Asian economies are looking up

The global economy shows signs of improving as major tail risks emanating from Europe and the US recede. This also brightens the prospects for Asia.

Private consumption and investment continue to be bolstered by favourable labour market conditions, with unemployment at multi-year lows in several Asian economies, including Hong Kong. Additional support comes from loose financial conditions across much of Asia.

In the absence of shocks to global food and commodity prices, inflation is expected to remain broadly unchanged from last year.

Risks around this baseline scenario have become more balanced over the past six months, mainly because the risk of an acute euro crisis has diminished and the US has avoided a fall from the "fiscal cliff". However, external shocks could still have a considerable impact on Asia's open economies.

To begin with, asset prices and private-sector indebtedness have kept rising in many Asian economies. Over time, there is a risk that this trend leads to excessive exuberance and financial imbalances that could set back economies when the tide of easy credit turns.

Other potential risks include trade disruptions from natural disasters or geopolitical tensions, a loss of confidence in Japan's efforts to revive growth or an unexpected further slowdown in China.

Asia's policymakers, therefore, face a delicate balancing act: maintaining appropriate support for growth while guarding against the rise of financial imbalances and gradually rebuilding policy space to be able to cope with future shocks.