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IMF Survey : Asia and Pacific: Still Going Strong, Says the IMF

October 10, 2014

  • Steady economic outlook for Asia and Pacific helped by supportive policies, accommodative financial conditions
  • Risks include abrupt tightening of global liquidity, stretched real estate markets, lower potential growth
  • Call for policymakers to push forward with structural reforms, rebuild macroeconomic policy space

Asia’s growth has been disappointing in the first half of 2014, but the economic outlook for the region remains solid.

Man reflected in Shanghai stock exchange electronic screen.  Asia should benefit from the ongoing global economic recovery, suggests the IMF (photo: TPS/Top Photos/Corbis)

Man reflected in Shanghai stock exchange electronic screen. Asia should benefit from the ongoing global economic recovery, suggests the IMF (photo: TPS/Top Photos/Corbis)

REGIONAL ECONOMIC OUTLOOK

GDP growth is expected to reach 5.5 percent in 2014, ticking up slightly to 5.6 percent in 2015, say IMF economists in the latest Asia and Pacific Regional Economic Outlook Update.

The region’s economies should benefit from the ongoing global economic recovery, and still supportive financial conditions and policies.

The modest global recovery will provide a lift to Asia’s exports, while relatively low interest rates, strong credit growth, and high asset prices will continue to support domestic demand, say the report’s authors.

Downside risks, medium-term challenges

While the likelihood of sluggish global growth in advanced economies and emerging markets has increased, valuations in financial markets have been further stretched, reflecting still-abundant global liquidity and greater risk appetite by investors.

A disorderly reaction to the normalization of monetary policy in the United States remains an important risk, as it would likely lead to a spike in global interest rates and sharp reversals in capital inflows. This would contribute to bouts of asset price volatility and a likely decompression in term premia and spreads.

Geopolitical tensions could also disrupt trade and capital flows in the region, although Asia is less exposed to the Russia-Ukraine situation than some other regions.

In the near term, the region could also be adversely impacted by a sharper correction in stretched real estate sectors such as in China or less-effective-than-envisaged Abenomics in Japan.

In China, real estate has been a significant growth engine, but it has shown growing signs of imbalance and is undergoing a correction. This could affect real and financial activity, given significant linkages between housing finance and shadow banking.

More broadly, declines in house prices elsewhere in the region would also adversely affect activity and private consumption: IMF estimates suggest that a 5 percent decline in house prices could lower GDP (relative to the baseline) by an average of 1.3 percent after one year.

In Japan, delays in implementing structural reforms—the third arrow of Abenomics—could lead to slower potential growth, which could, in turn, adversely affect regional trade and growth prospects.

Growing medium-term risks compound the region’s challenges. For the region as a whole, potential growth has already declined and could weaken further, particularly if reform implementation is delayed, and the investment outlook remains subdued.

Protracted weaker global potential growth could have a further impact on Asia’s export growth prospects.

Rebuilding buffers, delivering on reforms

As U.S. long-term rates rose last year, economies with stronger fundamentals, or those that undertook significant adjustments to lower their inflation and external imbalances, benefitted from positive differentiation by global investors. Further strengthening fundamentals and rebuilding policy space will help weather future turbulence in global markets. The authors of the report note that reforms to boost potential growth can also contribute to lower near-term vulnerabilities.

Tighter fiscal and monetary policies needed

Policymakers in the region need to pursue gradual fiscal consolidation assuming the global recovery firms up as expected. The extent and pace of fiscal consolidation should be stronger where fiscal positions are weak and/or where output is close to, or above potential.

Many economies in the region should also start or continue a gradual tightening of monetary conditions. As in the case of fiscal policy, the recalibration toward tighter monetary policy will depend on country circumstances, including the current stance as well as inflation and growth developments.

Considering their generally accommodative stance and limited spare capacity, and in some cases to ensure inflation expectations remain well anchored, a few central banks in the region, such as Malaysia, the Philippines, and New Zealand, have started hiking interest rates.

By contrast, in a few other economies including Korea and Thailand, interest rates have been cut to raise growth. Japanese monetary policy should remain accommodative until inflation is consistent with the current target.

Policies to defend against capital flow reversals

Exchange rate flexibility should remain the first line of defense in the event of capital flow reversals. As seen in the aftermath of the “taper tantrum” in May of last year, flexible exchange rates have facilitated macroeconomic adjustment.

Foreign exchange intervention can continue to help limit excess volatility, and smooth the impact of large exchange rate changes on balance sheets. Exchange rate liquidity provision in the event of market dislocations should also remain in the toolkit.

Macroprudential measures should continue to be deployed to address financial stability risks, but should remain a complement rather than a substitute to policy adjustments and structural reforms, say the IMF in the report.

After several years of tightening, the stance of macroprudential policies is generally tight across Asia. But some further tightening could be warranted where financial risks, such as growing corporate and household leverage and their potential impact on bank balance sheets, continue to build up. Easing certain measures could be considered in the event of a downturn in the financial cycle.

Structural reforms to secure global growth leadership

Given the region’s need to maintain high and sustainable growth over the medium term, policymakers should push vigorously to implement reforms. As potential growth in some of the major economies in the region has deteriorated, the report calls for the full and swift implementation of the structural reform agenda, which will help secure Asia’s global growth leadership while also lowering the region’s vulnerabilities.

The reform agenda varies considerably across the region. China should implement its comprehensive reform blueprint to rebalance the economy and achieve sustainable growth, while many other emerging and frontier economies should prioritize reforms to boost productivity, including addressing long-standing supply-side bottlenecks and improving the efficiency of tax and public spending.

Recent and ongoing efforts to lower fuel subsidies in India, Indonesia, and Malaysia are encouraging. For Japan and Korea, the priority is to tackle inefficient services and address the distinction between secure permanent workers and vulnerable temporary workers, often referred to as the dualism in the labor market.