The global economic outlook is darkening and growth in the Asia-Pacific region is expected to slow further as the effects of Russia’s invasion of Ukraine and other shocks continue.
Economic growth in Asia-Pacific is forecast to slow to 4.2% this year, 0.7 percentage points slower than we predicted in April and below the 6.5% growth rate in 2021. We have lowered our 2023 forecast by 0.5 percentage points to 4.6%.
The risks we highlighted in our April forecast, such as tightening financial conditions as the US central bank raises interest rates and rising commodity prices due to the war in Ukraine, are beginning to materialize, further exacerbating the spillover effects of China’s economic slowdown on regional growth.
China’s economic slowdown deepens
China, Asia’s largest economy, saw a significant slowdown in the second quarter as its zero-COVID policies locked down major cities and supply chain hubs. This has led us to cut our full-year growth forecast to 3.3% from 4.4% in April, and to lower our forecast for next year by 0.5 percentage points to 4.6%.
This decline in activity also reflects a longer and deeper downturn in the real estate sector, which is likely to have significant spillover effects for regional trading partners. Japan and South Korea, the region’s two largest economies, which are closely linked to global supply chains and China, will also see slower growth due to weaker external demand and supply chain disruptions.
However, despite China’s recent slowdown, there are signs of a recovery in economic activity as some of the pandemic-imposed travel restrictions are gradually being eased. Resilient manufacturing and a rebound in tourism are supporting the modest recoveries in Malaysia, Thailand and the Pacific Island countries.
The financial environment becomes tougher
Most emerging market economies in Asia, except China, are experiencing capital outflows on a scale comparable to that seen in 2013 when the Federal Reserve signaled it might begin tapering its bond purchases sooner than expected and global bond yields spiked. Outflows have been particularly high from India, where they have racked up $23 billion since Russia’s invasion of Ukraine. Outflows have also been seen from some advanced Asian economies, including South Korea and Taiwan, where the Federal Reserve has signaled it will continue to raise interest rates and geopolitical tensions are reverberating.
Asia’s share of global debt has risen from 25% before the global financial crisis to 38% since COVID-19, making the region more vulnerable to changes in global financial conditions. Sri Lanka is an extreme example where rising debt became unsustainable, the economy lost access to global capital markets, and defaulted on its external debt.
Effects of the war
Moreover, growing trade policy uncertainty and fraying supply chains are contributing to trends of geoeconomic fragmentation that are expected to slow economic recovery and exacerbate the scars of the pandemic in Asia, one of the biggest beneficiaries of decades of deepening global trade and financial integration.
At the same time as growth weakens, the war and resulting sanctions have driven up food and fuel prices worldwide, increasing inflationary pressures in Asia, hitting hardest the poor and vulnerable who are least able to cope, hurting consumption and raising the possibility of social unrest as seen in Sri Lanka and other countries.
Price Increase
While inflationary pressures in Asia remain moderate compared to other regions, price increases in many countries are exceeding central bank targets.
Targeted financial support
Countries facing rising debt levels need to tighten fiscal policies to complement monetary policies aimed at containing inflation, along with targeted temporary fiscal transfers to support vulnerable people facing new shocks, especially from higher energy and food prices.
In most cases, such support would have to be budget neutral and funded by raising new revenues or by restructuring budgets to avoid increasing debt and adverse effects on monetary policy. The exceptions are China and Japan, provided that medium-term fiscal policies remain in place.
Moreover, to boost productivity and improve people’s living standards, global and regional cooperative solutions are urgently needed to reduce trade policy uncertainty, remove harmful trade restrictions, and avoid the most severe disruptive scenarios. Economic reforms over the next 2-3 years should aim to increase aggregate supply to address rising inflation, address longer-term challenges such as adapting to climate change, invest in human capital, strengthen the green transition, and promote digitalization.
Integrated, multifaceted and customized response
In short, with inflation spreading to core prices excluding the more volatile food and energy sectors, some economies will have to raise interest rates rapidly to prevent an upward spiral in inflation expectations and wages that would otherwise require bigger hikes later.
At the same time, further interest rate hikes would strain the budgets of consumers, businesses and governments that have taken on large amounts of debt during the pandemic.
While the precise policy advice will vary from country to country, flexible exchange rates alone may not be sufficient or feasible in all countries, and other measures such as foreign exchange intervention, macroprudential policies and capital flow management could be useful tools to anchor expectations and manage systemic risks.
The IMF recently developed an Integrated Policy Framework to guide economic policymaking in precisely these circumstances, and we remain committed through our lending capabilities to help countries weather the looming crisis.
Countries should not wait until it is too late to adjust their policy mix as needed or rebuild external financing buffers where appropriate.
