Good times and uncertain times

Jarkko Turunen and Yong Sarah Zhou / Khmer Times No Comments Share:
Cambodia’s tourism sector is expected to grow further this year. KT/Chor Sokunthea

Cambodia’s economy continues its strong performance, benefiting from favourable global and regional developments. Significant risks and challenges, however, are on the horizon. Cambodia policymakers should accelerate reforms to promote stronger, more resilient, and more inclusive growth. It is important to fix the roof while the sun is shining, write the International Monetary Fund’s Jarkko Turunen and Yong Sarah Zhou.

As we note in our recently released Regional Economic Outlook, the Asia-Pacific region remains the main engine of the global economy, and near-term prospects have improved since our last report, in October 2017. But there are many risks on the horizon, including a tightening of global financial conditions, a shift toward protectionist policies, and an increase in geopolitical tensions.

In addition, over the longer run, Asian economies will face major challenges from population aging and slowing productivity growth, as well as the rise of the digital economy, which could yield huge benefits but also bring major disruptions. Given the many uncertainties, macroeconomic policies should be conservative and aimed at building buffers and increasing resilience, while taking advantage of strong economic conditions to implement structural reforms to promote sustainable and inclusive growth.

Regional growth is expected to remain strong at 5.6 percent in 2018 and 2019 – up by about 0.1 percentage points from our previous forecast – supported by strong global demand and favorable financial conditions. As in other regions, inflation in Asia has largely remained subdued despite the pickup in growth. We project that inflation will remain at 1.4 percent on average in advanced economies and 3.3 percent on average in emerging markets. Among the larger economies, China’s growth for 2018 is projected to ease to 6.6 percent from 6.9 percent in 2017, as financial, housing, and fiscal tightening measures take effect. Growth in Japan has been above potential for eight consecutive quarters and is expected to remain strong this year at 1.2 percent. And in India, after temporary disruptions caused by the currency exchange initiative and the rollout of the new Good and Services Tax, growth is expected to recover to 7.4 percent, making it once again the region’s fastest growing economy.

Risks to near-term growth in the region as a whole are balanced, but downside risks prevail over the medium term. On the upside, the global recovery could again prove stronger than expected. The new Comprehensive and Progressive Agreement for Trans-Pacific Partnership trade agreement and successful implementation of China’s Belt and Road Initiative – assuming debt sustainability and project quality are maintained – could support trade, investment, and growth. Asia, however, remains vulnerable to a sudden and sharp tightening in global financial conditions, while extended periods of easy financial conditions could risk a buildup of leverage and financial vulnerabilities.

More inward-looking policies in major global economies, as highlighted by recent tariff actions and announcements, could disrupt international trade and financial markets and have a substantial impact on Asia, which has benefited so much from economic integration. Finally, geopolitical tensions could have serious financial and economic repercussions.

In Cambodia, economic activity continues to grow at strong rate, at around 7 percent, supported by higher public spending and robust construction and tourism activity, while inflation has fallen (to 2.3 percent in February). Much like the rest of the region, Cambodia’s positive economic outlook is subject to downside risks. Macro-financial and external risks, as outlined in the 2017 staff report, remain significant and political uncertainties could dampen consumer and investor sentiment. On the upside, stronger global and regional growth may increase foreign demand for goods exports and tourism more than currently expected.

Over the longer run, growth prospects for Asia will be heavily affected by demographics, slowing productivity growth, and the rise of the digital economy. Population aging is an important challenge, as many economies face the risk of “growing old before they grow rich”, and the adverse effect of aging on growth and fiscal positions could be substantial. A second challenge is slowing productivity growth. Finally, the global economy is becoming increasingly digitalized, and while some recent advances could be truly transformative, they also bring challenges, including those related to the future of work. Asia is embracing the digital revolution, albeit with significant heterogeneity across the region.

The current strong economic outlook provides a valuable opportunity to focus macroeconomic policies on building buffers, increasing resilience, and ensuring sustainability. In many countries in the region, continued fiscal support is less urgent given strong economic performance, and policymakers should focus on ensuring that debt remains under control. Some countries should also focus on revenue mobilisation to create space for infrastructure and social spending and to support structural reforms.

As for monetary policy, the policy stance can remain accommodative in much of the region given that inflation is generally still muted. Nonetheless, central banks should be vigilant, since our analysis suggests that much of the undershooting of inflation targets in Asia has been explained by temporary, global factors, such as commodity prices and imported inflation, which could reverse.

Finally, tailored measures are needed to boost productivity and investment in Asia; narrow gender gaps in labour force participation; deal with the demographic transition; address climate change; and support those affected by shifts in technology and trade. And to reap the full benefits of the digital revolution, Asia will need a comprehensive and integrated policy strategy covering information and communications technology, infrastructure, trade, labor markets, and education.

Cambodia shares many of the near-term risks, as well as the longer-term challenges and opportunities, with the rest of the Asia region. Cambodia’s relatively young population continues to provide immense opportunities for the country and positions it well to take full advantage of both improved regional prospects and global trends, such as the digital revolution.

Strong economic conditions provide an opportunity for Cambodia to capitalise on its demographic dividends through implementation of much needed structural reforms to increase competitiveness and encourage diversification, including to lower energy costs, continuing to upgrade human capital and infrastructure, and strengthening rule of law and transparency. At the same time, macroeconomic policies should focus on managing elevated macro-financial risks and safeguarding fiscal sustainability.

Jarkko Turunen is the IMF mission chief to Cambodia and Yong Sarah Zhou is the IMF’s resident representative in Cambodia.

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