The Asia and Pacific region continues to deliver strong growth, in the face of widespread concerns about growing protectionism, a rapidly aging society, and slow productivity growth, according to the IMF’s latest regional assessment.

The Regional Economic Outlook for Asia and the Pacific estimates growth for the region to increase this year to 5.5 percent from 5.3 percent in 2016. Growth will remain strong at 5.4 percent in 2018, as the region continues to be the leader of global growth.

The report also cites the more favorable global environment with growth accelerating in many major advanced and emerging market economies-notably the United States and commodity exporters-as supporting Asia’s positive outlook. Risk appetite remains strong in global financial markets despite some bouts of capital flow volatility in late 2016.

‘The signs of growth in the region are encouraging so far. The policy challenge now is to strengthen and sustain this momentum,’ said Changyong Rhee, Director of the IMF’s Asia and Pacific Department.

Strong growth ahead

In China, the region’s biggest and the world’s second largest economy, policy stimulus is expected to keep supporting demand. Although still robust with 2017 first quarter growth slightly stronger than expected, growth is projected to decelerate to 6.6 percent in 2017 and 6.2 in 2018.

This slowdown is predicated on a cooling housing market, partly reflecting recent tightening measures, weaker wage and consumption growth, and a stable fiscal deficit.

Japan’s growth forecast for 2017 has been raised to 1.2 percent with support from expansionary fiscal policy and the postponement of the consumption tax hike (from April 2017 to October 2019). The expansion would slow down to 0.6 percent in 2018 as the boost from the fiscal stimulus wears off.

The outlook for other Asian economies is also positive, but with some exceptions. India’s growth is expected to rebound to 7.2 percent in FY 2017-18 as the cash shortages accompanying the currency exchange initiative ease.

In most of the Southeast Asian economies, growth is expected to accelerate somewhat, supported by robust domestic demand-an important driver of growth in these countries. Meanwhile, growth in Korea is projected to remain subdued at 2.7 percent this year despite the recent pick up in exports, mainly owing to weak consumption.

Uncertain outlook: downside risks

The region’s outlook, however, is clouded with uncertainty. On the plus side, larger-than-expected fiscal stimulus in the United States or stronger business and consumer confidence in advanced economies could provide a further boost to Asia’s exports and growth. Reforms, such as productive public investment in infrastructure in ASEAN and South Asian economies, could help prolong the positive momentum.

But if the U.S. fiscal stimulus leads to higher-than-expected inflation pressures, the Federal Reserve could accelerate the pace of interest rate increases in response, leading to a stronger U.S. dollar.

A sudden tightening of global financial conditions could adversely impact Asian economies with high external financing needs and weak private sector balance sheets, including by triggering capital outflows and unwinding of productive investment projects.

Asian economies are especially vulnerable to protectionism because of their trade openness and integration to global value chains. A global shift toward inward-looking policies could suppress Asia’s exports and reduce foreign direct investment to Asia. Furthermore, a bumpier-than-expected transition in China or geopolitical tensions in the region could also weaken near-term growth.

Highlights from the report:

Asian economies are expected to grow by 5.5% in 2017, slightly more than last year.

Growth outlook clouded by significant downside risks.

Near-term risks: tightening global financial conditions; more inward-looking policies; spillovers from China’s transition

Medium-term risks: population aging in some countries; limited productivity convergence

To tackle these longer-term challenges, countries need: more women and migrants in the work force; stronger pension systems; more trade and foreign investment, along with more research and advanced education.

Challenges to growth

Asia needs to tackle two longer-term challenges: population aging and slow productivity catch-up. According to the report, Asia is aging remarkably fast compared to the experience in Europe and the United States. As a population grows older, there will be fewer workers, and over time, a shrinking workforce and aging population can mean a rise in healthcare costs and pension expenditure.

This puts pressure on government budgets, and can translate into lower growth. The report estimates that over the next three decades, demographic trends could subtract 0.5 to 1 percentage point from average annual GDP growth in relatively old Asian economies such as China and Japan.

Slow productivity growth is another worry. The region has not been able to catch up to the high productivity levels of countries at the global technology frontier. Declines in trade and foreign direct investment could also be harmful to Asian economies given their vital roles in transmitting technology and promoting domestic competition.

Policies to reinforce growth

Given these challenges, macroeconomic policies should focus on supporting demand and structural reforms.

The report notes that monetary policy should stay accommodative in economies with economic slack and below-target inflation rates. Should inflation pressures gather pace, however, central banks should stand ready to raise policy rates.

Well-targeted structural reforms would help strengthen the region’s resilience to external shocks and sustain strong and inclusive long-term growth. Considering Asia’s rapid aging, policies aimed at protecting the vulnerable elderly population and prolonging strong growth take on a particular urgency. These include measures that promote labor force participation of women and the elderly, as well as strengthening pension systems.

These policies should be supplemented by productivity-enhancing reforms. Priorities differ across Asia’s dynamic economies. Advanced Asian economies should focus on making research and development spending more effective and raising productivity in the services sector.

In emerging and developing economies, attracting foreign direct investment and expanding the economy’s capacity to absorb new technology and boost domestic investment is more urgent. These steps will help the region to build on and continue with the growth momentum.

Source: IMF – International Monetary Fund