Asia is sailing in headwinds from rate hikes, war and China’s slowdown


Asia’s strong economic rebound earlier this year is running out of steam, with a weaker-than-expected second quarter. We have cut the growth forecast for Asia and the Pacific to 4% this year and 4.3% next year, well below the 5.5% average of the past two decades. Despite this, Asia remains a relative bright spot in an increasingly bleak global economy.

The waning momentum reflects three formidable headwinds, which could prove persistent:

  • A sharp tightening of financial conditions, which is increasing government borrowing costs and is expected to become even more restrictive, as central banks in major advanced economies continue to raise interest rates to rein in the fastest inflation since decades. Rapid currency depreciation could further complicate policy challenges.
  • The still raging Russian invasion of Ukraine continues to trigger a sharp slowdown in economic activity in Europe that will further reduce external demand for Asian exports.
  • China’s strict COVID-19 policy and associated lockdowns, which, together with growing turmoil in the real estate sector, have led to an unusual and sharp slowdown in growth, which in turn is weakening the momentum of connected economies.

General slowdown

After near zero growth in the second quarter, China will recover modestly in the second half to reach annual growth of 3.2% and accelerate to 4.4% next year, assuming pandemic restrictions are gradually eased.

In Japan, we expect growth to remain unchanged at 1.7% this year before slowing to 1.6% next year, weighed down by weak external demand. Korea’s growth in 2022 was revised up to 2.6% due to strong growth in the second quarter, but revised down to 2% in 2023, reflecting external headwinds. India’s economy will grow, albeit slower than expected, by 6.8% this year and 6.1% in 2023, due to weaker external demand and tighter monetary and financial conditions that are expected to weigh on growth.

Southeast Asia is expected to experience a strong recovery. In Vietnam, which is benefiting from its growing importance in global supply chains, we expect 7% growth and a slight moderation next year. The Philippines is expected to expand by 6.5% this year, while growth will reach 5% in Indonesia and Malaysia.

Cambodia and Thailand will experience faster expansion in 2023 thanks to a likely recovery in foreign tourism. In Myanmar, which suffered a deep recession due to the coup and the pandemic, growth is expected to stabilize at a low level this year amid continued unrest and suffering.

The outlook is more difficult for the other Asian frontier markets. Sri Lanka is still experiencing a severe economic crisis, although the authorities have reached agreement with IMF staff on a program that will help stabilize the economy.

In Bangladesh, the war in Ukraine and high commodity prices hampered a strong post-pandemic recovery. The authorities have preemptively requested an IMF-supported program that will strengthen the external position and access to the IMF’s new Resilience and Sustainability Trust Fund to meet their large need for climate finance, which will strengthen their ability to cope with future shocks.

Highly indebted economies such as the Maldives, Lao PDR and Papua New Guinea, and those facing rollover risks, such as Mongolia, also face challenges as the tide changes.

We expect growth in Pacific island countries to rebound strongly next year to 4.2% from 0.8% this year, as tourism-based economies benefit from the easing of travel restrictions.

Inflation remains high

Inflation is now above central bank targets in most Asian economies, driven by a combination of global food and energy prices, falling currencies against the US dollar and reducing production gaps. Core inflation, which excludes food and energy price volatility, has also increased and its persistence, driven by inflation expectations and wages, needs to be watched closely.

Meanwhile, the US dollar strengthened against most major currencies, with the Federal Reserve raising interest rates and signaling further hikes to come. Most Asian emerging market currencies have lost between 5 and 10% of their value against the dollar this year, while the yen has depreciated by more than 20%. These recent depreciations have started to trickle down to underlying inflation across the region, which could keep inflation high for longer than expected.

Finally, the spikes in global food and energy prices earlier this year threatened to sharply increase the cost of living in the region, with particularly strong implications for the real incomes of low-income households who spend more of their disposable income on these products.

Hard Times Policy

In a context of slowing growth, decision makers are faced with complex challenges that will require strong responses.

Central banks will have to persevere with their tightening policy until inflation returns to its target for a long time. Exchange rates should be able to adjust to reflect fundamentals, including the terms of trade – a measure of the prices of a country’s exports relative to its imports – and foreign monetary policy decisions. But if global shocks cause borrowing rates to spike unrelated to domestic policy changes and/or threaten financial stability or undermine the central bank’s ability to stabilize inflation expectations, foreign exchange interventions can become a useful element of the policy mix for countries with a reserve, alongside macroprudential policies. Countries should urgently consider improving their liquidity buffers, including by requesting access to the Fund’s precautionary instruments for eligible individuals.

Public debt has increased significantly in Asia over the past 15 years, particularly in advanced economies and China, and has increased further during the pandemic. Fiscal policy should continue its gradual consolidation to moderate demand alongside monetary policy, centered on the medium-term objective of stabilizing public debt.

Accordingly, measures to protect vulnerable populations from the rising cost of living will need to be well targeted and temporary. In highly indebted countries, aid will need to be budget neutral to maintain the path of fiscal consolidation. Credible medium-term fiscal frameworks remain an imperative.

Beyond the short term, policies must focus on repairing the damage caused by the pandemic and war. The scars of the pandemic and current headwinds are likely to be significant in Asia, in part due to high corporate leverage that will weigh on private investment and education losses from school closures that could erode human capital if corrective action is not taken today.

Strong international cooperation is needed to avoid further geo-economic fragmentation and to ensure that trade contributes to growth. There is an urgent need for ambitious structural changes to boost the region’s productive potential and address the climate crisis.


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