REGIONAL ECONOMIC OUTLOOK
Asia: Responding to Slower Growth and Tighter Global Liquidity
October 11, 2013
- Region well-placed to handle fallout from potential U.S. Fed tapering
- Potential remains for further capital outflows in coming months
- Emphasis needed on strong macro policies, productivity enhancing structural reform
Asia is likely to remain the world’s economic engine despite the recent soft patch in global growth and increasing volatility in international financial markets, says the International Monetary Fund.
Speaking at a press conference to mark the launch of the IMF’s update to its Regional Economic Outlook, Anoop Singh, the head of the Asia and Pacific Department, said “we are essentially optimistic that despite the more complex global environment, Asia will remain a growth leader with emerging Asia growing above six percent this year and next year.”
Weak growth in the United States and Europe has dampened demand for Asian exports and a slowing China is adding to pressure on manufacturers and commodity producers, particularly in emerging Asia. At the same time, homegrown impediments—such as infrastructure bottlenecks in India or overinvestment in China—have lowered the cruise speed of the region’s growth.
Despite these headwinds, in its semiannual report on the economic health of the region, the IMF’s Asia and Pacific Department says it expects Asia’s economy to grow at 5.3 percent in 2014, up from 5.1 percent in 2013.
Capital outflows as Fed contemplates “tapering”
The region has been hit by growing expectations that the U.S. Federal Reserve may soon “taper” its asset purchase program and there has been a reversal of capital inflows across much of emerging Asia. Stock prices have fallen, currencies have weakened, and borrowing costs for companies and governments have risen.
In most countries, the effects of the turnaround in capital flows have, so far, been “manageable,” says the report. Companies and banks are still healthy and, in some cases, the outflows may be welcome, slowing the run-up in asset prices that has led some investors to worry about potential overheating.
However, India and Indonesia have been harder hit. High inflation and a reliance on foreign borrowing have left both countries exposed to shifts in global liquidity. With investors differentiating between markets more than in the past, these countries have come under more pressure. In both countries, central banks have raised interest rates and further rises will likely be needed in the coming months.
Potential for further volatility
The update to the Regional Economic Outlook cautions that a renewed wave of outflows from stock and bond markets is a risk, and would cause an increase in borrowing costs in many Asian countries.
In such a global context, the report underlines the importance of allowing currencies to adjust to changing international conditions as a means to help cushion the impact of turmoil in global financial markets.
The report also notes that countries that are more dependent on foreign borrowing, and with poorer growth prospects are likely to experience a larger impact from these changes. Other potential risk factors are weak government budgets, insufficient international reserves at central banks, and weak banks and companies.
The events of recent months have shown that a large war chest of international reserves in central banks is not sufficient to ward off the problems associated with global financial turmoil as long as underlying economic indicators are weak.
With Asian economies increasingly interconnected, an unexpected slowdown in one of the larger economies represents another potential risk. This could come from a sharper and more persistent slowdown in India, China, or Japan, where recent policies have started to lift the economy out of deflation but bringing down the government deficit and comprehensive measures to raise growth are essential.
Focus on financial sector risks
The report highlights that in many countries, debts have grown and asset prices have risen over the past few years and this could become more visible as interest rates move up.
As a result, as the tide of global liquidity washes out, vigilance is needed and prudential policies should continue to play a role in safeguarding financial stability, say the IMF economists.
However, introducing controls on capital outflows is likely to be counterproductive in the current context. To mitigate the impact of a potential turnaround in capital flows, consideration should instead be given to rolling back some of the previously-imposed controls on inflows.
The report points out that in general, across the region, bringing down budget deficits will provide breathing room in case governments need to react to potential shocks down the road. This is especially a priority in countries with large deficits, such as India, Japan or Vietnam, where there is currently little room for fiscal stimulus in the event of a negative shock.
However, in countries with particularly large deficits, there is little room for a fiscal response in the event of a negative shock and deficit reduction should remain the priority. In Japan, raising the consumption tax is an important first step in this area. In China, the focus should be on tackling risks of local government debts and quasi-fiscal operations. In emerging, low-income and Pacific island countries, deeper fiscal reforms to make growth more inclusive and sustainable remain crucial.
Structural reforms key to continued growth
The authors underline that the changing global environment with higher global interest rates and a more uncertain outlook have strengthened the need for monetary, fiscal, and financial policies that are credible and well communicated.
Structural reforms to boost productivity and growth remain essential. The agenda differs across countries, but improving competition across the economy, reforming job market protections to encourage more hiring, and building more infrastructure are important in many cases.