Recent developments

GDP growth in the South Asia region registered 8.2 percent in 2007, moderating from a 25-year high of 9 percent in 2006.4
Slackening of growth was evident across all countries of the region, except Afghanistan and Bhutan.

Regional growth reflected continued—albeit softening—strength in domestic activity, dampened by tighter credit conditions.
An easing in demand from key export markets contributed to waning export growth and a widening in the regional current account deficit.

Into the first half of 2008, surging food prices, higher petroleum prices, and an overall deterioration in the external environment linked to the subprime crisis in the United States, are straining regional government coffers and external positions.
Early indicators for 2008 point to a sharper slowdown in growth and a challenging adjustment path ahead, aggravated by widespread subsidies for food and fuels, large investment demands, and rising inflationary pressures.

GDP growth in India eased to a still strong 8.7 percent in 2007, from 9.7 percent in 2006, and is projected to slow further to 7 percent in 2008, as monetary tightening in 2007 led to a softening in domestic demand.
Though slowing, consumption has maintained a strong tone resulting from healthy wage growth and large remittance inflows, with the latter primarily fueled by increased demand for migrant work in the oil-exporting countries of the Middle East.

Buoyant capital inflows, high capacity utilization, and reinvestment of corporate profits served to underpin investment growth in 2007.
The more restrictive monetary policy helped prevent an acceleration in inflation in 2007 but contributed to an appreciation of the rupee (on a trade-weighted basis, and particularly against the dollar), leading to a loss in competitiveness for India’s exporters.

Combined with rising import prices and a largely resilient domestic demand, this led to deterioration in the country’s current account deficit.
Starting in 2008, inflationary pressures began to build.

There are growing signs of a cooling economy, with a deceleration in industrial production to 3 percent in April 2008, year over year (see table below).

In Pakistan, output growth also slowed during 2007, moderating half a percentage point to 6.4 percent.
Heightened political uncertainty in the lead-up to elections in early 2008 undermined overall confidence and led to weaker investment and private consumption outlays.

Output was also disrupted by growing power shortages.
And, in part because of high fuel costs, Pakistan’s current account deficit deteriorated substantially in 2007 and has continued to further deteriorate into 2008.

To cover the widening current account deficit, about $3.4 billion in foreign exchange reserves have been drawn down since July 2007, bringing the merchandise import cover below three months, as of May 2, 2008—an unsustainable trend.
The fiscal deficit has also widened substantially.

This deficit primarily reflects a rise in government borrowing on the domestic market, as foreign lending has largely halted, the privatization program has stalled, and Pakistan’s spreads on international markets have risen.

Surging food and fuel prices are contributing to rising inflationary pressures.
Consumer price inflation was up 17.2 percent year over year in April 2008, from 14.1 percent in March; that is the fastest pace in at least 25 years.

GDP growth in Sri Lanka dropped to 6.8 percent in 2007, from 7.4 percent in 2006.
The deceleration is attributable in large measure to ongoing civil strife, continued inflationary pressures that squeezed household incomes, and a falloff in growth from the sharp recovery posted in the wake of the December 2004 tsunami.

Inflation accelerated sharply since 2006, rising to an average of over 15 percent during 2007, and to nearly 24 percent in March 2008.

Rising food prices in combination with strong credit growth—tied to both large fiscal deficits and negative real interest rates (to aid budget financing)—have fueled inflationary pressures.
However, this macroeconomic stimulus has not yet resulted in a deteriorating current account.

Sri Lanka’s trade deficit narrowed in 2007, given strong export growth and a deceleration in import growth.

In Bangladesh, growth slowed from 6.6 percent in 2006 to 6.4 percent in 2007.
This moderation mainly reflects a falloff in export growth, which was partly offset by a firming in domestic demand, particularly private consumption.

Growth decelerated in the interim, following the losses from two consecutive natural disasters in the second half of the year—severe flooding in July and a devastating cyclone in November—which resulted in the deaths of 4,400 people and displaced an estimated 8.7 million people.

The impact from these disasters will be captured in the 2008 growth figures (fiscal 2007–08).
Damage from the disasters is estimated at $2.7 billion, or the equivalent of about 3.7 percent of GDP.

Despite these sharp negative impacts to growth, domestic demand is being supported by strong, record-high remittance inflows.
Remittance inflows have cushioned the impact of surging import prices but have not prevented a narrowing of the current account surplus and a projected shift to deficit in 2008.

Further, a concerted drive against corruption and tax evasion, combined with a crimping of purchasing power caused by rising inflationary pressures, has dampened economic activity.

In Nepal, GDP growth decelerated to 2.5 percent in 2007, from 2.8 percent in 2006, amid election-related disturbances (including frequent blockades and strikes) that disrupted economic activity, labor unrest, power shortages, and high inflation.
Early indicators are for a firming of growth in 2008 on the strength of the recuperated agricultural sector and high tourism growth, as well as improved confidence following the peaceful April 2008 elections.

The Maldives experienced a slowing of growth to 6.6 percent in 2007, retreating from the double-digit rebound that occurred in 2006 following the tsunami-related disruptions of 2005.
Growth was supported by a revival in tourism but was partly offset by a particularly low fish catch, resulting in a sharp decline for the fisheries industry.

Given that the small island economy is dependent on imports, rising international price pressures were quickly transmitted into higher domestic inflation.

In contrast with developments in the rest of South Asia, growth in Afghanistan and Bhutan accelerated during the year, tied in part to special circumstances.
In Afghanistan, GDP growth increased to an estimated 14 percent, up from 6 percent in 2006, buoyed by recovery in agricultural output following the 2006 drought.

Security, however, continued to deteriorate throughout 2007 and early 2008, with a sharp rise in incidents.
Associated deaths have reached the highest levels since 2001.

The Tala hydroelectric power project in Bhutan, which led to a sharp rise in power exports to India and boosted government revenues, supported a vigorous expansion in GDP to an estimated 17 percent gain in 2007, more than double the 8 percent advance of 2006.

Growth has also been bolstered by vibrant tourism activity, as well as by improved confidence.
Bhutan held its first multiparty election in March 2008, which generated a high turnout and marked the advent of a democratic, constitutional monarchy in the country.

By early 2008 surging food prices had become a serious concern in South Asia, where food insecurity is relatively high and food represents close to 50 percent of total consumption in most countries (see figure on  page 3 of this regional outlook).5
The extreme poor spend even a greater proportion of their budgets on food.

The rapidly rising gap between food prices and wages indicates a sharp reduction in the purchasing power of the poor.

The situation has become increasingly acute across the region—especially in Afghanistan and Bangladesh.
Among other factors, rice producers, such as China, India, and Vietnam have introduced export restrictions to keep stocks for domestic use and to prevent sharp domestic price increases; these policies have contributed to the increase in international grain prices.

Food supply difficulties are prevalent across the region, affecting Afghanistan, where fighting continues; Bangladesh, where the November 2007 cyclone affected an estimated 8.7 million people and reduced the 2007 paddy production; and Nepal, which is experiencing sustained political instability despite the successful postwar elections.
India is self-sufficient, but grain stocks are low and crop production has been in decline.

Bhutan and the Maldives are also vulnerable, as they import over 30 percent of their grains.

In Pakistan, the U.N. World Food Programme estimates that nearly half of the country’s 160 million people are at risk of running short of food due to rising grain prices.
The poverty impact of the surge in food prices could be high and in some areas could wipe out years of gains in poverty reduction.

High international commodity prices, especially oil prices, combined with increasingly sluggish external demand, contributed to deterioration in the region’s current account deficit, despite sustained strong inflows of worker remittances.
The current account deficit of the region widened from $17 billion in 2006 to $27 billion in 2007.

Foreign reserves increased by a record $100 billion in 2007 compared with an increase of $40 billion in 2006; most of the increase resulted from a $96 billion increase in India’s reserves.

⁵ The share of undernourished in the total population of the South Asia region is estimated at close to 22 percent (2001–03), compared with a third of the population in Sub-Saharan Africa, and shares as low as about 6 percent in Europe and Central Asia. Source: United Nations Food and Agriculture Organization.