## 2015. Financial dislocations associated with higher global interest rates, and protracted weak growth in advanced and emerging market economies are the main downside risks to the outlook. ## Source details **Canonical URL:** [2015. Financial dislocations associated with higher global interest rates, and protracted weak growth in advanced and emerging market economies are the main downside risks to the outlook.](https://www.imf.org/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/reo/2014/apd/eng/areo1014.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/reo/2014/apd/eng/areo1014.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/reo/2014/apd/eng/areo1014.pdf.json) --- ### Outlook and near-term momentum - Asia’s GDP growth is forecast to reach 5.5 percent in 2014, accelerating slightly to 5.6 percent in 2015. - Despite a deceleration earlier in 2014, global growth is set to pick up in the second half of 2014 and into 2015, partly on accommodative monetary policies and a diminishing fiscal drag. - Portfolio inflows have picked up significantly since last spring, with strong equity flows contributing to boost domestic stock markets. - Long-term rates and sovereign CDS spreads have declined across the board, helping sustain strong credit growth and continued house price appreciation in most economies (with the notable exception of China). - Regional high-frequency indicators and an IMF short-term indicator model for Asia point to stronger momentum going into the fourth quarter. ### Country- and subregion-specific projections and developments - China - GDP growth in 2014 H2 should remain at around 7.5 percent (year-on-year), helped by targeted stimulus measures (boost to railway spending, support to agriculture, small- and medium-size enterprises, and social housing). - The growth outlook for 2015 will hinge partly on government policies and the (yet to be decided) growth target. - Assuming continued efforts to rein in vulnerabilities and steady implementation of reforms, growth should moderate to around 7 percent. - The inflation outlook would remain benign. - Japan - Abenomics continues to provide a boost, but GDP growth for 2014 is projected to slow to 0.9 percent—still above potential—following the larger-than-expected contraction in Q2 after the consumption tax hike. - Growth should remain broadly stable in 2015 as the planned fiscal adjustment is partly offset by rising private investment. - Headline inflation will decline next year as the recent consumption tax impact fades, but underlying inflation should rise toward the official target of 2 percent over the medium term. - India - GDP growth is forecast to rise to 5.6 percent in 2014, accelerating further to 6.4 percent in 2015, supported by lower uncertainty, improved business confidence, rising capital inflows, and a revival in investment and industrial activity. - India’s inflation is projected to decline gradually, reaching 7.8 and 7.5 percent in fiscal years 2014 and 2015, respectively. - Korea, Australia, New Zealand - Korea: growth set to reach 3.7 percent in 2014 and 4.0 percent in 2015, helped by external demand and policy stimulus. - Australia: GDP growth averaging 2.8 percent in 2014–15, as export volumes partly offset the unwinding of the investment cycle. - New Zealand: GDP growth expected to reach 3.6 percent in 2014 before moderating to 2.8 percent in 2015. - ASEAN-5 and other economies - ASEAN-5 economies to see a growth deceleration in 2014 and a rebound in 2015 as the global economy recovers and domestic policy uncertainty declines (notably in Thailand). - Indonesia: growth slowing to 5.2 percent in 2014, rising to 5.5 percent in 2015 on improved confidence after the recent election. - Malaysia, the Philippines, and Singapore should continue to experience solid growth in 2014–15. - Frontier and developing economies, Small States, and Pacific island countries: stronger trade, remittances, and tourism revenue should support a pickup in growth in 2014–15, though vulnerabilities associated with high fiscal and current account deficits and soft commodity prices have been rising in some cases (Mongolia and Lao P.D.R.). ### Main downside risks and channels of transmission - Principal downside risks to the regional outlook: - Financial dislocations associated with higher global interest rates. - Protracted weak growth in advanced and emerging market economies. - A sharper-than-anticipated downturn in China’s real estate sector. - Less-effective-than-envisaged Abenomics in Japan. - Geopolitical tensions that could disrupt trade and financial flows. - Financial market context: - Stock markets in major advanced economies are flirting with all-time highs; volatility in key markets, including currencies, remains subdued. - A disorderly reaction to U.S. monetary policy normalization could lead to a spike in global interest rates and sharp reversals in capital inflows, elevating asset price volatility and decompression in term premia and spreads (sovereign and corporate). - Currency risk reversals indicate that a number of regional currencies face a significant risk of depreciation in the near term. - Economies more dependent on external financing or with a large presence of foreign investors in domestic markets are more subject to capital flow reversal risk; countries with higher current account and fiscal deficits are more likely to be targeted. - Specific shock estimates: - Econometric estimates suggest that a 5 percent decline in the house price index could lower GDP (relative to the baseline path) by an average of 1.3 percent after one year. ### Mitigating factors and resilience - QE in Japan and the euro area might provide an offset if they lead to stronger capital flows into Asia. - Economic resilience has increased in parts of the region: - India: international reserves have risen and the current account deficit has been slashed, significantly reducing gross external financing needs. - Indonesia: foreign exchange reserves have increased. - Banks in the region are generally well capitalized and profitable. ### Policy recommendations and medium-term priorities - Overarching guidance: - Capitalize on the outlook to gradually rebuild policy space. - Push ahead with structural reforms to deliver sustainable growth. - Fiscal policy: - Fiscal consolidation should generally continue in a calibrated manner, especially where debt levels are higher. - Gradual fiscal consolidation should remain a policy priority, capitalizing on steady growth momentum. - While budget deficits in the region are generally manageable, fiscal positions have deteriorated in many economies even as growth has remained relatively strong. - Fiscal policy should focus on gradually rebuilding buffers. - In a few economies public debt levels are high (Japan), fiscal imbalances are large (India and Vietnam), and contingent liabilities could be a significant drain on fiscal resources if downside risks materialize (Malaysia). - Fiscal consolidation is desirable in some frontier and developing Asian economies, particularly where external imbalances are large (Cambodia, Lao P.D.R., and Mongolia). - Creating fiscal space would strengthen fiscal credibility and allow increased infrastructure investment to boost productive capacity. - Recent and ongoing efforts to reform fuel subsidies (e.g., in India, Indonesia, and Malaysia) are important steps. - The extent and pace of consolidation should vary with fiscal and cyclical positions. - Since there are, in general, no near-term sustainability concerns, automatic stabilizers should be allowed to operate. - Monetary policy: - Most economies in the region should start or continue a gradual tightening of monetary conditions. - Considering accommodative stances and limited slack, and to ensure inflation expectations remain anchored, a few central banks started raising policy interest rates this year (Malaysia, New Zealand, and the Philippines). - With a relatively benign inflation outlook and slowing growth, some central banks eased their stance (Korea and Thailand) and have room to wait for conditions to be ripe for an interest rate hike. - In India and Indonesia, previous interest rate hikes and other policy measures are helping contain price pressures, and the full effect of past monetary tightening is yet to be felt. - Close vigilance is warranted, particularly in the event of large cost-push shocks or if there is evidence that inflation expectations become unmoored. - In China, efforts to curb credit growth will help rebalance the economy and address financial stability risks despite a relatively favorable inflation outlook. - Japan: Monetary policy should remain accommodative until inflation is entrenched and consistent with the current target; clear communication about inflation objectives and the conduct of monetary policy is critical. - Exchange rate and macroprudential policies: - Exchange rate flexibility helped macroeconomic adjustment after the “taper tantrum” and should remain a major shock absorber in the event of capital flow reversals. - Foreign exchange intervention should aim to smooth volatility or provide foreign exchange liquidity during market dislocations. - Policymakers should continue to deploy macroprudential measures (housing, banking, and credit related) to address financial stability concerns, including those associated with the global financial cycle. - After several years of tightening, the stance of macroprudential policies is now tight in a number of economies and should remain responsive to the domestic financial cycle: - Some further tightening could be warranted where financial risks continue to build up. - Easing certain measures could be considered in the event of capital flow reversals and/or a downturn in the financial cycle. - Macroprudential measures should be a first line of defense to prevent systemic risk buildup but should not substitute for required macroeconomic policy adjustments or implementation of structural measures. - Structural reforms: - Continue using the solid outlook to address long-standing challenges; structural reforms can lower vulnerabilities while preserving or enhancing medium-term growth prospects. - Country-specific priorities: - China: implement its comprehensive reform blueprint—including financial, fiscal, and state-owned enterprise reforms—to transition to a more balanced and sustainable growth path while addressing financial stability concerns. - Japan: ensure effective implementation of the third arrow of Abenomics (services and labor market deregulation) to boost potential growth. - India: remove structural impediments to investment, including further liberalizing its FDI regime and labor market regulations; energy sector policies are also needed to boost industrial activity. - Other emerging and frontier economies: reforms to increase productivity through investment in infrastructure (regulatory, land acquisition, and financial reforms), enhanced labor market flexibility to encourage female labor force participation and formalization, and reductions in red tape and improvements in governance. - Fiscal reforms to complement spending rationalization and revenue mobilization: energy subsidy reforms (India, Malaysia, and Indonesia), better management of local government borrowing in China, and improved efficiency of state-owned enterprises in a number of countries (e.g., China and Vietnam). ### Impact scenario: advanced-economy shock and spillovers - A decline of 0.2 percent of GDP together with a concomitant decline in investment growth by about 1 percent in advanced economies could lower growth in Asia (relative to the baseline) by about 0.2 percentage point as a result of trade and financial spillovers. - The 5 percent drop in house prices is in line with the median decline observed during housing market busts during the 1995–2013 period. - The econometric analysis is based on vector autoregressions estimated on a sample of selected emerging Asian economies (covering up to 1995–2013 in some economies). The recursive model includes GDP, CPI, real credit, a house price index, a short-term interest rate, and the nominal effective exchange rate. ### Policy requirements: rebuilding buffers and implementing reforms - Clear and credible policy frameworks are essential, especially during “risk-off” episodes or when visibility about the direction of the global economy is low. - Economies in the region have buffers (international reserves, generally low fiscal deficits and inflation), but macroeconomic policies should: - Focus on gradually rebuilding fiscal buffers. - Ensure that inflation remains in check. - Safeguarding financial stability is a critical priority, underscoring the need to further strengthen regulation and supervision, including of shadow banking intermediation. - Micro- and macroprudential policies should continue to complement the monetary-fiscal policy mix. - Strong policy frameworks can mitigate higher volatility effects; economies with stronger fundamentals or those that have undertaken significant adjustments to lower inflation and external imbalances can benefit from positive differentiation by global investors. - Reforms to maintain high and sustainable growth will help lower near-term vulnerabilities. Examples: - Deliver higher growth and inflation in Japan. - Achieve a more balanced growth path in China. - Strengthen investment and efficiency in India. - Frontier, developing, and Pacific island economies would benefit from structural reforms to boost investment and lift potential growth. *Asia and Pacific Department REO Update, October 2014* ### 2015. Financial dislocations associated with higher global interest rates, and protracted ### 2015. Financial dislocations associated with higher global interest rates, and protracted weak growth in advanced and emerging market economies are the main downside risks to the outlook. ### Outlook and near-term momentum - Asia’s GDP growth is forecast to reach 5.5 percent in 2014, accelerating slightly to 5.6 percent in 2015. - Despite a deceleration earlier in 2014, global growth is set to pick up in the second half of 2014 and into 2015, partly on accommodative monetary policies and a diminishing fiscal drag. - Portfolio inflows have picked up significantly since last spring, with strong equity flows contributing to boost domestic stock markets. - Long-term rates and sovereign CDS spreads have declined across the board, helping sustain strong credit growth and continued house price appreciation in most economies (with the notable exception of China). - Regional high-frequency indicators and an IMF short-term indicator model for Asia point to stronger momentum going into the fourth quarter (Figure 5 reference). ### Country- and subregion-specific projections and developments - China - GDP growth in 2014 H2 should remain at around 7.5 percent (year-on-year), helped by targeted stimulus measures (boost to railway spending, support to agriculture, small- and medium-size enterprises, and social housing). - The growth outlook for 2015 will hinge partly on government policies and the (yet to be decided) growth target. - Assuming continued efforts to rein in vulnerabilities and steady implementation of reforms, growth should moderate to around 7 percent. - The inflation outlook would remain benign. - Japan - Abenomics continues to provide a boost, but GDP growth for 2014 is projected to slow to 0.9 percent—still above potential—following the larger-than-expected contraction in Q2 after the consumption tax hike. - Growth should remain broadly stable in 2015 as the planned fiscal adjustment is partly offset by rising private investment. - Headline inflation will decline next year as the recent consumption tax impact fades, but underlying inflation should rise toward the official target of 2 percent over the medium term. - India - GDP growth is forecast to rise to 5.6 percent in 2014, accelerating further to 6.4 percent in 2015, supported by lower uncertainty, improved business confidence, rising capital inflows, and a revival in investment and industrial activity. - India’s inflation is projected to decline gradually, reaching 7.8 and 7.5 percent in fiscal years 2014 and 2015, respectively. - Korea, Australia, New Zealand - Korea: growth set to reach 3.7 percent in 2014 and 4.0 percent in 2015, helped by external demand and policy stimulus. - Australia: GDP growth averaging 2.8 percent in 2014–15, as export volumes partly offset the unwinding of the investment cycle. - New Zealand: GDP growth expected to reach 3.6 percent in 2014 before moderating to 2.8 percent in 2015. - ASEAN-5 and other economies - ASEAN-5 economies to see a growth deceleration in 2014 and a rebound in 2015 as the global economy recovers and domestic policy uncertainty declines (notably in Thailand). - Indonesia: growth slowing to 5.2 percent in 2014, rising to 5.5 percent in 2015 on improved confidence after the recent election. - Malaysia, the Philippines, and Singapore should continue to experience solid growth in 2014–15. - Frontier and developing economies, Small States, and Pacific island countries: stronger trade, remittances, and tourism revenue should support a pickup in growth in 2014–15, though vulnerabilities associated with high fiscal and current account deficits and soft commodity prices have been rising in some cases (Mongolia and Lao P.D.R.). ### Main downside risks and channels of transmission - Principal downside risks to the regional outlook: - Financial dislocations associated with higher global interest rates. - Protracted weak growth in advanced and emerging market economies. - A sharper-than-anticipated downturn in China’s real estate sector. - Less-effective-than-envisaged Abenomics in Japan. - Geopolitical tensions that could disrupt trade and financial flows. - Financial market context: - Stock markets in major advanced economies are flirting with all-time highs; volatility in key markets, including currencies, remains subdued. - A disorderly reaction to U.S. monetary policy normalization could lead to a spike in global interest rates and sharp reversals in capital inflows, elevating asset price volatility and decompression in term premia and spreads (sovereign and corporate). - Currency risk reversals indicate that a number of regional currencies face a significant risk of depreciation in the near term. - Economies more dependent on external financing or with a large presence of foreign investors in domestic markets are more subject to capital flow reversal risk; countries with higher current account and fiscal deficits are more likely to be targeted. - Specific shock estimates: - Econometric estimates suggest that a 5 percent decline in the house price index could lower GDP (relative to the baseline path) by an average of 1.3 percent after one year. ### Mitigating factors and resilience - QE in Japan and the euro area might provide an offset if they lead to stronger capital flows into Asia. - Economic resilience has increased in parts of the region: - India: international reserves have risen and the current account deficit has been slashed, significantly reducing gross external financing needs. - Indonesia: foreign exchange reserves have increased. - Banks in the region are generally well capitalized and profitable (see IMF Global Financial Stability Report and April 2014 Asia and Pacific REO references in source). ### Policy recommendations and medium-term priorities - Policymakers in the region should: - Capitalize on the outlook to gradually rebuild policy space. - Push ahead with structural reforms to deliver sustainable growth. - Fiscal policy: - Fiscal consolidation should generally continue in a calibrated manner, especially where debt levels are higher. - Monetary policy: - Monetary normalization should proceed particularly where inflation pressures are high or building up. - Reform emphasis: - There is no one-size-fits-all approach; country-specific policies and sequencing matter, including efforts to rein in vulnerabilities related to investment, credit, and local government finances. *Prepared by Roberto Guimarães-Filho under the guidance of Romain Duval. Jeremy Zook provided research support and Socorro Santayana assisted with the production.* ### 0.2 percent of GDP with a concomitant ### 0.2 percent of GDP with a concomitant ### Impact scenario: advanced-economy shock and spillovers - A decline of 0.2 percent of GDP together with a concomitant decline in investment growth by about 1 percent in advanced economies could lower growth in Asia (relative to the baseline) by about 0.2 percentage point as a result of trade and financial spillovers. - The 5 percent drop in house prices is in line with the median decline observed during housing market busts during the 1995–2013 period. - The econometric analysis is based on vector autoregressions estimated on a sample of selected emerging Asian economies (covering up to 1995–2013 in some economies). The recursive model includes GDP, CPI, real credit, a house price index, a short-term interest rate, and the nominal effective exchange rate. ### Policy requirements: rebuilding buffers and implementing reforms - Clear and credible policy frameworks are essential, especially during “risk-off” episodes or when visibility about the direction of the global economy is low. - Economies in the region have buffers (international reserves, generally low fiscal deficits and inflation), but macroeconomic policies should: - Focus on gradually rebuilding fiscal buffers. - Ensure that inflation remains in check. - Safeguarding financial stability is a critical priority, underscoring the need to further strengthen regulation and supervision, including of shadow banking intermediation. - Micro- and macroprudential policies should continue to complement the monetary-fiscal policy mix. - Strong policy frameworks can mitigate higher volatility effects; economies with stronger fundamentals or those that have undertaken significant adjustments to lower inflation and external imbalances can benefit from positive differentiation by global investors. - Reforms to maintain high and sustainable growth will help lower near-term vulnerabilities. Examples: - Deliver higher growth and inflation in Japan. - Achieve a more balanced growth path in China. - Strengthen investment and efficiency in India. - Frontier, developing, and Pacific island economies would benefit from structural reforms to boost investment and lift potential growth. ### Fiscal policy - Gradual fiscal consolidation should remain a policy priority, capitalizing on steady growth momentum. - Observations and priorities: - While budget deficits in the region are generally manageable, fiscal positions have deteriorated in many economies even as growth has remained relatively strong. - Fiscal policy should focus on gradually rebuilding buffers (Figure 7). - With a few exceptions, fiscal positions have weakened relative to historical benchmarks (e.g., 2002–07 average) as the fiscal impulse after the global financial crisis has not been fully unwound. - In a few economies public debt levels are high (Japan), fiscal imbalances are large (India and Vietnam), and contingent liabilities could be a significant drain on fiscal resources if downside risks materialize (Malaysia). - Fiscal consolidation is desirable in some frontier and developing Asian economies, particularly where external imbalances are large (Cambodia, Lao P.D.R., and Mongolia). - Creating fiscal space would strengthen fiscal credibility and allow increased infrastructure investment to boost productive capacity. - Recent and ongoing efforts to reform fuel subsidies (e.g., in India, Indonesia, and Malaysia) are important steps. - Policy design: - The extent and pace of consolidation should vary with fiscal and cyclical positions. - Country-specific mitigating factors can matter—even where public debt is high (e.g., strong home bias in Japan), provided long-term measures to deliver credible and durable consolidation are taken. - Since there are, in general, no near-term sustainability concerns, automatic stabilizers should be allowed to operate. ### Monetary policy - Most economies in the region should start or continue a gradual tightening of monetary conditions. - Observations: - Considering accommodative stances and limited slack, and to ensure inflation expectations remain anchored, a few central banks started raising policy interest rates this year (Malaysia, New Zealand, and the Philippines). - With a relatively benign inflation outlook and slowing growth, some central banks eased their stance (Korea and Thailand) and have room to wait for conditions to be ripe for an interest rate hike—as shown by generally appropriate interest rate levels given the output gap and inflation trends (Figure 8). - In India and Indonesia, previous interest rate hikes and other policy measures are helping contain price pressures, and the full effect of past monetary tightening is yet to be felt. - Close vigilance is warranted, particularly in the event of large cost-push shocks or if there is evidence that inflation expectations become unmoored. - In China, efforts to curb credit growth will help rebalance the economy and address financial stability risks despite a relatively favorable inflation outlook. - Japan: - Monetary policy should remain accommodative until inflation is entrenched and consistent with the current target. - Clear communication about inflation objectives and the conduct of monetary policy is critical to ensure inflation expectations and underlying inflation measures continue to rise toward the target in a sustained manner. ### Exchange rate and macroprudential policies - Exchange rate flexibility helped macroeconomic adjustment after the “taper tantrum” and should remain a major shock absorber in the event of capital flow reversals. - Foreign exchange intervention should aim to smooth volatility or provide foreign exchange liquidity during market dislocations. - Over the past year, with capital flowing back into Asia, most countries further accumulated reserves while currencies generally appreciated; notable exceptions were Japan and Indonesia. - Policymakers should continue to deploy macroprudential measures (housing, banking, and credit related) to address financial stability concerns, including those associated with the global financial cycle (e.g., large increases in asset prices caused by capital inflows). - After several years of tightening, the stance of macroprudential policies is now tight in a number of economies and should remain responsive to the domestic financial cycle: - Some further tightening could be warranted where financial risks continue to build up. - Easing certain measures could be considered in the event of capital flow reversals and/or a downturn in the financial cycle. - Macroprudential measures should be a first line of defense to prevent systemic risk buildup but should not substitute for required macroeconomic policy adjustments or implementation of structural measures. ### Structural reforms - Continue using the solid outlook to address long-standing challenges; structural reforms can lower vulnerabilities while preserving or enhancing medium-term growth prospects, which have deteriorated over the last few years. - Country-specific priorities: - China: implement its comprehensive reform blueprint—including financial, fiscal, and state-owned enterprise reforms—to transition to a more balanced and sustainable growth path while addressing financial stability concerns. - Japan: ensure effective implementation of the third arrow of Abenomics (services and labor market deregulation) to boost potential growth; despite progress (including the recent consumption tax hike), further reforms are critical. - India: remove structural impediments to investment, including further liberalizing its FDI regime and labor market regulations; energy sector policies are also needed to boost industrial activity. - Other emerging and frontier economies: - Reforms to increase productivity through investment in infrastructure (regulatory, land acquisition, and financial reforms), enhanced labor market flexibility to encourage female labor force participation and formalization, and reductions in red tape and improvements in governance to reduce rent-seeking and boost investment. - Fiscal reforms to complement spending rationalization and revenue mobilization: energy subsidy reforms (India, Malaysia, and Indonesia), better management of local government borrowing in China, and improved efficiency of state-owned enterprises in a number of countries (e.g., China and Vietnam). *Asia and Pacific Department REO Update, October 2014* --- _Source: https://www.imf.org/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/reo/2014/apd/eng/areo1014.pdf_