II. Projections, Risks, and Policy Challenges
- International Monetary Fund. Asia and Pacific Dept
- Published Date:
- May 2010
A. Projections for 2010–11
GDP growth forecasts for many Asian economies have been revised upward relative to the October 2009 Regional Economic Outlook. For the region as a whole, growth now is forecast to be about 7 percent in 2010, 1¼ percentage points higher than projected in fall 2009, and to grow at the same pace in 2011 (Table 2.1). In particular:
In China, GDP growth is expected to accelerate to 10 percent in 2010. The contribution from investment is expected to remain high, though substantially below that in 2009, as the pace of new public and private investment moderates, largely reflecting tightening measures. Buoyed by ongoing structural reforms and fiscal measures, consumption growth should remain relatively robust, while the recovery in external demand implies that net exports would no longer subtract from growth. Rapid growth is projected to continue in 2011 but will be driven more by the private sector, with an increase in private investment offsetting falling public investment levels, and with the contribution of external demand turning positive again (Figure 2.1).
In India, growth is projected to rise to about 8¾ percent in 2010 and 8½ percent in 2011 (from nearly 6 percent in 2009), driven by strong domestic demand. Investment is projected to gather momentum, due to higher corporate profitability and favorable financing conditions, while consumption growth should remain strong on the back of better employment prospects and lower uncertainty. The public sector’s contribution should decline as the effect of stimulus measures wanes, while the contribution from net exports also should diminish due to faster imports (Figure 2.1).
Growth in the NIEs (Hong Kong SAR, Korea, Singapore, and Taiwan Province of China) is expected to accelerate to around 5½ percent in 2010 and about 5 percent in 2011, from a contraction of about 1 percent in 2009, driven primarily by a shift from public sector to private sector growth (Figure 2.2). Private investment and stock building, in particular, are expected to support growth in Taiwan Province of China and Korea, while net exports are not expected to contribute significantly in 2010. But as the global economy continues to recover, net exports will contribute to growth in 2011.
In the ASEAN-5 countries, growth is expected to reach about 5½ percent in 2010 and 2011, up from 1¾ percent in 2009 (Figure 2.2). In Indonesia, private and public consumption should continue to support the recovery, but investment growth also is expected to pick up strongly. In Thailand, without shocks, strengthening domestic demand and inventory restocking are expected to underpin growth through 2010 and 2011. In Malaysia and the Philippines recovery will be led by private consumption, thanks to resilient remittances in the former and improving employment conditions and higher commodity prices in the latter. Vietnam’s growth is expected to accelerate on the back of strong private consumption, a rebound in investment and the recovery of external demand.
Within Industrial Asia, Japan’s GDP growth is projected to return to positive territory at about 2 percent in 2010 and 2011, from -5 percent in 2009. Stronger external demand and continued support from policy stimulus are expected to push growth in the first half of 2010, together with a moderate pickup in business investment and higher household transfers. The recovery of domestic demand should continue into 2011, also on account of improving employment growth (Figure 2.3).
The Australian economy is expected to grow by 3 percent in 2010 and 3½ percent in 2011, with private domestic demand taking over from public demand as a main driver of growth. Private investment, particularly in the resource sector, will be boosted by strong commodity prices and resilient demand from China. Additional stimulus to private investment will also come from the public infrastructure investment, directed at addressing bottlenecks in the supply chain for commodity exports. Despite some negative impact on consumer confidence from rising mortgage rates, household consumption will be supported by real income growth, buoyed by the rebound in labor demand. Economic activity is expected to pick up in New Zealand, supported by ongoing fiscal stimulus, relatively low mortgage rates and improved commodity export prices (Figure 2.3).
|Hong Kong SAR||-2.7||5.0||4.4|
|Taiwan Province of China||-1.9||6.5||4.8|
|Emerging Asia excl. China||2.6||6.8||6.6|
|Emerging Asia excl. China and India||0.4||5.5||5.3|
|Asia||3.4||7.1||7.1|Figure 2.1China and India: Contributions to Growth
Source: IMF, WEO database.
Figure 2.2.NIEs and ASEAN-5: Contributions to Growth
Source: IMF, WEO database.
Figure 2.3.Industrial Asia: Contributions to Growth
Source: IMF, WEO database.
Inflationary pressures in the region should generally remain contained (Figure 2.4). In China, inflation is likely to remain subdued because of large excess capacity, despite some near-term pressures due to supply constraints on food. In India, Indonesia, and Vietnam, inflationary pressures are expected to reverse by 2011, as commodity prices stabilize and monetary conditions become less accommodative. In Japan, deflation will recede slowly in 2010, with the labor market stabilizing and investment expected to begin recovering in 2010, but is expected to persist until the middle of 2011. Inflation rates in Australia and New Zealand are expected to remain within their respective target ranges in 2010, reflecting above target inflation going into the downturn, and their experience of milder slowdowns compared to other Asian economies.
Figure 2.4.Asia: Consumer Prices1
Source: IMF, WEO database.
1 Wholesale prices used for India.
Asia’s overall current account surplus is projected to decline slightly over the next two years as a percent of GDP (Figure 2.5).7 The external surplus is expected to increase slightly in US$ terms (from about US$560 billion in 2009 to US$600 billion in 2011), but to decline as a share of GDP (from 3¾ percent in 2009 to 3¼ percent in 2011). However, this trend masks significant differences. China’s current account surplus is expected to expand from US$280 billion in 2009 (5¾ percent of GDP) to nearly US$400 billion in 2011 (6½ percent of GDP), as investment income continues to rise in line with the accumulation of foreign assets and import growth moderates in line with less infrastructure investment. As a result, China will remain the single largest contributor to the region’s external surplus, accounting for two thirds of it in 2011. By contrast, Asia’s current account surplus excluding China is expected to shrink from about US$280 billion in 2009 to about US$200 billion in 2011. Nearly all major regional economies, from Japan to the NIEs and ASEAN-4, will contribute to this decline, as import growth is expected to outpace the recovery in exports and commodity prices stabilize at higher levels. For Korea, the recent appreciation of the won also will likely contribute to the decline in the current account surplus. On the other hand, India’s current account deficit is expected to remain broadly stable, at about 2 percent of GDP over the next two years, while Australia and New Zealand are expected to continue to run current account deficits as foreign capital continues to fund private investment.
Figure 2.5.Asia: Current Account Balance
Source: IMF, WEO database.
B. Risks to the Outlook
While the outlook appears less uncertain now than last October, risks remain tilted to the downside (Figure 2.6):
The main downside risk to the baseline forecasts continues to stem from the fragility of the global recovery. As highlighted in the April 2010 World Economic Outlook, while the extraordinary policy support since the crisis began has prevented a greater disruption of economic activity and laid the foundations for the recovery, it also has introduced new risks and fragilities. Importantly, downside risks related to public debt burdens in advanced economies have become sharply more evident. The main concern is that room for policy maneuver in many advanced economies has either been largely exhausted or become much more limited, leaving their fragile recoveries exposed to new shocks. But even in the absence of new shocks, the large gross borrowing requirements faced by some advanced economies, and the need for more ambitious consolidation plans, could affect Asia by undermining the global recovery and increasing risk premiums.
In the near term, a risk is that market concerns about sovereign liquidity and solvency in the euro zone periphery may turn into a full-blown, contagious sovereign debt crisis (as discussed in the April 2010 Global Financial Stability Report). While Greece’s sovereign debt situation has not had a major impact on flows to the region—with a very limited rise in sovereign credit default swap (CDS) spreads—the main risk scenario is one of worsening global risk aversion, should the jitters spill over to some of the larger European economies. Moreover, problems in Europe could force a further retrenchment of European banks from the region, possibly reigniting some dollar and euro funding pressures in Asian markets. With European banks providing almost half of cross-border lending to Asia (about US$583 billion at end-September 2009), further balance-sheet deleveraging and some pullback from Asia also could affect funding of some key activities in the region, especially trade financing (Figure 2.7). The increase in global risk aversion and renewed pressures to deleverage could pose particular risks to Asian corporates and banks, as they face relatively higher refinancing needs in 2010 and 2011 than other emerging markets (Figure 2.8).
A further downside risk for parts of Asia stems from commodity prices remaining stronger than currently expected. As discussed in the April 2010 World Economic Outlook, with global demand growth likely to be sustained, food commodity markets may remain tight. In the absence of unanticipated increases in supply, the risk to real food prices remains tilted toward the upside. Greater-than-expected inflationary pressures may in turn induce more aggressive monetary tightening and weaken the virtuous cycle between strong economic activity, buoyant financial markets, and ample consumer confidence, which thus far has sustained private domestic demand in the region.
A marked downturn in China could spill over to much of the region. This could be induced by an overly aggressive normalization of credit conditions, or regulatory tightening in the housing market that sought to avoid a sharp deterioration in the quality of assets held by Chinese banks, or excessive increases in inflation or asset prices. Such a scenario would reverberate across the region, and especially affect economies that have benefited strongly from China’s resilient performance so far, particularly commodity exporters (Australia, Indonesia, and Malaysia) and exporters of capital goods (Korea and Taiwan Province of China).
On the upside, exports could contribute to growth more than currently envisaged in our baseline. This may reflect a stronger-than-expected recovery in advanced economies, in particular a more favorable evolution of private consumption in the United States stemming from a further reduction in uncertainty and stronger-than-expected improvement in financial market sentiment. But it may also reflect a consolidation of the recent gains in Asia’s external market shares.
Figure 2.6.Asia: GDP Growth
Source: IMF staff estimates.
Figure 2.7.Outstanding Consolidated Claims of BIS Reporting Banks vis-à-vis Major Asian Economies
Source: Bank for International Settlements.
Figure 2.8.Emerging Economies: Projected Rollover of Foreign Currency Bonds and Loans by Corporations
Source: IMF, Global Financial Stability Report, April 2010.
C. Policy Challenges
The main near-term policy challenge for policy makers is judging the appropriate pace for normalizing monetary and fiscal policy. With private domestic demand gaining strength over the course of 2009 in many regional economies, the risk of “false dawns” (discussed in the October 2009 Regional Economic Outlook for Asia and the Pacific) has declined substantially. As a result, policy normalization in Asia may well need to begin sooner than we anticipated in fall 2009, and almost certainly earlier than in advanced economies. But policymakers will have to weigh the strength of Asia’s recovery against the fragility of the global recovery, which argues for a cautious and gradual withdrawal of stimulus. Notwithstanding the difficulty of navigating during this period of more than usual uncertainty, most economies in Asia are fortunate to have some fiscal and monetary space to respond flexibly to external shocks. Moreover, the appropriate pace of exit will vary across regional economies, in line with the differences in cyclical positions and exposure to the various risks described above.
Indeed, a few economies in the region, including Australia, China, India, and Malaysia, already have started tightening monetary policy. In China and India, central banks have increased reserve requirements in early 2010, in an effort to withdraw liquidity, though these ratios are still well below pre-crisis levels. Australia’s central bank has increased the policy rate five times since October 2009, while India and Malaysia have also started raising policy rates in early 2010. In April 2010, the Monetary Authority of Singapore tightened the policy stance by recentering the exchange rate policy band and targeting a “modest and gradual” appreciation of the Singapore dollar in nominal effective terms for the period ahead. The appreciation of nominal exchange rates discussed in Chapter I is also helping to make financial conditions less accommodative in other regional economies.
Going forward, the process of monetary policy normalization will need to be guided by several considerations:
The degree of monetary accommodation currently in place, as measured for example by the distance from policy interest rates that are consistent with zero output gaps and stable inflation at around target levels. While estimates of these rates are subject to considerable uncertainty, staff estimates suggest that the distance is relatively large in some regional economies, such as India, Korea, and Thailand (see Box 2.1). In these economies, gradual increases in policy rates such as those expected by markets in April 2010 (Figure 2.9) still would leave monetary policy stances reasonably accommodative, but would help signal the authorities’ commitment to safeguard price stability.
The pace at which output gaps are closing. Based on staff estimates, output gaps are expected to close as early as late 2010 in India and Korea, but later in Malaysia (early 2012) and even later in Japan (2015) (Figure 2.10). In economies with a higher degree of slack and a greater exposure to external demand, the pace of normalization may be made conditional on further confirmation that the global recovery is firming up, and that private domestic demand is strengthening.
The emergence of inflationary pressures, both in consumer and asset prices. While part of the recent pickup in inflation can be explained by higher food and energy prices, higher core prices may also reveal upside risks from second-round effects of the more volatile components of consumer price index (CPI) baskets. Indeed, inflation expectations have increased in early 2010 relative to May 2009 in many economies in the region, particularly in China and Vietnam. Clearly, these risks may be exacerbated by the rapidly closing output gaps, so in economies where economic slack is still ample, the normalization of monetary policy can proceed more gradually. On the other hand, indications that excess liquidity may be fueling unsustainable run-ups in asset prices also would require a faster return to more normal monetary policy conditions.
Figure 2.9.Selected Asia: Policy Interest Rate and Implied 6-Month Forward Interest Rate 1
Sources: CEIC Data Company Ltd.; Haver Analytics; Bloomberg LP; and IMF staff calculations.
1 As of second week of April 2010.
Figure 2.10.Output Gap: Projected Closure Dates
Source: IMF staff estimate.
Figure 2.11.1-Year-Ahead Inflation Expectation: Change between 2009:Q2 and 2010:Q1
Source: Consensus Economics Inc.
While domestic cyclical considerations may argue in favor of an early monetary tightening, these also should be weighed against the risk of attracting further capital inflows. Large capital inflows may complicate macroeconomic management, because of their potential to generate overheating, increase vulnerabilities to credit and asset price cycles, and lead to steep and sudden real exchange-rate appreciation. An appropriate response against these risks could involve a variety of measures, depending on country circumstances:
Macroprudential measures: Some countries in the region already have in place prudential regulations to slow run-ups in asset prices, especially property prices, caused by excess domestic liquidity and low borrowing costs (Table 2.2). These measures already have had some impact, for example by reducing the growth of mortgage lending in Korea and Singapore (Figure 2.12).
More exchange rate flexibility also can help mitigate capital inflows, for two reasons. First, the higher growth divergence coupled with past resistance to appreciation pressures can lead market participants to expect currencies to strengthen over time. In the near term, the inflows will increase domestic liquidity and asset prices, and the expectation of future currency appreciation will reinforce this upward pressure. Letting the exchange rate appreciate can forestall short-term inflows. Second, without more currency appreciation, the pressure to sterilize the impact on the money supply will continue. While central banks may revert to using reserve requirement rules as a (cheap) sterilization tool, this carries the risk of introducing distortions into the domestic banking system.
The role of capital controls: in cases where the exchange rate is below its equilibrium value, the first line of defense in the face of large capital flows should be to allow the nominal exchange rate to appreciate while limiting volatility. If, however, inflows prove overwhelming in their speed and size, the authorities could temporarily tighten their existing regime of controls and delay any planned liberalization until the pressure abates. In some cases, countries might also consider liberalizing capital outflows, or financial reforms that may encourage outflows, for example by strengthening asset management, including for public pension funds.
|Hong Kong SAR Korea|| Mortgages for luxury properties have been capped at 60 percent of the value of the property.|
Maximum loan amount for mass-market property has been limited to HK$12 million (US$1.5 million).
Stamp duty on sales of more than HK$20 million has been increased by 50 basis points to 4.25 percent.
A nonbinding guidance on mortgage rates has been issued to curb excessively competitive lending.
|Korea||The ceiling on loan-to-value ratios has been reduced from 60 to 50 percent in the Seoul metropolitan area. |
The area of coverage for the debt-to-income ratio has been expanded to nonspeculative areas and it cannot exceed 55 percent in Seoul, and 65 percent of income in Incheon and Gyeonggi Province. The regulations apply to mortgage loans exceeding 50 million won.
|Singapore||Interest only loans have been disallowed. |
Special assistance programs for property developers have been wound down.
|China||Taxes on the resale of properties within five years of purchase have been increased. |
The minimum downpayment on first homes larger than 90 square meters has been set at 30 percent. Loan-to-value ratios for second homes have been capped at 50 percent.
Figure 2.12.Selected Asia: Mortgage Loans
Source: CEIC Data Company Ltd.
Fiscal policy is expected to remain accommodative in most of Asia, despite the planned withdrawal of part of the fiscal stimulus during the crisis in many regional economies. Staff forecasts of cyclically adjusted government budget balances show that they are likely to remain below pre-crisis levels (the average between 2005 and 2007) in 2010 and 2011 (Figure 2.13). A gradual removal of the fiscal stimulus appears generally appropriate, given that only Japan faces debt sustainability challenges as do many other advanced economies (Figure 2.14). Given the still significant downside risks to the outlook, maintaining targeted fiscal measures would appear to be a relatively affordable form of risk management, especially in economies where the recovery of autonomous private domestic demand is still fragile.
Figure 2.13.Asia: Cyclically Adjusted General Government Balance
Source: IMF, WEO database.
Figure 2.14.Public Debt
Source: IMF, WEO database.
At the same time, it is important to ensure that fiscal policy is expected to move to a more neutral stance over the medium term. The advantages of a medium-term fiscal consolidation strategy are threefold:
A key lesson for Asia from the global crisis is that countercyclical policy matters. It thus will be important to restore the fiscal space required to deal with future shocks, especially in those economies that are starting from relatively high levels of debt (India and Malaysia) or are facing certain aging-related spending pressures.
At the same time, a credible plan to create fiscal space for future stabilization will increase the effectiveness of today’s fiscal stimulus, precisely because it can reduce the uncertainty around future budget plans and therefore the premium on borrowing costs.
And finally, a gradual return to a more neutral stance could help cushion the negative spillovers from higher debt in advanced economies—in particular from an increase in long-term interest rates.
In Japan, stronger action may be required to stem deflation (Figure 2.15). In December 2009, the Bank of Japan responded to the reemergence of deflation by reiterating its aim to maintain the extremely accommodative financial environment and by introducing a new funds-supplying operation to encourage a further decline in longer-term money market interest rates. While these measures appear to have halted the decline of medium-term inflation expectations, further action would be warranted if deflation accelerates or persists for an extended period. The government’s plan to announce by mid-year details of its medium-term fiscal and growth strategy could also help strengthen confidence in Japan’s public finances and reduce the need for precautionary savings.
Figure 2.15.Japan: Consumer Price Inflation
Sources: Consensus Economics Inc; and CEIC Data Company Ltd.
A key medium-term challenge is to devise structural policies that will allow a durable rebalancing toward domestic demand. Recovery in the major advanced economies will be hampered by still-impaired financial sectors and weak household balance sheets, and as a result Asia’s exports will not be a strong engine of growth. To maintain rapid improvement in the standard of living, and increase the region’s resilience to external shocks, strengthening domestic sources of growth will be a strategic priority for many countries. This will require broad-based, underlying structural reforms, as discussed in more detail in Chapter III.
Box 2.1.Assessing Monetary Policy Stances in Asia
Asia’s faster-than-expected recovery has brought forward the beginning of monetary policy normalization in several Asian economies. A few central banks in the region already have begun to reduce the degree of monetary accommodation. The Reserve Bank of Australia was the first central bank in the region to raise rates, in October 2009, and since then has raised policy rates four more times. Bank Negara Malaysia raised policy rates in March 2010 and so did the Reserve Bank of India in both March and April. Other Asian central banks are expected to follow later in the year.
The extent to which policy rates need to be increased depends, among other things, on how far current rates are from the levels that are consistent with zero output gaps and stable inflation.
Selected Asia: Policy Rates
Sources: Haver Analytics; and IMF staff calculations.
However, these rates not directly observable. At any point in time they depend on the state of the economy and financial markets, and can be inferred only ex post by observing how inflation and output gap respond to policy shocks. These rates are also not constant, as they vary with changes in underlying macroeconomic conditions. As a result, simply observing that policy rates in Asia are currently well below pre-crisis levels, following the unprecedented cuts in 2009, does not allow us to assess how accommodative the monetary policy stance is in these economies.
In this box we present estimates of policy rates in several Asian economies—Australia, India, Indonesia, Korea, Malaysia, New Zealand, and Thailand—using a standard Taylor-rule monetary policy reaction function.
This monetary policy rule characterizes central banks’ decisions on policy rates as a response to the expected output gap and expected deviations of inflation from a target or desirable level. Estimating this equation over time allows assessing the policy rates that would be consistent with maintaining output at its potential level, and inflation at some stable or targeted rate. Following Cúrdia and Woodford (2009), we also allow policy rates to react to developments in financial markets (proxied by changes in the risk premium) as they affect the interest rates that matter for firms and households. For example, if the risk premium increases due to tighter financial conditions, policy rates should be lowered to keep the cost of credit for businesses and consumers unchanged.
The regression equation therefore takes the following form:
Where i t denotes the policy rate, Etπt + 1 and Etxt + t are expectations of inflation (year-on-year) and the output gap (estimated through a Hodrick-Prescott filter), respectively, π* is the targeted inflation (the explicit inflation target, or the average over the sample), and St denotes a measure of risk premium (proxied by sovereign 5-year CDS spreads).1 The equation is estimated following the methodology in Clarida, Calf, and Gertler (1998).2
Selected Asia: Estimated Nominal Taylor Rule Rates
Sources: Bloomberg LP; CEIC Data Company Ltd; and IMF staff estimates.
The results suggest that the policy rates prescribed by the Taylor rule decreased by an average of 150 basis points in the region during the crisis, and came close to historical lows reflecting negative output gaps and increases in risk premia. As the recovery gained momentum and financial markets stabilized, however, the rate suggested by the Taylor rule has increased. For 2010, the gap between actual policy rates and the Taylor rule rate is higher in India, Korea, and Thailand, while the monetary policy stance is closer to being neutral in Australia and Malaysia, partly owing to recent hikes in policy rates. Going forward, with Asia’s recovery projected to accelerate, the rates consistent with a neutral stance are estimated to increase, by another 75 basis points on average, by 2011.Note: The main author of this box is D. Filiz Unsal.1 We use 5-year spreads, as these contracts tend to be the most liquid. Still CDS spreads are likely to be an imperfect proxy for the risk premium, especially in economies with very low debt.2 The equation is estimated using monthly data, starting from 2003, and using generalized method of moment. This methodology provides consistent estimates, as ordinary least squares (OLS) would be biased by the fact that changes in the interest rate may affect future inflation and output gaps. The specification used accounts for at least 85 percent of the variations in the policy rate, and is supported by tests of over-identifying restrictions.
As in the past, these forecasts are based on current policies and assume constant real effective exchange rates.