East Asia's economies are growing at their swiftest pace since before the financial crisis with fewer people than ever living in extreme poverty, according to the latest East Asia and Pacific Regional Update, the World Bank's twice-yearly look at the region's economies.

Economic growth is expected to top 7 percent for East Asia and Pacific (excluding Japan), while developing economies in the region are expected to expand by more than 8 percent. High growth is being experienced by middle income and poor economies alike. Exports should turn in their strongest performance since 1988, supported by demand from China, the global recovery, a rebound in the global high-tech industry, and strong commodity prices. Investment has also recovered, contributing half of aggregate demand growth. This strong performance has lifted 40 million East Asians out of poverty, mostly in China, Indonesia, Thailand and Vietnam.

"We are estimating that by the end of this year, the number of people living on less than US$2 a day will be around one third of the region's population. Even excluding China, the absolute number of poor would be at their lowest level ever, finally overcoming the higher poverty created by the 1997 crisis," said Regional Vice President for East Asia and Pacific Mr. Jemal-ud-din Kassum. "This expansion is happening during a time of major political advances with a sweep of legislative and presidential elections, including Indonesia's first ever direct election of a president, capping what looks like being a remarkable year for the region."

Yet, amid these successes, there are growing concerns that the outlook for 2005 may be less favorable and more uncertain. The spike in oil prices, slower growth in rich countries, and downturns in the high-tech and commodity cycles are all unfavorable trends for East Asia. Major global macroeconomic balances, in particular record US current account deficits and East Asian surpluses, and the investment boom in China, still need to be brought onto sustainable paths, intensifying the risks facing the region.

"Although 2004 has been a strong year, recent data also suggest that the recovery in East Asia has peaked, and that economic activity is shifting into lower gear," said Mr. Homi Kharas, chief economist for the East Asia and Pacific region. "The risks we talked about in previous editions of the Regional Update are intensifying, making the outlook more uncertain."

The consensus view is that growth in the developed world, including the United States, Japan, and Europe, will slow temporarily but build into a sustained expansion. Although China's growth, investment and imports might also slow gradually, this would be more sustainable and add a measure of stability to the regional economy.

"Policy measures to cool down the economy are starting to show some success, but it is too early to call the end of the investment boom that has become known as 'overheating,'" Bert Hofman, lead economist for China said, noting that underlying incentives for over investment have not changed. "At the same time, the recent increase in interest rates, while modest, is encouraging, as it shows the authorities willingness to use this instrument when needed, and signals a further move to more market-based macroeconomic management."

For China, the World Bank expects that, with underlying inflationary pressures projected to remain limited, drastic macroeconomic measures to cool down the economy are unlikely to be imminent, and if the economy lands at all, it is likely to be a soft landing. Fears of a hard landing also remain limited in light of continued strong demand indicators in recent months. The World Bank expect GDP growth to ease to 91/4 percent for 2004 as a whole and around 8 percent in 2005.

The steep spike in global oil prices will increase the oil import bill for emerging East Asia by US$25 billion this year, reducing the incomes of the majority of regional economies that are net energy importers, as well as the region's primary export markets like Japan, the US, and Europe.

"The impact of higher oil prices could shave 0.5 to 1 percentage points off growth rates in the region next year," Mr. Kharas said, "with countries like the Philippines, Thailand and Korea at the upper end of this range."

Also of concern is the nature of adjustment required to reduce the size of current account surpluses in East Asia and deficits in the United States. "The best contribution East Asian economies can make is to reduce their surpluses by expanding domestic private investment and further liberalizing trade, especially in services," added Mr. Kharas.

What should policymakers do?

A key issue for policy makers, the report says, is to nurture the recent investment recovery in the region by strengthening the investment climate, so that the recovery is sustained through the present period of global uncertainties and cyclical slowdown.

"Rather than fretting too much about a cyclical slowdown that is inevitable to some extent, the focus is better placed on nurturing the emerging recovery in private investment," said Mr. Milan Brahmbhatt, a lead economist and principal author of the Regional Update. Increases in investment would broaden the recovery beyond the limitations of the current drivers of growth, exports and consumer demand. "Export growth could be crimped by the cyclical factors and the global outlook, and private consumption growth has its dangers when it is boosted by rapid growth in household credit, as recently shown in Korea and Hong Kong (China)," according to Mr. Brahmbhatt.

A Special Focus section at the end of the report, entitled Strengthening the Investment Climate in East Asia documents the key constraints and problems faced by firms in East Asia, based on responses from over 6500 businesses in five countries. The section points to country-specific actions that can be taken immediately to reduce uncertainty, lower the costs of investing and increase returns. It prioritizes among getting greater predictability in court judgments and interpretation of regulations, reducing macroeconomic risk, cutting business regulation, labor inflexibility and red tape, reducing bribes and corruption, improving the reliability of power and other infrastructure services, and building skills.

(China.org.cn November 9, 2004)