___________________________________________________________________________

2016/SFOM14/010 Session 2

Global and Regional Economic Outlook Purpose: Information Submitted by: Asian Development Bank

14th Senior Finance Officials’ Meeting Trujillo, Peru 26-27 May 2016

APEC Economy and Update on Regional Economic Integration Cyn‒Young Park Director, Regional Cooperation and Integration Division Economic Research and Regional Cooperation Department (ERCD) Asian Development Bank

APEC PERU 2016 Senior Finance Officials’ Meeting (SFOM) 26-27 May 2016 | Trujillo, Peru

Key Messages • Moderate outlook for ASEAN; PRC slowdown, financial volatility, and weak commodity prices are key downside risks to the outlook • PRC business cycle exerts increasingly large influence on APEC business cycles • PRC slowdown and its structural transformation present both opportunities & challenges for APEC • Capital flows return to the region, but remain vulnerable to sudden reversal and volatility due to their structural patterns: • FDI is mostly intraregional • Portfolio and other investments are interregional 2

Outline • APEC Outlook and Regional Economic Integration • Economic Outlook: Cyclical and Structural Factors • Business Cycles and Growth Spillovers • Potential Growth Slowdown

• Trade Slowdown and PRC • Trade Integration and Regional Value Chain

• Structural transformation in PRC

• Financial Integration and Volatility • Structural patterns of capital flows to Asia • FDI vs. Portfolio and other investment 3

APEC Outlook and Regional Economic Integration

Growth in APEC economies remains robust Real GDP Growth (y-o-y, %) Advanced APEC

10

APEC

Developing Americas

9.4 7.7

8

6.6

6

6.6

6.3

6.0

5.5 4.7

4

Developing Asia-APEC

4.5

3.4

4.4 3.5

3.2

3.2

3.0 2.3

2.2

2

5.6

1.6

1.6

1.9

3.0

2.2

3.0

2.6

2.4 1.7

1.6

0 2010

2011

2012

2013

2014

2015

Note: f = forecasts; weighted using gross national income (Atlas method). Source: Asian Development Outlook 2016, ADB and World Economic Outlook Database April 2016, IMF.

2016f 5

Large variations across economies GDP Growth Rates (y-o-y,%) Economy

2015

2016f

Advanced APEC

Economy

2015

2016f

Developing APEC─Asia

Australia

2.5

2.5

Brunei Darussalam

-1.1

1.0

Canada

1.2

1.5

PRC

6.9

6.5

Japan

0.5

0.6

Hong Kong, China

2.4

2.1

New Zealand

3.4

2.0

Indonesia

4.8

5.2

Russian Federation

-3.7

-1.8

Korea, Rep. of

2.6

2.6

US

2.4

2.3

5.0 5.8 9.9

4.2 6.0 4.3

Chile

2.1

1.5

Malaysia Philippines Papua New Guinea

Mexico

2.5

2.4

Singapore

2.0

2.0

Peru

3.3

3.7

Thailand

2.8

3.0

Viet Nam

6.7

6.7

Developing APEC─Americas

f: forecast, PRC = People’s Republic of China. Note: Developing APEC—Asia based on ADB’s definition. Source: Asian Development Outlook 2016, ADB and World Economic Outlook Database April 2016, IMF.

Growth of Developing APEC less correlated with the US

Note: Developing APEC-Asia includes the People’s Republic of China; Hong Kong, China; Indonesia; the Republic of Korea; Malaysia; Philippines; Singapore; and Thailand. Developing APEC-Americas includes Chile, Mexico, and Peru. Advanced APEC includes Australia, Canada, euro area, Japan, New Zealand, and Russian Federation. Three-year moving correlations based on cyclical Hodrick-Prescott filtered seasonallyadjusted gross domestic product at constant prices. Source: ADB calculations using data from Haver Analytics and national sources.

Growth of Developing APEC also more correlated with PRC recently

Note: Developing APEC-Asia includes the Hong Kong, China; Indonesia; the Republic of Korea; Malaysia; Philippines; Singapore; and Thailand. Developing APEC-Americas includes Chile, Mexico, and Peru. Advanced APEC includes Australia, Canada, Japan, New Zealand, Russian Federation, and the United States. Three-year moving correlations based on cyclical Hodrick-Prescott filtered seasonally-adjusted gross domestic product at constant prices. Source: ADB calculations using data from Haver Analytics and national sources.

Asian economies more vulnerable to growth shock from PRC and their own domestic shocks Share of Asian output variance due to external and local factors (%, x-axis = # of quarters)

Pre-GFC = 2001Q1 to 2008Q1; Post-GFC = 2009Q1 to 2015Q4. Average for sample economies. Source: ADB calculations.

9

Impacts of PRC’s gradual growth moderation Based on 1 percentage point decline in PRC GDP growth compared to the baseline Percentage point

0.4

Trade + Policies

0.0

Commodity prices

Total effect

0.00 -0.05 -0.25

-0.4

-0.25

-0.20 -0.35

-0.40

-0.8 US

Euro area

Japan

Emerging Asia ex PRC

Latin America

Others

World

Source: A. Abiad, et al. 2016. Moderating Growth and Structural Change in the People’s Republic of China: 10 Implications for Developing Asia and Beyond. ADB Briefs No. 53. ADB: Manila.

‹#›

Trade Slowdown and PRC Factors

Asia’s overall trade growth slows Trade and GDP Growth (%) 25

25

Asia

20

20

15

15

10

10

5

5

0

0

World

-5

Fall in trade growth due to: • Sluggish demand recovery in advanced economies. • Growth moderation in PRC. • Slower pace of expansion in global and regional value chains. 13

2014

2013

2012

2011

2010

2009

2008

2007

2006

Total Trade

2005

GDP

2004

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

-15 2003

-15 2002

-10

2001

-10

2003

Total Trade

2002

GDP

2001

-5

G-7 and PRC contribute about a half of world trade growth; but G-7 share shrinking, PRC share rising Shares in world trade volume (% of world trade volume)

Contribution to world trade volume growth (% of world trade volume growth)

100

16

90

14

80 70 60 50

2.1 3.5 1.0

2.4 6.5 2.0

3.4 8.7 3.4

40 30 20

49.4

51.3

47.6

4.3 12.4

4.6 12.8

4.7 12.5

11.5 5.1

13.4 5.2

13.1 4.9

13.9 10.9

12 10 8 6

4.1

4 38.5

37.2

37.5

10

2

2.5

2.8

2014

2015

0.2

0

0

1981 G-7 NIES

1990

2000

2010

BRICS ex PRC ASEAN ex SIN

2014 PRC ROW

2015

1981 G-7 NIES

1990

2000

2010

BRICS ex PRC ASEAN ex SIN

PRC ROW

G-7 = UK, US, France, Germany, Japan, Italy, and Canada. Note: Trade volume is estimated by using annual trade volume growth rates on 2001 trade values and extending the series in the specified years. 2015 trade estimates using 3-year compounded average growth rate based on WTO's latest forecast last September 2015. Source: ADB calculation using data from WTO Trade Statistics.

14

Correlation between growth of APEC exports and US non-oil imports 2000s

0.82

2010s

APEC (exc. US)

US non-oil imports

Dec-15 Aug-15

Jun-13

May-12

Apr-11

Mar-10

Feb-09

Jan-08

Dec-06

Nov-05

Oct-04

Sep-03

Aug-02

Jul-01

Jun-00

May-99

0.69

Apr-98

Mar-97

Feb-96

Jan-95

1990s

1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0

0.93

Jul-14

50 40 30 20 10 0 -10 -20 -30 -40

Correlation (RHS)

Note: APEC includes the 21-member economies excluding US. US non-oil imports computed by subtracting imports of energy-related petroleum products and crude petroleum. Source: ADB calculation using data from CEIC, US Census Bureau, and Direction of Trade Statistics, IMF.

Correlation between growth of APEC exports and PRC non-oil imports 100 0.77

2000s

80

0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0

0.75

2010s

60 1990s

40

0.46

20 0 -20 -40

APEC (exc. PRC)

PRC non-oil imports

Dec-15 Aug-15

Jul-14

Jun-13

May-12

Apr-11

Mar-10

Feb-09

Jan-08

Dec-06

Nov-05

Oct-04

Sep-03

Aug-02

Jul-01

Jun-00

May-99

Apr-98

Mar-97

Feb-96

Jan-95

-60

Correlation (RHS)

Note: APEC includes the 21-member economies excluding PRC. PRC non-oil imports computed by subtracting mineral fuel, lubricants, and related materials imports from the sum of total primary, manufactures, and commodities n.e.c based on SITC. Source: ADB calculation using data from CEIC: (US Census Bureau) and Direction of Trade Statistics, IMF. 16

Commodity exporters are hit Commodity Prices (nominal, monthly, 2010 = 100) Energy Fertilizers Precious Metals

Real Commodity Prices (2010=100, annual, based on 2005 US$) Energy Fertilizers Precious Metals

Agriculture Metals & Minerals

Agriculture Metals & Minerals

200

300

180 250

160 140

200

120 150

100 80

100

60 40

50

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Apr-16

Jan-15

Oct-13

Jul-12

Apr-11

Jan-10

Oct-08

Jul-07

Apr-06

Jan-05

Oct-03

Jul-02

Apr-01

0

Jan-00

20

Source: World Bank Commodity Price Data (the Pink Sheet).

17

Value-Added Export Decomposition─APEC (2011 ) ASEAN+3

ROW

Value-added export decomposition = Domestic value-added + Foreign value-added Note: Figures in bracket are for the PRC. APEC ex US includes Australia; Canada; PRC; Indonesia; Japan; Rep. of Korea; Malaysia; Mexico; Philippines; Thailand; Russian Federation; and Viet Nam. APEC-Asia refers to Australia; PRC; Indonesia; Japan; Rep. of Korea; Malaysia; Philippines; Thailand; and Viet Nam. APEC-Others refers to Canada; Mexico; and Russian Federation. Except for Bangladesh, Malaysia, the Philippines, Thailand and Viet Nam IO tables, which were constructed by ADB, the rest were sourced from the World Input-Output Database (WIOD). While the WIOD and ADB IO tables have been constructed in a clear conceptual framework on the basis of officially published input-output tables in conjunction with national accounts and international trade statistics, level numbers are likely to remain different from those officially released by the respective economies. Source: ADB calculations using data from World Input-Output (IO) Tables and ADB Multiregional Input-Output tables (ADB-MRIO), and methodology from Z. Wang, S-J. Wei, and K. Zhu. 2014. Quantifying International Production Sharing at the Bilateral and Sectoral Levels. NBER Working Paper No. 19677. Cambridge, MA: NBER.

Regional value chains are deepening Panel A: DVA Exports to APEC (% of total intraregional DVA)

Panel B: FVA Exports to APEC (% of total intraregional FVA)

PRC USA JPN CAN KOR AUS MEX INO RUS MAL THA VIE PHI

PRC KOR USA MEX CAN JPN THA AUS MAL INO VIE PHI RUS 0

5

10

15

20

25

Panel C: RDV Exports to APEC (% of total intraregional RDV)

0 5 10 Panel D: PDC Exports to APEC (% of total intraregional PDC)

USA PRC JPN CAN MEX AUS KOR INO RUS MAL THA VIE PHI

PRC KOR USA JPN CAN MEX AUS MAL THA INO RUS VIE PHI 0

20

40

60

80

100

2011

0

2005

10

15

20

20

2000

DVA = domestic value added, FVA = foreign value added, RDV = returned domestic value added, PDC = pure double 19 counting component.

25

30

PRC’s structural transformation presents both challenges and opportunities PRC’s imports from Asia ($ billion)

Top 20 Asian Exporters to the PRC (% of country’s total exports, 2014)

20

Overall trade costs need to be lowered Number of Documents to Export and Import in Asia and the Pacific by Subregion (2014)

Time to Export and Import by Region (2014, days) 7.0 7.7

North America

11.6 10.6

European Union Latin America & Caribbean

4.2

Southeast Asia

5.3 5.3

East Asia 16.7 18.5

4.2 7.1

The Pacific

8.4

17.6 18.3

Europe & Central Asia

18.7 19.8

East Asia & Pacific Middle East & North Africa

9.1

Oceania

19.0

6.9 7.0

South Asia

9.6

23.1 30.5

Sub-Saharan Africa

37.6 0

10 Time to export

20

30

40

Time to import

9.5

Central Asia

11.1 0

2

4

Documents to export

6

8

10

Documents to import

Source: Doing Business and World Development Indicators, World Bank.

21

12

Financial Integration and External Vulnerability

Financial Stress Index—APEC Asia 5 Turkish stock market crash (Mar–Jun 01)

4

Taper Tantrum (May ’13 – Jan ‘14)

Global financial crisis (Aug ‘08– Jul ‘09)

PRC currency devaluation, and stock market crash (Aug–Sep ‘15)

1st Greek bailout (May ’10)

3 Argentine crisis (Oct ‘01–Jan’02)

Euro crisis, Egypt and Indian economic woes (Aug ‘11 – Jan ‘12)

2

US policy normalization (Dec’15)

Economic impact of SARS outbreak, and Latin America crisis (Mar–Apr ‘03)

1

0

-1

-2

Mar-16 Jan-16

Sep-14

May-13

Jan-12

Sep-10

May-09

Jan-08

Sep-06

May-05

Jan-04

Sep-02

May-01

Jan-00

-3

Note: Includes Australia; People's Republic of China; Hong Kong, China; Indonesia; Japan; Rep. of Korea; Malaysia; New Zealand; Philippines; Singapore; Thailand; Viet Nam. Based on principal components analysis using the methodology in C.Y. Park and R.V. Mercado Jr. 2014. Determinants of financial stress in emerging market economies. Journal of Banking and Finance Vol. 45. pp 199-224. Source: ADB staff calculations using data from Bloomberg, Yahoo! Finance, and CEIC. 23

Non-Resident Portfolio Equity and Debt Flows—Emerging Asia and Latin America (monthly, $ billion) 50

Debt

Equity

Total

40 30 20 10 0 -10 -20 -30 Jan 12

Jun 12

Nov 12

Apr 13

Sep 13

Feb 14

Jul 14

Dec 14

May 15

Oct 15

Apr Mar 16 16

Note: Emerging Asia (based on IIF definition) includes People's Republic of China, India, Indonesia, Republic of Korea, Malaysia, Philippines, and Thailand. No data on debt flows for Malaysia. Latin America includes Brazil, Chile, and Mexico. 24 Source: Portfolio Flows Tracker, Institute of International Finance

Change in Foreign Exchange Rate (%) Japan Indonesia Australia Chile Malaysia Canada Thailand Singapore Brunei Darussalam Philippines Viet Nam Peru Hong Kong, China 3 months ending 15 Dec 2015 (% change)

People's Republic of China

3 months ending 15 March 2016 (% change)

Russian Federation Korea, Rep. of New Zealand Papua New Guinea Mexico -6

-4

-2

0

2

4

6

Note: Based on US$ value of local currency. An increase means appreciation, decrease means depreciation. Source: ADB calculation using Bloomberg.

8

10

25

Net International Investment Position (% of GDP)

Short-term external debt/ reserves SIN

SIN

HKG

HKG

JPN

JPN

MAL

THA

INO VIE THA

2015

PRC

2010

PHI

2013 2015

MAL

KOR

KOR

PRC

INO

PHI 0

100

200

300

400

Note: as of end-2014 for VIE. Source: ADB calculations using data from International Financial Statistics, IMF; and national sources.

-250

0

250

500

750 1000

Note: Based on BPM-6 data (assets less liabilities). Includes foreign direct investment, portfolio investment, other investment, and foreign reserves. 2015 refers to end Q3-2015 for INO and PRC; Q2-2015 for MAL. Source: ADB calculations using data from International Financial Statistics, IMF; and national sources.

26

Sources of Financial Outflows – Asia ROW, 631, 45%

ROW, -148, -18% EUA, -32, -4%

Asia, 332, 40% US, 310, 38%

Total Outflows from Asia (cumulative, 2010-2014, $ billion)

Asia, 216, 16%

US, 369, EUA, 27% 168, 12% Equity, 1384, 28%

ROW, 69, 3%

FDI, 2086, 42%

Debt, 462, 9% Bank Lending, 1061, 21%

EUA, 11, 1%

EUA, 722, 35%

Asia, 1135, 54%

US, 160, 8%

ROW, 97, 9% Asia, 509, 48% US, 444, 42%

FDI = foreign direct investment, EUA = euro area, ROW = rest of the world, US = United States Source: ADB staff calculations using data from ASEAN Secretariat, BIS, IMF, CPIS, OECD, and UNCTAD

27

Commodity Cycle, Financial Cycle, and Business Cycle 0.80 0.60 0.40

Correlation between Financial Cycle and Business Cycle Financial cycle Commodity cycle Business cycle (RHS)

0.04 0.03

0.59

Post-GFC 0.02

0.35

Pre-GFC 0.01

0.00

0.00

-0.20

-0.01

-0.40

-0.02

-0.60

-0.03 1989Q3 1990Q3 1991Q3 1992Q3 1993Q3 1994Q3 1995Q3 1996Q3 1997Q3 1998Q3 1999Q3 2000Q3 2001Q3 2002Q3 2003Q3 2004Q3 2005Q3 2006Q3 2007Q3 2008Q3 2009Q3 2010Q3 2011Q3 2012Q3 2013Q3 2014Q3

0.20

Note: Based on Baxter-King band-pass filter. Commodity cycle is based on Brent oil prices, financial cycle on MSCI AC World, and Business Cycle on US GDP. Pre-GFC refers to 2001-Q1 to 2008-Q3; Post-GFC refers to 2009-Q3 to 2014-Q3.

28

Estimated Volatility for Oil and Stock

Common Latent Factor for Oil and Stock Markets 5

0

1 Turkish stock market crash (Mar–Jun 01)

1st Greek bailout (May ’10)

0.8

Argentine crisis (Oct ‘01– Jan’02)

-5

Taper Tantrum 0.9 (May ’13 – Jan ‘14)

Euro crisis, Egypt and Indian economic woes (Aug ‘11 – Jan ‘12)

0.7 0.6

-10

0.5 0.4

-15

Global financial crisis (Aug ‘08– Jul ‘09)

Economic impact of SARS outbreak, and Latin America crisis (Mar–Apr ‘03)

-20

0.3 0.2 0.1 Sep-14

Jan-14

May-13

Sep-12

Jan-12

May-11

Sep-10

Jan-10

May-09

Sep-08

Jan-08

May-07

Sep-06

Jan-06

May-05

Sep-04

Jan-04

May-03

Sep-02

Jan-02

May-01

Sep-00

0 Jan-00

-25

Thank You! Cyn-Young Park Asian Development Bank Email: [email protected] Tel: 632-632-5473

31

Determinants of potential growth: Policy simulations Labor productivity growth (80%)

Initial income per capita, convergence effect: -0.33 per additional $1,000

Tertiary enrollment ratio, positive effect up to 50%

+ Labor force growth (20%)

Labor market flexibility Good institution: government effectivenes s

Trade ratio; positive effect up to 440% of GDP Financial integration

Working-age population (ages 15–64) growth, one-to-one effect on potential growth

32

Simulation: Average annual potential growth in 2015-2020 under various scenarios 6.80% 6.68%

6.64%

Potential growth in 2014

6.60%

6.40% 6.27% 6.20%

6.00%

Average annual potential growth in 2015-2020: Covergence + demographics

Average annual potential growyh in 2015-2020: Convergence + demographics + reforms (1)

5.90%

5.80%

Average annual potential growth in 2015-2020: Convergence + demographics + reforms (2)

5.60%

5.40% 1

Reform (1): closing the gaps in tertiary education, labour market flexibility, quality of institution, trade openness, and financial integration from the frontiers by 50% in 20 years Reform (2): closing the gaps in tertiary education, labour market flexibility, quality of institution, trade openness, and financial integration from frontiers by 50% in 10 years

Takeaways • Asia’s potential growth has slowed. • Factors driving down potential growth: (i) demographics; (ii) convergence process; (iii) diminishing returns of factors that increased labor productivity in the past. • Supply-side policies and reforms can boost potential growth:  Demographics to the extent that it is possible;

 Labor market flexibility; quality of institutions; trade openness; financial integration;  Investment in infrastructure, human capital, and technology.

• Sound macro-management can avoid volatility and reduce output gap.