©2011 International Monetary Fund

Cataloging-in-Publication Data

Regional economic outlook. Asia and Pacific. – Washington, D.C. : International Monetary Fund, 2005-

v. ; cm. – (World economic and financial surveys, 0258-7440)

Twice a year.

Began in 2005.

Some issues have also thematic titles.

1. Economic forecasting – Asia – Periodicals. 2. Economic forecasting – Pacific Area – Periodicals. 3. Asia – Economic conditions – 1945- – Periodicals. 4. Pacific Area – Economic conditions – Periodicals. 5. Economic development – Asia – Periodicals. 6. Economic development – Pacific Area – Periodicals. I. Title: Asia and Pacific. II. International Monetary Fund. III. Series: World economic and financial surveys.

HC412.R445

ISBN-13 978-1-61635-062-8

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Contents

• Definitions

• Executive Summary

• I. Asia After the Recovery: Managing the Next Phase

  • A. Maturing Recovery and Good Near-Term Growth Prospects

  • B. Pockets of Overheating Across the Region Pose New Risks to the Outlook

  • C. Capital Inflows Are Expected to Continue, but at a More Moderate Pace

  • D. Policy Challenges: Tightening Macroeconomic Policy Stances to Contain Overheating Risks

  • E. The Economic Impact of Japan’s Earthquake-Related Tragedy

  • F. Making Growth Balanced and Inclusive Over the Medium Term

• II. Capital Flows to Asia: Comparison with Previous Experience and Monetary Policy Options

  • A. Introduction

  • B. How Does the Current Episode of Capital Inflows Compare with Previous Episodes?

  • C. How Effective Is Monetary Policy in the Face of Large Capital Flows?

  • D. What Role Can Macroprudential Measures Play?

  • E. Conclusions

  • Appendix 2.1. Econometric Methods: Global Dynamic Factor Model, Structural VAR, and Panel Regression

  • Appendix 2.2. DSGE Model

• III. Implications of Asia’s Regional Supply Chain for Rebalancing Growth

  • A. Introduction

  • B. Asian Exporters: Between Partnership and Competition

  • C. Evolving Trade Networks: Old and New

  • D. How Does Vertical Integration Affect External Competitiveness and Rebalancing?

  • E. Conclusion

  • Appendix 3.1

• IV. Asian Low-Income and Pacific Island Countries: Policy Challenges After the Global Crisis

  • A. Capital Flows, Aid, and Remittances to Asian LICs

  • B. Impact of the Global Crisis on Asian LIC Banks

  • C. Timor-Leste: The Transition from Conflict to Development

  • D. Pacific Island Countries: Vulnerabilities to Commodity Price Shocks

• References

• Boxes

• 1.1 Spillovers from Emerging Asia to Australia and New Zealand

• 1.2 Vietnam: Restoring Macroeconomic Stability

• 1.3 Is China Overheating?

• 1.4 Channeling Capital Inflows to Its Most Productive Uses: Developing Corporate Bond Markets In Asia

• 1.5 How Effective Are the Bank of Japan’s Monetary Easing Measures?

• 2.1 Do Nonresident Bond Holdings Affect Long-Term Interest Rates in Emerging Markets?

• 2.2 Macroprudential Policy—An International Perspective

• 3.1 Horizontal Competition and the Real Effective Exchange Rate

• Tables

• 1.1 Asia: Real GDP Growth

• 1.2 Capital Flow Management Measures in Asian Economies

• 2.1 Episodes of Large Net Private Capital Flows to Emerging Asia: Summary Statistics

• 2.2 Financial Indicators Across Episodes of Large Net Capital Flows to Emerging Asia

• 2.3 Parameters of the Policy Rules

• 2.4 Performance of Policies in Reaction to a Financial Shock

• 2.5 Selected Asia: Impact of Macroprudential Measures

• 3A.1 Share in Intermediate Goods Exports

• 3A.2 Share in Capital Goods Exports

• 3A.3 Share in Consumer Goods Exports

• Figures

• 1.1 Asia: Changes in Real GDP at Market Prices

• 1.2 Asia: Exports of Goods

• 1.3 United States: Real Private Fixed Investment in Equipment and Software during Business Cycle Recoveries

• 1.4 Asia’s Exports to China and Retail Sales in China

• 1.5 Asia: Industrial Activity

• 1.6 Selected Asia: Credit to Private Sector

• 1.7 Emerging Asia: New Capital Raised by Corporations

• 1.8 Selected Asia: Effective Exchange Rates

• 1.9 Asia: Fiscal Impulse

• 1.10 Global Investment

• 1.11 Export-Oriented Asia: Private Domestic Demand and Exports

• 1.12 Selected Emerging Asia: Private Investment

• 1.13 Asia: GDP Growth

• 1.14 Selected Asia: Exports of Goods to the United States and Europe

• 1.15 Asia: Changes in Headline Inflation since 2009

• 1.16 Emerging Asia: Changes in Expectations of Annual 2011 Inflation since October 2010

• 1.17 Selected Asia: Purchasing Managers’ Index (PMI)—Input Costs for Manufacturing Industries

• 1.18 Asia: Consumer Prices

• 1.19 Asia: Headline Consumer Price Inflation

• 1.20 Asia: Pass-Through from Global Food and Energy Prices to Domestic Food and Energy Prices

• 1.21 Asia: Pass-Through from Domestic Food and Energy Prices to Core Inflation

• 1.22 Asia: Impact of 10 Percent Increase in Commodity Prices on Headline Inflation

• 1.23 Asia: Deviation of the Cyclical Component of Credit-to-GDP Ratios from Long-Term Averages

• 1.24 Selected Asia: Contribution to Growth in Credit to Private Sector

• 1.25 Selected Asia: Comparing Changes in Current Real Property Prices with Previous Boom-Bust Cycles

• 1.26 Asia: Government Bond and Stock Markets

• 1.27 Selected Asia: 12-Month Forward P/E Ratios

• 1.28 Emerging Asia: Net Capital Inflows

• 1.29 Emerging Asia: Equity and Bond Funds—Weekly Net Flows during 2010–11

• 1.30 Emerging Asia (excl. Hong Kong SAR and Singapore): Net Portfolio Capital Inflows

• 1.31 Selected Asia: Policy Interest Rates

• 1.32 Asia: Real Policy Rates

• 1.33 Asia: Real Effective Exchange Rates

• 1.34 Emerging Asia: Sources of Change in Stock of Foreign Exchange Reserves

• 1.35 Asia: General Government Cyclically Adjusted Fiscal Balances

• 1.36 Japan: Official Estimate of Damage to Capital Stock Following 1995 and 2011 Earthquakes

• 1.37 Selected Asia: Demand and Supply Exposures to Japan

• 1.38 Asia: Contributions to GDP Growth

• 1.39 Asia: Current Account Balances

• 1.40 Global Current Account Balances

• 1.41 Vulnerable Employment

• 2.1 Selected Emerging Asia: Real Policy Rates and Headline Inflation during Capital Inflow Surges

• 2.2 Emerging Asia: Net Private Capital Flows

• 2.3 Selected Asia: 10-Year Bond Spreads

• 2.4 Secondary Market Yield of 10-Year Government Bond

• 2.5 Contributions of U.S. 10-Year Yield and VIX to the Common Factor of Asian Bond Yields

• 2.6 Selected Asia: Variance Decomposition of Domestic 10-Year Yield by Sources during 2005–10

• 2.7 Selected Asia: Contribution of U.S. Long-Term Interest Rates to Variance of Domestic Yields by Maturity

• 2.8 Selected Asia: Importance of U.S. Interest Rates and Capital Account Openness

• 2.9 Selected Asia: Variance Decomposition of Industrial Production in Response to Shocks to Domestic Interest Rates

• 2.10 Selected Asia: Short-Term Corporate Debt

• 2.11 Selected Asia: Effect of Capital Flows on Monetary Transmission Mechanism

• 2.12 Selected Asia: Responses to a Financial Shock

• 3.1 Asia: Export Trends

• 3.2 Selected Asia: Contributions to Export Growth

• 3.3 Asia: Exports of Intermediate Goods

• 3.4 Asia (excl. China): Exports to G-2 and China

• 3.5 Share in U.S. Imports: Consumer Goods

• 3.6 Selected Asia: Export Similarity Index

• 3.7 Selected Asia: Direct and Indirect Intermediate Goods Trade

• 3.8 Japan and Korea: Export of Capital Goods

• 3.9 Selected Asia: Change in Intermediate Goods Trade

• 3.10 Japan: Trade Balance in Intermediate Goods

• 3.11 Selected Asia: Standard and Integrated Real Effective Exchange Rates (REER)

• 3.12 Asia: Real Effective Exchange Rates (REER) and Real Export Growth

• 3.13 Net Exports to World Markets: Consumer Goods

• 3.14 Selected Asia: Share in Trade Surplus vis-à-vis U.S.—Value Added and Gross Trade

• 4.1 Asian LICs: Gross Total Inflows

• 4.2 Selected Asia: Structure of Capital and Capital-Like Inflows, 2009

• 4.3 Selected Asia: Workers Moving Abroad, January 2006–January 2011

• 4.4 Selected Asia: Customer Deposit Growth

• 4.5 Selected Asia: Gross Loan Growth

• 4.6 Selected Asia: Customer Loan-to-Deposit Ratio

• 4.7 Timor-Leste: Real Non-Oil GDP Growth

• 4.8 Selected Asia: Consumer Price Inflation

• 4.9 PICs: Pass-Through of Oil Prices to Inflation

• 4.10 PICs: Pass-Through of Food Prices to Inflation

Definitions

In this Regional Economic Outlook: Asia and Pacific, the following groupings are employed:

• “Emerging Asia” refers to China, Hong Kong SAR, India, Indonesia, Korea, Malaysia, the Philippines, Singapore, Taiwan Province of China, Thailand, and Vietnam.

• “Industrial Asia” refers to Australia, Japan, and New Zealand.

• “Asia” refers to emerging Asia plus industrial Asia.

• “Newly industrialized economies” (NIEs) refers to Hong Kong SAR, Korea, Singapore, and Taiwan Province of China.

• “ASEAN-4” refers to Indonesia, Malaysia, the Philippines, and Thailand.

• “ASEAN-5” refers to Indonesia, Malaysia, the Philippines, Thailand, and Vietnam.

• “E.U.” refers to the European Union

• “G-2” refers to the euro area and the United States.

• “G-7” refers to Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.

• “G-20” refers to Argentina, Australia, Brazil, Canada, China, the European Union, France, Germany, India, Indonesia, Italy, Japan, Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, the United Kingdom, and the United States.

The following abbreviations are used:

The following conventions are used:

• In tables, a blank cell indicates “not applicable,” ellipsis points (…) indicate “not available,” and 0 or 0.0 indicates “zero” or “negligible.” Minor discrepancies between sums of constituent figures and totals are due to rounding.

• An en dash (–) between years or months (for example, 2007–08 or January–June) indicates the years or months covered, including the beginning and ending years or months; a slash or virgule (/) between years or months (for example, 2007/08) indicates a fiscal or financial year, as does the abbreviation FY (for example, FY2009).

• An em dash (—) indicates the figure is zero or less than half the final digit shown.

• “Billion” means a thousand million; “trillion” means a thousand billion.

• “Basis points” refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point).

As used in this report, the term “country” does not in all cases refer to a territorial entity that is a state as understood by international law and practice. As used here, the term also covers some territorial entities that are not states but for which statistical data are maintained on a separate and independent basis.

Executive Summary

The earthquake-related tragedy in Japan in mid-March 2011 resulted in terrible losses of life and property. The early and decisive actions by the Japanese government and the Bank of Japan have helped to contain the initial damage from the earthquake, but its aftermath continues to cast a pall over the region and indeed the world. The relatively limited negative impact of the tragedy on Japanese production and regional spillovers to the rest of Asia masks the scale of the humanitarian disaster and damage to the country’s infrastructure and capital stock.

Meanwhile, in Asia as a whole, the recovery has matured as both exports and domestic demand have fueled rapid economic growth, which reached 8.3 percent in 2010. Exports have benefited from the global investment cycle as well as strong final demand from emerging economies in both Asia and other regions. Domestic demand has also been robust, reflecting still-expansionary fiscal policies as well as growing private demand. Private demand has been broad-based across both investment and consumption. Investment is being driven by the need in many Asian countries to overcome capacity constraints and to build infrastructure. Consumption, meanwhile, is being propelled by rising employment, wages, and productivity.

Near-term prospects are favorable, with growth in the Asia and Pacific region projected to average nearly 7 percent in both 2011 and 2012. Growth is expected to be led by China and India, whose economies are presumed to expand by 9½ percent and 8 percent, respectively, in the next two years. Their growth will have important spillovers for other countries in the region (and the world), particularly through demand for commodities. In Australia, for example, growth is expected to pick up to 3 percent and 3½ percent, respectively, in 2011 and 2012, as emerging Asia’s demand for commodities increases and as private investment in mining emerges as the main driver of growth.

Risks to the growth outlook are evenly balanced. The prospects for sustained global growth have strengthened in recent quarters as uncertainties over private domestic demand in advanced economies have lessened. Meanwhile, new downside risks have emerged such as the turmoil in the Middle East and North Africa region—which could disrupt global growth and inflation—and spillovers from the earthquake-related tragedy in Japan. Meanwhile, fiscal and financial vulnerabilities continue to cloud the outlook for advanced economies, which are important trading partners for Asia.

Asia’s rapid growth is accompanied by the emergence of pockets of overheating across the region in both goods and asset prices. Asset price pressures are reflected in strong credit dynamics as well as in certain segments of property markets in a few economies. Headline consumer price index (CPI) inflation has accelerated since October 2010, owing mainly to higher commodity prices; these prices, however, are also spilling over into core inflation. Core inflation is being further driven by still-accommodative financial conditions across the region that owe in part to procyclical monetary policy stances. Interest rates remain below levels that are consistent with stable growth and low inflation and in many cases are still negative in real terms. Inflation is expected to increase further in 2011, before decelerating modestly in 2012 as global commodity prices stabilize and central banks across the region make further progress with tightening macroeconomic conditions.

The task of policy tightening has been complicated by capital inflows, which surged in the first three quarters of 2010. Policymakers have sometimes feared that higher policy rates could attract even more inflows. Inflows have generally moderated since October 2010, although they have still been extraordinarily large in a few Asian economies and remain a key concern of policymakers. Capital is expected to continue flowing into Asia in 2011 and 2012, attracted by the region’s strong growth prospects and fueled by abundant global liquidity and risk appetite. In this context, policymakers’ concerns have shifted to the instability associated with potential capital flow volatility should these inflows come to a “sudden stop” or even reverse. Several economies have introduced macroprudential measures targeted at reducing the risk of overheating in asset prices, and of subsequent busts if capital flows reverse. Chapter II argues that although these measures have been helpful, they are best seen as complements and not as substitutes for macroeconomic policy adjustment.

Further monetary tightening is necessary in economies that face generalized inflation pressures. In addition to higher policy rates, exchange rate flexibility is a key line of defense against overheating pressures. Exchange rate appreciation would result in a tightening of monetary conditions and reduce the burden to be borne by higher policy rates. Several economies also have scope for more fiscal consolidation, which will help to expand the fiscal space that would allow governments to respond more effectively to future shocks.

Looking beyond the near-term macroeconomic policy challenges, Asia faces a need to strengthen the platform for sustained strong growth over the medium term. Such a platform would depend on reducing inequality; raising employment prospects, which would also guard against risks to social stability; and continued efforts to rebalance growth by strengthening private domestic demand. Intra-Asian exports are a growing source of demand for many Asian economies, including exports of intermediate inputs to China in the context of the Asian “supply chain,” as Chapter III shows, but Asia is still reliant on demand from the rest of the world. In the absence of further measures to increase domestic demand, the region’s external balances would reemerge as the global economy recovers and demand from advanced economies picks up. As discussed in Chapter IV, policymakers in many Asian LICs and Pacific Island economies will also face the challenge of managing the social impact of higher commodity prices, and of maintaining sound financial systems in the face of rising and volatile capital inflows.