The IMF On Asia’s Near Term Prospects

Naoyuki Shinohara, the Deputy Managing Director of the IMF on Asia (excerpt; emphasis added)

Will Asia Remain Resilient to Global Economic Headwinds? Near-term Economic Prospects and Risks

As you know, external factors have played a major role in Asia, while domestic demand so far has remained fairly resilient. Spillovers from Europe have caused a marked export slowdown, as well as in a decline in net capital inflows despite their most recent rebound.

However, financial markets stress today is lower compared to about a year ago. In particular, a number of steps have been taken by Euro area officials, and a number of important announcements have been made, that have helped stabilize the situation...

...Given the promising decisions in Europe, and assuming they are implemented and deepened, our baseline is that growth in Asia will start to pick up gradually, but we are still assessing the weak recent indicators, which suggest a delayed and more gradual pick-up. This baseline also reflects accommodative policy stances. Indeed in many Asian economies real interest rates are still lower, and structural fiscal deficits larger, than before the global crisis…

…The most immediate risk to the outlook is that of heightened spillovers from a further escalation of the euro area crisis. Asia’s economic linkages with Europe imply that such spillovers could be considerable, especially if a generalized flight away from risk was also to occur…

…In addition to financial linkages, Asia’s strong dependence on exports implies that it could be substantially impacted by a sharper than forecast recession in the euro area…

…Another risk is the so-called US “fiscal cliff”, which refers to the major forthcoming fiscal tightening implied by existing budget law…

…Taking a step back, perhaps the biggest risk to the global economy today is what I will call the risk of a “muddle through”, that is the risk that policies do not fully address the problems in advanced economies, be it in Europe or the US, and the risk that such partial solutions create an extended period of slow growth with a negative impact on employment, incomes and poverty…

…Asia may be better able to withstand the above risks today than it was in the past thanks to improved fundamentals.

In many Asian economies, including those hit hard during the Asian financial crisis of the late 1990s, firms and banks have drastically reduced their leverage…

…Together with healthier bank and corporate sector balance sheets the reliance on foreign funding has also been reduced…

…But while fundamentals are stronger, there are new potential sources of vulnerability stemming from Asia’s greater interconnectedness with the rest of the world. For instance, foreign participation in local government bond markets has increased rapidly, such as in Indonesia and Malaysia; this benefits domestic financial conditions but also increases exposure to risks from a sudden shift in investor sentiment.

There are also social vulnerabilities, which have grown with rising income inequality across the Asia region. Although the region has enjoyed rapid growth over the last decade, and levels of absolute poverty have fallen sharply, growth has not been sufficiently inclusive.

This is in contrast to other emerging market regions, where income inequality has fallen…

…The main near-term challenge for policy makers is to support growth while minimizing legacy risks from past stimulus and rebuilding policy space…

…And should severe downside risks materialize there is overall ample space to ease monetary and fiscal policies aggressively, along with a range of measures aimed at stabilizing financial systems such as those taken during the global financial crisis…

…The best form of insurance against external risk remains strengthening domestic sources of growth. In that regard economic rebalancing, the topic of this year’s Conference, remains a policy priority for much of Asia.

Boosting intraregional trade could also help dampen the propagation of external shocks throughout the region, especially if horizontal trade benefited…

…Greater regional financial integration, which is currently lagging the degree of trade integration, could also make Asia more resilient…

…In fact, IMF research finds that so far, many of the more advanced Asian economies share financial risks, as reflected in the term structure of bond markets, substantially with the United States, but much less so with other Asian economies.

Second, deeper financial integration with better access of consumers and investors to financial services would also strengthen domestic demand in the region and support economic rebalancing.

There are quite a few interesting points here, though of immediate interest is the perspective on Europe – things aren’t as bad as they were a year ago. Some progress is being made towards resolving both the European debt problem and the Euro’s inherent institutional inconsistencies.

I’m not fully convinced of the long term viability of the Euro experiment, but it has to be said that the climate of fear and uncertainty isn’t as acute as it was in the latter half of 2011 when Europe was threatening to drag the global economy was threatening to go into a double dip recession.

For Asia, the point was also made that we are far less vulnerable than we were before the Asian Financial Crisis of 1997-98. Private and financial sector balance sheets are in much better shape, even if households aren’t.

The main source of vulnerability today is really inward capital flows, with the concomitant risk of a “sudden stop” reversal of these flows hitting domestic financial markets. But even here, “insurance” in the form of international reserves and reduced financial system exposure reduces the risk of a sudden drop in liquidity.

I do like the consistent message that the IMF and the World Bank have lately emphasised regarding tackling income inequality in Asia. Most Asian governments are giving this issue lip service – at best.

In Malaysia, we’ve made some moves towards addressing this issue, but not nearly enough to make a dent in the problem. Tackling poverty is one thing, but to restructure the distribution of wealth and income requires a whole lot of communicating on the issue and some pretty drastic measures, which I don’t see being done. We’re not going to get substantive changes otherwise.