Asia would have the most to lose if economic fragmentation worsens

The Asia-Pacific has more to lose than any other region if the global trading system splits in the wake of geopolitical tensions, the International Monetary Fund has warned.

Asia-Pacific countries could lose more than 3% in gross domestic product if trade is cut in sectors hit by recent US chip sanctions against China and if non-tariff barriers in other areas are raised to Cold War levels, the IMF said in a study which was announced on Friday.

That is twice as much as estimated global annual losses.

Sectors in Asian countries forced to contract due to reduced trade could suffer average employment losses of as high as 7%, the IMF added.

“When we talk about progression from increasing trade uncertainty and more restrictive measures, [it] will eventually escalate into fragmentation where the world is divided, Krishna Srinivasan, director of the Asia and Pacific Department of the IMF, said at a news conference in Singapore on Friday.

“Asia stands to lose a lot because it is a key player in global supply chains and in a fragmented world it stands to lose more than anyone else.”

Signs of global fragmentation emerged during the US-China trade war in 2018. But more worrying signs, such as the Russia-Ukraine war, have since emerged. Sanctions against Russia have added even more uncertainty to trade relations, the IMF said.

Policy uncertainty around trade, not just the restrictions themselves, could hamper economic activity as firms halt hiring and investment and new firms delay market entry, the IMF said.

For example, the IMF found that trade tensions between the US and China in 2018 reduced investment by about 3.5% after two years.

The impact of trade fragmentation is greater for emerging markets in Asia and for highly indebted firms.

The IMF said that while its research focused on the impact of fragmentation on trade, there could be other deeper downsides, such as the “dissolving of economic ties.”

“Financial fragmentation can lead to short-term costs from a rapid liquidation of financial positions, and long-term costs from lower diversification and lower productivity growth due to reduced foreign direct investment,” the IMF said.

The international body is urging countries to roll back harmful trade restrictions and reduce uncertainty through clearer communication of policy goals.

“Greater emphasis can be placed on digitization, investment in education … but most importantly, international cooperation, because we want to avoid the risk of fragmentation … it is important that we all act now, act together,” Srinivasan said.

There have been concerns over capital flows out of Asia as interest rates in the region lag behind those of the US. But so far, they remain “manageable,” Srinivasan said.

The situation in Asia has been mixed, Srinivasan added.

“For example, we saw a lot of capital flows for India, we saw capital flows for Taiwan, China, and moderate flows from Indonesia, moderate flows for Malaysia, but we saw some net inflows to Thailand. And more recently, we’re seeing flows back to India. So the picture is a bit mixed,” he said.