The global economy has entered a dangerous new phase. Growth in the West has slowed while downside risks to the global economic outlook have increased further. Financial market volatility has surged as private demand in the US failed to pick up sufficiently and sovereign debt and banking sector problems in Europe proved more tenacious than expected. International efforts are being made, including by the Group of Twenty (G20), to coordinate policies so as to avoid a major global disruption like the one we experienced in 2008-09. How is Asia faring amid this turbulence? In our recently released Asia-Pacific Regional Economic Outlook, we find that while growth in Asia has also moderated, domestic demand remains resilient. As a result, Asia is poised to grow at about 6¼% during 2011, increasing to 6¾% in 2012 under the baseline scenario. The latter reflects a lowering of only ¼ of a percentage point since our April forecast, compared to ¾ percentage points for our advanced economy growth projections during the same period. However, there are large downside risks to this benign outlook. The advanced economies are at the core of an effective resolution of current global stresses, and a lot depends on them to prevent the risk scenarios from materialising. But emerging market and developing economies’ ability to maintain their stability and growth is also key to an effective global response. The moderation in growth notwithstanding, our Outlook shows that inflation remains generally elevated in the region, with average headline inflation increasing to 5½% (year-over-year) in July 2011, from 4½% in January. This requires a balancing act on the part of Asian policymakers, as they need to guard against risks to growth, but also limit the adverse impact of prolonged easy financial conditions on inflation and balance sheet vulnerabilities. Where does India lie in this balance of risks? India’s inflation remains stubbornly high, registering at 9.7% in September (WPI, year-onyear), while growth is slowing from 8.5% in 2010-11 to 7.6% this year by our current estimation. This confluence has led to understandable public debates about the efficacy of the RBI’s actions. We are clearly of the view that the RBI’s monetary tightening has been necessary and is bearing fruit on the inflation front, and is not the dominant factor in the growth slowdown — that is already showing the early effects of the global slowdown. Thus, although some further monetary tightening is likely necessary under our baseline scenario to quell the entrenched inflationary momentum, the RBI certainly has the room to act quickly if major risks materialise. Indeed, as in 2008-09, the RBI’s ability and readiness to supply liquidity will play a critical role if a major external financial shock materialises. Fiscal policy has an important role to play in the balancing act as the authorities have emphasised. Restraining expenditure to the level of Budget FY2012 would help recreate the fiscal space to counter external shocks. It will also assist the RBI in combating inflation by moderating domestic demand pressures. Finally, a shift in government spending from consumption towards infrastructure, health and education, would help increase the economy’s capacity to grow strongly over time, while also making the growth process more inclusive as we argue in the REO. The government also has a role to play outside of fiscal policy. There is a sense that a reinvigorated pursuit of the outstanding structural reform agenda — such as the introduction of the goods and services tax, further liberalisation of the FDI regime, passage of long-pending financial sector legislation, and measures to improve the business environment — would attract investment currently being held back. This reinvigoration would help bring growth back to potential in the short run while relieving supply bottlenecks that could, otherwise, continue to stoke inflation. India has felt the repercussions of the current global uncertainties in its currency and equity markets. This is a natural outcome of India’s increasing integration with the global economy and reflects the sharp increase in global risk aversion in recent weeks and months. Nevertheless, India’s vulnerability to external shocks is relatively low at present. This is due, in substantial part, to the fact that banks are well regulated and have strong balance sheets, exports are surprisingly buoyant, and external debts are limited. And India has demonstrated its resilience by navigating the global financial crisis in 2008-09 relatively unscathed. Nevertheless, a high level of vigilance is needed in the coming months, and calls for continued efforts to create policy buffers.
(The author is director of the Asia and Pacific department of the International Monetary Fund) ET
