The Asia & Pacific remains a dynamic region despite a challenging year for the world economy. Global growth is expected to decelerate reflecting rising interest rates and Russia’s war in Ukraine. Inflation remains high, and banking strains in the United States and Europe have injected greater uncertainty into an already complex economic landscape. Asia’s domestic demand has so far remained strong despite monetary tightening, while external appetite for the region’s exports is weakening. The International Monetary Fund (IMF) projects, at the Regional Economic Outlook, that the Asia & Pacific region will contribute about 70 percent of global growth this year as growth increases to 4.6 percent from 3.8 percent last year. China’s reopening will provide fresh momentum, while other Asian emerging economies are on track to enjoy solid growth, though in some cases at slightly lower rates than last year.

The dynamic growth outlook does not mean policymakers can be complacent. Some risks such as elevated levels of public debt remain. Intensification of the recent global financial tremors could spark others. Global commodity prices have moderated after surging last year and supply chain pressures have eased, but inflation remains above central banks’ targets. Core inflation, which excludes food and energy, has proven sticky. Output gaps for Asian economies are either narrowing or have already closed, while economic capacity might have fallen because of so-called economic scarring from the pandemic. Last year’s currency depreciation against the US dollar is still passing through to prices. The impact could be greater than usual, because of the already-high inflation, especially for emerging economies. With real interest rates still low—and negative in some countries—central banks may need to keep interest rates higher for longer.

Significant uncertainty about global and regional financial conditions presents another challenge. The recent turbulence in some US and European banks, as they struggle with rising interest rates, serves as a cautionary tale about contagion risks. Similarly, banks in Asia—particularly in advanced economies—could suffer losses from increases in wholesale funding costs and sudden declines in the market values of assets. Lenders in some emerging economies could face liquidity stresses following sudden deposit withdrawals or retrenchment in external funding lines. Some countries and sectors are significantly exposed to a sharp increase in external borrowing costs, though these risks have recently diminished.

Domestic vulnerabilities are also evident. Leverage had increased even before the pandemic. Corporate debt is concentrated in firms at risk of insolvency and in a few sectors, such as property. Real estate prices in Asia are still historically high even after recent cooling; further declines could pressure banks’ balance sheets, especially those exposed to mortgage lending and real estate developers. Asian financial systems should be able to withstand these stresses as they are well capitalised and have strong liquidity buffers, but financial supervisors must be alert. Fiscal consolidation amid high debt and rising interest rates is another challenge. Public debt levels in the region have increased significantly compared to before the pandemic. Most governments are expected to tighten budgets this year and next. However, the projected consolidation may not be enough to stabilise debt. Rising interest rates would make the burden even heavier.

Finally, there are heightened risks to economic growth in coming years. Although China is expected to rebound this year, it is likely to slow over the medium term, implying the lowest such growth rates for Asia in decades. In addition, China’s growth is likely to shift from investment to consumption. This could have significant regional implications, especially for economies with sizable exports to China. Greater geoeconomic fragmentation would also add to pressures on growth potential.

The best remedy for financial stress is prevention—policymakers should keep a close eye on stresses and develop contingency plans. Unless strains in financial markets increase and raise broad-based stability concerns, central banks should separate monetary policy objectives from financial stability goals. To do so, they should use available tools—such as lending and discount facilities—to ease any liquidity constraints in the banking sector, while continuing to tighten policy to address inflationary pressures. Fiscal consolidation may need to be more aggressive to ensure sustainability over the medium term, while striking a balance between supporting growth, protecting the vulnerable, and addressing debt concerns. Moreover, the region must prioritise policy initiatives that foster innovation-driven economic development. The green transition presents a wide range of opportunities that can become the region’s new growth drivers. By investing in research and development, promoting entrepreneurship, strengthening education and digitalisation, Asian countries can foster sustainable, long-term growth.

In Nepal, following a strong post-pandemic recovery, growth is slowing, reflecting the impact of external shocks and necessary policy adjustment. The much-needed monetary policy tightening of last year, together with the gradual unwinding of Covid support measures, helped moderate credit growth and contributed to the moderation of inflation. At the same time, lower-than-expected revenue collection, owing to the earlier slowdown in imports, has resulted in near-term fiscal pressures and the need to rationalise spending to preserve fiscal discipline and debt sustainability. Execution of growth-enhancing capital projects has been muted. Bank asset quality has deteriorated, reflecting a decline in the repayment capacity of borrowers due to higher lending rates and rising leverage, a concern that is moderated by banks’ capital-adequacy ratios that are above the regulatory minima.

Progress with the implementation of Nepal’s Extended Credit Facility (ECF)-supported Fund programme has continued, despite a challenging global and domestic environment last year, including the impact of Russia’s war in Ukraine. With the economic policies and reforms consistent with the ECF, Nepal’s economy is expected to remain on a sustainable and inclusive growth path, with medium-term growth projected at around 5 percent, while maintaining adequate levels of international reserves, keeping public debt at a sustainable level, and strengthening financial stability.