The region can effectively navigate current challenges by focusing on safeguarding vulnerable populations, allowing for price adjustments, stabilizing inflation expectations, and fast-tracking structural reforms.
By Andrea Pescatori and Krishna Srinivasan
As Asia commenced 2026, it did so with notable strength. Despite the region’s exposure to US tariffs implemented last April and ongoing uncertainties surrounding trade policies, economic growth in 2025 remained robust, and trade activities continued to flourish. However, the recent conflict in the Middle East and subsequent energy supply disruptions have intensified inflationary pressures, weakened external balances, and constrained policy options, highlighting the region’s reliance on imported oil and gas.
Nevertheless, we anticipate that Asia will continue to be a key engine for global growth. The region’s growth rate of 5 percent in the previous year is expected to moderate to 4.4 percent in 2026 and further to 4.2 percent in 2027, based on the latest World Economic Outlook’s reference forecast, which assumes that the energy shock will be temporary. China and India are projected to account for approximately 70 percent of the region’s growth.
These economic headwinds will pose challenges to Asia’s resilience. Inflation is projected to rise to 2.6 percent this year, an increase of 0.4 percentage points compared to our January forecast and significantly higher than last year’s rate of 1.4 percent. If the supply shock continues or worsens, as outlined in the WEO’s adverse and severe scenarios, cumulative growth through 2027 could decline by 1 to 2 percent.
Strength in the face of adversity
Growth across numerous Asian economies exceeded earlier expectations in the latter half of last year, bolstered by a strong technology cycle, domestic policy support, and generally favorable financial conditions. The demand for semiconductors and related products remained high, benefiting countries like Korea, Malaysia, and Singapore that are intricately linked to technology supply chains. Intra-regional trade increased, and diversification of exports to other global markets helped mitigate the impact of reduced demand from the United States, particularly for non-technology exports.
However, domestic consumption exhibited inconsistencies. Recovery in consumer spending varied significantly across nations, while investment remained tepid due to uncertainty and specific national challenges.
The war has introduced a new, immediate obstacle that clouds Asia’s short-term outlook, considering that net oil and gas imports constitute roughly 2.5 percent of the region’s economic output.
Asia accounts for approximately 38 percent of global oil consumption and 24 percent of natural gas usage. It is also one of the largest crude oil refiners, holding around 35 percent of global refining capacity, predominantly concentrated in China, India, Korea, and Singapore.
Oil and gas consumption in the region represents about 4 percent of GDP, nearly twice the share found in Europe. In some countries, such as Malaysia and Thailand, this percentage exceeds 10 percent due to a greater reliance on transportation and industrial activities. These nations also depend heavily on gas-fired power plants and liquefied natural gas imports. The reliance on imports reflects limited domestic production capabilities and a manufacturing sector dependent on oil and gas.
Impact of the energy shock
Asia is the primary consumer of oil and gas transported through the Strait of Hormuz, accounting for approximately 80 percent of liquefied natural gas exports through this channel. This situation presents a direct challenge to Asian refineries, utilities, and manufacturers. The disruptions could also lead to local shortages of petroleum products and gas, particularly in countries with limited reserves. Interruptions in the delivery of fertilizers, petrochemicals, and essential materials such as helium and sulfur heighten the risk of broader supply chain disruptions if the conflict continues.
Channels of impact
The repercussions of these developments permeate the broader economy through multiple channels. First, elevated energy prices worsen the terms of trade for net oil and gas importers, redistributing income towards fossil fuel exporters. Second, the increase in fuel and electricity prices diminishes real incomes for the populace. Third, as energy is a critical input for transportation, industry, petrochemicals, and fertilizers, the shock escalates production costs across various sectors, adversely impacting business profits and potentially leading to wider inflationary pressures over time. Lastly, financial factors come into play, as rising bond yields, a stronger US dollar, currency depreciation, and increased risk premiums—especially for fossil fuel importers—amplify the shock’s effects. Moreover, country-specific elements, including production intensity related to fossil fuels and petroleum pricing structures, influence the overall impact.
Shifting economic outlook
The reference forecast suggests that Asia’s growth trajectory remains largely unchanged since January; however, it is accompanied by rising inflation, deteriorating external balances, constrained policy options, and heightened downside risks.
Growth across most of the region is expected to slow. An exception is Korea, which benefits from strong ties to the technology sector. Emerging Asia continues to be the primary engine of global growth, but growth is anticipated to decelerate by approximately 0.5 percentage points to 4.9 percent this year before stabilizing in the following year. A similar slowdown is projected for Advanced Asia. Additionally, growth in Southeast Asia and Pacific island nations is expected to decelerate, but with significant variation among countries.
Inflation rates are also on the rise. In emerging Asia, inflation is forecasted to increase from 1.1 percent in 2025 to 2.6 percent in 2026, influenced partly by upward adjustments in China and India. In advanced Asia, inflation trends are mixed: while inflation pressures have eased in Japan, they remain persistent in Australia, where the inflation forecast for 2026 has been significantly revised upwards.
Increased risks ahead
The reference forecast presumes a conflict of limited scope, with disruptions gradually diminishing over the year. However, a prolonged or escalated energy supply shock, broader trade disruptions, or renewed policy uncertainties would substantially weaken growth, further increase inflation, and tighten financial conditions. The capacity for policy intervention would diminish, limiting options for additional support.
In the WEO’s adverse scenario—characterized by a more extensive and slower fading energy supply shock—GDP growth in the major economies within the region could decline by nearly 1 percentage point in 2026 compared to the reference scenario, with more significant losses in countries that are highly dependent on imports and fossil fuels.
In the severe scenario—where the energy supply shock is even more pronounced and persists well into 2027—the adverse effects on growth would be magnified, with major economies experiencing a cumulative loss of about 2 percentage points by 2027 relative to the reference scenario. Headline inflation could also rise by 2.3 percentage points by 2027, with the impact being more pronounced in energy-dependent economies within the region.
Overall, this situation is likely to disproportionately affect economies that depend on imported energy, possess limited fiscal space, or are significantly influenced by the Middle East conflict through remittances, tourism, or commodities like fertilizers. This is particularly relevant for regions in South and Southeast Asia, as well as Pacific island nations. For instance, Sri Lanka relies on imported oil and remittances and tourism that flow from the Gulf. In agriculture-based economies, such as Lao P.D.R., Nepal, and Myanmar, rising fertilizer costs could decrease incomes and elevate food prices.
Policy actions and priorities
Governments in Asia are implementing various measures to manage prices and consumption, including promoting remote work. Many have resorted to subsidies, fuel funds, tax adjustments, or retail price controls to mitigate the impacts on individuals and businesses. While these measures can garner public support during emergencies and help alleviate temporary disruptions, they may not effectively address the underlying price signals necessary for demand adjustment.
For central banks, inflation expectations have generally remained anchored across most economies. This provides some leeway to overlook the initial spike in headline inflation; however, monetary policy needs to remain responsive. A prolonged energy crisis could weaken currencies and lead to more enduring inflationary pressures.
Interest rates in advanced economies are expected to remain stable or tighten to achieve disinflation. In Japan, where inflation expectations are approaching targets, the central bank can overlook the initial impacts of the energy shock and continue withdrawing accommodative measures. Conversely, in countries like Australia, where inflation is already above target and domestic demand remains strong, the ability to overlook the shock is limited. In economies such as Thailand and the Philippines, where inflation is below target, further rate cuts may be paused to maintain flexibility for future easing.
Exchange-rate flexibility should be prioritized as the primary line of defense. Interventions should be reserved for addressing market disruptions, consistent with the IMF’s Integrated Policy Framework.
Fiscal support should be temporary and specifically targeted to assist vulnerable individuals and viable businesses. Cash transfers can augment personal incomes and should be funded by reallocating budgets. This approach is crucial in a region where fiscal space has been constrained since the pandemic and due to rising interest burdens. If reallocating budgets is not feasible, it is essential for authorities to communicate plans for fiscal consolidation clearly. Broad fuel subsidies, tax reductions, and general price controls, while potentially easing inflation in the short term, can be costly, often regressive, and difficult to reverse. In fact, increased energy prices can quickly escalate fiscal expenses, not only by necessitating new support measures but also by inflating the costs of existing fuel subsidies, as seen in 2022.
The capacity for support varies across countries. While nations like Sri Lanka and Cambodia can provide assistance, it should be targeted and aligned with efforts to restore or maintain fiscal integrity. More constrained countries, such as Bangladesh, face tougher trade-offs due to limited budgetary flexibility, which reduces the scope for broad support.
Ultimately, this energy shock underscores the need for structural reforms. Enhanced social safety nets would better protect individuals without relying on general subsidies. Policies aimed at fostering job-rich growth and boosting domestic demand would help reduce reliance on external markets. In many Asian nations, youth unemployment remains high, and skill mismatches are hindering productivity and inclusiveness. The adoption of artificial intelligence could exacerbate these disparities if not accompanied by appropriate policies focused on skills development, inclusion, and governance. Greater integration of regional trade, services, and investments would bolster resilience, while investments in energy efficiency, power grid upgrades, and alternative energy sources would help safeguard against future fuel import crises.
