The Global Turmoil Has Led to Significant Equity Declines

Asian equity markets have been hit hard this year by the global turmoil. Contrary to 2007, when Asian equity markets were the top performers, share prices this year have fallen sharply, as the growth outlook for the region has weakened. The MSCI emerging market Asia index has declined in line with other regions, falling by 49.6 percent from end-2007 to October 2008, compared to 34.1 percent for the United States, 58.5 percent for emerging Europe, and 41.3 percent for emerging Latin America. The equity declines have been led by heavy net selling, primarily by foreigners, but in some cases, such as in China, also by local residents (Figure 1A.1). From August 2007 through October 2008, net equity outflows amounted to US$160 billion, while Asia-focused hedge funds were the worst performers worldwide, with their returns consistently below those of other emerging market funds. With redemption pressures rising, the loss of several key prime brokers, and the recent bans on equity short selling (including in Australia, Korea, and Taiwan Province of China), hedge funds, including those in emerging Asia, remain under intense pressure to deleverage and reduce positions.

External Financing Is Likely to Remain Tight

With the rise in global risk aversion, external financing conditions have tightened substantially. Since June, CDS spreads for Asian sovereign, corporate, and financial borrowers have widened in line with global trends. For a number of countries, basis spreads for cross-currency swaps have also increased, reflecting both increased counterparty risk and heavy demand for U.S. dollar liquidity (Box 1.1). The cost of wholesale financing, particularly on external debt, has risen significantly. This has affected all countries that have made use of such funding (notably Australia, Korea, and New Zealand). With U.S. dollar and euro bond markets affected by the global credit squeeze, corporates in Asia have increasingly turned for alternative financing to the samurai bond markets in Japan, as well as the Malaysian ringgit market, but these markets have also dried up with the distress among major global banks that serve as key underwriters.

Box 1.1.

The Widening of Basis Spreads in Asia

Cross-currency basis swap spreads (“basis spreads”) have widened for a number of Asian currencies, reflecting market stress over and beyond the volatility signaled by spot exchange rates. Basis spreads provide a useful indication of market funding pressures, and the recent negative shift suggests greater difficulties in obtaining U.S. dollar funding in the midst of the global credit crisis.

What Are Basis Spreads?

Basis spreads measure the deviation between the market interest rate and the interest rate implied by spot and forward exchange rates. For example, if one-year interest rates in the United States and Japan are 4 percent and 1 percent, respectively, the spot exchange rate is ¥103 to the dollar, and the one-year forward exchange rate is ¥100 to the dollar, then the basis spread is zero. The 3 percent interest rate advantage for the U.S. dollar matches the expected 3 percent appreciation of the yen, and the Japanese market interest rate is equivalent to that implied by the forward and spot rates.¹ In practice, however, the forward exchange rate is likely to entail a nonzero basis spread and would then represent riskless profit that would be available to an arbitrageur with no transactions costs and full access to all interbank markets.

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Example of a Cross-Currency Swap

Note: Initial exchange of principal is made at the prevailing spot rate.

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Basis spreads can also be calculated from cross-currency swaps, where parties exchange regular interest payments in two different currencies using the London Interbank Offered Rate (LIBOR) or a similar interbank benchmark rate. In a cross-currency swap, as opposed to a currency forward, the basis spread is generally quoted directly. In a basis swap—defined as a cross-currency swap in which the interest rates on both sides of the swap are floating and therefore not known in advance—the basis spread is quoted with respect to interbank rates as, for example, a five-year swap of floating yen against floating dollars at three-month yen LIBOR minus 30 basis points (the basis spread).² Cross-currency swaps are often used to borrow foreign currency, but the swaps themselves are not an original source of funding. For example, if a Korean firm wishes to obtain dollar funding using cross-currency swaps, it must first borrow in local currency, such as through the repo market, and then swap the proceeds into U.S. dollars. Although data are limited (as cross-currency swaps are traded mainly over the counter), cross-currency swap markets have emerged as important funding and/or hedging channels for both domestic and foreign players in Asia.

Why Do Basis Spreads Arise?

Nonzero basis spreads—representing a departure from a fundamental arbitrage condition—can arise for a number of reasons:

• Arbitrage constraints. The persistence of large spreads could indicate constraints on the free movement of capital. In the absence of capital account impediments, as with global currencies such as the euro or the yen, basis spreads rarely exceed 50 basis points. Basis spreads could thus be an indicator of currency pressures that are not being reflected in the spot market on account of capital account restrictions.

• Funding pressures. Just as basis spreads may signal demand for one currency, they may also reflect the difficulty of borrowing in the other currency in the swap or forward markets (i.e., relative shortage). Market volatility can also play a role in the widening of basis spreads.

• Counterparty risk. Concerns over the creditworthiness of a borrower would give rise to a risk premium in the basis spread. For example, during the banking crisis of the late 1990s, Japanese banks, with their lower credit rating relative to overseas banks, faced a premium in borrowing in foreign currency using cross-currency swaps.

• Foreign exchange intervention. Market intervention by a central bank can influence basis spreads, depending not only on whether the bank is buying or selling reserves, but also on whether the intervention is in the spot or forward market.

Basis Spreads in Asia Have Widened

In Korea, basis spreads have long been negative, mainly as a result of strong demand to hedge into domestic currency. Exporters, particularly shipbuilders, have sold U.S. dollars forward to domestic banks to hedge their long-term contracts. The banks in turn have hedged their exposure by borrowing U.S. dollars and exchanging them for won in the spot market. Since July 2007, Korean basis spreads have fluctuated widely (to as much as minus 400 basis points) during periods of financial stress when the onshore availability of U.S. dollars has dried up (consistent with the close correlation between Korean basis spreads and sovereign CDS spreads). Also, recent intervention through the foreign exchange swap markets may have widened the basis spread by driving up the forward rates relative to the spot rate.

Basis spreads in India have also widened amid greater volatility. Basis spreads in India have tended to persist, partly because of capital account controls that make cross-border arbitrage difficult. In early 2008, basis spreads widened to as much as minus 400 basis points as a result of an onshore shortage of U.S. dollars prompted in part by the earlier tightening of restrictions on external borrowing by Indian firms. Following a loosening of this restriction in May 2008, basis spreads narrowed but have remained negative, signaling continued U.S. dollar funding pressures.

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Cross-Currency Basis Spreads¹

Sources: Bloomberg LP; and IMF staff calculations.¹ Japan, Australia, and Korea are priced from 1-year basis swaps; India is priced from 3-month currency forwards.² Indian basis spreads are computed from 20-day moving average.

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In Japan, the widening of basis spreads reflects both U.S. dollar funding pressures and concerns over counterparty risk. Historically, yen–U.S. dollar basis spreads have been quite tight, reflecting the openness of Japan’s capital account. However, in October, one-year basis spreads widened to as much as minus 70 basis points, reflecting both growing U.S. dollar funding pressures onshore and Japanese banks’ concerns over the creditworthiness of foreign banks using swaps as a source of U.S. dollar funding. In April 2008, after the collapse of Bear Stearns, basis spreads for longermaturity yen-dollar swaps, such as for 10 years, swung in the opposite direction, turning sharply positive, by as much as 50 basis points, as foreign banks scrambled to repay yen obligations through the swap market as the exchange rate surged to a 13-year high of ¥96/U.S. dollar. This development stood in contrast to the “Japan premium” of the late 1990s and early 2000s, when Japanese banks had to pay a premium on their U.S. dollar borrowing from foreign banks on account of Japan’s lower credit rating.

Note: The main author of this box is Chris Walker. ¹This is equivalent to covered interest parity, that is, (1 + i) = (1 + i*)(S/F), where i is the U.S. dollar interest rate, i* is the local currency interest rate, S is the spot exchange rate in units of local currency to the dollar, and F is the forward rate. The basis spread can be thought of as the measured deviation from covered interest rate parity. ²In other words, Bank B lends yen at 30 basis points below yen LIBOR to Bank A, and Bank A lends dollars at the current dollar LIBOR rate to Bank B.

Emerging Asia private external financing (bond, equity, and loan issuance) has fallen steadily this year, reaching only US$137 billion through the third quarter of 2008, compared to US$211 billion over the same period last year (Figure 1.9). In addition, the domestic initial public offering (IPO) market, such as that in Hong Kong SAR, has collapsed (Figure 1.10). As funding has become more difficult, Asian corporations have delayed new bond issuances, refinanced at short maturities, or turned to local banks. If current trends continue, corporations are likely to face greater scrutiny of their ability to refinance their obligations, particularly during 2010–2012, when more than half of corporate bonds are estimated to fall due (Figure 1.11). Countries with sizable short-term external debt will also face greater difficulties in refinancing.

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Asian External Financing: Bond, Equity, and Loan

(In billions of U.S. dollars)

Sources: IMF, Bond, Equities, and Loans database; and Dealogic.

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Hong Kong SAR: Stock Market IPO

(In billions of Hong Kong dollars)

Source: Hong Kong SAR Securities and Futures Commission.¹ Shares of companies incorporated in mainland China that are traded on the Hong Kong Stock Exchange.

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Emerging Asia: Amount of Maturing Corporate Debt, 2008–2018

(In billions of U.S. dollars)

Source: Morgan Stanley.Note: Includes bonds and loans.

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Capital Flows Are Likely to Remain Volatile

Portfolio outflows this year have significantly weakened currencies in some countries. In general, countries with projected current account deficits for 2008 have experienced much larger depreciations in nominal effective terms (Australia, India, Korea, New Zealand, and Vietnam), while surplus countries, like China, Japan, and Singapore, have seen their currencies gain (Figure 1.12). Several countries in the region have experienced substantial reserve losses as they have intervened in the markets to support their currencies in the face of capital outflows (Table 1.1).¹ Amid increased volatility, yen carry trades have also declined.

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Current Account Projections versus Change in Nominal Effective Exchange Rate (NEER), 2008

Sources: CEIC Data Company Ltd; and IMF, WEO database.

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Table 1.1.

Asia: Official Reserves

(In billions of U.S. dollars, end-period)

Source: CEIC Data Company Ltd.

¹October data except for the following countries, for which data end in September: Australia, China, Hong Kong SAR, New Zealand, and Vietnam.

Table 1.1.

Asia: Official Reserves

(In billions of U.S. dollars, end-period)

			2006	2007	2008 October1
Industrial Asia			964	1,018	1,021
	Japan		895	973	978
	Australia		55	27	29
	New Zealand		14	17	15
Emerging Asia			2,477	3,259	3,628
	NIEs		775	848	813
		Hong Kong SAR	133	153	161
		Korea	239	262	212
		Singapore	136	163	162
		Taiwan POC	266	270	278
	China		1,073	1,534	1,912
	India		177	275	258
	ASEAN-5		226	301	322
		Indonesia	43	57	51
		Malaysia	82	101	110
		Philippines	23	34	36
		Thailand	67	87	102
		Vietnam	11	21	24
Emerging Asia excl. China			1,405	1,725	1,716
Emerging Asia excl. China and India			1,228	1,450	1,457
Asia			3,442	4,277	4,649

Source: CEIC Data Company Ltd.

¹October data except for the following countries, for which data end in September: Australia, China, Hong Kong SAR, New Zealand, and Vietnam.

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Table 1.1.

Asia: Official Reserves

(In billions of U.S. dollars, end-period)

			2006	2007	2008 October1
Industrial Asia			964	1,018	1,021
	Japan		895	973	978
	Australia		55	27	29
	New Zealand		14	17	15
Emerging Asia			2,477	3,259	3,628
	NIEs		775	848	813
		Hong Kong SAR	133	153	161
		Korea	239	262	212
		Singapore	136	163	162
		Taiwan POC	266	270	278
	China		1,073	1,534	1,912
	India		177	275	258
	ASEAN-5		226	301	322
		Indonesia	43	57	51
		Malaysia	82	101	110
		Philippines	23	34	36
		Thailand	67	87	102
		Vietnam	11	21	24
Emerging Asia excl. China			1,405	1,725	1,716
Emerging Asia excl. China and India			1,228	1,450	1,457
Asia			3,442	4,277	4,649

Source: CEIC Data Company Ltd.

¹October data except for the following countries, for which data end in September: Australia, China, Hong Kong SAR, New Zealand, and Vietnam.

In this environment, capital flows are expected to remain volatile, driven both by changes in global risk aversion and by the growth outlook. Given Asia’s close financial integration and high foreign participation in local markets, a further deterioration in global sentiment could trigger further capital outflows and weaken currencies across the region.

Local Banks Have Gained Market Share, Including Overseas

The global credit turmoil has also provided opportunities for Asian financial institutions to expand their overseas investment and business. With their relatively strong capital positions, Asian financial institutions have actively participated in capital increases by their European and U.S. counterparts. Since mid-2007, total capital injections from Asia have reached almost US$57 billion, representing nearly 15 percent of the total capital raised by European and U.S. institutions. Asian sovereign wealth funds, especially from China and Singapore, initially led the way, but more recently they have been joined by large Japanese banks and securities firms.

At the same time, Asian banks have gained market share in the global credit markets as European and U.S. banks have pulled back. In particular, Japanese banks have expanded their overseas lending (growing more than 20 percent year on year), mainly in the form of syndicated loans (Figure 1.14). Looking ahead, the capacity of Asian banks to expand their overseas lending will depend in part on their capital positions and ability to access international financing and/or hedge their foreign exchange exposure.

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Overseas Lending by Japanese Banks

(Year-on-year percent change)

Source: Bank for International Settlements.

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With Commodity Prices Stabilizing, Inflation Pressures Are Expected to Ease

Headline inflation across the region has shown signs of moderating along with the recent declines in commodity prices. The main source of inflation over the past year has been higher food and fuel prices, which make up nearly 35 percent of the consumer price index (CPI) baskets (for emerging Asia), compared to 20 percent in the euro area and the United States (Figure 1.21). The sharp rise in global food and fuel prices explains nearly two-thirds of the recent rise in inflation, with the impact being greater for countries with higher CPI shares of food and fuel, particularly ASEAN-5 and low-income countries (Box 1.2). Some of the recent increases also represent greater pass-through of higher import prices from the reduction in fuel subsidies (India, Indonesia, Malaysia, Taiwan Province of China), as well as weaker currencies.⁵ However, inflation has shown signs of decreasing along with declining commodity prices. Sequential indicators of inflation (seasonally adjusted three-month moving averages) suggest that inflation has already peaked in many countries, notably in India and in China, where CPI inflation in September fell to around 4½ percent, mainly in response to lower food prices (Figure 1A.4).

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Food’s Contribution to Inflation versus Its Weight in CPI, August 2008

Sources: CEIC Data Company Ltd; country authorities; and IMF staff calculations.¹ Data for India refer to wholesale prices.

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Moreover, there are few indications of second-round price effects from the earlier commodity price run-up. Core consumer price inflation (excluding food and fuel) has increased for ASEAN-5 countries and India (6½ percent and 10 percent year on year, respectively, in September), but less so in China and the NIEs (Box 1.3). However, on a sequential basis, core inflation also shows signs of peaking (although less so than for headline inflation), while wage and employment growth appear to be weakening. Although still higher than at the beginning of the year, consensus forecasts for 2009 inflation have also stabilized and, for some countries, have started to decline.

Box 1.2.

The Impact of High Food and Fuel Prices in Low-Income Asia—Implications for Inflation, Poverty, and Policies

Despite their recent decline, food and fuel prices remain well above historical levels. High food prices have undermined past gains in poverty reduction throughout the region, jeopardizing the achievement of the Millennium Development Goals. Going forward, further easing in commodity prices is expected to reduce inflationary pressures and could help alleviate their impact on poverty in low-income Asia.

Impact on Prices

Inflation has been rising in low-income Asia. Fueled by spikes in commodity prices, headline inflation has picked up since end-2007. Inflation is for the most part imported, driven by sharp increases in food and fuel prices, whose impact has been magnified by their large share in the consumer price index. In addition, for low-income countries, much of the food basket includes products that are unprocessed or have little value added, resulting in a relatively high pass-through of imported food prices.

Some supply-side factors have added to inflation. Adverse weather in Bangladesh has caused substantial crop damage, while Pacific Island countries that rely almost exclusively on oil-based fuel for their energy needs face limited scope for substitution in production.

Domestic demand pressures have also played a role. Credit growth remains high in some countries (Cambodia, Lao People’s Democratic Republic, Papua New Guinea, and the Solomon Islands), while fiscal policies have turned expansionary in several economies (Bangladesh, the Solomon Islands, Sri Lanka, Timor-Leste, and Vanuatu).

Higher commodity prices have spilled over to core inflation. Second-round effects are emerging in Papua New Guinea, Sri Lanka, the Solomon Islands, Timor-Leste, and Tonga as higher costs for inputs (e.g., animal feed, fertilizer, and energy) have created upstream pressures on prices. Wage pressures also appear to be increasing in Papua New Guinea and the Solomon Islands.

Impact on Poverty

Inflation is of particular concern in low-income Asia because of its substantial social implications. Inflation, especially in food prices, increases income inequality by acting as a regressive tax that hits the poor the hardest (Easterly and Fischer, 2001). Because the poor do not generally have financial assets that provide an adequate hedge against inflation, and instead hold only cash and bank deposits, inflation can quickly erode their purchasing power.

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Low-Income Asia: Headline Inflation

(Year-on-year percent change)

Sources: Country authorities; and IMF staff calculations.¹ Includes countries for which monthly inflation data are available (Bangladesh, Cambodia, Fiji, Lao P.D.R., Mongolia, Nepal, Solomon Islands, Sri Lanka, Timor-Leste, and Tonga).

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Low-Income Asia: Food Inflation

(Year-on-year percent change)

Sources: Country authorities; and IMF staff calculations.Note: Data for 2008 refer to August, except for data for Papua New Guinea and Vanuatu, which refer to June.

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Core Inflation¹

(Year-on-year percent change)

Sources: Country authorities; and IMF staff calculations.¹ Quarterly data.

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The urban poor are most affected by high food and fuel prices, as the rural poor are more likely in the short term to be partially self-sufficient in food supplies (IMF, 2008b). However, those living in remote areas, especially landless farmers, are also highly exposed. Food-related expenditure represents a large share (about 50 percent) of household spending in low-income Asia. Higher expenditure on food crowds out spending on health and education and agricultural inputs, further undermining the needed supply-side response (Asian Development Bank, 2008a). Most low-income countries have only limited social protection systems to shield the most vulnerable segments of the population.

On balance, the empirical evidence suggests that the impact of food prices on poverty will be substantial in some low-income Asian countries. A World Bank study shows that the first-round effects of food inflation on urban poverty are higher than average in Bangladesh and Cambodia (Dessus, Herrera, and de Hoyo, 2008). For example, a 20 percent increase in the relative price of food is estimated to increase the poverty rate—defined as the proportion of the population below the “dollar-a-day” poverty line—by almost 6 percentage points in Cambodia and 5 percentage points in Bangladesh, compared to an average of 3.7 percentage points for the 20 most severely affected countries. The Pacific Islands are also at risk. According to the Asian Development Bank, a 10 percent reduction in real income of low-income households would bring an additional 5 percent of the population of the Pacific Islands below the poverty line in 2008 (Asian Development Bank, 2008b).

Countries’ Policy Responses

Responses to cope with high food and fuel prices have varied across low-income Asia. Most countries have allowed full pass-through of commodity price increases for gasoline, but in a few countries, pass-through has been incomplete. The pass-through of diesel and kerosene prices has been much lower, since typically kerosene and diesel carry higher subsidies than gasoline, reflecting their importance for poor households. In Bangladesh, fuel subsidies on kerosene and diesel remain substantial. Additional measures introduced to limit the impact of higher prices include

Low-Income Asia: Food Weight in the CPI Basket

(In percent)

Sources: Country authorities.

¹Includes tobacco and beverages.

Low-Income Asia: Food Weight in the CPI Basket

(In percent)

Bangladesh1	64.5
Cambodia	42.7
Fiji	35.4
Lao P.D.R.	40.9
Marshall Islands	46.7
Micronesia	45.5
Mongolia	41.1
Myanmar	68.3
Nepal	53.2
Papua New Guinea	40.9
Samoa	50.3
Sri Lanka	45.5
Solomon Islands	42.9
Timor-Leste	57.8
Tonga	44.4
Emerging Asia	31.3

Sources: Country authorities.

¹Includes tobacco and beverages.

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Low-Income Asia: Food Weight in the CPI Basket

(In percent)

Bangladesh1	64.5
Cambodia	42.7
Fiji	35.4
Lao P.D.R.	40.9
Marshall Islands	46.7
Micronesia	45.5
Mongolia	41.1
Myanmar	68.3
Nepal	53.2
Papua New Guinea	40.9
Samoa	50.3
Sri Lanka	45.5
Solomon Islands	42.9
Timor-Leste	57.8
Tonga	44.4
Emerging Asia	31.3

Sources: Country authorities.

¹Includes tobacco and beverages.

Impact of a 20 Percent Food Price Shock on Poverty¹

(In percent)

Source: Dessus, Herrera, and de Hoyo (2008).

¹Refers to a 20 percent change in the relative price of food.

²Average for the 20 most affected countries.

Impact of a 20 Percent Food Price Shock on Poverty¹

(In percent)

	Before shock	After shock
	Poverty rate	Change in the poverty rate
Bangladesh	8.7	5.0
Cambodia	25.1	5.8
Lao P.D.R.	2.7	1.0
Sri Lanka	0.6	1.2
Most-affected countries2	18.7	3.7

Source: Dessus, Herrera, and de Hoyo (2008).

¹Refers to a 20 percent change in the relative price of food.

²Average for the 20 most affected countries.

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Impact of a 20 Percent Food Price Shock on Poverty¹

(In percent)

	Before shock	After shock
	Poverty rate	Change in the poverty rate
Bangladesh	8.7	5.0
Cambodia	25.1	5.8
Lao P.D.R.	2.7	1.0
Sri Lanka	0.6	1.2
Most-affected countries2	18.7	3.7

Source: Dessus, Herrera, and de Hoyo (2008).

¹Refers to a 20 percent change in the relative price of food.

²Average for the 20 most affected countries.

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Low-Income Asia: Pass-Through of International Gasoline Prices¹

(In percent)

Source: IMF staff calculations.¹ Absolute change of domestic retail prices in U.S. dollars between September 2008 (or latest available) and end-2007 divided by the absolute change of world prices over the same period.

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• Import duty and tax cuts. Many countries have lowered import tariffs or introduced exemptions for tariffs on food staples (Bangladesh, Marshall Islands, Mongolia, the Solomon Islands, and Timor-Leste) and fuel (Fiji). Mongolia, the Solomon Islands, and Timor-Leste have also cut the sales tax.

• Price controls and subsidies to consumers. In Bangladesh, rice is being provided to the poor at subsidized prices. Fiji has introduced some price controls and delayed scheduled electricity tariff increases. In Timor-Leste, the government has spent more than 2 percent of gross national income on imported rice that is being resold with a 50 percent subsidy. The Lao People’s Democratic Republic introduced a reference rather than a market price on fuel products for assessing taxation, effectively turning ad valorem taxes into specific taxes.

• Assistance/subsidies to farmers. In Bangladesh, Cambodia, and Timor-Leste, the governments have ensured adequate availability of agricultural inputs, including seeds, fertilizer, and diesel to farmers. In Sri Lanka, subsidies on fertilizer have increased in 2008 and are expected to cost around 0.6 percent of GDP.

• Other measures. Bangladesh and Nepal have introduced a ban on rice exports. Food reserves have been built up in Bangladesh (rice), the Lao People’s Democratic Republic (rice), and Mongolia (meat). Two countries have promoted food self-sufficiency (Bangladesh and the Solomon Islands). In Bangladesh, existing safety net programs are being scaled up, and a new employment guarantee scheme and cash transfers have been introduced to help people in distressed areas.

Policy Responses to High Oil and Food Prices in Low-Income Asia

Sources: Asian Development Bank; World Bank; and IMF country desks.

Policy Responses to High Oil and Food Prices in Low-Income Asia

	Reduce import duties	Build reserves/stockpiles	Export restriction	Price controls/consumer subsidies	Assistance/subs idy to farmers	Promote self-sufficiency	Cash transfer
Bangladesh	X	X	X	X	X	X	X
Cambodia			X		X
Fiji	X			X
Lao P.D.R.	X	X
Mongolia	X	X
Myanmar				X
Nepal			X	X
Marshall Islands	X
Sri Lanka					X
Solomon Islands	X					X
Timor-Leste	X	X		X	X

Sources: Asian Development Bank; World Bank; and IMF country desks.

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Policy Responses to High Oil and Food Prices in Low-Income Asia

	Reduce import duties	Build reserves/stockpiles	Export restriction	Price controls/consumer subsidies	Assistance/subs idy to farmers	Promote self-sufficiency	Cash transfer
Bangladesh	X	X	X	X	X	X	X
Cambodia			X		X
Fiji	X			X
Lao P.D.R.	X	X
Mongolia	X	X
Myanmar				X
Nepal			X	X
Marshall Islands	X
Sri Lanka					X
Solomon Islands	X					X
Timor-Leste	X	X		X	X

Sources: Asian Development Bank; World Bank; and IMF country desks.

The monetary policy response has also varied across countries. Some tightening has taken place. In Sri Lanka, the central bank has slowed reserve money, mainly through the sale of government paper; Bangladesh raised its policy rates by 25 basis points in September. In Cambodia, the central bank doubled the reserve requirement for foreign-denominated deposits in June. Because most of the Pacific Islands economies either are dollarized or have pegged exchange rates, the exchange rate plays a minimal role in curbing imported inflation. In Papua New Guinea—a country with a more flexible exchange rate—the central bank has increased the policy rate three times since June, but real interest rates remain negative. The central bank of the Solomon Islands has introduced standing deposit facilities to mop up excess liquidity.

Inflation pressures pose special challenges to low-income countries. Ideally, targeted transfer programs—as part of an integrated social safety net—could reach the poor efficiently. In the absence of effective safety nets, a package of measures building on existing programs (e.g., school feeding programs, cash transfers to the most vulnerable populations, reduction in education and health fees, and public transport subsidies) could be identified. Ad hoc general increases in public sector wages or changes in the tax system to alleviate the effects of commodity price hikes are not well-targeted and should be avoided.

A more effective approach would include targeted demand- and supply-side responses, combined with donor support. In general, countries should allow full pass-through of higher food and fuel prices to domestic prices, while allowing for some time to adjust. Longer-term measures, such as in agriculture, rural transport, and other support services, can increase domestic supply and reduce price pressure. Donor support, preferably in the form of grants, would also help limit the harm to real incomes and poverty.

Note: The main author of this box is Patrizia Tumbarello.

Box 1.3.

Measuring Underlying Inflation Trends

The recent volatility in commodity prices has raised the issue of whether to use headline or core inflation in setting monetary policy. Headline inflation has the advantage of being simple, widely recognized, and more representative in terms of covering household spending. At the same time, it also suffers from a number of limitations in guiding monetary policy—most critically, its short-run sensitivity to nearly every kind of economic shock. In this sense, underlying inflationary pressures may be better captured by measures that strip out from headline inflation the impact of temporary shocks over which the monetary authority has no control.¹

The appropriate measure of core inflation ultimately depends on its purpose.² Commonly used measures of core inflation that exclude volatile price components, such as food and energy prices, have the benefit of being simple, timely, and independently verifiable. These measures are well suited for communicating inflation developments to the public and for anchoring expectations, but may not be ideal for guiding monetary policy, as their construction may not sufficiently capture underlying trends in future inflation. Theory-based measures, such as the model-based measure proposed by Quah and Vahey (1995) and the persistence-weighted approach suggested by Cutler (2001), attempt to extract the permanent component of inflation and thus may be more useful for forward-looking analysis. Ideally these alternative measures of core inflation should be (i) “unbiased” (on average, equal to headline inflation); (ii) “cointegrated” (i.e., core and headline inflation should converge over time); and (iii) an “attractor” for headline inflation (headline should converge towards core inflation but not vice versa; i.e., core should be a leading indicator for headline inflation). One important drawback, though, is that these measures are rather complex and require faith that the model used is the right one.

The figure on the next page plots headline and alternative measures of core inflation for four Asian countries that have experienced significant increases in inflation—India, the Philippines, Sri Lanka, and Vietnam.³ In all four countries, the resulting measures of core inflation differ, but overall show underlying inflation subsiding. In India and Vietnam, most core inflation measures show underlying inflation running below the headline figure, while in the Philippines and Sri Lanka, they are running above the official measure of core inflation.⁴ When the alternative measures are evaluated, the results do not suggest one dominant measure of core inflation, but rather that monetary authorities would benefit from examining a broad range of core indicators when judging underlying inflation trends.

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Core Inflation Measures

(In percent, annualized)

Sources: CEIC Data Company Ltd; Central Bank of Sri Lanka; and IMF staff estimates.Note: The wholesale price index is used for India. Trimmed mean measures trim the tails of the distribution of the price changes. Reported trimmed mean measures differ across the countries depending on their desired statistical properties.

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Note: The main authors of this box are Souvik Gupta and Magnus Saxegaard. ¹See Chapter 2 of this Regional Economic Outlook for a discussion of core versus headline inflation measures when exogenous shocks are persistent. ²See, for example, Roger (2000), Heath, Roberts, and Bulman (2004), Mankikar and Paisley (2004), and Silver (2007). ³These measures include (i) one that excludes the most volatile 10 percent of the components of the price index; (ii) one that trims parts of the tails of the distribution of price changes; (iii) one that reweights the components of the price index according to the estimated persistence of inflation; and (iv) one based on an approach by Quah and Vahey (1995) that identifies core inflation as that component of inflation that has no medium- to long-term impact on real output (i.e., movements in core inflation are output-neutral once financial and wage contracts have been written to take them into account). ⁴In the Philippines and Sri Lanka, the official measure of core inflation excludes food and energy components from headline CPI. These account for 54.6 percent of the total weight in Sri Lanka’s CPI and 18.4 percent in the Philippines.

For 2009, our baseline forecast is for inflation to moderate back to 2007 levels. A key component of our forecast is the IMF’s commodity price baseline, which sees prices stabilizing in 2009. On this basis, headline inflation in Asia is projected to ease from 6 percent in 2008 to around 3 percent in 2009 (Table 1.4). Inflation in emerging Asia is projected to fall to 4 percent in 2009, while for industrial Asia inflation will be lower, at about ½ percent. In Japan, falling commodity prices are likely to push headline inflation down, possibly even below zero for a brief period, but inflation is expected to return to positive levels once commodity prices stabilize. The risks of more entrenched deflation seem low, given the improved balance sheets of banks and corporates and the supportive actions taken by the government and the Bank of Japan.

Table 1.4.

Asia: Headline CPI Inflation

(Year-on-year percent change)

Sources: CEIC Data Company Ltd; Consensus Economics; and IMF, WEO database.

¹Wholesale price index data for India; 2008 and 2009 forecasts are on a fiscal year basis.

Table 1.4.

Asia: Headline CPI Inflation

(Year-on-year percent change)

		2007	2008	2009	2008	2009	2008	2009
			Latest projections		Difference from October WEO		Latest consensus
Industrial Asia		0.4	2.0	0.4	-0.1	-1.0	2.1	1.5
	Japan	0.1	1.4	-0.3	-0.1	-1.2	1.7	1.1
	Australia	2.3	4.6	3.6	0.1	0.0	4.5	3.2
	New Zealand	2.4	4.2	3.8	0.0	0.0	4.2	3.3
Emerging Asia		4.3	7.3	4.0	-0.4	-1.0	7.0	4.7
	Hong Kong SAR	2.0	3.9	2.7	-0.9	-1.6	4.8	3.9
	Korea	2.5	4.7	3.0	-0.1	-1.0	4.8	3.6
	Singapore	2.1	6.5	3.1	0.0	-0.1	6.4	3.0
	Taiwan POC	1.8	3.7	1.0	-0.5	-1.5	3.8	2.5
	China	4.7	6.2	3.4	-0.2	-0.9	6.4	3.6
	India1	4.7	10.1	4.3	-1.5	-1.7	7.8	6.6
	Indonesia	6.3	10.0	9.0	0.2	0.3	10.5	8.2
	Malaysia	2.0	6.0	4.3	0.0	-0.4	5.8	4.1
	Philippines	2.8	9.8	6.0	-0.3	-1.0	9.9	7.1
	Thailand	2.2	5.6	3.0	-0.1	-0.2	6.5	3.7
	Vietnam	8.4	24.0	15.0	0.0	0.0	23.8	12.9
Asia		3.3	6.0	3.1	-0.4	-1.0	5.8	3.9

Sources: CEIC Data Company Ltd; Consensus Economics; and IMF, WEO database.

¹Wholesale price index data for India; 2008 and 2009 forecasts are on a fiscal year basis.

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Table 1.4.

Asia: Headline CPI Inflation

(Year-on-year percent change)

		2007	2008	2009	2008	2009	2008	2009
			Latest projections		Difference from October WEO		Latest consensus
Industrial Asia		0.4	2.0	0.4	-0.1	-1.0	2.1	1.5
	Japan	0.1	1.4	-0.3	-0.1	-1.2	1.7	1.1
	Australia	2.3	4.6	3.6	0.1	0.0	4.5	3.2
	New Zealand	2.4	4.2	3.8	0.0	0.0	4.2	3.3
Emerging Asia		4.3	7.3	4.0	-0.4	-1.0	7.0	4.7
	Hong Kong SAR	2.0	3.9	2.7	-0.9	-1.6	4.8	3.9
	Korea	2.5	4.7	3.0	-0.1	-1.0	4.8	3.6
	Singapore	2.1	6.5	3.1	0.0	-0.1	6.4	3.0
	Taiwan POC	1.8	3.7	1.0	-0.5	-1.5	3.8	2.5
	China	4.7	6.2	3.4	-0.2	-0.9	6.4	3.6
	India1	4.7	10.1	4.3	-1.5	-1.7	7.8	6.6
	Indonesia	6.3	10.0	9.0	0.2	0.3	10.5	8.2
	Malaysia	2.0	6.0	4.3	0.0	-0.4	5.8	4.1
	Philippines	2.8	9.8	6.0	-0.3	-1.0	9.9	7.1
	Thailand	2.2	5.6	3.0	-0.1	-0.2	6.5	3.7
	Vietnam	8.4	24.0	15.0	0.0	0.0	23.8	12.9
Asia		3.3	6.0	3.1	-0.4	-1.0	5.8	3.9

Sources: CEIC Data Company Ltd; Consensus Economics; and IMF, WEO database.

¹Wholesale price index data for India; 2008 and 2009 forecasts are on a fiscal year basis.

Financial Conditions Will Likely Tighten Further

As noted earlier, financial markets in Asia are expected to remain closely tied to developments outside the region. Exceptional policy responses by both advanced and emerging economies have helped to stabilize market conditions, but the financial impact from the sharp global downturn and credit turmoil has yet to be fully felt, as global deleveraging and rising corporate defaults are likely to continue through next year. As a result, Asia’s financial markets will likely remain under stress from the global credit turmoil and slowdown and represent an important downside risk to our baseline forecast.

Risks to the Outlook Are Firmly on the Downside

As already noted and as shown in Figures 1.22 and 1.23, the risks to our baseline forecast for the region are significant and tilted firmly to the downside.⁶ The main downside risks are external—stemming from a sharper-than-expected global slowdown that would affect Asia’s exports and a protracted period of financial turmoil that would tighten both external and domestic credit conditions (Figure 1.23). On the upside, further declines in commodity prices could give a boost to domestic demand and help to reverse some of the trend deterioration in the terms of trade, while larger-than-expected policy stimulus cannot be ruled out at this stage.

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Asia: GDP Growth

(Central forecast and 50, 70, and 90 percent confidence intervals; in percent)

Source: IMF staff assessment of the balance of risks.

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Risk Factors

(Contribution to balance of short-term risks for Asia’s growth forecast)

Source: IMF staff assessment.

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The possibility of significant deviations from the baseline scenario are much greater than usual. A severe global recession that is deeper and more protracted than expected, combined with a significant global credit squeeze, would have significant spillover repercussions for Asia. Previous Regional Economic Outlook analysis has shown that, while spillovers from the United States to Asia have been modest on average, they have increased over time as a result of Asia’s increased trade and financial integration with the rest of the world.⁷ A larger-than-anticipated slowdown in China would also have a significant impact given the growing importance of intraregional trade. In this context, corporate distress in the region stemming from lower demand and tighter financial conditions could impair bank assets and feed into a vicious macro-financial circle.

Financial Policies to Safeguard Stability

Financial policies will need to focus on anticipating and addressing spillovers from tighter global financial conditions and domestic risks arising from weaker growth. Given the potential spillovers from individual country actions, financial policy coordination at the regional level may be more effective in stabilizing financial conditions. While precise policies will vary across countries, generally they should cover

• Strengthening crisis management frameworks. Failures of several large distressed institutions have raised concerns over potential exposures to other highly leveraged players, including those in Asia. Further defaults can be expected, and policymakers should review contingency plans, including addressing possible fallout in interbank markets and ensuring the adequacy of deposit insurance and public recapitalization schemes. Early disclosure of exposures can help ease market concerns and help investors differentiate across institutions (and countries).⁸ Greater cross-border collaboration among the relevant authorities would help strengthen monitoring of financial distress overseas, while in countries whose financial systems are closely interconnected, coordinated policy action would be more effective and help prevent “beggar-thy-neighbor” consequences that would harm other countries. For countries that have implemented or are considering blanket guarantees on bank liabilities, the schemes should have firm deadlines for expiring, be sufficiently funded and transparent to enhance credibility, and include safeguards, such as enhanced supervision and limits on deposit rates, to prevent unfair competition nationally and across borders. While blanket guarantees may support financial stability and be a necessary response to guarantees introduced in other regions, they should be viewed as a temporary, not a final, solution to provide time for a more fundamental resolution of banking difficulties.

• Enhancing liquidity risk management. Supervisors will need to ensure that banks have proper regulatory standards for liquidity risk management, such as through avoiding maturity mismatches, more extreme stress testing, and contingency planning in the event of an extended cutoff in external financing. Central banks should also consider reviewing the range of available liquidity instruments, including in foreign currency. Expanding the range of acceptable collateral and shifting to a regular auction-type facility for discount lending may help minimize the market stigma attached to emergency funding. Central banks should also consider contingency plans to expand access of their standing facilities to nonbanks, securities firms, and even nonfinancial corporations to address possible liquidity shortages.

• Protecting access to cross-border funding, including trade financing. Foreign exchange and cross-currency swap markets have emerged as important U.S. dollar funding and hedging channels for both foreign and domestic players and have come under stress during the current period of high risk aversion. At the same time, the cost of trade financing and the demand for letters of credit and trade insurance have risen as international banks have scaled back their overseas lending. To ensure adequate cross-border funding, regulators should review plans to provide emergency foreign financing to banks and other intermediaries, including through swap arrangements, or possibly extend guarantees to cover trade credits in the event of a temporary cutoff in financing.

• Promoting the smooth refinancing of maturing corporate and financial sector debt. Markets are likely to pay closer attention next year to the bunching of corporate bonds maturing starting in 2010. Countries with a banking system that relies on wholesale financing, especially short-term external debt, are also likely to continue to face repayment pressures. Collecting and disclosing information on the aggregate profile of maturing debt, particularly external debt, could help individual firms to manage their obligations better and alert banks to potential demands for short-term financing.

• Strengthening risk management. With growth slowing, corporate default rates and nonperforming loans within the region are expected to rise. Regional banks with exposures to sectors that are more vulnerable to a domestic slowdown, such as housing or small and medium-sized enterprises, may be at greater risk. Supervisors will need to ensure that local banks are properly classifying loans and setting aside adequate provisioning against problem loans. At the same time, Asian banks are helping to fill in the lending void created by the distress among major global banks. Having in place robust credit risk systems will help Asian banks to manage their growing overseas portfolios while guarding against possible risks.

• Standing ready to recapitalize banking systems if needed. At this stage, the possibility of a larger than expected wave of corporate defaults leading to bank failures cannot be ruled out. Authorities should thus consider contingency plans in the event that public funds are required to prop up the capital base of financial institutions.

• Implementing longer-term financial reforms. Although the crisis is still unfolding and its lessons still being learned, policymakers may take this opportunity to implement longer-term reforms that would strengthen their financial systems, such as those recommended by the Financial Stability Forum (FSF) and discussed in the IMF’s Global Financial Stability Report. For Asia, this would include addressing the procyclical risks from changes in leverage, further developing local bond and hedging markets, and enhancing the monitoring of systemically important institutions, including those outside the banking system.

Monetary Policy to Address Downside Risks to Growth

With the balance of risks having shifted towards slowing growth, most central banks in Asia have ended their tightening cycle and, in many cases, have started to ease while providing exceptional liquidity to stabilize market conditions (Figure 1A.5). Japan, Australia, China, India, Korea, New Zealand, Taiwan Province of China, and Vietnam have either lowered rates or eased reserve requirements in response to slowing growth. Some countries, including India, Indonesia, and Korea, have also intervened to support their currencies, while Singapore has moved to an exchange rate band with zero appreciation. In Sri Lanka, given the still-high level of inflation, the authorities remain committed to a tight monetary program, but have taken measures to accommodate the liquidity shock from the global turmoil.

Real policy rates in many countries remain negative, whether adjusted for headline or core inflation, suggesting that the monetary stance is supportive. Measures of real monetary conditions that incorporate exchange rate changes also show that conditions are looser compared to 12 months ago (a key exception being China). However, a broader measure that includes credit risk indicates that financial conditions have tightened and are more restrictive than suggested by the stance of monetary policy as a result of the global credit turmoil.

In this highly uncertain environment, central banks face the difficult challenge of navigating their economies through a major global downturn, while stabilizing financial conditions. Given its flexibility, monetary policy should be the first line of defense. With the global credit turmoil tightening domestic financial conditions, monetary policy should stand ready not only to stabilize market conditions, but also to ease in response to slowing growth. The appropriate stance would vary across countries and depend on the outlook for domestic demand, exchange rate regimes, and financial conditions.

• In most countries, where domestic demand is weakening, financial conditions are tightening, and second-round price effects are modest, further monetary policy easing would be appropriate to address downside risks to growth. Central banks will need to respond flexibly in the event that domestic credit tightens appreciably and depresses activity.

• For inflation-targeting countries, greater communication on the risks to the outlook and their implications for monetary policy would help reinforce policy credibility. Explaining how and when inflation would be expected to fall back within the target range would help anchor price expectations over the medium term (Figure 1.24).

• More generally, excessive intervention creates the risk of one-way bets on the exchange rate and greater volatility. Countries where exchange rates have weakened in response to negative terms-of-trade shocks and capital outflows face the added challenge of containing the pass-through of the depreciation on domestic inflation. While a case can be made for intervention to smooth excess exchange rate volatility and address possible overshooting, sustained one-sided intervention may backfire, resulting in larger and more disruptive adjustments later. Instead, allowing exchange rates to adjust would help absorb market pressures and reduce the drain on reserves. In China, a key argument for greater flexibility would be to help rebalance growth towards consumption.

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CPI Inflation: Inflation-Targeting Countries versus Non-Inflation-Targeting Countries¹

(Year-on-year percent change)

Sources: CEIC Data Company Ltd; and IMF staff calculations.¹ Unweighted average. Inflation-targeting countries are Indonesia, Korea, Thailand, and the Philippines.

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Scope to Ease Fiscal Policy

With growth slowing and fuel and food subsidies higher, the fiscal deficit in Asia is expected to widen modestly by about ½ percentage point of GDP in 2008 but remain small (Table 1.5). The turnaround is the greatest for emerging Asia, particularly for the NIEs, where the fiscal balance has shifted by 2¼ percent of GDP. In 2009, the fiscal balance for Asia is projected to widen further, reflecting the effects of slower growth and policy measures to offset higher food and fuel prices and, in some cases, to support aggregate demand. Public debt levels (as a share of GDP) should continue to decline in Asia, but remain high in India and Japan.

Table 1.5.

Asia: Selected Fiscal Indicators

(In percent of GDP)

Sources: IMF, WEO database; and staff estimates.

¹Fiscal year ending June. Fiscal balance includes net surplus from state-owned enterprises.

²Fiscal year ending June. Fiscal balance is defined as operating balance net of gains and losses. Figures exclude net New Zealand Superannuation Fund asset returns.

³Central government only; balance excluding Social Security Fund.

⁴Consolidated central government debt including government-guaranteed debt for financial sector restructuring.

⁵Net debt.

⁶Fiscal year ending March; privatization receipts excluded from revenues.

⁷Public sector debt.

⁸Fiscal year ending September. 2009 fiscal balance is budget number.

Table 1.5.

Asia: Selected Fiscal Indicators

(In percent of GDP)

			General Government Gross Debt				Central Government Fiscal Balance
			2006	2007	2008 Proj.	2009 Proj.	2006	2007	2008 Proj.	2009 Proj.
Industrial Asia			163.9	163.8	166.1	168.9	-3.6	-2.4	-2.7	-2.9
	Japan		194.7	195.4	198.9	203.0	-4.7	-3.3	-3.7	-3.8
	Australia1		8.6	7.8	7.3	6.6	1.6	1.5	1.8	1.6
	New Zealand2		23.3	22.3	21.5	20.3	5.1	3.5	2.9	0.7
Emerging Asia			36.7	37.7	35.2	34.0	-1.1	0.0	-0.6	-1.3
	NIEs		29.0	28.3	28.0	29.6	0.6	2.2	-0.1	-0.6
		Hong Kong SAR	1.7	1.3	1.1	0.9	4.0	7.6	0.1	-0.2
		Korea3,4	32.2	32.1	32.4	34.2	-1.3	0.4	-1.3	-1.5
		Singapore	…	…	…	…	7.6	9.0	6.1	5.7
		Taiwan POC	34.9	33.3	32.0	33.7	0.3	0.9	-0.1	-1.1
	China5		16.5	20.9	17.1	15.8	-0.7	1.0	0.8	-0.6
	India6		80.5	79.9	78.3	76.1	-3.4	-2.8	-3.8	-3.3
	ASEAN-5		45.2	41.1	39.6	38.3	-1.0	-1.6	-1.6	-2.0
		Indonesia3	39.0	35.0	33.3	31.2	-1.0	-1.2	-1.0	-1.0
		Malaysia3	43.2	41.8	43.2	44.7	-3.3	-3.2	-4.6	-4.2
		Philippines7	73.9	60.9	60.8	56.6	-1.4	-1.7	-1.0	-1.7
		Thailand7,8	41.0	38.1	36.1	35.9	-0.3	-1.1	-0.5	-2.5
		Vietnam7	42.9	43.1	38.2	36.0	1.1	-2.2	-2.2	-2.0
Asia			72.4	71.5	68.8	67.1	-1.8	-0.6	-1.2	-1.7

Sources: IMF, WEO database; and staff estimates.

¹Fiscal year ending June. Fiscal balance includes net surplus from state-owned enterprises.

²Fiscal year ending June. Fiscal balance is defined as operating balance net of gains and losses. Figures exclude net New Zealand Superannuation Fund asset returns.

³Central government only; balance excluding Social Security Fund.

⁴Consolidated central government debt including government-guaranteed debt for financial sector restructuring.

⁵Net debt.

⁶Fiscal year ending March; privatization receipts excluded from revenues.

⁷Public sector debt.

⁸Fiscal year ending September. 2009 fiscal balance is budget number.

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Table 1.5.

Asia: Selected Fiscal Indicators

(In percent of GDP)

			General Government Gross Debt				Central Government Fiscal Balance
			2006	2007	2008 Proj.	2009 Proj.	2006	2007	2008 Proj.	2009 Proj.
Industrial Asia			163.9	163.8	166.1	168.9	-3.6	-2.4	-2.7	-2.9
	Japan		194.7	195.4	198.9	203.0	-4.7	-3.3	-3.7	-3.8
	Australia1		8.6	7.8	7.3	6.6	1.6	1.5	1.8	1.6
	New Zealand2		23.3	22.3	21.5	20.3	5.1	3.5	2.9	0.7
Emerging Asia			36.7	37.7	35.2	34.0	-1.1	0.0	-0.6	-1.3
	NIEs		29.0	28.3	28.0	29.6	0.6	2.2	-0.1	-0.6
		Hong Kong SAR	1.7	1.3	1.1	0.9	4.0	7.6	0.1	-0.2
		Korea3,4	32.2	32.1	32.4	34.2	-1.3	0.4	-1.3	-1.5
		Singapore	…	…	…	…	7.6	9.0	6.1	5.7
		Taiwan POC	34.9	33.3	32.0	33.7	0.3	0.9	-0.1	-1.1
	China5		16.5	20.9	17.1	15.8	-0.7	1.0	0.8	-0.6
	India6		80.5	79.9	78.3	76.1	-3.4	-2.8	-3.8	-3.3
	ASEAN-5		45.2	41.1	39.6	38.3	-1.0	-1.6	-1.6	-2.0
		Indonesia3	39.0	35.0	33.3	31.2	-1.0	-1.2	-1.0	-1.0
		Malaysia3	43.2	41.8	43.2	44.7	-3.3	-3.2	-4.6	-4.2
		Philippines7	73.9	60.9	60.8	56.6	-1.4	-1.7	-1.0	-1.7
		Thailand7,8	41.0	38.1	36.1	35.9	-0.3	-1.1	-0.5	-2.5
		Vietnam7	42.9	43.1	38.2	36.0	1.1	-2.2	-2.2	-2.0
Asia			72.4	71.5	68.8	67.1	-1.8	-0.6	-1.2	-1.7

Sources: IMF, WEO database; and staff estimates.

¹Fiscal year ending June. Fiscal balance includes net surplus from state-owned enterprises.

²Fiscal year ending June. Fiscal balance is defined as operating balance net of gains and losses. Figures exclude net New Zealand Superannuation Fund asset returns.

³Central government only; balance excluding Social Security Fund.

⁴Consolidated central government debt including government-guaranteed debt for financial sector restructuring.

⁵Net debt.

⁶Fiscal year ending March; privatization receipts excluded from revenues.

⁷Public sector debt.

⁸Fiscal year ending September. 2009 fiscal balance is budget number.

With progress in fiscal consolidation, many countries in Asia have room to ease to address downside risks to growth. Indeed, several countries have already announced fiscal policy measures to support aggregate demand, most notably China, which is commendably planning to undertake substantial spending in infrastructure and other areas over the next two years. Strengthening social safety nets to protect vulnerable households would also allow automatic stabilizers to play a more supportive role. In countries such as Japan or India where fiscal sustainability is an issue, it would be important not to lose sight of the need for medium-term fiscal consolidation. Despite progress in reducing deficits, the public debt ratios in these countries are expected to come down only slightly or remain at high levels.