Presentation by IMF's Deputy Managing Director Shinohara for the ASEAN Central Bank Governors’ Meeting

April 7, 2010
Nha Trang, Vietnam

1. Good morning. It is a great honor and a real pleasure for me to address this group.

2. In my presentation, I will cover four broad points. I will start with the global outlook, then consider the outlook for the Association of Southeast Asian Nations (ASEAN) and the policy challenges that this will pose. Finally, l will turn to the ways in which the IMF could help address these challenges. In brief, I will argue that the global economy may be evolving in ways we have not seen before. So, the policy challenges may be different from those we have seen in the past.

Global outlook ( a multi-speed recovery)

3. This recovery is not following the usual script. In most previous global cycles, advanced countries took the lead and emerging markets followed, with countries recovering at more or less the same pace. This time, we are experiencing something different. We are seeing a multispeed recovery, with emerging markets—especially Asian emerging markets— in the lead. And we expect this divergence to continue for the time being.

4. The global recovery has evolved better than expected. The IMF expects aggregate world output to expand by 4 percent in 2010 which is 1 percent higher than we predicted last October and similar to the January World Economic Outlook (WEO) updates and will continue to expand by a similar pace in 2011. This is actually quite a healthy rate, similar to the trend we saw in the 1990s. But the overall rate masks a highly uneven distribution of growth. Advanced economies are expected to expand by only 2¼ percent this year, not even enough to recoup the 3 percent decline in output experienced in 2009. In fact, they will not return to the pre-crisis level of GDP until 2011. In contrast, emerging and developing economies are forecast to grow by 6 percent, with emerging Asia growing by 8½ percent. This divergence in growth rates will create new policy challenges, including the need to carefully calibrate exits from policy support, manage capital inflows, and rebalance economies toward domestic demand.

5. Although a variety of risks to the global outlook have receded, downside risks related to the growth of public debt in advanced economies have arisen. In the near term, market concerns have focused on sovereign liquidity and solvency in the Euro zone periphery and the possibility that these turn into a contagious sovereign debt crisis.

6. Before exploring the policy challenges, I should address the underlying problem. Why are advanced economies expected to rebound so slowly? Essentially, because they are weighed down by the legacy of the financial crisis which will require a protracted period of deleveraging in both the private and public sector. Let me elaborate.

7. For advanced economies to recover strongly, private spending will need to accelerate sharply. But there is little prospect of this happening in the US or Europe, as credit remains difficult to obtain, high unemployment will constrain consumption, and investment will be held back by low capacity utilization. Private demand also remains weak in Japan, although for different underlying reasons. While the crisis left Japan’s financial system largely unscathed, its exports were hit extremely hard and have still not fully recovered, leaving a large amount of unused capacity, which in turn has triggered a slump in investment. Meanwhile, consumption has been held back by the weak labor market and low potential growth. The re-emergence of deflation has only added to the problem, as it has pushed real interest rates up to a 10-year high. So, all across the key advanced countries, private demand remains weak.

8. Meanwhile, the scope for additional policy stimulus is rapidly being exhausted. Interest rates have already been brought down to near zero levels. The weak recovery and well-anchored inflation expectations will likely keep the monetary policy in most advanced countries to stay accommodative, with ample global liquidity over the near term. As far as for the fiscal area, the slump in economic activities and, to a much lesser extent, stimulus measures have pushed the fiscal deficits to about 9 percent of GDP and are likely to take some time to come back down. So by 2014, government debt could average more than 100 percent of GDP, some 35 percentage points higher than before the crisis. Consequently, advanced countries now need to emphasize fiscal consolidation, which will dampen growth over the medium term.

ASEAN outlook and risks

9. If we are so cautious about the outlook for advanced countries, how can we be optimistic about the prospects for emerging economies, especially in export-dependent Asia? Several factors are at work.

10. First, for the moment, emerging Asia is benefitting from the global inventory cycle. During the downturn, emerging Asia’s exports plunged as advanced countries met demand by running down inventories. But now that advanced countries have stabilized, demand is being met from production, allowing Asia’s exports to recover. And since inventories now need to be rebuilt, this will provide a powerful boost to exports for the remainder of 2010.

11. The second factor is China. With a powerful monetary and fiscal stimulus, China has succeeded in restoring rapid growth, which has spilled over into imports, providing a lift to the rest of the region. For this reason, those Asian economies with larger exposure to China’s final demand—particularly commodity and capital goods exporters—have experienced a stronger recovery in GDP growth.

12. The third factor is linked to emerging Asia’s strong fundamentals. First, since the onset of the crisis, decisive policy support has given forward momentum to economic activity: fiscal stimulus has been larger than the G-20 average and monetary easing has been appropriately aggressive and swift. Second, the region’s reform efforts over the past decade have paid handsome dividends during the past two years. A preference for fiscal prudence has kept public debt burdens low and corporates have reduced their own indebtedness to manageable levels. Consequently, while advanced countries will be constrained by the legacy of the crisis, Asia’s balance sheets remain strong, allowing its export recovery to feed through quickly into private demand. Indeed, the resilience of Asia’s private domestic demand is striking compared to the aftermath of past recessions.

13. What do all these imply for the ASEAN outlook? The IMF expects that the ASEAN economies will grow vigorously by nearly 5½ percent on average this year and next. Over the coming year, exports will moderate as the inventory cycle fades, but then private domestic demand should take over as the main driver of growth in the upswing.

14. This is a very positive outlook even in a world where advanced economies remain sluggish. What are the risks that things could go wrong?

15. The main downside risk stems from the combination of weak fiscal positions and fragile domestic demand in advanced countries. Banks in major advance economies still face significant amount of asset write-downs and shortage of capital ahead. IMF estimates that credit growth will return to positive territory only in 2011 in the US and Euro area, but still remain much weaker than before the crisis. With severely limited room for policy to respond, an adverse shock could stall the recovery there with global repercussions. In a more extreme case, emerging Asia could also be affected by renewed market turbulence, if sovereign credit concerns in one country is transmitted back to banking systems or across borders. As you know, net equity flow to emerging markets turned negative late January of this year, when global risk aversion increased following concerns on Greece’s public debt solvency.

16. There are other risks, including a possible slowdown in China or a resurgence of commodity prices. Still, the degree of uncertainty facing ASEAN is clearly much smaller now than it was six months ago. As the global recovery has proceeded, it has become more likely that the inventory cycle will sustain ASEAN’s exports until the recovery in advanced countries becomes entrenched, while domestic demand in the region will continue to expand.

Policy challenges

17. What will be the key policy challenges in this emerging post-crisis world? I would like to highlight three.

18. The main near-term challenge will be to judge the appropriate pace for normalizing macroeconomic policy. With the risk of a “false dawn” for the global recovery receding, cautious policy normalization may need to begin sooner than we had earlier anticipated. Indeed, a few Asian economies have already started to raise policy rates or rein fiscal deficits. But with the recovery in advanced economies remaining sluggish and vulnerable to downside risks (including from a premature withdrawal of policy accommodation), the exit from policy support will need to be gradual.

19. The pace of monetary exit would need to be calibrated to several factors. Countries will need to start sooner and move more quickly where they have a larger distance to cover before policy rates turn “neutral”, where inflationary pressures have emerged, or where output gaps are likely to close within the next year. China, Korea, India, and Indonesia are cases in point—and monetary tightening has already started in some of these countries. However, in economies where private demand remains more tentative, tightening may be premature.

20. Over the medium term, fiscal policy will also need to move to a more neutral stance. ASEAN has benefitted considerably from its long tradition of fiscal prudence, which has given the region ample fiscal space to deal with the problems arising from the global crisis. It would be critically important to restore this space to deal with potential future shocks. Accordingly, some countries, including Malaysia and Vietnam, have already started reining in their deficits. But where private demand remains weak, maintaining fiscal support would be appropriate.

21. The second and related policy challenge stems from the potential for large capital inflows. Here, the multispeed recovery is creating a profound tension. The growth differential is already attracting capital inflows to the region, in marked contrast to previous cycles, when capital had been slow to return to Asia. Moreover, additional capital could flow in as emerging markets begin to tighten monetary policy ahead of advanced countries, reflecting their more advanced cyclical position. The result could be a deluge of inflows that gradually pushes asset prices beyond fundamentals.

22. How can ASEAN policymakers prevent this from happening? The precise strategy would depend on country circumstances. One option is to strengthen prudential frameworks—as some countries, including China, India, Korea, and Singapore, have already begun to do. For example by tightening loan-to-value ratios, limiting short-term borrowing by banks, or even limiting foreign currency loans by banks. In addition, fiscal policy could be tightened or exchange rate flexibility increased, thereby helping ASEAN decouple from advanced country monetary policy. Capital outflows could also be liberalized. As IMF staff has recently clarified, short-term capital controls could also be part of the appropriate response under certain circumstances. For example, if an economy is operating near potential, if the level of reserves is adequate, if the exchange rate is not undervalued, or if the flows are likely to be transitory.

23. The final key challenge for ASEAN policymakers will be to promote domestic demand as a durable “engine of growth”, since it is uncertain that the ongoing cyclical recovery will prove lasting. While ASEAN’s export orientation has proved extremely successful over a long period, in this post-crisis world, this strategy may not pay the same dividends as in the past. Over the medium term, demand from the US in particular is likely to be more subdued, as households scale back their consumption in response to income losses that the IMF projects could reach 15 percent of GDP relative to pre-crisis trends. Furthermore, the savings rate, which has already risen from low pre-crisis levels, is projected to rise further as U.S. households rebuild their balance sheets. Meanwhile, China may provide only a partial offset, given the still small relative size of its import market.

24. Rebalancing would entail different measures in different countries. In many cases, developing the financial sector could help boost investment and consumption, by lowering the cost and improving access to capital. In others, the focus needs to be placed on improving the environment for private investment and raising productivity in the service sector (by strengthening competition, human capital, and innovation). Greater exchange rate flexibility would also help, by raising households’ purchasing power and helping shift productive resources from tradable to nontradable sectors.

25. What about rebalancing in China? Here, our message has been that this requires a range of instruments. For example, a variety of measures could be taken to catalyze consumption further. The tax burden could be shifted from labor to property or estate taxes. The need for precautionary savings could be reduced by further expanding pensions, and developing full coverage for catastrophic health events and government-backed financing of tertiary education. Helpful supply- and demand-side changes could be fostered by realigning a range of relative prices including through increases in the cost of energy, land, water, and capital. Another key measure would be to promote financial sector development, since this is critical for improving the allocation of capital and alleviating the borrowing constraints that have forced corporations and households to sustain high savings. Indeed, one of the reasons why China has asked the IMF to conduct a Financial Sector Assessment Program (FSAP) is precisely to help identify a way forward for the financial system. In other words, while exchange rate adjustment is in the country’s own interest, it is one of the important elements of the solution.

IMF Reforms

26. Finally, I would like to turn to the role of the IMF. Although I have been at the Fund only for a short period, I strongly feel that the IMF is changing, just as the world is changing. We are working hard to make it more flexible and useful to the member countries. Allow me to mention just a few of these changes:

27. We have intensified surveillance of systemic countries. For example, we have been focusing on the problems in advanced countries’ financial systems, highlighting the write-down and recapitalization needs of their banks. We have also been focusing on potential spillovers from systemic countries, developing the Early Warning Exercise to alert countries about potential problems emanating from abroad.

28. Looking forward, a top priority for the IMF is the completion of outstanding governance reforms. The reforms on quota and voice agreed in April 2008 need to be implemented promptly. And we intend to complete the next step of quota reform and improve emerging and developing country representation by January 2011.

29. At the same time, we are reconsidering the IMF’s mandate. We are thinking of ways to strengthen the important part of our toolkit—bilateral surveillance—for example, by producing more thematic reports that would focus on economies facing shared policy concerns such as mineral or oil exporters, aid dependent countries, or countries with large reserve cushions. We are also considering giving more emphasis to multilateral surveillance for systemic countries. One idea is to produce reports assessing their outward spillovers on the rest of the world. Another is to make FSAPs mandatory for systemic countries, or adopt a new Multilateral Decision that elaborates the framework under which the IMF is to promote global economic and financial stability. I’d like to emphasize that these are just some options, some ways of achieving our broader objectives. We want to listen carefully to ASEAN’s ideas and views, so that we can arrive at true consensus on these issues.

30. We are also developing our regional surveillance. A key purpose is to complement our bilateral surveillance and support ASEAN’s regional efforts. For example, the IMF is currently writing a paper on developing financial markets in ASEAN, to support the region’s own initiatives in this area.

31. Another important component of our discussion on the IMF’s mandate is the lending instruments. The IMF has recently overhauled its own lending framework, introducing a flexible credit line (FCL) for strong-performing economies, abolishing “hard” structural conditionality and focusing on objectives rather than specific actions. Now, the IMF is considering ways to make its lending facilities even more flexible and better suited to our members. Next week, the IMF Board will begin initial discussions on various options such as modifications to the FCL’s design, introduction of multi-country swap line, and so on. The main purpose is to examine how we can strengthen the lending facilities for precautionary purposes. So, there may be scope to make IMF lending work more smoothly even with regional mechanisms.

32. In our view, there needs to be three levels of international safety net: national, regional, and global. There is an important role for each of these. We welcome last month’s activation of the CMIM, and we are always ready to collaborate with you in any way that its members wish.

33. Summing up, ASEAN is rebounding rapidly, but advanced economies remain sluggish, with dwindling policy space. This multispeed recovery is likely to bring new policy challenges, including the need to exit gradually to protect against risks, the need to manage capital inflows carefully, and the need to rebalance. The IMF remains firmly committed to the region. And we are listening carefully to the views of our members, as we collectively consider how to overcome the difficulties and navigate the risks that lie ahead.

Thank you.