Asia will be more severely hit by a world divided into trading blocs: IMF

RISING trade policy uncertainty and trade restrictions could derail global output, and the impact could be more severe for Asia given its significant role in global manufacturing and trade, the International Monetary Fund (IMF) warned on Friday (Oct 28).

In its report Regional Economic Outlook: Asia and the Pacific, the IMF said the region is starting to show signs of a slowdown due to headwinds from global financial tightening, the war in Ukraine, and the sharp and uncharacteristic slowdown of the Chinese economy.

Growth in Asia and the Pacific is expected to decelerate to 4 per cent in 2022, before rising to 4.3 per cent in 2023. These forecasts have been revised down by 0.9 percentage point and 0.8 percentage point, respectively, since the April 2022 World Economic Outlook report.

Most of the region’s economies will slow further in 2023. Inflation is expected to peak in late 2022, because of falling global commodity prices and less accommodative macroeconomic policies. Risks to the outlook stem from the intensification of the three headwinds.

Asia is now the largest debtor in the world besides being the biggest saver, and several countries are at high risk of debt distress.

Krishna Srinivasan, director of the IMF’s Asia and Pacific Department, said: “Public and private debt dynamics are already worse following the pandemic because of slower growth and higher debt levels.”

He warned that depreciations and rising interest rates could expose financial vulnerabilities from high leverage and unhedged balance sheets, and further raise public debt ratios. To rein in rising inflation, monetary policy will need to continue to tighten, except in China and Japan.

The economic scarring as a result of the Covid-19 pandemic is expected to be worse in Asia and the Pacific. 

“Much of the shortfall in growth in Asia relative to other regions can be explained by lower levels of investment following the pandemic. These output losses are also particularly severe in tourism-dependent economies and those with high debt,” Srinivasan said, adding that tackling corporate debt overhang and mitigating human capital losses will be important for many countries in the region.

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A sharper fragmentation scenario, where the world divides into separate trading blocs, would result in large and permanent output losses. Even in the absence of actual restrictions, greater trade policy uncertainty can have adverse macroeconomic consequences in the short term. A typical shock to trade policy uncertainty, like the 2018 build up of US-China tensions, cut investment by about 3.5 per cent after two years.

The impact on Asia could be “especially severe”, given the region’s significant role in global manufacturing and trade. Just the losses due to lower productivity could take up to 3.3 percentage points off regional output. Total losses are likely much larger due to the dent on investment as firms lose access to export markets. 

Beyond trade fragmentation, there is also a growing concern regarding financial fragmentation. More than half of Asian portfolio investments abroad are in the US, Europe, and other developed economies. About a fifth of US foreign direct investment positions are allocated to Asia. Such large cross-border holdings could add to vulnerabilities if geopolitical considerations result in the forced unwinding of positions.

Collaborative solutions are needed to avoid the adverse effects from greater fragmentation and to ensure that trade continues to act as an engine of growth. 

“The focus should be on rolling back damaging trade restrictions and reducing policy uncertainty through clear communication of policy objectives…,” IMF said, adding that Asia must ensure that overlapping trade agreements do not contribute to fragmentation but rather are an avenue to promote open and stable trading relationships.