Asia is rebounding fast from the depths of the global crisis. What explains this remarkable comeback? What challenges does the recovery pose to Asian policymakers?

Asia’s impressive recovery from the global downturn, even as output elsewhere remains sluggish, has prompted some observers to revive the notion that the region has “decoupled” from the rest of the world. The IMF’s latest Regional Economic Outlook for Asia and the Pacific, which was released in Seoul on October 29, examines this hypothesis—and finds that the opposite is true. The primary driver of Asia’s recovery has actually been a return towards normalcy following the abrupt collapse in global trade and finance at the end of 2008. Just as the near-collapse in international trade and finance triggered a super-sized fall in Asia’s GDP, now the normalisation of the global economy is generating an outsized Asian upturn.

The other key driver behind Asia’s recovery has been the region’s rapid, forceful, and comprehensive policy response.

This was made possible by the fact that, in many countries, government fiscal positions were sounder, monetary policies more credible, and corporate and bank balance sheets sturdier than at any time in the past. These initial conditions gave Asia the scope to cut interest rates sharply, and adopt large fiscal stimulus packages. As a consequence, overall domestic demand has held up remarkably well.

What lies ahead for the region? As detailed in the Regional Economic Outlook for Asia and the Pacific, conditions are expected to continue to improve in 2010. However, the global recovery is expected to be a tepid one.

Output in the G7 economies will grow by just 1 per cent next year, meager compensation for the 3 per cent contraction in global growth in 2009. Private demand in the large industrial countries will remain hobbled by the legacy of the crisis, limiting external demand for Asia’s products. Consequently, Asia’s GDP is forecast to grow 5 per cent in 2010, a good result but well below the 6 per cent average recorded during the past decade. It is also important to recognise that the scope for China to offset sluggish demand from the industrial countries is limited. China remains a relatively small importer of consumer goods, and the composition of its imports remains very different from those of current major import markets.

Going forward, Asian policymakers thus face two major challenges. In the near term, they will need to carefully balance, providing support until the recovery is sufficiently robust and selfsustaining while ensuring that such support is not maintained for so long that it ignites inflation pressures or concerns about fiscal sustainability. In China, a key concern is related to the risks posed by the extraordinary pace of loan growth in terms of increasing idle capacity and creating non-performing assets in the banking system.

With private demand clearly strengthening, it is now time to begin slowing the pace of this rapid credit growth.

The other major policy challenge will be to find a way to return to sustained, rapid economic growth without relying on strong G7 demand.

In this “new world”, Asia’s longer term growth prospects will be determined by the region’s ability to recalibrate its growth toward domestic sources. This will require action on a range of fronts: financial sector reforms and better social safety nets will be needed to boost private consumption; structural reforms will raise productivity and allow for a smooth reallocation of resources across the economy to compensate for the lower momentum from exports; and ways will need to be found to adapt to smaller current account surpluses and more flexible exchange rates.

The current crisis has proven the resilience of Asia’s economy to the largest shock since the 1930s. It also poses challenges to the region to re-orient its growth model. Now is the time to implement policies to make domestic demand a second engine of growth. Doing so will pave the way for Asia to emerge from the current downturn onto a path of strong and durable economic expansion. (By Anoop Singh In Beijing/ China Daily/ Asia News Network)

(The author is the Asia and Pacific director of the International Monetary Fund.)