National Reserve Bank of Tonga

Asia: Sailing in Turbulent Times

Asia: Sailing in Turbulent Times

Asia and Pacific Economic Regional Outlook Op Ed

by Elena Loukoianova
International Monetary Fund (IMF) Mission Chief for Tonga

Asian economies are sailing in choppy waters, facing severe headwinds from an uncertain and challenging global environment. First, the global recovery has been uneven and weaker than expected. On top of that, global trade has been sluggish and financial conditions have been volatile. The rise of China as a global economic superpower has also created challenges of its own, as China’s necessary rebalancing from manufacturing towards services and investment to a consumption-driven economy—critical for both China’s and global growth over the medium term—remains bumpy. As elsewhere, many Asian economies face risks associated with natural disasters and geopolitical and domestic political uncertainty. But all is not the doom and gloom, as Asia remains the major engine of the global economy: it continues to provide nearly two-thirds of global growth. In addition, the region has policy buffers such as current account surpluses and high reserve levels and is likely to benefit from further economic integration and regional and multilateral trade agreements such as the Trans-Pacific Partnership.

Asia’s growth is moderating slightly, in line with the rest of the global economy. According to the most recent IMF World Economic Outlook, activity in the region moderated in the second half of 2015, and is expected to continue decelerating in the near term. GDP growth for the region is forecast at 5.3 percent in both 2016 and 2017, a meager 0.1 percentage points lower than in 2015. In addition to weaker global growth and sluggish trade, the moderation in regional growth also reflects the ongoing necessary rebalancing in China. But while external demand is relatively weak, domestic demand, particularly consumption, is expected to remain resilient across most of the region. The relative strength of domestic demand is due to generally low unemployment, lower commodity prices (which is a bonus to oil and commodity importers), economic stimulus in some countries, and ongoing secular trends, including steadily rising disposable income. Among the small states in the Pacific, average real GDP growth was stronger at 3.0 percent in 2015 relative to 2.3 percent in 2014. While the main drivers of growth vary by country, the windfall provided by lower commodity prices played a role in supporting growth in oil importing countries. Many tourism-oriented countries also benefited from continued growth in tourist arrivals, especially from China while some Micronesian countries are also benefitting from strong fishing license revenue. Inflationary trends suggest varying speeds of pass-through of global oil price movements to Pacific small states. Inflationary pressures remained broadly contained, with some countries experiencing deflation in 2015, although in a number of countries, prices have trended higher from a low base. In Tonga, growth accelerated from 2.1 percent in FY2014 to 3.7 percent in FY2015 supported by construction, tourism, remittances, and strong private credit, despite weather related disruptions to agricultural production. In the meantime, year-on-year average inflation declined from 0.2 percent (year-on-year) at end-June 2015 to -0.3 percent at end-February 2016, reflecting declining global food and fuel prices. The domestic component of inflation, however, edged up to reflect higher prices of locally produced food. External position remains strong, supported by strong remittances, donor aid, and low global fuel prices.

The moderation in Asia’s growth masks important differences within the region. In China, GDP growth is expected to continue to moderate to 6.5 percent this year and 6.2 percent in 2017. This reflects ongoing rebalancing and other structural reforms, which are expected to continue to boost consumption and the services sector, while investment and manufacturing remains relatively weak until excess capacity is resolved. India, on the other hand, is expected to remain the fastest-growing large economy in the world, with GDP expanding by 7.5 percent in 2016-17, underpinned by strong private consumption and helped by lower oil prices. In Japan, GDP growth is projected to remain at 0.5 percent in 2016, slowing to -0.1 percent in 2017 as the widely anticipated consumption tax rate hike (from 8 to 10 percent) kicks in although the authorities are expected to introduce offsetting stimulus measures to boost the economy. Indonesia, which is exposed to commodities, is expected to benefit from a large infrastructure push. Average real GDP growth in small states in the Pacific is expected to moderate slightly to 2.8 percent in 2016 due to spillovers from the moderation in regional growth. The recent El Niño episode, which has turned out to be one of the most severe on record, is expected to weigh on agricultural output in the first part of this year. Inflationary pressures are expected to remain contained amid the broadly benign global commodity price outlook for 2016. Real GDP growth in Tonga is projected to remain relatively strong at 3.1 percent in FY2016 and 2.3 percent in FY2017 driven by a recovery in agriculture and an increase in construction activity in preparation for the Sixteenth South Pacific Games (the SPG) in 2019. Domestic demand will be supported by lower fuel prices, remittances, and aid inflows, while inflation will remain low.

Despite a robust outlook, downside risks continue to dominate the economic landscape. Global growth could slow by more than expected or financial conditions could tighten suddenly. As many economies in the region have seen debt levels rise rapidly over the last decade, a combination of slower growth and higher borrowing costs could tip some corporates and households over the edge and further constrain growth. For small states in the Pacific, Cyclone Winston that hit Fiji in February 2016 was yet another reminder of these countries’ continued vulnerability to natural disasters that can weigh on growth prospects. On the upside, large infrastructure projects in the pipeline in some countries can help sustain Pacific small states’ short- and medium-term growth performance. Protracted period of slower growth in advanced economies, particularly in Australia and New Zealand, and China slowdown could weigh on Tonga via aid, remittances, and tourism channels. On the domestic front, large increases in current expenditure, particularly the wage bill, could lead to higher public debt, jeopardizing debt sustainability. Slippages in delivery of policy reforms could affect the level of development partners’ budget support, leading to lower aid. Cost overrun related to the SPG could make it necessary to mobilize additional resources, potentially resorting to non-concessional borrowing and raising the public debt. Natural disasters and weather-related events could also take a toll on the economy. On the upside, Tonga would continue to benefit as a net energy and food importer, if oil and food prices remain low.

In addition, regional growth is more dependent on China than ever before. While rebalancing in China is a price worth paying for in terms of durable and resilient growth over the longer term, the short-term transition is likely to be bumpy and the impact on countries and markets is likely to vary. Countries that export goods that support China’s investment and construction (producers of metals, for example) would be adversely affected, while others that export consumer goods to China or are destinations for rapidly-growing Chinese tourism could benefit. In addition, China’s move to higher value-added production will provide opportunities for low-income Asian countries, particularly in labor-intensive sectors, such as apparel, footwear, furniture, and plastic toys. Already Bangladesh, Cambodia, and Vietnam have seen market share gains in these sectors. Financial linkages are also growing with regional markets becoming more sensitive to shocks from China after the global financial crisis. Over time, though, as economic rebalancing makes China’s growth model more resilient and sustainable, the region is likely to benefit.

A wide range of policies can be used to harness the region’s potential. In addition to building buffers, policymakers should deploy macroeconomic policies to boost demand if needed. But more importantly, structural reforms will be key to support economic transitions and the emergence of new growth models. This will bolster regional potential growth, and ultimately, strengthen the region’s resilience to global shocks. Structural reforms and policies, particularly fiscal policy, should also tackle long-standing challenges and promote inclusive growth. The key in this regard is to provide equality of opportunities, in particular to broaden access to education and health and promote financial and gender inclusion. In Pacific small states, structural reforms to lift growth potential and increase resilience to shocks—including the effects of natural disasters and climate change—continue to be critical, as well as maintaining adequate levels of external and fiscal buffers. Public investment in infrastructure can help boost long-term growth potential, and this can be supported by measures to deepen the financial sector and improve financial inclusion. The government of the Kingdom of Tonga has made significant progress in bringing structural reforms up to date, including in regulated utilities and labor market, public enterprises reform, and is developing legislation to facilitate formalization of the informal sector, including revising the foreign investment act and work permit rules. Revision of the Land Act would help further develop collateral for personal and business loans and improve access to finance. Still, more needs to be done in the years ahead to promote private sector development and inclusive growth.

Elena Loukoianova
Deputy Chief
ASEAN 4 Division
Asia Pacific Department
International Monetary Fund

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