Asia: Stabilising & Outperforming

Asia and the Pacific are doing well, with the region expected to remain the world’s growth leader. This contrasts with the global economic landscape, where growth remains uneven against a backdrop of falling oil prices, sharp variations in exchange rates of major currencies and potential financial market volatility. 

While momentum in advanced economies has picked up, several major emerging markets have lost steam. The prospect of a “new mediocre” for the world economy lingers, with medium-term forecasts being marked down again and potential growth constrained.  

According to the IMF’s latest Asia and Pacific Regional Economic Outlook, growth in the region is expected to hold steady at 5.6% in 2015, easing slightly to 5.5% in 2016. Domestic demand is forecast to remain strong, supported by healthy labour market conditions, historically low interest rates, and more recently, the fall in oil prices. Exports will continue to benefit from the recovery in advanced economies and weaker exchange rates in some economies, despite the slowdown in some major emerging markets and the trend decline in exports’ responsiveness to partner country demand, reflecting greater on-shoring of production. 

Growth momentum in the largest economies in Asia and the Pacific, while good overall, is expected to remain mixed. China’s economy is slowing to a more sustainable pace, with GDP projected to expand by 6.8% in 2015 and 6.3% in 2016 as the correction in the real estate sector continues to compress investment. 

Growth in Japan is expected to recover to 1.0 percent in 2015 and 1.2 percent in 2016, buoyed by consumption and exports. Thanks to recent policy reforms and lower oil prices, India will be one of the fastest growing economies in the world, expanding by 7.5 percent in 2015 and 2016.

Across most of the region, lower commodity prices are expected to boost incomes and reduce inflation, although commodity exporters such as Australia, Indonesia, and Malaysia will be adversely impacted. 

Sharp exchange rates swings in advanced economies reflecting in part divergent monetary policies are also being felt within the Asia and Pacific region. While commodity exporters have seen their currencies depreciate sharply against the US dollar, other currencies have weakened by considerably less or remained stable. These diverse exchange rate movements may create a dilemma for some policymakers seeking to balance competitiveness considerations with financial stability concerns arising from the build-up of foreign-currency-denominated debt during the past few years. 

However, downside risks could cloud this positive regional outlook. Lower-than-expected growth in China and Japan could spill over to other economies in the region. Volatile global financial conditions could be disruptive, particularly where debt levels are high. In addition, potential growth has moderated across much of the region, reflecting weaker productivity gains and labour force aging. On the upside, lower energy prices could present a larger boost to growth while also creating room for fiscal reforms, as we have already seen in a number of countries. 

Sri Lanka’s faces many of the same external risks with other emerging market countries, although its exposure to financial market volatility is more limited. The slowdown in fiscal consolidation, combined with lower investment, and an element of “policy drift” with respect to economics in the midst of the current political transition adds a layer of uncertainty to prospects for 2015.

In view of Asia and the Pacific’s outlook and risks, what policies are warranted? Given the wide diversity across the region, no “one size fits all” advice holds. In general, current settings for policy interest rates are broadly appropriate given prevailing economic conditions and inflation rates. 

Going forward, though, higher policy rates may be needed in some cases in the event of capital flow reversals to reinforce external stability. In Japan, where interest rates are already close to zero, aggressive stimulus through quantitative and qualitative easing should continue, in order to achieve positive inflation on a durable basis, accompanied by progress on structural reforms.

In countries where public and private debt is high, gradual fiscal consolidation would strengthen resilience. The decline in oil and food prices provides an opportunity to phase out budget subsidies and make room for infrastructure and social spending, including on health and education that can also help reduce income inequality. Macroprudential policies should address financial stability risks, and foreign exchange intervention could be considered to smooth excessive currency volatility. 

Potential growth has slowed across much of Asia. The decline reflects primarily decelerating total factor productivity, which may be attributed in part to slowing gains from participating in global value chains. An analytical chapter of the ‘Regional Economic Outlook’ explores how structural reforms can help increase Asian economies’ share of the global value chain pie. Sri Lanka is already well-integrated into global value chains for apparel and garments, but could move further up the ladder in this and other areas through workforce development, deeper trade integration (through bilateral, regional, or multilateral trade initiatives), and a renewed commitment to sound medium-term macroeconomic policies that would support a more substantial level of foreign and domestic investment. 

Over the medium term, Asia would also benefit from deeper intra-regional financial integration, which has lagged trade integration. Furthering financial integration holds the promise of a more efficient allocation of regional savings to meet the Asia’s large investment needs while also supporting financial inclusion. 

The writer is the IMF Mission Chief for Sri Lanka.