International Monetary Fund (IMF) in its World Economic Outlook says that economic activity in the region has been sustained by continued buoyancy in exports and strong private domestic demand. As envisaged in the April 2010 WEO, exports are being boosted by the global and domestic inventory cycles and by the recovery of final demand in advanced economies. Private domestic demand maintained its 2009 momentum across the region, despite less stimulative policy conditions and increased volatility in capital inflows and equity valuations after the euro area financial turbulence. In particular, private fixed investment has strengthened on the back of higher capacity utilization and the still relatively low cost of capital.

Against this background, GDP growth forecasts for Asia have been revised upward for 2010, from about 7 percent in the April WEO to about 7½ percent. For 2011, when the inventory cycle will have run its full course and the stimulus is withdrawn in several countries, Asia's GDP growth is expected to settle to a more moderate but also more sustainable rate (about 6¾ percent.)

The pace and drivers of growth will continue to differ substantially across the region. In China, given the strong rebound in exports and resilient domestic demand so far this year, the economy is now forecast to grow by 10½ percent in 2010, before slowing to about 9½ percent in 2011, when further measures are taken to slow credit growth and maintain financial stability. In India, growth is expected to accelerate to about 9½ percent in 2010, as robust corporate profits and favorable financing conditions fuel investment, and then to settle to 8½ percent in 2011. Both Newly Industrialized Asian Economies (NIEs) and ASEAN economies are expected to grow by about 6½ percent in 2010, as a result of surging exports and private domestic demand, before moderating to 4¾ percent and 5½ percent, respectively, in 2011. In Japan, growth is now expected to reach about 2½ percent in 2010, due mainly to stronger-than-expected exports during the first half of 2010, before easing to about 1¾ percent in 2011 as the fiscal stimulus gradually tapers off. In Australia and New Zealand, growth is expected to be about 3 percent in 2010, before accelerating to 3½ and 3¼, respectively, in 2011, with still-robust commodity prices boosting private domestic demand.

Although baseline growth forecasts for 2010 have been revised upward, downside risks have intensified for the second half of the year and for 2011 following the financial turbulence in the euro area. Asia has only limited direct financial linkages to the most vulnerable euro area economies, but a stall in the European recovery that spilled over to global growth would affect Asia through both trade and financial channels. Many Asian economies (especially NIEs and the ASEAN economies) are highly dependent on external demand, and their export exposure to Europe is at least as large as their export exposure to the United States. However, in the event of external demand shocks, the large domestic demand bases in some of the Asian economies that contribute substantially to the region's growth (China, India, Indonesia) could provide a cushion to growth. Significant contagion effects from a Europe-wide credit event could materialize through bank funding and corporate financing, especially in those regional economies that are more dependent on foreign currency financing. Further spikes in global risk aversion also could precipitate capital outflows from the region and could weaken equity valuations, undermining the positive feedback loop between favorable financial conditions and domestic demand.

It is worth noting, however, that in the event of such contagion, Asian central banks could swiftly redeploy tested instruments to overcome market seizures, as shown by the reestablishment of the U.S. dollar liquidity swap facility announced by the Bank of Japan in May 2010. Many regional economies also have room for further policy maneuver and could delay the planned withdrawal of monetary and fiscal stimulus in order to mitigate adverse spillovers to the real economy.