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.
Financial imbalances, once entrenched, are difficult to unwind. Hence, monetary policymakers should stand ready to respond early and decisively. Macro prudential measures will also have to play an important role in economies where rapid credit growth or large-scale capital inflows could pose problems for financial stability. Asia has buffers to cope with such risks, but rising leverage calls for monitoring and proactive responses.
Hong Kong represents a leading example in this regard. On the one hand, the local economy is most directly exposed to loose monetary conditions in the US. On the other, the authorities have been particularly forceful in countering risks to financial stability through a range of macro prudential measures. The Monetary Authority's guidance on mortgage lending has contained loan-to-value ratios at conservative levels, preventing households from running up too much debt.
However, tight prudential standards are always at risk of being circumvented, as long as the pressure from low real interest rates persists.
Tight macro prudential policy also does little to address the fundamental shortage of adequate housing in Hong Kong. It therefore remains crucial that the government delivers on its commitment to raise the supply of housing in a steady and sustained fashion.
Hong Kong is in an unusually benign position, boasting a history of budget surpluses and sizeable fiscal reserves, even though government spending has increased significantly.
The mildly supportive stance of the latest budget is appropriate from a cyclical perspective and should help to achieve real gross domestic product growth of around 3 per cent this year.
Meanwhile, continued fiscal prudence constitutes the bedrock of stability for Hong Kong, with its highly open economy, large financial sector and linked exchange-rate system.
Within this context, a key challenge is to ensure that Hong Kong's growing prosperity remains inclusive, offering broad economic opportunities and protecting the livelihoods of all its people. More affordable housing, a high-quality educational system and targeted social support mechanisms are critical in this regard.
Anoop Singh is director of the Asia and Pacific Department at the International Monetary Fund. Andre Meier is the IMF's resident representative for the HKSAR