IMF: Asia at risk from Europe, US spillover, outflows

(Reuters) — Near-term risks to Asia’s economies are “decidedly” rising due to Europe’s debt woes and a slowdown in the US, requiring policymakers to be nimble and prepared to rapidly reverse course, the International Monetary Fund said today.

The IMF also warned about a risk of capital outflows from the region, saying foreign investors from advanced economies could reverse the large positions they had built in Asian markets since 2009.

“A sudden liquidation of these positions could trigger a loss of confidence, and contagion could spread from bond and equity markets to currency and other markets,” the IMF said in its regional economic outlook report for the Asia and Pacific region.

“The sell-off in Asian financial markets in August and September 2011 underscores that an escalation of euro area financial turbulence and a renewed slowdown in the United States could have severe macroeconomic and financial spillovers to Asia,” it said.

For Asia, risks were “decidedly tilted to the downside”, the IMF said.

It noted that credit flows could also dry up if European and US banks cut credit lines in Asia when faced with large losses at home.

The IMF said heightened economic risks amid persistent overheating pressures confronted Asian policymakers with “a delicate balancing act”. “They need to guard against risks to growth but also limit the adverse impact of prolonged easy financial conditions on inflation.”

It said that many of the region’s countries needed to continue normalising easy macroeconomic policies to address inflation risks, both through higher interest rates and more flexible exchange rates.

“However, in economies where inflation is within central banks’ target ranges and the exposure to severe external shocks is greater, a pause in monetary tightening may be warranted until the global uncertainties have lessened,” it said.

Growth forecasts cut

The IMF last month cut 2012 growth forecasts for developing Asian countries as well as for Japan, citing slower growth in the rest of the world. It also slashed its global growth projections.

For now, the IMF maintained that domestic demand in the region remained strong and was expected to cushion the impact of weaker external demand on overall growth in the near term.

But listing some of the possible shocks originating elsewhere in the world, the IMF said a big drop in China’s exports and thus worsening of exporters’ balance sheets would increase Chinese banks’ non-performing loans and lead them to significantly tighten credit conditions.

Japan could suffer if a rise in global risk aversion spilt over to concerns about sustainability of its sovereign debt and led to tighter financial conditions, it said.

In general, Asian economies still had the scope to use a range of measures to cushion the impact of overseas shocks on economic activity, as many did in response to the 2008 global financial crisis, the IMF said.

“At the same time, the weakness in global demand only confirms that Asia would greatly benefit from further progress in rebalancing growth by developing domestic sources of demand,” it said, adding that structural reforms, infrastructure investment and social spending would be needed for such rebalancing.

Should extreme economic risks materialise, Asian policymakers could stop withdrawing fiscal stimulus and central banks could draw on their large foreign exchange reserves and regional reserve pooling arrangements, the Washington-based international lender said.