Introduction

South Asia's output grew by over 6 percent in 1996, with GDP growth expected to reach 6.8 percent in India, 6 percent in Nepal, and 5.5 percent in Bangladesh. In Pakistan, poor agricultural performance contributed to lowering growth to 3.1 percent, while in Sri Lanka, civil strife and poor weather conditions lowered growth to 3.7 percent. Progress on the fiscal front was mixed; India, for example, reduced its central government fiscal deficit from 5.5 to 5 percent of GDP, and its 1997 budget continues to build on earlier reforms. In Pakistan, however, the inability to cut the fiscal deficit substantially--and its resulting double-digit inflation--and the widening current account deficit impeded growth and poverty reduction.

Despite faltering performance in Nepal and Pakistan, the region's exports grew in 1996 by 7.5 percent. Yet even after rapid growth throughout the 1990s, South Asia generates only 1 percent of world trade, and its exports per capita are six times lower than the average for developing countries. The region's creditworthiness indicators continued to improve, and the region maintains its impressive record of debt servicing, having kept arrears low and avoiding debt restructuring over the past decade.

Newly liberalized investment regimes continued to attract foreign investors to the region, particularly India. In 1996, net capital flows to South Asia reached $17 billion ($11 billion from private sources), up from $9 billion the previous year, as equity flows rebounded from the effects of the 1994-95 Mexican crisis. The region attracted 6 percent of the total flows to developing countries in 1996, up from 4 percent in 1995. Foreign direct investment to South Asian countries rose, too, growing from $0.5 billion per year during 1990-92 to $2.6 billion in 1996. But at 0.5 percent of the region's GDP, far lower than other regions, this underscores sizable unexploited opportunities on the part of investors.

Reforms initiated in the 1990s enjoy broad political support, and the resulting rapid growth of manufactured exports and increased foreign investment flows are good news for South Asia, as is evidence of cooperation among countries in the region. India and Nepal, for example, recently signed a treaty to integrate their development plans for the Mahakali River, and India and Bangladesh have agreed on arrangements to share the water from the Ganges River and to restore rail links that have been severed since 1965. Under the auspices of the South Asian Association for Regional Cooperation (SAARC), countries took steps to liberalize intraregional trade and held discussions to facilitate further cooperation on trade, infrastructure, communications, and the use of natural resources, especially water, as a means to accelerate poverty reduction.

However, several factors constrained the region's performance. Some, such as the ongoing conflict in Afghanistan and the civil strife in Sri Lanka, are political in nature, but in many cases the incomplete reform agenda has hampered growth, development, and poverty reduction.