Growth in Asia is expected to pick up this year, after slowing in the last quarter of 2011, but Asian policymakers now face the challenging task of adjusting policies to support stable, non-inflationary growth, the International Monetary Fund (IMF) said in its latest Regional Economic Outlook (REO) for Asia and the Pacific, which was released in Kuala Lumpur, Malaysia, today.

Asia has continued to enjoy robust domestic demand against the background of fragile global growth. This has been reflected in low unemployment and robust credit growth in the region. Inflation expectations have also picked up in many countries, and capital inflows into emerging Asia have rebounded so far in 2012.

The IMF forecasts regional growth will be 6 percent this year, roughly the same level as in 2011, and about 6½ percent in 2013. But there remains considerable regional variation. While emerging Asia will remain the fastest growing region in the world, led by China and India, expanding about 8 ¼ percent and close to 7 percent, respectively, this year, industrial Asia is projected to grow only at 2.2 percent.

At the same time, the report cautions that escalation of the difficulties in Europe would clearly risk affecting Asia. In particular, a sharp fall in exports to advanced economies and a reversal of foreign capital flows would severely impact activity in the region. The report also cites higher and more volatile energy prices as a risk for activity, and a source of difficult trade-offs between inflationary pressures and budgetary pressures from energy and food subsidies.

There are also upside risks. Because macroeconomic policy has remained generally accommodative, further stabilization of global economic and financial conditions over the course of 2012 could boost growth and revive overheating pressures in the region. The report suggests that inflation will decline modestly in 2012, averaging some 3½ percent. But this partly reflects a normalizing of commodity prices and, in several cases, sustained demand pressures mean inflation is likely to remain above explicit or implicit target ranges.

So far, stronger economic and policy fundamentals have helped buffer Asian economies against adverse financial market spillovers from the euro crisis, but the IMF believes that the best way for Asia to protect itself against external shocks is by strengthening domestic sources of growth. Economic rebalancing remains a policy priority for much of Asia.

Lower trade surpluses in China and many ASEAN economies have raised hope that the shift of global demand to major surplus economies is taking place. China’s sustainable rebalancing will depend on its successful transition from investment-led to consumption-led growth. In India, improving the investment climate and facilitating trade will be keys to maximizing gains from its ongoing demographic transition. For many ASEAN economies, strengthening domestic demand will depend on improving the conditions for private investment, including by addressing infrastructure bottlenecks, and enhancing public service delivery.