Asia outpaces other regions

Asian giants China and India will continue to remain the fastest growing major economies, said the Organization for Economic Cooperation and Development (OECD) in its Economic Outlook released on Tuesday, November 25. While the pace of Indian economic expansion is expected to pick up to more than 6.5 percent in the coming years, China's GDP growth is projected to hover around 7 percent.

But in Japan, Asia's second largest economy, growth has been weak, the report stated. GDP expansion, however, is forecast to rebound to around 0.8 percent in 2015 and 1 percent in 2016 on the back of better labor market conditions and expanded monetary easing. The world economy is projected to grow only moderately as large risks and vulnerabilities persisted, the OECD noted.

Alvaro Pereira, director of the country studies branch of the OECD Economics Department, says in a DW interview that in order to further boost their competitiveness and accelerate economic growth, Asian economies should continue to pursue structural reforms and open up to the world.

DW: How do you expect major Asian economies to perform in 2015 and beyond?

Alvaro Pereira: Asia will continue to grow faster than other regions of the world, both for 2015 and further ahead. China's economy should experience a moderate slowdown towards a still fast, but more sustainable, growth rate of below 7 percent by 2016. By contrast, India's economy will pick up strongly this year following the sluggish growth of recent years, and should grow by more than 6.5 percent annually in the coming years.

We also anticipate that economic growth in Indonesia will rebound to 5.2 percent in 2015 and further accelerate to 5.9 percent in 2016. Further ahead, emerging Asian economies are expected to sustain strong growth rates and continue to play an increasing role in the world economy.

In turn, economic growth in South Korea is rebounding, thanks in part to monetary policy easing, fiscal stimulus and measures to boost the housing market. In addition, an upturn in exports due to stronger world trade and to the trade-promoting effects of South Korea's free trade agreements will sustain export growth. Output is projected to grow at around 4 percent in 2015-16.

In Japan, however, economic growth has been weak, in part due to the consumption tax increase, with real GDP falling in both the second and third quarters of 2014. Output growth slowed to around half percent in 2014, but is projected to rebound to around 0.8 percent in 2015 and 1 percent in 2016, supported by improving labor market conditions and expanded monetary easing. The weaker yen is expected to help sustain export growth and push inflation closer to the 2 percent target.

What are the main risks facing Asian economies looking ahead?

Asia's outlook is closely tied to the performance of the global economy. Growth of world GDP is relatively low, and although it is expected to pick up in the forthcoming months, it will likely remain weak compared to the recent past. While the US economy is recovering at a steady pace, the outlook for Europe and Japan is much less favorable.

We know that trade growth has been a key part of Asia's rise. However, since the onset of the crisis, world trade has been weaker. Any permanent weakening of trade therefore would have significant implications for Asia's growth model.

The world economy also faces other downside risks that would damage Asian growth. These include financial market and exchange rate volatility as US interest rates rise, the high level of debt in advanced countries and recent build-up of debt in many emerging economies. The weakening of the euro area will also affect Asia.

On the other hand, for most Asian economies, an upside risk could be declining oil prices, which could help boost economic activity in oil importing countries.

What sort of constraints do major Asian economies face in their attempts to ramp up economic expansion?

Japan faces a problem of high public debt. Indeed, gross public debt is around 230 percent of GDP, while net debt is 143 percent. The primary budget deficit is about 7 percent of GDP in 2014, making it difficult for the government to achieve its target of a primary surplus by the fiscal year 2020.

To achieve this target, significant additional measures to raise revenues and constrain spending, particularly that related to population ageing, are needed, and these will put downward pressure on output growth.

In South Korea, government debt is low at less than 40 percent of GDP. Instead, the high level of household debt, at 161 percent of household disposable income, is a headwind to private consumption. The government has a target of reducing the ratio. However, household debt is increasing at a rapid rate, due in part to recent measures to boost the housing market.

The Indian government's efforts to simplify administrative procedures, to fast track infrastructure projects, and to deregulate energy sectors as well as promote FDI, have boosted business sentiment and therefore investment plans. More reforms are needed, however, to bring back the economic growth to the higher levels seen in the recent past.

The combined fiscal deficit of the state and central governments remains large and public debt is high by emerging market standards. Inflation has come down substantially but inflation expectations are stubbornly high. Fiscal and monetary policies will thus have to remain tight until progress is well entrenched.

In addition, infrastructure bottlenecks, particularly in the energy and transport sector, the long and uncertain land acquisition process, stringent labor laws, still poor education and training systems, complex tax regulations are all weighing on the Indian economy's capacity to create more value-added and jobs. Further restraining India's growth potential is the low and declining female economic participation.

Indonesia also faces similar constraints. Major investment is required in infrastructure, particularly in transport and logistics, and reforms to education need to continue. The complete removal of costly energy subsidies would create some of the required fiscal space to lift public spending in these areas. Reforms to the tax system and improving tax enforcement would also boost revenues. Competitiveness would also be aided by labor market reforms, including to the wage setting regime.

What impact will falling Chinese economic growth have on other Asian economies?

We expect an orderly slowdown in China, from 7.3 percent in 2014 to 6.9 percent in 2016 on the back of property market correction and the working off of excess capacity in a number of heavy industries. The recent measures to support growth indicate that a much faster slowdown is unlikely as the government seems ready to step in, if needed.

The slowdown is expected to reduce imbalances, and is not jeopardizing job creation, which remains buoyant as the service sector expands. Indeed, attempts to spur growth would only draw out the correction process and aggravate already high leverage, misallocation of capital and accumulation of bad debt.

Lower investment growth in property and many heavy industry sectors will weaken commodity imports, and will adversely affect commodity-exporting countries, including Asian ones. However, consumption will remain relatively strong.

Risks to this outlook are mostly on the downside. The property market adjustment is a drag on economic growth. But delaying the correction would only build up further vulnerabilities and crowd out more productive investments. Another downside risk relates to the slowdown in property-related sub-national revenues, which would lead to lower investment spending.

However, a stronger-than-expected global recovery would boost exports, investment and growth. Lower oil prices will also help. Also, rapid increases in rural disposable income may result in higher consumption than projected.

What measures are needed to attract more foreign trade and investment into Asian countries?

Asia needs to continue to open up. In China, for instance, many sectors are closed to foreign, and in general, to private investment. Some of these sectors are gradually opening up, including health and banking. The Shanghai Free Trade Zone is a laboratory for experimenting with such changes.

In India, FDI regulation has been eased. Still, the complexity of the tax system and various other regulations, frequent changes to tax laws, power outages and the difficulty to acquire land have undermined foreign direct investment and competitiveness. Introducing rapidly the Goods and Services Tax (GST), reducing tariff and non-tariff barriers, a leaner and faster land acquisition process would all help the Indian manufacturing sector become more attractive and competitive.

The stock of inward direct investment in Japan and South Korea are the lowest in the OECD area. Corporate sector Merger & Acquisition activity - normally a key channel for FDI - is low in both countries, while corporate governance lags behind global standards. A complicated regulatory environment, high employment protection and a lack of labor mobility also holds back investment in both countries. In Japan, the high corporate income tax rate also discourages FDI inflows.

South Korea is making a major effort to increase its openness in trade through free trade deals. In addition to FTAs with the EU and the US, Seoul signed agreements this year with Canada, Australia, China and New Zealand.

Japan has a target of increasing the share of its trade covered by FTAs from 18 percent to 70 percent. In addition, it is negotiating to join the Trans-Pacific Partnership (TPP). However, Japan's ability to join such agreements is hindered by its high level of agricultural support, which is the second highest in the OECD.

Indonesia also needs to further open up and the regulatory environment needs to be improved.

Overall, it is crucial that Asia continues to pursue structural reforms to further boost its competitiveness and improve skills and productivity of the labor force. Asia should also continue to open up to the world and to be further incorporated into global value chains.

The last few decades have shown that there is a big growth dividend by pursing structural reforms in Asia. In this context, in the next few years, it is essential that the region continues to reform in order to be able to benefit from this growth dividend and from the unprecedented rise in living standards.

Alvaro Pereira is director of the country studies branch of the OECD Economics Department.