Paul Cashin & Andreas Bauer
The outlook for Asia and the Pacific is the strongest in the world, but it is shrouded by challenges at home and abroad, according to the latest IMF report for the region. The April 2017 Regional Economic Outlook for Asia and Pacific: Preparing for Choppy Seas finds that policy stimulus continues to support healthy domestic demand in China and Japan in the near-term, which is good for other economies in Asia as well. Broader global conditions are also favourable. Growth is accelerating in many major advanced and emerging market economies, notably the United States and commodity exporters, and financial markets are still resilient for the most part. Nonetheless, there are challenges ahead. Particularly, over the medium-term, there are fundamental headwinds to sustained strong growth, including from ageing populations in some countries and a slower catch-up in productivity.
After a slowdown in 2016, regional growth is forecast to speed up in 2017. Growth in the region decelerated to 5.3% in 2016 from 5.6% in 2015 despite broad improvement in economic activity in the second half of 2016. Net exports continued to pull down growth; domestic demand remained strong, supported by robust private consumption. GDP growth is forecast to reach 5.5% in 2017, revised up by 0.1 percentage point compared to the estimate in the IMF’s October 2016 World Economic Outlook, and 5.4% in 2018. Accommodative policies will underpin domestic demand, offsetting tighter global financial conditions. The acceleration in 2017 reflects expected recovery in Asian trade, resilient domestic demand, and continued policy support.
The aggregate outlook for the region, however, masks differences across countries. In India, the post-November 8, 2016, cash shortages and payment disruptions caused by the currency exchange initiative strained consumption and business activity, especially in the informal sector. Growth for FY2016/17 is expected to decelerate to 6.8%, down by about 4/5ths of one percentage point compared to the projection in the October 2016 World Economic Outlook. Growth is projected to rebound to 7.2% in FY2017/18 as cash shortages are offset by tailwinds from a favourable monsoon and continued progress in resolving supply-side bottlenecks.
Among the other large economies, projected growth in China and Japan for 2017 was revised up because of continued policy support and strong data toward the end of 2016. China’s GDP growth is expected to stay strong but continue to slow gradually to 6.6% in 2017 as recent tightening measures take effect—and to 6.2% in 2018. Japan’s growth is projected at 1.2%, with momentum set to continue into 2017, but will probably then weaken along with fiscal policy consolidation and the planned consumption tax increase. Some of the upward revision in Japan reflects the comprehensive revision of the national accounts in 2016. In Korea, growth is expected to remain subdued at 2.7% in 2017, owing to geopolitical uncertainty, and increase to 2.8% in 2018.
Near-term growth is encouraging, but downside risks continue to dominate the economic landscape. Global growth could get a boost from economic stimulus in some large economies, particularly the United States. However, continued tightening in global financial conditions could trigger further capital flow volatility. Private debt has risen in many economies in the region over the past decade, and higher borrowing costs could tip some companies and households over the edge and constrain growth. 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 also have serious repercussions.
Medium-term regional growth faces challenges from population ageing and slowing productivity. Asia is a diverse region, and some areas risk growing old before becoming rich. This is because the pace of ageing is faster in Asia compared with the experience in Europe and the United States. For many countries in the region, on current trends, per capita income (benchmarked against the United States) will be much lower than that reached by advanced economies at a similar peak in their ageing cycle. Slowing productivity growth since the global financial crisis, which kept the region from catching up with the United States and other countries at the technological frontier, has made matters worse.
The slowdown has been most severe in the advanced economies of the region. Without reforms, productivity growth will likely remain low for some time, with headwinds from rapid ageing becoming increasingly important. In India, the demographics are more favourable compared to the rest of the region. Nevertheless, greater labour market flexibility and product market competition would support job creation and employment, particularly in the formal sector.
Growth can be reinforced by appropriate demand support and structural reforms. Buffers are needed, especially for countries nearing full productive capacity. Policymakers should also deploy macroeconomic policies to support and complement structural reforms and external rebalancing and, if needed, to boost demand. Exchange rate flexibility should generally remain the main shock-absorber against a sudden tightening in global financial conditions or a shift toward protectionism in major trading partners. Policymakers should continue to rely on macroprudential policies to mitigate financial stability risks. But what is really needed is structural reforms to meet challenges of changing demographics to boost productivity. At the top of the list are labour market and pension system reforms. Advanced economies should focus on strengthening the effectiveness of research and development spending and taking measures to raise productivity in the services sector. Emerging and developing economies must focus on attracting foreign direct investment and expanding the economy’s capacity to absorb new technology and boost domestic investment. In India, policies should aim to reduce banking and corporate vulnerabilities, durably lower sticky inflation expectations, continue fiscal consolidation, and maintain the strong reform effort, notably by enhancing the efficiency of labour and product markets and pursuing further agricultural sector reforms.