I. Recent Developments and Main Themes

International Monetary Fund. Asia and Pacific Dept
Published Date:
May 2010
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A. Overview

One year after the deepest recession in recent history, Asia is leading the global recovery. Activity in many emerging and developing markets has continued to rebound swiftly over the course of 2009. The “green shoots” of recovery that emerged in Asia earlier than elsewhere in 2009 have continued through the first months of 2010 (Figure 1.1). In particular, key economic indicators are now growing at above long-term trends not only in China, but also in emerging Asia’s other economies with a large domestic demand base, namely, India and Indonesia. While growth also is solidifying in key Latin American and other emerging and developing economies, emerging Asia is in the lead. In contrast, the pace of the recovery in advanced economies outside the region has been weaker, held back by high unemployment rates, impaired household balance sheets, and anemic bank credit. At the start of 2010, the expansion of economic activity was still tentative in key advanced economies, such as Germany and the United Kingdom. Even where the expansion has gathered momentum, as in the United States, it remains sluggish relative to past recoveries and still heavily dependent on macroeconomic policy support (see the April 2010 World Economic Outlook). Among the advanced economies in the region, Australia and New Zealand experienced only a mild slowdown in economic activity (Australia escaped the recession altogether) and are recovering rapidly in part due to strong demand from China.

Figure 1.1.Assessing Global Growth Momentum1

Sources: Haver Analytics; Bloomberg LP; and IMF, Global Data Source database; and staff calculations.

1 The above figure is based on the four economic indicators, including industrial production, real retail sales, merchandise exports, and purchasing managers index (PMI). Some of the ratings—particularly for recent months—are based on both actual data as well as projections of the underlying variables.

Asia’s faster recovery seems to mark a break from the past. Supported by stronger potential growth in emerging Asia, GDP growth has exceeded that of advanced economies over the last three decades. However, the current episode stands out for at least three reasons. This is the first time Asia is leading a global recovery; in all previous global downturns (see April 2008 World Economic Outlook) Asia’s contribution to global recovery was lower than that of other regions (Figure 1.2). Second, Asia’s recovery in previous recessions generally was driven by exports (see May 2009 Regional Economic Outlook) but, this time, it also has been reinforced by resilient domestic demand (Figure 1.3). And, third, while in previous crises capital had been extremely slow to return to Asia, this time net capital inflows to the region have surged, a reflection of high levels of global liquidity, but also a testament to Asia’s improved resilience and economic framework (Figure 1.4). Still, as argued in Chapter III of this report, Asia’s fortunes remain closely linked to the global economy.

Figure 1.2.Contributions to Global Growth

(In percentage points)

Source: IMF, WEO database.

Figure 1.3.Asia: Domestic Demand Around Business Cycles1

(Median; peak of the cycles = 100)

Source: IMF staff calculations.

1 See May 2009 Regional Economic Outlook for details on business cycle episodes in Asia. Figure includes economies in recession.

Figure 1.4.Selected Emerging Asia: Growth Differential vis-à-vis the United States versus Net Capital Inflows1

Sources: CEIC Data Company Ltd.; and IMF, Balance of Payments Statistics.

1 Includes Indonesia, Korea, the Philippines, Singapore, Taiwan Province of China, and Thailand. Other economies are not included due to non-availability of data for the entire sample period.

In the near term, Asia is expected to continue to lead the global recovery, but with important differences within the region:

  • The global and domestic inventory cycle is likely to continue boosting Asia’s industrial production and exports for most of 2010, due to stronger-than-expected prospects for final demand in advanced economies.
  • Even with a partial withdrawal of policy stimulus, private domestic demand is expected to remain strong. With the recovery of economic activity becoming more entrenched, many governments are planning a gradual withdrawal of policy stimulus in 2010. Based on current budgetary plans, on average, about one-third of the fiscal stimulus injected in 2009 will be withdrawn in 2010. In addition, although some central banks have started removing policy accommodation, monetary policy is unlikely to fully normalize in 2010. At least over the near term, private domestic demand seems to have enough momentum to sustain growth in many regional economies while the effects of the policy stimulus gradually diminish.
  • The pace of the recovery will remain uneven within Asia. In China, growth is expected to return to double-digit figures in 2010, with private domestic demand boosted by measures to increase consumption and private investment. At the same time, the authorities have begun to stem the very rapid growth of credit to safeguard the quality of bank balance sheets. In Japan, private sector demand continues to face severe headwinds and inflation has fallen back into negative territory, requiring the authorities to reiterate their commitment to prolonged policy accommodation.

Somewhat paradoxically, Asia’s stronger cyclical position may also pose near-term risks to the outlook—by further intensifying capital inflows to the region. Brighter economic growth prospects and widening interest rate differentials with advanced economies are likely to attract more capital into the region. This could lead to overheating in some economies and increase their vulnerability to credit and asset price booms with the risk of subsequent abrupt reversals (October 2007 World Economic Outlook). Although asset price increases in Asia so far have been generally contained, with only a few local exceptions, the increase in excess liquidity in many regional economies over the course of 2009 raises some concerns and policymakers will need to be attentive to safeguarding the macroeconomy and financial system against the build up of imbalances in local asset and housing markets.

Over the medium term, Asia’s main policy challenge is to ensure that private domestic demand becomes a more prominent source of growth. Once the adjustment of inventories has run its course, Asia’s exports to advanced economies are expected to moderate somewhat, as domestic demand in these economies is not expected to return to pre-crisis growth (see April 2010 World Economic Outlook). And China may provide only a partial offset to weaker demand from advanced economies, given the small size of China’s import markets for consumer goods. The global crisis also has shown the importance for Asia of a second, domestic “engine of growth” available to smooth the impact of external shocks. This private domestic demand will need to be nurtured through more structural reforms, as discussed in Chapter III.

This chapter examines the outlook for Asia over the period 2010–11. The next section provides an overview of major trends in economic activity and financial market conditions since fall 2009. The following three sections then address some of the key questions on the regional outlook: How long will the inventory cycle last? What is the role of China in regional export trends? How strong is “autonomous” private domestic demand in Asia? What are the risks of asset-price bubbles in the region? Chapter II then presents the forecasts and risks to the outlook, and finally turns to the key policy challenges.

B. Recent Developments

The rebound of Asia’s exports has continued at a brisk pace since fall 2009, and export volumes have now returned to pre-crisis levels in newly industrialized economies (NIEs) and China (Figure 1.5). Electronics exports, which comprise about one-third of total exports and rebounded first in 2009, are still growing briskly boosted by the rebuilding of inventories through the supply chain in Asia. But nonelectronics exports also have accelerated since the second half of 2009, as the global recovery gathered momentum. Indeed, exports to both advanced economies (in particular the United States) and China have picked up momentum (on a sequential basis) in recent months.

Figure 1.5.Selected Asia: Exports

(July 2008 = 100; seasonally adjusted)

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

1 Includes China, Japan, Malaysia, NIEs, the Philippines, and Thailand.

Financial conditions have remained highly supportive of growth:

  • Equity inflows have resumed at a stronger pace in Asia than in other emerging markets, reflecting Asia’s brighter growth prospects and healthier fiscal balances. The spike in global risk aversion in early 2010—following worries about the deterioration in sentiment toward the euro area sovereign credit—induced a slowdown in portfolio inflows to the region, but flows have recovered rapidly in recent months (Figure 1.6). In particular, foreign buying in regional bond markets has continued to increase rapidly through 2010 against the backdrop of relatively attractive yields and the region’s strong economic fundamentals.
  • With corporate spreads declining (Figure 1.7), Asian firms had a strong incentive to increasingly tap domestic bond markets. Corporate issuances also provided a partial substitute for bank lending, which remained generally anemic through the region—though only for larger firms, as small- and mediumsized enterprises (SMEs) remain dependent on bank lending.

Figure 1.6.Net Flows to Equity Funds

(In billions of U.S. dollars; 4–week moving average)

Source: Emerging Portfolio Fund Research, Inc.

Figure 1.7.Selected Asia: Corporate Bond (AAA) Spread over Government Securities

(In basis points; 5–year maturity)

Sources: Reuters; Bloomberg LP; and CEIC Data Company Ltd.

With the continuation of capital inflows and the rebound in exports, exchange rates in the region generally have appreciated further since fall 2009. In particular, currencies have appreciated another 5 percent against the U.S. dollar in Indonesia, Korea, and the Philippines. The renminbi, however, has effectively remained pegged to the U.S. dollar. In real effective terms the appreciation is smaller, with many currencies close to their early 2008 levels, and the Korean won still about 20 percent below that level. The yen remains a notable exception, as it is up about 20 percent since early 2008 both against the U.S. dollar and in real effective terms, while the renminbi is 5 percent weaker than in March 2009 (see Box 1.1) in real effective terms.

Strong exports and easier financial conditions have continued to boost confidence and consumer spending, but business spending has started to recover only recently. Private consumption also benefited from a continued improvement in labor market conditions over the last two quarters, with both real wages and employment growth improving in many Association of Southeast Asian (ASEAN) economies and in China (Figure 1.8). Business spending has started to pick up in Korea and Thailand, as uncertainty over future prospects is dissipating and capacity utilization returns to more normal levels (Figure 1.9).

Figure 1.8.Selected Asia: Labor Market Conditions

(2008:Q1 = 100; seasonally adjusted)

Sources: CEIC Data Company Ltd.; and Haver Analytics.

Figure 1.9.Selected Asia: Manufacturing Capacity Utilization

(In percent; seasonally adjusted)

Sources: CEIC Data Company Ltd.; and Haver Analytics.

With growth momentum remaining strong, a few signs of inflationary pressures have also started to emerge. While it remains generally subdued on an annual basis, headline inflation has accelerated on a sequential basis. This partly reflects a recent pick-up in food prices, which remain highly volatile, but also more generalized price pressures from stronger domestic demand, as shown by the pick-up in core inflation, especially in India (Figure 1.10).

Figure 1.10.Emerging Asia: Consumer Prices1

(3–month percent change of 3–month moving average; SAAR)

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

1 Wholesale prices used for India.

Box 1.1.Recent Exchange-Rate Developments in Asia

Thus far in 2010, Asian nominal exchange rates have continued on their 2009 upward trend against the U.S. dollar. The Korean won and ASEAN currencies have appreciated owing to the weakness of the U.S. dollar. By contrast, the renminbi has remained effectively pegged to the U.S. dollar, motivated by the authorities’ desire to maintain stability during times of heightened global uncertainty. The yen rose to a 14-year high at the end of November 2009, but since has depreciated by around 8 percent partly reflecting lower short-term rates in Japan.

In real effective terms, many regional currencies have moved back closer toward their early 2008 levels. The Japanese yen, however, has appreciated considerably since early 2008. The yen has been among the strongest performing currencies during the global crisis, appreciating by 20 percent since the Lehman Brothers shock as a result of several factors, such as greater global risk aversion (which traditionally favors reserve currencies) and the unwinding of carry trades with the decline in global interest rates. The Korean won, on the other hand, has lost about 20 percent since early 2008, despite reversing much of the losses sustained in the aftermath of the collapse of Lehman Brothers.

Upward pressures on regional currencies were much stronger than implied by exchange rate movements. Indeed, most of the recent appreciation pressures have been absorbed through further reserve accumulation. In 2009, Asian economies accumulated about US$800 billion in official reserves, bringing the stock to some US$5.2 trillion—more than twice the sum of foreign reserves in other emerging markets. About half of this overall amount, however, is accounted for by China.

The renminbi appreciated in real effective terms as the global crisis unfolded and the U.S. dollar strengthened, but has depreciated by 5 percent over the past 12 months. The currency is now at around the level it reached in early 2002, despite significant productivity gains over the intervening period. Although significant uncertainty surrounds any particular point estimate, a range of indicators suggests that the renminbi remains undervalued. The current account surplus diminished from 11 percent in 2007 to less than 6 percent in 2009 as external demand collapsed, but under current policies, it is projected to reassert itself over the medium term as the global economy recovers. Despite the cyclical decline in the current account surplus, the pace of reserve accumulation has been at record levels, with around US$450 billion added to reserves in 2009.

Selected Asia: Nominal Exchange Rates Against U.S. Dollar

(January 2008 = 100; positive change implies appreciation)

Sources: Bloomberg LP; and IMF staff calculations.

Selected Asia: Real Effective Exchange Rate (REER)

(January 2002 =100)

Source: IMF, Information Notice System database.

Emerging Asia (excl. China): Exchange Market Pressure1


Source: IMF staff calculations.

1 The exchange market pressure (EMP) index is defined as: change in nominal exchange rate vis-à-vis U.S. dollar plus ratio of change in international reserves to monetary base.

Over the medium term, currencies in the region are expected to strengthen further. The strong export-led recovery from the global crisis is projected to carry on for the rest of 2010, and foreign capital will likely continue to flow into the region. As discussed in the text, further appreciation of regional currencies would be consistent with the need to safeguard Asian economies against the threat to price and financial stability from the rapid return to potential output levels and the persistence of large capital inflows.

Note: The main author of this box is Olaf Unteroberdoerster.

Within this overall recovery, key differences persist across the region. The more export-oriented economies in emerging Asia came out of the recession by the last quarter of 2009—and output is now at or above pre-crisis peaks in all of these economies, except Hong Kong SAR. The economies that escaped recession altogether in 2009, such as Australia, China, India, and Indonesia, have continued to enjoy solid growth. However, the pace and nature of recovery have differed within the region (Figure 1.11):

  • Japan: While the rebound in exports has accelerated over the last two quarters, this has not yet spilled over to domestic demand. Private consumption has been supported by the sizeable fiscal stimulus, but still-ample excess capacity and tight financial conditions for SMEs have weighed down investment (see Box 1.2). Financial markets have stabilized, in line with global developments, but the stock market’s rebound (by around 40 percent since the end of 2008) has lagged that in the rest of the region, partly a consequence of the yen’s appreciation and weakness in bank shares. Despite capital markets normalizing, bank lending has slowed, mainly because of weak loan demand.
  • China’s economy has continued to strengthen since fall 2009, with growth becoming more broad-based. Exports accelerated towards the end of 2009 and now exceed pre-crisis levels in volume terms, consistent with expanding industrial output. Meanwhile, private domestic demand has strengthened further, as evidenced by the above-trend growth in retail sales and more buoyant consumer confidence, which both reflect recent improvements in labor markets and continued fiscal support to household income and consumption.1 Indeed, the stronger-than-expected GDP outturn in the first quarter of 2010 (with growth at the fastest pace since 2007) reflected a strong contribution from consumption. Moreover, while government-led investment has been the main driver of growth for much of 2009, real estate investment rose rapidly in the second half of 2009, boosted by rising house prices in many cities, and still ample credit and liquidity.
  • In India, the strong growth momentum continued over the last two quarters, as industrial production and export growth gained further strength, while private domestic demand conditions remained very buoyant. Business and consumer confidence, in particular, have continued to improve, and financial conditions have remained favorable since fall 2009—TED spreads have fallen relatively more than in the rest of Asia, credit growth has picked up, and equity prices have remained elevated. As a result, retail sales and business spending have picked up strongly.

Figure 1.11.Asia: Growth Momentum

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

1 Three-month (or short-term) money market rate minus equivalent T-bill rate.

2 See Balakrishnan and others (2009). The index comprises seven variables capturing developments in the banking sector, the securities markets, and the foreign exchange markets.

3 Based on quarterly data.

Box 1.2.What is the Outlook for Japan’s Domestic Demand?

In Japan, investment activity has fallen by more than 15 percent since late 2008, about 1½ times more than in other advanced regions. Similarly, private consumption declined at a faster pace than in comparator countries, although the gap has narrowed since mid-2009. This box assesses reasons why domestic demand has not recovered to the same extent as in other countries in the region.

The absence of an autonomous domestic demand recovery in Japan is primarily the result of unfavorable external conditions during the rebound phase. In particular

  • The yen appreciated by 17 percent in real effective terms between September 2008 and January of 2009, the largest appreciation among advanced economies. The initial drivers were safe-haven capital inflows, since Japanese banks appeared largely insulated from the financial strains afflicting U.S. and European financial institutions. The unwinding of yen-carry trade positions led to a further strengthening of the yen, as interest rate differentials with U.S. dollars and the euro declined to an all-time low.
  • In 2009, Japan’s main trading partner demand grew by 1⅓ percent compared to 2–5 percent in Asia’s NIEs (Hong Kong SAR, Korea, Singapore, and Taiwan Province of China). This is mainly the result of a lower export share with China and developing Asia (about 26 percent in Japan compared to 32–55 percent in the NIEs in 2007) going into the crisis, reflecting Japan’s export orientation towards high-end consumer products.1

Real Gross Investment1

(2008:Q1 = 100)

Source: IMF staff calculations.

1 Small NIEs include Hong Kong SAR, Singapore, and Taiwan Province of China.

Change in Export Demand from Main Export Partners


Source: IMF staff calculations.

Impact on Export Volume

(2007–2009, in percent; size of bubble indicated below implies actual change in export volume)

Source: IMF staff calculations.

These two factors had a large impact on exports. Relative to other economies in Asia, Japan experienced the largest decline in exports and also the least favorable exchange rate and external demand developments. In contrast, Korea underwent a large depreciation and actually recorded positive export growth in 2009.

Against this backdrop, the absence of a domestic demand response in Japan is not entirely unexpected. The current 1-year lag between the start of Japan’s export and investment recovery is within historical standards, as in previous episodes of synchronized recessions (1992 exchange rate mechanism (ERM) crisis and 2000–01 recession). Total investment began to recover after 4½ quarters and machinery and equipment investment after 2½ quarters.

Looking ahead, several factors will likely limit the recovery of domestic demand:

  • Deflation. Core inflation has fallen rapidly since the beginning of the crisis and is currently in negative territory. By raising real borrowing rates, deflation will weaken the investment recovery. Prolonged deflation would also hamper bank lending, as rising real liabilities of borrowers weigh on repayment abilities.
  • A precarious fiscal situation. Japan’s high fiscal deficit and net public debt (over 10 percent and 105 percent of GDP, respectively, in 2009) may raise concerns about fiscal sustainability, and the anticipation of a sizeable fiscal adjustment in coming years could weigh on the recovery.
  • Low potential growth and a weak labor market. Japan’s potential growth rate is projected to fall from about 1½ percent in 2007 to around 1 percent over the medium term, led by a shrinking labor force and slower capital accumulation dampening the cyclical rebound. Low productivity growth in the domestic service sector (covering 70 percent of overall employment) would slow labor market recovery. Underlying consumption growth—excluding durables—was weak through 2009 and may be further constrained by the likely termination of fiscal stimulus directed at durables in the second half of 2010.

Japan: Contributions to Final Domestic Consumption Growth

(Quarter–on–quarter, in percentage points; SAAR)

Source: IMF staff calculations.

A broadening of the export-led recovery will depend crucially on whether Japan can rein in deflation and chart a path back to fiscal sustainability and economic growth. Sustained monetary policy accommodation will be key to keeping deflation in check, but a broader macroeconomic policy program would move the economy onto a more vigorous growth path. The main elements are the design of and commitment to a credible medium-term fiscal adjustment path, and the adoption of a comprehensive structural reform program, with supply- and demand-side measures.

Note: The main authors of this box are Pelin Berkmen and Stephan Danninger.1 Japan’s share of advanced manufacturing products such as cars, IT, and machinery account for a larger share of production than in other G-7 economies (Sommer, 2009), Japan’s main export partners are the United States, the euro area, China, and developing Asia excluding India and China, which account for more than 50 percent of the total exports of Japan.

Economic recovery in Asian low-income countries (LICs) has proceeded at a slower pace than in emerging Asia, as these economies generally were affected less by the global financial crisis, but also reflecting structural fragilities (see Box A1). The global economic crisis has caused significant setbacks in many of the Pacific Island economies (see Box A2) as incomes there have suffered from a series of factors including: falling remittances, job losses, and pressures on government wages and social and investment spending stemming from government revenue shortfalls. The sharp fall in tourism receipts and in tourism-related investment has also hurt these economies, in particular the Maldives (see Box A3).

C. Asia, the Inventory Cycle, and the Role of China

Three factors seem to have played a key role in driving Asia’s exports since early 2009, and these also may affect the outlook for exports in the near term. The first is the start of a global and domestic inventory cycle of high-technology manufacturing goods, where many Asian economies have built a strong comparative advantage, such as electronics. The second is the strength of China’s final domestic demand during the crisis. And the third is the ability of Asian exporters to increase market shares even through the global downturn.

Asia and the Inventory Cycle: How Long Will It Last?

Inventory adjustments have substantially amplified Asia’s industrial production and export cycle. This cycle typically consists of three stages. When the recession begins, inventories increase as the drop in shipments exceeds that of production, inducing firms to cut production even more to run down stocks—this helps to explain the sharp decline in industrial production in Asia during the latter part of 2008 and early 2009 (Figure 1.12). When the worst of the crisis is over, and demand begins to recover, firms boost industrial production to prevent inventories from falling further—this helps to explain the sharp rebound of Asia’s industrial production over the course of 2009, with inventories still declining but at a slower pace. Finally, as final demand regains traction, the need to rebuild inventories sustains, for some time, a higher level of industrial production than warranted by final sales.

Figure 1.12.Selected Asia: Industrial Production and Inventory Cycle1

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

1 Includes Japan, Korea, and Taiwan Province of China.

Regression estimates confirm that inventory adjustments tend to feed quickly into industrial production in Asia. In particular, these estimates show that, for every percentage point the inventory-to-shipment ratio deviates from trend, Asian industrial production growth rises or falls by about 0.1 percentage points the following month. This suggests that the inventory cycle may have contributed about one-fourth of the overall rebound of industrial production in Korea since its trough in 2009. GDP releases in the second and third quarters of 2009 show that inventories have indeed started to contribute to growth across a broad range of regional economies (including Australia, Korea, and ASEAN economies), likely reflecting the slowdown in the rate of depletion of inventories and, more recently, the rebuilding of stocks.

How long can the domestic inventory cycle last? The “inventory clock”—a four-quadrant chart that illustrates both inventories and the dynamics of shipments—suggests that Asia’s inventory cycle may be far from over. In Korea and Taiwan Province of China, shipments started growing again (on a year-over-year basis) at the end of 2009, but inventories are still somewhat depleted, which means that further restocking is on its way (Figure 1.13). In Japan, aggressive destocking appears to have ended in late 2009, but both manufacturing shipments and inventories are still significantly below trend. Assuming that the cycle will continue at the same speed as in 2009, it will take between two and four quarters for these economies to return to the initial position.

Figure 1.13.Selected Asia: Inventory and Shipments

(Since January 2008; 3–month moving average of year–on–year percent change, seasonally adjusted)

Sources: CEIC Data Company Ltd.; and Haver Analytics.

Given Asia’s dependence on external demand, the adjustment of inventories abroad also matters. In particular, cyclical variations of U.S. inventories (measured by deviations from trend of the inventory-to-shipment ratio) have generally had a powerful amplifying effect on Asian exports to the United States (Figure 1.14). Staff estimates suggest that, for every percentage point that the U.S. inventory-to-shipment ratio falls below trend, exports from Asia to the United States rise by about 1½ percentage points in the following quarter. With the inventory-to-shipment ratio in the United States running about 5 percent below trend in the first quarter of 2010, inventory adjustments there could add some 7 percentage points to sequential growth of Asia’s exports in the second quarter of 2010. Indeed, while the ratio of U.S. imports to retail sales for electronics appeared to plateau at about 10 percent below the long-term pre-crisis average in the fall of 2009, the ratio started rising again towards the end of the year, consistent with further replenishment of information technology (IT) inventories in the United States.

Figure 1.14.Asia’s Exports to the United States and Inventory Cycle in the United States

(In percent)

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

The Role of China

China’s impact on the regional export cycle appears to have changed relative to previous downturns (Figure 1.15).

  • Exports to the United States and the euro area (G-2) from China and the rest of Asia have declined in tandem during the recent global crisis, in contrast to the 2001 recession, when China’s exports to the G-2 were largely unaffected. The early 2000s marked the beginning of China’s rapid integration in Asia’s global supply chain and, thus, its growing share in the region’s final goods exports. With this process well advanced by the time of this global recession, Asia as a whole is even more coupled to cycles in advanced economies than in the early 2000s. The upshot is that both Chinese and Asian exports are now recovering together.
  • While Asia’s exports to China fell deeper and faster than China’s exports to the G-2 at the beginning of the crisis, during the recovery phase Asia’s exports to China have risen about three times faster than China’s exports to advanced economies (Figure 1.15). This may reflect that at least part of China’s imports from the rest of the region have served China’s final domestic demand. Indeed, value-added trade flows—which avoid counting intermediate goods going into Chinese reexports as exports to China—suggest that Asian economies with a larger exposure to China’s final demand (as opposed to demand from China’s export sector) have experienced a stronger recovery since the second quarter of 2009 (Figure 1.16).

Figure 1.15.Asia: Export Links

(3–month moving average; pre–downturn peak = 100)

Source: IMF staff calculations.

Figure 1.16Selected Asia: GDP Growth and Value Added Linked to China Final Demand

(In percent)

Source: IMF staff estimates.

Consistent with China’s dual role as regional trade hub and source of final demand, imports of both intermediary and final goods have increased in recent months. Initially in 2009, China’s imports were concentrated on intermediary goods and commodities. Strong commodity imports reflected China’s increased final demand, largely related to the infrastructure projects initiated in 2009. But they also may have reflected stockpiling of commodities, both in anticipation of future projects or as a store of value—as suggested by the increasing gap between iron ore imports and domestic steel production. However, imports of final consumer and investment goods also have picked up over the course of 2009 and into early 2010. While, to a large extent, these goods consist of machinery used for further processing, and thus ultimately are tied to final demand from outside the region, they also partly consist of consumer electronics, such as telecoms and motor vehicles.

While China’s strong growth cannot offset the decline in demand from advanced economies—it remains a relatively small importer of consumer goods—it will benefit some of Asia’s exporters. Given the large size of China’s imports of raw materials (about one-sixth of the world total), the resilience of China’s final demand will remain key for commodity exporters, both in the region (Australia, Indonesia, and Malaysia) and outside. But, it is likely to matter only at the margin for many other regional economies. As noted in the October 2009 Regional Economic Outlook, despite recording above-average import growth rates over the last 15 years, China’s imports of consumer goods still accounted for only 3 percent of global imports in 2008. However, the recent crisis suggests that emerging Asian economies are well positioned for a rotation of domestic demand from advanced economies to China and other emerging markets. For example, Korea’s exports of consumer goods to China have risen from an average 10 percent of its exports to the United States in the mid-1990s to an average of 60 percent during 2006–08. For capital goods, China is already a much larger market for Korea than the United States, receiving more than twice as many exports.

Gains in Market Shares

For most economies in the region, the rebound of exports in 2009 also reflected an increase in market shares. What has been driving these results? Part of the explanation may be the ability of Asia’s exporters to respond to challenging market conditions by increasing the price competitiveness of their products, expanding the variety of goods exported, and entering new markets (for example, China). This, in turn, has been made possible both by Asia’s superior productivity and by still relatively weaker exchange rates than in other regions, which have allowed Asian exporters to cushion the impact on (domestic currency) profits from a reduction in foreign currency prices. Indeed, there seems to be a negative relationship between changes in export market shares in 2009 and changes in REER over the last two years (Figure 1.17).

Figure 1.17.Selected Asia: Change in REER and World Export Market Shares

(In percent)

Sources: IMF, Direction of Trade Statistics; and staff calculations.

While the near-term outlook for Asia’s exports remains encouraging, export growth should moderate once the inventory cycle has normalized. The inventory cycle is expected to boost production for most of 2010, as final demand in advanced economies will continue recovering and both domestic producers and U.S. importers continue to rebuild their depleted stocks. This is also consistent with key forward-looking indicators of Asia’s exports, such as the U.S. book-to-bill ratio and U.S. PMI new orders (Figure 1.18). But, with household saving expected to increase, and investment plans hindered by scarce credit and excess capacity, the recovery of domestic demand in advanced economies is expected to proceed at a relatively sluggish pace over the next two years. As a result, Asia’s exports are likely to grow at a somewhat more moderate pace in 2011.

Figure 1.18.Asia’s Exports: Forward-Looking Indicators

Source: Haver Analytics.

D. Transitioning from Public to Private Domestic Demand?

A key dimension of Asia’s outlook is, therefore, the extent to which private domestic demand will remain resilient as policy stimulus is gradually withdrawn.

Public sector demand has played a large role in the resilience of domestic demand in Asia. Staff estimates based on the IMF Global Integrated Monetary and Fiscal (GIMF) model show that the overall impact on growth in the region of the fiscal packages implemented last year averaged about 1¾ percentage points (Figure 1.19). But the growth impact ranges from about ½ percentage points in the highly open emerging Asian economies (ASEAN-4, Hong Kong SAR, and Singapore), to over 2 percentage points in China, where the fiscal packages focused on high-multiplier infrastructure spending. Interestingly, when spill-over effects from stimulus measures in countries outside Asia are also taken into account, the average impact on Asia increases to about 3½ percentage points—reflecting Asia’s high dependence on external demand.

Figure 1.19.Impact of Fiscal Stimulus on 2009 Real GDP

(Deviations from baseline in percentage points)

Source: IMF staff estimates.

Private domestic demand also gained strength over the course of 2009. The composition of GDP growth from the national accounts shows that private domestic demand (excluding inventories) contributed about 40 percent to GDP growth in 2009 on average in Asia. While the aggregate result is largely driven by the economies with a larger domestic demand base, private domestic demand has still been more resilient in export-dependent Asia (excluding Japan) compared to the Asian crisis (Figure 1.20).

Figure 1.20.Selected Export-Oriented Asia: Contribution of Private Domestic Demand (excl. Inventories) to Growth

(Year–on–year; in percentage points)

Source: IMF staff estimates.

Fiscal measures contributed to the recovery of private consumption in Asia, both by providing direct incentives to consumption2 and indirectly by supporting employment and disposable incomes.3 Staff estimates based on a simple econometric model of private consumption in selected Asian economies suggest that fiscal policy may have contributed about one-fourth of the recovery of private consumption in these economies up to the third quarter of 2009 (Figure 1.21).

Figure 1.21Contribution to Recovery of Private Consumption in Asia1

(From trough to 2009:Q3; in percent)

Source: IMF staff estimates.

1 Estimated using a panel regression on data from Hong Kong SAR, Korea, Malaysia, the Philippines, Singapore, Taiwan Province of China, and Thailand.

But “autonomous” private consumption also has strengthened. Two factors are estimated to have accounted for about one-half of the recovery of private consumption:

  • The rapid increase in asset prices. Boosted by large capital inflows, higher equity prices have helped sustain consumer confidence and triggered wealth effects on consumption, (Figure 1.22) especially in those economies where stock market capitalization is relatively high, such as in Korea.
  • The improvement in labor market conditions. Employment levels in the region generally have been more resilient than in advanced economies and other emerging markets (Figure 1.23). Firms in Asia seem to have reacted to the fall in industrial production mainly by hoarding labor and reducing hours worked. With the worst of the crisis over, first hours worked, and then employment and wages, started to pick up, particularly in ASEAN economies. Japan remains a key exception, with few signs of employment picking up, and with wages still falling in nominal terms.

Figure 1.22.Selected Asia: Private Consumption, Consumer Confidence, and Stock Prices1

(Year–on–year percent change)

Sources: CEIC Data Company Ltd.; Haver Analytics; and Bloomberg LP.

1 Includes Australia, Hong Kong SAR, Indonesia, Korea, Malaysia, Taiwan Province of China, and Thailand.

Figure 1.23.Employment

(Index, 2008:Q1=100, seasonally adjusted; average across economies)

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

Accommodative monetary policy also contributed to consumption by easing overall financial conditions. Aggressive financial and credit policies have helped limit corporate bankruptcies and the impact of the crisis on employment levels, in contrast to the Asian crisis. The direct impact of lower interest rates on private consumption likely has varied across regional economies, partly as a function of differences in national financial systems. In particular, the effect likely has been stronger in those economies where households have greater access to credit, and thus have a higher debt burden, such as Industrial Asia, Korea, and Malaysia (Figure 1.24). Lower policy interest rates also have boosted equity valuations, which have supported consumption.

Figure 1.24.Household Credit, 2009

(In percent of GDP)

Sources: The Federal Reserve; CEIC Data Company Ltd.; and Haver Analytics.

In contrast, private investment fell sharply in export-dependent Asia and only returned to positive territory (on a year-on-year growth basis) towards the end of 2009 (Figure 1.25). The sharp decline is consistent with the strong ties between investment and the tradable sectors in these economies (see May 2009 Regional Economic Outlook). As exports collapsed and capacity utilization tumbled, so did private investment, especially in Japan and Korea. With exports recovering sharply and capacity utilization returning to more normal levels, the investment cycle has began to turn, driven by renewed spending on machinery and equipment in high value-added manufacturing sectors (e.g., automobiles in Korea and semiconductors in Taiwan Province of China). Even in China, investment in the manufacturing sector accelerated in the second half of 2009, though the bulk of the increase in private sector investment has been in the real estate sector (Box 1.3).

Figure 1.25.Selected Asia: Private Domestic Demand1

(Year–on–year percent change)

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

1 Includes NIEs and Thailand.

This turn in the investment cycle has been helped by a decline in the cost of capital, and took place despite bank credit remaining generally anemic in most of Asia—with the exception of China.

  • The cost of capital declined during the course of 2009, freeing up resources for investment (Figure 1.26).4 Bank lending rates and corporate bond rates have declined following aggressive reductions in central bank policy rates, and remain at much lower levels than before the crisis. The strong increase in equity valuations further reduced the cost of capital. This is in stark contrast with the Asian crisis, when the sudden stop in capital inflows and the associated problems in the banking sector across the region implied very substantial increases in the effective cost of capital for firms, contributing to a further decline in investment. In a few economies, such as Indonesia, lower inflation rates in 2009 (on an annual basis) have partly offset the decline in nominal interest rates, and in Japan negative inflation has led to a marginal increase in the real cost of capital, though the level of financing costs remain low.
  • While bank lending rates declined somewhat, bank credit to the corporate sector remained relatively flat in the second half of 2009 (Figure 1.27). This is another contrast with the recovery from the 2001 recession, when private investment and credit cycles turned almost in tandem in Asia. One possible explanation is that, somewhat like their Western peers, Asian banks have been more reluctant to lend than in previous recoveries, owing to uncertainty about the strength of the recovery and future financial regulation. Indeed, lending to the household sector has been expanding more strongly than to the corporate sector in several regional economies (Figure 1.28), consistent with the low risk weighting placed on mortgage loans.
  • The pick up of investment in the face of flat bank credit has two potential explanations, not mutually inconsistent. First, large firms entered the current crisis with strong balance sheets and ample cash reserves (Figure 1.29), and thus were able to fund investment through internally generated funds. Second, larger Asian corporates increasingly have tapped into capital markets for their funding needs. In particular, the revival of local currency bond issuance during 2009 indicates that this segment of capital markets has more depth and capacity to absorb new issues than in the past (Figure 1.30). The relatively lower cost and longer-term maturity (usually at three–five years) of bond financing may have provided an incentive for large firms to turn to the corporate bond market—in order to secure relatively cheap, long-term financing for both working and longer term capital investment.
  • China remains a notable exception to this story. Total new bank lending rose to about 30 percent of GDP in 2009 and funded infrastructure projects run by local governments (about one-half of the total), as well as other sectors of the economy, including manufacturing and real estate. Concerns over banks’ asset quality and local government finances due to excessively rapid growth in new loans have led authorities to target a less expansionary credit policy for this year—overall credit growth for 2010 has been targeted at a lower rate (18 percent of GDP) than last year.

Figure 1.26.Selected Asia: Change in Real Cost of Capital

(2009:Q4 vis-à-vis average of 2008:Q1 to 2008:Q3; in percentage points)

Sources: I/B/E/S Inc.; Consensus Economics Inc.; and IMF staff calculations.

Figure 1.27.Selected Asia: Bank Credit to Corporate Sector

(3–month percent change of 3–month moving average; SAAR)

Source: CEIC Data Company Ltd.

Figure 1.28.Selected Asia: Credit to Households and Corporations

(Change between June—December 2009; in percent)

Source: CEIC Data Company Ltd.

Box 1.3.China: An Extraordinary Investment Response in 2009

China’s investment is large by any standard. In absolute terms, it is the largest in the world at US$2 trillion per annum, more than double that of Japan, and making up 18 percent of global capital formation. And, at 44 percent of output, China’s investment is higher than anywhere else in the world and more than twice the average of the Organisation for Economic Cooperation and Development (OECD) economies. Real estate, manufacturing, and infrastructure investment each account for roughly a quarter of total investment in China.

China: Share in Fixed Asset Investment

Source: IMF staff calculations.

In 2009, China’s investment grew at an unprecedented pace—20 percent, double the annual average of the last three decades. And it contributed an unprecedented 8 percentage points to GDP growth.

Investment during 2009 showed four key characteristics:1

  • Infrastructure investment led the surge in investment, growing at an extraordinary 44 percent. The central government more than doubled its investment expenditure, and local governments brought forward a number of infrastructure projects that had been on the drawing board for a long time. This infrastructure expansion was largely financed by central government bonds and bank credit.
  • At the start of 2009, real estate investment was in the doldrums but recovered steadily during the year. This was facilitated by the government reversing course on a number of policies designed to cool the real estate market, including changes to minimum down payments.
  • Investment in the manufacturing sector increased by 30 percent, matching the average growth rate of the last five years, despite a precipitous fall in exports.
  • By contrast, investment in services remained low. The service sector, excluding utilities, transportation, and real estate, which comprises approximately one-third of output, was the destination for only 12 percent of total investment.

While public and bank financing of investment increased during the year, other sources of financing remained dominant. State financing and bank loans for fixed asset investment surged by more than 50 percent, while foreign financing shrunk. Other sources, including retained earnings, continued to provide three-fourths of all financing for investment.

Total investment growth should remain strong this year but decline below the extraordinarily high level observed last year as the government takes steps to reach its targets for loan and money growth, which are significantly below last year’s outcome. The government also intends to limit new starts in public sector projects.

Real estate investment should continue to increase rapidly this year as developers respond positively to government measures to increase the housing supply, especially at the lower-income level. However, it is far from clear whether these supply measures and measures announced so far to reduce speculative demand, will be sufficient to moderate real estate price increases.

China: Financing Fixed Asset Investment
(in percent of total)
State budget4.
Domestic loans18.818.516.915.717.2
Foreign capital4.
Self raised54.455.657.062.258.5
(growth in percent)
State budget32.928.919.135.753.7
Domestic loans18.823.617.511.852.4
Foreign capital25.913.219.02.7-15.6
Self raised36.928.231.531.430.9
Source: IMF staff calculations.
Source: IMF staff calculations.

In the coming years, investment growth will likely remain robust but with a transition away from public drivers and toward private sector-led capital formation. Real estate should continue its rapid pace of growth, driven by underlying forces of urbanization and the demand for housing as an alternative investment vehicle. This should support commodity and capital goods imports and build China’s capacity in the production of tradable goods.

However, if investment remains oriented toward manufacturing goods catering to external demand, there is a significant risk that existing excess capacity problems, for example, in the production of steel and aluminum, will broaden to more sectors. This in turn will reduce profits, lower return on investment, and raise nonperforming loans (NPLs) in the banking system.

China: Real Growth of Imports of Capital Goods and Fixed Asset Investments

(Year–on–year; in percent)

Source: CEIC Data Company Ltd.

Note: The main author of this box is Tarhan Feyzioglu.1 Based on urban fixed asset investment figures, which also include purchases of land, old equipment, and buildings.

Figure 1.29.Asia: Corporate Balance Sheet

(2–year average prior to selected recessions)

Source: IMF, Corporate Vulnerability Utility database.

Figure 1.30.Selected Asia: Bond Issuance in Local Currency

(In billions of U.S. dollars)

Source: Asian Development Bank.

However, a more sustained pick up in investment will require a turn in the credit cycle, especially for SMEs. Unlike their counterparts in advanced economies, banks in Asia have remained well-capitalized and very liquid throughout the crisis—with the growth of nonperforming loans (NPLs) much lower than anticipated at the onset of the crisis. With uncertainties dissipating and macroprudential measures containing growth of mortgage loans going forward, bank credit to the corporate sector should pick up—indeed there are some signs that the corporate credit cycle has started to turn in some regional economies, including India, Indonesia, and New Zealand. This will particularly benefit SMEs, whose access to credit has been most impaired by lower bank lending, even though government guarantee schemes and targeted lending facilities may have partly offset the impact. This is true especially in Korea, where bank lending to SMEs has actually increased relative to large firms (Figure 1.31).

Figure 1.31.Bank Credit to SMEs and Large Corporations

(2008:Q4 = 100)

Source: CEIC Data Company Ltd.

While these measures were timely, given the importance of the SME sector in accounting for a substantial share of employment across the region, their continuation poses fiscal risks and potential distortions (as discussed in the October 2009 Regional Economic Outlook). Unwinding this support, however, is likely to prove difficult as long as the overall recovery in credit remains tepid and the durability of the investment turnaround is in question.

Overall, private domestic demand is expected to remain robust over the near term, despite a less accommodative policy framework. The withdrawal of fiscal stimulus in 2010 (based on current budget plans) amounts to about 0.6 percent of GDP, compared with the 2 percent fiscal stimulus injected in 2009 (Figure 1.32). This aggregate measure, however, masks important differences among countries, with a more substantial pace of withdrawal in India and Korea offset by continuing stimulus in China. Staff estimates based on the IMF GIMF model show that the negative impact on growth will be only about 0.3 percent on average for the region, although with a peak of about 1 percent for Korea (Figure 1.33).

Figure 1.32.Asia: Fiscal Impulse, 20101

(In percent of GDP)

Source: IMF staff estimates.

1 Change relative to 2009 in structural fiscal balances related to measures taken in response to the crisis. A negative number implies withdral of fiscal stimulus.

Figure 1.33.Impact of Fiscal Stimulus on 2010 Real GDP

(Deviations from baseline in percentage points)

Source: IMF staff estimates.

E. Are Large Capital Flows Threatening Financial Stability?

After the sharp flight of capital out of emerging Asia in 2008 and early 2009, net capital inflows rebounded to a historic high in the third quarter of 2009 (Figure 1.34). The turnaround was quicker and larger than in previous instances of reversals of capital inflows, largely due to the rapid normalization of global financial conditions (undoubtedly helped by very low policy rates in the advanced countries). In particular, portfolio and cross-border bank flows have rebounded sharply after the steep retrenchment in late 2008–early 2009. Within Asia, net private capital inflows have been larger in countries with stronger growth prospects, such as China, India and Indonesia, and those with closer trade ties to China, such as Korea, while Japan continued to experience net capital outflows (Figure 1.35). Staff estimates from a model of the determinants of capital flows to Asia confirm that the two most important factors driving net capital inflows to the region are growth differentials relative to the United States and the degree of global risk aversion. A somewhat smaller role is also played by relatively higher interest rates in Asia, although expectations of exchange rate appreciation of Asian currencies may have boosted carry trade flows to the region.

Figure 1.34.Selected Emerging Asia: Net Capital Inflows1

(In percent of GDP)

Sources: CEIC Data Company Ltd.; and IMF, Balance of Payments Statistics.

1 Does not include China and Vietnam due to data limitations, and the financial centers, Hong Kong SAR and Singapore.

Figure 1.35.Selected Asia: Net Capital Inflows1

(In percent of GDP)

Sources: CEIC Data Company Ltd.; and IMF, Balance of Payments Statistics; and staff calculations.

1 China’s 2009:H2 data are not yet available.

Despite the slowdown since the end of last year, the outlook for capital inflows remains favorable. A major difference with previous episodes of large capital inflows is that this time real-money investors account for the bulk of new funds, rather than leveraged investors. These inflows are likely to persist, with European and U.S. managers getting larger mandates to invest in Asia, as the region is expected to outperform advanced economies, where monetary policies are set to remain more accommodative. Moreover, with emerging market equities still underweighted in global investor portfolios, even small shifts in portfolio allocations could translate into significant capital inflows to the region.5 There are also sizeable flows from Japanese institutional investors into emerging Asia, while local pension funds and insurance companies are bringing money back to the region.

Large capital inflows have boosted asset prices but, thus far, asset valuations remain broadly in line with long-run averages, though some signs of stress have appeared. Overall, however, equity prices are not out of line with previous recoveries from deep recessions, such as from the Asian crisis (Figure 1.36). Moreover, forward-looking P/E ratios are above their long-run averages only in China, Hong Kong SAR, and India. However, this may also reflect “excessively” optimistic earning expectations. Staff estimates, based on the historical relationship between earnings and GDP growth suggest that for many economies in the region earnings forecasts may be more optimistic than implied by IMF World Economic Outlook GDP growth forecasts. Moreover, in a few Asian economies (notably India, Indonesia, Korea, and Malaysia) the ratio of 10-year government bond yields and equity earning’s yields (the inverse of the P/E ratio) is now higher than its long-run average. To the extent that this average is a valid benchmark, this suggests that either bond prices must increase or equity prices must fall to bring the ratio back in line with its past average. Finally, concerns about excessive increases in property prices are limited to some urban areas in China and high-end luxury segments in Hong Kong SAR and Singapore (Figure 1.37).6

Figure 1.36.Emerging Asia: Equity Prices and Price-Earnings Ratio

Sources: I/B/E/S Inc.; and CEIC Data Comapny Ltd.

1 Long-run average is calculated over the period since late 1980 to June 2008.

Figure 1.37.Selected Asia: Property Prices

(Year–on–year percent change)

Sources: CEIC Data Company Ltd.; and Haver Analytics.

However, this should not lead to complacency—if history is any guide, asset price boom and bust cycles tend to develop gradually when paired with capital inflow surges. Episodes of large capital inflows to Asian economies over the period 1990–2009 indicate that asset price booms generally have developed over a longer horizon when associated with large capital inflows (see Box 1.4). Also, previous episodes of large capital inflows that spilled over into unsustainable asset price rises generally coincided with rapid growth in “excess liquidity” (broad-money supply growing much faster than nominal GDP). And during the current episode, excess liquidity has been rising across emerging Asia in recent months (Figure 1.38). This is in part a result of policy decisions to resist exchange rate appreciation pressures by increasing foreign reserves. In particular, China has only partially sterilized the impact of higher reserves on the money supply, de facto choosing to accommodate the robust demand for money associated with the strong growth in economic activity (Figure 1.39).

Figure 1.38.Emerging Asia (excl. China): Excess Liquidity and Net Capital Inflows

(In percent)

Sources: CEIC Data Company Ltd.; Haver Analytics; and IMF Balance of Payments Statistics.

Figure 1.39.China and India: Composition of Reserve Money

(In trillions of national currency unit)

Source: IMF, International Financial Statistics.

Box 1.4.Lessons from Past Episodes of Large Capital Inflows in Asia

As global risk appetite recovered together with Asia’s recovery, capital inflows have returned to the region, reversing much of the sudden stop at the end of 2008. Equity prices have rebounded and property prices have also increased, especially in some local markets. As growth and interest differentials with advanced economies are expected to remain wide in 2010, capital inflows to the region are expected to continue. Will this contribute to an increase in asset prices to levels that will prove difficult to sustain? What are the likely early macroeconomic signals that capital inflows are about to fuel asset price booms and subsequent busts?

To address these questions we look at previous episodes of large capital inflows and extreme asset price swings in Asia during the last two decades, and analyze the behavior of some key macro indicators around those episodes.1

We adopt the following definitions:

  • Large capital inflow episodes are defined as periods when the ratio of net private capital inflow to GDP is significantly above trend (at least one standard deviation above its 8-quarter moving average) and exceeds 1 percent of GDP.2
  • For equity prices, a bust occurs when the 4-quarter moving average (4qma) of the annual growth rate of real stock prices falls below 20 percent.3 The start of the preceding boom phase is deemed to be the first quarter in which the growth rate of prices turned positive in the run-up prior to the bust.
  • For property prices, a bust occurs when the 4qma of the annual growth rate of real property prices falls below 5 percent.4 The duration of the episode follows the criteria outlined in the case of real equity prices.
  • Next, we identify a subset of episodes that include large capital inflows, asset price booms, and subsequent busts which begin within six quarters of each other. In other words, an inflow episode is paired with an asset price boom and bust episode if the inflow starts in an interval spanning six quarters on either side of the start of the asset-price cycle. If the inflow episode starts outside of that interval, and there is no ongoing boom and bust episode, it is classified as an “isolated” episode. Similarly, an asset-price boom and bust is associated with an inflow episode if it starts in a window covering the six quarters prior to and following the start of an inflow episode.

Hong Kong SAR: Net Capital Inflows1

(In percent of GDP)

Sources: CEIC Data Company Ltd.; and IMF Balance of Payments Statistics.

1 Identified large capital inflow episodes are shown by shaded areas.

Hong Kong SAR: Real Equity Prices1

(Year–on–year percent change; 4–quarter moving average)

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

1 Identified boom-bust episodes in real equity prices are shown by shaded areas.

Using this definition, we identify a total of 58 capital inflow episodes in the sample, of which 24 are combined with the onset of a stock price boom and bust episode, and 9 are combined with the onset of a property price episode.5

Asset market booms and bust develop over long periods of time, and last longer when combined with capital inflow episodes.

These episodes show several interesting patterns. An initial result from the analysis is that asset-price boom and bust cycles generally develop over several quarters. The median duration of a stock-price boom-bust episode is 11 quarters, and that of a property price boom-bust episode is 16 quarters. When asset-price episodes are combined with large capital inflow episodes, they tend to last longer. The median duration for stock-price boom-busts that start within six quarters of a capital inflow episode is 12 quarters, while that of property price boom-busts is 28 quarters.

Excess liquidity growth is the main factor distinguishing episodes which have both high inflows and asset market booms and busts.

What distinguishes the combined inflow and asset-price boom-bust episodes from the isolated inflow episodes? We compare the two groups of episodes across a set of macro indicators (real exchange rate appreciation, loan-to-deposit ratio of the banking sector, inflation, reserve accumulation, private sector credit growth relative to GDP growth, and excess liquidity—defined as the difference between year-on-year growth of broad-money supply and of nominal GDP). For each of these indicators, the mean over the six quarters following the start of the inflow episode is calculated in both the paired and isolated groups, and statistical tests are run to assess whether the differences between the two means is significant at the 5 percent level.

Asia: Excess Liquidity Following Inflow Episodes

(In percent: averages across groups of episodes)

Source: IMF staff estimates.

The results indicate that paired inflow episodes tend to be characterized by significantly higher excess liquidity relative to the group of isolated inflow episodes. This phenomenon is confirmed using the data around the Asian financial crisis: large capital inflows were associated with a spike in excess liquidity growth, and with a continued run-up in asset prices and subsequent decline.6

By contrast, in episodes of large capital inflows that were not associated with asset-price volatility, excess liquidity generally was lower than in the preceding quarters.7 In these episodes asset prices rose steadily, even as excess liquidity remained sluggish and capital inflows declined, probably reflecting improvements in underlying fundamentals rather than excessively easy financial conditions.

Paired inflow and asset cycle episodes are associated with significantly higher intervention to resist appreciation, resulting in higher reserve accumulation.

Asian Crisis: Capital Inflows, Asset Prices, and Excess Liquidity1

Source: IMF staff calculations.

1 Plotted as number of standard deviations from average for the six quarters prior to and following onset of large inflows at t.

The policy response to inflows also appears to play an important role in distinguishing paired from isolated episodes. Reserve accumulation tends to be significantly higher in episodes where large capital inflows are paired with the beginning of an asset price boom-bust cycle, compared to isolated inflow episodes. This suggests that intervention to resist exchange rate appreciation pressures from large capital inflows also may contribute to the risk.

Paired inflow episodes are associated with significantly higher inflation.

Isolated Inflow Episodes: Capital Inflows, Asset Prices, and Excess Liquidity 1

Source: IMF staff calculations.

1 Plotted as number of standard deviations from average for the six quarters prior to and following onset of large inflows at t.

We also find that inflation tends to be significantly higher in the aftermath of paired inflow episodes compared to isolated inflow episodes. High liquidity around the time of paired inflow episodes therefore also may be partly due to a relatively more accommodative stance toward general price pressures.

Taken together, the evidence is consistent with the view that the combination of large capital inflows and accommodative monetary policy raises the risk of asset-price boom-bust cycles.

Note: The main authors of this box are Souvik Gupta, Malhar Nabar, and Shanaka Peiris.1 The dataset covers the Asian economies (Australia, China, Hong Kong SAR, India, Indonesia, Japan, Korea, Malaysia, New Zealand, the Philippines, Singapore, Taiwan Province of China, Thailand, and Vietnam) over the period 1990:Q1–2009:Q3.2 If only one quarter separates two adjacent surges, and the net capital flow is positive in that quarter, it gets combined with the two adjacent episodes to form one continuous episode. However, instances of a large inflow immediately followed by an outflow in the next quarter are not identified as an episode (along the lines of the October 2007 World Economic Outlook methodology).3 This is consistent with Fatas and others (2009).4 This is also along the lines of the definition proposed by Fatas and others (2009).5 The number of stock-price episodes is 46 and the number of property price episodes is 19.6 The identified paired inflow episodes are Hong Kong SAR (1997:Q1–Q4), Indonesia (1995:Q4–1997:Q1), Korea (1996:Q2–1997:Q1), Malaysia (1996:Q1–Q4), and Thailand (1995:Q2–1996:Q1). The Philippines also was affected at this time, but the initial onset of large inflows occurred in 1993:Q3. For consistency with the other cases, the time paths for the key variables for the Philippines are tracked over the six quarters prior to and following 1993:Q3.7 The inflow episodes isolated from property and equity-price boom and busts in the sample are—Australia (1993:Q2–1994:Q4 and 2002:Q2–2003:Q3), India (1993:Q3–1994:Q4), New Zealand (1992:Q2–Q4, 1995:Q2–1996:Q1, and 1999:Q1–2000:Q2), Singapore (1993:Q3–1994:Q4), and Taiwan Province of China (2002:Q2–2003:Q3).

Note: The main authors of this chapter are Ashvin Ahuja, Roberto Cardarelli, Sonali Jain-Chandra, Malhar Nabar, Runchana Pongsaparn, and Olaf Unteroberdoerster.


In particular, subsidies were provided for purchases of goods and transportation vehicles in rural areas; payments to the poor and elderly were increased; subsidies for health insurance were expanded and a new healthcare reform was rolled out; taxation of labor was reduced; pension coverage and portability were improved; and policies were put in place to discourage layoffs.


For example, through public services’ subsidies in Thailand; fuel price subsidies in Malaysia; rural home appliance subsidies in China; and tax incentives for the purchase of motor vehicles or other durables in Korea, Japan, and Taiwan Province of China.


For example, through cash transfers (Australia, Korea, Indonesia, and Thailand), income tax cuts (New Zealand), and subsidies to first-time home buyers (Australia), or through measures aimed at supporting employment levels (Hong Kong SAR, Japan, and Singapore).


The real cost of bank lending is the difference between prime bank lending rates and 1-year-ahead inflation expectations from Consensus Economics. The real cost of debt is the difference between yields on AAA corporate bonds and the same inflation measures. The real cost of equity is defined using the same methodology as in the October 2008 World Economic Outlook.


The April 2010 IMF Global Financial Stability Report estimates that a 1 percent shift in the holdings of U.S.-based unlevered institutional investors of domestic securities could translate into a US$45 billion reallocation to emerging market securities, in general, suggesting that about US$20–$25 billion of that could go to Asian economies.


See Chapter II for policy measures to address concerns about property price appreciation in these economies.

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