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East Asia Pacific Economic Update, October 2018: Navigating Uncertainty

Photo: Wenyong Li / World Bank


Growth in developing East Asia and Pacific (EAP) remained resilient in the first half of 2018.

o  Strong domestic demand underpinned this robust growth. In China, private consumption strengthened, as the government’s growth rebalancing strategy continued to take effect. Strong labor demand and wage growth supported consumption spending across the large ASEAN economies.

 

Despite a deterioration in the external environment, the regional growth outlook remains positive.

o  After peaking in 2017 at 6.6 percent, growth in developing EAP is expected to slow to 6.3 percent in 2018, due to the moderation in China’s economic expansion. 

China is expected to slow moderately to 6.5 percent in 2018, after growing faster than anticipated in 2017. Growth in developing EAP, excluding China, is expected to remain stable at 5.3 percent from 2018 to 2020, driven primarily by domestic demand. In Thailand and Vietnam, growth is expected to be robust in 2018 before slowing in 2019 and 2020 as stronger domestic demand only partially offsets the moderation in net export growth. Indonesia’s growth should be stable, thanks to improved prospects for investment and private consumption. Growth in 2018 in the Philippines will likely slow, but the expected expansion of public investment will boost growth over the medium term. In Malaysia growth is expected to ease, as export growth slows, and public investment is lower following the cancelation of two major infrastructure projects.

o  In EAP’s smaller economies, growth prospects remain robust, averaging over 6 percent annually in Cambodia, Lao PDR, Mongolia and Myanmar between 2018 and 2020. Growth is expected to resume in Timor-Leste following the resolution of a political impasse, while in Papua New Guinea it is expected to rebound in 2019, following the large earthquake earlier this year. Growth in the Pacific Island countries is expected to remain relatively stable, although highly vulnerable to natural disaster shocks.

Robust growth will continue to support further declines in poverty. Extreme poverty (based on the International Poverty Line of US$1.90/day 2011 PPP), which is already below 2 percent in EAP including China, and 4.4 percent excluding China, will be concentrated in a few lower-income countries and in remote areas in more affluent ones. At the lower middle-income class (LMIC) poverty line (US$3.20/day 2011 PPP), the poverty rate will fall from 9.4 percent in 2017 to 6.4 percent in 2020.

 

Inflation has begun to rise across the region. 

o  Solid economic growth, weaker regional currencies, higher food and fuel prices during the first half of the year, and rising wages have contributed to rising price pressures, although consumer prices generally remain within most central banks’ target bands. The Philippines, Vietnam and Myanmar are the exception, however, with consumer prices in these countries rising rapidly since early 2018.

o  With economies operating close to or above their potential, inflation is expected to rise during 2018-20.

o  Short-term inflationary pressures in the Philippines could be exacerbated by the impact of Typhoon Mangkhut, which caused widespread damage to agriculture and infrastructure in the north of the country in mid-September.  

 

Heightened uncertainty has intensified the risks to the region

o An escalation in protectionism could have more severe impacts on the region’s growth prospects. If higher US tariffs on Chinese exports weaken economic growth in China, there would likely be additional negative consequences for developing EAP exports to China, and global commodity prices. In an extreme scenario, a spillover of protectionist sentiment to investment would have more severe implications for regional—and global—growth.

Heightened financial market turbulence would complicate macroeconomic management. This could occur due to a sudden change in market expectations regarding the pace of U.S. interest rate rises, which could prompt foreign investors to rebalance their portfolios, leading to a surge in capital outflows from developing EAP. In addition, despite developing EAP’s robust growth and larger buffers, the risk of financial market contagion from vulnerable emerging markets and developing economies elsewhere has increased. In both scenarios, higher financing costs could induce limit the scope for countercyclical fiscal policy to offset downturns.

o  While rising protectionism and heightened financial market turbulence represent important risks in themselves, their combined impact would be much greater.  Domestic vulnerabilities—such as elevated domestic debt and large external financing needs which persist for some countries in EAP—would amplify the impact of external shocks, especially where policy buffers are limited, prompting further capital outflows and dampening growth.

 

Regional authorities are advised to pursue a four-pronged approach to enhance preparedness and resilience

o First, reduce short-term vulnerabilities and build policy buffers. Proactive macro-prudential policies can help address financial sector vulnerabilities. In countries that have flexible exchange rate regimes, exchange rate flexibility can help absorb and adapt to external capital shocks. Fiscal policies need to focus on preserving or rebuilding buffers to create fiscal space for the next downturn, and to enhance debt sustainability and financial resilience.

o Second, developing EAP can and should show global leadership by redoubling its commitment to an open, rules-based international trade and investment framework, including through deeper regional economic integration.

o Third, deepening structural reforms, including liberalizing key sectors, improving the business climate, and boosting competitiveness.

o Finally, strengthen economic security and promote economic mobility. Expanding targeted cash transfer programs and establishing effective, fiscally sustainable social insurance systems – can provide critical support to households in addressing adverse economic shocks. To promote economic mobility, priorities include: investing more in prenatal and early childhood development; addressing gaps in educational access and quality in geographically-disadvantaged areas; and targeted cash transfer programs aimed at promoting private investment in education.