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By Anoop Singh, Director of the IMF’s Asia and Pacific Department

If you needed further evidence about the fallacy of Asia's economy "decoupling" from that of the developed world, then this month's Asia and Pacific Regional Economic Outlook would be a good place to look.
The findings in this new report, just released in the Malaysian capital, Kuala Lumpur, illustrate how Asia's economic fate remains heavily dependent on events far beyond its immediate borders.

Consider two possible future scenarios to illustrate this ongoing interconnectedness: if global prospects continue to brighten following recent, concerted policy actions in the euro area and, if there are further indications of recovery in the United States, this will all augur well for trade-dependent Asia. Against this backdrop, the region could enjoy a boost in demand, fresh capital inflows and even a revival of overheating pressures.

But, were the financial turmoil in the euro area to escalate and spread globally, this would likely result in a sharp fall in demand for Asia's exports by advanced economies and a possible retrenchment of credit by stressed foreign banks, all of which would be a severe blow to Asia.

Or consider the impact on the region of a geopolitical crisis which pushes energy prices sharply higher. This would create difficult trade-offs between inflationary pressures and budgetary risks from energy and food subsidies.

Global developments

Consequently, the policies of Asia's decision makers will likely be largely determined by the direction of global developments. Under the more positive scenario of ongoing improved global economic and financial conditions, and any subsequent rising threat of inflation, the region's leaders will need to consider renewed tightening and continued normalization of monetary policy in pursuit of sustainable, noninflationary growth.

The fact is, the global outlook underpins any turnaround in Asia and at this point, it could go either way: too early to declare victory over the forces of financial volatility and contagion. The art then is being prepared for either eventuality and policymakers should be ready to shift gears if, and when, circumstances warrant.

If the first months of 2012 are anything to go by, then the outlook is favorable. Capital inflows into emerging Asia rebounded, stock markets recovered and most local currencies appreciated against the U.S. dollar. Inflation continued to fall, propelled mainly by the normalization of energy and food prices. But, a note of caution here, inflation expectations have increased in many countries, while macroeconomic policies remain generally accommodative in the region.

Differing by country

Beyond the immediate fight against inflationary pressures, over the medium-term many countries in Asia need to continue their pursuit of sustainable growth. How this is to be achieved will differ from country to country.

China, for example, needs to continue rebalancing away from investment-led toward consumption-led growth. During the recent IMF-World Bank Spring Meetings, the Vice-Governor of the People's Bank of China, Yi Gang noted that you only had to stroll through the shopping malls of the country to see consumption in action. Such continued rebalancing would be good for China and good for the world.

In the case of India, the country would benefit from improvements in the investment climate and raising its trade integration, whereas for ASEAN economies, public investment in infrastructure—within the framework of medium-term goals—would help attract private investment and promote more broad-based growth. The task for low-income countries in Asia is to attract foreign direct investment (including from other Asian economies), and so help these countries become part of the Asian miracle.

So yes, Asia's economic fate remains heavily dependent on events outside its borders. But another argument for rebalancing (were one needed) is that it would make the region less vulnerable to external shocks. But regardless of this interdependence, Asia continues to have plenty of space and the power to determine the shape of its economies.

Source: The Art of Shifting Gears