Asian policymakers face “a delicate balancing act” as the region’s economies return to stronger growth this year, the IMF says in its latest Asia economic outlook.
It warns that easy money and capital inflows are helping to build financial imbalances and driving up asset prices in several of the region’s economies, creating the potential for overheating if not watched carefully.
“Financial imbalances are often persistent and cannot be easily unwound, and output levels are close to or slightly above trend in most economies; hence, monetary policymakers should stand ready to respond early and decisively,” says the IMF report.
Despite the note of caution, it is a good set of problems to have. Regional financial conditions are easing, the global economy is stabilising and risk capital is flowing back to the region, all of which are promoting a brighter outlook.
The IMF notes that mutual fund flows reached pre-crisis levels in early 2013, led by Asean economies. As a result, most of the region’s stock markets have risen by more than 10% since the start of 2012, and more than 40% in Japan, Thailand, the Philippines and Vietnam.
Spreads on sovereign credit default swaps have fallen by around 100bp since their peak in mid-2012 and have stabilised at their lowest levels since 2010.
These positive conditions are reflected in the real economy too. Consumers are expected to start spending more freely this year, thanks to unemployment that is at multi-year lows, while inflation is stable across most of the region and the IMF is forecasting economic growth of 5.75% for 2013 and 6% for 2014.
Risks have also subsided. Fewer people are now worried about a hard landing in China, a breakup of the euro or a swan dive off America’s fiscal cliff.
Europe is still the wildcard, though the IMF says that the effect of European bank deleveraging on Asian financial systems continues to be “relatively small and measured”. Cross-border lending from eurozone banks declined at a pace of less than 0.25% of emerging Asia GDP during the third quarter of 2012, with Japanese lenders picking up much of the slack.
However, as risk aversion eases in the advanced economies and monetary easing continues, the fast-growing emerging Asian nations are the obvious place for capital to flow.
Facing such a prospect, the continued accommodative stance of Asian central banks may come under greater pressure as growth rises and unemployment falls.
“In general, Asia has buffers to cope with such risks, as banking and corporate sector balance sheets remain generally sound, but these imbalances require careful monitoring and adequate supervision.”
After sounding upbeat for much of the report, the IMF goes on to say that even if Asia’s emerging countries navigate the transition to a growing global economy successfully in the short run, they may still fail to beat the middle-income trap in the long run.
However, as the IMF notes, such predictions tend to be heavily biased by historical data, because so few countries have ever managed to make the transition. Whether Asia can beat the odds will probably depend entirely on what happens in China — such a big economy could easily help the rest of the region to get rich in its wake.
But Asia needs to navigate the short term first.