regional economic outlook-apac_0413

7/30/2019 Regional Economic Outlook-APAC_0413

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World Economic and Financia l Surveys

R e g i o n a l E c o n o m i c O u t l o o k

I N T E R N A T I O N A L M O N E T A R Y F U N D

Asia and Paci cShifting Risks,

New Foundations for Growth

13 A P R


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Cataloging-in-Publication Data

Regional economic outlook. Asia and Paci c. Washington, D.C. : International Monetary Fund, 2005-

v. ; cm. (World economic and nancial surveys, 0258-7440)

Once a year.Began in 2005.Some issues have also thematic titles.

1. Economic forecasting Asia Periodicals. 2. Economic forecasting Paci c Area Periodicals. 3. Asia Economic conditions 1945- Periodicals. 4. Paci c Area Economicconditions Periodicals. 5. Economic development Asia Periodicals. 6. Economicdevelopment Paci c Area Periodicals. I. Title: Asia and Paci c. II. International Monetary Fund. III. Series: World economic and nancial surveys.

HC412.R445

ISBN: 978-1-48436-083-5

Publication orders may be placed online, by fax, or through the mail:International Monetary Fund, Publication ServicesP.O. Box 92780, Washington, D.C. 20090, U.S.A. Tel.: (202) 623-7430 Fax: (202) 623-7201

E-mail: [email protected] www.imf.org

www.elibrary.imf.org

2013 International Monetary Fund April 2013


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iii

Conten ts

De nitions vi

Executive Summary ix

1. Managing Shifting Risks 1

Signs of Pickup amid Receding Tail Risks 1Stronger Prospects in the Period Ahead Hinge on Internal Demand Dynamics 4More Balanced, but Shifting Risks 12

A Transition to Rebuilding Policy Space 19Laying Foundations for Sustained and Shared Prosperity 29

2. Fiscal Policy: Dampening Cyclical Fluctuations and Supporting Inclusive Growth 37

The Role of Fiscal Policy in Dampening Cyclical Fluctuations in Asia 37Increasing Space to Support Sustained and Inclusive Growth 40

3. Is Middle-Income Asia at Risk of a Sustained Growth Slowdown? 47

What Is a Sustained Growth Slowdown? 47Are Middle-Income Economies Different? 49What Explains the Likelihood of Getting Trapped? 50

Are Middle-Income Asian Economies at Risk of a Sustained Growth Slowdown? 51Can Emerging Asia Get Old before It Gets Rich? 53

References 55Boxes

1.1 ASEAN-5 Integration as a Source of Resilience 81.2 Asias Electronics Sector: An Engine of Growth for All? 9

1.3 Effects and Spillover Channels of a Successful Re ation in Japan 101.4 Remittances: Shock Ampli er or Absorber for Emerging and Developing Asia? 141.5 Macroprudential Measures and Capital Flow Measures: The Experience in Asia 221.6 Chinese Capital Account Liberalization and the Internationalization of the Renminbi 25

1.7 How Will the Basel III Capital and Liquidity Requirements Affect Asian Banks? 27

1.8 MyanmarReintegrating with the World 301.9 Is Emerging Asia Shifting to Lower Trend Growth? 31

1.10 Lifting Potential Growth in the Paci c Islands: Structural Impedimentsand the Role of Policies 33

2.1 Cash Transfers in India 463.1 Identifying Sustained Slowdowns in Growth 50


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iv

REGIONAL ECONOMIC OUTLOOK: ASIA AND PACIFIC

Table

1.1 Asia and Paci c: Real GDP 6

Figures

1.1 GDP Growth and Financial Market Conditions 11.2 Selected Asia: Equity and Bond FundsQuarterly Net Flows during 201013 11.3 Asia: Stock Markets 21.4 Asia: Change in Credit to GDP, 2012 2

1.5 Asia: Effective Exchange Rates 21.6 Asia: Changes in Real GDP at Market Prices 21.7 Selected Asia: Exports to Major Destinations 31.8 Asia: Headline In ation 3

1.9 Asia: Contributions to 2012 Change in Headline In ation Rate 31.10 Asia: Current Account Balances 41.11 Indicator Model for Asia: Projected vs. Actual Real GDP Growth 51.12 Selected Asia: Contributions to Projected Growth 5

1.13 Asia: Financial Conditions Index (FCI) 51.14 Emerging Asia: Response of Credit Growth and Long-Term

Interest Rate to Non-FDI In ows 6

1.15 Emerging Asia: Response of Domestic Demand to Portfolio Equity Flows 61.16 Selected Asia: External Dependence and Role of U.S. and EU Demand

versus Japan and China 71.17 Asia: Headline Consumer Price In ation 71.18 Asia: Real GDP Growth 121.19 Asia Financial Stability Heat Map 13

1.20 Asia: Non nancial Corporate Debt-to-Equity Ratio 131.21 Corporate Debt-to-Equity Ratio 161.22 Selected Asia: Non nancial Corporate SectorReturn on Assets 161.23 Selected Asia: Tier 1 Capital Ratio 171.24 Selected Asia: Liquidity Ratio 17

1.25 Selected Asia: Return on Assets 171.26 Selected Asia: Nonperforming Loans Ratio 171.27 Selected Asia: Commercial Banks Loss-Absorbing Buffers 17

1.28 Selected Asia: Contribution to Export Growth 181.29 Selected Asia: Links to Japan and Export Growth in 2011:Q2 181.30 China Slowdown Scenario: Impact on Real GDP after Two Years 181.31 Japan Risk Contagion Scenario: Impact on Real GDP after Two Years 191.32 Selected Asia: Policy Rates 19

1.33 Selected Asia: Monetary Policy Stances 20


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CONTENTS

1.34 Output Gap vs. Credit Gap, Latest 20

1.35 Selected Asia: FX Reserve Accumulation 211.36 Selected Asia: Cyclically Adjusted Fiscal Balance 241.37 Selected Asia: Size of Automatic Stabilizers and Vulnerabilities to a

Slowdown in the United States and European Union 241.38 There Seems to Be a Middle-Income Trap 292.1 Correlation between Government Spending and GDP 382.2 Fiscal Impulse, 200712 38

2.3 Procyclicality and Institutional Strength, 19802011 392.4 Multipliers for Government Spending and Public Investment in Asia, Four-Quarters 402.5 Automatic Stabilizers, 200111 402.6 General Government Revenue and GDP per Capita, 2011 41

2.7 Yields from Personal Income Tax 412.8 Yields from Corporate Income Tax 422.9 Yields from VAT and Sales Tax 42

2.10 Selected Tax Revenues by Category 432.11 Public Investment and Infrastructure 43

2.12 Public Social Spending: Health and Education 442.13 Subsidies and Social Bene ts 442.14 Food and Energy Subsidies 443.1 Past Growth Trajectories 48

3.2 GDP per Capita Convergence in the Four Asian Tigers 483.3 GDP per Capita Convergence in Seven Emerging Asian Economies 48

3.4 Contributions to ASEAN Growth before and after the Global Financial Crisis 493.5 Frequency of Past Sustained Growth Slowdown Episodes by Region 49

3.6 There Seems to Be a Middle-Income Trap 493.7 The Impact of Changes in Fundamentals on the Probability of a Sustained Slowdown 513.8 Strengths and Weaknesses of Asian MIEs 523.9 Strengths and Weaknesses of Asian MIEs Relative to Other Emerging Regions 52

3.10 Overall Dependency Ratios 533.11 Tertiary Education Enrollment 543.12 Research and Development Expenditure 54


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vi

Definitions

In this Regional Economic Outlook: Asia and Paci c , the following groupings are employed:

ASEAN refers to Brunei Darussalam, Cambodia, Indonesia, Lao Peoples Democratic Republic,Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Vietnam, unless otherwise speci ed.

East Asia refers to China, Hong Kong SAR, the Republic of Korea, and Taiwan Province of China.

Emerging Asia refers to China, Hong Kong SAR, India, Indonesia, the Republic of Korea,Malaysia, the Philippines, Singapore, Taiwan Province of China, Thailand, and Vietnam.

Industrial Asia refers to Australia, Japan, and New Zealand.

South Asia refers to Bangladesh, India, and Sri Lanka.

Asia refers to ASEAN, East Asia, Industrial Asia, and South Asia. EU refers to the European Union.

G-7 refers to Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.

G-20 refers to Argentina, Australia, Brazil, Canada, China, the European Union, France,Germany, India, Indonesia, Italy, Japan, the Republic of Korea, Mexico, the Russian Federation,Saudi Arabia, South Africa, Turkey, the United Kingdom, and the United States.

The following abbreviations are used:

AEs advanced economies AEC ASEAN Economic Community ASEAN Association of Southeast Asian NationsCCT programs conditional cash transfer programsCDS credit default swapCPI consumer price indexECCU Eastern Caribbean Currency UnionFDI foreign direct investmentFESR Framework for Economic and Social ReformFY scal yearGDP gross domestic productGIMF Global Integrated Monetary and FiscalIT information technology LICs low-income countries

MIEs middle-income economiesOECD Organisation for Economic Co-operation and DevelopmentPICs Paci c Island countriesSMP Staff-monitored program

VAR vector autoregression VIX Chicago Board Options Exchange Market Volatility Index WEO World Economic Outlook


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vii

DEFINITIONS

This Regional Economic Outlook: Asia and Paci c was prepared by a team coordinated by Romain Duvalof the IMFs Asia and Paci c Department, under the overall direction of Anoop Singh. Contribu-tors include Shekhar Aiyar, Dennis Botman, Ezequiel Cabezon, Kevin C. Cheng, Julian Chow, R. SeanCraig, Christian Ebeke, Keiko Honjo, Changchun Hua, Andr Meier, Kum Hwa Oh, Alexander Pitt,Damien Puy, Phurichai Rungcharoenkitkul, Sampawende Tapsoba, Patrizia Tumbarello, Tao Sun, Olaf Unteroberdoerster, Yiqun Wu, Longmei Zhang, and Edda Zoli. Sidra Rehman and Dulani Seneviratneprovided research assistance. Lesa Yee provided production assistance. Joseph Procopio of the IMFsCommunications Department edited the volume with Gregg Forte and Martha Bonilla, and coordinatedits publication and release. This report is based on data available as of April 8 and includes commentsfrom other departments and some Executive Directors.

The following conventions are used:

In tables, a blank cell indicates not applicable, ellipsis points (. . .) indicate not available, and 0 or 0.0indicates zero or negligible. Minor discrepancies between sums of constituent gures and totals aredue to rounding.

In gures and tables, shaded areas show IMF projections.

An en dash () between years or months (for example, 200708 or JanuaryJune) indicates the years ormonths covered, including the beginning and ending years or months; a slash or virgule (/) between yearsor months (for example, 2007/08) indicates a scal or nancial year, as does the abbreviation FY (forexample, FY2009).

An em dash () indicates the gure is zero or less than half the nal digit shown.

Billion means a thousand million; trillion means a thousand billion.

Basis points refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent to of 1 percentage point).

As used in this report, the term country does not in all cases refer to a territorial entity that is a state asunderstood by international law and practice. As used here, the term also covers some territorial entities thatare not states but for which statistical data are maintained on a separate and independent basis.


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The global economy shows signs of improving as major tail risks emanating from advanced economieshave receded. Asia also faces better prospects. After a year of subdued economic performance, growthin Asia is set to pick up gradually in the course of 2013, to about 5 percent, on strengthening externaldemand and continued robust domestic demand. Consumption and private investment are expectedto be supported by favorable labor market conditionsunemployment is at multiyear lows in severaleconomiesand relatively easy nancial conditions. The latter re ect a combination of accommodativemonetary policies; rapid credit growth, particularly in China and some ASEAN economies; andthe rebound of capital in ows since the summer of 2012. Asia is also expected to bene t fromintraregional demand spillovers; they mainly re ect growing Chinese demand and the near-term scalstimulus in Japan but also, in the case of ASEAN economies, growing integration in nal consumergoods trade. Consistent with the moderate pickup in growth and absent shocks to global food andcommodity prices, in ation is expected to remain broadly unchanged from 2012 and generally withincentral banks explicit or implicit comfort zones.

Risks to the outlook have become more balanced since the October 2012 Asia and Paci c Regional Economic Outlook Update (IMF, 2012d), mainly because the risk of an acute euro area crisis hasdiminished and the U.S. scal cliff has been alleviated. However, the potential impact of externalshocks on Asias open economies remains considerable, and risks and challenges from within the regionhave come into clearer focus in recent months. To begin with, nancial imbalances and rising assetprices, fueled by strong credit growth and easy nancing conditions, are building in several economies.

A number of other regional risks are more dif cult to anticipate but could prove disruptive given Asiashighly integrated supply-chain network and growing dependence on regional demand and nance.

These include trade disruptions from a natural disaster or geopolitical tensions, a loss of con dence in

Japans efforts to restore economic health, or an unexpected slowdown in China. Asias policymakers face a delicate balancing act in the near term: guarding against a buildup of nancial imbalances and managing a transition to rebuilding policy space while delivering appropriatesupport for growth. Against the backdrop of uncertain growth prospects, Asian central banks in 2012maintained their already low policy rates or reduced them further. With in ation remaining low andstable, this accommodative stance has been welcome. But nancial imbalances are often persistent andcannot 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 to any prospectiverisks of overheating. However, the need and direction for future monetary policy action differssubstantially across economies, mainly in line with differing exposures to shifting growth risks and risksto nancial stability from past stimulus. In emerging Asia, macroprudential measures will also have to

play an important role where credit growth remains too rapid and could pose problems for

nancialstability, especially if accompanied by persistently strong capital in ows. In general, Asia has buffers tocope with such risks, as banking and corporate sector balance sheets remain generally sound, but theseimbalances require careful monitoring and adequate supervision.

Executive Summary

( continued )


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Country circumstancesincluding the need for demand rebalancing and the available policy space will also determine the appropriate pace of scal consolidation. In many Asian economies, structuralde cits that are higher than precrisis levels imply the need for greater efforts to rebuild scal space,especially as projected improvements in structural scal balances remain small on current policy. Some scal consolidation could also help preempt the potential overheating pressures from continued strong capital in ows. With risks more balanced than they were six months ago, automatic stabilizers shouldprovide a suf cient rst line of defense if, and as long as, growth were to disappoint only somewhat.

Strengthening scal space and frameworks is also needed to achieve sustained inclusive growth overthe medium term. As highlighted in Chapter 2, bold discretionary action in Asia during the globalrecession was emblematic of the regions increasingly effective scal management over the past decadein responding to shocks and thereby in helping to smooth GDP uctuations. However, there is thegrowing need to make revenue and expenditure policies more growth-friendly, make growth moreresilient through automatic stabilizers, and ensure that Asias growing prosperity is shared across allincome groups.

Furthermore, as agged in Chapter 3, emerging Asia is potentially susceptible to the middle-incometrap, a phenomenon whereby economies risk stagnation at middle-income levels and fail to graduateinto the ranks of advanced economies. To sustain high rates of per capita income growth acrossthe region, the policy agenda will have to vary by jurisdiction across a range of priorities, including economic rebalancing, strengthening infrastructure investment, reforms in goods and labor markets,and meeting the challenges from rapid demographic change.


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1

1. Managing Shifting Risks

Signs of Pickup amid RecedingTail Risks The global economy entered 2013 with receding tail risks as the U.S. scal cliff and an escalationof the euro area crisis had been averted. In theUnited States, activity, balance sheets, house prices,and credit were improving while major emerging economies were also seeing strengthening activity.In the euro area, however, economic prospectsremain fragile, with weak activity extending tocore countries. Meanwhile, nancial conditions are

ameliorating across the board, with equity pricesrising to multiyear highs, volatilities declining, andcredit spreads compressing (Figure 1.1). Whiledownside risks remain signi cant, risks are now more balanced than they were at the time of theOctober 2012 Asia and Paci c Regional Economic OutlookUpdate (IMF, 2012d) .

With global nancial conditions easing markedly since mid-2012 amid further loosening in monetary stances in major advanced economies, risk capitalbegan to return to emerging Asia (Figure 1.2).In particular, net portfolio ows gained strengthsince the third quarter of 2012, when they turnedpositive. Mutual funds data at the beginning of 2013 suggest weekly ows were comparable tothe strong levels seen before the global nancialcrisis, although capital in ows moderated morerecently. The turnaround has been led by ASEANeconomies where, in 2012:Q3, the swing in netportfolio ows amounted to about 3 percent of GDP. At the same time, the impact of Europeanbank deleveraging on Asian nancial systemscontinued to be relatively small and measured, withcross-border lending from euro area banks declining at a pace of less than percent of emerging Asia

Note: The main authors of this chapter are Kevin C.Cheng and Olaf Unteroberdoerster, with contributionsfrom Kum Hwa Oh. Sidra Rehman and DulaniSeneviratne provided research assistance.

Figure 1.1GDP Growth and Financial Market Conditions

0

50

100

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250

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Real GDP Growth(Q/Q SAAR)

Financial Market Conditions(January 2011=100)

Euro area

VIX index

Equities: MSCIWDLI

Globalbroad corp.bond index

United StatesProj.

Sources: IMF,World Economic Outlook ; and Bloomberg L.P.

GDP in the third quarter of 2012 and regionalbanks, notably from Japan, taking up the slack.

As a result, Asian nancial markets have beenbuoyant, and indicators of nancial stress have fallen

sharply. Most stock markets have risen by more than10 percent since early 2012, and gains have exceeded20 percent in a number of cases (Figure 1.3). Sincetheir peak in mid-2012, spreads on sovereign creditdefault swaps (CDS) have fallen by some 100 basispoints on average and stabilized at their lowestlevels since 2010. Bank CDS spreads indicate a

Figure 1.2

Selected Asia: Equity and Bond FundsQuarterly Net Flows during 2010131(In billions of U.S. dollars)

2015

105

05

1015202530

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Bond funds Equity funds Peak in 200607

Source: Haver Analytics.1 Includes exchange traded fund ows and mutual fund ows for Emerging Asia, Hong Kong SAR, Taiwan Province of China, Korea, and Singapore.


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3

growth has begun to pick up. In part, the risere ects a combination of supply-chain links and rming demand across Asia and from advancedeconomies, notably the United States (Figure1.7). In addition, purchasing managers indexesfor manufacturing have improved across theregion and reentered expansionary territory in recent months, although they remain below their averages before the global nancial crisis.

At the same time, notably in China and, toa lesser extent, leading ASEAN economies,private domestic demand has remained robust

with relat ively favorable nancial and labormarket conditions supporting stable consumercon dence, buoyant investment, and robustretail sales.

Across much of Asia, headline in ation slowedmarkedly through 2012, in many cases by some2 percentage points; the notable exceptions

were India, Indonesia, and, to a lesser extent, Thailand (Figure 1.8). Declines were generally driven by moderating food and commodity prices,although in several cases, second-round effectsfrom weaker activity also contributed (Figure 1.9).

Core in

ation in early 2013 was low and stable,at or below 2 percent in a number of economies,including China, Korea, and Malaysia. At the sametime, de ation persisted in Japan, where headlineand core in ation fell to a negative 0.1 percentand negative 0.2 percent, respectively, atend-2012.

Consistent with weak external demand andrelatively strong domestic conditions, the regionstrade and current account balances continued toshrink substantially in 2012. While China has playeda prominent role in this decline, balances have alsodeclined substantially in Japan, leading ASEANeconomies, and India (Figure 1.10).

Against the broad regional trends, the dynamics andcomposition of growth have varied signi cantly across Asia in 2012 and early 2013.

Figure 1.9

Asia: Contributions to 2012 Change in HeadlineInation Rate(In percentage points)

129

63

0369

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43

21

01234

I n d i a

I n d o n e s

i a

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K o n g

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K o r e a

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( r i g

h t )

Contribution from foodContribution from other pricesContribution from fuelChange in headline inflation rate

T a

i w a n

P r o v i n c e

o f C h i n a

Sources: CEIC Data Company Ltd.; Haver Analytics; and IMF staff calculations.

Figure 1.7

Selected Asia: Exports to Major Destinations(Three-month percent change of three-month moving average; SAAR)

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to U.S. to Euro area to Japan to China

Sources: CEIC Data Company Ltd; Haver Analytics; and IMF staff calculations.

Figure 1.8

Asia: Headline Ination(Year-over-year percent change)

4

0

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8

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2024

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i a

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End-2011 End-2012

T a

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Activity in Japan entered a short-lived recessionafter the middle of 2012 as consumption was hitby the expiration of eco-friendly car subsidies, andexports decreased in conjunction with weakening external demand. However, signs of a turnaroundemerged in early 2013 due to rising businesssentiment and gradually improving industrialproduction. Growth in Australia was around itstrend pace in 2012, after peaking at 4 percentin the rst half of 2012, although some non-mining sectors remained under pressure from the

strong currency, partly driven by the heightenedappetite of international investors for Australiasgovernment debt. In New Zealand, a modestrecovery from the 2012 earthquake, fuelled by reconstruction spending, was held back by highhousehold debt and sluggish private consumption.

In East Asia, the Chinese governments effortto achieve a soft landing has been con rmed

with a moderate pickup of growth in thefourth quarter of 2012, led in part by morecredit- nanced infrastructure investment and arecovery of exports. In Korea, exports that ledthe sharp slowdown in 2012 have stabilized, butconsumption remained subdued notwithstanding a cut in policy rates of 50 basis points and theadoption of two modest scal packages.

In South Asia, a drop of private investmentover rising policy uncertainty exacerbatedsupply bottlenecks in India, which contributed

to headline in ation that was high compared with that of most other Asian economies,despite a sharp growth slowdown during 2012.In Sri Lanka, tighter policies in early 2012 torein in credit and import growth contributed toslowing activity last year.

Many ASEAN economies, especially Indonesia,Malaysia, the Philippines, and Thailand,bucked regional trendsgrowth held up onrobust domestic demand, in part supported by accommodative monetary and scal stancesand fueled by rapid credit expansion.

Exports of Asian low-income economiesslackened, although external headwinds weremitigated in some cases: by privileged accessto advanced economies (such as the EuropeanUnion in the case of Cambodia), resilientremittances (Bangladesh and Nepal), andrapid domestic credit growth (Cambodia andthe Lao Peoples Democratic Republic). Morerecently, export growth has gained momentumfor a number of garment manufacturers, whilesharply higher exports and imports in Myanmarin the rst quarter of 2013 also re ectedan improved business environment and thesuspension of sanctions. On the other hand,recovery in the Paci c Island economies hascontinued to be held back by delays in growth-friendly structural reforms and in infrastructureinvestments to improve connectivity.

Stronger Prospects in the PeriodAhead Hinge on Internal DemandDynamics

A small, gradual pickup in growth is expectedto continue throughout 2013, underpinned by continued robust domestic demand and some

modest strengthening in external demand(Figure 1.11, re ecting readings from a broad rangeof high-frequency activity indicators covering industrial Asia, large emerging market economies,and smaller export-dependent economies). Growthfor Asia as a whole is forecast to increase to about5 percent in 2013 and 6 percent in 2014(Table 1.1 and Figure 1.12). The main elements

Figure 1.10

Asia: Current Account Balances(In percent of GDP)

6

4

2

0

2

4

6

8

Australia,Japan & New

Zealand

China East Asia(excl. China)

ASEAN 1 India

2010 2011 2012 (est.)

Source: IMF,World Economic Outlook .1 ASEAN includes Indonesia, Malaysia, the Philippines, Singapore, Thailand,and Vietnam.


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Box 1.3 (concluded )

rise; the more credible scal reforms are, the lower the risks of a sudden rise in bond yields. At present, theauthorities medium-term scal goals are based on commitments to the G-20halving the de cit-to-GDPratio between FY 2010 and FY 2015, and achieving surplus by FY 2020 of the national and local governmentsprimary balances. In the short term, scal consolidation reduces demand for imports from trading partners,but in the long term, it boosts global saving, thereby reducing interest rates and stimulating activity in trading partners (IMF, 2011c). Growth-enhancing structural reforms are likely to have positive spillovers. For example,

Japans participation in the Trans-Paci c Partnership agreement could yield positive welfare gains for countriesin the region and for emerging market economies more generally (IMF, 2011c).

Spillover channels of a successful effort to re ate Japan are likely to operate through the exchange rate as well ashigher growth in Japan but are complicated by supply-chain considerations.1 Prior to Japans new macroeconomicpolicies, the medium-term outlook for Japans economy included a very gradual recovery with mild in ation,trend real currency appreciation, and limited nominal wage growth; it also held the prospect of rising governmentbond yields, as the investor base would increasingly become nonresident given the rising nancing requirementamid population aging. Compared with this baseline, a successful re ation would entail higher growth, a moredepreciated currency, and possibly lower interest rates. Spillovers could occur through several channels:

Financial spillovers: Greater monetary easing in Japan, together with a rising current account surplus

over the medium term, would imply capital out ows. On past trends, only a modest share of these ows would go to the rest of Asia, where they would put downward pressure on interest rates and upwardpressure on the exchange rate. However, a successful exit from de ation and persistent yen depreciationcould reduce the home bias of domestic investors and lead to a rebalancing of their portfolios toinclude a larger share of foreign assets, especially from Asia. Japanese banks and businesses have already been increasingly active overseas, replacing retreating European banks in the region and diversifying theiractivities in the process, and increasing foreign direct investment (FDI)a rise of 1 percent of GDP in

Japanese FDI boosts growth by 0.50.7 percentage point in recipient countries (IMF, 2012c). Outward FDIis a long-term trend and unlikely to change in a fundamental way, as rms aim to locate where the demandis growing and take advantage of cost differentials. The scal dividends of a successful re ation could alsoreduce the medium-term risk of a sharp rise in yields on Japanese government bonds (see Chapter 1), whichcould adversely affect growth around the world through a tightening in lending conditions from the rise inrisk premiums.

Trade spillovers: Stronger growth in Japan would bene t other countries, especially those that supply nalgoods to Japan. A weaker yen has more complicated and mixed implications. For countries that directly compete with Japan in third markets, this may undermine their competitiveness. However, this effect ismitigated, as yen depreciation also raises production costs in Japan through higher costs of importedintermediate inputs, including energy. Likewise, many countries in the region import intermediate goods from

Japan, which become cheaper with yen depreciation, although possibly at the expense of domestic suppliersto exporters. For example, Japan accounts for one- fth of the worlds semiconductor production (constituting more than 50 percent of U.S. and Chinese imports) and for more than one-third of global exports of machinery and wafers (more than 35 percent of U.S. and Chinese imports) (IMF, 2011c). Hence, the spillovereffect of yen depreciation is far from uniform and depends on a countrys position in the supply chain.

1 The 2013 IMF Spillover Report (IMF, 2012c) will attempt to quantify these spillovers.

monetary easing framework in pursuit of the 2percent in ation target (Box 1.3).

In East Asia, growth is projected to be8 percent in China resulting from continued

robust domestic demand, both consumptionand investment, and some improvementin external demand in the course of 2013.Nevertheless, given signi cant, albeit


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12

uncertain, slack in the economy, in ation isexpected to pick up only modestly by about1 3 percentage point and average 3 percentin 2013. In Korea, an improved outlook forexports would support private investment,

with growth projected to rebound moderately while in ation, although rising, wouldremain at the lower bound of the targetband.

In South Asia, notwithstanding a modestgrowth recovery in India on a more favorableexternal demand environment, deep-rootedstructural challenges are expected to exert asubstantial drag on potential growth whilekeeping in ation at elevated levels by regionalstandards. In Sri Lanka, growth is expected

to remain broadly stable, as continuedmacroeconomic stabilization should restraindomestic demand, while export growth isprojected to remain tepid.

Growth in ASEAN economies is expectedto remain robust, mainly on account of resilient domestic demand. Over and abovethe supportive factors discussed above, inMalaysia, a large number of projects under theEconomic Transformation Plan will propelstrong investment; in the Philippines, robust

remittance

ows are expected to underpinprivate consumption and investment; and inIndonesia, demand would likely bene t froman external sourcea recovery of Chinesedemand for commodities.

A modest pickup of growth, generally lessthan percentage point, is also expected for

Asias low-income economies, in part becauseof stable or improving external demand forenergy and related commodities (the LaoPeoples Democratic Republic and Mongolia)and garments (Bangladesh and Cambodia). InMyanmar, moving to a higher potential growthtrajectory will depend on ongoing reformmomentum to promote private investment,

while the return to higher growth in Vietnamassumes further consolidation of recent gainsin macroeconomic stability and nancial sectorrestructuring.

More Balanced, but Shifting RisksRisks to this forecast have become more balancedsince the October 2012 Asia and Paci c Regional

Economic Outlook Update (Figure 1.18). In particular,global tail risks have receded, as highlightedin the April 2013 World Economic Outlook.Nevertheless, the considerable risks of a stalledor incomplete achievement of euro area policy commitments could derail the global economicrecovery. The impact of external risks on Asiaremains substantial. In the event of a severeglobal slowdown, capital ow reversals and falling external demand would exert a powerful drag on

Asias most open economies, including throughthe second-round impact of lower investmentand employment in export-oriented sectors. Forexample, a reassessment of sovereign risks inadvanced economies, possibly linked to setbacksin resolving the euro area crisis and prompting further scal tightening and lower growth (seethe April 2013 World Economic Outlook, Chapter 1),

would reduce growth in emerging Asia by about1 percentage point per year over 201314. Giventhat many developing and low-income economiesin the region are dependent on income remittedfrom abroad, a severe global slowdown could alsobe transmitted through lower remittances, althoughthere are certain mitigating factors that woulddampen the spillover effects (Box 1.4).

While global risks have receded, risks and challengesfrom within the region come into clearer focus. One

Figure 1.18

Asia: Real GDP Growth(Central forecast and selected condence intervals; in percent)

0

1

2

3

4

5

6

7

8

9

2009 2010 2011 2012 2013 2014

50 percent confidence interval 70 percent confidence interval90 percent confidence interval90 percent confidence interval (2012)

Central forecast

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


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14

Box 1.4

Remittances: Shock Amplier or Absorber for Emerging and Developing Asia?

Asia is a major recipient of global remittances, and many emerging market and developing economies in theregion rely heavily on them. With in ows of about $110 billion ( gure, top left), Asia and the Paci c accountedfor about one-fourth of all remittances sent worldwide in 2010.1 For many economies, remittances rival public aidand dwarf other ows such as net exports or net portfolio and foreign direct investment (FDI) in ows. Overall,remittances received during the past decade equaled 6 percent of GDP of the countries covered here, on par

with net aid and double the amount of net FDI receipts. In relative terms, the Paci c Island countries are mostdependent on income remitted from abroad ( gure, top right).

Remittances Inows in Selected Regions(In billions of U.S. dollars)

0

20

40

60

80

100

120

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Asia and PacificEastern Europe and Central AsiaLatin America and CaribbeanMiddle East and North Africa

Sub-Saharan Africa

Source: World Bank,World Development Indicators.

Net Foreign Earnings in Selected Asia andPacic Countries(Net ows in percent of GDP, 200011)

201510

505

1015202530

Middle income Low income Pacific islands

RemittancesFDI

Official aidPortfolio Net exports

Source: World Bank,World Development Indicators.

Overall, remittances have helped stabilize domestic business cycles, although they also increase exposure toexternal shocks originating in host countries.

To assess business cycle stabilization achieved via remittances, the determinants of output growth volatility havebeen estimated while controling for other determinants of volatility, such as openness, the level of development,and population. The econometric ndings show that, on average, remittances act as an important hedging instrument for developing economies in general and for those in Asia and the Paci c in particular (table).

Looking at synchronicity between host and recipient countries business cycles instead of output volatility, we nd that remittance ows play an important role in propagating home-country shocks to recipient countries.2

The size of this effect is similar to that of the impact of trade (table). By contrast, aid and FDI are not foundto be statistically signi cant determinants of business cycle comovements.

However, external spillovers from remittances are subject to threshold effects and are stronger the larger the owsbetween the host and recipient countries ( gure, bottom). The positive impact of remittances on the synchronization

Note: The main authors of this box are Christian Ebeke and Sampawende Tapsoba.1 Asian and Paci c countries covered in this note comprise six middle-income countries (India, Indonesia, Malaysia,Philippines, Sri Lanka, and Thailand), seven low-income states (Bangladesh, Cambodia, Lao Peoples Democratic Republic,Maldives, Mongolia, Nepal, and Vietnam), and seven Paci c Island countries (Fiji, Kiribati, Papua New Guinea, Samoa,Solomon Islands, Tonga, and Vanuatu).2 Estimated over a sample of 18 Asian and Paci c countries (India and Vietnam are excluded in the sample mentioned above)over the period 19902010. For a given home country X, host country real GDP growth is calculated as the average across themajor destinations for outward migration from X, using the migration shares as weights.


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16

States, the euro area, and, to a lesser extent,emerging economies in Latin America (Figure1.21). Furthermore, for most economies, Asianbusinesses have stronger liquidity positionsthan those in other regions, as indicated by higher quick ratios (the liquid assets of a rmnet of inventories divided by liquid liabilities).

The share of foreign currency debt is generally moderate in the region, despite some rapidgrowth in the issuance of foreign currency

debt in Indonesia in 2011, and to a lesser extent2012. Finally, pro tability ratios for Asiascorporate sector also remain rather solid andstable (Figure 1.22). For the household sector,leverage has picked up, particularly in Malaysia,New Zealand, and Korea, where lending by banks to households at around 60 percent ormore of GDP is relatively high for the region,but household debt-to-income ratios remainbroadly in line with historical averages.

The banking sector has weathered the global nancial crisis intact . Banks in Asia have generally strengthened their capital positions over the pastfew years, even though Tier 1 capital ratios inmost emerging Asia economies remain below capital ratios found in advanced economies andemerging market economies of Latin America(Figure 1.23). Furthermore, the global nancialcrisis also generally did relatively little damage to

Asian banks pro tability and liquidity, althoughmany Asian banks did not fare as well as theircounterparts in Latin America and the UnitedStates in these areas (Figures 1.24 and 1.25).Finally, the prevalence of nonperforming loanshas declined and is also generally small compared

with other regions, although this does not re ectthe potential adverse impact of the recent creditexpansion on asset quality (Figure 1.26).

That said,

nancial imbalances can worsen relatively quickly and are often dif cult to unwind. Whilebanks in the region have built up buffersTier1 capital in excess of regulatory levels plus loan-loss reserves minus bad loanswhich shouldhelp contain the impact of potential imbalances,buffers in a number of Asian economies remainsomewhat below those found in the United Statesand emerging market economies in Latin America(Figure 1.27). Moreover, a full assessment of risksis complicated where nancial intermediationundergoes rapid change. In China, in particular, the

use of more market based

nancial instrumentsmeans that total social nancing is growing fast andabout half of nancial intermediation now takesplace outside traditional banking channels in less

well supervised parts of the nancial system.

A number of other regional risks to growth aremore dif cult to anticipate. But Asias highly

Figure 1.21

Corporate Debt-to-Equity Ratio1(Cap-weighted mean; in percent; 2011)

Australia

China

Hong Kong SAR

India

Indonesia

Japan

Korea

Malaysia

New zealandPhilippines

Singapore

Taiwan Provinceof China

Thailand

Vietnam

Asia

Euro area

United States

Latin America

0

50

100

150

200

250

300

350

400

450

0 50 100 150 200

F i n

a n c

i a l

s e c

t o r

Nonfinancial sector

Sources: IMF,Corporate Vulnerability Utility (CVU); Thomson ReutersDatastream; and IMF staff calculations.1 Latin America is a market-cap-weighted average of Argentina, Brazil, Chile,Colombia, Peru, and Venezuela. Vietnam's data start in 2006. For thePhilippines, an outlier is excluded from the calculation of the cap-weightedmean for the nancial sector.

Figure 1.22

Selected Asia: Nonnancial Corporate SectorReturn on Assets(In percent; cap-weighted mean)

05

101520

J a p a n

N e w

Z e a

l a n

d

K o r e a

S i n g a p o r e

C h i n a

M a

l a y s i a

A u s

t r a

l i a

H o n g

K o n g

S A R

P h i l i p p

i n e s

T h a

i l a n

d

I n d i a

V i e t n a m

2

I n d o n e s i a

E u r o a r e a

A s i a

3

U n

i t e d S t a t e s

L a

t i n A m e r i c a

4

2011 2012 (est.) 1 Median (20022007)

T a

i w a n

P r o v i n c e

o f C h i n a

Sources: IMF, Corporate Vulnerability Utility; Thomson Reuters Datastream;Bloomberg L.P.; and IMF staff calculations.1 New Zealand, India, Australia and Japan 2012 data from CVU. Others latestavailable quarterly data from Bloomberg L.P.2 Vietnam's data starts in 2006.3 Asia 2012 is weighted by market-cap of 2011 from CVU.4 Latin America is a market-cap weighted average of Argentina, Brazil, Chile,Colombia, Peru, and Venezuela.


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integrated supply-chain network and growing dependence on regional demand and nancecould make those risks disruptive. They includedisruptions to trade; and, over the medium term, anunexpected slowdown in China, and in Japan a risein the sovereign risk premium in the absence of a

credible medium-term scal and growth strategy. Trade disruptions from, for example, a natural

disaster or geopolitical tensions . Asian economieshave formed highly integrated supply-chainnetworks. Across the region, intermediategoods have been the primary driver of exportgrowth for the past two decades, accounting for

Figure 1.23

Selected Asia: Tier 1 Capital Ratio(In percent)

02468

1012141618

I n d i a

C h i n a

A u s t r a

l i a

K o r e a

T h a

i l a n

d

N e w

Z e a

l a n

d

M a

l a y s

i a

J a p a n

H o n g

K o n g

S A R

I n d o n e s i a

S i n g a p o r e

P h i l i p p

i n e s

Latest Median 1 (200207) United States

L ati n Ameri ca E uro a rea

T a

i w a n

P r o v i n c e

o f C h i n a

Sources: Bankscope; and IMF staff calculations.1 For Korea and Malaysia median (2000-latest).

Figure 1.24

Selected Asia: Liquidity Ratio1(In percent)

05

1015202530354045

I n d i a

K o r e a

J a p a n

N e w

Z e a

l a n

d

A u s t r a

l i a

T h a

i l a n

d

S i n g a p o r e

M a

l a y s

i a

P h i l i p p

i n e s

I n

d o n e s i a

C h i n a

H o n g K o n g

S A R

Latest Median 2 (200207) United StatesLatin America Euro area

T a i w a n

P r o v i n c e

o f C h i n a

Sources: Bankscope; and IMF staff calculations.1 Total liquid assets to total deposits plus borrowing.2 For Korea and Malaysia median (2000-latest).

Figure 1.26

Selected Asia: Nonperforming Loans Ratio(In percent; asset-weighted mean)

0

2

4

6

8

10

12

H o n g

K o n g

S A R

C h i n a

A u s t r a

l i a

S i n g a p o r e

N e w

Z e a

l a n

d

K o r e a

I n d o n e s i a

M a

l a y s

i a

J a p a n

I n d i a

T h a

i l a n

d

P h i l i p p

i n e s


Latin America Euro area

T a

i w a n

P r o v i n c e

o f C h i n a


Figure 1.27

Selected Asia: Commercial Banks' Loss-Absorbing Buffers 1(In percent of risk-weighted assets; asset-weighted mean)

2

0

2

4

6

8

I n d i a

A u s t r a

l i a

J a p a n

N e w

Z e a

l a n

d

K o r e a

T h a

i l a n

d

C h i n a

M a

l a y s

i a

H o n g

K o n g

S A R

P h i l i p p i n e s

I n d o n e s i a

S i n g a p o r e

Tier-1 capital in excess of 8.5%Loan loss reserves less nonperforming loans

Effective buffer Latin America

T a i w a n

P r o v i n c e

o f C h i n a

United States Euro area Asia

Sources: Bankscope; and IMF staff calculations.1 Loss absorbing buffers are calculated as Tier 1 capital in excess of 8.5 percentplus loan loss reserves less impaired loans as percent of total risk-weighted assets.

Figure 1.25

Selected Asia: Return on Assets(In percent; asset-weighted mean)

0.0

0.5

1.0

1.5

2.02.5

J a p a n

K o r e a

A u s

t r a

l i a

N e w

Z e a

l a n

d

I n d i a

S i n g a p o r e

C h i n a

M a

l a y s i a

H o n g

K o n g

S A R

T h a

i l a n

d

P h i l i p p

i n e s

I n d o n e s i a


Latin Ameri ca Euro area

T a

i w a n

P r o v

i n c e

o f C h i n a



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20

continue to buy some insurance against downsiderisks by maintaining slightly lower policy rates thantheir past behavior would suggest (Figure 1.33).3 Ina context where in ation remained low and stable,this accommodative stance has served them well.

On the other hand, global tail risks have diminished,and risk appetite has increased, resulting in strong capital in ows and posing challenges to the defenseof nancial stability. As indicated in the previoussection, balance sheets of both businesses andbanks have improved, and buffers have been

built to address potential risks, but some risks areemerging and could potentially worsen. Indeed, inseveral Asian economies, credit ratios and outputlevels currently stand above trend (Figure 1.34).In this context, monetary policymakers shouldstand ready to respond early and decisively to any prospective risks of overheating.

At the same time, the need, scope, and direction forfuture monetary policy action differ substantially across economies, mainly re ecting differentexposures to shifting risks to growth and nancialstability.

3 In fact, given ample liquidity, money market rates aresubstantially lower than official policy rates for someeconomies, such as the Philippines and Indonesia.

In Japan, additional aggressive monetary easing to raise in ation to 2 percent in two yearsunder the Bank of Japans new quantitative andqualitative monetary easing policy would bebene cial and can be part of a broader set of policies, which should be complemented by anambitious medium-term scal consolidationand structural reform to raise growth in asustainable way.

In China, past credit-led stimulus has led to adebt overhang. Social nancing has remainedbuoyant, and the share of nonbank nancing has increased very signi cantly. Thus, thechallenge will be to continue supporting theeconomy while unwinding past credit stimulusand curbing the growth of off-balance-sheetand nonbank intermediation. This would

warrant accelerated liberalization to providemore market-based incentives for credit-risk management combined with strengthenedsupervision, including implementing comprehensive bank reforms and adopting bank resolution frameworks. The ChinaBanking Regulatory Commission (CBRC) hasannounced steps to strengthen the supervisionof banks off-balance sheet activities.

For countries where in ationary pressureshave been elevated, vigilance on in ation

Figure 1.33

Selected Asia: Monetary Policy Stances

0

2

4

6

8

10

N e w

Z e a

l a n

d

T h a

i l a n

d

K o r e a

C h i n a

M a

l a y s

i a

A u s

t r a

l i a

P h i l i p p

i n e s

I n d o n e s

i a

I n d i a

Policy rate (as of April 8, 2013)

Rate implied by usual reaction of the central bank

Sources: Thomson Reuters Datastream; Haver Analytics; IMF,World Economic Outlook ; and IMF staff calculations.

Figure 1.34

Output Gap vs. Credit Gap, Latest 1(In percent)

Japan AustraliaNew Zealand

China

Hong Kong SARKorea

Taiwan Provinceof China

Indonesia

Malaysia Philippines

Singapore

Thailand

India

4

2

0

2

4

6

8

6 4 2 0 2 4

C r e

d i t g a p

Output gap

Sources: CEIC Data Company Ltd.; IMF,World Economic Outlook ; and IMF staff calculations.1 Credit-to-GDP data as of 2012:Q4. Credit gap is calculated as a percentdeviation from the trend credit-to-GDP (approximated using the HP lter over the period 200012).


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will pay dividends for long-term growth. Forexample, in India, monetary policy can bestsupport growth by putting in ation on a cleardownward trend. Similarly, in Indonesia, within ation close to the upper bound of the targetband, a closed output gap, and a widening current account de cit, there might be a casefor higher policy rates over the projectionhorizon.

Greater exchange rate flexibility would play a useful role in curbing future overheating pressures and speculative capital inflows.Most exchange rate movements since theOctober 2012 Asia and Pacific Regional Economic Outlook Update have been consistent withfundamentals, with real effective exchange

rates rising in many emerging Asian economiesamid narrowed current account surpluses although weak external demand and othercyclical factors have played a role underpinning these adjustments. As a result, and subject to amore comprehensive assessment in the IMFsforthcoming External Stability Report, thedegree of currency undervaluation among Asiansurplus economies appears to have generally diminished. More specifically:

In Japan, the recent depreciation began from

a moderately overvalued level and re ectsa number of factors such as the widening trade de cit, lower global risk aversion, andnew monetary policy initiatives that areappropriately focused on correcting domesticimbalances.

In some of emerging Asias surpluseconomies, greater exchange rate exibility

would discourage a one-way bet and thusprovide more room to cope with speculativecapital ows. In some cases, greater

exchange rate

exibility would also dampenthe pressures of reserve accumulation onmonetary aggregates, which has helpedfuel rapid credit growth (Figure 1.35). Thatsaid, ad hoc interventions throughout theadjustment process may be warranted to avoiddisorderly overshooting.

Safeguarding Financial Stability amidVolatile Capital Flows

Macroprudential and capital ow measures willalso have a role to play where conventionalmonetary management proves insuf cient toaddress speci c nancial stability issues. Many

Asian economies have resorted to a broad rangeof prudential measures in recent years, which haveoften been focused on stability risks arising fromoverheating property markets, such as caps onloan-to-value (LTV) ratios for mortgages(Box 1.5). When prudential measures took theform of capital ow measures, they were aimedat safeguarding nancial system stability in theface of surging capital in ows, often with a view to affect the composition and duration of ows.

While macroprudential and capital ow measureshave generally been seen as a useful addition tothe authorities toolkit, their effectiveness has

varied across countries, in part according to thedegree of economic and nancial development,exchange rate regime, vulnerability to certainshocks, and the accompanying macroeconomicpolicies.

For example, credit-related measures such astightening LTV ratios have helped curb therapid growth of property prices in a number of

Figure 1.35

Selected Asia: FX Reserve Accumulation(Change since October 2012)

54321

012345

6

201510

505

101520

25

J a p a n

I n d o n e s i a

T h a

i l a n

d

I n d i a

M a

l a y s

i a

P h i l i p p

i n e s

H o n g

K o n g

S A R

K o r e a

S i n g a p o r e

C h i n a

In billions of U.S. dollars Percentage change (right)

T a i w a n

P r o v i n c e

o f C h i n a



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Box 1.5

Macroprudential Measures and Capital Flow Measures: The Experience in Asia

Macroprudential policy measures aim to enhance systemic

nancial stability by constraining the incentives forexcessive risk taking. They are usually classi ed into three types: credit related (e.g., caps on the loan-to-value[LTV] ratio), liquidity related (e.g., reserve requirements), and capital related (e.g., countercyclical or time-varying capital requirements). Capital ow management policies are designed to address risks associated with speci ctypes of capital ows, in particular their potential impact on certain asset markets or their short-term nature.Capital ow management involves two sets of policies: residency-based capital controls and other policiesthat do not discriminate on the basis of residency but are nonetheless designed to in uence ows. Wheremacroprudential measures in uence capital ows, they are considered a subset of capital ow policies.

A Brief Survey of Policies

Asian countries have resorted to a broad range of macroprudential measures, but in recent years most of themhave focused on stability risks arising from overheating property markets (table). In particular, LTV caps formortgage loans and debt-to-income limits have been used (e.g., China, Hong SAR, Singapore), often together

with other real estate lending restrictions and real estate taxes. To address broader-based banking system risks,several economies have also imposed capital measures (Australia), tightened provisioning rules (India), and variedreserve requirements (China, India, Sri Lanka). A number of Asian economies have also resorted to capital ow management when they were faced with macroeconomic and nancial stability risks in the face of surging capitalin ows. Such measures, which have often overlapped with macroprudential measures, have focused on limiting external borrowing by the corporate and banking sectors through restrictions on derivative positions (e.g., Korea)or interest rate caps (e.g., India). Other capital ow management policies have sought to reduce volatility by shifting the composition away from short-term ows, including by setting minimum holding periods for securities(e.g., central bank bills in the case of Indonesia since mid-2010) or discouraging in ows through withholding taxeson foreign holdings of government securities (e.g., Thailand and Korea, where they apply equally to residents). Insome instances, measures were also taken to ease certain existing restrictions on out ows (e.g., China, Malaysia).

Selected Asia: Use of Macroprudential and Capital Flow ManagementMeasures, 201013

Total measures 1 Percent share

Macroprudential measures 47 57

Credit measures

LTV 13 16

Other 15 18

Capital measures 6 7

Liquidity measures 3 4

Noncredit real estate measures 9 11

Other 1 1

Capital flow measures 35 43

Limits on foreign exchange exposure and borrowing 11 13

Restriction on foreign access 7 9

Taxation on nonresident holdings 2 2

Other inflow measures 3 4

Liberalization of inflows 6 7

Liberalization of outflows 6 7

Sources: IMF (2012); IMF country teams; and country authorities.1 Measures are defined as changes to existing regulations or new regulations, and can include multiple measuresper country during observation period. Based on a sample including Australia, Bangladesh, China, Hong Kong SAR,India, Indonesia, Japan, Korea, Malaysia, New Zealand, the Philippines, Singapore, Sri Lanka, Taiwan Province of China, Thailand, and Vietnam.


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Lessons from Recent Experience

According to an IMF survey, most country authorities that have used macroprudential instruments believe that

they are effective. In fact, in many instances they are considered a necessary complement to more conventionalmonetary tools and can offset undesirable side effects. Such is the case in Singapore, where monetary tightening through faster future exchange rate increases may induce domestic interest rates to fall today and stimulate interest-sensitive demand for real estate assets. Another case is China, where stimulus in response to the global nancialcrisis generated rapid credit growth, prompting the authorities to use macroprudential measures to contain houseprice increases. In addition, empirical estimates suggest that some macroprudential measures may help dampenbusiness cycle uctuations (Lim and others, 2011). Similarly, capital ow measures have offered economies a swift

way to safeguard nancial system stability and enhance resilience to a sudden reversal of ows. After the global nancial crisis, surges in capital in ows occurred when economies in the region had begun raising policy rates tomore neutral levels; the scope for sterilized exchange rate intervention was limited by already high levels of reservesand costly interest rate differentials. The capital ow measures helped strengthen banks balance sheets by reducing dependence on foreign wholesale funding, such as in the case of Korea, and in a number of other instances helpedslow the in ow into short-term government bond markets. However, there have also been instances where other

regulations, such as double-taxation treaties, have limited the impact of withholding tax measures. The experience of Asian economies with macroprudential policies and capital ow measures has been an importantfactor shaping the evolving institutional view of the IMF. Whether these measures are appropriate mainly dependson the need and room for macroeconomic policy adjustment, the time required for policies to become effective,and the degree of uncertainty surrounding the source of nancial sector risks and their impact on the realeconomy. As such, these measures should be clearly targeted and communicated and generally be temporarythey can only buy time but cannot substitute for longer-term macroeconomic and nancial sector policies.

Note: The main authors of this box are Tao Sun and Olaf Unteroberdoerster.

cases (China, Hong Kong SAR, Singapore, andMalaysia); but when price pressures resurfacedand domestic credit constraints became lessbinding, they often had to be complementedby additional measures, such as higherstamp duties or restrictions on ownership of investment properties.

For China, new supervisory challenges havearisen with the rapid expansion in off-balance-sheet bank and nonbank nancing. While thismarks a move toward more market-based

instruments playing a larger role in

nancialintermediation, it also ampli es risk taking,given the administrative controls in the nancialenvironment. With intermediation migrating toless-supervised parts of the system, it can alsoblunt the effectiveness of more conventionalbank-based macroprudential measures.

In other instances, capital ow measures may have affected the composition and types of risks associated with exposures to large foreigncapital in ows (such as efforts in Indonesia toimpose minimum holding periods on centralbank securities), but they seem to have beenless effective in curbing the overall size of ows in the face of attractive yield differentials.

As a result, a number of jurisdictions, including China and Thailand, have also chosen tofurther liberalize out ows.

Implementation of macroprudential and capital ow measures will thus need to be carefully calibrated with the shifting stances in monetary and exchange rate policies. Speci c challenges

will vary depending on country circumstances,but credibility and effectiveness of measures

will be enhanced if they are well targeted and


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A threshold autoregressive (TAR) model is applied tothe daily spot CNY and CNH differential beginning inSeptember 2010. The estimated band width is 253 pips(that is, about one-fourth of a percentage point), withthe basis trading within this band only 56 percent of the time ( gure, bottom). Statistical tests con rm thatthe basis follows a random walk within the band andan autoregressive process outside it (table).

The estimation results imply that integration betweenonshore and offshore markets is st ill relatively limited.

The substantial share of time that the basis tradesoutside the no-arbitrage band (44 percent), and thelarge absolute positive and negative values for the basis(which peak at 1,795 and 1,235 pips, respectively),suggest that investors and rms face relatively high

basis risk, which discourages them from using CNH in place of CNY. The results also indicate that arbitrage ismuch slower when CNH is stronger than CNY.

For example, when CNH trades at a premium to CNY ( rst episode, November 2010May 2011) arbitragetakes an average of 25 days to close half the gap to the band (the half life). By contrast, when the CNHtrades at a discount to CNY (second episode, September 2011October 2012) the half life is only six days. Inthe rst episode, capital out ows from the mainland are needed for arbitrage as this increases the supply of CNH offshore. In the second episode, arbitrage involves capital in ows to the mainland that reduces the supply of offshore CNH. These in ows occur through a conversion window that allows (the weaker) CNH to beconverted into CNY at parity. But capital controls allow it only for certain types of transactions, such as trade-related payments, which effectively limits the size of arbitraging capital ows. This faster rate of convergenceimplies that capital controls are less restrictive on capital in ows than on out ows during this period, suggesting that liberalization measures may need to focus more on out ow to lessen the future risk of a large, persistent

widening of the basis. The estimation results show only limited integration of the onshore and offshore markets for the renminbi.Liberalizing the capital account to facilitate faster arbitrage between the two markets would reduce basis risk andencourage greater use of the CNH. The results here also indicate that liberalization to expand the use of arbitragefor capital out ows may be more effective in reducing this basis risk. Recent liberalization measures have focusedmore on easing constraints on in ows; thus, this asymmetry may have become even more pronounced recently.

That said, country circumstances will alsodetermine the appropriate pace of scalconsolidation.

In Japan, while the recently adopted scalstimulus will help support a quick exit fromrecession, the overarching priority remains acredible strategy for bringing down debt andimplementing growth-enhancing reforms.In this regard, con rming consumption tax

increases planned for 2014 and 2015 remainsan important starting point. By contrast, inChina, a broadly unchanged scal stance

appears appropriate. There is also amplespace to use the budget as a primary meansto nance infrastructure in order to improvethe transparency of quasi- scal activitiesand targeting of infrastructure spending.

This would help mitigate the further build-up of nancial stability risks related to local

TAR Model Estimation: Summary of Results

CNY weaker than CNH (posit ive bas is ) 15% of time

Autoregressive coefficient 0.97***

Implied half life 25 days

CNYCNH basis trades within band 56% of time

CNY stronger than CNH (negative basis) 29% of time

Autoregressive coefficient 0.88***

Implied half life 6 days

Source: IMF staff estimates.Note: *** indicates significance at the 1% level.


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Box 1.7

How Will the Basel III Capital and Liquidity Requirements Affect Asian Banks?

As of early 2013, most of the larger Asian economies started implementing Basel III or were set to do so shortly.Some have even opted to go beyond the internationally agreed minimum standards by, for example, setting more conservative capital de nitions or surcharges for systemic institutions. Asias lead role re ects the relatively strong starting position of its banks and a track record of prudent regulatory oversight. Nonetheless, the new requirements are likely to affect Asian banks. Some critics even worry that Basel III might pose a serious risk tothe regions nancial and economic development. This box attempts a tentative assessment of the question.1

There is little doubt that Asian banks are in a goodposition to meet the new capital requirements rightfrom the outset. Tier 1 capital ratios generally remained

well above Basel II benchmarks in 2012, and indeedin many cases the Basel III standard of 8.5 percent(including capital conservation buffers) that will begradually phased in by 2019.

Even so, continued fast credit growth could outpaceinternal capital generation, creating a medium-term needto raise fresh capital. Illustrative staff projections con rmthe consensus view among analysts that the capital needs

will be concentrated on banks in India and China andshould be manageable. Only if banks were shut outof the equity market for an extended periodperhapsbecause of low valuations that make shareholdersreluctant to dilute their holdingscould capital becomea serious constraint on new bank lending ( gure). Of course, in cases where credit growth exceeds prudentrates, that would be a welcome development.

The precise path for future capital needs depends on anumber of uncertain variables, including bank pro ts,payout ratios, and the pace at which nonbank sources of credit will expand. The latter trend, in particular, couldprovide considerable relief. Recent data show a marked pick-up in corporate bond issuance across Asia that morethan offsets a slump in syndicated bank lending. In China, other nontraditional sources of credit, such as trustloans, have also been growing at high double-digit rates. Although these new funding channels pose risks thatneed to be monitored carefully, they clearly widen the range of nancing options for businesses.

Meanwhile, concerns have been raised over the impact on trade nance of the simple 3 percent leverage ratiothat is part of the new capital framework. The argument is that the indiscriminate 100 percent credit conversionfactor for off-balance-sheet exposures will penalize trade credit, potentially creating a critical shortage of funding for Asian industry. However, the Basel Committee on Banking Supervision in 2011 decided to maintain the originalleverage ratio rules, which serve as a simple backstop to the more sophisticated, risk-weighted capital requirements.

Should we expect a signi cant retrenchment of trade nance? Even assuming a very high cost of capital anda strictly binding leverage ratio, the relevant increase in capital charges should not exceed 3050 basis points atmosta manageable magnitude given historical uctuations in credit pricing. Anecdotal evidence also suggests

Note: The main authors of this box are Julian Chow and Andr Meier.1 See also Financial Stability Board (2012).

Projected Medium-Term Capital Needs for Asian Banking Systems under Different GrowthScenarios 1 (In billions of U.S. dollars)

0.41.7

0.3 0.4 0.305

10152025

3035

I n d i a

C h i n a

K o r e a

P h i l i p p

i n e s

T h a

i l a n

d

S i n g a p o r e

M a

l a y s

i a

I n d o n e s i a

Strong g rowth Weak growth WEO basel ine g rowth

Capital needs under stronggrowth scenario in percent of GDP

Sources: Bankscope; Bloomberg L.P.; and IMF staff calculations.1 Projected amounts of capital raising by major banks (comprising at leasthalf of domestic banking system assets) through end-2018 to meet BaselIII Tier 1 capital requirement, including conservation buffer. Strong-growthscenario raises capital needs because of higher growth in risk-weightedassets (informed by historical panel data regression). Higher capital needsin weak-growth scenario are driven by lower bank earnings. Projected returnon equity based on 10-year historical averages, adjusted by +1 and 2standard deviations under strong and weak growth scenario, respectively.


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Box 1.8

MyanmarReintegrating with the World

Over the last year, Myanmar has continued to make rapid progress on its ambitious set of reforms, which aimto comprehensively modernize the economy and re-integrate it into the global economy. Joining the ASEANEconomic Community (AEC) at its planned launch in 2015 is a key pillar in this strategy, as is the resumptionof orderly nancial relations with the international community. Early 2013 saw the completion of a number of critical steps along this road.

The governments broad economic goalsthe Framework for Economic and Social Reforms (FESR)werepresented to the international community in January 2013. In addition to opening the economy, they includeraising growth in a sustainable way, reducing poverty, and achieving greater equity. Donors supported the goalsand, through the Nay Pyi Taw Accord, pledged to support them in a coordinated manner. The key challenge forthe authorities will lie in managing the economic reform program; and coping with strong aid in ows.

The authorities key macroeconomic policy priorities are to maintain low and stable in ation within a consistentmacroeconomic framework; and build international reserve buffers in light of the ongoing liberalization of

imports and the foreign exchange regime. The IMF is assisting the authorities with monitoring the progresstoward these objectives through a Staff-Monitored Program (SMP). To build the institutions and instrumentsneeded to ensure macroeconomic stability, the SMP focuses on the following areas: (1) eliminating remaining exchange restrictions and multiple currency practices in line with Myanmars AEC commitments; (2) modernizing the nancial sector, including the Central Bank of Myanmar, to facilitate macroeconomic management andgrowth; and (3) laying the foundations for improving scal revenues in the medium term for sustainabledevelopment spending.

The FESR and SMP helped lay the foundations for the normalization of Myanmars nancial relations withthe international community. Early 2013 saw the clearance of Myanmars arrears to the Asian DevelopmentBank and World Bank, and agreement on the concessional rescheduling of its arrears with Paris Club creditors.International sanctions were also further relaxed and the nancial sector strengthened its links through theestablishment of international transactions.

The coming months will see further progress. The 2013/14 budget will be the rst to re ect the priorities of theFESR, a new central bank law is expected to be passed by Parliament and international nancial relations willbe strengthened through the completion of the Paris Club rescheduling process. With these achievements andprovided the reform momentum is maintained, growth over the next ve years is projected to rise to around 7percent.

An SMP is an informal and exible instrument for dialogue between the IMF and a member country on itseconomic policies. It is not accompanied by nancial support from the IMF. In Myanmars case, it will involvejoint monitoring of progress on the governments reform plans.

Note: The main author of this box is Alexander Pitt.

potential growth and reduce risks of a persistentslowdown through, among other things, regulatory reforms (product-labor markets), infrastructurespending, and further regional trade integration. Asfor low-income economies such as Paci c Island

countries, steadfast implementation of structuralreformsincluding to improve the investmentclimate and infrastructurewould play an equally crucial role in lifting potential growth over themedium term (Box 1.10).


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Box 1.10 (continued )

administrative frameworks, have blocked these countries from tapping international capital markets and attracting capital in ows.

The Paci c Island countries are heavily exposed to exogenous shocks and vulnerabilities (Sheridan, Tumbarello,and Wu, 2012), including terms of trade, external demand, and nancial shocks; natural disasters; and climatechange. Indeed, terms of trade, aid, and current account balances are all, on average, more volatile than in othersmall states. A key vulnerability is these countries small domestic markets and heavy reliance on imports, whichlead them to rely on aid and remittances to nance their structural trade de cits.

Policy tools are also limited. Five out of the 11 Paci c Island countries do not have a central bank (Kiribati, MarshallIslands, Micronesia, Palau, and Tuvalu). The use of dollarization or of xed/managed exchange rate regimes for theotherswith the exception of Papua New Guinea, which has a oating exchange ratere ects the xed costs of operating an independent monetary policy as well as weak monetary transmission mechanisms. The latter is largely the result of the structural characteristics of nancial marketsfor example, shallow money markets, the absenceof institutions such as credit bureaus that facilitate bank lending, and small market size (Yang and others, 2011).

As a result of these factors, real GDP per capitain the Paci c Island countries is among the lowestamong the small states, and they seem to be stuck ona low-growth path. Since 1990, their real GDP percapita (in PPP terms) has increased by less than 25percent, compared with 45 percent in the countriesof the Eastern Caribbean Currency Union (ECCU)and more than 30 percent for the small states average.Growth has been weak over the past two decades,averaging just 2 percentmuch lower than the

Asian low-income countries (6 percent), the ECCUcountries (4 percent), and the small state average (4percent) ( gure, bottom). Indeed, econometric analysis(Tumbarello, Cabezon, and Wu, 2013) suggests that,even after controlling for some standard variables (thatis, education, GDP volatility, government consumption,and initial GDP), the Paci c Island countries suffer a disadvantage in per capita GDP growth of about 2percentage points compared with an average small state over the past 20 years.

Nevertheless, policies still matter and can help build resilience and raise potential growth. The Paci c Islandcountries should continue rebuilding policy buffers, which were lost in part during the global recession, in a way that reinforces efforts to implement growth-enhancing reforms. In particular:

Strengthening domestic revenue mobilization would support the rebuilding of policy buffers while helping tocreate scal space to meet critical development spending needs.

Improving the composition of public spending with regard to education, health, and infrastructure would

foster inclusive growth by crowding-in private investment, thereby promoting more broad-based growth,including by attracting foreign direct investment and stimulating more tourism.

Sound structural policies can enhance long-term resilience to shocks and boost growth potential. Inparticular, implementing reforms that enhance the business environment can boost investor con dence andprivate-sector growth. The Paci c Island countries also have enormous untapped marine resources, andfurther effort is needed to properly exploit and manage them.

Pacic Island Countries: Real GDP Growth,19902012(In percent)

6

4

2

2

0

4

6

1 99 0 1 99 2 1 99 4 1 99 6 1 99 8 2 00 0 2 00 2 2 00 4 2 00 6 2 00 8 2 01 0 2 01 2

Caribbean small statesPICsPIC commodity importers

Sources: IMF,World Economic Outlook ; and World Bank,World

Development Indicators.


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2. Fiscal Policy: Dampening Cyclical Fluctuationsand Supporting Inclusive Growth

Sustained rapid growth, macroeconomic stability,and improvements in living standards are some of the remarkable achievements of Asian economiesover the past decade. Nevertheless, importantchallenges remain, as countries strive to maintainrobust long-term growth, reduce income inequality,and ght poverty. Against this background,this chapter assesses whether scal policy hascontributed to lower output volatility in Asia in thelast decade and discusses how it can help addressthe critical challenges ahead.

A number of conclusions emerge from the analysis.Fiscal policy has become more countercyclical inthe past 10 years, and discretionary policies havebeen effective in dampening the business cycle.Indeed, for the period 200111, when real GDPper capita fell by 1 percentage point relative to itstrend, real government expenditure is estimatedto have responded by an increase of 1 percentagepoint on average, compared to a softer response of 0.3 percentage points over 19802011. Moreover, scal multipliers are typically positive across theregion and in some cases above 1.

Building on the progress achieved over the pastdecade, scal policy can play a key role in laying thefoundations for sustainabl

regional economic outlook-apac_0413

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