For Asia, solid growth still seen

Growth in Asia has shifted to a lower gear. Sluggish demand from advanced economies has weighed on the region, but domestic headwinds from within its three largest emerging economies have also played a major role and more than offset a clear pickup in Japan.

Expectations of an earlier-than-previously-anticipated tightening of global funding conditions have triggered capital outflows from Asian emerging economies and led to repricing of assets and currency depreciations, especially in India and Indonesia where fundamentals were weaker.

In a few Asean (Association of Southeast Asian Nations) economies, the overall tightening in financial conditions has been modest and may help unwind some buildup of financial imbalances.

Against the backdrop of weaker activity and benign global commodity price trends, headline inflation remains generally within comfort zones of central banks, with the exception of India and Indonesia, where the most recent spike largely reflects recent administered fuel price hikes.

In the Philippines, brisk economic activity continued into 2013, underpinned by dynamic private and public demand. After growing 6.8 percent in 2012, the economy accelerated further in the first half of 2013 to 7.6 percent on robust consumption and investment, while external demand was subdued.

As in the rest of Asia, Philippine assets saw selling pressure that caused the peso to weaken and market interest rates to rise following the US Federal Reserve announcement in late May, although the delay in the start of tapering of asset purchases by the US Federal Reserve led to some reversal of asset price declines more recently. Inflation fell below the 4±1 percent target band and current account surplus rose to 4.2 percent of GDP (gross domestic product) in the first half of 2013.

The near-term outlook for Asia is for solid growth, hinging on a gradual pickup in external demand and resilient domestic demand underpinned by favorable financial and labor conditions. Growth for Asia as a whole is forecast to be around 5½ percent in 2013 and 2014, about 0.2-0.3 percentage point below the April 2013 Regional Economic Outlook (REO).

Risks are, however, tilted to the downside. A further tightening of global funding conditions could trigger renewed portfolio outflows, with effects on domestic asset prices, overall financial conditions and, ultimately, growth.

As the euro area and other advanced economies remain a key source of final demand for the region’s export-dependent economies, renewed growth setbacks there would weigh on Asia’s most open economies. Risks originating from within the region include the buildup of financial imbalances across Emerging Asia documented in the April 2013 REO, although it has not been large in most countries, and corporate and banking sector balance sheets appear generally robust. A persistent deceleration in investment activity, not least in China and India, is yet another concern.

Economic growth for 2013 is forecast to remain strong at 6¾ percent in the Philippines, easing to about 6 percent in 2014, which is still somewhat faster than potential output.

In addition, risks to growth in the Philippines continue to lie more on the upside. When the US Fed tapering does begin, the Philippines’ strong fundamentals—including strong current account receipts, its net creditor status, steady reductions in public debt, and low foreign participation in government securities markets—may enable the economy to adjust smoothly to the accompanying capital flow reversal and slowdown in regional growth.

On the domestic front, absorbing the ample liquidity in the banking system into productive sectors may prove challenging. Part of the liquidity may finance credit used to fuel demand for real estate.

As Asia’s growth moves to a lower gear and investors increasingly discriminate across countries according to their fundamentals, the case for structural reforms to lift total factor productivity growth and weather future economic turbulence is becoming clearer. IMF projections for potential growth in major emerging economies have been repeatedly revised downward in recent editions of REOs. This has reflected to a large extent increasingly binding supply bottlenecks in India and signs of declining marginal returns to capital in China.

A diverse agenda in different economies—ranging from reforms in goods and labor markets in most countries, energy sector and broader institutional reforms to boost infrastructure spending in India, rebalancing towards consumption-driven growth in China—would go a long way toward fostering sustainable inclusive economic growth over the future.

In the Philippines, continuing to improve the investment climate would help channel savings into productive activities and raise potential growth further. Further relaxing limits on foreign ownership and regulatory reforms may substantially raise FDI—particularly as the Asean integration is set to deepen—and increase competition in key sectors.

Additional efforts are needed to enhance revenues through reforms and parallel efforts to broaden the tax base, particularly the rationalization of tax incentives. This will help level the playing field and finance public infrastructure, catalyzing private investment in productive sectors.

(The author is director of the Asia and Pacific Department of the International Monetary Fund.)