While the global recovery has slowed, Asia continues to lead the economic rebound. Almost all economies in Asia grew well above trend in the first half of 2010, fueled by exports and investment.
Indonesia was one of the world’s best performing economies during the 2008−2009 global financial crisis, and the only G20 economy to lower its public debt-to-GDP ratio in 2009.
The IMF recently concluded its annual consultation on Indonesia’s economic policies and outlook (reports are available at www.imf.org/external/country/IDN/index.htm). That review admired and applauded the way that Indonesia steered the economy through the global financial crisis with the support of strong macroeconomic fundamentals and robust domestic demand.
In our recently-released Asia-Pacific Regional Economic Outlook, we envisage that, in Asia as a whole, GDP will grow by 8 percent in 2010 and 7 percent in 2011. In contrast, we expect growth in advanced economies in 2010−2011 to be relatively sluggish. This performance will provide less export demand to Asian countries than occurred in late 2009 and early 2010.
Earlier in the recovery, Asia had benefited from a restocking of inventories, which boosted production and exports. The current moderation in growth in part reflects a normal turn in the global and regional inventory cycle, particularly for information technology products, which are important exports for many Asian economies.
What will underpin Asia’s growth? Although export demand from advanced economies will moderate, we see improvements in employment and wages supporting domestic demand in Asia.
In addition, the monetary policy easing that occurred during the crisis, and is just now being gradually withdrawn, is supporting credit growth.
Low interest rates in advanced countries, and Asia’s higher expected rates of return and low debt levels are likely to continue to draw capital flows to the region.
The main risk for Asia remains the global environment. While international financial conditions have improved in the last six months, underlying sovereign and banking vulnerabilities in several advanced economies have not been solved. Asia has important trade and financial links with these countries, and a deterioration in financial conditions or a slowdown in the recovery in advanced economies would have repercussions for Asia.
In addition, recent capital inflows to the region are supporting growth, but carry risks. These inflows can contribute to overheating, inflation, and asset price bubbles. A reversal of capital inflows could spur asset market volatility and hurt growth in the region by lowering consumer and business confidence and increasing the cost of capital. Several countries have taken macro prudential measures to minimize these risks, but a tightening of monetary conditions may be needed, including through exchange rate appreciation.
In view of the strong economic expansion, and emerging signs of inflation pressures, the time has come to normalize policy stances across the region. The significant policy easing that occurred during the crisis was necessary. Several economies in Asia have started to take steps to gradually normalize policy, but monetary and fiscal policies are still accommodative.
With output gaps closing rapidly, inflation pressures could intensify next year. In particular, tight capacity constraints could exacerbate the effect of supply shocks on inflation.
In Indonesia, growth is expected to remain strong at 6−6.2 percent in 2010−2011. However, the issue of emerging inflation pressures is already evident. Bank Indonesia’s recent decision to raise reserve requirements is a step in the right direction. Indonesia still has somewhat higher and more volatile inflation than its trading partners and other emerging markets.
A more proactive monetary policy along with continued improvements in public communication regarding inflation objectives could lower inflation and its associated risk premium, reduce interest rates, and create a much more conducive climate for higher investment and sustainable credit growth.
Over the medium term, sustaining robust growth in Asia will require continued progress with rebalancing growth toward domestic demand. For Asia as a whole, only limited progress has been made toward reducing external imbalances. With external demand from advanced economies unlikely to return to pre-crisis trends, Asia will need to rely more on domestic demand to support its growth.
The normalization of cyclical policy conditions in Asia needs to be accompanied by continued measures to support consumer spending and investment. In our current Asia-Pacific Regional Economic Outlook, we focus on the challenge of raising investment and investigate measures that facilitate access to credit and support private sector investment.
Supportive policies for investment will be key to achieving long-term growth potential in Indonesia.
Economic growth is targeted by the government to accelerate from 6 percent this year to 7−8 percent over the medium term. For Indonesia to achieve these levels, it will need to address long-standing constraints on growth. Public investment has been low by international standards.
Roads and ports in particular need improvement. President Susilo Bambang Yudhoyono recently made infrastructure projects a key priority in his Independence Day speech and recent developments show policies are moving in the right direction. Several power projects appear to be progressing and the Investment Advisory Board has become a one stop shop focusing on key priority projects.
The IMF remains closely engaged with Asia, and with Indonesia in particular. Our policy dialogue with Asian authorities is being deepened through initiatives like a Regional Advisory Group which draws senior figures from Asia to advise us in our work in the region.
In addition, in July we held a large conference on Asia’s prospects in South Korea, and in October we will hold an important conference in Shanghai to bring together senior figures to discuss financial sector management and global initiatives. Through these and other efforts we are committed to supporting a bigger role and larger voice for Asia in global economic policy discussions.
The writer is director of the IMF’s Asia & Pacific Department.