The outlook for the world economy has grown gloomier, and development in Asia and the Pacific is expected to slow down much more due to the ongoing effects of Russia's invasion of Ukraine and other shocks.
The pace of economic growth in Asia and the Pacific is expected to drop this year, falling to 4.2 percent from 6.5 percent in 2021, which is 0.7 percentage points less than April prediction. IMF 2023 prediction was reduced by 0.5 percentage points to 4.6 percent.
Risks like tightening financial conditions linked to rising central bank interest rates in the US and rising commodity prices as a result of the conflict in Ukraine that we emphasized in our April prediction are now becoming a reality. The effects of China's downturn on regional economy are subsequently being amplified by this.
With the exception of China, the majority of Asia's emerging market economies have seen capital outflows equivalent to those of 2013, when the Federal Reserve signaled it would stop buying bonds earlier than anticipated, which caused steep increases in global bond yields.
Since Russia's invasion of Ukraine, India has experienced outflows of $23 billion. As the Fed indicates continued rate hikes and geopolitical tensions rise, outflows have also taken place from certain advanced Asian countries, including Korea and Taiwan Province of China.
Asia now accounts for 38 percent of all global debt, up from 25 percent before the global financial crisis and 25 percent after COVID, making the area more vulnerable to changes in the state of the world economy. As a result of its unsustainable debt load and lack of access to international capital markets, Sri Lanka is an extreme example of a country that has defaulted on its external debt.
In comparison to other regions, Asia's rising inflation pressures are still relatively mild, but price rises in many nations have recently exceeded central banks' targets.
In countries with high debt levels, fiscal policy will need to be tightened as a complement to monetary policy measures to control inflation. At the same time, specialized and transient fiscal transfers are required to assist those in need who are experiencing fresh shocks, particularly from rising energy or food prices.
The majority of the time, such fiscal support must be budget-neutral, paid for by increasing new revenues or reshaping budgets to prevent increasing debt or going against monetary policy. China and Japan are exceptions to this rule, assuming that their medium-term budgetary policies remain grounded.
So, in order to avoid a spiraling higher of inflation expectations and wages that would later necessitate larger hikes if left uncontrolled, several economies will need to raise rates quickly since inflation is expanding to core prices, which exclude the more volatile food and energy categories.
Further rate increases will further put pressure on budgets for households, businesses, and governments that incurred significant debt as a result of the pandemic.
Flexible exchange rates alone may not be sufficient or practical in all countries, and other measures like foreign exchange interventions, macroprudential policies, and capital-flow management may be useful tools to help ground expectations and manage systemic risks. Precise policy advice will vary depending on the country in question.
The Fund recently created the Integrated Policy Framework to precisely direct economic policy decisions in situations like this. Through its funding function, the Fund continues to be a devoted partner to nations in order to assist them in navigating the impending storm.
Countries should not put off making required changes to their policy mix or rebuilding their external financing buffers until it is too late.
Source: IMF Blogs