Highlights from East Asia Pacific Economic Update

The global economic recovery remains on track. Following several years of subdued performance, global growth is projected to accelerate to 3.0 percent in 2014, 3.3 percent in 2015, and 3.4 percent in 2016. The recovery will be led by high-income countries, aided by reduced policy uncertainty, a slower pace of fiscal consolidation, and renewed private sector activities. Growth in high-income countries is projected to strengthen from 1.3 percent in 2013 to 2.1 percent in 2014 and 2.4 percent in both 2015 and 2016. Growth in developing countries is expected to pick up from 4.8 percent in 2013 to 5.0 percent in 2014, 5.4 percent in 2015, and 5.6 percent in 2016.

Stronger global growth will help most developing East Asia Pacific (EAP) countries grow at a steady pace while they adjust to tighter global financial conditions. Developing EAP successfully navigated thestalled global economic recovery in the first half of 2013, and the expectations of a scaling back of quantitative easing in the second half, to grow by 7.2 percent in 2013 -- only marginally lower than the 7.4 percent in 2012. The region also remained the largest regional contributor to global growth and trade. Growth is expected to remain at 7.1 percent in 2014 as well as in 2015 and 2016. The tailwinds from improving global trade will offset the headwinds from the tightening of global financial markets.

Growth is likely to ease moderately in most of the larger economies. Growth in China is expected to decrease marginally to 7.6 percent in 2014 and 7.5 percent in 2015, from its current pace of 7.7 percent in 2012 and 2013. The larger Association of Southeast Asian Nation (ASEAN) economies are operating close to potential and facing tighter global financial conditions and higher levels of household debt. In 2014, growth is expected to slow in Indonesia (5.3 percent) and the Philippines (6.6 percent), remain unchanged in Thailand (3.0 percent) and accelerate modestly in Malaysia (4.9 percent). Among the smaller economies, some, notably Mongolia, face risks of overheating, while the growth prospects for most of the Pacific Islands remain dependent on aid and remittances from the advanced economies.

The structure of domestic demand is undergoing adjustment as countries are trying to unwind internal imbalances and respond to external vulnerabilities. Over the past quarters, domestic demand, particularly investment, has weakened in Indonesia and Malaysia, reflecting tighter credit, higher debt servicing costs, ongoing fiscal consolidation, reduced profits from commodities, and higher import costs due to weaker currencies. In Thailand, implementation delays and political uncertainties have been the major contributors. Unlike the ASEAN-4, which had limited room to ease policies, China launched an economic support program in mid-2013 centered on boosting government expenditures. The program helped stabilize growth, but also led to the reemergence of investment as the main driver of demand— thereby slowing the rebalancing of the economy.

External positions have steadily improved in EAP countries, making them better prepared to manage further normalization of monetary policy in advanced economies. After deteriorating during the first half of 2013, the trade and current account balances of several EAP countries have improved on the back of rising external demand and weaker currencies. In addition, foreign direct investment flows into developing EAP countries have remained robust. These developments have helped the EAP countries offset the portfolio outflows associated with the scaling back of the quantitative easing program by the United States. They have also further accumulated reserves to insure against temporary trade and external financial shocks.

With the global policy cycle shifting, maintaining macroeconomic stability will remain high on the agenda. Recent developments have reinforced the importance of having a flexible exchange rate regime to defend against external shocks, including capital flow reversals. While credit growth has started to decelerate, the legacy of past credit booms remains a concern, especially among the region’s larger economies, including China. In some of the smaller economies, overheating is a bigger concern and will require further monetary tightening and fiscal consolidation. The authorities in some of the large economies have employed macro-prudential measures to contain the risks arising from asset price boom including in the real estate market. China’s priority is to further reduce total credit growth in the economy, which is still well above nominal GDP growth. There are modest fiscal consolidation efforts underway in several countries, with an emphasis on rationalizing fuel and rice subsides, although more needs to be done to rebuild policy buffers and create space for priority spending.

The downside risks to the economic prospects of developing EAP are evenly balanced with opportunities for more rapid growth, including through deeper structural reforms. At the global level, a slower-than-expected recovery in advanced economies or a steady rise in interest rates, coupled with increased volatility in commodity prices due to recent geopolitical tensions could mean a less hospitable environment for growth. On the other hand, continued steady recovery of the world economy could provide an opportunity for deeper reforms, including the steps needed to create the ASEAN Economic Community by 2015. Similarly, at the regional level, spillovers from a disorderly rebalancing in China could undermine growth prospects for commodity exporters. But, if rebalancing in China were to be successful, it could yield considerable payoffs for its regional trade partners who provide agricultural products, consumption goods, and modern services. And these benefits would be greater if countries were to undertake reforms to facilitate expansion of their services sector.