Recent Economic Performance

Overview

Economic growth in the GMS remained strong at close to 8% in 2005 although it was lower than in the previous year, primarily reflecting lower growth in Thailand, its largest economy. Growth in most other economies continued its upward trend. Inflationary pressures have increased in some countries with the persistent rise in world oil prices and higher food prices. But inflation rates remain well within single digits as monetary policy has become more restrictive and the fiscal stance is stable. The current account reverted to a deficit in Thailand for the first time since the 1997 financial crisis, partly reflecting higher oil imports and subdued tourism revenues, and partly imports required for the strong growth in investment in the past several years as the economy recovered from the crisis. In Viet Nam, the deficit narrowed for the second year helped by higher revenues from oil exports. Over the past few years, trade has expanded rapidly and the share of trade within the GMS has increased relative to that with the rest of the world. Net capital inflows were more than sufficient to finance the current account deficits and foreign exchange reserves remain at comfortable levels.

GDP Growth

The GMS is one of the fastest growing subregions in the world. In the 10 years to 2004, GDP in the subregion grew at an average annual rate of over 6%, in spite of a number of adverse shocks including the 1997 financial crisis, the slowdown in the global and regional economies in 2001, the onset of the severe acute respiratory syndrome (SARS) in 2003, and more recently, the ongoing threat from avian flu and the persistent rise in oil prices.

Economic growth in the subregion accelerated in the past few years to 8.8% in 2004 (Figure 1 [ PDF 91KB | 1 pages ]). Growth moderated to 7.9% in 2005, primarily reflecting a slowdown in Thailand, the largest economy within the GMS with a 41% weight. Thailand's economy was buffeted by a number of shocks, including a prolonged drought, the decline in tourism following the tsunami at end-2004, and higher oil prices. As the weather normalized and the effects of the tsunami moderated over the course of the year, growth picked up to 5.1% in the second half from 3.9% in the first.

Most of the other economies recorded stronger growth in 2005 than in previous years. Cambodia's growth in particular surged to 13.1% last year as the agriculture sector rebounded with the alleviation of drought that had led to stagnant agricultural output in 2004. The tourism and construction sectors continued to perform well. The garment industry expanded by 12%, reflecting strong exports to the United States (US), its largest market.

Inflation

The inflation rate increased over the past couple of years in Cambodia, Thailand, and Viet Nam (Figure 2 [ PDF 92.5KB | 1 pages ]), although it remains within single digits. A large part of the increase can be attributed to the direct and indirect effects of the rise in world oil prices and the countries' efforts to align domestic with international prices to reduce the cost of fuel subsidies and to promote energy efficiency.

Another prominent reason for the increase in inflation rates was higher food prices, partly reflecting the trend in world food prices and partly abnormal weather patterns that affected domestic agricultural output as in Thailand. In Cambodia, although the agricultural output rebounded in 2005, higher prices in Thailand and Viet Nam led to increased exports of fish and rice to these markets as a result of which domestic prices remained at elevated levels. In Viet Nam, apart from the effects of higher prices for food and fuel, the 30% increase in public sector salaries in October 2004 is also likely to have contributed to higher inflation in 2005.

The Lao PDR's inflation rate moderated from a recent peak of 15.5% reached in 2003 to 7.2% in 2005. The authorities have taken steps to restrain credit in the past couple of years so that broad money supply (M2) growth slowed to 8.1% in 2005 from 23% in 2004 and the kip's nominal exchange rate against the US dollar and the Thai baht remained broadly stable.

Monetary policy was more restrictive in the subregion in general in order to stem inflationary pressure and in response to rising global interest rates. Cambodia, along with the Lao PDR, has relatively little flexibility in independently adjusting its monetary policy considering the high degree of dollarization of its economy. In Thailand as well, the 14-day repo rate (policy interest rate) was raised successively to 4.75% in April in line with the increase in the US Federal Funds target rate. Viet Nam raised key interest rates in 2005, following an increase in the required reserve ratio for banks in the previous year, as authorities attempted to curb credit growth to dampen inflationary pressure. Credit growth is estimated to have slowed from nearly 42% in 2004 to 32% in 2005.

Myanmar's data for 2005 are not available, but the data for 2004 show a sharp deceleration in inflation to single digits, probably reflecting the lagged effect of a deceleration in broad money supply growth in the previous year. M2 rose only 1.4% in 2003 compared with 35% in 2002 as credit to nonfinancial public enterprises was cut back drastically. However, money supply growth was back up to around 30% in 2004-2005. Coupled with the eightfold increase in domestic fuel prices in October 2005, this suggests that inflation probably rose significantly over the past year.

Fiscal Balance

The fiscal performance of the GMS economies remained broadly stable in 2005 (Figure 3 [ PDF 159.1KB | 1 pages ]). Thailand continued to post a surplus for the third consecutive year, albeit of a smaller magnitude. Revenues grew strongly while expenditures were contained within the original budget target in spite of a mid-year supplementary budget of 50 billion baht (about 0.7% of GDP).

In Viet Nam, the fiscal deficit narrowed to just above 2% of GDP in the past 2 years from 4.3% of GDP in 2003. Revenues remained buoyant at around 22% of GDP, the highest in the subregion, supported by a 46% rise in oil receipts in 2005 to 4.6% of GDP.

The fiscal deficit fell significantly as well in Cambodia and, to a lesser extent, in the Lao PDR over the last 2 years. In both countries, however, revenues amount to a relatively low 11% of GDP, constraining the Government's ability to increase development and other expenditures.

Current Account Balance

The current account reverted to a deficit in Thailand last year for the first time since the 1997 crisis (Figure 4 [ PDF 88.3KB | 1 pages ]). Total export growth slowed from 22% in 2004, but was still significant at 15% as manufactured exports, particularly of high-tech products, increased 17%. However, strong import growth, partly reflecting a 58% increase in oil imports and continued strength in investment, and a decline in tourism receipts as a result of the effects in the first half of the December 2004 tsunami resulted in a deficit for the full year.

In Viet Nam, the deficit narrowed for the second consecutive year, reflecting strong exports and buoyant revenues from tourism and workers abroad. Exports increased 20% in 2005, driven by sales of fuel, wood products, and electronic goods. Net fuel exports have risen from 3.5% of GDP in 2003 to 4.8% in 2005. Textile and garment exports rose by about 10%. The country is not yet a member of the World Trade Organization (WTO) and is still subject to quotas on textiles and garments in the US. Its impending accession to WTO membership would allow quota-free access and should benefit this sector. With imports expanding at a slower pace than exports, and the strong growth in remittances from workers abroad and in tourism receipts, the current account deficit fell for the second year to 3.6% of GDP in 2005.

The current account deficit narrowed somewhat in Cambodia over the past two years. Garment exports, which account for 80% of total receipts, rose about 12% in 2005. Although this was half the rate in 2004, it alleviated previous concerns of a slump in garment exports following the expiration at the end of 2004 of the global quota system under the WTO Agreement on Textiles and Clothing. Re-imposition of restrictions by the US and the European Union (EU) on clothing imports from the PRC in the second half of the year helped support the increase in garment exports from Cambodia. Imports increased 17% on the back of higher oil prices. However, strong performance of the tourism sector helped hold the current account deficit to about 10% of GDP, similar to that in the previous two years.

In the Lao PDR, with the opening up and expansion of gold and copper mines over the past two years, the surge in mining exports led to an estimated 50% growth in total exports in 2005. Coupled with strong tourism revenues, the expansion in exports contributed to a marginal decrease in the current account deficit from the 2004 level, in spite of a continued increase in import requirements for the mining and the hydropower projects, as well as for fuel.

Direction of Trade

The direction of trade over the past few years suggests a rapid expansion of GMS economies' trade both among themselves and with the rest of the world. Over the 2000-2004 period, the recorded trade with the world rose at a rapid compound annual average rate of 22%, but trade flows within the GMS increased even faster at a rate of 25%.

There is considerable variation among countries in their direction of trade (Figure 5 [ PDF 89.3KB | 1 pages ]). As would be expected, the share of intra-GMS trade in total trade is higher for the smaller economies than for the larger ones. But the larger countries, especially Thailand and Viet Nam, show notable increases in the past few years. Among the countries, the Lao PDR's share is the highest, probably reflecting its landlocked geography. Recorded trade flows from the Lao PDR to other GMS countries declined during 2001-2004 to a still-high share of 63%. The decline reflected lower trade with Cambodia and Viet Nam. Trade with the PRC and Thailand continued to increase at an average annual rate of 29% and 11%, respectively, during the period. For the subregion as a whole, intra-trade increased to 4.4% in 2004 from 4% in 2000.

Some of the potentially important factors contributing to this increase in intra-GMS trade are proximity of the countries to each other, better physical connectivity through cross-border infrastructure, tariff reductions under the ASEAN Common Effective Preferential Tariff (CEPT) framework, and other measures to facilitate trade. Cross-border linkages are likely to improve further and compliance with the ASEAN CEPT commitments is also likely to continue. Combined with Viet Nam's impending accession to WTO, and the start of negotiations for the Lao PDR's accession, this should enhance prospects for further integration of GMS economies with the global markets and among themselves.

External Financing and Foreign Exchange Reserves

Net capital inflows to the GMS countries were more than sufficient to finance the current account deficits in 2005. Foreign exchange reserves, in US dollar terms, rose in all the countries (Figure 6 [ PDF 89.6KB | 1 pages ]). Reserves were sufficient to cover about 3 months of merchandise imports in Cambodia, Lao PDR, Myanmar, and Viet Nam and 5 months in Thailand.

In Thailand, net capital inflows turned positive for the first time since the 1997 crisis, mirroring the trend in the current account deficit. The private and state enterprise sector recorded capital inflows of $11 billion, compared with an outflow of $3.8 billion in 2004. Part of these inflows included a tripling in net foreign direct investment to $3.4 billion. The government and the banking sectors showed net capital outflows, partly reflecting continued net repayments on their debt. For the economy as a whole external debt declined further to 32% of GDP from 36% in 2004.

Foreign direct investment inflows into Viet Nam increased in 2005 to above $2 billion, equivalent to 4% of GDP. Coupled with disbursements of about $1.5 billion from official development assistance (ODA), this was more than sufficient to fund the current account deficit. External debt has fallen steadily as a share of GDP to 33% in 2005 and debt service payments are a modest 5.2% of exports of goods and services.

Cambodia and the Lao PDR are more reliant on ODA to finance their current account deficits. However, FDI inflows are assuming greater importance in these countries as well, especially as debt levels are high. Total external public debt in Cambodia amounted to an estimated $3.2 billion (52% of GDP), nearly two thirds of which is owed to the Russian Federation and the US and is not being serviced while they are under renegotiation. In the Lao PDR, external public debt in 2005 was an estimated $2.4 billion (78% of GDP), of which about $390 million is owed to the Russian Federation and is under renegotiation. Most of the external debt is on concessional terms so that the debt service payments are modest in terms of exports, although they are significant in terms of government revenues, reflecting low revenue mobilization.

In the remainder of this economic overview of the Mekong region, we discuss the increasing importance of FDI in Cambodia, Lao PDR, and Viet Nam as an additional source of funds to fill the savings-investment gap as reflected in their current account deficit, and, perhaps more significantly, to boost overall economic productivity.

Comment(s)

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1. Hong, Sung Ho
   (posted 05 November 2006 / 07:05:25 PM)
   
   I think that the country needs to be in the position where they can control the FDI, in other words, they have to attract the foreign countries' investors in many area of industries.
   
   Having a FDI on what the investors think they can have most profit. It may not be the same industry that the country who is getting a FDI wants to improve on.
   
   In the long run, in order to trigger the spillover or synergy effect, the country needs to have a specific and long term economic growth plan so that they know what industry needs FDI. I think that a country that is getting a FDI needs to diversify to attract foreign investors and more importantly they (government) needs to have a long term economic plans.