The overall impact of the recent wave of capital outflows across Asia has been manageable so far, but some countries have been subject to greater stress. If global financial conditions tighten further and capital flow pressures emerge again, flexible currencies should be the principal line of defense. That said, those with weak fundamentals may be forced to respond with policy tightening that would amplify the effect on activity.

Credibility and clarity of policy is of the essence in a more challenging global environment. Announcing credible medium-term reforms in a range of areas are needed to rebuild market confidence, boost productivity, and ease policy trade-offs between supporting growth and achieving financial stability.

Successful reforms in Japan will contribute to stronger growth in the region. The initial effects of 'Abenomics' have been positive: exports have risen without weakening growth in other countries, and overseas lending and investment by Japanese banks and businesses are spurring activity in Asia. Progress on domestic growth reforms is key to ensure that Abenomics becomes a lasting success.

Recent Developments and Outlook

Growth for Asia as a whole is forecast to remain robust at around 5 percent in 2013 and about 5¼ percent in 2014. Emerging Asia is projected to grow at around 6¼–6½ percent in these two years.

Since last spring, expectations of Fed tapering have ignited capital outflows from many emerging markets. The adjustment process has mostly been orderly and the Fed’s September decision to delay tapering has eased outflow pressure. However, India and Indonesia have seen more concerted pressure.

This tightening in external funding conditions is expected to weigh on growth in emerging Asia. In addition, domestic structural impediments, such as supply bottlenecks in India and declining returns to investment in China, will also be a drag. But, counteracting forces include a stronger growth outlook for advanced markets, weaker currencies, and robust domestic demand.

These general trends, however, mask considerable heterogeneity across the region:

In China, growth is projected to decelerate to 7.6 percent in 2013 and 7.3 percent in 2014 as structural forces move China steadily onto a lower growth path. In India, the fallout from recent financial stress has led to a lower growth forecast. In Indonesia, growth is expected to slow given tighter financing conditions as well as weakening investment, before some stabilization next year. In most other ASEAN economies, growth remains relatively robust.

For the most part, low-income economies in Asia have generally been spared from recent volatility. However, in a number of cases, rapid credit growth and external imbalances are of concern. Japan has been a bright spot in the region as Abenomics has reignited the economy and is starting to lift the country out of chronic deflation. The IMF expects some slowdown in 2014 as a result of the introduction of the consumption tax, but still healthy underlying growth. The IMF's latest Japan forecast of 1.2 percent for 2014 does not yet include the effects from new stimulus announced on October 2.


There are considerable risks to the outlook. A faster than expected tightening of global funding conditions could substantially affect Asia, with a larger impact on economies with weaker fundamentals and higher exposures. Uncertainty in global markets is also a risk for Abenomics as it could undermine confidence and slow the recovery and the exit from deflation.

Policy Challenges

The tighter and more uncertain global financial environment has strengthened the need for coherent macro-economic frameworks that are clear, credible, and well communicated. Flexible currencies should be viewed as a principal line of defense in the event of renewed capital outflows, alongside guarded use of FX intervention to smooth volatility and ensure orderly market functioning.

On the monetary side, current accommodative monetary stances provide some insurance against downside risks in economies with subdued inflation and slowing activity. But where inflationary pressures are already elevated and there is reliance on foreign inflows - such as India and Indonesia - or where credit growth has been overly expansionary - as in Mongolia and Laos - monetary policy will likely need to be further tightened.

On the fiscal front, for most countries, a moderate pace of consolidation is warranted to rebuild fiscal space. Should growth disappoint, there is generally scope to allow automatic stabilizers to operate or even provide fiscal support.

In China, slowing the growth of credit, especially in the shadow banking sector, is a priority. Another priority is to advance financial reforms in order to prevent a further buildup of risks, foster a more efficient allocation of investment, and boost household capital income. Strengthening the management, transparency, and overall governance framework of local government finances would help contain fiscal risks.

In Japan, inflation and inflation expectations have started to rise. These are good signs, and the IMF currently does not see a need for further monetary easing.

Rather, the priority now is to advance growth reforms. For Abenomics to work, Japan’s long-term economic problems need to be tackled. Discussions have been underway for some time on a new growth strategy, including labor market reform, deregulation, and efforts to revamp the services and agricultural sectors. The IMF believes that these are all key areas, but there is now a premium on concrete action. It is hoped that the current special session in the Diet will deliver tangible results to keep the current economic momentum going. On the fiscal front, reforms need to continue given the large stock of public debt. Raising the consumption tax rate in 2014 has been the right decision given the strong recovery; as a next step the government should outline a more specific fiscal plan to explain how it will achieve its goal of a declining public debt-to-GDP ratio by 2020. In this regard, the second stage of the consumption tax increase in late 2015 and maintaining a uniform rate are important next milestones. But based on IMF calculations, additional fiscal savings of around 5 percent of GDP are needed beyond 2015 to bring down debt. The measures to achieve these savings should now be identified in broad terms.

The medium term and conclusion

In terms of structural reforms, Japan has been a forerunner in Asia in many respects: it has and still is an incredibly dynamic economy but also faced many headwinds, especially from aging and other structural impediments to growth. As Asia’s growth slows down, there are constraints on further macroeconomic policy support for growth.

With investors increasingly discriminating across countries according to their fundamentals, the case for structural reforms is becoming ever clearer. They are needed to boost productivity growth and thereby re-energize growth in Asia. And, as the past few months have shown, reforms can further build the strong fundamentals that enable some countries to weather turbulence better than others. So now is the time for decisive progress on this front.

In conclusion, despite the more complex global context, the IMF remains cautiously optimistic about the region’s ability to navigate smoothly and to put in place the right policy mix to tackle short-term challenges and support long-term growth.

Japan has an important role to play. It can help the region through overseas investment and lending, as we have seen this year. But Japan can also contribute to faster regional growth over the long haul through strengthening its domestic economy, which would create new demand and opportunities for trading partners and investors.

Source: International Monetary Fund