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South Asia: A subdued recovery

Feb 25, 2010

World Bank new report, Global Economic Prospects 2010 examines the consequences of the crisis in developing countries. It points out that though South Asia appears to have escaped the worst effects of the global economic crisis, the slowdown in regional GDP growth was the lowest among all developing regions.

Global Economic Prospects 2010

Publisher: World Bank, 2010

The global financial crisis contributed to deceleration in real GDP growth in South Asia, from 8.7% in 2007 to 6% in 2009. This was largely driven by a pronounced decline in investment growth and private consumption. Although the global financial crisis had a sharp negative impact on South Asia, the region’s GDP growth of 6% in 2009 remains unchanged from 2008.

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Since private capital inflows to South Asia is less significant as a share of its GDP as compared to other regions, the region escaped from a key transmission channel of the crisis. Also, domestic demand in the region was relatively resilient, having been cushioned by counter-cyclical macroeconomic policies. Growth is expected to rebound to 6.9 and 7.4% in 2010 and 2011.

The report warns that while the worst of the financial crisis may be over, the global recovery is fragile. It predicts that the fallout from the crisis will change the landscape for finance and growth over the next 10 years.

From a global perspective, this crisis is the most severe and widespread downturn since 1945. Global GDP is estimated to have contracted by 2.2% in 2009 (the first absolute decline in global GDP among the postwar crises). Global GDP is expected to grow 2.7% this year and 3.2% in 2011. But considerable uncertainty continues to cloud the outlook.

The report warns that, even when the world return to positive growth, it will take several years before economies recoup the losses already endured. It estimates that about 64 million more people will be living in extreme poverty (on less than $1.25 a day) in 2010 because of this crisis.

Lower oil prices have eased pressures on fiscal deficits stemming from fuel price subsidies. Real incomes were also boosted by the collapse in global commodity prices. Domestic demand in South Asia was relatively resilient, having been cushioned by countercyclical macroeconomic policies. Interest rates were rapidly cut across most economies, which represent a large share of regional household outlays.

Bangladesh, India, Pakistan, and Sri Lanka cut policy interest rates. Activity in Bhutan and Nepal, where the currencies are tied to the Indian rupee, was supported by India’s expansionary monetary policy stance. Regional fiscal positions deteriorated in 2009 in response to a combination of reduced tax receipts resulting from the decline in economic activity. Even before the crisis, fiscal deficits were already a problem for many South Asian countries. While stimulus measures helped offset the negative effects of the global crisis, they led to higher fiscal deficits in nearly all of the regional economies.

Although regional GDP growth is projected to accelerate, a return to boom-period growth rates is not expected in near future. The regional fiscal deficit is projected to narrow on reversal of stimulus measures introduced to support demand during the crisis.

The recovery path for the individual economies will vary substantially. Countries that entered the crisis with stronger fundamentals, such as Bangladesh Bhutan, and India, weathered the crisis better. India, Bangladesh, and Bhutan are expected to emerge from the global crisis with stronger growth performances. These three countries generally have sound economic policies and greater resilience of trade, investment, and remittances. Growth has been weakest in countries that entered the crisis with large internal and external imbalances, such as the Maldives, Pakistan, and Sri Lanka.

Sri Lanka is also forecast to post a relatively firm recovery, supported by the recent surge in capital inflows following the cessation of fighting after nearly three decades of civil war. The conflict-affected countries— Afghanistan, Pakistan, and Nepal—are expected to face more moderate growth outputs, as political uncertainty and fighting continue to disrupt economic activity.

Trade

South Asia’s import volumes through July 2009 declined 32% compared with the previous year. The decline in the region’s merchandise export volumes was less severe. This partly reflects the low manufacturing and commodity content of the region’s exports. The region’s greater reliance on services trade provided a buffer to the crisis, as services tend to be more resilient during downturns. But smaller countries with important tourism sectors, such as the Maldives, were hit hard.

Some sectors demonstrated marked resilience during the crisis, such as ready-made garments in Bangladesh, Sri Lanka’s partnerships with mid- to high-end retailers in the United States and the European Union, and India’s information technology industry.
Overall, the combination of a sharp fall in the value of imports, a less steep decline in exports, and resilient remittance inflows have mitigated the negative effects.

Remittance

A key source of foreign exchange for South Asia, remittance, declined in 2009 due to decline in economic activity and the rise in unemployment in migrant host countries. Remittance inflows, however, remained relatively strong compared with other sources of foreign exchange, and indeed are above their 2007 levels.

Growth in the Arabian Gulf and East Asian economies, which host a significant share of South Asia’s migrant workers, has not been as adversely affected as growth in other key host economies, such as the United States and the European Union.

Among South Asia’s economies, India—the largest recipient of remittances in the world in dollar terms—posted a contraction in remittance inflows in 2009, while Bangladesh, Nepal, Pakistan, and Sri Lanka, experienced a slower pace of growth of remittances inflows.

Risks

As the global economic recovery begins, the risks to the GDP growth forecast for South Asia have lessened. Downside risks to the forecast are the region’s large fiscal imbalances and its high reliance on trade taxes.

The region’s large fiscal imbalances also represent a potential drag on long-term growth. The region has a very low tax base compared with other developing regions, so improving tax collection would help alleviate fiscal pressures.

Remittances inflows could fail to recover in the event of a prolonged global recession or a jobless economic recovery. The recent debt payment problems of Dubai World in the United Arab Emirates that erupted in late-November 2009 could pose risks for South Asian migrants working in the Gulf. But, if a significant portion of expatriate workers return home with accumulated savings due to the downturn in the Gulf, near term remittances inflows might rise.

Source : World Bank
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