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Asia: Exiting from Stimulus in an Uncertain World

I blogged last from China, and this week I am in India to present our latest Asia-Pacific Regional Economic Outlook in New Delhi. India is of course, along with China and some other countries, an important driver of the Asian recovery. And Asia in turn is leading the global recovery.

At the same time, the global recovery also influences Asia’s growth, given Asia’s high dependence on export demand and its growing integration with international financial markets. And the global outlook is subject to downside risks, which came to the forefront again last week in the form of developments in Europe and continue to be reflected in financial market volatility all across the world.

So, while recent Asian performance has been strong and the outlook remains relatively positive, we are not yet out of the woods.

Getting the pace right

Against this uncertain background, the main near-term challenge for Asian policymakers is to judge the appropriate pace for normalizing monetary and fiscal policy conditions.

With Asia recovering ahead of and faster than advanced economies, policy conditions in the region will need to start normalizing sooner than in several other parts of the world. But the fragility of the global recovery means that the withdrawal of stimulus will have to be cautious and gradual.

One fortunate consideration in this regard is that thanks to the strengthening of policy frameworks across the region in recent years, most Asian economies have some fiscal and monetary “space” to respond flexibly to external shocks. The right pace of “exit” is different for different economies, as it depends in each on the stage of the cycle and exposure to various risks.

The pace of monetary normalization will need to be guided by a few key considerations, such as the degree of monetary accommodation that is still in place, the pace at which output gaps are closing, and the emergence of inflationary pressures.

In economies with less economic slack and smaller exposure to external demand, the pace of normalization can proceed faster than in economies that are operating far from capacity constraints or are highly exposed to uncertain external demand. The pick-up in consumer price inflation in a few economies, including India, in recent quarters also bears watching.

Part of the pick-up has owed to food and energy prices, but a part also owes to rising “core” prices, indicating a spread of inflationary pressure beyond the volatile food and energy components.


Now monetary tightening of course carries with it the risk of attracting further capital inflows that could complicate macroeconomic management.

Countries could consider several measures to deal with large inflows, as many in the region are already doing. Such measures could include prudential regulations to address unduly rapid rises in asset prices, such as equity and property prices, and greater exchange rate flexibility.

On fiscal policy, many Asian economies are planning to withdraw this year part of the stimulus that they put in place during the crisis. Still, I expect fiscal conditions to remain accommodative in most of Asia.

Such a gradual removal of fiscal stimulus seems to me to be entirely appropriate, given the low levels of public debt in most of the region (Japan being an exception). Also, given the still large downside risks to the outlook, it is good risk management to keep in place some targeted fiscal measures to support growth.

It is nonetheless still important for policymakers to look beyond the short term, and to have in place plans to move to a more neutral stance over the medium term in order to safeguard their fiscal space to deal with future shocks and to maintain policy credibility and effectiveness.