TOKYO China has the scope to shield its economy from global risks and Beijing's response would help soften the impact if Europe's debt woes and faltering U.S. growth escalated into a global crisis, a senior International Monetary Fund official said on Thursday.
Anoop Singh, head of the IMF's Asia and Pacific department, suggested it was also the responsibility of the world's No. 2 economy and other export-reliant economies to help rebalance the global economy by strengthening domestic sources of growth.
He said China "has the scope to respond" should downside risks to the global economy materialise. "What's important to notice is that even China's response would only offset a part of the shock. It could not offset the entire shock," Singh told a news conference.
Singh was presenting the IMF's outlook for Asia-Pacific, which warned that near-term risks to Asia's economies are "decidedly" rising, requiring policymakers to be nimble and prepared to rapidly reverse course.
"China would be more affected by trade than financial channels. That is clear. That is because China has been highly depending on external demand," he said.
"What it underscores.. is that the time has come for China and other countries of Asia that rely on exports to accelerate steps to build domestic engines of growth."
The IMF report also highlighted the threat of capital outflows from the region, saying foreign investors from advanced economies could reverse the large positions they have built in Asian markets since 2009.
"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.
Singh said though, that over time capital was likely to flow back to Asia attracted by the region's high economic growth.
One way financial and economic woes of rich nations could have a knock-on effect on Asia was if European and U.S. banks cut credit lines in Asia when faced with large losses at home, the IMF said.
It said heightened economic risks amid persistent overheating pressures confront 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."
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, the IMF said.
"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 added.
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.
DEMAND STILL STRONG IN ASIA
For now, the IMF maintained that domestic demand in the region remains strong and is 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' nonperforming loans and lead them to significantly tighten credit conditions.
Japan could suffer if a rise in global risk aversion spills over to concerns about sustainability of its sovereign debt and leads to tighter financial conditions, it also said.
But in contrast to Japanese policymakers and executives raising alarm over yen levels close to record highs, Singh said the currency's present level did not pose an immediate risk to Japan's economic recovery. He also said recent data reinforced the view that recovery from the devastating March earthquake and tsunami was taking hold.
In general, Asian economies still have 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.
(Editing by Tomasz Janowski and Richard Borsuk)