1. The recovery in advanced economies is more sluggish than anticipated at the time of our April 2011 REO, and the global outlook has become increasingly uncertain. The handover from public stimulus to private demand has stalled in the United States, and euro area financial turbulence has intensified. While the outlook for advanced economies is for a continuing, though weak, expansion over the remainder of 2011 and 2012, the risk of a renewed slowdown has increased.
2. Growth in Asia also has moderated since the second quarter of 2011, mainly as a result of weakening external demand. Domestic demand has been generally resilient, and overheating pressures remain elevated in a number of economies, with credit growth still robust and inflation momentum generally high. In line with the weaker global outlook, growth in Asia is expected to be around 6½ percent in 2011-12, slightly lower than forecast in April 2011, but still healthy on the back of domestic demand. Inflation is expected to recede modestly after peaking in 2011. Risks for the region are clearly tilted to the downside: an escalation of euro area financial turbulence and a renewed slowdown in the United States could have severe macroeconomic and financial spillovers to Asia.
3. The downside risks to growth amid persistent overheating pressures present Asian policy makers with a delicate balancing act. In economies where overheating pressures are more elevated and monetary conditions still accommodative, the return to more neutral monetary stances should continue. However, in economies where inflation has abated and exposure to external shocks is greater, a pause in monetary tightening may be warranted until global uncertainties have lessened. Meanwhile, the normalisation of fiscal policy stances should run its course, though, if downside risks materialise, Asian economies would have the space for stimulus.
4. The weakness in global demand confirms that many countries in Asia would greatly benefit from further progress in rebalancing growth by developing domestic sources of demand. In addition to structural reforms, this would require a reprioritisation of fiscal spending toward critical infrastructure investment and social priority expenditure, which would help increase domestic demand over time, increase resilience to shocks, and make growth more inclusive. Measures that deepen regional financial integration would also help rebalancing, by improving access to finance and strengthening domestic demand.
5. Asian low-income and Pacific Island economies face particular challenges in the near and medium term. In low-income countries, the fight against inflation is complicated by strong second-round effects, the need to phase out subsidies, and less well anchored inflation expectations. Pacific Island economies need to undertake further structural reforms to lift potential growth.
6. In Sri Lanka, by contrast, the economy continues to grow rapidly, at an expected 7½ per cent pace this year. Inflation has moderated along with food prices. Credit is growing fast — at some 35 per cent year-on-year — but this is from a low base, and the authorities are closely monitoring any signs of overheating pressures, suggesting that the monetary stance remains appropriate. The current account deficit, however, continues to widen, led by strong imports, and while gros s reserves are still healthy, non-borrowed reserves still need to be restored. The 2011 fiscal deficit target of 6¾ percent of GDP remains broadly within reach, and the authorities plan a further reduction in the deficit next year, although. High oil prices and the recent lack of rains are burdening the State energy enterprises.
7. Looking forward, with continued sustainable policies, we see bright prospects for the Sri Lankan economy. There is a need to maintain prudent fiscal and monetary policies, 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 steadily shrunk relative to GDP since the late 1990s. Flexibility in the exchange rate is an essential component in helping export competitiveness. Enhancing regional integration seems especially important since, by developing export markets in Asia, Sri Lanka can capitalise on the region’s fast growth. And in that connection, both the Government’s ‘five-hub strategy’ and the proposed Comprehensive Economic Partnership Agreement with India are key priorities.
8. The IMF remains committed to supporting the Sri Lankan authorities in whatever way is deemed most helpful when the current Standby Arrangement expires in May 2012. And throughout the region, we remain committed not just to offering lending support where needed, but also to continuing our surveillance of individual countries and our analyses of cross-country effects and spillovers.
(The writer is Director, Asia Pacific Department of the International Monetary Fund.)