Asia: Sailing in turbulent times

Sri Lanka’s near-term prospects hinge most critically on its own policies rather than external factors alone

By Todd Schneider and Eteri Kvintradze

Asian economies are sailing in choppy waters, facing severe headwinds from an uncertain and challenging global environment, but the region also has many strong points in its favour.

The global recovery has been uneven and weaker than expected. On top of that, global trade has been sluggish and financial conditions have been volatile. The rise of China as a global economic superpower has also created challenges of its own, as China’s necessary rebalancing from manufacturing towards services and investment to a consumption-driven economy—critical for both China’s and global growth over the medium term—remains bumpy.

As elsewhere, many Asian economies face risks associated with natural disasters and geopolitical and domestic political uncertainty. But all is not the doom and gloom, as Asia also has considerable strengths on which policy makers can build. 

The region remains the major engine of the global economy: it continues to provide nearly two-thirds of global growth. In addition, the region has policy buffers such as current account surpluses and high reserve levels and has used macroprudential policies well to help bolster financial stability. It is also likely to benefit from further economic integration and regional and multilateral trade agreements such as the Trans-Pacific Partnership.

Asia’s growth is moderating slightly

Asia’s growth is moderating slightly, in line with the rest of the global economy. According to the most recent IMF World Economic Outlook, activity in the region moderated in the second half of 2015, and is expected to continue decelerating in the near term. 

GDP growth for the region is forecast at 5.3% in both 2016 and 2017, a meagre 0.1 percentage points lower than in 2015. In addition to weaker global growth and sluggish trade, the moderation in regional growth also reflects the ongoing necessary rebalancing in China. 

But while external demand is relatively weak, domestic demand, particularly consumption, is expected to remain resilient across most of the region. The relative strength of domestic demand is due to generally low unemployment, lower commodity prices (which is a boom to oil and commodity importers), economic stimulus in some countries, and ongoing secular trends, including steadily rising disposable income.

Important regional differences

The moderation in Asia’s growth masks important differences within the region. In China, GDP growth is expected to continue to moderate to 6.5% this year and 6.2% in 2017. This reflects ongoing rebalancing and other structural reforms, which are expected to continue to boost consumption and the services sector, while investment and manufacturing remains relatively weak until excess capacity is resolved. 

India, on the other hand, is expected to remain the fastest-growing large economy in the world, with GDP expanding by 7.5% in 2016-17, underpinned by strong private consumption and helped by lower oil prices. In Japan, GDP growth is projected to remain at 0.5% in 2016, slowing to -0.1% in 2017 as the widely anticipated consumption tax rate hike (from eight to 10%) kicks in, though this forecast does not incorporate likely offsetting measures to support activity. Indonesia, which is exposed to commodities, is expected to benefit from a large infrastructure push. 

Sri Lanka’s near-term prospects hinge most critically on its own policies—the implementation of a clear and consistent set of macroeconomic policies, supported by a market-oriented structural reform agenda—rather than external factors alone.

  

Downside risks dominate

Despite a robust outlook, downside risks continue to dominate the economic landscape. Global growth could slow by more than expected or financial conditions could tighten suddenly. 

As many economies in the region have seen debt levels rise rapidly over the last decade, a combination of slower growth and higher borrowing costs could tip some corporates and households over the edge and further constrain growth. 

China to the fore

In addition, regional growth is more dependent on China than ever before, which presents both challenges and opportunities. While rebalancing in China is a price worth paying for in terms of durable and resilient growth over the longer term, the short-term transition is likely to be bumpy and the impact on countries and markets is likely to vary. 

Countries that export goods that support China’s investment and construction (producers of metals, for example) would be adversely affected, while others that export consumer goods to China or are destinations for rapidly-growing Chinese tourism could benefit. In addition, China’s move to higher value-added production will provide opportunities for low-income Asian countries, particularly in labour-intensive sectors, such as apparel, footwear, furniture, and plastic toys. Already Bangladesh, Cambodia, and Vietnam have seen market share gains in these sectors. 

Financial linkages are also growing with regional markets becoming more sensitive to shocks from China after the global financial crisis. Over time, though, as economic rebalancing makes China’s growth model more resilient and sustainable, the region is likely to benefit. 

Harnessing potential for Sri Lanka via policies

A wide-range of policies can be used to harness the region’s potential. For Sri Lanka, the first order of business is to push forward with a coordinated set of macroeconomic policies to reduce the fiscal deficit, lower public debt, and restore equilibrium to the balance of payments. 

With macro stability in place, Sri Lanka will have the room to address long-standing bottlenecks to higher growth. Structural reforms will be key to supporting economic transitions and the emergence of new growth models. This will bolster Sri Lanka’s potential growth, and ultimately, strengthen resilience to global shocks. 

Structural reforms and policies, particularly fiscal policy, should also tackle long-standing challenges, such as rising inequality, which will help make growth more inclusive. The key in this regard is to provide equality of opportunities, in particular to broaden access to education and health and promote financial and gender inclusion.

Todd Schneider is the IMF Sri Lanka Mission Chief and Eteri Kvintradze is IMF Resident Representative in Sri Lanka