ADB Sri Lanka Country Director Dr. Richard Vokes briefing journalists this week on the report

The Asian Development Bank (ADB) this week released its annual Asian Outlook 2008 report where it talks of many issues that confront the Asian and world economies, particularly the impact from oil and commodity prices.

Excerpts of the report:
Moderating growth and rising inflation have characterized developing Asia in the first 8 months of 2008. High international commodity prices are likely to stay for the long haul and have exacerbated homegrown inflation pressures. But containing inflation in the face of a serious global downturn will lead to a slowdown in regional growth in 2008 and 2009. This short-term sacrifice is required for longer-term economic, social, and political gain. Prudent macroeconomic management with reforms tackling the fundamental causes of tight commodity balances is also essential, if developing Asia is to ride out the global storm, weigh anchor, and set course for faster medium-term growth and modest inflation.

Developing Asia’s 9.0% expansion in 2007 was the highest in almost two decades. However, the many years of robust growth supported by accommodative monetary policies buttressed excessive aggregate demand that nurtured price pressures. Turbulence in global markets has fanned the flames of inflation. Developing Asia’s consumer price inflation is therefore seen rising from 4.3% in 2007 to 7.8% in 2008 before ebbing to 6.0% in 2009. The confluence of these external and internal factors is expected to slow growth to 7.5% in 2008 and 7.2% in 2009.

Risks—such as a prolonged slowdown in major industrial countries, continued elevated levels of international oil and food prices, persistence of high inflation, and policy reticence—are bearing down on the regional outlook, which is more heavily tilted to the downside than in April.

Oil
The global oil market remains tight. While oil prices are likely to soften somewhat in the short run, they will stay high and volatile. Since food prices are heavily influenced by oil prices, the days of cheap food also seem to be over.

Developing Asia will have to learn to adjust to this high global commodity price environment and to undertake the necessary structural reforms. But first, it must reestablish macroeconomic stability through sound monetary, fiscal, and exchange rate policies.

Political pressures are building up in some countries, and these could result in the authorities’ reluctance to pass needed reforms, and this risks deepening macroeconomic imbalances. Prolonged periods of political instability could inhibit investment and affect growth prospects in the medium term.

Outlook for 2008 and 2009
Events in the first 8 months of 2008 suggest some major changes in the external environment affecting the assumptions made in April when Asian Development Outlook 2008 was released. The slowdown in the G3 (United States, eurozone, and Japan) is now seen continuing until the end of 2009. As a result, growth in the volume of world trade will slow. Both food and fuel prices, which have surged this year, are forecast to come down but will remain higher than in 2007 for the rest of this year and next. With the continuing turmoil in financial markets, the cost of new capital will become higher, and access harder, for developing Asia.

In addition to the regional slowdown in growth and jumps in inflation, current account surpluses are diminishing and deficits are widening. Currencies are depreciating, putting upward pressure on inflation. Another danger is that although central banks have begun to tighten monetary policy, some may have let the inflation genie out of the bottle by doing too little, too late, since interest rates in most countries are still lower than inflation.

Containing inflation will take time as monetary policy works with a lag. In 2009 when inflation is reined in, regional growth will slow—also hit by the slowdown in export growth to the G3.
Growth - South Asia

South Asia’s growth will decelerate from 8.6% in 2007 to 7.1% in 2008 and to 6.7% in 2009. Inflation is forecast to more than double from 5.5% to 11.8%, and then recede to 9.2% in this 3-year period. Current account deficits are forecast to widen significantly. Overheating from excessive aggregate demand, aggravated by imported cost-push factors, has made inflation the critical macroeconomic concern. South Asia needs to strengthen its macro management as well, to rein in fiscal deficits and so avoid a hard landing.

In India, growth in the April–June quarter of the current fiscal year (ending March 2009) slowed to 7.9% from the 9.2% seen in the first quarter of FY2007, for the slowest rate of growth since 2004. Inflation in the first quarter of FY2008 was 9.5% compared with 5.3% in the same quarter a year earlier. India’s monetary policy has been tightened significantly. The inflation forecast for this and the next fiscal year are 11.5% and 7.5%, respectively. Growth is forecast to edge down from 7.4% in FY2008 to 7.0% in FY2009 as inflation is ironed out. A pause in growth accompanied by prudent macroeconomic management and reforms to improve efficiency and productivity would set the stage for the pursuit of a higher growth trajectory over the medium term.

Commodity price shocks
Elevated commodity prices and their pronounced volatility in international markets have been features of the first 8 months of 2008. Food and oil prices are closely interlinked. If high oil prices are here to stay, so are high food prices. This has important implications for developing Asia.

Oil: Prolonged period of high and volatile prices
While oil prices have come down from their peaks of $147 per barrel in July 2008, they will stay high in the long run. Inflation-adjusted oil prices will remain well above $100 per barrel until about 2020, according to research commissioned by the Asian Development Bank.

The price runup in oil has been driven mostly by the fundamentals of demand and supply. Surging global demand and the inability of global supply to keep pace have relentlessly generated upward price pressures.

Limited surplus capacity has led to greater price volatility, amplifying the effects of even the smallest demand or supply shocks. Financial speculation may have compounded price spikes.
In the future, global oil prices will continue to be determined by fundamentals. Global demand growth will be increasingly driven by demand from developing Asia and the Middle East. The growing appetite for transportation fuel will be of particular importance. On the supply side, the near-term peaking of output from oil producers who are not members of the Organization of the Petroleum Exporting Countries (OPEC), and constraints on the expansion of OPEC’s output capacity in the medium term, will put severe strains on meeting incremental global oil demand.

Food prices to stay high
The price of rice—the basic food staple for billions of Asians—has fallen from peak levels reached earlier this year yet remains more that twice as high as it was at the start of 2008. The surge in prices of rice and other staple foods reverses a decades-long decline in real prices.

The causes of this runup are complex, but have four fundamental drivers. First, rapid economic growth in emerging economies, particularly the People’s Republic of China and India, has put upward pressure on prices of a range of commodities, including food. Demand has simply outpaced supply. Second, a sustained decline in the dollar since 2004 has added to upward price pressure on dollar-denominated commodities—particularly on crude oil—and this has fueled a search for hedges against a weak dollar.

hird, the combination of high oil prices and legislative mandates to raise production of biofuel substitutes for gasoline and diesel fuel has established a price link between feedstocks, such as corn and vegetable oils, and fuel prices. Fourth, to some degree at least, financial speculation arising from low interest rates has motivated commodity price changes.