bank bills (SBIs), compared to just10 percent and 25 percent in Thailand and Malaysia respectively. While reserves have been boosted by these infows,

the increased asset holdings o oreign investors also leave the economy vulnerable to outfows due to changes in

sentiment, as seen in late 2008 and May 2010.

This vulnerability was again highlighted during August and September 2011 when international market turbulence,

associated with the debt crisis in the Eurozone and a downgrade in global growth epectations, triggered a sharp

sello by oreign investors (Bo Figure 2). In total, oreign investors reduced their holdings o SUNs by US$3.3 billion

over September and o SBIs, on which there is a minimum si-month holding period, by US$1.6 billion. Overall, net

portolio outfows amounted to US$4.7 billion, prompting intervention by Bank Indonesia in the currency market and in

the domestic government bond market. This intervention drained oreign reserves by US$10 billion, or eight percent,

over September to US$114.5 billion. This decline in reserves compares with a drop o 10 percent to US$50.6 billion

during the market turmoil o October 2008.

While equity markets ell sharply (by 15 percent rom end-August to early October), the central banks intervention

helped limit the Rupiahs depreciation against the U.S. dollar to 4.3 percent to IDR 8,960 over this period. In contrast,

although one-year domestic currency government bond yields rose by over 100 basis points over the period, longer-

dated bond yields remained relatively stable and well below the levels seen in other recent periods o market stress.

For eample, ve- and ten-year yields in late September reached 6.7 percent and 7.5 percent respectively. By

comparison, in late 2008 the echange rate reached IDR 12 thousand per U.S. dollar and ve-year government bond

yields peaked at just over 20 percent.

Indonesias recent eperience highlights a dilemma or countries that intervene to support domestic bond markets

during periods o oreign investor outfows. This could smooth ecess volatility in nancial markets, which can inject

uncertainty and raise the costs o borrowing or the economy. But it could also implicitly put a foor on potential

losses or investors, creating stronger incentives or short-term infows. Continued feibility in the echange rate

can minimize any perceptions o one-way bets. Over the medium- to long-term, a urther deepening in domestic

capital markets and a widening o the domestic investor base can help to urther diversiy unding sources or both

governments and local corporations. It can also, in addition to structural reorms and investments that attract urther

FDI, play a role in reducing dependence on short-term portolio infows.

Bx Fi 1. Reserves have increased in parallel with the rise innon-resident portolio holdings

2011 Volumes as percent o 2010 volumes

Sep-08 May-10 July-11 Sep-11

Sources: BI, KSEI, CEIC and World Bank.Note: Short-term eternal debt by remaining maturity.

Bx Fi 2. Non-resident portolio outfows rose sharply inSeptember

Growth (percent)

Equities SUN SBI Reserves (LHS)

Sources: BI, CEIC and World Bank.Note: Flows or SUN (local currency government securities) and SBI (BI certicates)indicate changes in holdings.

0 5025 17510075 150125

Non-residentSBI holdings

Non-resident localgov. securities

Non-residentequity holdings

Short-termexternal debt*

Total FX Reserves

150

125

100

75

50

25

5

0

2.5

-2.5

-5

-7.5

1/08 1/09 1/10 1/11


18 II. POLICIES REFOCUS ON SUPPORTING GROWTH


27/110

Box 3 What kind o landing or China?

As the industrialized countries ear dipping into another recession, much o the prospects or inter-dependent East

Asia continue to rest on Chinas resilience. Concerns have been resuracing that this engine o regional growth might

be heading towards a sudden slowdownoten called a hard landingthat might result in a large negative growth

shock or the region and the world.

The epansionary policies that supported strong growth in the atermath o the nancial crisis also have ed a real

estate boom. Rapid credit growth may also have undermined the portolio quality o banks.More recently, successul attempts have been made

to cool parts o the economy: interest rates were

raised several times, statutory reserve ratios or

commercial banks were raised, o-balance-sheet

lending was included or determining capital and

reserve requirements, andmost importantly

growth in ormal bank lending has been constrained.

As a result, broad money growth slowed sharply,

and real estate prices have started to ease in some

markets. Because real estate is usually used by

ormal and inormal lenders as collateral or as an

investment, it is a growing risk or the banking

system and or inormal creditors. Moreover, localgovernments may be put under pressure given their

revenues rely to a considerable etent on selling land

leases or real estate development. Weakening o

land revenues could also impact local government

borrowing. Reportedly, over 30 percent o GDP has

been borrowed by local governments through special purpose vehicles, with most o it guaranteed by land and

invested in inrastructure. Because Chinese households tend to put more money down and have smaller mortgages,

a deleveraging o the magnitude seen in the U.S. is unlikely. Even so, real estate price corrections would still have

a strong impact on domestic demand and consumer sentiment. As o mid-November 2011, real estate prices had

already started declining in Wenzhou province.

Across China, residential properties are about ve-times households annual earnings, which is comparable to the

U.S. In Beijing and Shanghai, property prices eceed annual earnings thirteen- to seventeen-old, although these

markets have cooled recently (Bo Figure). The government would be reluctant to ease monetary policy to supportgrowth while infation is high. Nonetheless, markets have been worried that, should monetary conditions be tightened

urther, or growth slow more than epected, alling housing prices would result in a decline in construction activity,

and a deleveraging by ormal and inormal banking system and local governments.

Some relie could come in the planned social housing construction. Additionally, central and local governments are

working to increase land supply, and new construction starts data remains strong. Chinas economy is projected to

grow by above eight percent in 2011. The government also has ample scal space and room or monetary policy

normalization should such a need arise, more so now that infation seems to be on the wane again. As such, while

adjustments in the property markets may well happen, there could still be a sot landing or China.

prices could undermine bank balance sheets, construction and associated sectors, and household spending (see

Figure 37 or ocial lending only). I these risks were to materialize, Chinas growth could slow substantially. However,

with the scal and monetary space available and given that markets have been cooling gradually, its impacts can be

mitigated (Bo 3). The deterioration in the global environment is not helping authorities in Vietnam who have been

trying to stabilize the economy. They have slowed credit growth, tightened public spending, and raised interest ratesabove any other countrys in the region, yet infationary pressures eased only slightly (Figure 35).

Bx Fi. Housing prices cooled in large cities

Percent quarterly growth based on inde

Shanghai Beijing Hong Kong SAR, China

Source: Haver.

40

30

20

10

0

-10

-20

-30

9/05 9/06 9/07 9/08 9/09 9/10 9/11




28/110

Currencies under pressure, central banks losing reserves

Ater the European debt crisis intensied in May, currencies depreciated quickly against the U.S. dollar,

easing concerns about competitiveness. Echange rates in East Asia depreciated in nominal terms, eectively

erasing the appreciation that took place during rst hal o the year (Figure 38). Most middle-income countriescurrencies appreciated in comparison to their trading partners since beore the most recent crisis (Figure 39). Chinas

echange rate appreciated by 6.1 percent in nominal terms against the dollar, and by ve percent in real eective

terms between January 2010 and August 2011.

Foreign exchange reserves declined in September, but are still very substantial. As capital fows started

reversing and valuation adjustments took place, reserves declined (Figure 40). For eample, in Indonesia, reserves

ell by 8 percent or US$10.1 billion over September as authorities intervened in support o local currency and bond

markets (see Bo 2). Reserves in the region remain substantial, however, and should be sucient to withstand

Fi 38. Most currencies have depreciated against the US$since mid-year

Changes in local currency rates to the US$, in percent

Jul 29Nov 3 Jan 3Jul 29


Fi 39. Middle-income countries real exchange rates hadappreciated relative to their trading partners since beore the2008 crisisAppreciation o real eective echange rate, in percent

J an 20 05 S ep 20 11 J an 20 07 Se p 2 011 J an 20 09 S ep 2011

Source: IMF.

Korea

Singapore

Malaysia

Taiwan, China

Indonesia

Thailand

Philippines

Vietnam

Hong Kong, SAR China

China

-10 -5 100 5Depreciation Appreciation

35

30

25

20

15

10

5

0

-5

-10China Philippines Indonesia MalaysiaVietnam Thailand

Fi 40. Reserves declined in September in all countries,including China...

Changes in international reserves, ecluding gold, in US$, billions

Indonesia Malaysia Philippines Thailand Hong Kong SAR, China

Korea Singapore Taiwan, China China


200

150

100

50

0

-50

-100

1/10 5/10 9/10 1/11 9/115/11

Fi 41. ...but levels o reserves still provide a strong buer incase o a sudden stop

International reserves, in percent o total eternal liabilities, and in percent o GDP

Reser ves, % o ex ternal liabilities Reser ves, % o GDP


140

120

100

80

60

40

20

0

China Taiwan, China Thailand IndonesiaPhilippines Malaysia Korea, Rep.




29/110

urther shocks. For the median economy in mid-2011, they were equivalent to 50.4 percent o GDP, 8.9 months o

imports, and 35.9 percent o eternal liabilities as measured at end-2010 (Figure 41).

Fiscal policy: fne-tuning needed?

Even though policy continued to normalize, scal balances have not yet returned to their pre-crisis levels. As

countries implemented stimulus packages, primary balances ell sharply between 2006-07 and 2009. In the middle-

income countries, these declines ranged rom 1.9 percentage points in Indonesia to 4.8 percentage points in Thailand

(Figure 42). Fiscal balances improved as the stimuli were withdrawn between 2009 and 2011, but cyclically-adjusted

scal decits8 still remain at levels higher than beore the crisis (Figure 43).

Should the need arise, there is space or a new scal stimulus in most middle-income countries. General

government balances are mostly epected to improve in 2011 (Figure 44). The scal stance in the Philippines is

improving due to better ta compliance, but also due to under-spending. Vietnam is pursuing scal consolidation

as a part o macroeconomic stabilization program. Indonesias epected decit or 2011 has been revised upwards

mainly due to higher energy subsidies, but with other spending likely to all below target, the movement will likely be

moderate. The Thai government decit is also orecast to worsen, due to the impact rom the fooding and because

o higher-than-epected uel subsidies (see also Bo 1). The Mongolian scal balance is set to weaken largely due to

the introduction o universal cash transers. Debt burdens also came down in Indonesia and the Philippines between

2007 and 2011. In the Philippines, however, the debt service-to-revenue ratio remains high at 26 percent (Figure 45).Public debt burdens in Malaysia, Mongolia, and Vietnam are high and rising. In Malaysia, this refected increases

in the wage and subsidy bills that went unmatched by non-oil revenue growth, but measures have been recently

taken to address the situation. While o-budget borrowing by subnational authorities complicates the measurement

o overall (central and subnational) public debt in China, statistics are beginning to include subnational debt which

increased by 10 percentage points o GDP to 26 percent o GDP in 2010 rom 17 percent in 2007; a conservative

8 Cyclically adjusted primary balances (CAPB) are general government primary balances adjusted to lter out cyclical movements associatedwith changes in output, thus allowing a ocus on the underlying scal stance and the impact o discretionary policy.

Fi 42. Fiscal policy continued to normalize as the stimuliwere slowly withdrawn...

Primary balances, in percent o GDP

200607 2009 2010 2011

Source: IMF Fiscal Monitor, September 2011.

Fi 43. ...but cyclically adjusted scal decits are still higherthan beore the crisis

Cyclically adjusted primary balances, in percent o potential GDP

200607 2011 Change 200607 to 2011

Source: IMF Fiscal Monitor, September 2011.

43

2

1

0

-1

-2

-3

-4

-5

PhilippinesChina Indonesia Malaysia Thailand

43

2

1

0

-1

-2

-3

-4

-5

PhilippinesChina Malaysia Indonesia Thailand




30/110

estimate o the central and local government debt was thereore at around 44 percent o GDP in 2010. In the low-

income countries, there is less scal space or renewed interventions. Especially small countries, like the Pacic

islands, are not scally well-placed to deal with new eternal shocks.9 Overall, scal risks appear to be lower than in

other regions (Figure 46).

Growing costs o external borrowing could,

however, add to scal pressures in the uture. The

European debt crisis is negatively impacting emerging

markets spreads (Figure 47). As perceptions o risk

changed, spreads have grown, as have the costs o

insuring against deault (Figure 48). While spreads on

East Asian bonds are still lower than in other emerging

markets (or eample, in Latin America), sovereign

issuers with lower credit ratingssuch as Vietnam and

Mongoliacould eperience problems in obtaining

eternal nancing going orward. These risks need to

be kept in mind in designing any stimulus programs.

The slowdown in East Asias growth has already

prompted some governments to adjust their scal

strategies. Indonesia has introduced some feibilityinto its 2012 budget and allocated contingent unds

to acilitate responses to any potential slowdown. Leveraging on improved revenue collection, the Philippines

announced a US$1.7 billion disbursement acceleration plan which is speeding up eisting programs and projects,

ater alling short on programmed spending in the rst three quarters o the year. Malaysia is considering increasing

social cash transers and boosting transportation spending within the eisting scal envelope. Thailand increased

9 See specic country pages at the end o this report or more detail.

Fi 44. General government balances are mostly expected toimprove

General government balances, percent o GDP

2007 2010 2011

Source: World Bank.

Fi 45. Debt burdens are manageable in most middle-incomecountries

Percent o GDP, percent o revenue and grants, percent change

Debt 2007 Debt 2011 Interests as % revenues and grants 2011

Source: World Bank.Note: Data are or the national (central or ederal) level o government only.

1

0

-1

-2

-3

-4

-5

-6

-7Indonesia China Philippines MalaysiaThailand Vietnam

60

50

40

30

20

10

0PhilippinesChina Indonesia MalaysiaVietnamThailand

Fi 46. Fiscal risks in Emerging Asia grew compared to 2006,but are the lowest in the world

Fiscal indicators inde

Latin America Emerging Asia Emerging Europe Advanced Europe

Source: IMF Fiscal Monitor 2011.Note: Larger value o the scal indicators inde suggests higher scal risk. The inde isbased on 12 indicators that provide early warning signals about etreme governmentunding diculties, such as hyperinfation, sovereign bond spreads, debt deaults orrestructuring, or access to IMF support.

0.5

0.4

0.3

0.2

0.1

0

2 00 1 2 00 2 2 00 3 20 04 20 05 2 00 6 20 07 20 08 2 00 9 20 10 2 011




31/110

minimum wages, lowered corporate income taes, and introduced a rice mortgage scheme to support armers (see

Bo 4). The devastating food that has reached Bangkok would increase government spending through recovery

and reconstruction programs, raising the scal decit in 2012 to 4.5 percent o GDP. Should ood or energy prices

increase, consumer subsidieswhere they are in placecould lead to wider increases in the scal decit.

But any possible stimulus needs to be more long-term and structurally oriented. Even presuming an orderly

resolution o the crisis in Europe, the weaknesses in the global economy are likely to continue into the medium- to

long-term. In this case, it is timely to rethink whether new stimulus is the answer. Given the outlook or protracted

low global growth, should the authorities decide in avor o a new round o stimulus programs they should be

scally sustainable, well-targeted, and directed at promoting the structural transormation needed to sustain stronger,

domestically-driven growth.

Much o the emphasis should be on stimulating investment. In low-income countries that were less aected by

the global economic weakness, programs or poverty reduction and growth should take priority over the short-term

considerations o stimulating demand. Higher investments are particularly important or the middle-income countries

where investment shares have yet to recover to pre-Asian crisis levels and particularly where the quality or quantity o

inrastructure lags behind middle-income averages (see discussion in Chapter III). Improving the investment climate,

including through more or better public investment in productive inrastructure, would attract private investment.

This would be a priority or the Philippines, or eample, where the quality o inrastructure had been lagging other

middle-income countries in the region.

Encouraging higher consumption spending might be a more appropriate target or other countries whereinvestment levels are already high. Better targeted, and more productive, investment or long-term growth will

mean increasing the eciency o public investment programs in China, Vietnam, and Mongolia. Continued and closer

attention to pension and social security systems is also a useul way to increase consumption, ght poverty, and

prepare or uture crises. Further improvements in the covered share o the labor orce and the ratio o retirement to

pre-retirement income will be especially important in China, Indonesia, Thailand, and Vietnam.10

10 Park, Donghyun, 2009. Ageing Asias Looming Pension Crisis, Working Paper Series No. 165, Asian Development Bank.

Fi 47. Sovereign borrowing costs in Asia are rising...

EMBI global stripped spreads, basis points

Vietnam Philippines Malaysia

Indonesia China Latin America

Source: JPMorgan, via Thomson Datastream.

Fi 48. ...as is sovereign risk and thus the costs o insuringagainst deault

Change in CDS spreads on ve-year sovereigns bonds, July 29Nov 3, 2011, inbasis points

Source: Thomson Datastream.

1,200

1,000

800

600

400

200

0

1/07 9/07 5/08 1/09 5/109/09 9/111/11

300

250

150

200

wb_báo cáo kt Đông Á & ca tbd 2011

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