Asia's strong economic rebound early this year is losing momentum, with a weaker than expected second quarter. The International Monetary Fund has cut growth forecasts for Asia and the Pacific to 4% this year and 4.3% next year, which are well below the 5.5% average over the last two decades.
Despite this, Asia remains a relative bright spot in an increasingly dimming global economy.
Waning momentum reflects three formidable headwinds, which may prove to be persistent:
- A sharp tightening of financial conditions, which is raising government borrowing costs and is likely to become even more constricting as central banks in major advanced economies continue to raise interest rates to tame the fastest inflation in decades. Rapidly depreciating currencies could further complicate policy challenges.
- Russia's invasion of Ukraine, which is still raging and continues to trigger a sharp slowdown of economic activity in Europe that will further reduce external demand for Asian exports.
- China's strict zero-Covid policy and related lockdowns, coupled with deepening turmoil in the real estate sector, leading to an uncharacteristic and sharp slowdown in growth that is weakening momentum in connected economies.
In Thailand, we expect growth of 2.8% this year. While the headwinds listed above are weighing on the outlook, a gradual recovery is supported by strong domestic consumption and the revival of tourism. In 2023, growth is projected at 3.7%, supported by a likely uptick in foreign tourist arrivals.
INFLATION CHALLENGE
Alongside waning growth momentum, inflation exceeds central bank targets in most Asian economies, driven by a mix of global food and energy prices, currencies falling against the US dollar, and shrinking output gaps.
Core inflation, which excludes volatile food and energy prices, has also risen and its persistence -- driven by inflation expectations and wages -- must be closely monitored.
Inflation in Thailand has reached levels not seen in more than a decade, largely reflecting rising energy and food prices. Average headline inflation accelerated to 6.2% year-on-year in the first nine months of 2022 from an average of 1.2% recorded in 2021.
While inflation remained subdued during the first half of the year, core inflation has started to increase and tallied 3.12% in September year-on-year, driven by a fast increase in prepared food prices. However, medium-term inflation expectations appear to remain anchored thus far.
Meanwhile, the US dollar has strengthened against most major currencies as the Federal Reserve raises interest rates and signals 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%.
The baht also depreciated against the dollar, in line with regional currencies. These recent depreciations have started passing through to core inflation and this may keep inflation high for longer than previously expected.
Finally, spikes in global food and energy prices early this year threatened to abruptly raise the cost of living, with particularly strong implications for the real incomes of lower-income households that spend more of their disposable income on these commodities.
POLICY PRIORITIES
Amid lower growth, policymakers face complex challenges that will require strong responses.
Central banks will need to persevere with their policy tightening until inflation durably falls back to target ranges. Exchange rates should be allowed to adjust to reflect fundamentals, including the terms of trade -- a measure of prices for a country's exports relative to its imports -- and foreign monetary policy decisions.
But if global shocks lead to a spike in borrowing rates unrelated to domestic policy changes, and/or threaten financial stability or undermine a central bank's ability to stabilise inflation expectations, forex interventions may become a useful part of the policy mix for countries with adequate reserves such as Thailand, alongside macroprudential policies.
Public debt has risen substantially in Asia over the past 15 years, particularly in the advanced economies and China, and rose further during the pandemic.
In Thailand, public debt increased from 41% of GDP in 2019 to 58% in 2021. While Thailand still has some fiscal space, fiscal policy should continue its gradual consolidation to moderate demand alongside monetary policy, focused on the medium-term goal of stabilising public debt.
Accordingly, measures to shield vulnerable populations from the rising cost of living will need to be well-targeted and temporary. Beyond the short term, policies must focus on healing the damage inflicted by the pandemic and war.
Scarring from the pandemic and current headwinds are likely to be sizeable in Asia, in part because of elevated leverage among companies that will weigh on private investment, as well as education losses from school closures that could erode human capital if remedial measures are not taken today. In this regard, a renewed push for investments in human capital, R&D, and digital and green technologies would help to boost productivity and enhance resilience to future shocks.
Krishna Srinivasan is the director of the Asia and Pacific Department of the International Monetary Fund. Shanaka J Peiris is the department's division chief of regional studies.