China's zero-Covid economic drag could be 'significantly bad' for Asia: IMF

China's "sharp and uncharacteristic" economic slowdown could spell trouble for its Asian neighbours with whom it has strong trade and financial ties, the International Monetary Fund (IMF) said on Friday, offering a bleak outlook for the region's economy.

The IMF shaved its growth forecast for Asia to 4 per cent this year, down 0.9 percentage points from an earlier projection, citing in its Asia-Pacific regional economic outlook report that countries also had to navigate tighter global financial conditions and inflation stemming from the war in Ukraine.

While Asia's economies were expected to expand by 4.3 per cent in 2023, Krishna Srinivasan, director of IMF's Asia-Pacific department, warned that growth could be lower if the headwinds intensified.

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"That's the kind of risk you're dealing with," he told This Week In Asia in an interview on the sidelines of the report launch on Friday.

Srinivasan said China's economy has been hurt in part by its hardline zero-Covid strategy that involved strict border controls and intermittent lockdowns though he was optimistic that there could be some relief soon.

"That's clearly a big factor why China has slowed," he said. "What we assume in our baseline is that starting now, slowly, these zero-Covid [measures] will be modified and they will be gradually opening up the economy and things will become more normal."

But he was less sanguine about the real estate crisis grappling China, with a growing number of property developers defaulting on their debt and facing exacerbated liquidity stress.

These factors have spread to other parts of the Chinese economy, making the slowdown more "broad-based across sectors", the IMF report said. The organisation had earlier said it expected China's growth to slow to 3.2 per cent this year, its smallest expansion in around four decades, excluding the first year of the pandemic.

With economies in the United States and Europe slowing sharply, Asia would feel the pinch of China's muted economic growth, Srinivasan said, pointing out that intraregional trade stood at about 50 per cent.

"To the extent that China has been a key player in global supply chains [and] a key hub for trade, if China slows, it could be significantly bad for Asia, especially for countries which have very strong trade links with China, for example Japan and [South] Korea," he said.

The Chinese government also had medium to longer-term issues to address, including productivity loss and a fast-ageing population, he added.

While inflation has not been as acutely felt in Asia compared to other regions, Srinivasan said central banks must continue raising interest rates to ensure that inflation expectations do not become de-anchored.

In the region, most central banks have followed in the footsteps of the US Federal Reserve in hiking rates, although there has been some resistance in Western nations that the monetary policy has been too reactive.

Asked about the task governments have in managing inflation and slowed growth, Srinivasan tacitly approved what central banks have done, saying it was important for countries to address inflation "head on".

"You risk losing credibility if inflation expectations get unanchored. I think it's very important to address that," he said. If inflation was not dealt with because of economic ambitions, inflation could spiral and that would come at a high cost.

Governments, he suggested, should adopt complementary forward-looking monetary and fiscal policies while providing targeted support to vulnerable populations.

Also threatening the region's economic recovery story was the potential trade fragmentation. Already, the IMF report noted that there were early signs of it, with a jump in the number of trade restrictions imposed by countries.

The fraying of global linkages first spiked in 2018 amid rising US-China trade tensions and again in recent months, as a result of Russia's invasion of Ukraine.

Srinivasan warned there were risks of countries thinking of so-called friendshoring, where countries decide to trade with friends and give up on efficiency. "In a situation where fragmentation really materialises, you can have a significant impact on growth in Asia," he said.

"Asia suffers the most because it's the biggest player in global supply chains. Some countries may gain because of trade diversion but overall, Asia will lose."

In one fictitious scenario presented in the IMF report, countries were divided in two blocs based on how they voted on the United Nations motion to condemn Russia's invasion of Ukraine.

Under that scenario, there would likely be a fragmentation in energy and hi-tech sectors between Russia and countries that supported Moscow and those positive-voting ones, with Asia-Pacific losing 1.5 per cent of GDP as a result.

The takeaway, Srinivasan said, was that it was important for globalisation and multilateralism to be preserved.

"Let's not forget that we have gained so much in terms of output and employment over the last 20 to 30 years and a large part of that was because of globalisation," he said.

"Let's not forget the past because of myopic geopolitics. My hope is that countries will come together and realise that there's a lot more to lose in a fragmented world."

This article originally appeared on the South China Morning Post (SCMP).

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