I. Overview

International Monetary Fund. Asia and Pacific Dept
Published Date:
April 2008
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2008 is shaping up as a challenging year for Asia. Activity in the region remains fairly buoyant so far. But growth in the United States and, to a lesser extent, Europe is slowing sharply and the IMF’s April 2008 World Economic Outlook (WEO) now calls for a contraction in activity this year in the former and much slower growth in the latter. Given its extensive trade and financial linkages with the rest of the world, Asia is unlikely to decouple, and growth in the region in 2008 is foreseen to decline by 1¼ percentage points to 6.2 percent. Moreover, the still-unfolding global financial crisis adds a dimension of uncertainty as to how developments in the region will evolve, and the balance of risks remains tilted toward the downside. In this environment, policymakers will need to remain particularly vigilant and be prepared to utilize their scope for stimulatory measures as conditions warrant.

Recent Macroeconomic Developments

In line with the U.S.-led global slowdown, signs of moderating activity emerged in Asia in late 2007 and early 2008. While growth remains high, led by China and India, and domestic demand is still buoyant, key activity indicators suggest that momentum in the region is easing. Both export and import growth have picked up in recent months, although this development partly reflects price effects. Given the still-robust pace of activity, inflation pressures have risen as food and commodity price increases have begun to generate some second-round effects; producer price pressures have risen as well. Current account surpluses and reserve accumulation continue to be prominent in the region as exchange rate appreciation, particularly as measured on an effective basis, remains modest.


GDP growth remained strong throughout Asia in 2007, although momentum tailed off in the fourth quarter (Figure 1.1). For the region as a whole, growth in 2007 was 7.4 percent, with the emerging economies recording growth of more than 9 percent, led by China and India.1 This was slightly above the projections in the October 2007 Regional Economic Outlook: Asia and Pacific (REO).

Figure 1.1.Emerging Asia: Real GDP Growth

(Quarter-on-quarter percent change, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

Domestic demand was again an important source of growth across much of Asia in 2007. This was particularly true in the ASEAN-5 (Figure 1.2), where domestic demand accounted for all growth in the fourth quarter, and to a lesser extent in the newly industrialized economies (NIEs) (Figure 1.3). Activity in China and India continued to be investment-led. In industrial Asia, domestic demand remained weak in Japan, and strong in Australia, and began to weaken in New Zealand late in the year.

Figure 1.2.ASEAN-5: Contributions to GDP Growth1

(Year-on-year change in percent of previous year’s GDP)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

1 Excludes Vietnam.

Figure 1.3.NIEs: Contributions to GDP Growth

(Year-on-year change in percent of previous year’s GDP)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

Key activity indicators in Asia have begun to soften. Measured sequentially,2 industrial production growth has declined since the third quarter of 2007, and now stands in the single digits across emerging Asia, although it has picked up recently in ASEAN-5 (Figure 1.4). Retail sales volume growth has slowed, turning negative in the NIEs and moderating in China (Figure 1.5). Business and consumer confidence are trending sideways in emerging Asia, but continue to decline in Japan. In contrast, the continued rise in non-oil imports across much of the region suggests some ongoing strength in domestic demand.

Figure 1.4.Selected Asia: Industrial Production

(3-month percent change of 3-month moving average, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

Figure 1.5.Emerging Asia: Retail Sales Volume

(3-month percent change of 3-month moving average, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

1 Proxies used for Malaysia (manufacturing sales), the Philippines (car sales), and Thailand (composite consumption).

Recent trade performance has remained positive in the face of the U.S. slowdown. Export growth in the larger economies shows signs of stabilizing (Figure 1.6), while exports in NIEs and ASEAN-5 have trended higher in recent months, in the latter partly reflecting rising commodity prices (Figure 1.7).3 A notable development in the region is the steady decline in electronics export growth apart from ASEAN-5. (For recent performance and prospects in the electronics sector, see Box 1.1.) In terms of destination, exports to the United States and the European Union—Asia’s two largest trading partners—peaked in mid-2007. Exports to China remain robust, as do exports to “nontraditional” regions such as Latin America, eastern Europe and Russia, the Middle East, and Africa (Box 1.2). Import growth has picked up as well recently, including after netting out the effects of oil (Figures 1.8 and Figure 1.9).

Figure 1.6.Japan, China, and India: Exports of Non-Oil Goods

(3-month percent change of 3-month moving average, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

Figure 1.7.Emerging Asia: Exports of Goods

(3-month percent change of 3-month moving average, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

Figures 1.8.Japan, China, and India: Imports of Non-Oil Goods

(3-month percent change of 3-month moving average, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

Figures 1.9.Emerging Asia: Imports of Goods

(3-month percent change of 3-month moving average, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff calculations.


In contrast to the situation described in the October 2007 REO, inflation pressures are now strong or rising across most of Asia (Figure 1.10). Headline inflation has increased noticeably in India in recent months and has picked up anew in China, after having leveled off in the latter part of 2007.4 Inflation in ASEAN-5 has risen as well, but has turned down in the NIEs. In industrial Asia, inflation pressures remain a concern in Australia and New Zealand. That being said, currency appreciation in some countries in the region has dampened imported inflation pressures. While the initial rise in headline inflation in much of the region reflected supply-related food price shocks and higher global commodity prices (where they were allowed to pass through), price increases are now starting to become more broad based. Core inflation has begun to rise more rapidly in recent months, especially in the ASEAN-5 and India (Figure 1.11).

Figure 1.10.Emerging Asia: Consumer Prices

(3-month percent change of 3-month moving average, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

Figure 1.11.Emerging Asia: Core CPI

(3-month percent change of 3-month moving average, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

Producer price inflation has also picked up sharply across Asia. This reflects higher costs for energy as well as other raw material inputs. The increase has been particularly pronounced in the ASEAN-5, where producer price inflation has risen sharply from less than 8 percent in August to reach 20 percent in December, the fastest pace in two years (Figure 1.12). China, India, and the NIEs are all now experiencing double-digit producer price increases as well. As a result, at the regional level, producer prices are currently rising faster than consumer prices, with attendant pressure on firms’ profit margins (Figure 1.13).

Figure 1.12.Emerging Asia: Producer Prices

(3-month percent change of 3-month moving average, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

Figure 1.13.Emerging Asia: Consumer and Producer Prices

(3-month percent change of 3-month moving average, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

1 Excluding Vietnam.

An accurate measurement of underlying inflation pressures is hampered in much of emerging Asia (largely excluding the NIEs) owing to infrequently adjusted administered prices, primarily for energy products and foodstuffs. (For a review of the impact of recent energy price developments on Asia, see Box 1.3.) In addition to complicating an assessment of building price pressures, the lack of pass-through to consumers distorts price signals and results in fiscal costs through either direct budgetary support to firms to offset cost differentials, or less transparent mechanisms, such as reduced dividend transfers from public entities absorbing such costs.

External Sector

Capital account developments in late 2007 and early 2008 in Asia have again been driven by portfolio flows. Equity markets sold off in February–March 2008 as views by foreign investors regarding emerging Asia’s growth prospects and relatively high valuations soured in response to lower growth forecasts in the advanced economies (Figure 1.14). The ongoing rise in risk aversion has led to an unwinding of carry positions in the currency markets, resulting in an appreciation in funding currencies such as the yen and some downward pressure on high-yielding target currencies, particularly in emerging Asia. Despite the adverse effects of volatility on the carry trade, regional fixed income markets have been supported to some extent by widening interest rate differentials against U.S. dollar assets.

Figure 1.14Price-Earnings Ratio

Sources: CEIC Data Company Ltd; and Datastream.

1 Based on MSCI country index.

Box 1.1Asian Electronics Exports: Recent Developments and Outlook

Since peaking in the third quarter of 2007, electronics exports have lost momentum across much of Asia. The slowdown has been broad based across goods categories, with electrical and office machinery decelerating especially sharply. However, sequential export growth remains relatively healthy, averaging around 13 percent. The ASEAN-5 economies, where tech export growth has been more subdued, are exceptions to this downward trend, perhaps reflecting their exposure to different market segments.

This loss of momentum has been broad based in terms of destination. Excluding Japan, exports to all major trading partners have softened in line with the deterioration in global economic conditions. In particular, exports to Europe—which have buoyed Asia’s electronics exports in recent quarters—have slowed from their stratospheric rates, from annualized growth of some 80 percent in August 2007 to 7 percent in January 2008.

The moderation has occurred against the backdrop of a renewed fall in the price of semiconductors, which account for about one-third of emerging Asia’s electronics exports. Following a brief hiatus during the third quarter of 2007, semiconductor prices have resumed their downward trajectory, largely reflecting softer demand and, despite some reining in since mid-2007, the persistence of excess supply conditions (forecast to continue through this year). Prices for DRAM and NAND flash memory products have also weakened since the third quarter. While the former are showing signs of having bottomed out, this is thought to reflect higher assembly costs rather than increased demand.

Asia-Pacific Semiconductor Shipments and Prices

(Seasonally adjusted, 3-month moving average)

Sources: Haver Analytics; SIA Bluebook; and IMF staff estimates.

Asia: Electronic Exports

(3-month percent change of 3-month moving average, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff estimates.

1 Excludes Indonesia and Vietnam.

Selected Asia: Electronic Exports to Major Partners1

(3-month percent change of 3-month moving average, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

1 “Selected Asia” consists of Japan, Korea, and China.

2 Exports of electronics to EU only consist of Japan and China.

Selected Asia: Exports of Electronics by Commodity1

(3-month percent change of 3-month moving average, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

1 Japan, Korea, Singapore, Hong Kong SAR, Taiwan POC, and China.

Forward-looking indicators are almost uniformly negative. Echoing these, a newly developed Leading Composite Index suggests a conservative outlook, forecasting a further decline in sequential Asian electronics export growth toward mid-single digits in the first quarter of 2008.1 Financial markets also suggest weak prospects: excluding China and Korea, electronics stocks have been especially hard hit by the decline in Asian equity markets since late 2007, mirroring falls in the Nasdaq index and reflecting concerns about a sharp global slowdown, U.S. dollar weakness, and rising raw material prices. In recent months, spreads on credit default swaps have also risen to record levels for some of Asia’s leading chip makers, although they retreated somewhat in late March 2008.

Selected Asia: Electronic Stock Performance

(July 2, 2007 = 100)

Source: Bloomberg LP.

Electronics: Forward-Looking Indicators

(3-month moving average)

Sources: CEIC Data Company Ltd; Haver Analytics; and IMF staff calculations.

Asian Tech Sector: Credit Default Swap Spreads

(Basis points)

Source: Bloomberg LP.

Accordingly, the near-term outlook for Asia’s electronics sector has weakened, with a slowing global economy likely to dampen exports in the first half of 2008, especially for cyclically sensitive consumer electronics and related inputs. Malaysia, Singapore, Korea, and Taiwan Province of China—where electronics exports make up a significant proportion of exports and GDP—would be especially vulnerable to such a development, although the impact is unlikely to be as significant as during the technology-centered 2001 recession. This time around, much will also depend on the extent to which Europe and Japan, which have been supporting emerging Asia’s electronics exports for the past year, are affected.

1 The index is composed of a core set of leading indicators found to have the most informational content for predicting Asian electronics exports.

Box 1.2.Asia’s “Nontraditional” Export Markets

The growth of overall Asian exports remains strong despite exports to the euro area and the United States, the region’s two largest trading partners, having peaked around mid-2007. This poses somewhat of a puzzle. Part of the answer lies in buoyant exports to “nontraditional” markets, defined here as eastern Europe and Russia, the Middle East, Latin America, and Africa. Over the past several years—particularly for Korea, China, and Japan—exports to these nontraditional markets have grown relatively fast, resulting in rising export shares.1 However, whether foreign demand from these sources will hold up in the current global slowdown and provide a meaningful offset to weaker demand from traditional export markets is an open question.

Export growth from Asia to nontraditional markets has remained high into early 2008. Measured as a 12-month percentage change of the three-month moving average, exports are growing at 40 percent to Latin America, 30 percent to both non-EU Europe and the Middle East, and 20 percent to Africa. These rates compare with 19 percent total export growth for Asia over the same period.

Selected Asia: Exports to Europe Excluding the European Union

(12-month percent change of 3-month moving average)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

1 Excludes India, Indonesia, Thailand, and Vietnam.

2 Malaysia and the Philippines.

Selected Asia: Exports to Latin America

(12-month percent change of 3-month moving average)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

1 Excludes India, Indonesia, Thailand, and Vietnam.

2 Malaysia and the Philippines.

Selected Asia: Exports to the Middle East

(12-month percent change of 3-month moving average)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

1 Excludes India, Indonesia, Thailand, and Vietnam.

2 Malaysia and the Philippines.

Selected Asia: Exports to Africa

(12-month percent change of 3-month moving average)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

1 Excludes India, Indonesia, Thailand, and Vietnam.

2 Malaysia and the Philippines.

The fast growth of exports to nontraditional destinations has resulted in their market shares rising across Asia. For the economies in the sample, the share of exports going to nontraditional destinations rose from 7 percent in 2004 to 9 percent in 2007. However, in three cases—Korea, China, and Japan—the market share rose by twice as much and from a higher base, surging from 11½ percent of all exports in 2004 to 15½ percent in 2007. For both the entire sample and the “top three,” Latin America is the most important nontraditional market.

Korea has the largest share of its exports going to the four nontraditional markets, at 19 percent in 2007, followed by China at 14½ percent, and Japan with 13 percent. Nearly 40 percent of Korea’s exports to nontraditional markets go to Latin America, which also accounted for almost one-half of the 5 percentage point share gain since 2004. About one-third of China’s exports to nontraditional markets go to Latin America, which, as with Korea, accounted for most of the recent growth in export shares. In contrast, Japan’s recent growth to these markets has been led by exports to eastern Europe and Russia. In terms of goods, anecdotal evidence suggests that ships (Korea),2 intra-firm exports related to outward foreign direct investment, or FDI (Japan, Korea), and consumer goods (China) are driving recent export performance to nontraditional markets.

Selected Asia: Exports to Nontraditional Markets

(In percent of total exports)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

The other economies in the sample show much less dynamism in their export shares to nontraditional markets. Malaysia sends 7 percent of its exports to these markets and almost one-half of that amount to the Middle East, which also accounted for most of the recent share increase. The remaining four economies—Taiwan Province of China, Singapore, Hong Kong SAR, and the Philippines—have had broadly unchanged export shares to nontraditional markets over the past three years, but this needs to be viewed against the backdrop of healthy export growth overall.

A key question is whether demand from nontraditional markets will hold up as growth continues to slow in the United States and the European Union. Eastern European growth has been propelled by convergence-related demand pressures and it remains to be seen how the region, with a number of its countries dependent on external financing, weathers the ongoing financial turmoil. For the Middle East, Latin America, parts of Africa, and Russia, growth has benefited from high commodity prices, which in turn reflect marginal demand from large, fast-growing emerging economies like China and India. Continued high global commodity prices would thus partly reflect the extent to which growth in these economies is able to delink from growth in the advanced economies.

Note: The main authors of this box are Paul Gruenwald and Xiangming Fang.1 Data consistency and coverage issues limited the sample to China, Hong Kong SAR, Japan, Korea, Malaysia, the Philippines, Singapore, and Taiwan Province of China. The high volatility of the data implied the need to smooth the underlying series; thus, the 12-month percentage change of the three-month moving average was used.2 Export destination data in the shipping industry may not give an accurate picture of the location of ultimate final demand since ships are initially exported (in an accounting sense) to the country of registry.

Box 1.3Impact of High Oil Prices on Asian Economies: So Far Largely Benign?

The surge in international petroleum prices toward the end of 2007 followed significant increases since 2003. The spot price of Dubai oil increased 3.4 times over the period to just over $87 a barrel. Prices have continued to increase during the first quarter of 2008, to over $100 a barrel, and in real terms oil prices are close to their peak at the start of the 1980s.

This box looks at the impact of higher oil prices on the components of growth and inflation in Asia as well as the range of policy responses. It examines why the economic effects of the rise in oil prices have been relatively muted so far, suggesting that the impact may have been borne unevenly and that there may be concerns going forward if prices remain high.

Average Spot Oil Prices

(U.S. dollars per barrel)

Sources: IMF, Commodity Price System; and CEIC Data Company Ltd.

1 Deflated by U.S. CPI.

Rising oil prices worsened terms of trade for the region as a whole, but other factors have mitigated the impact. First, higher oil prices have benefited net petroleum exporters, notably Malaysia, Vietnam, Brunei, Timor-Leste, and Papua New Guinea.1 Net oil import bills elsewhere have increased from 1¾ percent of GDP in 2003 to over 3¼ percent of GDP in 2007, with the deterioration particularly pronounced in the low-income countries.

Change in Oil and Current Account Balances, 2003–07

(Percentage points of GDP)

Sources: IMF, WEO database, and staff calculations.

Terms of Trade, 2003–07

(Percentage change)

Sources: IMF, WEO database, and staff calculations.

1 Excludes Fiji and Tonga.

Nonetheless, the strong world economy has helped to boost Asian exports and spur inward investment. Therefore, despite declining oil balances the overall current account balance in the region rose by 2.3 percent of GDP between 2003 and 2007, with the rise concentrated in Japan,2 China, and other emerging market economies. Current account deficits have generally widened among the Pacific Island economies and in Sri Lanka, while international demand has buoyed garment exports from Cambodia and Bangladesh. Moreover, rising prices of non-oil commodities such as gold and copper, and crops such as rice and wheat, have mitigated the terms of trade impact for some low-income countries, such as Mongolia and Papua New Guinea, as well as Indonesia.

For many countries, the rise in the U.S. dollar price of oil has also been partially offset by an appreciation of the domestic currency. For example, while the average price of oil almost tripled in U.S. dollar terms between 2003 and 2007, for a few countries, such as New Zealand and Australia, the impact in local currency terms has been closer to a doubling of prices. Conversely, in countries that have experienced large falls in the value of their currencies, such as Bangladesh, the price of oil has gone up more than 3½ times during 2003–07. Overall, this is consistent with the finding that, in the long run, a 1 percent depreciation of the U.S. dollar is associated with an increase in the nominal oil price of more than 1 percent.3

Inflation rates generally edged higher in Asia over 2004–07. However, inflation has risen fastest in the net oil-producing countries, where domestic demand pressures may be rising as a result of higher energy incomes, although inflation rates have also picked up in low-income countries, with a number approaching double-digit rates.

Change in Annual CPI Inflation, Averages 2004—07 less 2000—03

Sources: IMF, WEO database, and staff calculations.

(Percentage point change)

Estimated Direct Impact of a 10 percent Oil Price Increase on Annual Headline CPI Inflation

Source: IMF staff calculations.

(Percentage points)

Moreover, the overall increase in consumer prices has been modest relative to the global increase in the price of oil. One reason is that the direct first-round impact on retail fuel prices is fairly small, although the impact on transportation and utilities is often two or three times larger and may subsequently be magnified in other items, such as food. Second, monetary and exchange rate policy have generally been effective in containing inflation pressures. Third, the limited available information suggests that companies may not have been able, or allowed, to pass on the impact of higher energy costs to consumers in recent years, with producer prices generally rising faster than retail prices, thereby squeezing profit margins.

Country-specific energy policies and rising downstream costs have also played a significant role in determining domestic retail prices. Despite rising international prices, many countries have been moving toward more market-based pricing regimes. Over the past few years, China, Vietnam, and the Philippines have removed at least a large portion of their retail gasoline subsidies, resulting in substantial price increases. Other countries, such as Indonesia, Bangladesh, and India, have made periodic upward adjustments to their regulated prices. However, retail prices have recently not kept pace with world market price developments, and subsidies have generally grown.

Nonetheless, in all but the net oil-producing countries the relative increase in international gasoline prices has largely been passed on to consumers.

In contrast to gasoline pricing, the increase in international diesel and kerosene prices does not appear to have been passed on to consumers. The price of kerosene, in particular, is politically sensitive because it is used as cooking fuel by many rural poor. When Indonesia adjusted administered fuel prices in 2005 by about 30 percent, kerosene was exempted. Bangladesh has lowered tax rates on fuels used by the poor, such as kerosene and diesel, while taxes on gasoline remain much higher (although gasoline prices remain administered).

Despite the general move toward more deregulated fuel pricing, energy subsidies remain significant as countries try to shield consumers from the full impact of higher world prices. The largest energy subsidies are in oil-producing countries, where budget subsidies often exceed 1 percent of GDP and losses by national oil and utility companies can be larger, but difficult to quantify. Owing to administered retail prices, state-owned oil companies (refineries and distributors) have also made significant losses in China, India, Bangladesh, and Sri Lanka. The fiscal costs of trying to smooth adjustments can be significant. For example during 2004–05, in response to what were thought of as temporary price increases, Thailand introduced price ceilings on petroleum products, which were subsequently abolished in 2005, having reportedly cost the government about $2.2 billion. In addition to the fiscal costs and broader efficiency considerations, generalized subsidies tend to be less effective than well-targeted safety nets at mitigating the impact of higher petroleum prices on the poor or other social groups.4

Petroleum Product Price Pass-Through, 2003—071

(In percent)

Sources: IMF, WEO database, and staff calculations.

1 Absolute change in domestic retail prices, in US$, between end-2003 and end-2007 divided by absolute change in world prices over the same period.

2 Excludes New Zealand, Bhutan, Fiji, Mongolia, Myanmar, Samoa, Solomon Islands, Tonga, Vanuatu, and Brunei.

3 Excludes Australia, Singapore, China, Lao P.D.R., Malaysia, and Brunei.

Explicit and Implicit Energy Subsidies, 2003—07 Average1,2

(In percent of GDP)

Source: IMF staff calculations.

1 Comprises budget oil subsidies and losses of state-owned energy enterprises.

2 No data for Taiwan POC, Bhutan, Fiji, Mongolia, Myanmar, Samoa, Solomon Islands, Tonga, and Vanuatu.

It is unclear whether Asia will remain relatively shielded from the effects of high global petroleum prices. Countries whose currencies have strengthened considerably, often based on strong export demand, may not be able to sustain such an appreciation in a weakening global environment. The cost to countries with large fuel subsidies is also rising and will eventually have to be addressed, most likely through more periodic price adjustments and the restructuring of loss-making national companies. The current round of energy price increases may also boost inflationary expectations unless countered by tightening monetary policy. Measures to try to reduce the impact of rising energy costs—for example, the Philippines has introduced an oil tariff reduction mechanism—will also have to be financed. The general drive for increased energy efficiency is likely to contain demand pressures only in the medium to long term.

Note: The main author of this box is Theo Thomas.1 Vietnam’s net oil surplus has declined over the period, largely owing to a rapid increase in consumption. Indonesia’s net oil balance turned negative in 2004. Singapore has a positive net oil balance due to its significant refining capacity, although for the purposes of this box it is not included as a producer.2 In the case of Japan, increased investment income and a fall in imports in 2007 boosted the current account surplus.3 See Box 1.4 of the April 2008 WEO, “Dollar Depreciation and Commodity Prices.”4 See Mati (2008) and Davis, Ossowski, and Fedelino (2003).

Exchange rate trends have become less uniform across Asia since the October 2007 REO. While the region as a whole has appreciated marginally in NEER terms over the period, much of this is being driven by the sharp appreciation of the Japanese yen (Figure 1.15a).5 Emerging Asian currencies as a block have weakened somewhat, led by the NIEs (Figure 1.15b) and India, where the rupee declined by 3 percent. The Chinese renminbi was up by 2 percent over the period in NEER terms while the ASEAN-5 was flat (Figure 1.15c). Individual currency performance within the ASEAN-5 varied substantially, counter to the notion that currencies in this group are tied closely to the Chinese renminbi. The appreciation of the Philippine peso and Malaysian ringgit have offset weaker currencies in the ASEAN-5. In the NIEs, the Hong Kong dollar and Korean won weakened sharply, offset to some extent by the ongoing strength of the Singapore dollar and, more recently, the New Taiwan dollar.

Figure 1.15.Nominal Effective Exchange Rates

a. Selected Asia

b. NIEs

c. ASEAN-5

Sources: IMF, Information Notice System, and staff calculations.

Reserve accumulation continues apace with the region’s total reaching $4½ trillion in early 2008, 25 percent higher than a year earlier. China leads the region with $1.5 trillion in official reserves. As in recent years, current account surpluses were the main driver of the region’s reserve accumulation in 2007, with the region’s aggregate current account surplus reaching 5.2 percent of GDP. Valuation changes were also a factor in central banks that mark-to-market their reserves, since the U.S. dollar fell by 12 percent against the euro and by 6 percent against the yen during the year, and prices of U.S. treasury bills rose.

Recent Financial Market Developments

Asian markets have not been immune to contagion from the global financial turbulence. Equities are much lower than at the beginning of the turmoil, and credit spreads have increased substantially. Risk aversion remains high, and fund managers in the region have reportedly moved toward cash and high-quality paper. However, while certain segments of the credit market have remained frozen, there are few signs of a credit crunch. Indeed, limited exposure to nonperforming structured credit products, the global shortage in U.S. dollar funding, and widening interest rate differentials vis-à-vis the U.S. dollar are lending some support to local currency loan and debt markets in the region. Investor sentiment on long-term prospects for Asia remains positive.

Global contagion and growing concerns about the severity of a U.S.-led slowdown have taken a toll in Asia, particularly on equity markets (Table 1.1 and Figure 1.16). Following a volatile second half of 2007 (several indices hit new highs in October), selling began anew in January 2008 as market participants’ views of Asia decoupling from the United States and Europe faded. Foreign investor sentiment broadly paralleled these market moves (Figure 1.17). Negative sentiment was exacerbated by the delay in prospects for further Chinese capital account opening through Hong Kong SAR and the realization that the profitability growth required to sustain relatively high price-earnings (P/E) ratios had become unrealistic, especially in China.

Table 1.1.Price-Earnings Ratios1(Period average)


Emerging Asia17.
Hong Kong SAR19.420.517.616.3
Taiwan POC16.218.728.023.6
Emerging markets15.916.614.317.2
Latin America15.615.713.517.7
Europe & Middle East13.114.114.612.4
Sources: Datastream; and IMF staff calculations.

Figure 1.16Selected Asia: Stock Market Indices

(January 2006=100)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

1 Weighted by market capitalization.

Figure 1.17Selected Asia: Net Equity Inflows

(In billions of U.S. dollars)

Source: Bloomberg LP.

By mid-March 2008, most Asian equity indices were down 15–25 percent for the year. Markets in Taiwan Province of China and Thailand performed comparatively well, with losses of under 10 percent reflecting perceived improvements in the political and investment environment. In Thailand, there were expectations—subsequently validated—of the removal of capital account restrictions. Shares in Vietnam were relatively weak, falling by 40 percent, as monetary policy was tightened on concerns of overheating.

Given their focus on equity long/short strategies, the total investment returns of hedge funds based in emerging Asia broadly followed equity market performance (Figure 1.18). This led to losses in August, November, and January 2008. In January alone, 90 percent of hedge funds suffered declines, with average returns of minus 8 percent. Returns bounced back in February, although year-to-date Asian-based hedge fund returns have underperformed those of eastern Europe and, by a wide margin, Latin America. Concerns about possible redemption pressures and margin calls have reportedly risen. Recent survey data suggest that, given the uncertain environment, hedge fund as well as real money managers have become more cautious in their allocation decisions. Portfolios are reportedly now cash-heavy and invested in perceived safer, liquid markets in the region.

Figure 1.18Hedge Funds: Total Return

(In percent)

Source: Bloomberg LP.

Credit conditions have tightened in Asia in line with global trends, although there are no signs of a credit crunch. Credit default swap (CDS) spreads across a broad range––from sovereign credit (Figure 1.19a) to the i-Traxx Asia ex-Japan investment grade index (Figure 1.19b) to banking and technology-sector CDS (Figures 1.19c and 1.19d)––have continued to rise, with the price for protection in mid-March trading in many cases at more than twice the level observed at the previous peak in November 2007 despite some recent easing. (Relatedly, the collapse of Bear Stearns in mid-March had only minimal effects on credit markets in Asia.) As in the rest of world, this has affected the most leveraged borrowers, such as special situation hedge funds and private equity firms, diminishing their capacity to borrow.6 Moreover, the market for structured credit products, particularly the cash market, remains largely shut down; volumes in the synthetic CDO market are reportedly 60–70 percent lower than in early 2007. Spreads in U.S. dollar loan markets have also widened, but to a lesser extent.7

Figure 1.19Selected Asia: Credit Risk

(Basis points)

a. Sovereign Credit Default Swap Spreads

b. iTraxx Indices1

c. Banking Sector Credit Default Swap Spreads2

d. Tech Sector Credit Default Swap Spreads2

Sources: Bloomberg LP; and IMF staff calculations.

1 iTraxx Indices are a set of CDS indices covering regions or sectors and contain the most liquid names in that market, based on a dealer poll.

2 Country spreads are weighted averages based on relative assets.

By contrast, local currency loan and debt markets in Asia have been relatively resilient. Local banks in the region have maintained stable funding and—with the exception of Australia, Korea, and, to a lesser extent, India and New Zealand—remained largely free of liquidity risk, given their comparatively low loan-to-deposit ratios (Figure 1.20). Indeed, significantly tighter lending standards by domestic banks have reportedly been limited so far only to some selected real estate markets (in Australia, New Zealand, and China, and, more recently, Singapore). Against this background, corporate bond issuers—particularly investment-grade ones—still have access to credit, albeit at higher spreads. Nonetheless, lower issuance volumes suggest that some borrowing plans are being delayed although many corporates retain sufficient internal resources to fund operations and investments.8

Figure 1.20Selected Asia: Bank Loan-to-Deposit Ratios

(In percent)

Source: CEIC Data Company Ltd.

1 Covers entire financial system.

The resilience of funding markets in the region in part reflects limited exposure of financial institutions to structured credit products, including subprime. Although there is no comprehensive database on the issuance, transactions, and holdings of such products, data from investment banks suggest that financial institutions and, to a lesser extent, corporate treasuries in China, Korea, and Taiwan Province of China have been the most active buyers in Asia. However, given information disclosed so far and various private sector estimates, implied losses appear to be minimal as a share of assets, and therefore are unlikely to pose a systemic threat anywhere in the region. Indeed, even in the worst-case scenario, the effects of subprime and related exposure on Asia are seen to be limited to an “earnings event.”9 (Lessons for Asia from the subprime crisis appear in Box 1.4.) Moreover, entities in the region reportedly do not have significant direct exposure to monoline insurers.

Asian currency, money, and interbank markets have also remained orderly in the recent period. Liquidity in most countries in the region has remained ample. Despite the recent turbulence in global money and credit markets, the liquidity risk indicator for the main markets in the region declined from earlier peaks, although it has drifted higher in 2008 (Figures 1.21a and 1.21b).

Figure 1.21.Liquidity Risk: Composite Indicator1

(January 2005=100)

a. Advanced Asia2

b. Emerging Asia3

Sources: Bloomberg LP; and IMF staff calculations.

1 The index is calculated based on (1) currency bid-ask spreads, (2) spreads between interbank rates and treasury bills, and (3) daily equity market return-to-volume ratios. A higher value indicates higher liquidity risk.

2 Includes Japan, Australia, and NIEs excluding Korea.

3 Includes China, India, Indonesia, Thailand, and Malaysia.

Amid rising yen-dollar volatility, a declining interest rate spread with the United States, and growing risk aversion, yen-funded carry trades have reportedly been unwound, leading to a sharp strengthening in the yen to a 12-year high in March 2008. Japanese retail investor flows into foreign securities investment trusts have declined, and Japanese yen positions by margin traders have moved into net long territory in recent months for the first time in two years. Elsewhere, fixed-income inflows owing to widening interest rate differentials with the United States have provided support to some of the region’s higher-yielding currencies.

While the functioning of markets in Asia has remained smooth for the most part, some strains have appeared in those countries with greater overseas funding. In Korea, money and bond markets have been jittery on concerns over the heavy reliance of domestic banks on wholesale funding. CD rates have been volatile and CDS spreads on banks increased in early 2008 as they were faced with temporary funding pressures partly reflecting domestic factors.10 In India, sharp equity price declines starting in mid-January, the announced delays in some IPOs, and concerns about overseas financing needed by the corporate sector to sustain the investment boom led foreign investors to pull out. As sentiment changed, exporters and others followed suit by not bringing dollars onshore, leading to some dislocation in currency and swap markets. Given earlier attempts by the authorities to curb offshore borrowing, banks were also reluctant to provide dollar funds. Relatively high foreign funding of banks is also a feature in Australia and New Zealand, where borrowing costs have risen but there has not been any market disruption thus far. Maturity mismatches, elevated housing prices (a key bank asset), and swings in foreign risk appetite pose potential challenges going forward.

With global U.S. dollar markets remaining tight, some corporate and financial sector issuers have shifted to alternative sources of financing in more liquid markets. Examples are the Samurai market in Japan (Figure 1.22), as well as the nonresident Singapore dollar and Malaysian ringgit markets.11 On the demand side, recent surveys point to growing, although still selective, fund manager interest in local currency credits, reflecting positive views on currencies and growth. These flows are providing an opportunity to develop local currency debt markets inside Asia and thereby help foster regional financial integration.

Figure 1.22Japan Domestic Bond Issuance: Samurai Bonds

(In billions of yen)

Source: Bloomberg LP.

Despite the increased volatility from the global market turbulence, investor sentiment on longer-term prospects for Asian capital markets remains positive. For one, given the region’s attractive long-term growth prospects, many global real money investors—including U.S. and European pension funds—are intent on reducing their underweight share of assets invested in the region. Also, as the supply of U.S. dollar-denominated bonds from the region is shrinking, more fund managers are considering raising their exposure to Asia in the form of local currency bonds.

Outlook and Risks

The external environment facing Asia has weakened substantially since the previous REO. Given its growing trade and financial integration with the rest of the world, Asia is unlikely to “delink.” The baseline forecast for 2008 calls for a reduction in GDP growth for Asia as a whole by 1¼ percentage points to 6.2 percent as weaker external demand lowers the region’s export growth. Domestic demand growth should remain relatively buoyant but soften. A modest recovery is projected for 2009. But the risks to the outlook have heightened and remain on the downside. The main risk is a further credit-led deterioration in financial market conditions with knock-on effects on trading partner growth as well as spillovers to confidence within the region.

Box 1.4.Asia: Lessons from the Subprime Crisis

Exposure to Subprime-Related Products and the Potential Risks

The reported subprime-related exposure of Asian financial institutions is substantially lower than that in the United States and Europe. Estimates of the aggregate exposure to subprime and related assets (CDOs and SIVs) in Asia (ex-Japan) vary from $20 billion to $30 billion (5–10 percent of the bank capital). In Japan, total subprime-related exposures of deposit-taking institutions are reported to be about $15 billion, representing 3 percent of aggregated Tier 1 capital.

It is unlikely that subprime-related losses will trigger widespread financial sector distress in Asia. Based on market data and losses announced to date, losses in Asia (ex-Japan) may amount to 15–20 percent of these exposures, or $2–5 billion. Subprime-related losses for Japanese banks have risen to $6.5 billion, still well within their capital buffers and operating profits. Consequently, the direct impact of the global credit crisis for Asian financial institutions will most likely be limited to an “earnings event.”

Nonetheless, greater risk related to structured subprime-related products and liquidity pressures may emerge. Market participants have expressed discomfort with the level, quality, and timing of disclosure by some Asian financial institutions,1 although they do not expect large surprises. Some market participants are of the view that a number of local institutions in Asia may still be unaware of their overall exposure to subprime-related structured products. In particular, some Chinese banks may have provisioned insufficiently for their likely subprime-related losses.

Why Was Subprime Exposure in Asia Much Lower than in Other Regions?

The limited reported exposure to subprime-related products in most Asian markets reflects a combination of factors:

  • Many emerging Asian banks were less involved in structured credit and related derivative products. Banks in Asia (especially emerging Asia) are at an early stage in the securitization process; they were not directly involved in subprime or similar high-risk mortgage lending and did not originate complex structured credit instruments.2 Also, Asian banks started investing in such products more recently than did financial institutions in the United States and Europe.

  • In many Asian countries, bank lending has been profitable, including to consumers (in a rising per capita income environment), which has limited the need to look for higher yields in alternative investments, including structured products, outside the region.

  • Asian banks rely more on traditional banking services, with revenues from fixed income, currency, and commodities businesses accounting for a significantly smaller portion of their income compared with leading western banks.3 Moreover, Asian banks have been relatively prudent in running their own investment portfolios, which are focused mostly on government bonds and treasuries.

  • According to market participants, regulators in the relatively advanced Asian economies, Japan, Hong Kong SAR, and Singapore, have had a more proactive role compared with other economies in the region, in ensuring that smaller local banks have sufficient risk management capacity before they start investing in complex structured products. For example, under Basel II, many banks in Hong Kong SAR upgraded their risk management systems, improving their capacity for prudent investment strategies. In the Philippines, the authorities have sharply limited banks’ participation in structured credit markets and are watching these developments closely, in line with Basel II implementation.

Lessons from the Subprime Crisis

Although Asian subprime exposure and losses to date are low and unlikely to pose systemic concerns, the current global credit crisis presents an opportunity for financial institutions and supervisors in the region to draw lessons from the global experience.

  • Markets and regulators globally were seen as ill-equipped to deal with the complexities of structured products, and shortcomings in valuation, implementation of international accounting standards, and disclosure contributed to weak due diligence and market discipline. The introduction of Basel II in several Asian economies will help supervisors strengthen their regulatory regimes. The key changes relate to (1) the Pillar 1 capital treatment of securitization of some complex products, (2) the Pillar 2 adequate stress tests and capital provisioning requirements, and (3) the Pillar 3 disclosure requirements to improve transparency of exposures to structured credit products.

  • There is need for greater investment in firm-wide risk management capabilities. As market participants note, at least some Asian institutions could not easily aggregate their subprime exposure when the crisis emerged, with the recent announcement by ICICI Bank (India) being a good example of late recognition of losses. With improved risk management practices, banks and regulators need to rely more on the systematic use of stress tests and scenario analyses, including to assess liquidity risks.

  • Regulators need to reinforce implementation of existing rules on the use of off-balance-sheet entities by banks and may need to strengthen guidelines regarding the circumstances under which risk transfers to off-balance-sheet entities warrant capital relief. More broadly, there will also be a need to clarify the framework and incentives for the originate-to-distribute model of securitization and risk transfer markets. Central banks and regulators should use their financial stability reports to examine these issues in greater depth.

  • Supervisors should improve monitoring of liquidity positions to keep up with banks’ changing risk profiles and growing vulnerability to market-based shocks. Although liquidity has not tightened appreciably in most Asian countries, national supervisors should continue to closely monitor the liquidity situation of their banking sectors and individual banking institutions to ensure their resiliency to market volatility.

  • Given the recent growth in housing markets in Asia, authorities in several countries have established government housing agencies to jump-start their home mortgage market. In addition, country authorities may introduce measures to strengthen developing housing markets (1) to ensure adequate customer protection for new products, (2) to improve the secondary market for residential mortgage-backed securities (RMBSs), and (3) to harmonize mortgage regulations across banks and nonbank mortgage lenders.

The introduction of Basel II in several Asian economies, as well as global efforts to strengthen the regulatory approach to risk transfer, should help Asian authorities to address several of these challenges and safeguard financial stability in the future.

Note: The main author of this box is Elena Loukoianova.1 For example, in the case of Taiwan Province of China, the biggest life insurer recently revealed that local currency CLOs were packaged with CDOs related to U.S. subprime products.2 Although in some cases (e.g., Taiwan Province of China) underwriting standards were weak, the decline in collateral quality to date has not been of a magnitude comparable to that in the United States.3 In general, these revenues account for 15—20 percent of total revenues of large western banks.

Baseline Forecast

A key input into Asia’s baseline forecast is the state of the global economy. As detailed in the IMF’s April 2008 WEO and Global Financial Stability Report (GFSR), global growth is set to decline sharply this year owing to a contraction of activity in the United States and slower growth in Europe. Asia is not expected to delink from developments in the rest of the world. (This issue is explored in Chapter II.) Indeed, the region’s increased integration into the global economy on both the trade and financial fronts suggests that, if anything, Asian economies are more reliant on developments outside the region than ever before.

  • Although intraregional trade is booming, reflecting the specialization of many of the region’s economies as part of sophisticated production chains, final demand for Asia’s exports still emanates largely from outside the region.12 Indeed, Asia’s exposure to demand elsewhere in the global economy—including the United States and Europe—continues to rise.

  • On the financial side, links between Asia and the rest of the world have increased across asset classes. As has been seen in a number of recent episodes, changes in investors’ risk appetite or expectations for the paths of key variables (e.g., U.S. growth or interest rates) can quickly translate into large changes in financial asset prices across Asia, with both direct (balance sheet) and indirect (confidence) effects.

Turning to the forecast itself, growth in Asia as a whole is projected to decline from 7.4 percent in 2007 to 6.2 percent in 2008, and to rise modestly in 2009 (Table 1.2). This markdown reflects lower export growth as the drop in external demand from the United States and Europe affects the region foremost through the trade channel, including the dampening effects on demand of sustained high world oil prices. The quarterly growth profile (year-on-year basis) is projected to decline steadily throughout 2008, falling by 1 percentage point for the region as a whole—but by 3 percentage points in China and the NIEs—before recovering gradually during 2009 (Figure 1.23).

Figure 1.23Emerging Asia: Quarterly GDP Growth Forecasts

(Year-on-year percent change)

Source: IMF, WEO database.

Table 1.2Asia: Real GDP Growth(Year-on-year percent change)
REO Oct '07Latest Proj.
Industrial Asia2.
New Zealand1.
Emerging Asia9.
Hong Kong SAR7.
Taiwan POC4.
Emerging Asia excl. China7.
Emerging Asia excl. China & India5.
Sources: CEIC Data Company Ltd; and IMF, WEO database.

In terms of demand components, real export growth is projected to decline by 4 percentage points in emerging Asia in 2008, led by China (Table 1.3). Domestic demand is seen as holding up reasonably well in most emerging Asian economies, supported by strong momentum, steady consumer and business confidence, and healthy household and bank balance sheets. Investment will be more affected than consumption, owing to a relatively sharp decline in India, although parts of the region will see a modest increase (Table 1.4). Consumption growth should moderate across most of the region, falling by ½ percentage point overall (one-half the pace of the decline in investment growth). (See Table 1.5.) Domestic demand should ease in industrial Asia as well. Broadly speaking, Asia’s GDP growth should rebound in line with the gradual global recovery in 2009. Reflecting these developments, Asia’s aggregate current account surplus is seen to decline from 5.2 percent of GDP in 2007 to about 4 percent of GDP in 2008 and 2009.

The financial contagion channel from the rest of the world to Asia is seen as secondary to the trade channel in the baseline forecast (although it contributes to larger risks—see below). This mainly reflects the reportedly low exposure of the region’s banks and other financial institutions to subprime and related structured products, and the prevalence of self-funded firms in the region. The flow of credit is thus seen to be relatively less impeded in Asian financial markets, although, as noted earlier, banks in a number of countries face some funding risks. On the other hand, the high correlation of asset markets in the region with the rest of the world implies that recent price declines in equities and key fixed income markets (e.g., U.S. agency bonds)13 as well as increases in spreads will have direct effects on firms’ balance sheets and income statements. The baseline assumes a gradual normalization of credit market conditions, with risk appetite recovering and then stabilizing, albeit at less favorable levels than before the onset of the turbulence in August 2007.

Table 1.3Asia: Real Export Growth(Year-on-year percent change; national accounts basis)
REO Oct '07Latest Proj.
Industrial Asia8.
New Zealand1.
Emerging Asia18.713.712.612.09.611.7
Hong Kong SAR9.
Taiwan POC10.
Emerging Asia excl. China14.
Emerging Asia excl. China & India10.
Sources: CEIC Data Company Ltd; and IMF, WEO database.
Table 1.4Asia: Investment Growth(Year-on-year percent change; constant prices)
REO Oct '07Latest Proj.
Industrial Asia1.
New Zealand−
Emerging Asia11.610.712.411.79.810.0
Hong Kong SAR7.
Taiwan POC0.
Emerging Asia excl. China8.710.
Emerging Asia excl. China & India4.
Sources: CEIC Data Company Ltd; and IMF, WEO database.
Table 1.5Asia: Private Consumption Growth(Year-on-year percent change; constant prices)
REO Oct '07Latest Proj.
Industrial Asia2.
New Zealand2.
Emerging Asia8.
Hong Kong SAR6.
Taiwan POC1.
Emerging Asia excl. China5.
Emerging Asia excl. China & India4.
Sources: CEIC Data Company Ltd; and IMF, WEO database.

In emerging Asia, growth in 2008 should decline by 1½ percentage points to 7.6 percent.

  • China’s growth in 2008 is projected to drop by about 2 percentage points to 9.3 percent, reflecting a decline in net exports as demand from major trading partners slows. Investment should stabilize somewhat, with the authorities using administrative controls to contain excessive growth. A modest easing in consumption is forecast.

  • India’s growth is expected to decline by 1¼ percentage points to 7.9 percent, driven by a slowdown in investment on tightening credit conditions. Fiscal stimulus will provide a partial offset.

  • Growth in the NIEs is forecast to fall by 1½ percentage points owing to the group’s relative openness and oil dependency. Declines on the order of 4 percentage points in Singapore owing to a sharp decline in investment, and 2–3 percentage points in Hong Kong SAR and Taiwan Province of China are foreseen. Growth in Korea, in contrast, should decline more moderately as the drop in exports is lessened by a weaker won, while domestic demand remains solid, supported by the pro-growth policies of the new government.

  • ASEAN-5 growth should decline only modestly in 2008, reflecting buoyant domestic demand and the subregion’s commodity resource endowment. In Indonesia, a relatively closed economy, growth is expected to remain led by domestic demand. Growth should pick up in Thailand, assuming political normalization, and remain supported in Malaysia owing to ongoing public investment projects. The Philippines is enjoying strong consumption and remittance flows, while Vietnam will continue to face overheating pressures related to its post-WTO accession boom, although growth will decline in both economies.

In industrial Asia, growth is forecast to decline by ½ percentage point in 2008 to 1¾ percent. In Japan, the pace of activity should ease to 1½ percent owing to weaker foreign demand and tepid consumption. Growth should moderate in Australia and New Zealand as domestic demand slows owing to tighter credit conditions, in spite of continued favorable terms of trade.


Despite the markdown in 2008 baseline growth for Asia since the previous REO, the risks, on balance, remain on the downside. These relate largely to external factors linked to the potentially negative effects of a worsening of the slump in the U.S. housing market and a further deterioration of conditions in global credit and money markets.14 As in the past, some upside risks to growth emanate from domestic demand, particularly in the larger economies in the region. The main risks to the baseline forecast are the following:

  • A further, marked deterioration of financial market conditions leading to sharply lower global growth. This scenario includes a large deterioration of confidence, a sharp rise in counterparty risk, and concerns over the adequacy of bank capital, leading to a full-blown credit crunch in advanced economies. A protracted slowdown in activity would ensue. The trade effects of lower growth on Asia are relatively straightforward: IMF staff estimates show that a 1 percentage point reduction in U.S. growth would reduce growth in Asia by ¼ to ½ percentage point.15 However, it is likely that the transmission of financial turbulence could be larger and more complicated, and could adversely affect domestic demand across the region. These effects could include (1) the balance sheet impact of lower equity and other asset prices; (2) lower consumer and business confidence, leading to sharp declines in consumption and investment; and (3) a spike in counterparty risk leading to sharply higher funding costs for banks (and corporates). The possibility of “financial accelerator” effects (a vicious circle of a loss of confidence—deleveraging—asset price declines—capital preservation—credit crunch) kicking in implies that the impact of the financial channel could be nonlinear. The accompanying reduction in global risk aversion would also have uncertain effects on capital flows in Asia with the perceived riskier economies seeing larger outflows.

  • Domestic demand remains resilient. An upside, and relatively low probability, risk to growth in emerging Asia would be if domestic demand were more resilient than expected, particularly in the largest economies. In China, this could reflect less-than-successful efforts by the authorities to rein in investment, while in India it could reflect continued portfolio inflows feeding into high credit growth and inflation pressures. Stronger-than-envisaged domestic demand stemming from higher-than-desirable credit growth is also a concern in Vietnam (Figure 1.24). On the other hand, if the resilience in domestic demand were the result of higher confidence and delinking, this would be a positive development for the region.

Figure 1.24Selected Asia: Private Sector Credit Growth

(3-month percent change of 3-month moving average, SAAR)

Sources: CEIC Data Company Ltd; and IMF staff calculations.

Policy Implications

Policymakers in Asia face potentially difficult choices now. The current growth momentum and inflation levels suggest that growth concerns should be balanced against inflation concerns. As such, the room for monetary policy maneuver appears limited in a number of countries, although greater exchange rate flexibility in many countries would help. However, if the downside risks to growth materialize and the region finds itself in a substantially weaker growth environment, most Asian economies have considerable scope to ease macroeconomic policies, particularly on the fiscal front.

Monetary, Exchange Rate and Financial Sector Policies

Country authorities in Asia have used a range of tools to combat rising inflation pressures. In China, interest rates (Figure 1.25) and reserve requirements have been raised and window guidance applied in an effort to curb lending for investment, while India has used reserve requirements and benefited from a stronger rupee to contain inflation. The Philippines has used an appreciation of the peso to tighten monetary conditions (allowing for a modest lowering of policy rates), while Singapore has steepened the slope of its currency band. On the other hand, lower inflation pressures led the authorities in Indonesia and Thailand to lower rates (although inflation pressures have recently reemerged in both cases).

Figure 1.25Selected Asia: Changes in Policy Rates Since January 1, 2007

(In percentage points)

Source: CEIC Data Company Ltd.

In the baseline scenario, only a handful of countries in emerging Asia appear to have scope to loosen monetary settings in response to the projected moderation of growth. Although inflation expectations remain generally well anchored (Figure 1.26), price pressures are on the rise and monetary conditions have loosened across much of the region, particularly in the NIEs and ASEAN-5 (Figure 1.27).16

A potentially thorny monetary policy issue facing a number of Asian policymakers in the baseline scenario is the interaction between interest rates visà-vis the United States, capital inflows, and the exchange rate. With the U.S. Federal Reserve aggressively lowering policy rates, there is pressure on some Asian central banks to follow suit, including to stem interest rate sensitive inflows that could feed into undesired additional domestic bank lending and (asset price) inflation in those economies where nominal exchange rates remain sticky. However, given rising inflation pressures—and in some cases relatively new inflation-targeting frameworks—many central banks may find it difficult to lower policy rates.

Figure 1.26Selected Asia: Private Sector Inflation Forecasts

(Annual percentage change)

Sources: Consensus Economics; and CEIC Data Company Ltd.

Figure 1.27Selected Asia: Real Monetary Conditions Indices

Sources: CEIC Data Company Ltd; and IMF staff calculations.

Should the downside risks to the forecast materialize, it is expected that a monetary policy response would be appropriate for most countries. In this scenario, growth would decline substantially and inflation pressures would be expected to moderate. This would afford room for authorities in the region to lower policy interest rates or otherwise loosen monetary settings.

Regarding specific countries’ scope for monetary policy loosening in the baseline scenario, China is constrained because policy remains aimed at curbing inflation and reducing investment growth, while India has limited scope to move, particularly since inflation pressures have recently picked up. In the NIEs, Hong Kong SAR remains committed to its peg to the U.S. dollar, while in Singapore the inflation outlook is likely to remain a concern. However, there could be some scope for easing in Korea and Taiwan Province of China. In the ASEAN-5, Indonesia is facing renewed inflation pressures and Thailand has limited ammunition after the lowering of rates last year. Malaysia and the Philippines both have scope for easing, while in Vietnam any monetary policy response would need to be weighed against the risks of overheating. The situation for industrial countries is clearer. Japan is heavily constrained by interest rates already being very low, while monetary policy in Australia and New Zealand needs to remain firm until inflation pressures moderate.

As argued in past REOs, more flexible exchange rates would be in the interest of a number of economies in the region. First and foremost, this would create room for more independent monetary policy. In cases where exchange rate pressures remain on the strong side, appreciating currencies would also help to dampen inflation pressures by lowering import costs. Moreover, where currencies remain substantially undervalued, as in China, stronger currencies would facilitate a rebalancing in the composition of growth toward nontradables as well as contribute to a resolution of global imbalances. In this connection, the focus of authorities in the region should be placed on real effective exchange rates, given that recent bilateral appreciation against the U.S. dollar has been largely neutralized in real effective terms, reflecting the dollar’s decline on a multilateral basis.

Given the prominence of financial sector risks in the downside scenario, monetary and supervisory authorities in the region could usefully review their relevant contingency plans. In countries where the structure of bank funding poses vulnerabilities, central bank liquidity facilities may have to be activated, implying a need for clarity on terms of access as well as the types of collateral that the monetary authorities would accept. Careful attention should be paid to counterparty risk, especially vis-à-vis entities in regions where an increase in financial turmoil is likely to have the most negative effects. With ongoing questions regarding exposure to structured and other potentially impaired credits as well as the size of any future price movements of such products, stress testing of balance sheets takes an added importance, including in the nonbank financial sector. The authorities should carefully monitor mark-to-market exposure and funding risks and formulate plans to handle potential calls for bank recapitalization.

Fiscal Policy

Most policymakers in Asia have followed prudent fiscal policies during the recent period of strong growth. As a result, “fiscal space” has been generated that could be used to combat any serious growth slowdown (Table 1.6). Small fiscal deficits (or even surpluses) and modest debt levels suggest that, should the downside risks to growth materialize, most countries could allow automatic fiscal stabilizers to work or even run countercyclical policies if necessary, provided that these are timely and temporary.

Table 1.6Asia: Selected Fiscal Indicators(In percent of GDP)
General Government Gross DebtCentral Government Fiscal Balance






Industrial Asia164.0164.1165.1163.3−3.6−2.5−2.6−2.6
New Zealand 223.323.621.820.
Emerging Asia36.737.736.434.9−0.90.2−1.0−0.9
Hong Kong SAR1.−0.32.9
Taiwan POC34.932.131.329.
Vietnam 743.043.743.742.7−0.3−3.4−2.1−2.5
Sources: IMF, WEO database, and staff estimates.
  • China has sufficient fiscal space to keep growth relatively high (in the baseline as well as the downside scenario), including scope for bolstering social spending to reduce the high level of precautionary saving, while India, in contrast, has little room for maneuver owing to high public debt. That being said, the need for fiscal stimulus in India is seen as limited.

  • In the NIEs, Hong Kong SAR and Singapore have large surpluses and strong public sector balance sheets and thus ample scope to combat a growth slowdown, while Korea and Taiwan Province of China must be mindful of potentially large medium-term spending pressures related to rapidly aging populations.

  • In the ASEAN-5, both Malaysia and Thailand have room for a fiscal policy response. Indonesia’s scope for action is somewhat less since the fiscal stance has been eased via higher energy subsidies, and that in the Philippines is still limited by a relatively high public debt stock. Vietnam is constrained by ongoing overheating pressures.

  • In the industrial economies, any countercyclical fiscal policy in Japan would be significantly constrained by the need to stabilize the large public debt stock. In contrast, both Australia and New Zealand have ample space to loosen fiscal policy, but have limited macroeconomic space to use discretionary fiscal policy given inflation pressures.

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