Future challenges for Asian economies in changing world

David Burton

This week's World Bank IMF Annual meetings in Singapore are the first to take place in Asia since the Hong Kong meetings nearly a decade ago. As global financial Ieaders gather here, the contrast for the region could hardIy be starker. In the intervening nine years, Asia has recovered from a financial crisis and re-established itself as the most dynamic and rapidly growing region in the global economy.

As the IMF's current Asia and Pacific Regional Economic Outlook shows prospects continue to look good. Economic growth in emerging and industrial Asia is expected to reach 71/4 percent this year, and remain at about 7 percent in 2007. Inflation should also remain well contained. Indeed, Asia has shown considerable resilience, reflected by its quick recovery from global financial market volatility in May and June. Prospects for capital flows to support investment are solid.

It is true that the global economic environment presents real risks for Asia. Growth in the United States, in particular, remains critical to the region's prospects. Higher oil prices could also reduce growth and push up inflation. And a more fundamental turn Away from investment in emerging markets than seen in the midle of the year could slow growth and weaken regional financial markets. On the whoe though, the region is placed to deal risks.

Looking to the next decade, Asian policymakers will face new challenges as they seek to maintain economic momentum and extend the benefits of rapid growth to all. The IMF's current Regional Outlook focuses on several of these challenges.

First, sustaining Asia's impressive economic performance over the medium term will require a rebalancing of growth, away from a heavy dependence on exports and toward more autonomous domestic demand. Such rebalancing would also contribute along with structural reforms in the European Union, fiscal consolidation in the United States, and increased exchange rate flexibility in Asia to an orderly unwinding of global imbalances.

Consumption in emerging Asia has failecl to keep up with rapid GDP growth, reflecting in part is still young population, which favors saving for the future. Indeed, the prospective aging of much of Asia, which will bring many of its own challenges, should raise consumption over the medium term, in some cases dramatically.

But poiicies can help. While the right approach will vary from one country to the next, reducing the need for precautionary savings-by ensuring adequate provision of education, health care and social safety nets-and enhancing household access to bank lending and capital markets can play a significant role.

Investment also continues to lag in some countries, in particuiar for small and medium-sized enterprises producing for domestic markets. Again, expanding access to bank lending-for example by improving information on credit risk-and developing capital markets, including for corporate bonds, would help.

Second, as suggested above, continued development of Asian financial sectors is critical for sustaining rapid growth. Asia's economies have become increasingly integrated with world financial markets, and this has played an important role in the development of its capital markets.

But regional financial intregation remain much less advanced, and more progress in this area would provide further stimulus for capital market development. Broader development of capital markets would also produce more balanced growth. More people would have access to the savings generated, and be able to share in rapidly growing corporate profits through equity markets.

Regional integration is progressing well. Countries are are developing domestic bond markets, strengthening market infrastructure, harmonizing rules and practices, removing impediments to cross-border capital flows, and providing financing through the Chiang Mai initiative. But greater integration also brings new risks, which will place a premium on better risk-based supervision and more international cooperation and supervision.

Third, Asia is facing a growing divide between rich and poor. For many years, emerging Asia experienced the best of both worlds-rapid growth and increased equality-but more recently the region has seen steadily rising inequality and growing polarization. This has been prevalent along both geographic and urban and rural lines.

This matters, because rising inequality makes it more difficult to reduce poverty, and also because large income disparities can make it harder to achieve consensus on good policies. These disparities only make for a more volatile macfoeconomic environmenl, and lower economic growth over the longer term.

No singie factor can explain the rise in inequality. It is a global phenomenon, and no single policy measure can reverse it. But governments interested in spreading economic opportunity may need to consider increased and more efflective education spending, providing economic infrastructure, especially in lagging regions, and reform to eliminate both labor market dualism and barriers to financial sector access by the poor.

Asia's leaders are well awareof these challenger, each of which will require considerable attention in coming years. Others, perhaps not yet anticipated, may also arise. But the region appears well equipped to meet these challenges and to continue its role as a global leader in the decade ahead.

The writer is Director, Asia Pacific Department, International Monetary Fund.