## 1.  Preparing for Choppy Seas

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### Global Outlook and Risks
- Baseline: faster rebound in activity in advanced economies; marginally weaker growth in emerging market and developing economies.
- Inflation and financial conditions:
  - Headline inflation has increased in advanced economies; core inflation remains subdued and heterogeneous.
  - In emerging market economies, headline inflation revival is nascent; core inflation generally muted and broadly stable.
  - For 2017 and 2018, with the uptick in commodity prices, a broad-based increase in headline inflation rates is projected in advanced, emerging market, and developing economies.
  - Global financial conditions have started to tighten but remain accommodative on balance with favorable market sentiment.
  - Expectations of looser fiscal policy and tighter monetary policy in the United States contributed to a stronger dollar, higher U.S. Treasury interest rates, and higher yields elsewhere.
- Downside risks (policy uncertainty and other shocks):
  - possible sharp increase in risk aversion;
  - wide range of outcomes from U.S. policy actions affecting the United States and the global economy;
  - adverse feedback loops between weak demand and balance sheet problems in parts of Europe;
  - disruption of global trade, capital, and labor flows from inward policy shifts, deterring investment and lowering global growth;
  - tightening economic and financial conditions in emerging market economies, amplified by balance sheet weaknesses in some economies and vulnerabilities in China’s financial system;
  - noneconomic factors such as geopolitical tensions, domestic political discord, and terrorism and security concerns.

### Regional Financial Developments: Resilience amid Volatile Capital Flows
- Capital flows and reserves:
  - Net portfolio inflows to major Asian emerging market economies (excluding China) reached $51 billion in 2016, up from $42 billion in 2015 and below the $72 billion peak prior to the U.S. elections.
  - In China, capital outflows accelerated since September 2016, with total outflows reaching an estimated $320 billion in 2016; pressure subsided to $26 billion during January–February 2017.
  - China’s foreign exchange reserves fell below $3 trillion temporarily in January 2017 for the first time since 2011, with an overall decline of about $1 trillion from their peak of nearly $4 trillion in mid-2014.
- Market and credit conditions:
  - Equity markets across Asia rose significantly in the year prior to mid-March 2017.
  - Sovereign bond yields have increased since mid-2016; rise accelerated after the U.S. elections—India was an exception where yields declined owing to the currency exchange initiative.
  - Sovereign CDS spreads increased in some emerging market economies but are generally below levels on the eve of the “taper tantrum” in May 2013; Australia, Japan, and Korea have CDS spreads at or close to the lowest levels of the past four years.
  - Exchange rate movements:
    - After the U.S. elections, regional exchange rates depreciated on average by 2 percent.
    - The yen depreciated against the dollar by 8 percent.
    - The renminbi weakened somewhat against the U.S. dollar but by less than most emerging market currencies and was broadly stable in effective terms.
  - Domestic financial conditions have begun to tighten in some countries; indices for the largest 14 economies suggest overall conditions have started to tighten across most of the region.
- Credit and debt dynamics:
  - Credit growth (adjusted for inflation) in 2016 remained robust but was well below the previous decade’s average in most economies, except Hong Kong SAR, New Zealand, and the Philippines.
  - In China, credit growth continues at twice the pace of nominal GDP; the stock of total social financing (adjusted for local government bond swaps) grew at 16 percent in 2016.
  - Private sector debt levels remain high across the region; corporate debt rising—particularly in emerging Asia—with leverage accelerating after the global financial crisis; corporate debt levels in Asia are higher than in other regions, notably in China and India.
  - Household-debt-to-GDP increased by more than 20 percentage points between 2007 and 2015 in China, Malaysia, and Thailand; household debt is high in Australia, Korea, and New Zealand.
- Credit gaps and measurement caveat:
  - The credit-to-GDP gap is declining in Hong Kong SAR, Indonesia, Malaysia, Singapore, and Thailand; remains substantial in several economies; still increasing in China.
  - Caveat: credit gaps were computed by the BIS using the one-sided Hodrick-Prescott filter with lambda equal to 400,000; results are sensitive to filter choice and smoothing parameter.
- Financial stability indicators:
  - House prices are above long-term averages in Australia, China, Hong Kong SAR, Malaysia, New Zealand, and Thailand.
  - Benchmark equity indices are above long-term averages in Australia, India, Indonesia, and the Philippines.
  - Tier 1 capital ratios increased in most economies—particularly in Hong Kong SAR, Indonesia, and Thailand—but declined in the Philippines.
  - Bank liquidity (loan-to-deposit ratios) was stable in major economies.
  - Nonperforming loan ratios remain relatively low across most economies but have increased recently in several countries and are relatively high in India.
  - Bank profitability has generally declined.

### Regional Activity: Recovery since mid-2016 with Positive Momentum
- Aggregate and drivers:
  - Asia’s growth declined to 5.3 percent in 2016 from 5.6 percent in 2015.
  - Net exports subtracted 0.1 of a percentage point from regional growth in 2016.
  - Asia’s export growth (in values) recovered in the second half of 2016, particularly to China and Japan; export volumes rose less than nominal values, partly reflecting higher commodity prices.
  - Domestic demand remained strong, supported by robust private consumption and household income growth.
- Country-specific highlights and 2016 outcomes:
  - China: growth 6.7 percent in 2016.
  - Japan: growth 1 percent in 2016.
  - India: growth for FY2016–17 expected to decelerate to 6.8 percent.
  - Korea: growth 2.8 percent in 2016.
  - Hong Kong SAR: growth slowed to 1.9 percent in 2016.
  - Australia: growth 2.5 percent in 2016.
  - New Zealand: growth accelerated to 4 percent in 2016.
  - Selected ASEAN economies:
    - Indonesia: growth accelerated to 5 percent.
    - Malaysia: growth 4.2 percent in 2016.
    - Thailand: growth 3.2 percent.
    - Philippines: growth 6.8 percent.
    - Singapore: growth 2 percent.
    - Vietnam: growth 6.2 percent.
  - Frontier and small states: varied outcomes (examples: Lao P.D.R. growth 6.9 percent; Nepal growth 0.6 percent; Bangladesh growth 6.9 percent; Cambodia growth 7 percent).
- Near-term aggregated projections:
  - Aggregate Asia: GDP growth forecast to reach 5.5 percent in 2017 and 5.4 percent in 2018.
  - Growth in 2017 revised up by 0.1 of a percentage point versus October 2016 WEO.
  - Asia’s projected growth, excluding India and Korea, revised upward in 2017 by 0.3 of a percentage point versus October 2016 WEO.
  - Credit gaps have started to decline in several major economies; credit growth expected to remain mildly supportive of domestic demand near term.

### Inflation and Commodity Prices
- Commodity-driven inflation:
  - Recovery in commodity prices has modestly pushed up headline inflation in many Asian economies; core inflation generally stable at low levels.
  - Commodity price levels remain comparatively low—barely reaching their mid-2015 levels.
  - In China, producer price inflation turned significantly positive and consumer price inflation picked up.
  - Headline inflation in Japan fell during most of 2016; core inflation remained negative but edged up closer to zero.
  - Among the largest economies, headline inflation exceeded 3 percent in 2016 only in a few economies.
  - Inflation expectations (Consensus Forecasts) remain weak in most economies, with slight upticks in a few (China and the Philippines).
  - Core inflation increased in several countries, including China, the Philippines, New Zealand, Singapore, and Vietnam.
- Regional projections:
  - Headline inflation projected to rise to 2.9 percent in 2017 and 2018.
  - Consumer price inflation expected to remain low across most of the region due to well-anchored inflation expectations and relatively low pass-through.
  - In frontier economies with highest inflation (Myanmar and Nepal), inflation expected to remain within single digits.

### Current Account Balances and External Balances
- Regional aggregates and country movements:
  - Asia’s current account surplus declined to an estimated 2.5 percent of GDP for 2016, down from 2.7 percent in 2015.
  - Industrial Asia: current account balances increased by 1.2 percentage points in 2016 to 2.4 percent of GDP.
    - Japan: current account rose to 3.9 percent of GDP.
    - Australia and New Zealand: current account deficits narrowed.
  - East Asia and ASEAN: reduced current account surpluses in aggregate in 2016.
    - China: current account surplus narrowed to 1.8 percent of GDP from 2.7 percent in 2015.
    - Korea: current account surplus narrowed to 7 percent.
    - Malaysia: current account balance declined to 2 percent of GDP.
    - Philippines: current account surplus fell to 0.2 percent of GDP.
    - Thailand: current account surplus increased to 11.4 percent of GDP.
- Outlook:
  - Current account for the region as a whole expected to decline to 2.1 percent of GDP in 2017 and to 2 percent of GDP in 2018.
  - China’s current account surplus expected to decline further; India’s current account deficit expected to widen as domestic demand strengthens; Japan’s current account projected to rise.

### Monetary and Fiscal Stance
- Policy rates and real rates:
  - Policy interest rates generally low in nominal and real terms across most of the region.
  - Except for India, real rates are below 1 percent in all major regional economies and are negative in a number of them.
  - In several economies, nominal policy rates broadly in line with or slightly below levels implied by augmented Taylor rules.
- Fiscal posture:
  - Fiscal stimulus (changes in cyclically adjusted fiscal balances) expected to increase in 2017 in several economies including China, the Philippines, Singapore, and Thailand.
  - Fiscal stance in 2017 slightly less supportive in India and Vietnam.
  - In 2018, fiscal stimulus projected to increase in Indonesia, the Philippines, and Thailand; fiscal policy projected to be less supportive in Japan and China as stimulus effects fade.
  - Delivering on medium-term fiscal consolidation remains critical where debt levels are high and/or fiscal credibility needs enhancement.

### Risks to the Outlook and Scenarios
- Key downside risks:
  - Shift toward protectionism in major trading partners.
  - Continued tightening in global financial conditions triggering capital flow volatility.
  - Bumpier-than-expected transition in China; geopolitical tensions; idiosyncratic political problems.
  - Medium-term secular headwinds: population aging and limited productivity convergence.
- Upside risks:
  - Stronger global activity from larger-than-expected policy stimulus, especially in the United States.
  - Supply-friendly structural reforms that entrench momentum.
- Tighter global financial conditions — channels and vulnerabilities:
  - Expansionary U.S. fiscal policy could raise U.S. inflationary pressures, leading to a steeper federal funds rate path and decompression of the term premium.
  - Substantial tightening (stronger U.S. dollar and higher interest rates) could have large negative spillovers for Asia, especially for economies with high dollar-denominated corporate and sovereign debt.
  - Capital outflows, higher financing costs, and fiscal sustainability concerns could force an unwarranted tight policy mix and amplify macroeconomic and financial stability risks.
- Relative resilience and heterogeneity:
  - On average, Asian emerging market economies appear relatively better positioned versus other regions due to stronger external buffers (IMF’s Assessment of Reserve Adequacy metric), lower external financing needs, and lower foreign-currency-denominated debt shares for nonfinancial corporations and governments.
  - Large intra-region heterogeneity: examples include relatively high external financing requirement in Malaysia and relatively high foreign share of nonfinancial corporate debt in Indonesia.
- Risk of deglobalization:
  - Disruption of global trade, capital, and labor flows would deter investment, reduce productivity, and lower global growth.
  - Asian economies are particularly vulnerable given high trade openness and participation in global value chains.
  - Remittances: remittances from the Gulf Cooperation Council, the euro area, the United Kingdom, and the United States collectively accounted for about three-quarters of total remittance inflows to Asian emerging markets in 2015.
  - Remittances as share of GDP: Nepal (almost 25 percent of GDP); Philippines, Sri Lanka, Bangladesh, and Vietnam (4.5 to 7 percent of GDP).

### China’s Rebalancing and Spillovers
- China’s transition:
  - China’s growth is slowing as it transitions to a more consumption-based economy but continues to drive global growth, accounting for about one-third of it.
  - Import intensities: investment import intensity about 25 percent; consumption import intensity 15 percent.
  - Commodity exposure: China accounts for about 40 percent of global demand for metals and about 10 percent for crude oil demand.
  - IMF analysis suggests China’s rebalancing accounted for between one-fifth and one-half of the declines in broad commodity price indices between mid-2011 and mid-2015.
  - Financial spillovers from China have increased significantly since the global financial crisis, particularly in equity and foreign exchange markets.

### Remittance Inflows (Selected Figures)
- Remittance inflows to emerging Asia (listed values as presented): 23.7%, 3.2%, 5.6%, 10.2%, 28.5%, 28.8%, 34%
- Migrant stock to selected destinations (percent of total migrant stocks): 21%, 3%, 6%, 9%, 27%
- Note: Recipient and source Asian countries include China, India, Indonesia, Malaysia, the Philippines, Sri Lanka, Thailand, and Vietnam; Gulf Cooperation Council countries listed include Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, United Arab Emirates.

### Policy Recommendations: Broad Priorities
- Maintain policy flexibility focused on:
  - Addressing vulnerabilities and rebuilding buffers where needed.
  - Reducing domestic and external imbalances while safeguarding against external shocks.
  - Preserving gains from trade integration through balanced growth, trade initiatives, and inclusive policies.
- Structural reforms to sustain long-term growth, address demographic transition, and boost productivity.

### Reinforcing Growth Momentum: Demand Support and Structural Reforms
- Monetary policy guidance:
  - Monetary policy should generally remain accommodative given below-target inflation and slack.
  - Some central banks could lower interest rates if growth slides further (example: Malaysia and Thailand), provided external stability not compromised.
  - Central banks should be ready to raise policy rates if inflationary pressures gather (examples: India, Indonesia, and Vietnam).
  - Consider risks to inflation, asset prices, and domestic financial conditions; enhance macroprudential settings (example: China).
  - Large capital outflows and rapid exchange rate depreciations may warrant policy tightening.
- Fiscal policy guidance:
  - Fiscal support should be considered to support and complement structural reform efforts.
  - Fiscal action should weigh fiscal space and the need to support demand and external rebalancing (examples: Korea and Thailand).
  - Deliver medium-term fiscal consolidation where debt levels are high or fiscal credibility needs enhancing (examples: Mongolia, Sri Lanka).
  - Adjust composition of spending to allow for infrastructure and social spending; in China emphasize reducing public investment in favor of consumption.

### Preserving Financial Stability: Vulnerabilities and External Volatility
- Exchange rate regime guidance:
  - Exchange rates should generally remain the first line of defense against sudden tightening in global financial conditions or protectionism.
  - Judicious foreign exchange intervention can be deployed to prevent or mitigate disorderly market conditions if sufficient reserve buffers exist.
  - Intervention should not resist currency movements reflecting changing fundamentals or substitute for macroeconomic policy adjustments.
  - Effective communication of policy goals can bolster confidence and lower volatility.
- Macroprudential and capital flow measures:
  - Continue reliance on macroprudential policies to mitigate systemic risks from high corporate and household leverage.
  - Step up efforts to identify pockets of leverage and fragility.
  - Capital flow management measures could be considered if flow volatility increases systemic risk; they should not substitute for necessary macroeconomic adjustments.

### Demographic Transition and Productivity
- Challenges and priorities:
  - Rapid aging at relatively low per capita income levels requires urgent policies to protect vulnerable elderly and prolong growth.
  - Structural reforms in labor markets, pension and retirement systems; ensure debt sustainability; productivity-enhancing reforms; strengthen regional trade integration.
  - Advanced economies: strengthen R&D effectiveness and productivity in services.
  - Emerging and developing economies: increase absorptive capacity and domestic investment, maintain FDI inflows, and increase education and human capital.

### Selected Boxes — Key Facts and Findings
- Box 1.1 India’s Currency Withdrawal:
  - Action: On November 8, 2016, withdrawal of legal tender status of existing 500 and 1,000 rupee banknotes; affected notes with total value about 15 trillion rupees, about 86 percent of all cash in circulation; new 500 and 2,000 rupee notes introduced.
  - Operational issues: supply of new banknotes insufficient; cash exchange suspended and caps on withdrawals imposed; several temporary exemptions granted.
  - Structural context: currency in circulation at end-2015 about 12 percent of GDP; cash accounted for about three-quarters of narrow money base.
  - Short-term impacts:
    - India’s PMI for services collapsed from 55 in October 2016 to 43 in November, 2016.
    - Growth of credit to the nonfood private sector decelerated from 9 percent at end-October 2016 to 4 percent by end-December, 2016.
    - Consumer goods IIP component declined about 7 percent in December 2016; consumer durables fell by 10 percent.
    - Domestic motor vehicle sales declined 20 percent in December 2016 compared to December 2015.
    - Overall industrial production fell by less than ½ of 1 percent year-over-year.
    - Number of new investment projects announced in October–December 2016 was lowest in over a decade; combined value about one-half of the average in previous two years.
  - Remonetization: about 75 percent of the predemonetization level of currency in circulation was restored by late March.
  - IMF staff estimates: cash shortages likely to slow FY2016/17 growth by about 4/5 of 1 percentage point and FY2017/18 growth by about ½ of 1 percentage point (relative to October 2016 IMF WEO forecasts).
  - Potential medium-term gains: broaden tax base, possible one-off revenue from unreturned cash, increased banking system liquidity, weighted average lending rate on new loans declined by 56 basis points during November 2016 to January 2017; risks include potential further buildup of nonperforming loans.
  - Financial inclusion: 250 million previously unbanked Indians provided bank accounts recently; about 350 million Indians do not yet have cell phones; 250 million own smartphones.
- Box 1.2 ASEAN-5 financial spillovers:
  - Two transmission channels: global risk aversion (portfolio flows and asset prices) and U.S. interest rates (bond yields and credit conditions).
  - Capital outflows and weaker asset prices historically largest exogenous drivers of ASEAN-5 business cycle fluctuations.
  - Exchange rate depreciation can cushion tightening conditions; rising domestic bond yields can lower property prices, dampen construction, and weigh on domestic demand.
- Box 1.3 Rising Household Debt in Asia:
  - Household debt ranged from 10 percent of GDP in India to 124 percent of GDP in Australia in 2015.
  - Between 2007 and 2015 household-debt-to-GDP ratio increased by more than 20 percentage points in Thailand, Malaysia, and China; more than 15 percentage points in Australia, Korea, and Hong Kong SAR.
  - Total household debt above 60 percent of GDP in most Asian economies, except China, India, and Indonesia.
  - Empirical findings (fixed-effects estimations): dependent variable, t-1: 0.565*** (0.0435); Δ short-Term Interest Rate, t-1: 20.118** (0.0584); Per Capita GDP, t-1: 0.0383** (0.0158); Per Capita GDP Growth, t-1: 0.257*** (0.0522); Δ Top 1% Income share, t-2: 0.421*** (0.131).
  - Policy implications: tackle income inequality; strengthen resilience via buffers and prudential macro policies.
- Box 1.4 Potential U.S. Policy Changes:
  - WEO assumption: shift toward more expansionary U.S. fiscal policy and tighter U.S. monetary stance relative to October 2016 WEO.
  - Corporate tax reforms and DBCFT could lead to U.S. dollar appreciation; potential effects on Asian inflation, external debt burdens, reserves, trade balances, and FDI.
  - U.S. trade policy shifts toward protectionism or bilateralism could negatively affect Asia’s exports and technology transfers.
- Box 1.5 Myanmar financial reforms (model experiments):
  - Financial liberalization, inclusion, and infrastructure-targeted scenarios analyzed via a DSGE model.
  - Financial liberalization would increase savings, private credit, and growth; may raise some measures of intra-rural and intra-urban inequality.
  - Complementary fiscal and targeted policies needed to avoid worsening income distribution while boosting growth and reducing poverty.

*International Monetary Fund | April 2017 — areo0517c1*

### 1.  Preparing for Choppy Seas

### 1.  Preparing for Choppy Seas

### Global Outlook and Risks
- The global baseline envisages a faster rebound in activity in advanced economies and marginally weaker growth in emerging market and developing economies.
- Headline inflation has increased in advanced economies; core inflation remains subdued and heterogeneous.
- In emerging market economies, the revival in headline inflation is more nascent; core inflation is generally muted and broadly stable in most emerging market economies.
- For 2017 and 2018, with the uptick in commodity prices, a broad-based increase in headline inflation rates is projected in advanced, emerging market, and developing economies.
- Global financial conditions have started to tighten but remain accommodative on balance with favorable market sentiment.
- Expectations of looser fiscal policy and tighter monetary policy in the United States contributed to:
  - a stronger dollar and higher U.S. Treasury interest rates,
  - higher yields elsewhere.
- Market sentiment has been strong, with notable equity gains in advanced and emerging market economies, higher risk appetite, and relatively low financial market volatility.
- Risks are slanted to the downside given policy uncertainty; notable risks include:
  - a possible sharp increase in risk aversion;
  - wide range of upside and downside outcomes from U.S. policy actions affecting the United States and the global economy;
  - adverse feedback loops between weak demand and balance sheet problems in parts of Europe;
  - disruption of global trade, capital, and labor flows from inward policy shifts that would disrupt global value chains, deter investment, reduce productivity, and lower global growth;
  - tightening economic and financial conditions in emerging market economies, amplified by balance sheet weaknesses in some economies and vulnerabilities in China’s financial system;
  - noneconomic factors such as geopolitical tensions, domestic political discord, and terrorism and security concerns.

### Regional Financial Developments: Resilience amid Volatile Capital Flows
- Net portfolio inflows to major Asian emerging market economies (excluding China) reached $51 billion in 2016, up from $42 billion in 2015 but below the peak of $72 billion prior to the U.S. elections.
- In China, capital outflows accelerated since September 2016, with total outflows reaching an estimated $320 billion in 2016, driven by residents’ asset purchases abroad.
  - Pressure subsided in early 2017, amounting to $26 billion during January–February 2017, with tighter capital controls and resumed portfolio inflows.
- Portfolio inflows to Asia returned, reflecting strong fundamentals and favorable growth differentials.
- Equity markets across Asia rose significantly in the year prior to mid-March 2017.
- Sovereign bond yields have increased since mid-2016 following increases in advanced economies; the rise accelerated after the U.S. elections—India was an exception where yields declined owing to the currency exchange initiative.
- Sovereign CDS spreads increased in some emerging market economies but are generally below levels on the eve of the “taper tantrum” in May 2013.
  - In economies such as Australia, Japan, and Korea, CDS spreads are at or close to the lowest levels of the past four years.
- Exchange rate movements:
  - Exchange rates generally depreciated over the past year and a half, reflecting a stronger U.S. dollar.
  - After the U.S. elections, exchange rates depreciated across most of the region by an average of 2 percent.
  - The yen depreciated against the dollar by 8 percent.
  - The renminbi weakened somewhat against the U.S. dollar but by less than most emerging market currencies and was broadly stable in effective terms.
- Foreign exchange reserves:
  - Broadly stable for most countries; China’s foreign exchange reserve losses picked up.
  - China’s reserves fell below $3 trillion temporarily in January 2017 for the first time since 2011, with an overall decline of about $1 trillion from their peak of nearly $4 trillion in mid-2014.
- Domestic financial conditions have begun to tighten in some countries; indices for the largest 14 economies suggest overall conditions have started to tighten across most of the region.
- Credit and debt dynamics:
  - Credit growth (adjusted for inflation) in 2016 remained robust but was well below the previous decade’s average in most economies, except Hong Kong SAR, New Zealand, and the Philippines.
  - In China, credit growth continues at twice the pace of nominal GDP; the stock of total social financing (adjusted for local government bond swaps) grew at 16 percent in 2016.
  - Foreign bank lending to Asia has risen; corporate debt issuance (including syndicated loans) is generally lower.
  - Private sector debt levels remain high across the region, with corporate debt rising—particularly in emerging Asia—and leverage accelerating after the global financial crisis; corporate debt levels in Asia are higher than in other regions, notably in China and India.
  - Household-debt-to-GDP increased by more than 20 percentage points between 2007 and 2015 in China, Malaysia, and Thailand; household debt is high in Australia, Korea, and New Zealand.
- Credit gaps:
  - The credit-to-GDP gap is declining in Hong Kong SAR, Indonesia, Malaysia, Singapore, and Thailand, remains substantial in several economies, and is still increasing in China.
  - Caveat: credit gaps were computed by the BIS using the one-sided Hodrick-Prescott filter with lambda equal to 400,000; results are sensitive to the filter choice and smoothing parameter.
- Financial stability heat map highlights risks from house prices and equity market overvaluation:
  - House prices are above long-term averages in Australia, China, Hong Kong SAR, Malaysia, New Zealand, and Thailand.
  - Benchmark equity indices are above long-term averages in Australia, India, Indonesia, and the Philippines.
- Banking sector indicators:
  - Tier 1 capital ratios increased in most economies—particularly in Hong Kong SAR, Indonesia, and Thailand—but declined in the Philippines.
  - Bank liquidity (loan-to-deposit ratios) was stable in major economies.
  - Nonperforming loan ratios remain relatively low across most economies but have increased recently in several countries and are relatively high in India.
  - Bank profitability has generally declined.

### Regional Activity: Recovery since mid-2016 with Positive Momentum
- Asia’s growth declined to 5.3 percent in 2016 from 5.6 percent in 2015.
  - In some countries, idiosyncratic factors affected growth; for example, in India activity slowed due to cash shortages following the currency exchange initiative.
- Net exports subtracted 0.1 of a percentage point from regional growth.
- Export performance:
  - Asia’s export growth (in values) to major economies recovered in the second half of 2016, particularly to China and Japan and, to some extent, the United States.
  - Exports to the euro area recovered but remained year-over-year declining.
  - Export volumes rose less than nominal values (partly reflecting higher commodity prices) but have started to show improvement.
  - Drivers of the export recovery include strong growth in China, recovery in advanced economies, and an end to inventory destocking—particularly in electronics—so Asian exports now more closely follow demand in advanced economies.
- Domestic demand:
  - Remained strong, supported by robust private consumption due to continued household income growth.
  - Retail sales were generally solid; high-frequency indicators show retail sales declined sharply in India due to the currency exchange initiative.
  - In Hong Kong SAR, retail sales remained depressed owing to a downturn in tourism arrivals from mainland China.

*International Monetary Fund | April 2017*

### 1.  PREPARING fOR ChOPPy sEAs

### 1. PREPARING fOR ChOPPy sEAs

### Inflation and Commodity Prices
- The recovery in commodity prices has modestly pushed up headline inflation in many Asian economies, while core inflation generally remains stable at low levels.
- Commodity price levels are still comparatively low—barely reaching their mid-2015 levels.
- In China, producer price inflation turned significantly positive and consumer price inflation picked up.
- Headline inflation in Japan fell during most of 2016, while core inflation remained negative but edged up closer to zero.
- Among the largest economies in the region, headline inflation exceeded 3 percent in 2016 only in a few economies.
- Inflation expectations (from Consensus Forecasts) remain weak in most economies and have declined recently, but a few economies saw a slight uptick (for example, China and the Philippines).
- Core inflation has been low across most of Asia, but has increased in several countries, including China, the Philippines, New Zealand, Singapore, and Vietnam.

### Current Account Balances
- Asia’s current account surplus declined to an estimated 2.5 percent of GDP for 2016, down from 2.7 percent in 2015.
- Industrial Asia: current account balances increased by 1.2 percentage points in 2016 to 2.4 percent of GDP.
  - Japan: current account rose to 3.9 percent of GDP due to a stronger goods trade balance.
  - Australia and New Zealand: current account deficits narrowed, reflecting higher prices of commodity exports.
- East Asia and ASEAN: reduced current account surpluses in aggregate in 2016.
  - China: current account surplus narrowed to 1.8 percent of GDP from 2.7 percent in 2015, driven by a lower trade surplus and an increase in the services deficit.
  - Korea: current account surplus narrowed to 7 percent, owing to lower exports due to temporary disruptions in automobile and smartphone production, and the bankruptcy of a major shipping company.
  - Malaysia: current account balance declined to 2 percent of GDP mainly on weaker oil and gas trade balances.
  - Philippines: current account surplus fell to 0.2 percent of GDP due to strong growth in imports, particularly capital goods.
  - Thailand: current account surplus increased to 11.4 percent of GDP due to buoyant tourism and weak imports as domestic demand slowed.

### GDP Growth Trends and Country-Specific Dynamics
- China:
  - Growth was 6.7 percent in 2016, slightly higher than projected in the October 2016 World Economic Outlook, reflecting rebounding housing market, robust consumption growth, and continued policy support; net exports continued to be a drag.
- Japan:
  - Growth in 2016 was 1 percent.
  - Growth in 2013–15 was revised upward due to a comprehensive revision of the national accounts.
  - Strong net exports played the most significant role in 2016; private investment and consumption contributed modestly, supported by fiscal policy.
- India:
  - Growth for FY2016–17 is now expected to decelerate to 6.8 percent, 0.8 of a percentage point lower than the projection in the October 2016 World Economic Outlook.
  - The post-November 8, 2016, currency exchange initiative caused cash shortages and payment disruptions that strained consumption and business activity, especially in the informal sector.
- Korea:
  - Growth was 2.8 percent in 2016, mainly driven by stronger construction investment; private consumption was weaker than expected reflecting political uncertainties.
- Hong Kong SAR:
  - Growth slowed to 1.9 percent in 2016 due to an anemic global trade environment and a sharp downturn in tourism arrivals from mainland China, with signs of recovery in the second half of 2016 on the back of strong public investment.
- Australia and New Zealand:
  - Australia’s growth was 2.5 percent in 2016, reflecting drag from mining investment and slightly weaker consumption.
  - New Zealand’s growth accelerated to 4 percent, driven mainly by construction activity; expansion more recently has been broad based across most sectors.
- ASEAN economies:
  - Indonesia: growth accelerated to 5 percent, supported by robust private consumption.
  - Malaysia: growth at 4.2 percent in 2016—the slowest rate since the global financial crisis—driven mainly by private domestic demand; net exports contributed negatively.
  - Thailand: growth reached 3.2 percent, driven primarily by exports of services (notably tourism) and public investment.
  - Philippines: growth increased to 6.8 percent, mainly driven by domestic demand; investment growth was particularly strong reflecting higher public infrastructure spending and private construction; net exports were a drag.
  - Singapore: growth was 2 percent.
  - Vietnam: growth slowed to 6.2 percent due to a severe drought impacting agriculture and a sharp contraction in oil production.
- Frontier economies and small states:
  - Lao P.D.R.: growth declined to 6.9 percent owing to a slowdown in major trading partners, lower metals prices, and poor weather for agriculture.
  - Mongolia: growth slowed sharply as uncertainties sapped private sector confidence.
  - Nepal: growth decelerated to 0.6 percent due to the 2015 earthquakes and border blockade disruptions.
  - Sri Lanka: growth decelerated to 4.3 percent due to a contraction in agriculture driven by floods in May and drought since September.
  - Bangladesh: growth reached 6.9 percent, largely driven by private consumption.
  - Bhutan: growth recovered to 6.2 percent, driven by a pickup in services, mining, and hydropower-related construction.
  - Maldives: growth recovered to 3.9 percent following reduced policy uncertainty and political tension.
  - Cambodia: growth remained strong at 7 percent, driven by garment exports, real estate, and construction.
- Pacific island countries:
  - Growth dampened overall as a result of lower commodity prices.
  - Papua New Guinea: growth decelerated owing to low commodity prices and a major drought.
  - Fiji: growth disrupted by Cyclone Winston.
  - Fiji and Vanuatu: benefited from strength of the U.S. dollar against the Australian and New Zealand dollars and rapid growth of Chinese tourism; effect less noticeable in Palau due to base effects.

### Near-Term Regional Outlook and Projections
- Aggregate Asia:
  - GDP growth is forecast to reach 5.5 percent in 2017 and 5.4 percent in 2018.
  - Growth in 2017 was revised up by 0.1 of a percentage point compared to the forecast in the October 2016 World Economic Outlook.
  - Accommodative policies will underpin domestic demand, offsetting tighter global financial conditions.
  - Asia’s projected growth, excluding India and Korea, was revised upward in 2017 by 0.3 of a percentage point compared to the projection in the October 2016 World Economic Outlook.
- Trade and domestic demand:
  - Asian trade is expected to recover, with net exports projected to be less of a drag on growth for most economies owing to improved global growth outlook and higher commodity prices.
  - Domestic demand remains resilient, with robust labor markets, healthy disposable income growth, and continued policy support; in most economies real incomes are being boosted by continued low inflation.
  - High-frequency indicators and purchasing manager indices suggest continued strength in activity into early 2017.
  - The IMF’s Asia and Pacific Department’s indicator model points to strong growth momentum, with projections slightly higher than World Economic Outlook projections.
  - Credit gaps have started to decline in several major economies, but credit growth is expected to remain mildly supportive of domestic demand in the near term.
- Country-specific near-term projections:
  - China: GDP growth is projected to remain robust but continue to slow gradually to 6.6 percent in 2017 and 6.2 percent in 2018; moderation assumes a cooling housing market, consumption moderating with weaker wage growth, and a stable augmented fiscal deficit.
  - Japan: Growth is projected at 1.2 percent in 2017; the fiscal stimulus and postponement of the value-added tax hike generated a slightly expansionary 2016–17 fiscal stance supporting 2017 growth; growth is expected to weaken thereafter as fiscal stimulus effects fade.
  - India: Growth is projected to rebound to 7.2 percent in FY2017–18 and further to 7.7 percent in FY2018–19 as cash shortages ease and monsoon and supply-side improvements provide tailwinds; headwinds from weak bank and corporate balance sheets will weigh on near-term credit growth.
  - Korea: Growth is expected to remain subdued at 2.7 percent in 2017 and increase to 2.8 percent in 2018.
  - Australia: Growth is expected to reach 3.1 percent in 2017 and 3 percent in 2018.
  - New Zealand: Growth is expected at 3.1 percent in 2017 and 2.9 percent in 2018.
  - Hong Kong SAR: Growth is expected to recover gradually to 2.4 percent in 2017 and to 2.5 percent in 2018.
  - ASEAN economies (selected):
    - Indonesia: growth projected to accelerate slightly to 5.1 percent in 2017 and to 5.3 percent in 2018.
    - Malaysia: growth projected to improve to 4.5 percent in 2017 and to 4.7 percent in 2018.
    - Thailand: growth projected at 3 percent in 2017, increasing to 3.3 percent in 2018.
    - Philippines: growth projected at 6.8 percent in 2017 and at 6.9 percent in 2018.
    - Singapore: growth projected at 2.2 percent in 2017 and 2.6 percent in 2018.
    - Vietnam: growth projected at 6.5 percent in 2017 and 6.3 percent in 2018 owing to healthy domestic demand, a rebound in agricultural production, and strong activity.

*International Monetary Fund | April 2017*

### 1.  PREPARING fOR ChOPPy sEAs

### 1.  PREPARING fOR ChOPPy sEAs

### Regional growth and outlook
- Frontier economies and small states expected to rebound in 2017 and 2018 owing to better global trade growth and a recovery in commodity prices.
- Sri Lanka: GDP growth projected to recover to 4.5 percent in 2017 and to 4.8 percent in 2018 as growth in manufacturing, construction, and services is expected to offset the drought-stricken agriculture sector.
- Mongolia: Growth expected to remain subdued in 2017 on account of large fiscal consolidation; strengthening of policies under the EFF and some major expected mining developments should boost growth substantially in 2018.
- Pacific island countries: Growth projected to rebound in 2017 and 2018 owing to recovery in commodity prices for gas and oil exporters, including Papua New Guinea; Fiji expected to have a strong recovery from last year’s cyclone.
- Tourism and fishery activities expected to continue to support growth in the region.

### Inflation and output gaps
- Headline inflation projected to rise to 2.9 percent in 2017 and 2018.
- Despite recovery in commodity prices and an increase in producer price inflation, consumer price inflation is expected to remain low across most of the region due to well-anchored inflation expectations and relatively low pass-through.
- Estimated output gaps for some regional economies suggest sufficient slack across the region, exerting downward pressure on inflation.
- In frontier economies with the highest inflation rates in the region, such as Myanmar and Nepal, inflation is expected to remain within single digits.

### External balances
- Current account for the region as a whole expected to decline to 2.1 percent of GDP in 2017 and further to 2 percent of GDP in 2018.
- China: Current account surplus expected to decline further, driven by a lower trade surplus and an increase in the services deficit.
- India: Current account deficit expected to widen as domestic demand strengthens and commodity prices gradually rebound.
- Japan: Current account projected to rise due to a stronger goods trade balance.

### Monetary and fiscal stance
- Policy interest rates generally low in nominal and real terms across most of the region.
- With the exception of India, real rates are below 1 percent in all major regional economies and are negative in a number of them.
- In several economies, nominal policy rates broadly in line with or slightly below levels implied by augmented Taylor rules (which include exchange rates and foreign interest rates).
- Fiscal stimulus, measured by changes in the cyclically adjusted fiscal balances, expected to increase in 2017 in several economies including China, the Philippines, Singapore, and Thailand.
- Fiscal stance in 2017 slightly less supportive of growth in other major economies including India and Vietnam.
- In 2018, fiscal stimulus projected to increase in Indonesia, the Philippines, and Thailand; in Japan and China, fiscal policy projected to be less supportive of growth as effects of fiscal stimulus fade.

### Risks to the outlook — overview
- On balance, the outlook is clouded by significant downside risks, including a possible shift toward protectionism in major trading partners.
- Near-term growth could be supported by economic stimulus in some large economies, particularly the United States.
- Continued tightening in global financial conditions could trigger capital flow volatility, with repercussions to the region given balance sheet weaknesses in a number of economies.
- A bumpier-than-expected transition in China, geopolitical tensions, and idiosyncratic political problems could burden the outlook.
- Medium-term growth faces secular headwinds, including population aging and limited productivity convergence.

### Upside risks
- Stronger global activity resulting from larger policy stimulus than currently projected, especially in the United States, is an upside risk.
- Recent gains in business and consumer confidence in advanced economies could underpin stronger momentum in consumption and investment.
- Stronger U.S. fiscal stimulus would further boost Asian exports and increase growth in the region unless offset by significantly tighter financial conditions or protectionist trade policies.
- Supply-friendly structural reforms could entrench momentum and sustain a longer pickup in activity.

### Tighter global financial conditions — channels and vulnerabilities
- Expansionary U.S. fiscal policy could lead to higher U.S. inflationary pressures, requiring a tighter-than-expected monetary stance, including a steeper path for future increases in the federal funds rate and further decompression of the term premium.
- A substantial tightening of financial conditions—via a stronger U.S. dollar and higher interest rates—could have large negative spillovers for Asia, particularly for economies with high dollar-denominated corporate and sovereign debt.
- Capital outflows, higher financing costs, and fiscal sustainability concerns could push countries into an unwarranted tight policy mix, amplifying macroeconomic consequences and financial stability risks.
- A sudden upward shift in domestic yield curves would be a large shock to indebted firms and households, potentially derailing domestic-demand-based growth financed by low borrowing costs.
- Corporate bonds largely held by domestic banks imply corporate stress could weaken banks’ balance sheets and affect financial stability.

### Relative resilience and heterogeneity
- On average, Asian emerging market economies appear relatively better positioned to deal with external shocks than emerging markets in other regions:
  - Stronger external buffers as measured by foreign exchange reserves in terms of the IMF’s Assessment of Reserve Adequacy metric.
  - Lower external financing needs.
  - From a balance sheet perspective, Asian nonfinancial corporations and governments on average less exposed to sudden exchange rate fluctuations due to lower foreign-currency-denominated debt shares.
  - Banking system capital adequacy ratio lower than in other regions but only by a small margin.
- Large intra-region heterogeneity noted: for example, external financing requirement in Malaysia is relatively high; foreign share of nonfinancial corporate debt in Indonesia is relatively high.
- In scenarios with rising global risk premia or rising economic nationalism, corporate vulnerabilities in China and India would significantly worsen.

### Risk of deglobalization
- Deglobalization poses a substantial downside risk to the region.
- Disruption of global trade, capital, and labor flows from inward-shifted policies, including protectionism, would deter investment, reduce productivity, and lower global growth.
- Asian economies are particularly vulnerable to trade shocks given generally high trade openness ratios and significant participation in global value chains.
- A slowdown in global trade and FDI due to a U.S. pullback from cross-border economic integration could hinder technology transfers and undermine productivity growth and Asia’s growth model.
- Disruption of labor flows could reduce remittance inflows to emerging Asian countries; remittances from the Gulf Cooperation Council, the euro area, the United Kingdom, and the United States collectively accounted for about three-quarters of total remittance inflows to Asian emerging markets in 2015.
- Remittances particularly significant in Nepal (almost 25 percent of GDP), followed by the Philippines, Sri Lanka, Bangladesh, and Vietnam (4.5 to 7 percent of GDP).
- More restrictive immigration policies in traditional destination countries could reduce migration out of Asia and diversify destinations to other economies, including within Asia.

### China’s slowdown and spillovers
- China’s growth is slowing as it transitions to a more consumption-based economy but continues to drive global growth, accounting for about one-third of it.
- Sustained progress on reforms and reining in vulnerabilities will reduce downside risks, boost confidence, and lift investment in trading partners.
- China’s transition is expected to be positive overall over the medium term, but the growth slowdown will continue to generate large spillovers that vary by country and region, and some spillovers may be negative in the near term.

*International Monetary Fund | April 2017*

### 1. Emerging Asia: Remittance Inflows from Selected Sources

### 1. Emerging Asia: Remittance Inflows from Selected Sources

### Remittance Inflows and Migrant Stock (Figure 1.30)
- Remittance inflows to emerging Asia: 23.7%, 3.2%, 5.6%, 10.2%, 28.5%, 28.8%, 34%
- Migrant stock to selected destinations (percent of total migrant stocks): 21%, 3%, 6%, 9%, 27%
- Note: The recipient Asian countries consist of China, India, Indonesia, Malaysia, the Philippines, Sri Lanka, Thailand, and Vietnam; the Gulf Cooperation Council countries consist of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, United Arab Emirates.
- Note: The source Asian countries consist of China, India, Indonesia, Malaysia, the Philippines, Sri Lanka, Thailand, and Vietnam; the Gulf Cooperation Council countries consist of Bahrain, Kuwiat, Oman, Qatar, Saudi Arabia, United Arab Emirates.
- Sources: World Bank Bilateral Remittances Matrix, 2015; World Bank Bilateral Migration Matrix, 2013; and IMF staff estimates.

### Key Context on Spillovers from China’s Rebalancing
- Rebalancing in China is projected to pull China’s GDP growth below the no-reform scenario in the short term (IMF 2016) but spillovers turn positive over the medium term as reform and successful rebalancing from investment to consumption brings growth dividends.
- Channels and quantitative import intensities:
  - Import intensity of investment: about 25 percent.
  - Import intensity of consumption: 15 percent.
- Commodity exposure:
  - China accounts for about 40 percent of global demand for metals.
  - China accounts for only about 10 percent for crude oil demand.
- IMF staff analysis (April 2016 Regional Economic Outlook: Asia and Pacific, Chapter 3) suggests China’s rebalancing accounted for between one-fifth and one-half of the declines in broad commodity price indices between mid-2011 and mid-2015, with marked differences across commodities.
- Financial spillovers:
  - Financial spillovers from China have increased significantly since the global financial crisis, particularly in equity and foreign exchange markets, magnified by direct trade exposures (April 2016 Regional Economic Outlook: Asia and Pacific, Chapter 2).

### Geopolitical, Climate, and Other Risks
- Risks identified:
  - Escalation of geopolitical tensions could hurt tourism, FDI, and trade.
  - Climate change and natural disasters pose important risks to small states and Pacific island countries.
  - Withdrawal by global banks of correspondent banking relationships (“de-risking”) remains an important risk.
- Recent natural disaster examples:
  - Severe cyclones in Tonga (2014), Myanmar and Vanuatu (2015), and Fiji (2016).
  - 2015 earthquake in Nepal.
- World Risk Index, 2016 (selected averages and country list context):
  - Pacific island countries average: 19
  - Small states (excl. PICs) average: 8
  - Nonsmall states average: 7
  - Countries listed in figure context include Vanuatu, Tonga, Philippines, Guatemala, Bangladesh, Solomon Islands, Brunei Darussalam, Costa Rica, Cambodia, Papua New Guinea, El Salvador, Timor-Leste, Mauritius, Nicaragua, Guinea-Bissau, Fiji.

### Policy Recommendations: Broad Priorities
- Maintain policy flexibility focused on:
  - Addressing vulnerabilities and rebuilding buffers where needed.
  - Reducing domestic and external imbalances while safeguarding against external shocks.
  - Preserving gains from trade integration through balanced growth, trade initiatives, and inclusive policies.
- Structural reforms to sustain long-term growth, address demographic transition, and boost productivity.

### Reinforcing Growth Momentum: Demand Support and Structural Reforms
- Monetary policy guidance:
  - Monetary policy should generally remain accommodative, given that inflation is below target and there is slack in most economies in the region.
  - Some central banks could have room to lower interest rates if growth slides further (example: Malaysia and Thailand), provided external stability is not compromised.
  - Central banks should stand ready to raise policy rates if inflationary pressures gather pace (examples: India, Indonesia, and Vietnam).
  - Consideration of risks to inflation, asset prices, and domestic financial conditions and enhancement of macroprudential settings (example: China).
  - Large capital outflows and rapid exchange rate depreciations may warrant policy tightening to address balance of payments pressures.
- Fiscal policy guidance:
  - Fiscal support should be considered to support and complement structural reform efforts.
  - Fiscal action should weigh fiscal space and the need to support demand and external rebalancing consistently (examples: Korea and Thailand).
  - Delivering on medium-term fiscal consolidation plans remains critical where debt levels are high and/or fiscal credibility needs to be enhanced (example: EFF aims at restoring debt sustainability in Mongolia and improving debt trajectory in Sri Lanka).
  - Fiscal consolidation should be undertaken together with adjustments to the composition of spending to allow for further infrastructure and social spending in a number of economies (though in China, emphasis should be on reducing public investment in favor or consumption).
  - Real growth in public spending has been high across most of the region, suggesting room for gradual adjustment over time, including in relatively rigid public spending components such as wages.

### Preserving Financial Stability: Vulnerabilities and External Volatility
- Exchange rate regime guidance:
  - Exchange rates should generally remain the first line of defense against sudden tightening in global financial conditions, a shift toward protectionism, or a bumpier-than-expected transition in China.
  - Judicious foreign exchange intervention can be deployed to prevent or mitigate disorderly market conditions or where rapid exchange rate movements threaten financial or corporate stability, provided there are sufficient reserve buffers.
  - Foreign exchange intervention should not be used to resist currency movements that reflect changing fundamentals or as a substitute for macroeconomic policy adjustments.
  - Effective communication of policy goals can bolster confidence and lower market volatility.
- Macroprudential and capital flow measures:
  - Continue reliance on macroprudential policies to mitigate systemic risks associated with high corporate and household leverage and rising interest rates.
  - Step up efforts to identify pockets of leverage and fragility stemming from concentration of debt.
  - Macroprudential tools have been used to contain risks associated with rising house prices and household leverage.
  - Capital flow management measures could be considered should capital flow volatility lead to increases in systemic risk and dislocations; they should not substitute for necessary macroeconomic policy adjustments.

### Demographic Transition and Productivity
- Challenges:
  - Rapid aging at relatively low per capita income levels requires urgent policies to protect vulnerable elderly populations and prolong strong growth.
- Policy and reform priorities:
  - Structural reforms in labor markets, pension systems, and retirement systems.
  - Ensure debt sustainability proactively.
  - Productivity-enhancing reforms to raise productivity growth if external factors are less supportive than before the global financial crisis.
  - Strengthen regional trade integration where possible.
  - Advanced economies: focus on strengthening R&D effectiveness and raising productivity in services.
  - Emerging and developing economies: increase absorptive capacity and domestic investment, maintain FDI inflows, and increase education and human capital.

### Box 1.1 — India’s Currency Withdrawal: Key Facts and Impacts
- Action taken:
  - On November 8, 2016, the Government of India withdrew the legal tender status of all existing 500 and 1,000 rupee banknotes, effective the next day.
  - The initiative affected notes with a total value of about 15 trillion rupees, which accounted for about 86 percent of all cash in circulation.
  - Introduction of a new series of 500 and 2,000 rupee banknotes was announced.
- Immediate operational issues:
  - Supply of new banknotes was insufficient in the months following the initiative.
  - The government suspended cash exchanges and imposed tight caps on cash withdrawals by individuals and corporations.
  - Several temporary exemptions were granted to ease the cash crunch for public offices, the farming sector, payments for public utility services, and purchasing key primary products.
- Structural reasons for disruption:
  - At end-2015, currency in circulation in India stood at about 12 percent of GDP.
  - Cash accounted for about three-quarters of the narrow money base.
  - Numbers of bank branches and ATMs per capita are relatively low.
  - Few payment cards with a cash function exist (Figure 1.1.1).
  - Average number of transactions per Indian made with payments instruments in 2015 totaled 11 transactions (Figure 1.1.2).
- Short-term economic impacts:
  - India’s Purchasing Manager’s Index for services collapsed from 55 in October 2016 to 43 in November, 2016 (Figure 1.1.3).
  - Growth of credit to the nonfood private sector decelerated from 9 percent at end-October 2016 to 4 percent by end-December, 2016.
  - The consumer goods component of the index of industrial production declined by about 7 percent in December 2016; production of consumer durables fell by 10 percent.
  - Domestic sales of motor vehicles declined by 20 percent in December 2016 compared to December 2015; largest drop in three-wheel and two-wheel passenger vehicles.
  - Overall industrial production fell by less than ½ of 1 percent from the previous year, but investment activity was severely affected.
  - Number of new investment projects announced during October–December 2016 quarter was the lowest in over a decade; combined value was about one-half of the average recorded during the previous two years.
- Remonetization progress:
  - About 75 percent of the predemonetization level of currency in circulation was restored by late March.
- IMF staff analysis and growth impact estimates:
  - Cash shortages are likely to slow FY2016/17 growth by about 4/5 of 1 percentage point and FY2017/18 growth by about ½ of 1 percentage point (relative to October 2016 IMF World Economic Outlook forecasts).
  - The currency shortage is assumed by staff to gradually unwind through early 2017, corresponding to substantial tightening of monetary conditions in initial weeks, easing as currency is replaced.
  - Based on the IMF’s India Quarterly Projection Model, GDP growth is expected to slow in the second half of FY2016/17, before gradually rebounding in the course of FY2017/18 (Figure 1.1.4).
- Data notes and sources referenced in the box:
  - Source: Bank for International Settlements.
  - *China data are for 2014.
  - Figures cited: Figure 1.1.1 (Number of Payment Cards, 2015, per capita), Figure 1.1.2 (Number of Transactions with Payment Instruments, 2015, per capita), Figure 1.1.3 (India: Purchasing Managers’ Index for Services and Manufacturing, Index, > 50 signifies expansion).
  - References cited: Kumar (2014); Anand and Tulin (2016); IMF (2017a,b).
  - Prepared by Volodymyr Tulin.

*Source: areo0517c1 - 1. Emerging Asia: Remittance Inflows from Selected Sources (PDF chapter/section).*

### Box 1.1 (continued)

### Box 1.1 (continued)

### India: Currency Withdrawal (Demonetization) — Near-term Risks and Medium-term Scope for Gains
- Near-term risk: losses from the currency withdrawal remain a key domestic risk in India, in part as the near-term adverse economic impact of accompanying cash shortages remains difficult to gauge.
- Potential medium-term gains if complemented by reforms to strengthen India’s formal economy and the financial system:
  - Fiscal gains
    - Bank deposits of large amounts (above US$4,000) were expected to attract high scrutiny from the Indian tax authorities and the information obtained as a result of income verification could lead to a durable impact on the tax revenue base.
    - With only about 1 percent of the Indian population paying personal income taxes, the scope for broadening the tax base is clearly large.
    - In principle, unreturned cash could also produce a one-off revenue gain for the Reserve Bank of India that can enable an increased dividend transfer to the Government of India.
    - Any such windfall revenue would need to be clearly established, should be only realized once, and should be absorbed prudently and preferably in a non-recurring manner, for example through greater capital injections to public sector banks.
  - Banking sector liquidity
    - The increase in banking system liquidity as a result of the currency exchange initiative has been massive, and it can reduce banks’ funding costs and thereby lead to a decline in bank lending rates.
    - The weighted average lending rate of banks on new loans declined by 56 basis points during November 2016 to January 2017.
    - Authorities should remain vigilant to risks—including potential further buildup of nonperforming loans, including among private banks and elevated corporate sector vulnerabilities—and ensure prudent support to affected economic sectors.
  - Digitalization and de-cashing
    - Over the past few years, 250 million previously unbanked Indians have been provided with a bank account.
    - Improvements in customer identification include rollout of Aadhaar and adoption of know-your-customer technologies.
    - An important technological milestone was the rollout of the Unified Payment Interface (instant virtual fund transfer between two bank accounts using a mobile platform), accompanied by rollout of e-payment and point-of-sale technologies.
    - Remaining access gaps: about 350 million Indians do not yet have cell phones, and only 250 million people own smartphones.

### Box 1.2: Global Financial Spillovers to the ASEAN-5 (Indonesia, Malaysia, the Philippines, Singapore, Thailand)
- Market developments and recent shocks
  - Markets in the ASEAN-5 underwent significant corrections since the U.S. election, although they generally performed better than other emerging markets since the 2013 taper tantrum.
  - Following the U.S. election, the ASEAN-5 experienced capital outflows, exchange rate depreciations vis-à-vis the U.S. dollar, and rising 10-year sovereign bond yields in most countries.
- Two key macro-financial transmission channels of global financial shocks (empirical finding using a principal component model, following Miranda-Agrippino and Rey (2015)):
  - A channel related to global risk aversion that largely impacts portfolio capital flows and asset prices.
  - A channel linked to U.S. interest rates that mainly affects bond yields and credit conditions.
- Implications for ASEAN-5 growth and domestic financial conditions
  - Capital outflows and weaker asset prices historically have been the largest exogenous drivers of business cycle fluctuations in the ASEAN-5 (preliminary Bayesian vector autoregression).
  - Exchange rate depreciation may cushion tightening domestic financial conditions, but a rise in domestic bond yields (historically closely linked to U.S. rates) could:
    - Potentially lower property prices (and dampen construction) and soften domestic demand.
    - Weigh on growth since domestic demand is an important driver of ASEAN-5 growth.
  - The balance sheet impact of exchange rate depreciation may outweigh net export benefits in countries with high corporate leverage and foreign exchange exposures.
- Empirical note: determinants of sovereign bond yields in the ASEAN-5 show differing contributions of domestic factors and global factors before and after U.S. unconventional monetary policies (UMP).

### Box 1.3: Rising Household Debt in Asia — Trends, Risks, and Drivers
- Cross-country patterns and magnitude
  - Household debt is heterogeneous across Asian economies—ranging from 10 percent of GDP in India to 124 percent of GDP in Australia in 2015.
  - Between 2007 and 2015, the household-debt-to-GDP ratio increased by more than 20 percentage points of GDP in Thailand, Malaysia, and China.
  - The rise was also sizable in Australia, Korea, and Hong Kong SAR, at more than 15 percentage points of GDP.
  - Total household debt currently stands above 60 percent of GDP in most Asian economies, with the exception of China, India, and Indonesia.
- Risks from high and rising household debt
  - Rising house prices in many countries have accompanied increases in household indebtedness; housing remains a key household asset in Asia.
  - A decline in house prices could:
    - Lower collateral values, weaken household and bank balance sheets, tighten credit availability.
    - Weigh on consumption and domestic demand through a wealth effect.
  - Rapid increases in household debt since 2007 have been associated with lower future income growth in many countries.
  - Recent cross-country studies suggest a rise in household debt predicts lower future output growth over the medium run.
- Drivers of household debt (empirical framework and findings)
  - Model: single-equation fixed-effects framework for an unbalanced panel of 19 countries (including six Asian countries) over 1973–2015; ΔDit denotes change in household debt (percent of GDP); explanatory variables lagged by one year; inequality entered with a two-year lag.
  - Key empirical findings (Table 1.3.1; fixed-effects estimations; standard errors in parentheses; significance levels preserved):
    - Dependent variable, t-1: 0.565*** (0.0435)
    - Δ short-Term Interest Rate, t-1: 20.118** (0.0584)  [sign indicates coefficient value as reported]
    - Per Capita GDP, t-1: 0.0383** (0.0158)
    - Per Capita GDP Growth, t-1: 0.257*** (0.0522)
    - Δ Top 1% Income share, t-2: 0.421*** (0.131)
  - Interpretation: rising income and cheaper credit have been associated with increases in household debt; rising income inequality has also been associated with an increase in household indebtedness.
- Policy implications and recommendations
  - Tackle income inequality to reduce pressures toward household indebtedness.
  - Strengthen resilience to risks associated with rising household indebtedness by:
    - Enhancing buffers.
    - Tightening prudential macro policies where needed.

### Box 1.4: Potential U.S. Policy Changes and Implications for Asia
- Macroeconomic policy mix (April 2017 World Economic Outlook assumptions)
  - Short-term projection assumes a shift toward more expansionary fiscal policy and tighter monetary stance in the United States relative to October 2016 WEO.
  - Fiscal expansion could stem mainly from anticipated changes in U.S. federal tax policies, including lower individual and corporate income tax rates.
  - U.S. monetary policy would tighten in response to higher demand and inflation prospects, leading to normalization of the U.S. term premium and appreciation of the U.S. dollar.
  - If U.S. fiscal expansion is productive, stronger U.S. demand would benefit Asian exporters, provided financial markets remain orderly; if not productive, faster term premium normalization and greater U.S. dollar appreciation could make spillovers to Asia negative.
- Corporate income tax reform and destination-based cash flow tax (DBCFT)
  - Reform proposals include lowering the highest tax rate; a one-time tax rate reduction for repatriation of U.S. corporate profits overseas; eliminating various tax credits and deductions.
  - DBCFT features under consideration: immediate expensing of capital investment; eliminating deduction of net interest payments; deduction of earnings from exports and elimination of deduction of imported inputs (border tax adjustment).
  - Short-term implications of a transition to a DBCFT:
    - U.S. dollar would appreciate in real effective terms with the introduction of a border tax adjustment.
    - If real appreciation is driven by nominal exchange rate appreciation rather than U.S. domestic prices, Asian economies with flexible exchange rates could face higher consumer price inflation (via import prices) and higher external debt burdens.
    - Economies pegged to the U.S. dollar or dollarized could see increased downward pressures on foreign exchange reserves and domestic prices.
    - Trade balances could worsen in absence of, or with limited, exchange rate depreciation.
  - Longer-term implications:
    - Incentives for U.S. companies to shift production or income to lower-tax jurisdictions outside the United States would diminish.
    - Asian supply chains linked to the United States (notably in China, Malaysia, and Vietnam) could weaken as FDI inflows into Asia slow.
    - The one-time repatriation tax cut could trigger capital outflows from deposit countries, tighten offshore dollar funding conditions, and accelerate U.S. dollar appreciation.
- International trade policies
  - U.S. trade policy focus may pivot toward greater protection of domestic players and increased use of trade remedy and enforcement tools.
  - Preference for bilateral trade negotiations over multilateral ones (e.g., withdrawal from the Trans-Pacific Partnership) could increase tension and uncertainty.
  - Increased uncertainty and a U.S. pullback from cross-border economic integration could negatively affect Asia’s exports to the United States and hinder technology transfers through slower global trade and FDI.

*International Monetary Fund | April 2017*

### Box 1.4 (continued)

### Box 1.5. Myanmar: Macroeconomic and Distributional Implications of Financial Reforms

### Context and background
- Myanmar’s financial sector reform is a government priority; a financial sector development strategy has been developed with IMF and World Bank assistance, and a financial inclusion road map has been launched.
- The Central Bank of Myanmar continues to finance a significant portion of the fiscal deficit, generating inflation and exchange rate depreciation pressures while placing a disproportional burden on the poor.
- Administrative controls on interest rates—a floor on deposit rates and a ceiling on lending rates—have led to financial suppression in the face of relatively high inflation.
- Access to basic financial services is very low, with over 75 percent of adults not having a bank account and the majority of the population relying on unregulated lenders, often at very high costs.
- Agriculture accounts for 30 percent of GDP and employs more than half of the population, but receives only a small fraction of total outstanding bank loans; small and medium-sized enterprises are also underserved.

### Policy experiments analyzed
- Four policy experiments were conducted using a dynamic stochastic general equilibrium model tailored to Myanmar:
  - Financial reform/liberalization: The government reduces central bank financing and pursues gradual liberalization of interest rates.
  - Financial inclusion: Policy changes in the “financial reform/liberalization” scenario plus easier rural access to private credit.
  - Higher infrastructure investment: Policy changes in the “financial inclusion” scenario plus the channeling of the reform-generated higher tax revenues toward economy-wide infrastructure investment.
  - Higher infrastructure investment in agriculture: Policy changes in the “financial inclusion” scenario plus the channeling of the reform-generated higher tax revenues toward rural infrastructure investment.

### Macroeconomic effects (findings)
- Financial liberalization (reducing central bank financing and allowing higher real interest rates) would:
  - Increase savings, private credit, and ultimately economic growth (Figure 1.5.1).
  - A higher real interest rate as a result of lower inflation and a higher nominal interest rate on savings motivates households to save more.
  - Increased household savings leads to a reduction in the real interest rate on private credit, boosting investment.
  - Investment increases and the industrial sector expands; the industrial expansion boosts labor demand and urban wages, inducing migration from rural areas.
  - A larger and wealthier urban population increases demand for consumption goods and overall economic activity increases.

### Distributional effects (findings)
- While financial liberalization would boost growth and reduce poverty, it may also increase some dimensions of inequality:
  - It may increase intra-rural and intra-urban income inequality (Figures 1.5.2 and 1.5.3).
  - Financial liberalization tends to disproportionately benefit those who already have financial access.
  - Even with a general increase in credit access for needy sectors, rural households that benefit most are usually those that are better-off (typically with larger land holdings, high productivity, and better managerial skills).
- An increase in infrastructure investment funded by reform-generated revenue—even if targeted toward rural areas—can lead to increased inequality within the rural sector despite likely improvements in income distribution between rural and urban areas.
- Key insight: Reforms that boost growth and reduce poverty can simultaneously worsen certain aspects of income distribution without changes to the existing institutional setup and appropriate targeting.

### Policy recommendations and implications
- Complementary policies are important when pursuing economic liberalization to avoid worsening some dimensions of income inequality.
- Where equality is an important policy objective, financial liberalization needs to be supported by policy measures that target disadvantaged groups.
- Such support may require fiscal measures or sound financial policies that directly help disadvantaged groups.

*Source: IMF staff estimates.*

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_Source: https://www.imf.org/-/media/files/publications/reo/apd/2017/areo0517c1.pdf_