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Executive Summary

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
May 2018
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The economic outlook for Asia and the Pacific remains strong, and the region continues to be the most dynamic of the global economy. Near-term prospects have improved since the Regional Economic Outlook Update: Asia and Pacific in October 2017, and risks around the forecast are broadly balanced for now. Over the medium term, however, downside risks dominate, including from a tightening of global financial conditions, a shift toward protectionist policies, and an increase in geopolitical tensions. Given the many uncertainties, macroeconomic policies should be conservative and aimed at building buffers and increasing resilience. Policymakers should also push ahead with structural reforms to address medium- and long-term challenges, such as population aging and declining productivity growth, and to ensure that Asia is able to reap the full benefits of increasing digitalization in the global economy.

Growth in Asia is forecast at 5.6 percent in 2018 and 2019, while inflation is projected to be subdued. Strong and broad-based global growth and trade, reinforced by the US fiscal stimulus, are expected to support Asia’s exports and investment, while accommodative financial conditions should support domestic demand. China’s growth is projected to ease to 6.6 percent, partly reflecting the authorities’ financial, housing, and fiscal tightening measures. Growth in Japan has been above potential for eight consecutive quarters and is expected to remain strong this year at 1.2 percent. And in India, growth is expected to rebound to 7.4 percent, following temporary disruptions related to the currency exchange initiative and the rollout of the Goods and Services Tax.

Risks around the outlook are balanced for now but tilted to the downside over the medium term. On the upside, the global recovery could again prove stronger than expected, and over time the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and successful implementation of the Belt and Road Initiative—assuming debt sustainability and project quality are maintained—could both support trade, investment, and growth. On the downside, Asia remains vulnerable to a sudden and sharp tightening of global financial conditions, while too long a period of easy conditions risks a further buildup of leverage and financial vulnerabilities. These vulnerabilities could be exacerbated by excessive risk taking and a migration of financial risks toward nonbanks. The gains from globalization have not been shared equally, and, as highlighted by recent tariff actions and announcements, a shift toward inward-looking policies is another risk, with the potential to disrupt international trade and financial markets. Geopolitical tensions remain another important source of risk. Finally, cybersecurity breaches and cyberattacks are on the rise globally, and climate change and natural disasters could continue to have a significant impact on the region.

Long-term growth prospects for the Asia and Pacific region are impacted by demographics, slowing productivity growth, and the rise of the digital economy. One important challenge is population aging, as many economies in the region face the risk of “growing old before they grow rich,” and the adverse effect of aging on growth and fiscal positions could be substantial. A second challenge is slowing productivity growth. Finally, the global economy is becoming increasingly digitalized, and while some recent advances could be truly transformative, they also bring challenges, including those related to the future of work. Asia is embracing the digital revolution, albeit with significant heterogeneity across the region.

Chapter 2 analyzes the factors behind low inflation despite strong growth, and how long this is expected to last. The findings highlight that temporary global factors, including imported inflation, have been key drivers of low inflation. And indeed, in line with an upturn in oil prices over recent months, headline inflation in the region has picked up, while core inflation has remained subdued and below target in many economies. Second, while inflation expectations are generally well anchored to targets, the influence of expectations in driving inflation has declined, as the inflation process has instead become more backward looking. Third, there is some evidence that the sensitivity of inflation to economic slack has diminished—in short, the Phillips curve has fattened.

Inflation in the Asia and Pacific region may increase once global factors, including US inflation and commodity prices, become less favorable, and policymakers should stand ready to act. In addition, higher inflation may persist on account of the increasingly backward-looking inflation process. And with a fatter Phillips curve, the output cost of disinflating could be higher. Accordingly, policymakers should be vigilant in responding to early signs of inflation pressure, though the response to commodity price shocks should be to accommodate first- but not second-round effects. Improved monetary policy frameworks and central bank communications could increase the role of expectations in driving inflation and thus make inflation less sticky. More flexible exchange rates could mitigate the role of imported inflation, and macroprudential policies can help address financial stability risks.

With output gaps closing in much of the region, continued fiscal support is less needed, and most economies in Asia should turn to strengthening buffers, increasing resilience, and ensuring sustainability. Some economies should also focus on improving revenue mobilization to create space for infrastructure and social spending and help support structural reforms. The strong economic outlook makes this an opportune moment to pursue such reforms. Tailored measures are needed to boost productivity and investment, narrow gender gaps in labor force participation, deal with the demographic transition, address climate change, and support those affected by shifts in technology and trade. And finally, to reap the full benefits of the digital revolution, Asia will need a comprehensive and integrated policy response covering information and communication technology, infrastructure, trade, labor markets, and education.

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