Asian policy makers must push ahead with structural changes to ensure the region continues to lead global growth and withstand volatility as the U.S. reduces monetary stimulus, the International Monetary Fund said.

Asian economies will face higher interest rates and bouts of volatility in capital flows and asset prices as global liquidity tightens amid a recovery in advanced nations, the Washington-based lender said in its Regional Economic Outlook for Asia and Pacific released Monday.

Tightening of global liquidity is one of the four main risks confronting Asia this year and next year, the IMF said. Other dangers include a sharper-than-envisaged slowdown in China, waning effectiveness of growth-supporting policies in Japan, and political and geopolitical tensions that disrupt trade, it said. 

“Asia is well positioned to meet the challenges ahead provided it stays the course on reforms,” the IMF said. “Reforms are critical not only to sustain Asia’s growth leadership over the medium term, but also, in some cases, to maintain investor confidence and secure financial stability in the near term.”

Economic expansion in Asia will be more than twice as fast as advanced nations this year, while growth in the emerging Asian economies, which includes China and India, will be three times faster, the IMF estimates. Even so, productivity has decelerated in recent years and the region needs a new wave of reforms to boost potential growth and to continue to attract inward investment, according to the report.

Asian economies are now more resilient to global financial volatility after implementing policies to address their vulnerabilities, the IMF said, noting that India and Indonesia were among nations that were able to better weather January’s rout in emerging-market currencies and equities as the Federal Reserve began withdrawing stimulus.

Yet a sudden or sharper-than-anticipated tightening of global financial conditions remains “a key downside risk” for Asia, the IMF said. Low inflation in most economies will allow central banks to loosen monetary policy and cushion the blow on growth, it said.

Within the region, the IMF highlighted risks posed by China and Japan, Asia’s two largest economies. It estimates China will expand 7.5 percent this year and 7.3 percent next year, while Japan will grow 1.4 percent and 1 percent.

A sharper-than-envisaged slowdown in China would have “significant spillovers” for the region, especially in economies linked to the regional supply chain and commodity exporters, according to the report.

Increasing stress in China’s non-banking financial sector and high local government borrowing are potential systemic dangers and further news of credit problems or debt servicing issues could “spark adverse financial market reaction both in China and globally,” according to the report.

“The challenge is to slow the growth of credit, especially in the shadow banking sector, and minimize the buildup of risks in the financial sector without causing a steep deceleration in growth,” the IMF said, calling on the government to push ahead with interest-rate liberalization and rein in money-supply growth.

In Japan, the risk is that Prime Minister Shinzo Abe’s policies could prove less effective than envisaged in terms of supporting growth, increasing nominal wages, sustaining the recent increase in inflation expectations or boosting private investment, according to the report.

“The third arrow of Abenomics ― structural reforms ― is essential for Japan to avoid the risk of falling back into lower growth and deflation, a further deterioration in the fiscal situation and an over reliance on monetary stimulus, with negative consequences for the region,” the IMF said. (Bloomberg)