This pick up in growth, after a year of subdued economic performance, is driven largely by continued robust domestic demand. Consumption and private investment will be supported by favorable labor market conditions, with unemployment at multiyear lows in several economies. Relatively easy financial conditions, which include accommodative monetary policies, rapid credit growth particularly in China and some ASEAN economies, and the rebound of capital inflows since the latter half of 2012, are also key factors behind this expansion.

Chinese demand and Japanese stimulus should also provide a boost to the region. In fact, for some of the more advanced open economies, direct and indirect demand from China and Japan is as important as demand from the United States and Europe. In the case of ASEAN economies, growing integration in final consumer goods trade should further contribute to favorable intraregional demand dynamics.

The REO makes clear that the favorable outlook is not without risks. While the external risk of severe economic fallout from an acute euro area crisis has diminished, regional risks are coming into clearer focus. These include some ongoing buildup of financial imbalances and rising asset prices, although this has generally not been excessive so far and is occurring amid still strong corporate and banking sector balance sheets. Other risks include an unexpected slowdown in China, weaker-than-expected effects from ongoing stimulus in Japan, or trade disruptions from a natural disaster or geopolitical tensions.

Policy makers in the region face a delicate balancing act in the near term: guarding against the potential buildup of financial imbalances while delivering appropriate support for growth. Monetary policy makers should stand ready to respond early and decisively to any prospective risks of overheating, and with macroprudential measures playing an increasing role, especially where credit growth is too rapid and accompanied by strong capital inflows. In many Asian economies, structural deficits that are higher than pre-crisis levels imply the need for greater efforts to rebuild fiscal space. Some fiscal consolidation could also help preempt the potential overheating pressures from continued strong capital inflows.

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