IMF: Asia Needs to Prepare for Possible Capital Outflow in Medium Term

While IMF estimates Asia’s economy—accounting for 60% of global growth—to expand 5.6% this year and next, the fund warns that downside risks dominate over the medium term.

“The outlook is supported by strong global demand, as well as still accommodative policies and financial conditions,” said IMF in a statement.

The fund forecast China’s growth to moderate to 6.6% in 2018 as financial, housing, and fiscal tightening measures take effect and growth in India to rebound to 7.4%in FY 2018/19 as the economy recovers from disruptions related to the currency exchange initiative and the rollout of the new goods and services tax.

IMF also predicts that Japan’s growth will remain strong at 1.2% this year and growth in ASEAN to stay at 5.3 percent both this year and next.

In the near term, both upsides and downsides largely balance out in the region, the fund pointed out.

On the upside, growth momentum could be more durable than expected amid strong consumer and business confidence and still loose financial conditions, said IMF.

“The rollout of the fiscal stimulus in the U.S. as well as a stronger recovery in the euro area could lift global growth, with positive spillovers to Asia,” the fund noted.

Medium-term vulnerabilities

However, Asia over the medium term is vulnerable to a tightening of global financial conditions, spurred by higher U.S. interest rates, which could trigger capital outflows, IMF said.

In addition, a global shift toward inward-looking policies would be worrying given Asia’s trade openness—suppressing Asia’s exports and reducing foreign direct investment in the region, it added.

Other factors that might impact the region’s medium term growth include escalating geopolitical risks, natural disasters, and cyberattacks, IMF observed.

Over the longer term, Asia faces a number of important challenges from population aging, slowing productivity growth, and the digital revolution, which of course brings huge opportunities along with risks, IMF said.

Inflation remains subdued

While present rates of inflation in Asia are some of the lowest in decades, IMF said that temporary global factors, including commodity prices and imported inflation, have been key drivers of this trend. “But these factors could reverse, and inflation could rise,” the fund said.

In addition, inflation has become more backward-looking, meaning that past inflation drives current inflation more than future expectations, said IMF, adding that this suggests that if inflation rises, it may persist.

“There is some evidence that the sensitivity of inflation to economic slack has decreased, suggesting that if inflation rises, there may be a large hit to output when reducing it,” IMF noted. “All of these mean that central banks should watch out closely for signs of inflation pressure now and stand ready to respond.”