Asia Economic Monitor 2005

Transcription

1 Asia Economic Monitor August The Asia Economic Monitor (AEM) is a semiannual review of East Asia s growth, financial and corporate sector restructuring, and emerging policy issues. It covers the Association of Southeast Asian Nations member countries plus the People s Republic of China and the Republic of. Contents Recent Economic Performance 3 Real Sector Developments 3 Financial Markets 7 Monetary and Fiscal Policies 8 Financial Restructuring and Prudential Indicators Nonperforming Loans, Capital Adequacy, and Bank Profitability Asset Resolution by Asset Management Companies 2 Banking Sector Divestment and Consolidation 3 Financial and Corporate Reforms 4 Bank Lending 7 Prudential Indicators 8 Economic Outlook, Risks, and Policy Issues 9 External Economic Environment 9 Regional Economic Outlook 22 Individual Country Outlook 24 Risks and Policy Issues 28 Boxes. Local Currency Bond Markets in East Asia 5 2. Higher Oil Prices and East Asian Growth Global Payments Imbalance: The Need for a Shared Approach 3 4. Implications of the s and s Move to a Managed Floating Regime 34 How to reach us Asian Development Bank Office of Regional Economic Integration 6 ADB Avenue, Mandaluyong City 55 Metro Manila, Telephone Facsimile aric_info@adb.org Highlights Growth and Restructuring in the First Half of Higher oil prices, softness in the IT cycle, and the loss of economic momentum in major industrial markets have led to a gradual deceleration in East Asia s GDP growth. Exports grew at a slower rate in the first half of this year, continuing the trend since the middle of in all East Asia s larger economies except the. The growth of domestic demand was also lower in the first quarter of this year than in the previous two quarters in most of the larger economies of East Asia due to weaker export growth, higher oil prices, and a bias toward tighter macroeconomic policies. The region s stock markets have held up well in most countries, while East Asia s currencies have generally remained stable or depreciated against the US dollar. In general, progress in financial and corporate reforms continues to improve the health and robustness of financial sectors in the region. Various prudential indicators also continue to improve. Economic Outlook for and 26 The external economic environment facing East Asia is expected to be somewhat less favorable this year, with the softening of growth in major industrial countries and the weakening of global demand for IT products. Less favorable external economic environment and record oil prices are expected to lead to a moderate slowdown in East Asia s GDP growth this year. The July survey by Consensus Economics Inc. projects East Asia s average GDP growth to be lower than last year s actual figure of 7.6%, but still a robust 6.8%. Excluding the, the region s average GDP growth this year is forecast to be much lower at 4.4%, compared with 5.5% last year. In 26, East Asia is forecast to grow by 6.6%. Risks and Policy Issues The above forecasts are subject to risks from further increases in oil prices and a disorderly adjustment of the global payments imbalance. Continued overleaf A private institution that collates forecasts from about 2 economic and financial forecasters from more than 7 countries.

2 Acronyms, Abbreviations, and Notes A D B A E M A M C ARIC ASEAN ASEAN+3 BB C A R CBRC C L I C P I DRAM G D P IBRA I E A I I F I M F I S M I T J C I KAMCO KLCI KOSPI Lao PDR LPS mbd NASDAQ NBFI N P L OECD OPEC OREI PCOMP PHIBOR P P A P R C R O A SARS S&P S E T SIBOR S O E S P V S T I TA M C WTI Asian Development Bank Asia Economic Monitor asset management company Asia Regional Information Center Association of Southeast Asian Nations ASEAN plus, Japan, and book-to-bill capital adequacy ratio China Banking Regulatory Commission composite leading indicator consumer price index dynamic random access memory gross domestic product n Bank Restructuring Agency International Energy Agency Institute of International Finance International Monetary Fund Institute of Supply Management information technology Jakarta Composite Index Asset Management Corporation Kuala Lumpur Composite Index Republic of n Stock Price Index Lao People s Democratic Republic Deposit Guarantee Corporation million barrels per day National Association of Securities Dealers Automated Quotation nonbank financial institution nonperforming loan Organisation for Economic Co-operation and Development Organization of Petroleum Exporting Countries Office of Regional Economic Integration Philippine Composite Index Philippine Interbank Offered Rate Perusahaan Pengelola Aset (State-owned Asset Management Company) People s Republic of China return on assets Severe Acute Respiratory Syndrome Standard & Poor s Stock Exchange of Interbank Offered Rate state-owned enterprise special purpose vehicle Straits Times Index () Thai Asset Management Corporation West Texas Intermediate In terms of policy response, there is a case for: fiscal consolidation in many countries, with the notable exceptions of,, and to a lesser extent, tightening of monetary policy in,, Lao PDR, Myanmar,,, Viet Nam, and to a lesser extent, greater exchange rate flexibility, building on the 2 July exchange rate regime shift by and, and structural reforms in the financial and corporate sectors. q-o-q y-o-y quarter-on-quarter year-on-year B baht P peso R M ringgit Rp rupiah yen Note: $ denotes US dollars unless otherwise specified. The Asia Economic Monitor August was prepared by the Office of Regional Economic Integration of the Asian Development Bank and does not necessarily reflect the views of ADB's Board of Governors or the countries they represent.

3 East Asia s Growth and Restructuring A Regional Update Recent Economic Performance Real Sector Developments 5 5 Figure : Real GDP Growth (y-o-y, %) -5 2Q 3Q 4Q 5Q Source: ARIC Indicators. The gradual deceleration in East Asia s gross domestic product (GDP) growth that began in the middle of has continued this year. The seven big economies in the region for which quarterly GDP data are available People s Republic of China (),, Republic of (),,,, and taken together posted a 6.8% year-on-year GDP growth in the first quarter of this year, compared with 7.3% in the fourth quarter of and 7.6% for last year as a whole (Figure ). 2 The factors that have contributed to slower regional growth over the past year include higher oil prices, softness in the information technology (IT) cycle that began in the second half of last year, the loss of economic momentum in major industrial markets, and, from a technical standpoint, a return to trend growth following the post-sars (severe acute respiratory syndrome) bounce until the first half of. Nonetheless, there were variations in the performance of countries within the region. GDP growth in the remained robust at 9.5% in the second quarter of, similar to the first quarter rate, but slightly lower than at the beginning of when the rate of economic expansion was close to %. s growth was 6.4% in the first quarter, marginally lower than the postcrisis record rate of 6.7% achieved in the previous quarter. The impact of the devastating tsunami at end-december was mainly limited to a part of Aceh and had only a modest overall effect on the economy. s economy expanded by 5.7% in the first quarter, similar to the 5.8% rate in the final quarter of. In the, growth decelerated from a postcrisis peak of 6.6% in the second quarter of to 5.4% in the final quarter and further to 4.6% in the first quarter of this year, as the effects of El Niño induced a sharp downturn in agricultural output. s growth improved modestly to 3.3% in the second quarter of from 2.7% in the first. However, it was lower than the 4.6% growth posted in as exports were more sluggish and domestic demand, although improving, Defined here as the members of the Association of Southeast Asian Nations (Brunei Darussalam, Cambodia,, Lao People s Democratic Republic,, Myanmar,,,, and Viet Nam) plus the People s Republic of China and the Republic of. 2 Unless otherwise indicated, all growth figures are year-on-year.

4 remained weak. In, domestic demand decelerated in conjunction with a sharp moderation in export growth. s GDP growth was 3.9% in the second quarter, faster than the 2.8% posted in the first, but significantly lower than the 6.5% in the final quarter of. In, a prolonged drought, the dampening effects of the tsunami on tourism, unrest in some southern provinces, and the negative effects of avian flu added to the deleterious effect of higher oil prices and contributed to a slower first quarter growth of 3.3%, compared with 5.3% in the previous quarter. Figure 2: Growth of Domestic Demand (y-o-y, %, at constant prices) 4Q3-4 4Q Q 5Q2 Based on national income accounts except for which is the sum of retail sales and fixed investment (at constant 997 prices). Sources: OREI staff calculations based on ARIC Indicators and CEIC. The growth of domestic demand, including changes in inventories, was lower in the first quarter of this year than in the previous two quarters in the larger economies of East Asia, except in the and, where public spending helped offset some of the slowdown in private sector demand (Figure 2). The general slowdown in domestic demand was likely the result of weaker export growth (especially in countries that are more dependent on external demand), higher oil prices, and a bias toward tighter macroeconomic policies. Changes in inventories contributed significantly to the extent of the slowdown in some countries. There was a sharp drawdown of inventories in and and, to a lesser extent, in the and. Nonetheless, the trend in domestic demand is similar if changes in inventories are excluded, except in. In, the contribution of domestic demand to overall GDP growth rose to 2.5 percentage points in the second quarter of this year from. percentage points in the first quarter and. percentage point in the final quarter of if changes in inventories are excluded Figure 3: Growth of Private Consumption (y-o-y, %, at constant prices) -4 2Q 3Q 4Q 5Q Growth of retail sales deflated by the retail price index (997=). Sources: ARIC Indicators and CEIC. Domestic demand rose the fastest in the in the first quarter, with a continued, albeit slower, rise in fixed investment and robust consumer spending. Growth in retail expenditures, in real terms, accelerated to.9% in the first quarter from.7% in the previous quarter on the back of strong employment and income growth (Figure 3). Private consumption also remained strong in, with growth of.%, partly reflecting improved terms of trade from high commodity prices. In,, and, private consumption growth continued to moderate. The deceleration was particularly sharp in, probably reflecting a combination of a slowdown in exports and a sharp contraction in the volatile pharmaceutical industry that dampened manufacturing output. In, there are signs that private consumption has started to strengthen, following a decline since the household credit bubble burst in 22, although it still remains weak. Private consumption rose by 2.7% in the second quarter, following growth of.4% in the first quarter and a decline of.5% in. 4

5 Figure 4: Growth of Fixed Investment (y-o-y, %, at constant prices) Q 3Q 4Q 5Q Nominal fixed asset investment (year to date, y-o-y growth). Sources: ARIC Indicators and CEIC. Figure 5: Growth of Exports of Goods and Services (y-o-y, %, at constant prices) Q3 4Q4 5Q 5Q2 Based on national income accounts except, which is based on merchandise exports (at constant 997 prices). Source: ARIC Indicators. Fixed investment growth slowed generally across the region in the first quarter of this year (Figure 4). However, it is growing at doubledigit rates in,, and. In the, nominal fixed investment grew by 23% in the first quarter compared with a peak rate of 43% a year earlier as restrictive measures implemented over the past year and a half took effect. But, at around 5% of GDP, it remains high. Fixed investment growth decelerated sharply in the and, and remained weak in, probably reflecting the softness in exports and generally weak economic prospects. In, private fixed investment rose by a strong.2%, but government efforts at fiscal consolidation over the past year by scaling back development spending led to an % contraction in public investment, and hence total fixed investment rose only modestly. The deceleration in domestic demand mirrors a corresponding slowdown in exports. The slowdown in major industrial markets and softer demand for high tech products contributed to the slower growth of the region s exports. Real exports of goods and services rose at a slower rate in the first quarter of this year, continuing the trend since the middle of in all East Asia s larger economies except the (Figure 5). The slowdown was particularly sharp in, which in addition to region-wide shocks, was buffeted by several countryspecific shocks, including the effect of the drought on agricultural exports and the tsunami-induced 9% decline in tourist arrivals. Except, the region s larger economies also posted slower import growth in line with softer domestic demand, so that net exports of goods and services contributed significantly to GDP growth, especially in. Monthly data since the first quarter suggest that, in most countries, the growth of merchandise exports in US dollar terms, although falling, was more stable in the past several months (Figure 6). Although nominal oil prices have increased further in the past few months, healthy growth in the US and the probably contributed to greater stability in regional export growth. There is also some evidence that the downturn in the high tech cycle may be bottoming out. The semiconductor bookto-bill ratio, a measure of future orders relative to current shipments, rose to.85 in May from a recent low of.77 in February, while the spot price of DRAM chips has stabilized at $2.5 since April this year, following successive declines from a year earlier. Furthermore, the effect of some of the factors that suppressed economic growth in the first quarter, such as the tsunami s impact on tourism in, and adverse weather conditions in the and, may also be diminishing. 5

6 Figure 6: Growth of Merchandise Exports (y-o-y, %) Figure 7: Headline Inflation Rates (y-o-y, %) Figure 8: Core Inflation Rates (y-o-y, %) -9 Aug Apr Nov Three-month moving average of dollar Jul -3 Aug Apr Source: ARIC Indicators. Nov Jul -3 Aug Apr Nov Jul Sources: Bank of, Bangko Sentral ng Pilipinas, and OREI staff estimates derived from Bloomberg data. values. Source: OREI staff calculations based on ARIC Indicators. In the first half of this year, headline consumer price inflation remained high in and the and started to accelerate in and (Figure 7). Inflation moderated in,, and, starting in the second half of last year, with a slowdown in demand, stronger currencies (in trade-weighted terms), and more stable food prices. The most persistent increase in headline inflation this year was evident in and to a lesser extent, reflecting a reduction in oil subsidies and, in, a contraction in agricultural production as well. In the, too, inflation accelerated persistently over the past year, although it has moderated somewhat in June and July this year. In the and, inflation spiked in February and March, but has trended down in recent months. In the, the spike was associated with the lunar new year and a sharp jump in food prices, while in, cutbacks in oil subsidies led to an average 29% rise in fuel prices in March. Core inflation has followed a trend similar to that of headline rates, with and showing some moderation in recent months (Figure 8). In the, core prices rose at a slower rate in the past several months, but remained high at 6.8% in July. posted a notable increase in core inflation, reflecting partly the pass-through of higher oil prices to non-oil sectors and adjustment of administered prices of transportation and utilities. 6

7 Financial Markets Figure 9: Composite Stock Price Indexes (weekly average, first week of =, local index) Feb 5 Apr 3 Jun 29 Jul Weekly averages of JCI (), KOSPI (), KLCI (), PCOMP (), STI (), and SET (). For, the index is calculated based on the weekly averages of the Shanghai Composite and Shenzen Composite, weighted by the market capitalization of each market. Source: OREI staff calculations derived from Bloomberg data. Figure : Percent Change in Stock Market Index Relative to Russell 3 Index (between 7 and week ending 29 Jul ) -2-2 Weekly averages of JCI (), KOSPI (), KLCI (), PCOMP (), STI (), and SET (). For, the index is calculated based on the weekly averages of the Shanghai Composite and Shenzen Composite, weighted by the market capitalization of each market. Source: OREI staff calculations derived from Bloomberg data. The region s stock markets have held up well this year, except in the, despite the loss of growth momentum (Figure 9). The resilience likely reflects in part some reduction of the risk of a hard landing in the, the measured and predictable pace of increases in US interest rates, and the market expectation that the global IT cycle has bottomed out. As of end-july this year, stock markets (in local currency terms) rose more than 25% in, 6% in, and 2% in. They fell in, reflecting lower-than-expected economic growth, and in the, where the stock market continued to remain weak with a decline of 4% so far this year. Relative to the US Russell 3 index, the performance of the regional stock markets ranged from a 9% decline in the to an 8% increase in (Figure ). The weak performance of the stock market reflects mostly structural shortcomings such as the supply overhang from the large proportion of shares held by state-owned or state-controlled entities which are likely to be sold as part of the financial reform agenda, as well as limits on foreign ownership. The weak performance may also be related to cyclical concerns, such as the uncertainty about further policies to ensure a soft landing of the economy. East Asia s currencies generally remained stable or depreciated against the US dollar this year, partly reflecting the desire of authorities to maintain price competitiveness in the face of weaker exports and the US dollar s strength against the euro and yen (Figure ). Currencies in the and have appreciated by 2% against the US dollar following the 2 July shift in the exchange rate regimes of these countries, from a US dollar peg to one of a managed float with reference to a basket of currencies. The n won and the Philippine peso, after giving up in June much of the gains realized in the earlier part of the year, are marginally up against the dollar compared with the beginning of the year. The dollar has declined by %, the n rupiah by 5%, and the Thai baht by 6% since the beginning of this year. The broad strength of the US dollar, and the concomitant weakness of the currencies of East Asia s other trading partners, has meant that the nominal effective exchange rates of the seven regional currencies are stronger than the regional currencies against the US dollar (Figure 2). Data available up to June show that only the n rupiah and the Thai baht depreciated. The nominal effective exchange rates of the Philippine peso and the n won strengthened by 4 6%. The yuan and the n ringgit, pegged to the US dollar until 2 July, appreciated by 2 3%. 7

8 8 Figure : Exchange Rate Indexes (weekly average, first week of =, $/local currency) 6 4 Figure 2: Nominal Effective Exchange Rate (Dec =) 6 4 Figure 3: Real Effective Exchange Rate (Dec =) Feb 5 Apr 3 Jun Source: OREI staff calculations derived from Bloomberg data. 29 Jul Dec Feb Apr Jun An increase is an appreciation. Trade weights are total trade from top trading partners. Source: OREI staff calculations Dec Feb Mar Apr May An increase is an appreciation. Trade weights are total trade from top trading partners. Source: OREI staff calculations. Figure 4: Gross International Reserves Less Gold, End of Period ($ billion) ASEAN ,2 Two Years Ago One Year Ago Latest Month 2 From latest month. 2 May for,, and ; April for others. Source: International Monetary Fund, International Financial Statistics Online. The real effective exchange rates exhibit a similar trend with a few exceptions (Figure 3). In, a higher inflation differential with trading partners led to a slight appreciation of the real effective exchange rate. Conversely, in and, lower inflation contributed to a depreciation of the real effective rate. Authorities have continued to intervene in foreign exchange markets in order to keep their currencies competitive. The rate of accumulation of foreign exchange reserves accelerated over the past year (Figure 4). Total foreign exchange reserves of the seven East Asian countries rose by $29 billion to $,53 billion in the year to April, higher than the $22 billion increase in the previous year. The faster rate of increase was mostly in the, where reserves rose by $29 billion in the year to April, compared with $23 billion in the previous year. Monetary and Fiscal Policies Several countries have maintained a tighter bias to monetary policy since last year. However, with only a moderate increase in inflation rates and some flexibility in exchange rates, the rise in policy rates has lagged that in the US. has significantly tightened monetary policy, reflecting concerns about the effect of the oil price increase on inflationary expectations. The Bank of raised the 4-day repo 8

9 policy rate three times this year from 2% to 2.75%, after increasing it three times since August last year when it was.25%. The cumulative 5 basis point increase in the current cycle is still below the 225 basis point increase in the US Federal Funds rate to 3.25% Figure 5: Short-term Interest Rates (nominal, end of month, %) / 5 Aug Apr Nov Others 5 Jul Three-month interbank lending rates : average of interbank borrowing and lending rates (People's Bank of China); : weighted average of banks interbank lending rates (Bank ); : certificate of deposit (3 month); : average of interbank deposit rates (Bank Negara ); : PHIBOR (Banker's Association of the ); : SIBOR (Association of Banks in ); : interbank offer rate (Bangkok Bank). Source: ARIC Indicators Figure 6: Short-term Interest Rates (real, end of month, %) -4 Aug Apr Nov Three-month interbank lending rates. Source: ARIC Indicators Jul In, the monetary authority has retained the tighter bias adopted in April last year when it shifted its policy of zero percent appreciation of the nominal effective exchange rate to one of modest and gradual appreciation. In, the depreciation of the currency and concerns about its effect on inflation led the central bank to tighten policy more forcefully starting in March this year, so that the one-month Bank Certificate (Sertifikat Bank ) rate rose to 8.49% in mid-july from 7.42% in March, and from a cyclical low of 7.32% in May last year. Similar concerns prompted the Philippine central bank to increase its overnight repo and reverse repo rates in April this year by 25 basis points to 9.25% and 7% respectively, and in July, the Monetary Board increased the regular reserve requirement and liquidity reserve requirement by one percentage point each. s monetary policy has been on hold in, following two reductions in the policy rate last year, as inflation has remained manageable and domestic demand, although improving, remains weak. In the, a number of measures were implemented over the past 8 months, including a 27 basis point hike in benchmark interest rates in October for the first time in nine years, an increase in reserve requirements, and restrictions on new lending to dampen credit and investment growth, to bring economic expansion to more sustainable levels. The moderation in inflation over the past year and the deceleration of investment growth have reduced the risk of a hard landing of the economy. However, concerns about overheating in the property sector have kept authorities vigilant on monetary policy. In March, the government allowed commercial banks to set their own mortgage rates and to raise the minimum required downpayment on property from 2% to 3%. Perhaps more significantly, in July, the authorities changed the exchange rate regime from a peg to the US dollar to one of managed float with reference to a basket of currencies, the first change in the regime since 994, allowing the yuan to appreciate 2.% from 8.28 yuan to the US dollar to 8.. Nominal short-term interest rates have edged up in,, and more recently in and the, from historically low levels (Figure 5). Real short-term interest rates have remained low over the past year, except in, where the real short-term rate rose to 2.3% in June from -.% a year earlier (Figure 6). 9

10 Real interest rates remain negative in,, and. Figure 7: Fiscal Balance Actual (% of GDP) 2 3 Data refer to central government for,,, and ; federal government for ; central and local governments for ; and consolidated budget for. 2 Data are FY Apr Mar. 3 Data are FY Oct Sep. Sources: ARIC Indicators; Ministry of Finance (,, and ); and Ministry of Finance and Economy (). Figure 8: Fiscal Balance Budget (% of GDP) Data refer to central government for,,, and ; federal government for ; central and local governments for ; and consolidated budget for. 2 Data are FY Apr Mar. 3 Data are FY Oct Sep. Sources: th National People s Congress and Chinese People s Consultative Conference (); Bank (); Ministry of Planning and Budget (); Ministry of Finance (); Bureau of the Treasury (); Ministry of Finance (); and Bureau of the Budget (). In general, governments in the region have consolidated their fiscal positions. In all the larger economies, except, the fiscal outturn in improved compared with the previous year, when many economies suffered the effects of SARS in the first half of the year (Figure 7). The fiscal account, excluding social security, financial sector restructuring costs, and privatization revenues, moved to a deficit in last year, and the deficit is projected to widen modestly this year. Considering the weakness in domestic demand and decelerating export growth, as well as its relatively low public debt, a stimulus would be appropriate. The improved performance in other economies reflected primarily higher revenues by approximately.8 % of GDP in,,, and.5% in. In and the, expenditure reduction was the main contributor to the decline in the fiscal deficit. Further fiscal consolidation is expected this year in these economies (Figure 8). In the, where medium-term fiscal sustainability is a key source of concern, the overall deficit is expected to narrow to 3.4% of GDP in from 3.8% of GDP last year. In, the government expects to reduce the deficit further to.8% of GDP from.2% last year. Fuel subsidies are slated to amount to 3% of GDP (Rp77 trillion) this year, the same proportion as last year, when subsidies doubled from as the government attempted to insulate domestic fuel prices from higher world prices. With international prices rising further, the authorities increased domestic fuel prices by an average 29% in March this year in order to keep the subsidies within target. In, the budget for this fiscal year (October September ) includes.7% of GDP (B5 billion) in supplementary spending to support domestic demand while maintaining fiscal stability. The overall fiscal position is expected to be in balance, compared with an actual surplus of.3% of GDP last fiscal year. Against the backdrop of persistently high world oil prices, a view to promote efficiency in energy use, and to build better demand management in the long run, abolished fuel subsidies in July. These amounted to.2% of GDP (B82 billion) between uary (when they were implemented) and mid-april this year. In, the deficit is projected to narrow to 3.8% of GDP from an actual gap of 4.3% of GDP in as development spending is reduced further., a large net exporter of oil, has also gradually

11 begun to adjust its domestic oil prices. The government expects subsidies to decline to.2% of GDP (RM5.3 billion) this year from.5% of GDP (RM6.3 billion) last year. Financial Restructuring and Prudential Indicators Figure 9: NPLs of Commercial Banks (% of total commercial bank loans) Data on NPLs exclude those transferred to AMCs. NPLs are on a three-month accrual basis in, and three months or more in and. 2 Available official statistics from the China Banking Regulatory Commission start in. 3 Data refer to NPLs in the banking sector. 4 NPL criteria were changed so no comparable data are available prior to Data refer to local commercial bank NPLs as a percent of nonbank loans. Sources: ARIC Indicators, China Banking Regulatory Commission, and Monetary Authority of. Figure 2: NPLs Purchased by AMCs ($ billion) Apr 5 Mar 5 Mar 5 4 Jun Dec Dec 2 Dec 3 Oct 3 May 5 Mar 5 Dec Dec 2 Dec 3 8 May 5 Mar 5 Mar 5 June Dec 4 Latest Available Sources: OREI staff calculations based on data from China Banking Regulatory Commission (), IBRA (), KAMCO (), Danaharta (), and TAMC (). 2 Dec 4 Latest Available Nonperforming Loans, Capital Adequacy, and Bank Profitability Nonperforming loans (NPLs) as a percentage of total outstanding loans of commercial banks continued to fall in most East Asian countries for which data are available, partly due to continued disposal of bad assets by banks and partly due to improved performance. Latest available data show that the NPL ratio stood at.7% in, 4.7% in, 5.7% in, 6.7% in,.5% in,.% in, and 3.3% in (Figure 9). Since the third quarter of, the volume of NPLs declined by 7 8% in and the and 5-6% in and. The cumulative NPLs transferred to centralized asset management companies (AMCs) since the 997 financial crisis now stands at $5.4 billion in, $.8 billion in, $36.8 billion in, $2.2 billion in, and $2.6 billion in (Figure 2). In the, where privately-owned Special Purpose Vehicles (SPVs) were established under the SPV Act of 22 to help clean up balance sheets of commercial banks, the cumulative NPLs transferred to SPVs stood at $. billion as of June. The average capital adequacy ratio (CAR) of commercial banks continues to be above the 8% international norm in,,,,, and (Figure 2). The generally stable capital positions of banks largely reflect improved economic fundamentals, tighter prudential regulation, and better risk management in these countries. In the, although the CAR of a large part of the commercial banking sector remains below the 8% norm, there were significant improvements in the capital base of the commercial banks in. According to the China Banking Regulatory Commission (CBRC), the average CAR for joint-stock commercial banks improved to 6.6% at the end of from 3.4% a year earlier. The average CAR of the four state-owned commercial banks increased by 2.6 percentage points during the same period. These improvements were largely attributed

12 4 3 2 Figure 2: Capital Adequacy Ratios of Commercial Banks (%) Mar 5 May 5 Mar 5 Apr 5 Sep 4 May Dec Dec 3 Latest Dec 2 Dec 4 Available Refers to CAR of the banking system. Sources: ARIC Indicators and Monetary Authority of. Figure 22: Banking Sector Profitability (%) Rate of return on assets for all commercial banks in,,, and ; banking/financial system in ; and local commercial banks in. 2 As of April for and March for. Sources: Bank ; Financial Supervisory Service, ; Bank Negara ; Bangko Sentral ng Pilipinas; Monetary Authority of ; and Bank of. Figure 23: NPLs Resolved by AMCs (% of NPLs purchased) 25 5 Dec Dec 3 Dec 2 Dec 4 Mar 5 Oct 3 June 5 Mar 3 Mar 5 75 Latest Available Refers to those held by China Banking Regulatory Commission (), IBRA (), KAMCO (), Danaharta (), and TAMC (), as of dates indicated. Source: ARIC Indicators. to the government s bank recapitalization programs and the transfer of NPLs from banks to AMCs. It also reflects progress in banking reform. In, four East Asian countries most affected by the 997 financial crisis saw improvements in the rate of return on assets (ROA) for commercial banks compared with levels (Figure 22), with the improvement particularly significant in,, and. The better ROAs were partly attributed to improved asset quality of commercial banks and reduced loan loss provisions. The ROA, however, declined slightly in the and in from the previous year. The latest available data suggest that, in the first quarter of, the average ROA of the commercial banks remained more or less at its level in and. Asset Resolution by Asset Management Companies With substantial progress made in the resolution of distressed assets during the past years, most centralized and publicly-owned AMCs in the region have started to wrap up operations. The n Bank Restructuring Agency (IBRA) ceased operations in, and the Stateowned Asset Management Company (PT Perusahaan Pengelola Aset [PPA]), the AMC established to manage the free and clean assets of IBRA, was able to divest government shareholdings in four banks (Bank Danamon, Bank Internasional, Bank Niaga, and Bank Permata) as of May. With respect to the problem assets of IBRA taken over by the Ministry of Finance, while the settlement team has wrapped up its asset assessments, there has been no asset disposition or transfer as yet. In, as of June, the Asset Management Corporation had resolved 65.8% of its acquired NPLs using public funds with a recovery rate of 49.4%. In, Danaharta had worked out the resolution of all NPLs purchased and had collected 94% of its total expected recovery by end-, and is expected to have a recovery rate of 59% by its targeted closing date at the end of this year. In, the Thai Asset Management Company had resolved 98.8% of its acquired NPLs by March with an expected recovery rate of 49.2% (Figure 23). In the, the Special Purpose Vehicle Act of 22, enacted to support the resolution of distressed bank assets, lapsed in April. As of May, a total of 97 Certificates of Eligibility had been issued. Draft legislation is now pending in congress to amend the law to extend the registration and establishment of SPVs and the accompanying tax incentives. 2

13 Banking Sector Divestment and Consolidation Bank recapitalization programs implemented after 997 in most crisisaffected countries left governments as significant shareholders in many banks. Significant progress has been made in the divestment of this state ownership and consolidation of the banking sector. In, the government has continued to divest its stakes in the banking sector. PPA sold state-owned shares in four banks in and early, and is planning to fully divest state shareholdings in six banks under its purview through 28. There is also an expected acceleration in the implementation of the n Banking Architecture Program by identifying anchor banks around which mergers and acquisitions will revolve. In, the investment in KorAm Bank by Citigroup in early eventually led to the merger of KorAm Bank and Citibank N.A. Seoul Branch into Citibank in November. In April, Standard Chartered Bank fully acquired First Bank from Newbridge Capital and the government. This reduced the number of government-controlled commercial banks to two. Related to this is the amendment to the Financial Holding Company Act that mandates the government to dispose its shares in state-owned and controlled financial holding companies within seven years. After consolidating the domestic banking sector into ten banking groups, is focusing on improving operational efficiencies and streamlining business structures. An integrated commercial bank and finance company framework, also referred to as the Bafin framework, was adopted in to rationalize commercial banks and finance companies within the same banking group. This led to the merger of five finance companies with their respective commercial banks during the year. In March, a framework for establishing investment banks, aimed at rationalizing merchant banks, stockbroking companies, and discount houses within the same banking group, was finalized and is ready for implementation in the second half of this year. Under this framework, the ceiling of foreign equity in investment banks will be raised to 49%, in line with the country s commitment to liberalize the banking sector. In the, the consolidation of commercial banks continues with the acquisition by Banco de Oro Universal Bank of the branch network of United Overseas Bank in May. As a result of this transaction, the selling bank will have to operate as a thrift bank. In July, Bank of the Philippine Islands announced 3

14 its purchase of Prudential Bank. These transactions will reduce the number of commercial banks to 4. In, the Financial Sector Master Plan is paving the way to the restructuring and consolidation of the banking sector. A merger plan between two commercial banks is awaiting government approval while three commercial banking licenses have been granted to merging finance companies late last year. Finance companies and credit fonciers have also obtained retail banking licenses. Financial and Corporate Reforms There have been a number of important developments in the area of financial and corporate reforms in the region. First, several East Asian countries are in the process of establishing deposit insurance systems. A deposit insurance law will take effect in in September, while proposals for deposit insurance schemes are being studied in,, and. For, the Deposit Insurance Act has been approved by the cabinet. Second, many countries are in the process of establishing or strengthening credit information bureaus.,, and have initiated efforts to establish credit information bureaus. In, financial institutions submitted a plan to the Financial Supervisory Commission last November to set up a credit bureau for information sharing. In, mergers between existing credit information bureaus were completed in May. Third, national efforts in developing local currency bond markets as an effective way to avoid currency and maturity mismatches that were at the heart of the 997 Asian financial crisis are being complemented by efforts at the regional level (Box ). Fourth, measures are being taken in,,,,, and to move towards Basel II standards in the next two to three years. Apart from these developments, some of the country-specific financial and corporate reforms are highlighted below: Cambodia. The government has drafted a proposal that lays down the legal framework for government and corporate securities. Another pending reform is a draft law on negotiable instruments and payment transactions intended to reduce risks in the payment system.. In April, the government injected $5 billion into the Industrial and Commercial Bank of China, making it the third stateowned commercial bank to receive capital infusion. Also, the Bank of Communications, one of joint-stock commercial banks in the country, completed its initial public offering in June. To stimulate reforms in the state-owned enterprise (SOE) sector, the government 4

15 Box : Local Currency Bond Markets in East Asia Since the 997 financial crisis, East Asia has taken important steps at both national and regional levels to develop local currency bond markets. The objectives of these efforts are (i) to reduce the risks associated with excessive reliance on short-term external financing, thereby mitigating the currency and maturity mismatch problem; (ii) to provide an alternative vehicle for channeling domestic savings into productive investment and reducing dependence on bank lending; and (iii) to support economic and financial integration within East Asia. Partly as a result of these efforts in the past several years there has been a rapid expansion of local currency bond markets in the region. Between 997 and, the size of these markets more than tripled (from $355.5 billion to $,39. billion), with registering the fastest growth, having the largest amount of bonds outstanding, and achieving the highest ratio of local currency bonds outstanding to GDP. Although the growth has been skewed toward the government sector (at 27% annually for East Asia as a whole), corporate bond markets have also seen rapid growth (at about 8% annually during the last eight years). Consequently, the importance of local currency bond markets as a source of financing for domestic investment in East Asia has been increasing. In, bond financing accounted for 9.4% of total domestic financing for East Asia as a whole, up from 3.3% in 997, while bank lending accounted for 6%, down from 67% in 997 (Figure B.). The role of bond issuances in corporate finance has also increased. In 997, bank lending accounted for 7.9% of total corporate finance, with bond financing at 8.4%. In, the corresponding shares were 64.6% and.7 %, respectively (Figure B.2). The structure of East Asian local currency bond markets has also changed in recent years. These include, among others, (i) issuance of longer tenor bonds extending yield curves in several countries, (ii) increases in the issue size of benchmark bonds, (iii) strong growth of asset-backed securities and the emergence of a wider issuer base Figure B.: Domestic Financing Profile in East Asia (% of total domestic financing) Bank financing Bond financing Equity financing Sources: International Monetary Fund (bank financing); Bank for International Settlements (bond financing); and World Federation of Exchanges (equity financing). backed by strong investor appetite, and (iv) the launch of the Asian Bond Fund 2, likely to provide a boost to investment in local currency bond markets in the region. East Asian local currency bond markets still have great potential to grow compared with those of the developed countries. As a percentage of GDP, the average size of East Asian local currency bond markets is only a little over 4%, compared with the average size of OECD countries of more than 2%. Increasing bond market liquidity is also a significant challenge. Policy makers in the region are working together under the ASEAN+3 Asian Bond Markets Initiative to address these key policy issues in local currency bond market development. Figure B.2: Corporate Domestic Financing Profile in East Asia (% of total corporate domestic financing) Bank financing Bond financing Equity financing Sources: International Monetary Fund (bank financing); Bank for International Settlements (bond financing); and World Federation of Exchanges (equity financing). Based on ADB s Asia Bond Monitor, November and April, available at asianbondsonline.adb.org. 5

16 announced a package of tax breaks for SOEs with approved debtto-equity swap transactions.. In implementing the n Banking Architecture Program, the government has initiated measures to strengthen the financial infrastructure. In uary, a package of regulations was issued to foster risk management and corporate governance by banks, stimulate lending, and improve the reporting system for information on borrowers. Also, the regulation and supervision of nonbank financial institutions are in the process of being consolidated under the Capital Market Supervisory Agency.. The Securities Class Action Suit Law became effective in uary for companies with assets above W2 trillion. Amendments to the Monopoly Regulation and Fair Trade Act were passed in December and became effective in April. These were intended to reinforce the deterrence against cartels, improve the merger and acquisition review system, and encourage improvement of corporate ownership and governance structure. Moreover, the amendments provide the legal and institutional foundation to the 3-year Market Reform Roadmap of the n government. The Consolidated Insolvency Law was enacted in March, and is to take effect in March 26. Lao PDR. The full implementation of the regulation on loan classification issued in May is expected in. There is also an amendment to the banking law pending in the legislature for the opening up of the banking sector to more foreign institutions.. The incorporation of market risk into the capital adequacy framework is currently being implemented with banks required to comply with the minimum CAR by the second quarter of. In the area of corporate reform, the n Institute of Corporate Governance is working on corporate governance rules to improve the quality of listed companies, to be released by end-. This is in preparation for the cross-trading of equities between and, and the eventual liberalization of capital markets.. In March, the Fixed Income Exchange started operating with the launch of the interdealer trading platform for secondary market trading of government securities. Several legislative amendments have been proposed aimed at strengthening the supervisory and regulatory powers of the central bank.. The Competition Commission of, the government agency tasked to check anti-competition practices, 6

17 began operating in uary and has started issuing guidelines to implement the Competition Act of. In the area of corporate governance, the Exchange has proposed stricter listing rules.. Bank supervision is being strengthened to cover market risks. At the same time, banks have been permitted a wider range of instruments for risk management Figure 25: Real Bank Credit (seasonally adjusted, 997=) 997 Figure 24: Nominal Bank Credit Growth (y-o-y, %) Oct 22 Feb 999 Sep Mar 2 Jul Apr Claims on the private sector: deposit money banks. Source: OREI staff calculations based on ARIC Indicators. May Claims on the private sector: deposit money banks. Source: OREI staff calculations based on ARIC Indicators. May Viet Nam. The government infused D trillion into five state-owned commercial banks as of end- to help them implement restructuring plans. As of June, two state-owned commercial banks had submitted equitization plans to the central bank, with one already approved and the other pending. In an effort to improve monitoring of bank lending, a new regulation was issued in May expanding the number of loan classification categories from two to five, together with the requirement for banks to set up a fund to cover future repayment defaults. Bank Lending During the past 2 months or so, bank credit to the private sector has increased particularly in and, and to a lesser extent, the and, reflecting the progress in financial restructuring and improvement in the business environment. Outstanding bank credit to the private sector increased by 3% in and 23% in in April compared with its level a year earlier (Figure 24). Although the growth rate was much lower in the and, at about 7% and 9%, respectively, these represent a significant improvement from the situation one or two years ago. In the, growth of outstanding bank credit has slowed significantly since the second half of last year, largely due to government measures to control excessive investment growth in certain sectors of the economy. In, outstanding bank credit to the private sector has been falling since the end of 22 partly due to sluggish business investment as a result of continued economic weaknesses and because of low borrowing by households already burdened with a high level of debt. Despite the increased growth, however, in real terms, outstanding bank credit to the private sector remained below the pre-997 crisis levels in,, and (Figure 25). In many countries, recent growth in bank credit to the private sector was driven to a large extent by lending to households. At end-december, outstanding household credit grew by 37.8% year-on-year in, 6.4% in, 3.6% in,.6% in, 7

18 Figure 27: Household Credit (% of GDP) 2Q 2Q4 3Q3 4Q2 5Q 9 Figure 26: Growth of Household Credit (y-o-y, %) 2Q 2Q4 3Q3 4Q2 5Q Sources: Bank, Bank of, Bank Negara, Bangko Sentral ng Pilipinas, and Bank of. Figure 28: Current Account Balance (% of GDP) Sources: Bank, Bank of, Bank Negara, Bangko Sentral ng Pilipinas, and Bank of. As of March. Sources: OREI staff estimates and ARIC Indicators. and 6.% in (Figure 26). The growth remained strong in and in the first quarter of. However, as a percentage of GDP, outstanding household credit is stable, at 6% in, 23% in, below 3% in, a little over % in, and below 3% in (Figure 27). Prudential Indicators In general, improvements in the health of the financial sectors in the region have been accompanied by improved external payment positions and other prudential indicators in recent years. First, the current account was in surplus in,,,,,, and for the past seven consecutive years (Figure 28). Latest available data show that the current account remained in surplus in these countries in the first quarter of with the exception of, which recorded a deficit amounting to 3.3% of GDP, mainly due to high oil prices. The latest Consensus Economics survey (July ) projects that the current account will record another surplus in for,,,,, and, but with a marginal deficit for. Second, the sustained current account surpluses and strong private capital inflows have resulted in a continued buildup of foreign reserves. Consequently, most countries in the region have seen stable or falling external debt to foreign reserve ratios (Figure 29). Although the ratio of short-term external debt to foreign reserves increased slightly in,, and in the first quarter of, it is still very much within prudent levels (Figure 3). Third, the debt service ratio has continued to fall in in,,, and (Figure 3). In, total debt service as a percentage of exports of goods, services, and income increased in the first two months of, but only marginally. Strong external payment positions, improved macroeconomic fundamentals, and healthier banking sectors have led to improved perception of credit risk in most countries in the region. Rating outlooks were revised upward for,, and last year and for early this year by at least one of the three major global ratings agencies Moody s, Standard & Poor s (S&P), and Fitch IBCA. More recently, S&P upgraded the sovereign credit rating for the and. The exception is the, where the sovereign rating was downgraded by S&P and Moody s earlier this year, due mainly to concerns over fiscal conditions, and its outlook revised downward more recently, due to political uncertainties. 8