IMF Regional Outlook Report Cites Asia's Continued Robust Growth, but Highlights Risks and the Need to Strengthen Domestic DemandPress Release No. 06/86
May 1, 2006
The International Monetary Fund (IMF) today released the May 2006 Asia-Pacific Regional Economic Outlook (REO). Ms. Wanda Tseng, Deputy Director of the IMF's Asia and Pacific Department, highlighted the report's main findings:
"This year should be another good one for Asia. Growth for the region is forecast at 7 percent, the same as in 2005. This favorable outlook derives mainly from the momentum that Asia has gathered in recent quarters. In Japan, domestic demand is strengthening on the back of robust corporate investment and a firming labor market, which in turn is stimulating household incomes and consumption. Meanwhile, economies in emerging Asia are benefiting from a surge in external demand for the region's products, particularly electronics. And while domestic demand had long been tepid—China and India excepted—it has been gaining traction since early 2005.
"At the same time, inflation remains subdued, projected to average around 3 percent in 2006. However, the situation varies across the region, with price pressures being stronger in the ASEAN-4 countries (Indonesia, Malaysia, the Philippines, and Thailand). Even there, inflation should slow over the course of the year, as the influence of domestic oil price adjustments wanes and recent monetary tightening takes hold.
"Despite this generally favorable outlook, the REO stresses that significant risks remain. Prime among these is the risk of higher oil prices. Rising oil bills have so far had only a moderate impact on Asia's growth, but this may change going forward, especially as concerns about future supply—rather than unexpected increases in demand—have become the prime mover of prices. Higher oil prices could also intensify inflationary pressures, particularly in countries where domestic prices remain below world levels, necessitating further large administered price adjustments.
"A second risk comes from the tightening of global financial conditions. So far, the region has benefited from a benign environment of low long-term interest rates in the U.S. and low risk aversion, which has fueled declines in Asia's bond spreads and increases in its equity prices. As the global environment changes, however, Asia's financial markets will be tested. The region should be able to weather such disturbances, since in sharp contrast to the mid-1990s, asset prices are not significantly overvalued and external vulnerabilities are relatively low. Still, there are some grounds for caution, especially because household borrowing has expanded rapidly, and consumers could come under strain as credit tightens and interest rates rise.
"The global current account imbalances are another risk, since a disorderly unwinding of these imbalances that causes a sharp slowdown in U.S. demand would have significant consequences for the region's exports. Also, the risk of an avian flu pandemic is worth noting, because a pandemic would have potentially devastating consequences if it did occur.
"In this environment, there are three key issues for macroeconomic policy makers. First, central banks will need to engage in a delicate balancing act, maintaining a monetary stance firm enough to deal with the inflationary pressures arising from high oil prices, without endangering the recent improvements in domestic demand. Second, some governments need to strengthen their fiscal positions, reducing their debts, while creating the fiscal space needed to meet the costs of population aging and upgrading public infrastructure. Third, governments will need to invigorate domestic demand, to support growth while reducing external imbalances.
"In emerging Asia (excluding China), invigorating demand requires reviving investment. Investment fell by nearly 10 percent of GDP in the aftermath of the 1997 financial crisis, and it has not recovered since. In part, the fall was a reaction to the unsustainable boom prior to 1997. So a return of investment to pre-crisis level is not likely to be desirable. Nevertheless the question remains as to how to facilitate a recovery in investment. With progress in banking and financial sector restructuring during recent years, weakness in these sectors no longer seem to be a constraint on investment.
"Rather, there is some evidence, set out in a chapter on "Asia's Investment Decline", that corporations are responding to an increase in risk, as export and output volatility have increased with the region's shift in production toward advanced industries such as electronics. This evidence suggests that boosting investment would require reforms on two fronts. The financial sector needs to be developed further, to promote its ability to transfer risk from the corporate sector to the wider investing public. Also, the investment climate needs to be improved, to reduce uncertainty and increase the rate of return on investment.
"In China, by contrast, investment has grown as a share of GDP while consumption's share has fallen by more than 10 percentage points since 1980 to around 40 percent of GDP—much lower than in other countries. These developments are explored in a chapter on "Rebalancing Growth in China". It turns out that consumption growth has been relatively strong, but GDP growth has been even stronger, and much of the fall in the consumption-to-GDP ratio coincides with a fall in the share of disposable income to GDP. Households in China also tend to save a large portion of their disposable income (roughly 30 percent in recent years), primarily for precautionary reasons, as they face growing uncertainties about the provision of pensions, health care, and schooling.
"To rebalance growth in China toward greater reliance on consumption will require a combination of macroeconomic policy changes and structural reforms. In particular, the government has a major role to play in reducing uncertainties in the provision of education, health care, and pensions, thereby reducing the need for precautionary saving. In addition, reforms of the banking sector will improve household access to credit, allowing them to reduce their saving to finance major purchases and small businesses that they own. Finally, greater exchange rate flexibility, which would likely lead to an appreciation in the near term, could raise consumption by boosting households' purchasing power."
The full text of the May 2006 Asia-Pacific Regional Economic Outlook can be found on the IMF's website, www.imf.org.