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IMFSurvey Magazine: Countries & Regions

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Inflation, Capital Inflows: Asia and the Challenges of Success in 2011

Chinese dragon dance to celebrate the lunar new year. China and India are leading Asia’s dynamic growth, but risks remain (John Heaton/Corbis)

ASIA IN 2011

Inflation, Capital Inflows: Asia and the Challenges of Success in 2011

IMF Survey online

January 4, 2011

  • Asian growth expected to slow to more sustainable levels
  • Future risks posed by financial spillovers and possible slowing of global economy
  • Exchange rate flexibility, macroprudential policies needed to manage capital inflows

Asia—including the Association of Southeast Asian Nations, industrial and Emerging Asia—is expected to post an average of 7 percent growth in 2011, one percentage point slower than last year, but the region will still need to continue managing its exit from stimulus programs and the large capital inflows pouring into the region, says one of the IMF’s leading economists.

In a wide-ranging interview with IMF Survey online looking at the prospects for the world’s fastest growing region, the head of the IMF’s Asia and Pacific Department, Anoop Singh, warned that the strength of Asia’s growth could lead to the threat of inflation.

Asia also had to contend with the risks posed by possibly weaker global economic growth and financial spillovers from advanced economies, suggested Singh, but he predicted that the region’s economic importance would continue to increase. Following is the text of the interview:

IMF Survey online: Let’s begin by looking back at 2010. It was a pretty good year for Asia. The region led the recovery from the global downturn. What was behind this strong performance in Asia?

Singh: As you said, Asia performed remarkably well the last year. It led the global recovery. Policymakers have managed effectively their response to the global crisis.

Regional economies grew well above trend in the first half of 2010, supported by both domestic and external factors. We saw that appropriate policy stimulus in Asia played an important role. But also, Asia benefited from the rebound in global manufacturing, which boosted Asian exports. Beyond these two issues, I will say that domestic demand also played an increasing role in contributing to Asia’s momentum last year.

IMF Survey online: Was this strong performance apparent throughout the whole region or were there regional variations?

Singh: The big recovery was in the first half of the year. The second half of the year did see some moderation, but this means it was moderating to a more sustainable base. Also, throughout the year we saw that China and India were leading Asia’s growth, but we also saw in the Association of Southeast Asian Nations (ASEAN) region and in the export-dependent parts of Asia, there was a strong recovery which was linked to the rebound that we saw in global manufacturing, which boosted the exports from these countries.

IMF Survey online: That is the very positive picture from last year. Let’s look ahead to 2011. What are your expectations for the region in the coming year?

Singh: Well, we expect growth to remain strong. We expect it to settle at a more sustainable rate of about 7 percent for Asia as a whole, slightly down from 8 percent in 2010. We see China and India continuing to lead Asia’s growth.

Despite this positive outlook, there are still downside risks, but these mainly come from the external environment: the risk that global growth could be weaker than we anticipate. Also financial spillovers from advanced countries, especially in Europe, could be another source of concern, and constitute another downside risk.

IMF Survey online: Seven percent is still a very high rate of growth. There must be worries about overheating and also I’m particularly thinking about capital inflows. There’s been a lot of talk about the dangers of the destabilizing effects of capital flows. What’s the thinking there?

Singh: Yes, these are two challenges coming from the strong growth which we expect to continue in 2011.

The first will involve managing the timing and exit from policy stimulus that many countries in Asia have used. And this is because output is growing above potential in most economies. In fact, output gaps are closing and inflation pressures are emerging. So our view is that although many countries have taken steps to remove monetary stimulus, there still is further room to remove policy stimulus.

So I think the withdrawal of monetary and fiscal stimulus needs to be accelerated and this needs to be managed in conjunction with stronger currencies. [We need] greater upward flexibility in the currencies of many countries in Asia.

The second point is how to manage capital inflows that have clearly flooded many parts of Asia. Partly this is due to the growth divergence. We see higher growth in Asia compared to advanced economies.

On the one hand, these inflows certainly present many opportunities, but we need to build the economic framework to ensure these capital inflows can create momentum for investment and broader coordination over the medium term.

However, in the near term, they create challenges for financial stability. And, therefore, countries are taking measures—including macroprudential measures—to try to deal with them. I do believe that there is more room to take macroeconomic measures and also I will say that greater exchange rate flexibility offers an important buffer against the risks we see posed by the large capital inflows.

We are in close collaboration and contact with the authorities about capital inflows. We’ve recently done a major report on capital inflows into Asia and what to do with them, and it has been an important topic in our discussions not only in our bilateral consultations, but also with our advisory group.

IMF Survey online: Let’s look at the wider picture. I remember in the 1980s and the early 1990s when people were writing extensively about Japan and talking about rising Japan. Are we seeing the same thing, but rising Asia this time?

Singh: I think what you’re been seeing in the last decade has been the further rise of Asia, and this time I will say it is a large part due to the rapid growth in China and India and this is expected to continue over the medium and the long term.

Certainly the region has a certain dependence that needs to be rebalanced so that the momentum comes from a broader set of policies. It is true that across Asia the region has been more dependent on exports than other emerging markets in the world. And, therefore, in order to maintain these high growth rates we do believe the region should reduce its reliance on export growth and we have emphasized the importance of rebalancing. That is, to raise domestic demand in Asia. This is also a major topic in our discussions with countries in Asia.