Asian economies: Managing spillovers and advancing economic rebalancing

The IMF’s recently released Asia and Pacific Regional Economic Outlook (REO) shows the region continuing to lead global growth and expected to gain momentum over the course of 2012. This forecast, however, remains subject to downside risks related to the global economy, including the possibilities of a sharp fall in exports to advanced economies and a reversal of capital flows, as well as commodity price shocks.

Global economic prospects have improved somewhat in 2012. After a sharp slowdown at the end of 2011, there is growing evidence that global activity is set to strengthen in the second half of 2012. Financial conditions have eased considerably and risk appetite rebounded in the first quarter after policymakers circumvented an imminent crisis in the euro area.

Growth in Asia is also expected to gain momentum over the course of 2012. Although activity slowed markedly across the region in the last quarter of 2011, mainly due to weakening external demand, domestic demand has generally remained strong.

In the first months of 2012, leading indicators of activity strengthened, inflation expectations picked up, and capital inflows into Emerging Asia rebounded. Growth for the Asia and Pacific region as a whole is projected to be at six per cent in 2012, broadly unchanged from last year, before rising to about 6½ per cent in 2013.

Nevertheless, the global economy remains fragile, and while there are upside risks to our central scenario, downside risks seem more pressing. The debt crisis in the euro area has not been fully resolved, and financial turmoil there could still escalate and spread globally, while increased geopolitical risks could push energy prices sharply higher.

So far, stronger fundamentals have helped buffer Asian economies against the global financial crisis, but a sharp fall in exports to advanced economies and a reversal of foreign capital flows would severely affect activity, while energy price shocks could slow growth and also contribute to inflationary and fiscal pressure.

Against this background, Asian policymakers face the difficult task of calibrating policies to support stable, noninflationary growth. Pausing the normalisation of macroeconomic policies when the global recovery stalled in late 2011 was fully warranted, but now, policymakers should be ready to shift gears and renew their tightening cycle as overheating pressures become evident. Of course, some economies can afford to pause longer than others, and similarly, the pace of fiscal consolidation should be calibrated to country-specific circumstances.

The best form of creating insurance against the risk of external shocks remains strengthening domestic sources of growth. China has already moved to lower trade surpluses, but sustainable rebalancing will require a successful transition from investment-led to consumption-led growth.

In India, improving the investment climate and infrastructure, and education, as well as facilitating trade and easing labour laws will be keys to maximising gains from its ongoing demographic transition. Among ASEAN economies, public infrastructure investment within appropriate medium-term frameworks would help crowd-in private investment and promote more broad-based growth while safeguarding fiscal sustainability.

Asian low-income and small island economies face particular challenges. In low-income countries, attracting foreign direct investment (including from other Asian economies) is critical. Island economies must improve resilience to adverse global economic spillovers and broaden sources of growth over the medium term.

In Sri Lanka, policymakers have recently introduced a series of measures — including a move to exchange rate flexibility and a tightening of both monetary and fiscal policy — to control the current account deficit and stem the loss of Central Bank reserves, which occurred at a relatively rapid pace in the second half of 2011.

Growth, which topped eight per cent in 2010 and 2011, is expected to slow down as a result, perhaps to around seven per cent — still higher than in Asia as a whole — and inflation will rise, while remaining in the single digits. But these are appropriate tradeoffs to make to strengthen the underpinnings of the Sri Lankan economy and ensure that recent economic progress can be sustained over the long run.

Looking forward, we see bright prospects for the Sri Lankan economy, provided sensible policies continue to be pursued. There is a need to allow exchange rate flexibility, maintain a prudent fiscal and monetary stance, strengthen the performance of SOEs, improve the business climate, increase infrastructure investment (particularly from the private sector), invest further in education and training and develop the corporate bond and equity markets.

And while many Asian countries need to focus more on developing domestic demand, in Sri Lanka we would point to the need to arrest the decline of exports, which have shrunk relative to GDP since the late 1990s. Enhancing regional integration seems especially important since, by developing export markets in Asia, Sri Lanka can capitalise on the region’s fast growth.

The IMF stands ready to assist Sri Lanka as it moves to realise its enormous potential.



(The writer is Director, Asia Pacific Department – International Monetary Fund.)