REAL GDP growth in East Asia has been moderating after a sharp rebound from the global crisis.

The slowdown in growth since mid-2010, even though smaller than earlier projected, has occurred despite a stronger-than-expected recovery in high-income economies and only gradual withdrawal of the monetary and fiscal stimulus across the region.

The World Bank projects real GDP growth will settle to about 8 percent in 2011 and 2012 from about 9.6 percent in 2010.

Inflation has become the key short-run challenge for the authorities in the region, complicated by a surge in portfolio capital inflows and rapidly increasing food and commodity prices that hit low-income households disproportionately. Price shocks are affecting core inflation that could trigger a wage-price spiral.

For many middle-income countries in East Asia, lowering inflation presents difficult policy choices. Most have eschewed the use of capital controls, and allowing exchange rates to appreciate may protect against importing inflation but jeopardizes international competitiveness.

And the independence of monetary policy is partially constrained by open capital accounts. This places the bulk of the adjustment burden on fiscal policy where the challenge lies in lowering deficits more rapidly while creating the fiscal space to finance infrastructure to drive future growth and assuring necessary social investments and cash transfers to the poor.

The sharp increase in commodity prices portends increased volatility for the foreseeable future. All commodity prices are on an upswing, some either at all-time highs or at levels exceeding those reached only two years ago. These latest price developments continue the trend that began earlier this decade of a steady climb in real commodity prices, interrupting a decade-long downward trend in the 1990s.

Over the medium-term, East Asia has the potential to sustain rapid increases in living standards even as the global economy enters a more challenging phase.

Volatile prices

Unlike the framework of stable exchange rates and closed capital accounts that characterized the background for the rise of Western Europe, Japan, and the newly industrialized economies (NIEs) after World War II, the future will likely be dominated by sharply increased volatility in commodity prices, capital flows, and exchange rates.

If history is any guide, periods of sustained monetary expansion in high-income economies tend to be followed by a surge in global inflation, high nominal interest rates, and economic instability. If such a scenario unfolds, as is likely, it will test the resolve of governments in East Asia and circumscribe the policy options available to maintain rapid but steady growth.

China, today the world's second largest economy and its leading exporter and manufacturer, will remain a powerful source of external demand for East Asian producers in the foreseeable future. The trend toward increasing intra-regional trade, with China a larger final consumer of regional product, is likely to continue.

Rising wages in coastal China are forcing companies located there to either move up the value chain or relocate further inland or to neighboring low-income countries (and occasionally to lower-cost regions in neighboring middle-income countries).

And with China deploying its large foreign exchange reserves, capital flows to the region could rise substantially. Tighter regional integration will ensure that these trends further boost the international competitiveness of developing East Asia while also providing an engine of growth that is relatively less dependent on the slow-growing high-income countries.

Rising inequality

But even as developing East Asia continues to grow rapidly, rising inequality is a matter for concern and could pose a challenge to future social stability.