Global Market: IMF warns of energy shock, AI correction risks to Asia's growth outlook

The International Monetary Fund on Thursday warned that Asia's economic growth is likely to moderate next year as an energy shock triggered by the Iran war, a potential correction in the artificial intelligence boom and rising global bond yields pose growing risks to the region's outlook, according to a report by Reuters.

In its latest Asia-Pacific regional economic outlook, released during the IMF's annual meetings in Bangkok, the global lender also cautioned that uncertainty over the US monetary policy path could keep Asian financial markets volatile, with exchange rates and capital flows facing increased pressure.

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The IMF projected Asia's economy to grow 4.8% in 2026 and 4.4% in 2027, according to Reuters. While the projections are higher than those made in April, they indicate a slowdown from the region's 5% growth in 2025.

The upward revisions largely reflect the boost from the artificial intelligence boom to advanced Asian economies, whose growth is expected to accelerate to 3.2% in 2026 from 2.5% last year. Emerging Asia, however, is expected to remain the region's primary growth engine while expansion moderates.

Growth in emerging Asia is projected to ease to 5.1% in 2026 from 5.6% in 2025, as higher energy prices weigh on economic activity, the IMF said.

Middle East conflict, AI boom pose downside risks

The IMF said the risks to its economic outlook remain tilted to the downside, warning that a prolonged stalemate in the Middle East conflict could keep commodity prices elevated and deplete global oil reserves.

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A correction in AI-related demand could also weigh on global economic growth, with the impact potentially more pronounced in Asia because of the region's extensive exposure to the artificial intelligence production chain.

Asian economies are deeply integrated into the manufacturing and supply networks supporting the AI boom, making them vulnerable to any sharp reversal in technology investment or demand for AI-related products.

Financial market volatility presents another challenge. According to Reuters, the IMF said foreign investment inflows into the region remained generally robust, but currency depreciation pressures and portfolio outflows had emerged in some markets, including South Korean technology stocks.

The lender also warned that financial stress among major sovereign borrowers, including the United States, the United Kingdom, the euro zone and Japan, could spill over into Asian bond markets as global yields rise.

Higher yields could increase borrowing costs across the region and aggravate existing fiscal vulnerabilities. With public debt and financing requirements still elevated across much of Asia, an abrupt tightening of financial conditions could further strain government finances by increasing debt-servicing costs, the IMF said.

Central banks urged to prioritise price stability

Inflation, government debt and rising bond yields have emerged as key concerns during this week's IMF meetings, adding to policymakers' challenges from the energy shock associated with the Middle East conflict.

The increase in energy prices has contributed to broader inflationary pressures, while stronger-than-expected US inflation data has fuelled concerns that interest rates could remain higher for longer.

Krishna Srinivasan, director of the IMF's Asia and Pacific Department, said central banks across the region should continue to prioritise price stability even as inflation expectations remain broadly anchored.

According to Reuters, Srinivasan said monetary authorities should communicate their policy intentions clearly and remain prepared to raise interest rates where inflation expectations are less firmly anchored, policy frameworks lack credibility or price pressures prove persistent.

He also stressed the importance of preserving central bank independence.

Market concerns over inflation and interest rates were reflected in Thursday's trading, when Japan's Nikkei share average tumbled nearly 5%. Technology stocks came under pressure amid concerns about the profitability of AI-related investments, while hotter-than-expected US inflation data intensified fears of higher interest rates.

IMF calls for targeted fiscal support

The IMF also warned that elevated public debt levels were limiting governments' ability to respond to economic shocks through additional spending.

With public debt across much of Asia still above pre-pandemic levels, the scope for further fiscal expansion has become increasingly constrained, Srinivasan said.

The lender urged governments to keep fiscal support targeted and temporary, cautioning against blanket fuel subsidies and broad price controls that could impose significant costs on public finances, as per the report.

The recommendations underscore the policy challenge facing Asian economies as they seek to cushion households and businesses from higher energy prices without worsening fiscal pressures or allowing inflation to become entrenched.

The IMF's outlook highlights the competing forces shaping the region's economic trajectory: continued support from AI-related investment, the drag from higher energy costs and the risk that rising global borrowing costs could tighten financial conditions just as governments face mounting demands for fiscal support, according to Reuters.

(Disclaimer: This article is based on inputs from agencies. These do not represent the views of The Economic Times)