2014 Year-end Update - UN ESCAP...• The steep decline in oil prices will have varying impacts on balance of payments, inflation and fiscal space of countries. o ESCAP analysis indicates

2014 Year-end UpdateECONOMIC AND SOCIAL SURVEY

OF ASIA AND THE PACIFIC

ESCAP is the regional development arm of the United Nations and serves as the main economic and social development centre for the United Nations in Asia and the Pacific. Its mandate is to foster coop-eration between its 53 members and 9 associate members. ESCAP provides the strategic link between global and country-level programmes and issues. It supports Governments of countries in the region in consolidating regional positions and advocates regional approaches to meeting the region’s unique socio-economic challenges in a globalizing world. The ESCAP office is located in Bangkok, Thailand. Please visit the ESCAP website at www.unescap.org for further information.

*The shaded areas of the map indicate ESCAP members and associate members.

This publication was prepared by the Macroeconomic Policy and Development Division of ESCAP. For further information on publications in this series, please address your enquiries to:

DirectorMacroeconomic Policy and Development DivisionEconomic and Social Commission for Asia and the Pacific (ESCAP)United Nations BuildingRajadamnern Nok AvenueBangkok 10200, ThailandTel: (662) 288-1628Fax: (662) 288-1000, 288-3007E-mail: [email protected]: www.unescap.org

I

2014 Year-end UpdateEconomic and Social Survey

of Asia and the Pacific

II ECONOMIC AND SOCIAL SURVEY OF ASIA AND THE PACIFIC: 2014 YEAR-END UPDATE

United Nations publicationCopyright © United Nations 2015All rights reservedPrinted in BangkokST/ESCAP/2705January 2015

The designations employed and the presentation of the material in this publication do not imply the expression of any opinion whatsoever on the part of the Secretariat of the United Nations concerning the legal status of any country, territory, city or area or of its authorities, or concerning the delimitation of its frontiers or boundaries.

Bibliographical and other references have, wherever possible, been verified.

Mention of firm names and commercial products does not imply the endorsement of the United Nations.

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III

KEY MESSAGESGrowth in Asia and the Pacific is projected to rise from 5.6% in 2014 to 5.8% in 2015, driven by better performance in a number of major developing economies. Inflation is likely to remain relatively subdued in 2015, falling to 3.5% from 3.9% in the previous year.

• A number of major economies, including Bangladesh, India, Indonesia, Papua New Guinea, theRepublic of Korea and Thailand are projected to post improved growth.

• Prospects for some of these economies will be aided by the progress in implementing structural reformprogrammes in 2015, which are expected to improve the domestic business environment.

• Exporting economies will continue to be adversely affected by slow growth in some developedeconomies, although accommodative monetary and fiscal policies will support growth. The Russian Federation will face particular challenges due to the imposition of economic sanctions, while the Islamic Republic of Iran will benefit from the easing of sanctions imposed against it.

Despite a decent economic performance and outlook, the region faces a number of risks and challenges.

• Infrastructure deficits and lack of availability of decent jobs are the main domestic structural concernswhich are impeding the supply potential of economies.

• Likely capital volatility in 2015 stemming from monetary policies of developed economies may affectmacroeconomic stability and investment in the region.

o ESCAP analysis indicates that the impact may negatively affect GDP growth of some countries inthe region by up to 0.7 percentage points.

• The steep decline in oil prices will have varying impacts on balance of payments, inflation and fiscal space of countries.

o ESCAP analysis indicates that a further $10 fall in oil prices in 2015 could increase GDP growthby up to 0.5 percentage points in some regional economies.

The Year-end Update offers three key policy recommendations for managing the challenges the region may face in 2015. They are as follows:

• Address domestic structural weaknesses through measures to increase infrastructure financing andlabour market reforms to promote decent jobs.

• Use a variety of measures to tackle capital volatility resulting from the monetary policies of developedeconomies. They should include ensuring good macroeconomic fundamentals, judicious foreign exchange intervention, and use of macroprudential policies to encourage entry of long-term capital.

• Remove fuel subsidies during the window of opportunity presented by lower oil prices. As a result,macroeconomic fundamentals will improve, with the impact on consumers likely to be less severe than if this step had been taken prior to the steep decline in oil prices.

IV ECONOMIC AND SOCIAL SURVEY OF ASIA AND THE PACIFIC: 2014 YEAR-END UPDATE

ACKNOWLEDGEMENTSThe Economic and Social Survey of Asia and the Pacific 2014 Year-end Update analyses challenges for the region since the release of the Survey 2014 in August and provides recommendations on appropriate responses for policy-makers.

This report was prepared under the overall direction and guidance of Shamshad Akhtar, Under-Secretary-General of the United Nations and Executive Secretary of the Economic and Social Commission for Asia and the Pacific (ESCAP), and under the substantive direction of Aynul Hasan, Officer-in-Charge, Macroeconomic Policy and Development Division. The core team led by Muhammad Hussain Malik (Chief, Macroeconomic Policy and Analysis Section) included Shuvojit Banerjee, Sudip Ranjan Basu, Steve Loris Gui-Diby, Hamza Ali Malik and Vatcharin Sirimaneetham. Other contributors from the Division were Daniel Jeongdae Lee, Oliver Paddison and Marin Yari. ESCAP staff who provided comments included: Yejin Ha, ESCAP Subregional Office for East and North-East Asia; Matthew Hammill, ESCAP Subregional Office for South and South-West Asia; Elvira Mynbayeva, ESCAP Subregional Office for North and Central Asia; and Sanjesh Naidu, ESCAP Subregional Office for the Pacific.

Achara Jantarasaengaram, Pannipa Ongwisedpaiboon and Kiatkanid Pongpanich provided research assistance. Sutinee Yeamkitpibul proofread the manuscript and undertook all administrative processing necessary for the issuance and launch of the publication.

Alan Cooper of the Editorial Unit of ESCAP edited the manuscript. The graphic design and layout was created by Natthakhom Jira, and printing was provided by Advanced Printing Service, Thailand.

Francyne Harrigan of the Strategic Communications and Advocacy Section coordinated the launch and dissemination of the report.

V

CONTENTSKEY MESSAGES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . IIIACKNOWLEDGEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . IVABBREVIATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . VIIINTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11. Outlook and performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.1. Growth and inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.2. Macroeconomic and reform policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10 1.3. Trade and financial markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132. Risks and challenges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 2.1. Domestic structural concerns. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 2.1.1. Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 2.1.2. Labour . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 2.2. Global monetary policy developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 2.3. Oil price developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .233. Policy considerations and suggestions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 3.1. Addressing domestic structural weaknesses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 3.1.1. Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . 26 3.1.2. Labour. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . 27 3.2. Policies to manage capital volatility. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 3.3. An opportune time to reduce fuel subsidies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

BOXESBox 1. Progress of reform agenda in China in the second half of 2014. . . . . . . . . . . . . . . . . . . . . . . . . . . .14Box 2. Potential impact of United States increase in interest rates on Asia-Pacific economies . . . . . . . . . . 21Box 3. Potential impact of a drop in oil prices on Asia-Pacific economies . . . . . . . . . . . . . . . . . . . . . . . . . . .24

VI ECONOMIC AND SOCIAL SURVEY OF ASIA AND THE PACIFIC: 2014 YEAR-END UPDATE

FIGURESFigure 1. Developing Asia-Pacific and major developed economies’ growth, 2005-2015, and growth in ESCAP subregions, 2013-2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2Figure 2. Real GDP growth in selected East and North-East Asian economies, 2011-2015 . . . . . . . . . . . 4Figure 3. Contributions of consumption and investment to GDP growth in selected developing Asia-Pacific economies, 2012-2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5Figure 4. Real GDP growth in selected South and South-West Asian economies, 2011-2015 . . . . . . . . . .6Figure 5. Real GDP growth in selected South-East Asian economies, 2011-2015 . . . . . . . . . . . . . . . . . 7Figure 6. Real GDP growth in selected North and Central Asian economies, 2011-2015 . . . . . . . . . . . . . 8Figure 7. Real GDP growth in selected Pacific island developing economies, 2011-2015 . . . . . . . . . . . . . . 9Figure 8. Consumer price inflation and real interest rates in selected developing Asia-Pacific economies, 2012-2014. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10Figure 9. Public debt and fiscal balance as a percentage of GDP, 2007-2013 . . . . . . . . . . . . . . . . . . . . . .12Figure 10. Real GDP growth of major developed economies, 2000-2016 . . . . . . . . . . . . . . . . . . . . . . . . . . 16Figure 11. Growth in merchandise exports in selected developing Asia-Pacific economies,

year-on-year, 2007-2014. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17Figure 12. Exchange rate indices in selected developing Asia-Pacific economies, 2005-2014 . . . . . . . . . .18Figure 13. Unemployment rates in selected Asia-Pacific economies, 2013-2015 . . . . . . . . . . . . . . . . . . . . 20Figure 14. Oil production in Middle East and North America, and Brent crude spot price,

2012-2014, dollars per barrel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23Figure 15. Vulnerability yardstick (short-term foreign exchange commitments as a percentage

of foreign reserves) in selected Asia-Pacific economies, latest available data . . . . . . . . . . . . . . 29

TABLETable 1. Selected economies of the ESCAP region: rates of economic growth and inflation, 2013-2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3

VII

ABBREVIATIONSADB Asian Development BankAEC ASEAN Economic CommunityAIIB Asian Infrastructure Investment Bank APEC Asia-Pacific Economic CooperationASEAN Association of Southeast Asian NationsCIS Collective Investment SchemeESCAP Economic and Social Commission for Asia and the PacificFTAAP Free Trade Area of the Asia-PacificGDP gross domestic productGST goods and services taxIEA International Energy AgencyMOU memorandum of understanding PPPs public-private partnershipsSMEs small and medium-sized enterprisesSOE state-owned enterpriseTFA Trade Facilitation AgreementTPP Trans-Pacific PartnershipWTO World Trade Organization

1INTRODUCTION

INTRODUCTIONAsia and the Pacific is forecast to post a moderate increase in growth to 5.8% in 2015 from 5.6% in 2014. This will be driven by improved growth in a range of developing economies in the region, including Bangladesh, India, Indonesia, Papua New Guinea, the Republic of Korea and Thailand. Moreover, a number of economies, such as India and Indonesia, are expected to make progress in carrying out much-needed structural reforms, which is likely to boost their performance. The ongoing rebalancing programme of China is also expected to have important implications on trade and investment in the region. The Russian Federation will face challenges from economic sanctions imposed in 2014 while the Islamic Republic of Iran will benefit from easing of sanctions imposed against it. Many exporting economies will exhibit relatively unchanged growth at moderate levels, with a positive factor being the seemingly sustained recovery in the United States although slow growth in the eurozone and Japan will continue to pose a challenge.

Inflation in the region is forecast to decrease to 3.5% in 2015 from 3.9% in 2014. Many economies will be able to maintain accommodative monetary policies to support growth due to moderate or decreasing inflation. In 2014, monetary policy remained largely unchanged across the region, with interest rates being maintained at tight or accommodative levels depending on country circumstances. Countries with high inflation or capital outflow pressures, such as Indonesia and the Russian Federation, pursued tight monetary policy while those with low inflation and constrained demand, such as China, the Republic of Korea, Thailand and Viet Nam followed an accommodative monetary policy stance. In the wake of recent volatility in asset markets and exchange rates, some economies, such as the Russian Federation, used foreign exchange reserves to manage the impact of capital outflows and the extent of currency depreciations.

Despite a fairly positive outlook, the region faces a number of risks and challenges. These include the following: domestic structural concerns; likely impact of capital volatility; and the varying implications of falling oil prices. Two key cross-cutting domestic structural challenges are affecting the supply capacity of economies — infrastructure

deficits and labour market imperfections. Lack of infrastructure has held back growth in manufacturing and trade across the region. Failure to boost the rate of human capital formation through education and skills training that meets the needs of higher value-added business sectors has led to insufficient creation of decent jobs. A short-term challenge to macroeconomic stability is the impact of monetary policies of developed economies on capital markets in the region, particularly the ongoing monetary policy normalization being undertaken by the United States of America. Another one is the dramatic recent fall in oil prices, which is likely to have significant macroeconomic policy implications, both positive and negative, depending on the degree of commodity-dependence of an economy.

Addressing structural challenges will involve a mix of domestic and regional policies. At the domestic level, the contribution of the private sector to infrastructure development can be significantly increased through growth in capital markets and better use of public-private partnerships (PPPs). At the regional level, recent developments in establishing regional financial intermediation institutions for infrastructure development are positive steps which should be built upon. Labour market programmes should include active labour market policies aimed at improving job quality, enhancing skills and boosting productivity and wages.

Appropriate macroeconomic policies will help to manage developments arising from capital market volatility and falling oil prices. Economies can reduce the instability caused by excessive volatility in capital flows by ensuring that macroeconomic fundamentals are sound through appropriate monetary and fiscal policies. Furthermore, macroprudential measures can serve as an important element in encouraging the entry of longer-term portfolio capital. Finally, falling oil prices offer a window of opportunity for governments to permanently decrease fuel subsidies while ensuring less impact in the short-term for prices and livelihoods of the poor.

The following sections consider the region’s performance, prospects and challenges since the publication of the Economic and Social Survey 2014 and then offer a number of policy recommendations. The first section begins with a discussion of the macroeconomic outlook for the region in 2015. It contains the latest forecasts for growth and inflation,

2 ECONOMIC AND SOCIAL SURVEY OF ASIA AND THE PACIFIC: 2014 YEAR-END UPDATE

a discussion of recent domestic macroeconomic and reform policies of governments, and an update of trade and capital market developments. The next section considers some risks and challenges to the outlook, namely domestic structural concerns in terms of infrastructure and labour market weaknesses, risks from global monetary policy developments and risks and opportunities from the dramatic fall in oil prices in recent months. The final section offers a number of policy considerations and suggestions with respect to the challenges highlighted earlier. Specifically, they relate to addressing domestic structural weaknesses to increase the supply capacity of economies, considering a range of policies to manage capital volatility, and availing of the opportunity offered by lower oil prices to further reduce fuel subsidies in order to strengthen fiscal positions.

1. Outlook and performance1.1. Growth and inflation

Growth in Asia and the Pacific is projected to increase to 5.8% in 2015 from an estimated 5.6% in 2014 (see figure 1). The overall economic

performance of the region will continue to far outstrip growth in major developed economies of the world in 2015 and thus continue to drive the global recovery. With the exception of North and Central Asia, all the subregions are expected to experience increased growth. This positive outlook is based on expected improved economic conditions in a number of major developing economies, including Bangladesh, India, Indonesia, Papua New Guinea, the Republic of Korea and Thailand (see table 1). Some of these economies are undertaking reform programmes under new administrations. These reform programmes are expected to generate additional positive results in 2015. Meanwhile, the outlook for exporting economies remains less upbeat due to slow growth in the eurozone and Japan, as well as in China, which is the major source of intraregional final demand. Moreover, despite better growth prospects, many developing economies in the region will continue to face structural constraints. These constraints are preventing the domestic sector from playing an even greater role in supporting growth. Of particular concern are barriers to infrastructure development and labour market reform, which have led to supply constraints.

Figure 1. Developing Asia-Pacific and major developed economies’ growth, 2005-2015, and growth inESCAP subregions, 2013-2015

Sources: ESCAP, based on national sources; United Nations Department of Economic and Social Affairs, World Economic Situation and Prospects 2014 (Sales No. E.14.II.C.2). Available from www.un.org/en/development/desa/policy/wesp/wesp_current/wesp2014.pdf; IMF, World Economic Outlook database; ADB, Asian Development Outlook 2014 (Manila, 2014); CEIC Data. Available from www.ceicdata.com; and web site of the Interstate Statistical Committee of the Commonwealth of Independent States, www.cisstat.com. Notes: Forecasts are as of 5 January 2015; Major developed economies comprises 36 economies including the United States and the 18 economies of the eurozone.

-8

-4

0

4

8

12

2005Pre-crisis

2007Crisis

2009 2011Post-crisis

2013 2015Forecast

Real

GDP

gro

wth

(per

cent

age)

Developing Asia-Pacific economies Major developed economies

0 4 8 12

Developed ESCAP economies

South-East Asia

South and South-West Asia

Pacific island developingeconomies

North and Central Asia

East and North-East Asia

Real GDP growth (percentage)

201320142015

3Growth and inflation

Table 1.

PercentageReal GDP growth a

2013 2014b 2015c 2013 2014b 2015c

Averagepre-crisis growth

2005-2007East and North-East Asia d,e 6.7 4.2 3.5 4.0 1.5 2.3 1.9East and North-East Asia (excluding Japan) d,e 10.9 6.6 6.3 6.2 2.4 1.9 1.9 China 12.7 7.7 7.3 7.0 2.6 1.9 1.7 Democratic People’s Republic of Korea 0.5 .. .. .. .. .. .. Hong Kong, China 6.8 2.9 2.2 3.3 4.3 4.3 3.7 Japan 2.1 1.5 0.5 1.5 0.4 2.7 2.0 Macao, China 16.5 11.9 8.4 9.0 5.5 6.0 6.3 Mongolia 8.7 11.7 6.3 6.2 8.6 13.5 9.5 Republic of Korea 4.8 3.0 3.4 3.8 1.3 1.3 2.0North and Central Asia

Pacific island developing economiesPacific

d 8.2 2.1 1.0 0.2 6.7 7.5 7.2North and Central Asia (excluding Russian Federation)d 13.0 6.5 5.1 5.6 5.9 6.1 6.3 Armenia 13.6 3.5 3.2 3.5 5.8 3.0 3.8 Azerbaijan 28.6 5.8 3.0 4.4 2.4 2.0 3.0 Georgia 10.4 3.3 5.0 5.0 -0.5 3.3 5.0 Kazakhstan 9.8 6.0 4.6 4.8 5.8 6.7 6.0 Kyrgyzstan 3.8 10.5 3.0 4.9 6.6 10.0 8.9 Russian Federation 7.4 1.3 0.3 -0.8 6.8 7.8 7.3 Tajikistan 7.2 7.4 6.5 6.0 5.0 6.6 8.3 Turkmenistan 12.0 10.2 10.1 11.5 9.0 6.6 8.3 Uzbekistan 7.9 8.0 7.5 7.6 11.2 10.0 11.2

d,e 3.4 2.4 2.5 3.2 2.3 2.0 2.9d 3.2 4.2 5.9 10.1 4.0 4.1 4.5

Cook Islands 1.2 3.2 2.2 2.5 1.9 1.6 2.5 Fiji -0.1 4.6 4.2 4.0 3.4 1.5 3.5 Kiribati 2.1 2.9 3.0 2.7 -1.5 2.5 2.5 Marshall Islands 2.0 3.5 3.0 1.5 1.9 1.5 1.5 Micronesia (Federated States of) 0.2 -4.0 0.5 2.0 2.2 2.0 1.5 Nauru -11.8 4.5 10.0 8.0 1.4 5.0 7.0 Palau 3.4 -0.2 2.3 5.0 2.8 4.0 4.0 Papua New Guinea 4.5 5.1 8.4 15.5 5.0 5.9 5.5 Samoa 3.7 -0.5 2.0 2.5 -0.2 -1.2 2.0 Solomon Islands 6.4 2.9 -1.0 3.0 5.4 6.0 5.0 Tonga -1.3 0.3 1.5 2.5 0.7 2.3 2.0 Tuvalu 2.7 1.3 2.0 2.5 2.0 2.5 2.0 Vanuatu 6.3 3.2 3.5 4.0 1.4 2.5 3.0

Developed countries (Australia and New Zealand) 3.4 2.4 2.5 3.1 2.2 1.9 2.8 Australia 3.4 2.4 2.5 3.0 2.4 2.0 3.0 New Zealand 2.8 2.4 2.5 3.8 1.1 1.5 1.7South and South-West Asia d,f 8.1 4.1 4.5 5.3 11.2 8.3 7.2 Afghanistan 10.2 3.6 3.2 4.5 7.4 6.1 5.5 Bangladesh 6.3 6.0 6.1 6.5 7.7 7.4 6.5 Bhutan 10.6 4.2 6.0 6.8 5.5 8.1 8.4 India 9.5 5.0 5.5 6.4 9.5 6.7 6.3 Iran (Islamic Republic of) 6.1 -1.7 1.7 2.2 34.7 17.0 15.8 Maldives 7.2 8.8 8.5 10.5 4.0 3.0 3.1 Nepal 3.2 3.7 5.5 6.0 9.9 9.0 7.8 Pakistan 7.2 3.7 4.1 4.5 7.4 8.6 7.0 Sri Lanka 6.9 7.3 7.8 8.0 6.9 3.8 4.0 Turkey 6.7 4.1 3.3 4.0 7.5 9.0 6.3South-East Asia d,f 6.1 4.9 4.3 5.0 3.9 3.8 3.5 Brunei Darussalam 1.7 -1.8 5.1 2.5 0.4 0.2 0.7 Cambodia 11.4 7.4 7.2 7.3 3.0 4.5 3.5 Indonesia 5.8 5.8 5.2 5.6 6.4 6.4 5.0 Lao People’s Democratic Republic 7.7 8.2 7.5 7.2 6.4 5.5 6.0 Malaysia 5.9 4.7 5.7 5.2 2.1 3.0 4.0 Myanmar 12.9 8.3 8.5 8.5 5.7 6.6 6.3 Philippines 5.8 7.2 6.0 6.4 2.9 4.2 3.8 Singapore 7.8 3.9 2.8 3.1 2.4 1.1 1.5 Thailand 4.9 2.9 0.8 3.9 2.2 1.9 1.2 Timor-Leste 5.0 8.1 8.0 8.0 10.6 3.0 5.4 Viet Nam 8.4 5.4 5.8 6.0 6.6 4.1 5.0Memorandum items:Developing ESCAP economies (excluding North and Central Asia) 9.5 5.7 5.6 5.8 5.0 3.9 3.5Developing ESCAP economies (including North and Central Asia) 9.4 5.3 5.1 5.2 5.2 4.3 3.9

Least developed countries g 6.0 5.4 5.6 5.9 6.7 6.5 5.8Landlocked developed countries 11.7 6.2 5.0 5.4 6.1 6.1 6.2Small island developing States 3.7 4.9 6.3 10.0 4.3 4.0 4.4

Developed ESCAP economies 2.3 1.6 0.8 1.8 0.7 2.6 2.1Total ESCAP 6.8 4.0 3.5 3.9 3.5 3.7 3.3

Table 1. Selected economies of the ESCAP region: rates of economic growth and inflation, 2013-2015

Sources: ESCAP, based on national sources; United Nations, Department of Economic and Social Affairs. World Economic Situation and Prospects 2014, Sales No. E.14.II.C.2. Available from www.un.org/en/development/desa/policy/wesp/wesp_current/wesp2014.pdf; IMF, International Financial Statistics databases. Available from http://elibrary-data.imf.org; ADB, Asian Development Outlook 2014 (Manila, 2014) and Pacific Economic Monitor (December 2014); CEIC Data. Available from www.ceicdata.com; and web site of the Interstate Statistical Committee of the Commonwealth of Independent States, www.cisstat.com.Notes: a Changes in the consumer price index.

b Estimates.c Forecasts (as of 5 January 2015).d GDP figures at market prices in United States dollars in 2010 (at 2005 prices) are used as weights to calculate the regional and subregional aggregates.e Forecasts for 2015 are available for selected economies.f The estimates and forecasts for countries relate to fiscal years defined as follows: 2015 refers to fiscal year spanning 1 April 2015 to 31 March 2016 in India and Myanmar; 21 March 2015 to 20 March 2016 in Afghanistan and the Islamic Republic of Iran; 1 July 2014 to 30 June 2015 in Bangladesh, Bhutan and Pakistan; and 16 July 2014 to 15 July 2015 in Nepal.g Samoa is excluded from the calculation from 2014 onwards due to its graduation from the least developed countries category.


1 Bank of Japan, “Statement on monetary policy”, 7 October 2014. Available from www.boj.or.jp/en/announcements/release_2014/k141007a.pdf.

Figure 2. Real GDP growth in selected East and North-East Asian economies, 2011-2015

Source: Based on Table 1.Note: Figures for 2014 are estimates while figures for 2015 are forecasts.

Inflation is forecast to remain subdued in the region as a whole but vary significantly among economies as a result of particular circumstances. Inflation in the Asia-Pacific region is forecast to fall to 3.5% in 2015 from 3.9% in the previous year. As a majority of the economies in Asia and the Pacific are net oil importers, the decline in oil prices is expected to restrain inflationary pressures in the region as a whole. This, however, will not be the case for the oil-exporting economies, such as the Russian Federation and the Islamic Republic of Iran. Reduced oil exports have and will continue to put downward pressure on their respective currencies, which in turn could result in imported inflation. Economies in South and South-West Asia will continue to experience the highest level of inflation in the region, particularly due to high domestic demand relative to constrained supply. However, encouragingly the level of inflation is expected to decrease from 8.3% in 2014 to 7.2% in 2015, the lowest rate in four years in the subregion, led by decreases in India, Pakistan and Bangladesh. Inflation in South-East Asia and East and North-East Asia is forecast to be generally subdued in line with relatively weak demand for products from exporting economies.

Growth in East and North-East Asia is expected to increase slightly to 4% in 2015 from 3.5% in 2014 (see figure 2). This is due to a projected increase in growth in Japan to 1.5% in 2015 from 0.5% in the previous year. Further economic gains in Japan will be challenging

in the absence of fresh policy measures. Following the enactment of monetary and fiscal stimulus policies in 2013, the country initially witnessed a boost in growth, but the momentum steadily decreased throughout the year. In the second quarter of 2014, the Japanese economy contracted sharply due to a hike in the consumption tax in April from 5% to 8%. The slowdown continued in the third quarter. Further pressure on growth may emanate from another proposed hike in the consumption tax, although the Government pledged to delay the increase by one year following a renewed mandate gained in the elections that were held in December 2014. In response to the current slowdown, the central bank has reinforced its policy of quantitative easing, raising its annual target in October 2014 to 80 trillion yen ($673 billion) annually from the previous target of 60-70 trillion yen, with the objective of achieving an inflation rate of 2% by 2015.1 The country’s quantitative easing programme is now 80% of the size, at its peak, of the last quantitative easing programme of the United States. The Government is also expected to renew its focus on a host of structural reforms after its December 2014 election victory under the so-called “third arrow” of the Abenomics reform programme.

With the exclusion of Japan, developing countries in East and North-East Asia are expected to experience a slight overall economic slowdown; from 6.3% in 2014 to 6.2% in 2015. This is largely due to the ongoing deceleration in China. Growth in China is forecast to slow moderately to 7% in 2015 from 7.3% in 2014 during its rebalancing programme. Growth

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Figure 3. Contributions of consumption and investment to GDP growth in selected developing Asia-Pacific economies, 2012-2014

Sources: ESCAP, based on CEIC Data. Available from ceicdata.com (accessed 5 January 2015); and national sources.Note: GDP data is calculated as year-on-year percentage change.

in the third quarter of 2014 stood at a five-year low of 7.3% year-on-year. An analysis of the components of domestic demand indicates that investment growth declined slightly more than that of consumption, which offers some support to the rebalancing efforts (see figure 3). A combination of external and domestic factors is behind the slowdown in the Chinese economy. Externally, China, in common with other regional exporters, is being affected by the slow recovery in major developed countries. To compensate for this, the Government is reluctant to launch large-scale fiscal and monetary stimulus as it did at the start of the financial crisis. This is due to the Government being aware that the economy is unbalanced, with an excessive role of investment which has led to unprofitable projects. Reluctance to stimulate investment, while commendable in that it ensures long-term sustainability of growth, is likely to imply a trend of slower growth from an historical performance in coming years.

The economic outlook for the Republic of Korea is marked by moderately recovering domestic demand supported by expansionary policies. Growth is forecast to increase to 3.8% in 2015 from 3.4% in 2014. For the 2015 fiscal year, the Government has introduced the most expansionary budget since 2009, with large increases in welfare spending. Backed by such policy support, economic growth in 2015 is expected to improve further. Private

consumption is projected to recover moderately in line with an increase in consumer sentiment after the fatal ferry accident in April 2014, but high household debt will continue to act as a constraint. Investment has recently increased in line with improving exports, but remains constrained by ample unused capacity throughout the manufacturing sector. The Government is of the view that rising corporate wealth among large firms is not being adequately transferred to households through wages, dividends or new job-creating investments.

South and South-West Asia is set to enjoy economic growth of 5.3% in 2015, a four-year high (see figure 4). The positive outlook is mainly led by an increase in growth in India. The economy of India is likely to expand by 6.4% in 2015 as compared to 5.5% in 2014. Positive expectations regarding the extent of reforms to be proposed and implemented by the new Government boosted consumer and business confidence in the latter part of 2014, resulting in increased economic growth. However, the country experienced a negative contribution of investment to growth in the third quarter of 2014, which indicates the continuing pressing challenge of improving the business climate. Consumer price inflation in November 2014 fell to its lowest level since a new CPI index began being tracked in January 2012. It declined to 4.4% year-on-year, comfortably below the target of the central bank for that year of 8% and

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Figure 4. Real GDP growth in selected South and South-West Asian economies, 2011-2015

even approaching the 2016 target of 6%. It is therefore likely that monetary policy can be somewhat eased in the near future if the trend of lower inflation stays intact. Such a move would further support growth.

Improved growth is also projected for Bangladesh, Pakistan and Sri Lanka, supported by steady remittances, moderating price pressures, accommodative fiscal policy, and the economic recovery in the United States which remains the key export market for many countries in the subregion. Nonetheless, Pakistan’s macroeconomic fundamentals remain fragile due to poor security conditions, political instability and low fixed investment constrained by a shortage of domestic savings. Growth in the Islamic Republic of Iran is forecast to continue to recover, aided by the easing of severe international economic sanctions that had contributed to the recession recorded during 2012-2013.

Economic growth for South-East Asia in 2015 is expected to be relatively strong for many economies, though challenges remain. Growth for the subregion is forecast to increase to 5% in 2015 from 4.3% in 2014 (see figure 5). The onset of the ASEAN Economic Community will further improve the business environment and contribute to growth performance across the subregion. The outlook for the largest economy in the subregion, Indonesia, is higher growth of 5.6% in 2015 compared with 5.2% in 2014, subject to some uncertainty stemming from challenges faced by the new Government in

undertaking a comprehensive reform programme. A decline in investment as well as in exports contributed to a fall in the growth rate in the third quarter of 2014 to its lowest level in five years. The economy has been expanding at a lower rate in recent years mostly due to supply-side constraints. These constraints have contributed to increasing inflation, which forced the central bank to respond by implementing a tight monetary policy. Hikes in interest rates have also been required to support the currency due to capital outflows as investors have become wary of the country’s twin current account and budget deficits. In an effort to restore fiscal balance, the Government reduced fuel subsidies in November 2014 and eliminated gasoline subsidies in January 2015. The currency may remain under pressure in coming months as the ongoing process of United States normalization of monetary policy leads to more capital outflows from the region. This, in turn, will require that the country maintain its relatively high interest rates.

The economy of Malaysia is set for another year of robust growth in 2015 at 5.2%, driven by private consumption, investment and exports, although falling oil prices in recent months have put pressure on exports and the government budget. This forecast reflects some moderation of growth from 2014 due to the introduction of a goods and services tax, higher inflation and a tighter monetary stance. Nevertheless, the moderating effect on domestic demand of these policies is expected to be offset by an improvement in exports, particularly for electronics. Private



Figure 5. Real GDP growth in selected South-East Asian economies, 2011-2015

consumption will continue to benefit from favourable labour market conditions and investment from the Economic Transformation Programme, which has established a pipeline of infrastructure and industry projects since its launch in 2010.

The economic outlook for the Philippines also remains robust. In 2015, growth is expected to reach or exceed 6% for the fourth consecutive year, propelled by private consumption and a revival in investment in recent years. In 2014, private consumption continued to drive the economy, benefiting from employment growth in services and construction as well as from steady overseas workers’ remittances. Fixed investment in machinery and durable equipment continued to increase strongly, although investment as a share of GDP remains relatively low at about 20%. Public spending, after slowing in 2014 following legislative challenges, is expected to accelerate again and support growth. Post-typhoon reconstruction activities will also pick up. With inflation rising rapidly in 2014, the central bank has steadily tightened its monetary stance. Prices are projected to be more stable in 2015 and not act as a drag to domestic demand. Keeping up the recent revival in manufacturing activities, including through increased public infrastructure outlays and effective industry roadmaps, will be important for sustained, job-creating economic growth in the coming years.

The outlook for growth in Thailand is somewhat more

positive than in recent years although longer-term sustainability of the performance will be based on the evolution of politics and economic policy. Growth is forecast to increase to 3.9% in 2015 from the sharp slowdown to 0.8% in 2014. Political uncertainty has led to the drop in the contribution of investment to growth since mid-2013. The assumption of power of a military government in mid-2014 has increased consumer and investor confidence in the short-term as it has brought a halt to an extended period of political instability. The main economic action of the government in 2014 has been to resume government budgetary spending and planning for large infrastructure spending. The growth forecast for 2015 somewhat reflects this increased economic activity. However, it is also due to the base effect of very low growth in 2014. The stated aim of the Government is to move towards a return to democracy, however uncertainty during this process has the potential to exert renewed pressure on consumer and investor confidence in coming months.

The economic outlook for Viet Nam faces some challenges as problems in the banking sector are constraining domestic demand. Growth in 2015 is forecast to increase slightly to 6% from 5.8% in 2014. Non-performing loans as a percentage of total lending were reported to have increased in the first half of 2014, after declining throughout 2013 while credit growth remained weak in 2014 despite the lowering of interest rates by the central bank. After peaking at double-digits in 2011, inflation has

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declined significantly, largely a reflection of the weak domestic sector of the economy. On the positive side, exports have been strong despite disruptions in factory production and tourism in mid-year following a maritime territorial dispute with China. Under the Government’s plan to give the private sector a greater role in steering the economy, the reform of state-owned enterprises is also moving forward. Such reforms could help enhance the quality of investment in coming years. Following recent reforms, economic growth in Myanmar stood at 8.5%, supported by new investments and natural gas exports. It is expected to sustain this rapid pace in 2015. The economies of Cambodia, the Lao People’s Democratic Republic and Timor-Leste are expected to continue to expand at a robust pace of between 7% and 8% in 2015. Human resource development and economic diversification, however, are key challenges for these economies in ensuring sustainable growth.

Growth in North and Central Asia is expected to deteriorate in 2015 due to a continued slowdown in the Russian Federation, the largest economy in the subregion. Overall, the subregion is forecast to grow by 0.2% in 2015 after growing by 1% in 2014 (see figure 6). The outlook for the Russian Federation is difficult in the near-term and subject to considerable uncertainty, with a contraction of 0.8% forecast in 2015. The economy has been slowing in recent years. Growth in 2013 was already far lower at 1.3%

than the levels of about 4% reached between 2010 and 2012. The slowdown was compounded in 2014 by the effects of geopolitical instability and sanctions by the European Union and United States, causing the rouble to tumble by more than 40% against the dollar in 2014. The sanctions have made it difficult for local banks to refinance themselves and therefore sustain normal domestic banking operations. The weak rouble has affected the corporate sector by raising the cost of foreign debt. Beyond these immediate concerns, the economy remains affected by longer-term challenges. Its lack of diversification is a major concern, with excessive dependence on oil and gas exports. Non-oil investment, both foreign and domestic, in the country remains below potential due to concerns about the investment climate, while productivity growth in the economy has also been stagnant. The contribution of investment to growth has been negative since 2013.

The economy of Kazakhstan is set to expand by 4.8% in 2015, slightly higher than in 2014. Growth will be sustained by government expenditure, and sizeable fiscal stimulus packages provided to small and medium-sized enterprises (SMEs) and agroindustry. Moreover, the impact of the 2014 devaluation of the tenge is expected to end and this will contribute to an increase in household consumption. In the other net energy-exporting countries of the subregion, Azerbaijan and Turkmenistan, new hydrocarbon infrastructures, which are expected to

Figure 6. Real GDP growth in selected North and Central Asian economies, 2011-2015



be in operation in 2015, will significantly contribute to the expansion of their economies. Slightly higher economic growth in Uzbekistan will be mainly driven by government expenditure. The economy of Georgia will continue to benefit from fiscal stimulus, while the economic performances of Armenia, Kyrgyzstan and Tajikistan are highly dependent on the economic situation in the Russian Federation and its repercussions on remittances and exports.

Growth in the Pacific island developing economies is forecast to increase dramatically in 2015, led by Papua New Guinea. The subregion is expected to expand by 10.1% compared to 5.9% in 2014. Growth in Papua New Guinea is forecast to increase to 15.5% (see figure 7) from 8.4% in 2014 due to the commencement of liquefied natural gas (LNG) production and export. The economy expanded above expectations in 2014 primarily on the back of early commencement of LNG production, combined with the Government’s expansionary fiscal policy. The outlook for economic growth in the next few years remains broadly steady, with the mineral sector contributing to double-digit GDP growth. Government fiscal spending is expected to boost

demand but the spending has also contributed to high import demand. High import demand has led to depreciation of the exchange rate and thus has caused inflationary pressures, with annual headline inflation for 2014 of 5.9%. In the immediate term, the Government faces the challenge of finding employment for local workers laid off from construction of the LNG projects.

Growth in Fiji is forecast to be slightly lower in 2015 at 4% from an estimated 4.2% in 2014. In recent years, large infrastructure projects, as well as good performance in the sugar industry and the tourism sector have helped boost the economy. Consumption spending was supported by higher disposable incomes, while remittances and investment spending also remained firm. It is foreseen that growth in 2015 will be at a somewhat lower but sustainable pace, spurred by recent infrastructure development and the return to civilian rule following elections in September 2014. A key concern for policymakers is the need to boost job creation through further structural reforms to enhance the business environment.

Figure 7. Real GDP growth in selected Pacific island developing economies, 2011-2015

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1.2. Macroeconomic and reform policies

Monetary policy remained largely unchanged across the region in 2014, with interest rates being maintained at tight or accommodative levels depending on country circumstances. In countries with high inflation or capital outflow pressures, tight monetary policy was required in 2014 (see figure 8). This included countries in South and South-West Asia that experienced supply constraints and high domestic demand, as well as countries that additionally faced capital outflow pressures. Policy interest rates were raised in the Russian Federation, Indonesia, Malaysia, and the Philippines, among others. The policy interest rate reached 17% in the Russian Federation after being hiked by 150 basis points in October and by 100 and 650 basis points in December. In Malaysia, the policy interest rate was raised in the middle of the year for the first time in three years, by 25 basis points to 3.25%. The Philippines raised its policy interest rate also for the first time in three years, by 25 basis points in July. It hiked the rate by an additional 25 basis points in September, to its current level of 4%. In addition to the rate hikes, the country increased its reserve requirements twice during the year. In both Malaysia

and the Philippines, inflation had been edging up and real interest rates were entering negative territory. Also, Malaysia had experienced high household debt and in the Philippines, the banks’ exposure to the real estate sector had increased rapidly. Also of note, Indonesia raised its policy rate by 25 basis points to 7.75% in November following the Government’s decision to cut fuel subsidies.

As for other economies, however, overall demand remained below capacity and therefore inflation stayed at low levels and monetary policy remained accommodative. This included many export-led economies in East and North-East Asia and South-East Asia that had experienced relatively low external demand. Policy interest rates were lowered in China, the Republic of Korea, Thailand and Viet Nam. In the first half of the year, Thailand cut its policy interest rate by 25 basis points, bringing it to 2.25%, as the economy contracted and Viet Nam cut by 50 basis points to support growth. In the second half of the year, the Republic of Korea cut its policy interest rate by a total of 50 basis points to reach 2%, matching its record low in 2009.

Figure 8. Consumer price inflation and real interest rates in selected developing Asia-Pacific economies,2012-2014

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11Macroeconomic and reform policies

Figure 8. continued

Source: ESCAP, based on data from CEIC Data. Available from www.ceicdata.com (accessed 5 January 2015).

Real interest rates

China attempted to manage slowing growth in 2014 through the use of a number of monetary stimulus policies. The Government initially took a cautious approach by not undertaking full-scale monetary stimulus through interest rate decreases even though monthly inflation rates fell to their lowest levels in nearly five years. Instead, it introduced targeted monetary stimulus measures with the intention of supporting growth in a limited manner while maintaining financial stability. Measures undertaken in 2014 included direct loans from the central bank to large state-owned lenders and easing of rules on mortgage lending. However, the Government indicated its growing concern about the growth performance by making its first interest rate cuts in two years in November 2014, lowering the deposit and lending rates by 25 and 40 basis points, respectively. This decision was supported by a continuing decrease in inflation, which reached 1.4% year-on-year in November 2014.

Financial stability was a cross-cutting concern for governments in 2014, regardless of whether policy rates were raised or cut. Viet Nam made further progress in addressing poor asset quality of banks, including through mergers and acquisitions; the central bank is targeting a 50% reduction in the number of commercial banks in the next three years. In the Philippines, several measures were introduced to alleviate banks’ rapidly growing exposure to the property sector. Among them were

2 Federal Reserve Bank of San Francisco, “Priority sector lending in Asia”, Asia Focus, September 2014.

developing a credit risk management framework, setting a real estate stress test, and expanding the definition of real estate exposures.

In some economies, monetary policy was also used to ensure that adequate credit was channelled to the agricultural and rural sectors, as well as to small - and medium-sized enterprises. In 2014, China lowered the reserve requirements for rural banks and smaller financial institutions that cater to small businesses, and cut policy lending rates to small firms. A number of countries, such as India, Indonesia, Malaysia, the Philippines, Thailand and Viet Nam, implemented some form of priority sector lending, through, for example, lending quotas or interest rate caps.2

Fiscal policy also took divergent paths in 2014, with some countries, such as the Republic of Korea, shifting to a more pro-growth fiscal stance while others, such as Malaysia and India, moved towards consolidation. The Government of the Republic of Korea announced in July 2014 a stimulus package of $40 billion. Malaysia, on the other hand, affirmed its target to reduce the fiscal deficit to 3.5% of GDP in 2014 from 3.9% in 2013, while in India, the outgoing Government lowered the deficit to 4.5% in FY13 from 4.9% in FY12 (see figure 9). Still, across most countries, the general trend had been to implement more targeted measures, long-term investments and structural reforms.

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Figure 9. Public debt and fiscal balance as a percentage of GDP, 2007-2013

diesel prices by 44% and 22% respectively, in mid-2013, and again increased prices in November 2014 by over 30%, followed by an end to gasoline subsidies in January 2015. Malaysia marginally increased fuel prices in September 2013 and further increased gasoline and diesel prices by 10% in October 2014. In December 2014, Malaysia removed fuel subsidies and moved to a managed float system to determine the retail price of fuel.

Infrastructure investment continued to be a priority area in 2014. China accelerated urban infrastructure and social housing investment, in line with the urbanization plan for 2014-2020, released in March, which envisions the following: the urbanization rate will rise from the current level of 54% to 60% by 2020; all cities with at least 500,000 residents will be covered by high-speed rail; and a civil aviation network will be accessible to 90% of the population. Malaysia, under the Economic Transformation Programme, has created a pipeline of public and private investment projects, including large infrastructure projects such as a mass rail transit system. There were also positive developments in Indonesia and the Philippines.

The Philippines recently awarded PPPs equivalent to around 1.5% of GDP, and plans to raise total infrastructure spending to 5% of GDP by 2016. Indonesia pledged to direct savings from lower fuel subsidies towards infrastructure development, including in agricultural and rural infrastructure and maritime infrastructure.

Employment, social protection and welfare-related spending and reforms were also on the rise. India announced significant reforms in late 2014 pertaining to financial inclusion and structural change in favour of manufacturing. It also loosened some of its regulations. The country undertook an initiative to open bank accounts for 75 million poor households by February 2015.3 The Republic of Korea introduced a stimulus in the middle of the year targeted at small firms and low-income households. Government spending is set to further increase in 2015, with the largest increase being in welfare spending. Relief and reconstruction of natural disaster-affected areas was also high on the agenda. In the Philippines, which was hit by a severe typhoon and an earthquake in late 2013, the Government launched a website to transparently track the reconstruction effort and provide a comprehensive overview of proposed, approved, and ongoing reconstruction projects.4

On the revenue side, a number of countries broadened their tax base and strengthened tax administration. Malaysia announced that a 6%

3 “India’s Modi seeks bank accounts for 75 million poor households”, Financial Times, 28 August 2014. Available from www.ft.com/intl/cms/s/0/1195110e-2dd1-11e4-8346-00144feabdc0.html#axzz3G6r9GJAt.4 www.openreconstruction.gov.ph.

Source: ESCAP, based on national sources and data from CEIC Data. Available from www.ceicdata.com, (accessed 5 January 2015).

A major area of reform was fuel subsidies in economies in which maintaining them was a heavy burden on the government budget. India removed diesel subsidies in October 2014 after having gradually reduced them on a monthly basis starting in January 2013. Indonesia increased gasoline and

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13Macroeconomic and reform policies

goods and services tax (GST) would be introduced in April 2015, which will reduce reliance on oil revenues. The Government of the Philippines raised taxes by 1.2 percentage points of GDP in the last three years. In China, the revision of the Budget Law, which took effect in August 2014, allows sub-national governments to issue debt, thereby reducing maturity mismatches and financing costs. Reform of state-owned enterprises is a priority in Viet Nam. The recently issued Resolution 15 contains a comprehensive action plan to step up state-owned enterprise (SOE) divestment. Seventy-four SOEs in 2013 and another 40 in the first half of 2014 were privatized, including some large ones, such as Vietnam Airlines and Vietnam Textiles & Garments.

Both India and Indonesia have announced plans to encourage structural change in favour of manufacturing. India launched the “Make in India” campaign in September 2014 with the goal to make it easier to establish and operate a business in India. An important part of the campaign is the establishment of a one stop-shop for investors. The country also eased barriers to entry for investment in the defence production industry and removed a number of administrative details which impeded the operation of enterprises. The new Government in Indonesia announced in November 2014 plans to establish a one-stop shop to sharply cut waiting times for investment licences.

Although there was a lack of major announcements, the reform agenda in China saw wide-ranging developments during 2014 (see box 1). The implementation of the decisions of the third plenary of the eighteenth Communist Party of China Central Committee meeting in November 2013 has been ongoing on many fronts simultaneously. Due to the large scale and internal heterogeneity, the Government has had to establish consensus among various stakeholders and interest groups on the detailed design of major reforms. Furthermore, the policies and implementation pace have been different among provinces and lower administrative levels. When a reform involves high-level inherent uncertainty or consensus cannot be achieved, experiments in certain pilot areas are to be carried out. Such experiments may take years to show results and may also point to different regional solutions. In such cases, the central government usually sets policies based on the results. Therefore, major reforms in China should be viewed

as continual processes which may comprise many interlinked smaller-scale reforms instead of only one detailed master plan.

1.3. Trade and financial markets

Merchandise trade in Asia and the Pacific continues to face considerable challenges due to the economic situation, both externally and within the region. Merchandise trade did not pick up in 2014, and was still burdened with the impacts of the 2008-2009 global financial crisis. Merchandise exports of the developing Asia-Pacific region are estimated to have grown by 4.8% in 2014, which is only 0.2 percentage points above the figure posted in 2013.5 Notably, this sluggish export growth performance is far below average export growth of 20% recorded in the pre-crisis years of 2002-2007.

ESCAP forecasts that merchandise export growth could increase to 6.8% for the developing Asia-Pacific region in 2015. This rebound will be conditional upon several factors, including among others (a) sustained recovery and growth in developed economies and (b) policy support measures being put in place to stimulate trade in major developing countries in the region.

The significant drop in export growth in recent years can be attributed to tepid GDP growth and a lower than expected pick up of consumer demand in the developed economies. Furthermore, as discussed in the Survey 2014, the continuation of trade-reducing policies by the developed countries has restricted export growth of the region.6 The recovery of the eurozone, which is almost at par with the United States in terms of being a trading partner with the Asia-Pacific region, is under threat amid growth declining to anaemic levels (see figure 10) and the possibility of entrenched deflation. Growth in Japan, the developed economy in the region with deepest ties to its neighbours through trade and investment links, has also stalled since the country hiked its consumption tax in April 2014. A positive factor for the region is the seemingly sustained recovery in the United States, which is providing the main support for the region’s exports.

Within the region, recent policies in China towards rebalancing the economy have further affected the export prospects of several countries. This has been through two channels: (a) direct exports link and (b) regional supply chains. For example,

5 ESCAP, Asia-Pacific Trade and Investment Report 2014, Recent Trends and Developments. (Sales No. E.15.II.F.2).6 ESCAP, Economic and Social Survey of Asia and the Pacific 2014: Regional Connectivity for Shared Prosperity. (Sales No. E.14.II.F.4).


Box 1. Progress of reform agenda in China in the second half of 2014

Notable progress on the reform agenda in the latter half of 2014 included:

• Reforms of budgetary process and the governance of public debtIn August 2014, China’s Congress passed a new budget law which aims to strengthen the accountability and transparency of the budgeting process of governments at different levels and further rationalize transfer payments from the central government to local governments. In particular, the new law partially lifted the restriction on local governments to issue debt while significantly enhancing the regulation on local government borrowing via platform vehicles (corporations). Later in October, the state council announced a detailed reform plan targeting local government debt management. The new policies prohibit local government borrowing via platform vehicles and require the existing debt for non-public-service projects to be delinked from government and transformed to normal corporate debt. The plan also emphasized PPPs as complementary financing mechanisms for public projects.

• Urbanization and land reformThe differentiation of agricultural and non-agriculture civil registration (or Hukou in Chinese) was abolished at the end of July 2014. This marked a revolutionary progress in civil administration and will pave the way for the establishment of a unified social welfare system and for greater equality in public services provision. The reform also liberalized the rural-urban migration to small and medium-sized cities with populations of less than 1 million which would further boost urbanization and improve the livelihood of new city immigrants.

• Energy development and climate changeChina announced its new ambition for green energy development and emission reduction during the Asia-Pacific Economic Cooperation (APEC) meeting in November 2014. The objective is to “achieve the peaking of CO2 emissions around 2030” and increase the share of non-fossil fuels in primary energy consumption to around 20% by 2030. Later in the same month, China unveiled its energy strategy for 2014-2020 and set the target for non-fossil fuel share in primary energy consumption by 2020 at 15%. Moreover, a cap on total primary energy consumption was set, restricting average annual energy consumption growth during the period to 3.5%.

• Microfinance and internet financeAs in the past, economic transformation in China is often driven by private sector institutional and technological innovations rather than deliberate government policies, and government reforms in these cases are to accommodate and facilitate such private innovations. The synergy of e-commerce and microfinance is such an example. This innovation is mainly driven by the leading e-commerce companies which are trying to exploit their competitive advantage in borrower credit evaluation based on the “big data” they have accumulated over the years. In response, the Government issued the first batch of licenses for private credit record services in late October 2014. According to studies, out of the 850 million individuals registered in the central bank’s credit record system, only some 300 million people have valid records while for the remaining more than 500 million there is no valid information. While this implies a huge potential market in this area, it also poses significant challenges for the regulatory agencies to keep up with the pace of financial innovation.

15Trade and financial markets

ASEAN economies’ total exports to China grew by an average of 30% in the pre-crisis years, plummeted during the crisis (3% in 2008-2009), and then averaged only 18% export growth during the period 2010-2013. A similar trend has been observed for other countries in the region. Due to falling demand from China, which is linked to the country’s active policies to shift towards domestic consumption-driven growth, countries which have trade links with China experienced slower than expected growth in exports in 2014.

Apart from the China factor, developed economies in the region registered a significant decline in their import demand in the first three quarters of 2014. For example, Japan registered a drop in import growth of 1.7% in the first three quarters of 2014, while Australia’s import growth fell by 4.6% in the first two quarters of 2014. This not only contributed to the overall slow growth in the exports of major developing economies, but had a significant adverse impact on regional value chains and trade in intermediate inputs.

Owing to current trade developments, quarterly data clearly shows that several countries in East and North-East Asia and South-East Asia failed to register positive export growth in year-on-year terms in 2014 (see figure 11). Two major South-East Asian economies, Indonesia and Thailand, recorded negative average export growth in the first two quarters of 2014. Malaysia, the Philippines, the Republic of Korea and Viet Nam exhibited varied rates of average export growth until the third quarter of 2014. Average export growth of China remained at only 4.8% during the first three quarters of 2014. Countries in the South and South-West Asia subregion also recorded differing levels of export performance. Export growth of India remained subdued in the first half of 2014. Pakistan and Sri Lanka registered average export growth rates of 5.7% and 16.8%, respectively, during the first three quarters of 2014. Merchandise exports trended higher in Bangladesh and Turkey in 2014 due to pick up in some specific sectors. The Russian Federation and Kazakhstan witnessed a drop in their export dynamism in 2014.

At the regional level, a slowdown in manufacturing activities in major developing countries further decelerated the expansion in trade in 2014. Further

enhancement of trade in intermediate inputs through regional supply chains can stimulate flows of goods in the region, especially by reducing barriers to regional supply chains. Several countries, such as the Philippines, Thailand and Turkey have undertaken trade policies aimed at strengthening competitiveness by investment in productive capacities. The prospects for trade in 2015 could improve if these policies are directed at stimulating production activities of large firms and creating an enabling environment for SMEs to access credit and other liquidity support.

On the trade policy front, there has been some optimism for multilateral trade-negotiations under the World Trade Organization (WTO) in 2014. The implementation of the Trade Facilitation Agreement (TFA), agreed at the ninth WTO Ministerial Conference in December 2013, known as the Bali Package and adopted for ratification in November 2014, could boost trade prospects and job opportunities in the region.7 TFA was intended to simplify and enhance the transparency of trade procedures among countries. The deadlock at the WTO Doha Development Round trade negotiations until recently has been accompanied by a flurry of regional trade agreement discussions. To push forward the work towards the goal of establishing the Free Trade Area of the Asia-Pacific (FTAAP), the APEC leaders’ meeting, which was held in Beijing in November 2014, formally agreed on advancing regional trade integration through a step-by-step approach.8 The proposed Trans-Pacific Partnership (TPP) is being led by the United States along with seven countries of the Asia-Pacific region with various levels of economic structure and trade openness.9 The proposal is moving forward at a slow rate due to differences on trade issues related to intellectual property rights and market access for agricultural products. As recognized in the Bangkok Declaration of December 2013, ESCAP has consistently supported member States of the region to consolidate subregional and smaller free trade blocks into a region-wide integrated market through cooperation and integration in trade and investment. New trade developments at the regional level are expected to further boost trade and investment flows in 2015 and beyond.

In 2014, further progress was made in the development of the ASEAN Economic Community.

7 For details of the Bali Package, see https://mc9.wto.org/.8 APEC Ministerial Meeting, 2014. Joint Ministerial Statement, Beijing, China, 8 November 2014. Available from www.apec.org/Meeting-Papers/Ministerial-Statements/Annual/2014/2014_amm.aspx.9 The countries in this grouping include 7 Asia-Pacific economies (Australia, Brunei Darussalam, Japan, Malaysia, New Zealand, Singapore, and Viet Nam) and 4 economies from the Americas (Canada, Chile, Mexico and Peru). See www.ustr.gov/tpp.


Figure 10. Real GDP growth of major developed economies, 2000-2016

Sources: Japan, based on CEIC Data (accessed 5 January 2015); Cabinet Office, “Gross domestic product: third quarter 2014” (1st Preliminary Estimates); Bank of Japan, “Outlook for economic activity and prices” (October 2014), based on fiscal year. United States, based on CEIC Data (accessed 5 January 2015); Bureau of Economic Analysis, U.S. Department of Commerce, “Gross domestic product” 3rd Quarter 2014 (third estimate) (December, 2014); Federal Reserve Bank Economic Projections (December, 2014). EA and EU: European Commission, European economic forecast, Autumn Economic Forecast, (November, 2014); Eurostatistics Data for Short-term economic analysis, Issue number 12/2014 (December, 2014).

At their 25th summit in November 2014, ASEAN leaders noted that 82.1% of the 229 prioritized deliverables identified for 2013 and an additional 61 deliverables for 2014-2015 under the AEC Blueprint had been implemented.10 The priority for 2015 is to fast track the implementation of remaining measures aimed at: addressing non-tariff barriers; realizing the customs single window; and deepening services and investment liberalization. These measures are arguably more challenging as they require significant domestic reforms. It was agreed that measures not achieved by the end of 2015 would be incorporated into a post-2015 agenda. Malaysia, the chair of ASEAN in 2015, is also committed to increase outreach with stakeholders such as SMEs with the intention to raise awareness of the opportunities presented by AEC and listen to concerns.

In the realm of financial integration, Malaysia, Singapore and Thailand made further progress in the cross-listing of stocks through the ASEAN Trade Link11 and the cross-border distribution of funds under the ASEAN Collective Investment Scheme (CIS)

framework.12 Other members, such as Indonesia, faced hurdles in this area.13 The varying degrees of progress illustrates that financial integration is certainly an area in which the pace of reforms will differ across countries, requiring a flexible approach (“ASEAN minus X”).

A key challenge to increasing the contribution of exports to growth and development is providing more comprehensive trade finance to SMEs, which account for 80-90% of Asia-Pacific businesses but are less likely to export than larger enterprises.14 SMEs are critical in providing livelihoods to people and lifting them out of poverty as they have the ability to make growth inclusive by generating decent jobs and income-earning opportunities for the working population, especially for the youth. However, SMEs in the region have limited access to trade finance, making it difficult for them to engage in international trade or to participate in international supply chains. Several factors are often identified as the major barriers preventing them from accessing trade finance: high transaction

10 See para 25 of the Chair’s statement of the 25th ASEAN Summit in Nay Pyi Taw, Myanmar, 11-13 November 2014. The AEC Blueprint was adopted in late 2007, setting clear targets and timelines for implementation across the four AEC pillars of single market and production base, competitive economic region, equitable economic development, and integration into the global economy.11 ASEAN Trade Link is an initiative of the ASEAN Exchanges, which consists of seven exchanges with a joint market cap of $2.9 trillion (the seventh largest in the world) and over 3,600 listed companies as of late 2014. 12 The ASEAN CIS Framework is an initiative of the ASEAN Capital Markets Forum, and allows fund managers operating in a member jurisdiction to offer CIS constituted and authorized in that jurisdiction to retail investors in other member jurisdictions under a streamlined authorization process. 13 For instance, the Indonesian law does not accommodate foreign firms from entering its bourse for a listing. Also, for other domestic reasons, Indonesia opted out of the Asia Region Funds Passport initiative under the ASEAN CIS framework. 14 Estimates by the International Finance Corporation (IFC) suggested that only 15% of regional SMEs are already exporters. IFC, Scaling-Up SME Access to Financial Services in the Developing World (Washington D.C., 2010). Available from www.gpfi.org/sites/default/files/documents/G20_Stocktaking_Report_0.pdf. 15 International Trade Centre, How to Access Trade Finance: A Guide for Exporting SMEs (Geneva, 2009). Available from www.intracen.org/uploadedFiles/intracenorg/Content/Trade_Support_Institutions/Delivering_services_to_exporters/Evaluating_trade_credit_applications/How_to_Access_Trade_Finance.pdf.

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17Trade and financial markets

Figure 11. Growth in merchandise exports in selected developing Asia-Pacific economies, year-on-year,2007-2014

costs; imperfect information; high default risk; and limited collateral.15 The Asia-Pacific region needs to create an enabling environment to support SMEs in developing countries to have better access to trade finance and to support the development of capacity to identify and overcome wider constraints to trade and financing sources.

Economies in the region have witnessed volatility in asset markets and exchange rates in recent months with financial flows being driven by United States monetary policy and growth differentials (see figure 12). In many cases, asset markets during 2014 returned to the levels preceding the “taper tantrum” of mid-2013. The calm in markets, which facilitated the increase in values, was reversed in late-2014 on increasing concerns over negative data on growth prospects coupled with fears the United States would be less likely to prop up global markets through monetary stimulus. Concerns about currency competition have been raised as the yen fell to seven-year lows against the dollar, aided by monetary easing in Japan. Exchange rates across the region have also fallen to their lowest levels in a number of years. The Turkish lira depreciated to record lows against the dollar, while the Indonesian rupiah in December declined to its lowest level since the 1997-1998 Asian financial crisis. The

Malaysian ringgit also fell to a five-year low, while the Korean won touched a 15-month low. The Russian Federation faced particular depreciation pressure due to geopolitical uncertainty, a sharp decline in oil prices and sanctions.

Other than allowing for currency depreciation, some countries also used interest rate policy to manage capital outflows, which has, in turn, affected the ability of governments to support growth. A number of countries that experienced substantial outflows chose to maintain relatively high interest rates to increase the attractiveness of their currencies to foreign investors. Some prominent examples are India, Indonesia and Turkey. Countries that maintained higher interest rates than those reflecting the strength of domestic demand have faced downward pressure on growth. High interest rates have been a significant factor underlying the relatively low growth of these economies in recent years as compared to previous performances.

Foreign reserves have also been used to manage the impact of capital outflows. Some economies that were affected during the “taper tantrum” in mid-2013, namely India, Indonesia and Turkey, sold some of their foreign exchange reserves to manage the falls in their currency values. These countries

Sources: ESCAP, based on data from World Trade Organization. Available from www.wto.org/english/res_e/statis_e/short_term_stats_e.htm; CEIC Data Available from www.ceicdata.com.; and Fiji Bureau of Statistics. Available from www.statsfiji.gov.fj (accessed December 2014).

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Q3

2011

Q1

2011

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2014

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2014

Q3

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China India IndonesiaRepublic of Korea Russian Federation Fiji


16 Vladimir Kuznetsov, “Russia Central Bank under pressure as rate-increase bets surge”, Bloomberg, 5 December 2014. Available from www.bloomberg.com/news/2014-12-05/bank-of-russia-sold-1-9-billion-on-dec-3-to-stem-ruble-decline.html.17 Asian Development Bank, Infrastructure for a Seamless Asia (Manila, 2009), p. 169, contains an estimate of $750 billion per year, 50% of which represents energy investments. The $375 billion estimate excludes energy. 18 ESCAP, Review of Developments in Transport in Asia and the Pacific 2013: Transport as a Key to Sustainable Development and Regional Integration (ST/ESCAP/2667), tables 3.1 and 3.2.19 Asian Development Bank, Energy Outlook for Asia and the Pacific (Manila, 2013), table 7.4. These estimates are based on cumulative investments of respectively $12.6 trillion and $7.3 trillion over 26 years (2010-2035).

have mostly recovered the reserves lost during the last bout of outflows, although concerns remain about reserve adequacy in some cases. The levels of foreign exchange reserves in India and Indonesia have recovered to their previous values, while that of Turkey has remained at a lower level due to country-specific challenges mentioned earlier. On the other hand, the Russian Federation has been depleting its reserves due to the strong downward pressure on its currency in recent months. The central bank announced in October 2014 that it would limit its intervention to $350 million per day to support the currency; far smaller than previously, moving the currency closer towards a relatively free-float. The depth of the fall in the rouble in November 2014 however prompted renewed large-scale intervention. The country used more than $70 billion in reserves in 2014 to defend the currency.16

2. Risks and challenges2.1. Domestic structural concerns2.1.1. Infrastructure

A key ongoing concern for economies in the region is increasing their supply potential by bridging infrastructure gaps. To overcome the structural

factors inhibiting growth, a major policy issue is sustained cooperation at the subregional and regional levels to invest in physical infrastructure. The region’s financing requirements are massive. The Asian Development Bank (ADB) estimated in 2009 that the region would need $375 billion per year to close its infrastructure gaps in transport, telecommunications, and water and sanitation by 2020.17 This estimate, however, does not include necessary investments for the maintenance of roads and railways, which a recent ESCAP publication estimated at $160 billion per year.18 With regard to the energy sector, ADB estimated annual needs of $280 billion per year to invest in energy-efficient technologies in the energy-using sectors, such as transport, manufacturing and residential buildings.19

Although these various estimates are based on somewhat different country groupings and base years, adding them provides a preliminary estimate of the region’s total infrastructure investment requirements of $815 billion per year.

A number of major developing economies are stymied from financing projects from government funds due to fiscal concerns. India and Indonesia are two major economies that have pinpointed infrastructure provision as a key requirement in their reform programmes. However, both economies are

Figure 12. Exchange rate indices in selected developing Asia-Pacific economies, 2005-2014

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Source: ESCAP, based on data from CEIC Data. Available from www.ceicdata.com (accessed 5 January 2015).Note: These indices are calculated vis-à-vis the United States dollar. Lower value signifies depreciation against the United States dollar. QE1,QE2 and QE3 refer to the three rounds of quantitative easing by the United States Federal Reserve.

19Domestic structural concerns

20 See e.g. Timothy Irwin and Tanya Mokdad, Managing Contingent Liabilities in Public-Private Partnerships Practice in Australia, Chile, and South Africa (Washington, D.C., World Bank, 2010) for a useful discussion.21 ESCAP, Review of Developments in Transport in Asia and the Pacific 2013: Transport as a Key to Sustainable Development and Regional Integration (ST/ESCAP/2667).22 International Labour Organization, Project LINK meeting, October 2014.

hampered by budget deficits. This supports the need to have the private sector play an important role in the provision of infrastructure in the region and for governments to collaborate through PPPs. Notably, PPPs have become more attractive in the Asia-Pacific region over the last few decades because of their potential to close gaps in national and regional development financing. In addition, they are seen as a way to take advantage of private sector efficiency and innovation capacity.

A clear policy is essential to set out a stable and long-term-vision for PPP development in the Asia-Pacific region. PPP projects typically take several years to be developed and are often politically sensitive. As such, PPPs are vulnerable to government change, which could result in a position reversal. Private operators have to carry out full due diligence of the legal and fiscal environment and are unlikely to do so if the policy direction of the government is unclear. In this context, legal and regulatory frameworks are critical for protecting the rights of the private sector. The legal framework has to be clear with regard to what type of sectors are eligible for PPP mechanisms, which authority is mandated with approving PPP projects and what procurement rules have to be followed. Such clarity will limit the risk of challenges to the validity of PPP contracts and will facilitate the work of government officials. The availability of adequate dispute resolution mechanisms is also critical for creating confidence that private sector rights will be protected. Institutional arrangements that build internal capacity in implementing PPP projects are by nature relatively complex and require specific expertise. To build such expertise, many governments have established specialized units or programmes to develop and supervise PPP projects. These play a “catalytic” role in promoting and developing PPP solutions as they allow the concentration and availability of required expertise through the accumulation of experience and the possibility of adequate training.

In addition to the above, there needs to be a body of financial support measures that ensures that projects are sufficiently profitable and safe for attracting private investors. Overall, the guarantees provided in connection with PPP projects might have substantial financial implications in the long run and should be carefully assessed. Therefore, it is important to ensure good governance in the way these financial support mechanisms are provided. There is also a growing demand and need to

ensure that these guarantees are correctly reflected in national accounts. Monitoring and publishing the value of contingent liabilities, such as those arising from revenue guarantees, and introducing contractual clauses to restrict government risks should be assessed to avoid potentially disruptive future budget implications.20

While developing their policies, governments must keep in mind that PPP solutions are not suitable for all type of projects. Even in countries where PPPs have been intensively pursued, they rarely comprise more than 20% of public infrastructure projects.21 In this respect, it is worth noting that PPPs have been a particularly promising avenue in revenue-generating sectors, such as energy, information communications technology and transport, in which user charges can be used to repay the investment.

2.1.2. Labour

The region is still struggling to create adequate jobs in the formal sector. Inequality in access to basic public services has been a critical factor in inhibiting youth and adults from getting decent and productive jobs in recent years. In several economies, labour markets are still functioning at less than full capacity due to lack of availability of basic services. Many labour markets are faced with the following challenges: (a) non-availability of a skilled labour force; (b) lack of quality of educational infrastructure, including vocational training institutions; and (c) limited access to higher education facilities. These factors have exacerbated the falling labour productivity at the national level across several countries in the region. Furthermore, the slow-pace in reforming labour markets and related institutions has contributed to jobless growth in the region.

Lack of labour market reform policies and failure to strengthen institutional wage-setting mechanisms have limited several countries’ ability to tackle the need to create jobs. Globally, the unemployment rate stood at 5.9% in 2014, while the youth unemployment rate remained as high as 12.9%.22 In the region, several countries have recorded unemployment rates that exceeded 10%. Similarly, two developed countries in the region (Australia and New Zealand) and some major developing countries, such as Indonesia, the Russian Federation and Turkey, have also experienced unemployment rates in the range of 5% to 10% in 2013 and 2014. Alarmingly, unemployment rates are expected


Figure 13. Unemployment rates in selected Asia-Pacific economies, 2013-2015

23 International Labour Organization, “World of Work Report 2014: Youth unemployment rates across the world”. Available from www.ilo.org/global/about-the-ilo/multimedia/maps-and-charts/WCMS_244259/lang--en/index.htm.24 See ESCAP, Economic and Social Survey of Asia and the Pacific 2013: Forward-Looking Macroeconomic Policies for Inclusive and Sustainable Development (Sales No. E.13.II.F.2).

to remain unchanged in 2015 unless countries initiate significant national programmes to generate employment (see figure 13).

Women and youth are particularly affected by the jobs challenge. Women in the region are more likely than men to be in precarious jobs. Furthermore, in most economies, youth unemployment rates remained significantly higher in 2014 than total unemployment, which was elaborated in the Survey 2014. For example, youth unemployment rates were recorded at more than 20% in Indonesia and Turkey, followed by Afghanistan (19.4%), the Philippines (16.7%), the Russian Federation (14.5%) and Malaysia (11.1%). The rates also exceed 10% in China and India.23 The higher incidence of youth unemployment rates is often due to: the quality of education and the lack of targeted labour market policies and programmes linked to skills and training systems; lack of private sector participation; and lack of youth entrepreneurship services.

Importantly, concerns about job quality were pervasive throughout developing Asia and the Pacific in 2014 as a high number of workers continued to remain employed as own-account or contributing family workers. For example, based on available data for recent years, the share of own-account

and contributing family workers in total employment was more than 50% in Indonesia, Pakistan, Thailand and Viet Nam. These own-account and contributing family workers are often informally employed with limited opportunities for regular, salaried jobs, which tend to be more productive and secure.

2.2. Global monetary policy developments

Volatility in global and regional financial markets over the next few months appears likely due to changes in expectations regarding the timing of interest rate rises in the United States, which may exert significant pressures on Asia-Pacific economies. The region is likely to be more affected by capital outflows due to United States tightening than other regions, as a number of economies in Asia and the Pacific have received large capital inflows in the past few years. Growth in the region is vulnerable to the possibility of this capital being withdrawn. It also may lead to hikes in interest rates to prevent capital from leaving, which, in turn, would depress investment and consumption. Some economies would be particularly keen to prevent outflows as they have current account deficits that are being financed by short-term capital inflows.

Source: ILO, Global Employment Trends 2014. Available from http://ilo.org/global/about-the-ilo/multimedia/maps-and-charts/WCMS_233936/lang--en/index.htm. Note: The 2014 and 2015 figures are ILO projections of unemployment rates (%).

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21Global monetary policy developments

ESCAP analysis indicates the possible impact of higher interest rates in the United States on the region (see box 2). Annual GDP growth rates for developing Asia-Pacific economies could be between 0.3-0.7 percentage points lower than the baseline if domestic interest rates were to increase by 1 percentage point in response to developments in the United States. Asia-Pacific economies that are most sensitive to higher borrowing costs are Hong Kong, China; the Republic of Korea; and Singapore where the growth impact is estimated at 0.6-0.7

percentage points. The estimated effects on China and Thailand are also sizeable at 0.4-0.5 percentage points. Although the growth impact is estimated to be relatively large, macroeconomic stability is likely to continue in these economies due to favourable macroeconomic fundamentals. In contrast, countries that rely heavily on external funds to meet their financing needs, such as Kyrgyzstan, Maldives, Mongolia and Sri Lanka, could experience a sharp economic slowdown as tighter domestic monetary conditions cannot be offset by fiscal support.

Box 2. Potential impact of United States increase in interest rates on Asia-Pacific economies

Amid the economic rebound in the United States, interest rate normalization is widely expected to start at a gradual pace in 2015. The three-month Treasury bill rate has been below 0.1% since 2011, relative to 4.4% in 2007. Unwinding that takes place earlier or sharper than market expectations could lead to a similar episode of capital market turbulences as seen in mid-2013 when the tapering of quantitative easing was thought to start earlier than initially anticipated. A more fundamental issue is the macroeconomic impact of a higher interest rate in the United States on developing Asia-Pacific economies. Interest rates in the region may need to rise in order to maintain margins with the rates in the United States, especially considering that a narrower growth differential between the region and the United States would also increase pressure for capital outflows from Asia-Pacific. The box illustrates that the macroeconomic impact of higher borrowing costs in major developing regional economies could be considerable, although macroeconomic stability is likely to be maintained given the economies’ favourable macroeconomic fundamentals. In contrast, several smaller countries in the region that rely heavily on external funds to finance investment needs could be particularly affected, partly because of limited room for fiscal policy response.The impact of a 1 percentage point increase in domestic short-term interest rates in response to an increase in United States interest rates is quantified for 44 developed and developing economies worldwide. This increase is in line with the forecasts of various agencies regarding the size of the increase in United States interest rates following the start of interest rate normalization.25 In developing Asia-Pacific, annual GDP growth rates could be between 0.3-0.7 percentage points lower than the baseline (see figure A). The impact is generally larger than in developed economies and developing economies outside the region. Asia-Pacific economies that are most sensitive to higher borrowing rates are Hong Kong, China; the Republic of Korea; and Singapore where the growth impact is estimated at 0.6-0.7 percentage points. Annual fixed investment growth in these economies could be up to 1.0-1.1 percentage points lower than the baseline. The estimated growth effect on China and Thailand is also sizeable at 0.4-0.5 percentage points. As expected, an economy’s sensitivity to interest rate change is positively correlated with its size of domestic credit. In all five economies mentioned above, domestic credit amounts to at least 110% of GDP (see figure B). Fairly high levels of credit have been directed to certain sectors in those economies, such as the household sector in the Republic of Korea and Thailand, and the government sector in China.

25 See, for example, Congressional Budget Office, 2014. An Update to the Budget and Economic Outlook, 2014 to 2024. August 2014. Available from www.cbo.gov/sites/default/files/45653-OutlookUpdate_2014_Aug.pdf.


Box 2. continued

More broadly, economies that rely on foreign capital to finance investment needs tend be more affected by higher borrowing rates. Such saving-investment gaps are generally reflected in the current account deficit. In Bhutan, the Lao People’s Democratic Republic, Maldives, Mongolia and Papua New Guinea, the average current account shortfalls were at least 20% of GDP during the period 2010-2013. These economies exhibit lower foreign-currency sovereign ratings, which further push up borrowing costs. As credit defaults tend to rise amid higher interest rates, economies with healthy banking sectors tend to cope better with the rate hike. In the major economies where the growth impact is estimated to be sizeable, banking sectors appear solid. Capital adequacy ratios are typically high, while asset quality, as measured by the share of non-performing loans, is generally favourable. In addition to strong banking sectors, economies with adequate fiscal space tend to weather the rate rise more smoothly in the wake of tighter monetary conditions. Fiscal support, such as temporary tax exemptions, can be introduced to support vulnerable households and small firms that face higher debt burdens. However, most of the small economies with large current account deficits highlighted earlier have relatively high public debt levels and/or weaker debt repayment ability in the event of adverse shocks, so such fiscal support is less feasible.

Figure A. Higher interest rate could hold back economic growth significantly

Figure B. Economies with higher domestic debt-to-GDP ratios are generally more affected

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Thailand

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Republic of Korea

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Reduc&on in GDP growth rela&ve to the baseline (percentage points)

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Source: ESCAP, based on Oxford Global Economic Model.Note: CHN=China; HKG=Hong Kong, China; IND=India; IDN=Indonesia; KOR=Republic of Korea; MYS=Malaysia; PHL=Philippines; RUS=Russian Federation; SGP=Singapore; THA=Thailand; and TUR=Turkey.

Despite upcoming tightening by the United States, high global liquidity will still remain an important feature of the global economy in 2015 due to the actions taken in the eurozone and by Japan. Indeed, the total stock of global liquidity will continue to increase in coming months as the European Central Bank and Bank of Japan would be injecting liquidity while the Federal Reserve would only be halting rather than withdrawing liquidity injections. It is estimated that total global liquidity will increase in 2015 by 1.3% as a percentage of global GDP, as

compared to 0.3% in 2014.26 New funds released through easing by Japan and in the eurozone have the potential to serve to some degree as a buffer to outflows from the region. This is because interest rate and GDP growth differentials between the newly easing economies and Asia-Pacific economies may once again spur investors to buy currencies and assets in the region. On the other hand, it is possible that this new liquidity will go primarily to other markets, such as the United States, as has been seen recently with money exiting the region.

26 Financial Times, 2014. “Bank of Japan opens the floodgates”. 2 November 2014. Available from http://blogs.ft.com/gavyndavies/2014/11/02/bank-of-japan-opens-the-floodgates/.

23Global monetary policy developments

27 International Energy Agency. “Oil Market Report: October 2014”. Available from www.iea.org/oilmarketreport/.28 “Cheaper oil: both symptom and balm”. 18 October 2014. Available from www.economist.com/news/finance-and-economics/21625819-oil-price-tumbling-good-or-bad-news-world-economy-both.

Figure 14. Oil production in Middle East and North America, and Brent crude spot price, 2012-2014,dollars per barrel

Sources: ESCAP, based on data from United States Energy Information Administration. Available from http://tonto.eia.doe.gov/dnav/pet/pet_pri_spt_s1_d.htm; and CEIC Data. Available from www.ceiedata.com (accessed 5 January 2015).

2.3. Oil price developmentsA major global development has been the sharp drop in oil prices over recent months, which may be the start of a longer-term trend (see figure 14). The price of Brent dropped by more than 40% in 2014, reaching a five and a half-year low. With the region being largely composed of oil-importing countries, this decline has come as a welcome relief for most countries. There are two main reasons for the decline in prices. One is the slow global economic recovery, with demand from the largest global economies, comprising the major developed countries and China, lower than historical values due to their constrained growth. The International Energy Agency (IEA) in October 2014 lowered its estimate of global oil demand growth by 250,000 barrels a day due to lower global GDP growth, suggesting that global oil demand will grow at its slowest pace in five years.27 The other reason for the decline in prices is the coming on-stream of United States oil production derived from shale, the underground source of energy deposits, which comprises the majority of such deposits found in that country. Since April 2013, there has been a significant increase in total global oil supply, by 1 million to 2 million barrels/day more than the previous year, with a large proportion of this increase coming from the United States.28

ESCAP analysis indicates that the drop in oil prices will exert significant and diverse impacts on the

region (see box 3). For energy-importing countries with available data in Asia-Pacific, a scenario of oil prices being $10 per barrel lower in 2015 would result in an increase in GDP growth of up to 0.5 percentage points, with the Republic of Korea, the Philippines, Singapore and Thailand reaping the greatest benefit. China would experience the highest decrease in inflationary pressures, of 0.6 percentage points, and Thailand would experience the highest increase in current account balance, of 2.2% of GDP. Among net energy-exporting countries, deterioration in the current account and government balances of the Russian Federation could potentially result in an additional reduction in GDP growth of 1.1 percentage points. In a second set of effects due to a drop of oil prices, a contraction of the Russian economy could significantly affect neighbouring economies through the remittance channel. It is estimated that at least $1.7 billion would not be remitted to the countries of origin of migrant workers, with Kyrgyzstan and Tajikistan being the most affected economies. Remittances are likely to decrease further as the amount sent from host countries outside the region that are oil exporters, particularly from the Middle East, will decline. Receiving countries that are likely to be most affected are among others, Bangladesh, India, Pakistan, the Philippines and Sri Lanka.

15 000

20 000

25 000

30 000

55

70

85

100

115

130

Jan‐2012

Jun‐2012

Nov

‐201

2

Apr‐2013

Sep‐20

13

Feb‐20

14

Jul‐2

014

Dec‐20

14 Thou

sdan

ds barrels pe

r day

Dollars per Barrel

Europe Brent Spot Price FOB (Dollars per Barrel)

North America crude oil production (thousands barrels per day)

Middle East crude oil production (thousands barrels per day)


29 As of mid-December 2014, the 2015 Brent oil price in the Oxford Global Economic Model is projected at $70 per barrel. Similarly, the United States Energy Information Adminis-tration forecast the price at $68 per barrel.

Box 3. Potential impact of a drop in oil prices on Asia-Pacific economies

Lower global oil prices will have diverse impacts on major developing economies in Asia and the Pacific. Although oil-importing economies will generally benefit from lower oil prices through smaller import bills and lower inflation, the net positive effect may be smaller than expected, depending on their linkages with large, oil-exporting economies where economic activity is constrained by lower oil revenues. The second part of this box illustrates such spillover effects, showing how the expected economic contraction in the Russian Federation could cut workers’ remittances received by small, oil-importing economies, such as Kyrgyzstan and Tajikistan.

The estimated impact of lower oil prices is based on the Oxford Global Economic Model and is calculated for all regional economies covered by the model. The simulation assumes an average Brent crude oil price for 2015 at about $10 per barrel lower than the baseline.29 In economies that rely heavily on imported energy, such as the Republic of Korea, the Philippines, Singapore and Thailand, economic growth in 2015 could be between 0.3-0.5 percentage points higher than the baseline (see figure A). Smaller import bills should push up the current account surpluses for economies in the region by 0.3-2.2% of GDP (see figure B), with Thailand benefiting the most. In addition to more favourable external accounts, lower oil prices support domestic demand through lower inflation. China, the Philippines and Thailand would experience the greatest decrease of inflationary pressures, of 0.5-0.6 percentage points. In economies, such as India, where price pressure has been persistently strong, lower inflation could provide leeway to ease monetary policy.

In the Russian Federation, the major oil exporter in the region, economic growth in 2015 is estimated to be as much as 1.1 percentage points below the baseline. The economy is likely to face a deeper economic contraction than what is projected under the baseline. The current account balance is expected to deteriorate by 2.1% of GDP, hence turning the small current account surplus under the baseline into a deficit in 2015. Reflecting lower oil-related revenues and subdued economic activity, a widening of the fiscal deficit is also expected. Economies that have sizeable hydrocarbon resources and are not covered by the model such as Azerbaijan, the Islamic Republic of Iran, Kazakhstan, Turkmenistan and Uzbekistan, would also be affected through these channels. The magnitude of the impact would depend on the country’s reliance on oil export revenue and the linkages between the resource and non-resource sectors in the country.

An analysis of international flows between the Russian Federation and other North and Central Asian economies shows that remittance inflows from the Russian Federation are the most important international flows received by Armenia, Kyrgyzstan and Tajikistan, and would be the most important channel of transmission of potential difficulties faced by the Russian Federation. North and Central Asian economies could also be moderately affected by an expected economic contraction in the Russian Federation through the export channel. For example, in Turkmenistan, exports and remittance inflows represent about 77% and 21%, respectively, of total inflows received from the Russian Federation.

Estimates of spillover effects in the North and Central Asia subregion are based on econometric analyses, particularly vector autoregressive (VAR) models and impulse function responses (IFRs), which use the growth rate of seasonally adjusted variables. The VAR models include, among other variables, the growth rate of quarterly GDP of the Russian Federation, and remittances from the Russian Federation to neighbouring countries.

25Oil price developments

Box 3. continued

Figure A. Lower oil prices would push up growth in most Asia-Pacific economies

Figure B. External accounts would improve while inflation decreases

-1.2 -0.9 -0.6 -0.3 0.0 0.3 0.6

Russian Federation

Indonesia

Malaysia

Australia

Japan

Hong Kong, China

China

India

Turkey

Thailand

Singapore

Philippines

Republic of Korea

Change in GDP growth relative to baseline (percentage points)

AUS

CHN

HKG

IND

IDN

JPN

KOR

MYS

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TUR

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tion

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tive

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asel

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cent

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ts)

Change in current account/GDP relative to baseline (percentage points)

Source: ESCAP, based on Oxford Global Economic Model.Note: AUS=Australia; CHN=China; HKG=Hong Kong, China; IND=India; IDN=Indonesia; JPN=Japan; KOR=Republic of Korea; MYS=Malaysia; PHL=Philippines; RUS=Russian Federation; SGP=Singapore; THA=Thailand; and TUR=Turkey.

As migrant workers generally hold vulnerable jobs, they would be the first to be affected by a potential deterioration of the economic situation in their host country. In total, it is estimated that potentially, at least $1.7 billion would not be remitted to the countries of origin of migrant workers, with Kyrgyzstan and Tajikistan being the most affected economies (see figure C). These impacts would be significant for low-income households as the poverty rates (based on national poverty lines) in those two countries are above 37%.

Figure C. Drop in oil prices: Potential effects on remittance flows from the Russian Federation to otherNorth and Central Asian countries, in millions of dollars

-‐800

-‐700

-‐600

-‐500

-‐400

-‐300

-‐200

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0 Tajikistan Kyrgyzstan Armenia Azerbaijan Kazakhstan

Remi

%ance infl

ows in m

illion

US d

ollars

Source: ESCAP, based on Oxford Global Economic Model and vector autoregressive (VAR) analyses.


3. Policy considerations and suggestions

The following sections highlight three key policy recommendations to manage the challenges facing the region in 2015. First, is the fundamental need to address major domestic structural weaknesses holding back the supply potential of economies. Second, is the need for appropriate measures to tackle macroeconomic volatility resulting from developed economy monetary policies. Third, is a call to dismantle fuel subsidies using the window of opportunity presented by lower oil prices, which would improve macroeconomic fundamentals and fiscal and monetary flexibility.

3.1. Addressing domestic structuralweaknesses

3.1.1. Infrastructure

For infrastructure provision, there is an important potential role for alternative sources of funds from the region. At the domestic level, available fiscal resources can be increased by reforming fuel subsidies in many economies (see section 3.3). However, there remains a mismatch between the depth of requirement in major developing economies and the resources available domestically. Yet, Asia and the Pacific is home to investors with large sums of money looking for productive investment opportunities. The region had gross national savings amounting to $8.4 trillion in 2012, representing more than half of the world’s total savings. It also holds the largest share of global foreign exchange reserves, $7.5 trillion in mid-2014. And according to some estimates, the region’s high net worth individuals had $12.7 trillion in assets in 2012, while the region’s mass affluent had $20.5 trillion in assets.30

What is lacking is better financial intermediation. Financial markets in Asia and the Pacific should provide an implementable framework to efficiently channel savings and reserves to productive investments. Institutional investors, such as asset managers, pension funds and sovereign wealth funds in Asia and the Pacific can contribute to financing infrastructure. Pension funds have traditionally invested in infrastructure through listed companies and fixed income instruments. However, over the last two decades, they have started to recognize infrastructure as a distinct asset class

which, although illiquid, could be beneficial to enhance portfolio diversification. Pension funds’ and other institutional investors’ long investment horizons enable them to afford the risk of investing in less liquid and longer-term assets, such as infrastructure.31

At the national level, countries need to identify projects and programmes at the sectoral level to engage the private sector in infrastructure development. Relevant policy issues may include the following:

• PPP project pipeline: Governments need tosupport proactive and effective policy actions to mobilize private resources through PPPs in long-term development projects. Policymakers should also institutionalize policies to set up conditions for generating a steady flow of PPP projects and to stimulate government contracting agencies such as ministries, to consider PPP solutions for infrastructure development.

• Institutional frameworks: Governments mustestablish institutional frameworks that support project identification and preparation, promote good governance in procurement, and ensure adequate monitoring. Designing institutional arrangements is necessary for countries to understand the viability and their impact on development.

• PPP cost-sharing and risk-sharing mechanisms:Typical PPP projects rely heavily on debt financing. Meanwhile, the private sector faces higher borrowing costs than the public sector. This suggests that there should be better public sector policy support for risk- or cost-sharing mechanisms that will facilitate access to finance for PPP projects at a reasonable cost, while keeping the impact on public finance sustainable in the long run.

• Harmonize PPP legislation: National policiesrelevant to PPP projects should be harmonized to reduce contradictory policies and uncertainty for the private sector. In particular, effective coordination between PPPs and land and environment policies should be established to avoid unexpected difficulties and delays in the implementation stage. This will help create mechanisms to harmonize national policies, especially those related to dedicated PPP laws.

• Inclusive PPPs: Policies need to ensure that PPP

30 High net worth individuals own $1 million or more in assets; mass affluent individuals own between $100,000 and $1 million in assets. PwC, Asset Management 2020: A Brave new world (PricewaterhouseCoopers International, 2014). Available from www.pwc.com/gx/en/asset-management/publications/pdfs/pwc-asset-management-2020-a-brave-new-world-final.pdf. According to Wealth-X and UBS, the region’s ultra-high net worth individuals (UHNWIs), those with a net worth of $30 million or more, held $7.5 trillion of net wealth in 2012-2013. Wealth-X and UBS (2014), World Ultra Wealth Report 2012 – 2013 (2014) Available from http://wealthx.com October/wealthreport/. 31 OECD, “Report on pension funds’ long term investments: survey of large pension funds and public pension reserve funds”, (Paris, 2013). Available from www.g20.org/sites/default/files/g20_resources/library/LargestPensionFunds2012SurveyFINAL.pdf.

27Addressing domestic structural weaknesses

mechanisms can benefit all citizens and do not result in more exclusion. In particular, policies need to ensure that “user-pays” mechanisms do not exclude the poorest citizens from basic public services or that less densely populated areas with a lower commercial profitability are not underserved by PPPs.

At the regional level, ESCAP has, for many years, proposed the creation of a financial intermediation facility for development financing, which would include a system of intermediation between the region’s large savings and its unmet investment needs.32 Notably, the ESCAP theme study in 2006 proposed the creation of a large-scale regional infrastructure investment facility.33 In this regard, ESCAP has undertaken a series of working group meetings based on the outcome of the first Asia-Pacific Ministerial Conference on Regional Economic Cooperation and Integration which was held in 2013, to help promote regional approaches to address the financing gap in physical infrastructure.

Recently, China has initiated the creation of a regional development institution to help infrastructure development and promote sustainable growth. As founding members, 21 countries from the Asia-Pacific region signed the memorandum of understanding (MOU) on establishing the Asian Infrastructure Investment Bank (AIIB) in Beijing on 24 October 2014.34 The MOU specifies the authorized capital of AIIB to be $100 billion and the initial subscribed capital is expected to be around $50 billion. A similar initiative of the BRICS (Brazil, Russia, India, China and South Africa) countries to create a new development bank is also expected to provide financing and expertise required for the development of infrastructure in the region.35 These new financing institutions are set to play a catalytic role in accelerating the funding modalities and solutions for financing countries’ infrastructure requirements, especially for least developed countries in the Asia-Pacific region.

3.1.2. Labour

It is clear that the region continues to face a host of problems in the labour arena that require policy actions. A lot of jobs in the formal sector are not “decent” jobs, as pay is often inadequate and in many countries, labour codes are not adequately enforced. There is also a large amount of informal jobs even in the formal sector. Moreover, in many countries, the majority of workers remain in the informal sector with unstable and inadequate working conditions. Among sections of the population, youth remain particularly affected by unemployment and underemployment. An increasingly pressing issue for governments is improving the participation of women in the workforce. Realizing women’s full economic potential is essential for driving growth and achieving more inclusive and balanced development.

Policies to increase the amount of citizens in decent jobs and reduce youth unemployment should place more emphasis on matching the abilities of workers with the needs of the current and future marketplace. Asia-Pacific countries have to initiate active labour market policies aimed at improving job quality, enhancing skills, and boosting productivity and wages, including minimum wages.36 Some good examples are already available in the region. For example, Turkey (increased employment opportunities through emphasis on education), the Philippines (increased human capital investment) and India (increase in community colleges and vocational courses, and entrepreneurship), among others, are in the process of implementing national plans to boost employment opportunities through a variety of labour market policies.

Improving women’s job prospects requires a fundamental shift in social perceptions and attitudes, as well as stronger anti-discrimination legislation for workplaces. Other important measures include quality education and training that promotes non-conventional tracks for women, access to quality

32 See, for example, ESCAP, 2010. Economic and Social Survey of Asia and the Pacific 2010. (Sales No. E.10.II.F.10) Chapter 3. Available from www.unescap.org/resources/economic-and-social-survey-asia-and-pacific-2010.33 See ESCAP, 2006. Enhancing Regional Cooperation in Infrastructure Development Including that Related to Disaster Management. Theme Study of the sixty-second Commission session (Sales No. E.06.II.F.13). Available from www.unescap.org/resources/theme-study-sixty-second-commission-session-enhancing-regional-cooperation-infrastructure.34 The remaining countries are Bangladesh, Brunei Darussalam, Cambodia, India, Kazakhstan, Kuwait, Lao People’s Democratic Republic, Malaysia, Mongolia, Myanmar, Nepal, Oman, Pakistan, the Philippines, Qatar, Singapore, Sri Lanka, Thailand, Uzbekistan and Viet Nam. More information is available from: http://news.xinhuanet.com/english/business/2014-10/24/c_133740149_2.htm.35 VI BRICS Summit, 2014.“Agreement on the New Development Bank”, Press release, July 2015. Available from http://brics6.itamaraty.gov.br/media2/press-releases/219-agreement-on-the-new-development-bank-fortaleza-july-15.36 See ESCAP, 2013. Economic and Social Survey of Asia and the Pacific 2013: Forward-Looking Macroeconomic Policies for Inclusive and Sustainable Development. (Sales No. E.13.II.F2).


and affordable child care and maternity protection, reducing gender wage disparities and fostering demand that creates decent jobs. The Republic of Korea has provided a good example on how to address this issue. In 2013, the Government declared the intention to significantly increase the labour participation rate through such measures as the provision of child care and maternity leave benefits.37

3.2. Policies to manage capital volatility

Amid increasing sources of capital volatility, the economies of Asia and the Pacific need to adopt a range of policies to ensure macroeconomic stability. The timing of the increase in interest rates in the United States, increased quantitative easing by Japan and new unconventional monetary policies in the eurozone will increase the volatility of capital flows in the region. A key lesson from recent episodes of capital outflow in the region is that the economies most affected are the ones possessing weaker macroeconomic fundamentals. Particular areas of concern for investors have been twin deficits — budget deficits and current account deficits — as well as inflation. Thus, economies with some of these concerns, such as India, Indonesia and Turkey, were particularly adversely affected by capital withdrawals. It is therefore clear that one of the fundamental requirements to reduce vulnerability to capital outflows is to maintain appropriate monetary and fiscal policies that ensure good macroeconomic fundamentals. This will necessitate tight monetary policies when required and government spending in line with fiscal space.

Governments may need to be cautious in their use of foreign exchange intervention in cases of currency pressure due to concerns about size of funds available and lack of effectiveness in maintaining asset market stability. Regarding reserve adequacy, the ESCAP vulnerability yardstick indicates that potential requirements for foreign capital exceed foreign reserves for a number of economies in the region exposed to volatile capital flows (see figure 15). An additional issue with the buildup of large reserves solely for the purpose of protecting currency values is the high cost of maintaining such reserves on government budgets. In order to keep the reserves liquid and easily accessible, they are usually invested in low-return government bonds of the major developed economies, primarily those

denominated in the United States dollar or the euro. This implies a significant opportunity cost, as the funds could instead be invested in opportunities in domestic markets at higher rates of interest. There is also an actual cost to governments of these reserves, to the extent that governments undertake sterilization operations while accumulating reserves by issuing local currency bonds. The interest rates of these bonds tend to be higher than rates earned on foreign reserves. An even more fundamental concern with using reserves as a tool for maintaining macroeconomic stability is that they do not deal with asset market volatility. Therefore, while currency values may be protected by spending reserves, asset market declines due to capital outflow will nevertheless occur. Sharp asset market declines, such as in equity and property markets, have the potential to cause banking sector distress and significantly jeopardize household incomes and macroeconomic stability.

Macroprudential measures are also important additional tools for maintaining stability in asset and currency markets. Macroprudential measures should be aimed at encouraging the entry of foreign capital to support development of the real economy. Directing capital towards the real economy could be incentivised by increasing the cost of entry of capital for investment in particularly risky areas of the economy, such as property. A number of economies across the region such as Singapore and Hong Kong, China have adopted measures, such as increased deposit requirements for mortgages and higher stamp duties, to deal with speculative property purchases. These have proved effective as the speed of house price rises has slowed following implementation of these measures. A similar area of concern is speculative short-term secondary market equity and bond purchases. A number of countries have adopted measures to encourage long-term entry of portfolio capital, such as through unremunerated reserve requirements on non-resident deposits, withholding taxes, or restrictions on non-resident holdings of domestic assets.

3.3. An opportune time to reduce fuel subsidies

The current trend of declining global oil prices provides a valuable opportunity for many regional economies to consider cutting fuel subsidies. A

37 Republic of Korea, Ministry of Strategy and Finance, “Roadmap to achieve 70 percent employment rate”, 4 June 2013.

29Policies to manage capital volatility

Figure 15. Vulnerability yardstick (short-term foreign exchange commitments as a percentage of foreignreserves) in selected Asia-Pacific economies, latest available data

0 50 100 150 200 250 300

Malaysia

Kazakhstan

Republic of Korea

Indonesia

India

Thailand

Philippines

Russian FederaAon

China

January 2014 January 2015

Most vulnerable

Least vulnerable

Sources: ESCAP calculations based on data from CEIC Data Available from www.ceicdata.com (accessed 5 January 2015).Note: Vulnerability yardstick is the sum of short-term external debt, latest quarterly imports based on four-quarter moving average and estimated international portfolio investment position.

38 See ESCAP, 2014. “Sustainable development financing: perspectives from Asia and the Pacific”, background paper, Asia-Pacific Outreach Meeting on Sustainable Development Financing, Jakarta, Indonesia, 10-11 June 2014. Available from www.unescap.org/resources/background-paper-sustainable-development-financing-perspectives-asia-and-pacific.

number of countries have taken significant steps to reduce their fuel subsidy burden since 2013. Nevertheless, fuel-related subsidies continue to represent a very large share of budgets for many countries in the region, such as Indonesia, Thailand and Viet Nam.

In many countries, energy subsidies are often regressive; they inherently encourage wastage and result in fuel-intensive production. Importantly, poorly targeted energy subsidies have had little impact on either enhancing inclusive growth or reducing extreme poverty. However, curbing increasing levels of non-development expenditure and removing or reducing harmful subsidies are politically challenging; in many countries, the removal of subsidies has sparked protests, especially from influential interest-groups.

Reducing subsidies can raise significant public financial resources for productive investment in the region and could make well-needed funds available for financing sustainable development. According to ESCAP estimates, savings from these subsidies would be sufficient to finance a comprehensive policy package comprising income security for the entire elderly population and all those with disabilities, as well as providing universal access to health and

education in Indonesia, Malaysia, the Philippines, and Thailand.38 Reducing these subsidies also has important environmental consequences.

At the national level, several countries offer good examples of programmes of energy subsidy reform as part of comprehensive packages to better target government spending. Such policy measures support efforts for fiscal consolidation and for releasing financial resources for inclusive growth. The Governments of Indonesia and Malaysia have offered assistance to low-income households through compensatory cash transfers and increased welfare payments. Subsidy rationalization in Indonesia should help provide greater fiscal resources for social spending, such as on universal health-care, which was launched in 2014 for full implementation by 2019. These examples illustrate that policy reforms should be directed at tackling the net welfare effect of reducing fuel subsidies, especially on poor and vulnerable households.

Now is a particularly critical and opportune time to decrease subsidies. It is critical because countries which have high budget and current account deficits due to fuel subsidies are among those most prone to macroeconomic instability from capital


outflows. Indeed, this has been the experience of, for example, Indonesia and India during the “taper tantrum” of 2013. Reducing the budgetary strain of subsidies would put governments in a better position to deal with higher global borrowing costs resulting from United States interest rate normalization. At the same time, it is a highly opportune time to reduce subsidies because of the decline in fuel prices over recent months. This has made the gap between market and subsidized prices of fuel far lower than in previous years, thus reducing the burden on citizens of reducing subsidies.

United NationsEconomic and Social Commission for Asia and the PacificMacroeconomic Policy and Development DivisionUnited Nations BuildingRajadamnern Nok AvenueBangkok 10200, ThailandTel : (662) 288-1628Fax: (662) 288-1000, 288-3007E-mail: [email protected]: www.unescap.org

Asia and the Pacific is forecast to see a moderate increase in growth in 2015. This will be driven by better growth in a range of developing economies, aided by structural reform programmes which are likely to improve the domestic business environment. Several exporting economies will exhibit relatively unchanged growth at moderate levels, with a positive factor being the seemingly sustained recovery in the United States, although slow growth in the eurozone and Japan will remain a challenge. At the same time, moderate or decreasing inflation in several economies could allow them to maintain accommodative monetary policies to support growth. Moreover, the dramatic recent decline in oil prices is likely to have significant macroeconomic policy implications, both positive and negative, depending on the level of commodity-dependence of each economy.

Despite a fairly positive outlook, the region faces a number of risks and challenges. These include domestic structural concerns and the likely impact of capital volatility. There are two key cross-cutting domestic structural challenges that affect the supply capacity of economies – infrastructure deficits and labour market imperfections. Lack of infrastructure has prevented growth in manufacturing and trade for domestic and export markets across the region. Lack of human capital formation through education and skills training that meet the needs of higher value-added business sectors has led to insufficient creation of decent jobs. A short-term challenge to macroeconomic stability is the impact of monetary policies of developed economies on capital markets in the region – particularly the ongoing monetary policy normalization by the United States.

This Year-end Update of ESCAP’s annual flagship publication, the Economic and Social Survey of Asia and the Pacific, considers the implications of these challenges for policymakers in the region. The key messages are that addressing structural challenges will involve a mix of domestic and regional policies. Examples of such policies are strengthening the role of the private sector and establishing regional financial intermediation institutions for infrastructure development. Similarly, an appropriate mix of monetary and fiscal policies, together with the supportive role of macro-prudential measures, will help to manage developments arising from capital market volatility and falling oil prices.

Documents

2014 Year-end Update - UN ESCAP...• The steep decline in oil prices will have varying impacts on balance of payments, inflation and fiscal space of countries. o ESCAP analysis indicates