1. Preparing for Choppy Seas
Author: Mr. Ranil M Salgado
Language:
English
Keywords:
REO; dividend; economy; core inflation; currency exchange initiative; investment slowdown; purchasing manager's Index; a number of economy; Inflation; Currencies; Commodity prices; Fiscal stimulus; Consumption
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Abstract

The Asia-Pacific region continues to be the world leader in growth, and recent data point to a pickup in momentum. Growth is projected to reach 5.5 percent in 2017 and 5.4 percent in 2018. Accommodative policies will underpin domestic demand, offsetting tighter global financial conditions. Despite volatile capital flows, Asian financial markets have been resilient, reflecting strong fundamentals. However, the near-term outlook is clouded with significant uncertainty, and risks, on balance, remain slanted to the downside. On the upside, growth momentum remains strong, particularly in advanced economies and in Asia. Additional policy stimulus, especially U.S. fiscal policy, could provide further support. On the downside, the continued tightening of global financial conditions and economic uncertainty could trigger volatility in capital flows. A possible shift toward protectionism in major trading partners also represents a substantial risk to the region. Asia is particularly vulnerable to a decline in global trade because the region has a high trade openness ratio, with significant participation in global supply chains. A bumpier-than-expected transition in China would also have large spillovers. Medium-term growth faces secular headwinds, including population aging and slow productivity catchup. Adapting to aging could be especially challenging for Asia, as populations living at relatively low per capita income levels in many parts of the region are rapidly becoming old. In other words, parts of Asia risk “growing old before becoming rich.” Another challenge for the region is how to raise productivity growth—productivity convergence with the United States and other advanced economies has stalled—when external factors, including further trade integration, might not be as supportive as they were in the past. On policies, monetary policy should generally remain accommodative, though policy rates should be raised if inflationary pressures pick up, and macroprudential settings should be tightened in some countries to slow credit growth. Fiscal policy should support and complement structural reforms and external rebalancing, where needed and fiscal space is available; countries with closed output gaps should start rebuilding fiscal space. To sustain long-term growth, structural reforms are needed to deal with challenges from the demographic transition and to boost productivity.

Recent Developments and Near-Term Outlook

The Asia-Pacific region continues to be the world leader in growth, and recent data point to a pickup in momentum. Growth is projected to reach 5.5 percent in 2017 and 5.4 percent in 2018. Accommodative policies will underpin domestic demand, offsetting tighter global financial conditions. Despite volatile capital flows, Asian financial markets have been resilient, reflecting strong fundamentals. However, the near-term outlook is clouded with significant uncertainty, and risks, on balance, remain slanted to the downside. On the upside, growth momentum remains strong, particularly in advanced economies and in Asia. Additional policy stimulus, especially U.S. fiscal policy, could provide further support. On the downside, the continued tightening of global financial conditions and economic uncertainty could trigger volatility in capital flows. A possible shift toward protectionism in major trading partners also represents a substantial risk to the region. Asia is particularly vulnerable to a decline in global trade because the region has a high trade openness ratio, with significant participation in global supply chains. A bumpier-than-expected transition in China would also have large spillovers. Medium-term growth faces secular headwinds, including population aging and slow productivity catchup. Adapting to aging could be especially challenging for Asia, as populations living at relatively low per capita income levels in many parts of the region are rapidly becoming old. In other words, parts of Asia risk “growing old before becoming rich.” Another challenge for the region is how to raise productivity growth—productivity convergence with the United States and other advanced economies has stalled—when external factors, including further trade integration, might not be as supportive as they were in the past. On policies, monetary policy should generally remain accommodative, though policy rates should be raised if inflationary pressures pick up, and macroprudential settings should be tightened in some countries to slow credit growth. Fiscal policy should support and complement structural reforms and external rebalancing, where needed and fiscal space is available; countries with closed output gaps should start rebuilding fiscal space. To sustain long-term growth, structural reforms are needed to deal with challenges from the demographic transition and to boost productivity.

Global Developments: Stronger Near-Term Momentum amid Rising Uncertainty

The global economy is gaining momentum. The pace of economic activity has strengthened in advanced economies, including the United States, as well as in some emerging market and developing economies. Market sentiment has been favorable. Asset price changes generally reflect both a more optimistic market environment, with stronger risk appetite, and shifting expectations regarding policy setting in major economies. In particular, markets expect a shift toward looser fiscal and tighter monetary policy in the United States. At the same time uncertainty remains high, both on the specifics of U.S. fiscal policy and on other aspects of the new administration’s policy agenda, including trade and regulation.

World economic growth is forecast to accelerate from 3.1 percent in 2016 to 3.5 percent in 2017 and 3.6 percent in 2018—a slight upward revision for 2017 compared with the October 2016 World Economic Outlook (WEO) forecast. Underlying the forecast is also a shift in expectations about the strength of economic activity across country groups. In line with the stronger-than-expected pickup in growth in advanced economies and weaker-than-expected activity in some emerging market economies along with the assumed fiscal stimulus in the United States, the forecast envisages a faster rebound in activity in advanced economies and marginally weaker growth in emerging market and developing economies. Headline inflation has increased in advanced economies, but core inflation remains subdued and heterogeneous (consistent with the diversity in output gaps). In emerging market economies, the revival in headline inflation is more nascent. Core inflation is generally muted and broadly stable in most emerging market economies. For 2017 and 2018, with the uptick in commodity prices, a broad-based increase in headline inflation rates is projected in advanced, emerging market, and developing economies (see the April 2017 World Economic Outlook).

While global financial conditions have started to tighten, they remain accommodative on balance with favorable market sentiment. Expectations of looser fiscal policy and tighter monetary policy in the United States have contributed to a stronger dollar and higher U.S. Treasury interest rates, pushing up yields elsewhere. Yet market sentiment has generally been strong, with notable gains in equity markets in both advanced and emerging market economies, as well as higher risk appetite and relatively low financial market volatility.

With buoyant market sentiment, there is now more tangible upside potential for the near term, particularly owing to policy stimulus in some larger economies. Nonetheless, in light of broad policy uncertainty, risks remain slanted to the downside, including a possible sharp increase in risk aversion. The uncertainty over the likely effects of U.S. policy actions implies a wide range of upside and downside risks to the current baseline forecast for the United States as well as for the global economy. Risks of adverse feedback loops between weak demand and balance sheet problems in parts of Europe persist. A disruption of global trade, capital, and labor flows resulting from an inward shift in policies in some advanced economies would disrupt the operation of global value chains, deter investment, reduce productivity, and lower global growth. A tightening of economic and financial conditions in emerging market economies, given continued balance sheet weaknesses in some economies and building vulnerabilities in China’s financial system, would have large spillovers given their increased weight in the world economy. Noneconomic factors, including geopolitical tensions, domestic political discord, and terrorism and security concerns, have been on the rise in recent years, burdening the outlook for various regions.

Regional Financial Developments: Resilience amid Volatile Capital Flows

Asian financial markets have been resilient, reflecting global and regional factors. Net portfolio inflows rebounded after initial uncertainty about China’s transition in early 2016 and stayed positive for most of the year. The region experienced net capital outflows for a short period following the Brexit referendum and in the last two months of 2016 following the change in market expectations after the U.S. elections. Capital flows stabilized by the end of the year, with cumulative portfolio inflows (bonds and equities combined) to major Asian emerging market economies (excluding China) reaching $51 billion in 2016, well above the $42 billion in 2015, but below the peak of $72 billion prior to the U.S. elections (Figure 1.1). In China, capital outflows have accelerated since September 2016, with total outflows reaching an estimated $320 billion in 2016, driven by residents’ asset purchases abroad. The pressure subsided in early 2017, amounting to $26 billion during January–February 2017, with the tightening of capital controls and resumed portfolio inflows. More broadly, portfolio inflows to Asia returned, reflecting the region’s strong fundamentals, including favorable growth differentials.

Figure 1.1.
Figure 1.1.

Asia: Cumulative Portfolio Flows

(Billions of U.S. dollars)

Sources: Bloomberg L.P.; Haver Analytics; and IMF staff calculations.Note: Equities coverage: India, Indonesia, Korea, Philippines, Sri Lanka, Taiwan Province of China, Thailand, Vietnam; bonds coverage: India, Indonesia, Korea, Thailand.

Generally mirroring global markets, Asian stock markets overall rose significantly in the year prior to mid-March (Figure 1.2), and sovereign bond yields have increased since mid-2016 following the rise in yields in advanced economies (Figure 1.3). The increase in yields accelerated following the U.S. elections—one exception is India, where yields declined owing to the currency exchange initiative (Box 1.1). Sovereign credit default swap (CDS) spreads have also increased in some emerging market economies, but are now in general below their levels on the eve of the “taper tantrum” episode in May 2013. Demand for frontier and developing Asia’s debt remains strong (for example, Mongolia’s recent bond issue was heavily over-subscribed). In some economies (for example, Australia, Japan, and Korea), CDS spreads are at or close to the lowest levels reached during the past four years (Figure 1.4).

Figure 1.2.
Figure 1.2.

Asia: Equity Prices and Price-to-Earnings Ratios

(Change in stock market index; percent)

Sources: Bloomberg L.P.; and IMF staff calculations.Note: PE = price to earnings.
Figure 1.3.
Figure 1.3.

Asia: Ten-Year Sovereign Bond Yields

(Basis points)

Sources: Bloomberg L.P.; and Haver Analytics.
Figure 1.4.
Figure 1.4.

Sovereign Credit Default Swap Spreads

(Levels in basis points; five year)

Source: Bloomberg L.P.

Exchange rates have generally depreciated over the past year and a half, reflecting a stronger U.S. dollar. In particular, after the U.S. elections, exchange rates depreciated across most of the region, especially against the dollar, by an average of 2 percent (Figure 1.5). The yen depreciated against the dollar by 8 percent, owing to expectations about divergent monetary policies among major advanced economies. The renminbi weakened somewhat against the U.S. dollar, but by less than most emerging market currencies, and was broadly stable in effective terms, in part due to increased foreign exchange intervention and capital controls, which limited its further depreciation. While foreign exchange reserves were broadly stable for most countries, China’s foreign exchange reserve losses picked up (Figure 1.6). China’s reserves fell below $3 trillion temporarily in January 2017 for the first time since 2011, with an overall decline of about $1 trillion from their peak of nearly $4 trillion in mid-2014.

Figure 1.5.
Figure 1.5.

Selected Asia: Exchange Rates

(Percent change since June 2015)

Sources: CEIC Data Company Ltd; Haver Analytics; and IMF staff calculations.Note: A positive value represents appreciation of the national currency.
Figure 1.6.
Figure 1.6.

Selected Asia: Foreign Exchange Reserve Accumulation

(Billion of U.S. dollars)

Sources: CEIC Data Company Ltd.; Haver Analytics; and IMF staff calculations.Note: China on right scale.

While financial conditions in the region are still accommodative, they have begun to tighten in some countries.1 Domestic financial conditions in the region are sensitive to global factors, such as global risk aversion and U.S. interest rates (Box 1.2). Even though credit growth (adjusted for inflation) in 2016 remained robust in the region, it was well below the average of the previous decade in most economies, with the exception of Hong Kong SAR, New Zealand, and the Philippines (Figure 1.7). In China, credit growth continues at twice the pace of nominal GDP, as the stock of total social financing (adjusted for local government bond swaps) grew at a strong 16 percent in 2016. While foreign bank lending to Asia has risen (Figure 1.8), corporate debt issuance (including syndicated loans) is in general lower (Figure 1.9).

Figure 1.7.
Figure 1.7.

Selected Asia: Real Private Sector Credit Growth

(Year-over-year change; percent)

Sources: CEIC Data Company Ltd.; Haver Analytics; and IMF staff calculations.Note: Private sector credit is based on the IMF’s depository corporations survey.
Figure 1.8.
Figure 1.8.

Consolidated Foreign Claims

(Immediate risk basis; year-over-year change; percent)

Sources: Bank for International Settlements, International Banking Statistics database; and IMF staff calculations.Note: Data labels in the figure use International Organization for Standardization (ISO) country codes.1Newly industrialized economies (NIEs) comprise Hong Kong SAR, Korea, Singapore, and Taiwan Province of China.
Figure 1.9.
Figure 1.9.

Asia: Nonfinancial Corporate Sector Debt Issuance

(Percent of GDP)

Sources: Dealogic; and IMF, World Economic Outlook database.Note: Includes both bond issuance and syndicated loan issuance. Data compiled on residency basis.

Private debt levels remain high across most of the region, owing to rapid credit growth and significant corporate bond issuance over the past decade. While corporate debt has been rising across the region, most notably in emerging Asia, the buildup of leverage accelerated following the global financial crisis. As a result, corporate debt levels in Asia are higher than in other regions, particularly in China and India (see the October 2015 Global Financial Stability Report and the October 2016 Regional Economic Outlook Update: Asia and Pacific). Household debt has also increased considerably. For instance, between 2007 and 2015, the household-debt-to-GDP ratio increased by more than 20 percentage points in China, Malaysia, and Thailand (Box 1.3). Consequently, household debt is high in several economies in the region, including Australia, Korea, and New Zealand.

There is some evidence that excessive credit growth is decelerating in many major economies in the region. Although the credit-to-GDP gap or credit gap—a measure of excess credit—is declining in such economies as Hong Kong SAR, Indonesia, Malaysia, Singapore, and Thailand, it remains substantial in several economies, while still increasing in others (China).2 While part of the credit gap reflects desirable financial deepening, excessive credit growth can lead to an unintended buildup of systemic risks, and a large credit gap has been found to provide an early warning signal of increasing vulnerabilities for advanced and emerging market economies (Drehmann and others 2010; Drehmann, Borio, and Tsatsaronis 2011; and Drehmann and Tsatsaronis 2014).

The financial stability heat map points to risks associated with house prices and equity market overvaluation in some economies in the region (Figure 1.10). Notably, house prices in Australia, China, Hong Kong SAR, Malaysia, New Zealand, and Thailand are above their long-term averages. In the case of equity markets, benchmark equity indices are above their long-term averages in several economies, including Australia, India, Indonesia, and the Philippines.

Figure 1.10.
Figure 1.10.

Asia: Financial Stability Heat Map

Sources: Bloomberg L.P.; CEIC Data Company Ltd.; Haver Analytics; IMF, Global Housing Watch data; and IMF staff calculations.Note: Colors represent the extent of the deviation from long-term median expressed in number of median-based standard deviations (median-based Z-scores). Medians and standard deviations are for the period starting 2000:Q1, where data are available.1Estimated using house price-to-rent and price-to-income ratios.2Year-over-year growth of credit-to-GDP ratio.3Estimated using price-to-earnings and price-to-book ratios.

While banking sector capitalization has improved in general over the past few years and liquidity has been stable, asset quality and profitability have deteriorated in a number of Asian economies. Tier 1 capital ratios increased in most economies (Figure 1.11, panel 1)—particularly in Hong Kong SAR, Indonesia, and Thailand—while they declined in the Philippines. Bank liquidity, measured by loan-to-deposit ratios, was stable in major economies (Figure 1.11, panel 2). While nonperforming loan ratios remain relatively low across most economies, they have increased recently in several countries and are relatively high in India (Figure 1.11, panel 3). In addition, banks’ profitability has in general declined (Figure 1.11, panel 4).

Figure 1.11.
Figure 1.11.

Selected Banking Indicators

Source: IMF, Financial Soundness Indicators database.

Regional Activity: Recovery since mid-2016 with Positive Momentum

Growth in the region decelerated overall in 2016 despite broad-based improvement in economic activity in the second half of the year (Figure 1.12):

Figure 1.12.
Figure 1.12.

Asia: Changes in Real GDP at Market Prices

(Percent)

Sources: CEIC Data Company Ltd.; Haver Analytics; IMF, World Economic Outlook database; and IMF staff calculations.Note: SAAR = seasonally adjusted annualized rate.1ASEAN includes Indonesia, Malaysia, the Philippines, Singapore, and Thailand.

  • Asia’s growth declined to 5.3 percent in 2016 from 5.6 percent in 2015 (Table 1.1). In some countries, idiosyncratic factors were key drivers of growth performance. For example, in India activity slowed as a result of cash shortages following the currency exchange initiative.

  • Net exports continued to be a drag on growth for the region as a whole, subtracting 0.1 of a percentage point. However, Asia’s export growth momentum (in values) to major economies recovered in the second half of 2016, particularly to China and Japan, and, to some extent, the United States (Figure 1.13). Exports to the euro area also recovered, but are still declining year over year. While export volumes increased less than the nominal values (partly reflecting higher commodity prices), they have started to show some improvement. Several factors are likely driving the export recovery, including strong growth in China and the recovery in advanced economies. Also, there is some evidence that inventory destocking, particularly in electronics, may have ended, as Asian exports now more closely follow demand in advanced economies (Figure 1.14).3

  • Domestic demand remained strong, supported by robust private consumption owing to continued growth in household income. Retail sales have been relatively solid in general (Figure 1.15). However, high-frequency indicators suggest that retail sales declined sharply in India due to the currency exchange initiative. In Hong Kong SAR, retail sales remain depressed owing to a downturn in tourism arrivals from mainland China.

Table 1.1.

Asia: Real GDP

(Year-over-year percent change)

article image
Sources: IMF, World Economic Outlook database; and IMF staff estimates and projections.

Emerging Asia includes China, India, Indonesia, Malaysia, the Philippines, Thailand, and Vietnam. India’s data are reported on a fiscal year basis.

India’s data are reported on a fiscal year basis. Its fiscal year starts from April 1 and ends on March 31.

Simple average of Pacific island countries and other small states which include Bhutan, Fiji, Kiribati, Maldives, the Marshall Islands, Micronesia, Palau, Papua New Guinea, Samoa, Solomon Islands, Timor-Leste, Tonga, Tuvalu, and Vanuatu.

Figure 1.13.
Figure 1.13.

Selected Asia: Exports to Major Destinations

(Year-over-year change; percent)

Sources: CEIC Data Co. Ltd.; Haver Analytics; and IMF staff calculations.Note: Selected Asia comprises China, Hong Kong SAR, Japan, Korea, Malaysia, Taiwan Province of China, Thailand, the Philippines, Singapore, and Vietnam. Indonesia is excluded due to data lags.
Figure 1.14.
Figure 1.14.

Emerging Asia: Exports and Demand in the West

(Year-over-year change; percent)

Sources: Haver Analytics; and IMF staff calculations.Note: Emerging Asia comprises China, Indonesia, Malaysia, the Philippines, and Thailand.; 3 mma = 3-month moving average.
Figure 1.15.
Figure 1.15.

Selected Asia: Retail Sales Volumes

(Year-over-year change; percent)

Sources: CEIC Data Company Ltd.; Haver Analytics; and IMF staff calculations.1ASEAN comprises Indonesia, Malaysia, the Philippines, Singapore, and Thailand.

The recovery in commodity prices has modestly pushed up headline inflation in many Asian economies, while core inflation generally remains stable at low levels. While commodity prices have rebounded, commodity price levels are still comparatively low—barely reaching their mid-2015 levels (Figure 1.16). In China, producer price inflation turned significantly positive and consumer price inflation picked up. Headline inflation in Japan fell during most of 2016, while core inflation remained negative but edged up closer to zero. Among the largest economies in the region, headline inflation exceeded 3 percent in 2016 only in a few economies (Figure 1.17). Inflation expectations (from Consensus Forecasts) remain weak in most economies and have declined recently, but a few economies saw a slight uptick (for example, China and the Philippines). Similarly, core inflation has been low across most of Asia, but has increased in several countries, including China, the Philippines, New Zealand, Singapore, and Vietnam (Figure 1.18).

Figure 1.16.
Figure 1.16.

Global Commodity Prices

(Index, 2012 January 1 = 100)

Sources: Bloomberg L.P.; IMF data; and IMF staff calculations.Note: WTI = West Texas Intermediate.
Figure 1.17.
Figure 1.17.

Selected Asia: Headline Inflation

(Year-over-year change; percent)

Sources: Haver Analytics; and IMF staff calculations.Note: For India, inflation expectation and 2016 projection are on a fiscal-year basis.1 Based on Consensus Economics Forecasts.
Figure 1.18.
Figure 1.18.

Selected Asia: Core Inflation

(Year-over-year change; percent)

Sources: CEIC Data Company Ltd; and Haver Analytics.Note: Vietnam data as of August 2016.

Current account balances decreased slightly in major Asian economies in 2016. Overall, Asia’s current account surplus declined to an estimated 2.5 percent of GDP for the year, down from 2.7 percent in 2015. However, this overall picture masks considerable heterogeneity across the region (Figure 1.19):

Figure 1.19.
Figure 1.19.

Asia: Current Account Balances

(Percent of GDP)

Sources: IMF, World Economic Outlook database; and IMF staff calculations.1ASEAN includes Malaysia, the Philippines, Singapore, Thailand, and Vietnam.

  • Industrial Asia: Current account balances increased by 1.2 percentage points in 2016 to 2.4 percent of GDP. In Japan, the current account rose to 3.9 percent of GDP due to a stronger goods trade balance. In Australia and New Zealand, current account deficits narrowed, reflecting higher prices of commodity exports.

  • East Asia and the Association of Southeast Asian Nations (ASEAN): These economies saw reduced current account surpluses in aggregate in 2016. In China, the current account surplus narrowed to 1.8 percent of GDP from 2.7 percent in 2015, driven by a lower trade surplus and an increase in the services deficit. In Korea, the current account surplus narrowed to 7 percent, owing to lower exports due to temporary disruptions in automobile and smartphone production, and the bankruptcy of a major shipping company. Malaysia’s current account balance declined to 2 percent of GDP mainly on weaker oil and gas trade balances. In the Philippines, the current account surplus fell to 0.2 percent of GDP due to strong growth in imports, particularly capital goods. By contrast, in Thailand, the current account surplus increased to 11.4 percent of GDP due to buoyant tourism and weak imports, as domestic demand slowed.

GDP growth trends in specific countries continue to show considerable heterogeneity:

  • In China, growth gradually slowed amid continued rebalancing. Growth was 6.7 percent in 2016, slightly higher than projected in the October 2016 World Economic Outlook,4 reflecting the rebounding housing market, robust consumption growth, and continued policy support, while net exports continued to be a drag on growth.

  • Japan’s growth in 2013–15 was revised upward due to a comprehensive revision of the national accounts, and growth in 2016 was 1 percent. Strong net exports played the most significant role in 2016, while private investment and consumption contributed modestly, supported by fiscal policy.

  • India’s currency exchange initiative and its associated cash shortages weighed on activity in the last couple of months of 2016 (see Box 1.1). Growth for FY2016–17 is now expected to decelerate to 6.8 percent, 0.8 of a percentage point lower than the projection in the October 2016 World Economic Outlook.5 The post-November 8, 2016, cash shortages and payment disruptions caused by the currency exchange initiative have strained consumption and business activity, especially in the informal sector.

  • In Korea, growth was 2.8 percent in 2016, mainly driven by stronger construction investment, while private consumption was weaker than expected, reflecting political uncertainties.

  • In Hong Kong SAR, growth slowed to 1.9 percent in 2016 due to an anemic global trade environment and a sharp downturn in tourism arrivals from mainland China, but the economy showed signs of recovery in the second half on the back of strong public investment.

  • Australia’s growth was 2.5 percent in 2016, mainly reflecting the drag from mining investment and slightly weaker growth in consumption. New Zealand’s growth accelerated to 4 percent, driven mainly by construction activity following the 2011 Canterbury earthquake, though more recently the expansion has been broad based across most sectors.

  • Growth in the ASEAN economies increased in 2016, but economic cycles within the region continue to diverge. In Indonesia, growth accelerated to 5 percent, supported by robust private consumption. The Malaysian economy saw a moderate expansion, with growth at 4.2 percent—the slowest rate since the global financial crisis—driven mainly by private domestic demand, while net exports contributed negatively. Thailand’s economy continued to recover at a moderate pace, with growth reaching 3.2 percent, primarily driven by exports of services (notably tourism) and public investment. In the Philippines, growth increased to 6.8 percent, mainly driven by the strength of domestic demand—investment growth was particularly strong, reflecting higher public infrastructure spending and private construction—while net exports were a drag on growth. Singapore’s growth was 2 percent, consistent with the significant slowdown in recent years that reflects structural and cyclical factors—population aging, tighter limits on immigration, the turning of the financial cycle, and external headwinds. In Vietnam, growth slowed to 6.2 percent, reflecting the impact of a severe drought on agriculture and a sharp contraction in oil production.

  • Growth in the frontier economies and small states, on average, slowed in 2016, though there have been considerable variations. Among countries where activity moderated, growth in Lao P.D.R. declined to 6.9 percent owing to a slowdown in major trading partners, lower metals prices, and poor weather for agriculture. Growth in Mongolia slowed sharply as uncertainties sapped private sector confidence. In Nepal, growth decelerated sharply to 0.6 percent due to the 2015 earthquakes and the disruption to trade and economic activity resulting from border blockades. Sri Lanka’s growth decelerated to 4.3 percent due to a contraction in agriculture driven by floods in May and drought since September.

  • By contrast, activity generally accelerated in several other countries. Growth reached 6.9 percent in Bangladesh, largely driven by private consumption. Bhutan’s growth recovered to 6.2 percent, driven by a pickup in services, mining, and hydropower-related construction. Growth in Maldives recovered to 3.9 percent following reduced policy uncertainty and political tension. In Cambodia, economic activity remained strong at 7 percent, driven by garment exports, real estate, and construction.

  • Growth in Pacific island countries was dampened overall as a result of lower commodity prices. Papua New Guinea’s growth decelerated owing to low commodity prices and a major drought, while growth in Fiji was disrupted by Cyclone Winston. Countries with significant tourism sectors (Fiji and Vanuatu) benefited from the strength of the U.S. dollar against the Australian and New Zealand dollars, as well as the rapid growth of Chinese tourism, although this was less noticeable in Palau due to the base effect (strong tourist growth in 2015).

Near-Term Regional Outlook: Steady Growth

Asia’s growth outlook remains strong, with expectations of benign but rising inflation:

  • GDP growth is forecast to reach 5.5 percent in 2017 and 5.4 percent in 2018 (Figure 1.20 and Table 1.1). Growth in 2017 was revised up by 0.1 of a percentage point compared to the forecast in the October 2016 World Economic Outlook. Accommodative policies will underpin domestic demand, offsetting tighter global financial conditions.

  • The aggregate outlook for the region, however, masks significant revisions in a number of countries. For example, projected growth in China and Japan for 2017 was revised upward owing to continued policy support and strong data toward the end of 2016, with part of the upward revision in Japan due to the comprehensive revision of the national accounts in 2016. Growth was revised downward in India due to the currency exchange initiative and in Korea owing to political uncertainty. Asia’s projected growth, excluding India and Korea, was revised upward in 2017 by 0.3 of a percentage point compared to the projection in the October 2016 World Economic Outlook. Over the near term, moderating growth in China is expected to be partially offset by a rebound in India.

  • Asian trade is expected to recover, with net exports projected to be less of a drag on growth for most economies in the region owing to the improved global growth outlook and higher commodity prices.

  • Domestic demand remains resilient, with robust labor markets, healthy disposable income growth, and continued policy support. In addition, in most economies, real incomes are being boosted by continued low inflation.

Figure 1.20.
Figure 1.20.

Selected Asia: Contributions to Projected Growth

(Year-over-year change; percent)

Sources: IMF, World Economic Outlook database; and IMF staff calculations.1ASEAN includes Indonesia, Malaysia, the Philippines, Singapore, Thailand, and Vietnam.

High-frequency data and leading indicators point to a pickup in growth momentum, though the durability of the upturn remains uncertain. Recent momentum is particularly strong in the largest economies in the region, partly reflecting policy stimulus in China and Japan. This could create knock-on effects on other economies. More broadly across the region, forward-looking indicators such as purchasing manager indices suggest continued strength in activity into early 2017. The IMF’s Asia and Pacific Department’s indicator model for growth in Asia (which draws on a number of high-frequency indicators for several economies in the region) also points to strong growth momentum (Figure 1.21), with projections slightly higher than World Economic Outlook projections. Finally, while credit gaps have started to decline in several major economies in the region, credit growth is expected to remain mildly supportive of domestic demand in the near term.

Figure 1.21.
Figure 1.21.

Indicator Model for Asia: Projected versus Actual Real GDP Growth

(Percent; quarter-over-quarter annualized rate)

Source: IMF staff calculations.Note: PPP = purchasing power parity.

Country-specific factors will continue to play an important role in shaping dynamics in the region (Tables 1.1, 1.2, and 1.3):

Table 1.2.

Asia: General Government Balances

(Percenf of fiscal year GDP)

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Sources: IMF, World Economic Outlook database; and IMF staff estimates and projections.

Emerging Asia includes China, India, Indonesia, Malaysia, the Philippines, Thailand, and Vietnam. India’s data are reported on a fiscal year basis.

India’s data are reported on a fiscal year basis. Its fiscal year starts from April 1 and ends on March 31.

Simple average of Pacific island countries and other small states which include Bhutan, Fiji, Kiribati, Maldives, the Marshall Islands, Micronesia, Palau, Papua New Guinea, Samoa, Solomon Islands, Timor-Leste, Tonga, Tuvalu, and Vanuatu.

Table 1.3.

Asia: Current Account Balance

(Percent of GDP)

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Sources: IMF, World Economic Outlook database; and IMF staff estimates and projections.

Emerging Asia includes China, India, Indonesia, Malaysia, the Philippines, Thailand, and Vietnam. India’s data are reported on a fiscal year basis.

India’s data are reported on a fiscal year basis. Its fiscal year starts from April 1 and ends on March 31.

Simple average of Pacific island countries and other small states which include Bhutan, Fiji, Kiribati, Maldives, the Marshall Islands, Micronesia, Palau, Papua New Guinea, Samoa, Solomon Islands, Timor-Leste, Tonga, Tuvalu, and Vanuatu.

  • In China, the near-term growth outlook has been revised up due to continued policy support (especially the rebound in the real estate market), and inflationary pressure is picking up. However, continued rapid credit growth exacerbates already-high vulnerabilities. GDP growth is projected to remain robust but continue to slow gradually to 6.6 percent in 2017 and 6.2 percent in 2018. The moderation assumes a cooling housing market as a result of recent tightening measures, consumption moderating with weaker wage growth, and a stable augmented fiscal deficit (that is, including contingent liabilities from estimated off-budget local government borrowing).

  • In Japan, growth momentum is set to continue into 2017, but weaken thereafter as the effects of fiscal stimulus fade. Growth is projected at 1.2 percent, with the contribution from net exports expected to narrow as imports recover from exceptionally weak levels in 2016, while exports are boosted by foreign demand. The fiscal stimulus, combined with the postponement of the hike in the value-added tax (from April 2017 to October 2019), generated a slightly expansionary 2016–17 fiscal stance, supporting 2017 growth through higher consumption and private investment. The assumed dissipation of the impact stemming from the fiscal stimulus in 2018 is expected to reduce growth despite anticipated private investment related to the 2020 Tokyo Olympics.

  • In India, growth is projected to rebound to 7.2 percent in FY2017–18 and further to 7.7 percent in FY2018–19. The temporary disruptions (primarily to private consumption) caused by cash shortages accompanying the currency exchange initiative (see Box 1.1) are expected to gradually dissipate in 2017 as cash shortages ease. Such disruptions would also be offset by tailwinds from a favorable monsoon season and continued progress in resolving supply-side bottlenecks. The investment recovery is expected to remain modest and uneven across sectors as deleveraging takes place and industrial capacity utilization picks up. Headwinds from weaknesses in India’s bank and corporate balance sheets will also weigh on near-term credit growth. Confidence and policy credibility gains, including from continued fiscal consolidation and anti-inflationary monetary policy, continue to underpin macroeconomic stability.

  • In Korea, growth is expected to remain subdued at 2.7 percent in 2017 and increase to 2.8 percent in 2018. Lower consumption will weigh on growth, reflecting heightened uncertainty amid political turmoil.

  • Australia’s growth is expected to reach 3.1 percent in 2017 and 3 percent in 2018, with increasing contributions from domestic demand as the adjustment to the bust in commodity prices and rapid decline in mining investment advances further. Export growth is expected to slow, as the initial boost from new mining capacity should moderate. In New Zealand, growth is expected at 3.1 percent in 2017 and 2.9 percent in 2018, supported by a strong pipeline of construction activity and sustained strength in migration inflows, as well as improved prices of key dairy exports.

  • In Hong Kong SAR, growth is expected to recover gradually to 2.4 percent in 2017 and to 2.5 percent in 2018 on account of soft external conditions—with the U.S. rate cycle turning up, tepid global trade growth, and mainland China rebalancing—and the financial cycle turning. The pace of tightening of monetary conditions is now expected to be somewhat faster in line with changes in expectations of U.S. monetary policy tightening.

  • The outlook in ASEAN economies varies, reflecting the heterogeneity of those economies:

    • In Indonesia, growth is projected to accelerate slightly to 5.1 percent in 2017 and further to 5.3 percent in 2018. Private investment is expected to gradually recover in response to the recent rise in commodity prices.

    • Growth in Malaysia is projected to improve to 4.5 percent in 2017 and further to 4.7 percent in 2018. Domestic demand remains the main driver of growth, while a small drag from net exports will remain in 2017 and disappear in 2018. Improvements in the labor market and the 2017 fiscal measures will support private consumption, while higher inflation, high household debt, and macroprudential policy settings could hold consumption back.

    • In Thailand, growth is projected at 3 percent in 2017, increasing to 3.3 percent in 2018. Public investment is expected to increase, crowding in private investment and imports, while exports are projected to strengthen along with external demand. However, overall net exports are expected to be a bigger drag on growth.

    • In the Philippines, growth is projected at 6.8 percent in 2017 and at 6.9 percent in 2018, led by strong private domestic demand and a modest recovery in exports.

    • Singapore’s growth is projected at 2.2 percent in 2017 and 2.6 percent in 2018 on the back of recovering private domestic demand.

    • In Vietnam, growth is projected at 6.5 percent in 2017 and 6.3 percent in 2018 owing to healthy domestic demand, a rebound in agricultural production, and strong manufacturing growth supported by foreign direct investment (FDI).

  • Frontier economies and small states are expected to rebound in 2017 and 2018 owing to better global trade growth and a recovery in commodity prices. In Sri Lanka, GDP growth is projected to recover to 4.5 percent in 2017 and to 4.8 percent in 2018 as growth in manufacturing, construction, and services is expected to offset the drought-stricken agriculture sector. Under the IMF’s Extended Fund Facility (EFF), 2016 fiscal performance has been solid, but the net international reserves fell short of the target. In Mongolia, growth is expected to remain subdued in 2017 on account of large fiscal consolidation, but the strengthening of policies under the EFF, along with some major expected mining developments, should boost growth substantially in 2018. Growth in Pacific island countries is projected to rebound in 2017 and 2018 owing to the recovery in commodity prices for gas and oil exporters, including Papua New Guinea. Fiji is expected to have a strong recovery from last year’s cyclone. Tourism and fishery activities are expected to continue to support growth in the region.

The inflation outlook remains benign but with upside risks. Headline inflation is projected to rise to 2.9 percent in 2017 and 2018 (Table 1.4). Despite the recovery in commodity prices and the increase in producer price inflation, consumer price inflation is expected to remain low across most of the region given generally well-anchored inflation expectations and relatively low pass-through. Estimated output gaps for some regional economies also suggest that there is sufficient slack across the region, which will put downward pressure on inflation (Figure 1.22). Inflation in other countries—where output gaps are nearly closed and credit gaps remain significantly large—may face upside risks. In frontier economies with the highest inflation rates in the region, such as Myanmar and Nepal, inflation is expected to remain within single digits.

Table 1.4.

Asia: Consumer Prices

(Year-over-year percent change)

article image
Sources: IMF, World Economic Outlook database; and IMF staff estimates and projections.

Emerging Asia includes China, India, Indonesia, Malaysia, the Philippines, Thailand, and Vietnam. India’s data are reported on a fiscal year basis.

India’s data are reported on a fiscal year basis. Its fiscal year starts from April 1 and ends on March 31.

Simple average of Pacific island countries and other small states which include Bhutan, Fiji, Kiribati, Maldives, the Marshall Islands, Micronesia, Palau, Papua New Guinea, Samoa, Solomon Islands, Timor-Leste, Tonga, Tuvalu, and Vanuatu.

Figure 1.22.
Figure 1.22.

Asia: Output Gap versus Credit Gap

Sources: Bank for International Settlements; CEIC Data Company Ltd.; IMF, World Economic Outlook database; and IMF staff calculations.Note: The output gap is based on IMF country team estimates for 2016.The credit gap is based on BIS estimates as of September 2016.

Current account surpluses are expected to narrow gradually for the region as whole (Table 1.3). The current account is expected to decline to 2.1 percent of GDP in 2017 and further to 2 percent of GDP in 2018. This mainly reflects the recovery in commodity prices and the pickup in import growth as domestic demand remains strong. However, there is considerable heterogeneity across the region. China’s current account surplus is expected to decline further, driven by the lower trade surplus and an increase in the services deficit. In India, the current account deficit is expected to widen as domestic demand strengthens further and commodity prices gradually rebound. However, Japan’s current account is projected to rise due to a stronger goods trade balance.

Monetary and fiscal policies are broadly accommodative across most of the region. Policy interest rates are generally low in nominal and real terms. For example, with the exception of India, real rates are below 1 percent in all major regional economies and are negative in a number of them (Figure 1.23). In several economies, nominal policy rates are broadly in line with or slightly below the levels implied by augmented Taylor rules (which include exchange rates and foreign interest rates) (Figure 1.24). Fiscal stimulus, measured by changes in the cyclically adjusted fiscal balances, is expected to increase in 2017 in several economies in the region, including China, the Philippines, Singapore, and Thailand (Figure 1.25). In other major economies, the fiscal stance, while still accommodative, is expected to be slightly less supportive of growth, including in India and Vietnam. In 2018, fiscal stimulus is projected to increase in Indonesia, the Philippines, and Thailand. In other economies, such as Japan and China, fiscal policy is projected to be less supportive of growth as the effects of fiscal stimulus fade.

Figure 1.23.
Figure 1.23.

Selected Asia: Real Policy Rates

(Percent)

Sources: CEIC Data Company Ltd.; Haver Analytics; Consensus Economics; and IMF staff calculations.Note: The real policy rate is based on one-year ahead inflation forecast from Consensus Economics. For Japan, the uncollateralized overnight rate is used. For India, the three-month Treasury bill rate is used as the proxy for the policy rate. To improve monetary transmission effectiveness, the Bank Indonesia Board of Governors changed its policy rate from the BI rate to the seven-day reverse repo rate effective August 19, 2016.
Figure 1.24.
Figure 1.24.

Estimated Central Bank Reaction Functions

(Percent)

Sources: Haver Analytics; and IMF staff estimates.Note: As of February 2017, with monthly data.1 Estimated as it = α + γ1Et[πt + 1 − π*] + γ2EtOutputGapt + 1 + δ1REERt + δ2US_3Myieldt + εt.
Figure 1.25.
Figure 1.25.

Selected Asia: Cyclically Adjusted Fiscal Balance

(Percent of GDP)

Sources: IMF, World Economic Outlook database, and IMF staff calculations.

Risks to the Outlook: On Balance to the Downside

While there are some upside risks to near-term growth, the outlook, on balance, is clouded by significant downside risks, including a possible shift toward protectionism in major trading partners. In the near term, growth could be supported by economic stimulus in some large economies, particularly the United States. Continued tightening in global financial conditions could, nonetheless, trigger further capital flow volatility, with repercussions to the region especially in light of balance sheet weaknesses in a number of economies. More inward-looking policies in major global economies would significantly impact Asia given that the region has benefited substantially from cross-border economic integration. A bumpier-than-expected transition in China would have large spillovers. Geopolitical tensions and idiosyncratic political problems could burden the outlook for various countries. Medium-term growth faces secular headwinds, including population aging and limited productivity convergence.

Upside Risks: Strong Momentum and Larger Policy Stimulus

Stronger global activity resulting from larger policy stimulus than currently projected, especially in the United States, is an upside risk for the region. Recent gains in business and consumer confidence in advanced economies, as reflected in survey outcomes as well as equity prices, could underpin stronger momentum in consumption and investment in the short term. If followed by supply-friendly structural reforms, the momentum could become entrenched and sustain a pickup in activity for a longer period. Another source of short-term upside risk stems from the possibility that policy easing exceeds expectations in the United States. A stronger U.S. fiscal stimulus than currently anticipated would further boost Asian exports and increase growth in the region, unless positive spillovers are tempered by significantly tighter financial conditions or protectionist trade policies.

Tighter Global Financial Conditions

Expansionary U.S. fiscal policy could lead to higher U.S. inflationary pressures and may require a tighter-than-expected monetary stance, including a steeper path for future increases in the federal funds rate and further decompression of the term premium (Figure 1.26). An even steeper path for interest rates would be necessary to contain inflation if the fiscal stimulus does not lead to a significant increase in supply potential (see the April 2017 World Economic Outlook). Expectations of these policy changes have already resulted in a significant repricing of assets, as noted earlier.

Figure 1.26.
Figure 1.26.

United States: Interest Rates

Source: Bloomberg L.P.Note: FOMC = Federal Open Market Committee.

Stronger demand in the United States would benefit Asian exporters—and indirectly other countries in the region through potential knock-on effects—provided financial markets remain orderly and U.S. fiscal sustainability remains safeguarded. However, the size of these gains could hinge on the sequencing of U.S. policy implementation (see Box 1.4). For example, the benefits would be offset if the United States were to introduce new trade protection measures. At the same time, a substantial tightening of financial conditions, resulting from a significantly stronger U.S. dollar and higher interest rates, could have large negative spillovers for Asia. The impact would be greater in emerging and developing economies with external vulnerability, especially the economies with high dollar-denominated corporate and sovereign debt. Capital outflows, higher financing costs, and concerns over fiscal sustainability could push a number of countries into an unwarranted tight policy mix, amplifying the macroeconomic consequences and risks to financial stability. A sudden upward shift in domestic yield curves would be a large shock to indebted firms and households, which could derail domestic-demand-based growth financed by low borrowing costs. In addition, corporate bonds, which have been an important source of financing for Asian firms, are largely held by domestic banks, so corporate stress could have implications for financial stability by weakening banks’ balance sheets if downside risks materialize.

On average, Asian emerging market economies appear relatively better positioned to deal with external shocks than do emerging market economies in other regions (Figure 1.27). Asian emerging markets have relatively stronger external buffers, as measured by the level of foreign exchange reserves in terms of the IMF’s Assessment of Reserve Adequacy metric, and lower external financing needs, both of which point to their relatively greater resilience to capital outflows compared to emerging markets in other regions. From a balance sheet perspective, Asian nonfinancial corporations and governments, on average, are less exposed to sudden exchange rate fluctuations, as indicated by lower foreign-currency-denominated debt shares. The banking system’s capital adequacy ratio is lower than in other regions but only by a small margin. The comparison of regional averages, however, should be taken with caution in light of large intra-region heterogeneity for some of these indicators. For example, the external financing requirement in Malaysia is relatively high; and the foreign share of nonfinancial corporate debt in Indonesia is relatively high (Figure 1.28). In addition, as shown in the April 2017 Global Financial Stability Report, in a scenario with rising global risk premia or rising economic nationalism, corporate vulnerabilities in China and India would significantly worsen.

Figure 1.27.