Press Release No. 10/193

Press Releaes: IMF Says Asia Leading World Recovery, Cautions Against External Risks

May 12, 2010

Asia is leading the recovery of the world economy even though the region needs to remain attentive to downside risks, the International Monetary Fund (IMF) said today in New Delhi in its presentation of the Regional Economic Outlook (REO) for Asia and the Pacific. The IMF also said India is likely to maintain its strong growth momentum driven by the robust domestic demand. Higher corporate profitability and favorable financing conditions in the country will support its private investment while its consumption growth will also remain strong on the back of better employment prospects and lower uncertainty.

“One year after the deepest recession in recent history, Asia is leading the global recovery,” said Anoop Singh, Director of the IMF’s Asia and Pacific Department, at a seminar presentation hosted by Indian Council for Research on International Economic Relations (ICRIER). “Key economic indicators are now growing at or above long-term trends not only in China, but also in emerging Asia’s other economies with a large domestic demand base, like India and Indonesia.” Underpinning Asia’s strong performance are two factors. First, the global and domestic inventory cycle is likely to boost Asia’s industrial production and exports further for most of 2010 as final demand recovers in advanced economies. Second, although macroeconomic policies may become less accommodative in the region, private domestic demand is expected to remain robust thanks to sustained consumer confidence, high asset values, and a return of capacity utilization to more normal levels.

Risks to the baseline forecasts, however, remain tilted to the downside, the REO cautioned. They include the still fragile global recovery and Asia’s strong dependence on external demand. The regional report also noted that a more immediate risk is that market concerns about sovereign liquidity and solvency in the euro zone periphery may turn into a potentially contagious sovereign debt crisis. While Greece’s sovereign debt situation has so far not had a major impact on flows to the region, “the increase in global risk aversion and renewed pressures to deleverage could pose particular risks to Asian corporates and banks” that face relatively higher refinancing needs than in other regions, the report noted.

Asia’s relatively strong cyclical position may also ironically pose near-term risks to the outlook, the REO said, in particular if brighter growth prospects and widening interest rate differentials with advanced economies lead to further capital inflow to the region. “This could lead to overheating in some economies and increase their vulnerability to credit and asset price booms with the risk of subsequent abrupt reversals.” While asset-price inflation in Asia has “so far been generally contained,” policymakers “will need to be attentive to safeguarding the macroeconomy and financial system against the buildup of imbalances in local asset and housing markets,” the report warned.

The key near-term challenge for policy makers is, therefore, judging the appropriate pace for normalizing monetary and fiscal policy, the report said. On the monetary policy, policymakers will need to consider: the degree of monetary accommodation that is still in place; the pace at which output gaps are closing; and the emergence of inflationary pressures in a few regional economies, including India. On the fiscal front, policy is expected to remain accommodative in most of Asia, despite the planned withdrawal of part of the fiscal stimulus during the crisis in many regional economies. As few Asian economies face debt sustainability challenges of the same order than in many advanced economies outside the region, and given the still significant downside risks to the outlook, maintaining targeted fiscal measures would appear to be a relatively affordable form of risk management. At the same time, the report stressed, “it is important to ensure that fiscal policy is expected to move to a more neutral stance over the medium term,” in order to help safeguard fiscal space to deal with future shocks, as well as provide greater policy credibility and effectiveness of the current stimulus and reduce negative spillovers from higher debt in advanced economies—in particular from an increase in long-term interest rates.

Over the medium term, Asia’s main policy challenge will remain to achieve a rebalancing of growth from external to domestic sources, the report noted. Giving a closer look at the issue, Chapter III, entitled “Does Asia Need Rebalancing?”, concluded that rebalancing efforts by Asia toward domestic demand will require many regional economies to act across a range of areas. “Some economies may need to increase consumption, others will need to increase investment, and many will need to boost productivity in service sectors,” the report said. “A comprehensive package of measures adopted in the region—including fiscal measures, reforms in product, labor, and financial markets and more exchange rate flexibility—will crucially contribute to the rebalancing of global demand.” As for India, with demand already well balanced between external and domestic sources, the country would benefit from financial reform and fiscal consolidation to catalyze private sector participation in infrastructure investment and support faster growth, the report noted.