The tumultuous developments in geopolitics, trade and financial markets so far this year provide a warning that economic prospects may not be as benign as many forecasters have assumed. Trade-reliant Asian economies need to assess the downside risks more carefully.
In recent weeks, the International Monetary Fund and the World Bank among others have upgraded their expectations for the global economy in 2026. This measured optimism stems from the unexpected resilience of economic activity in the face of the greater protectionism.
Optimism
There are good reasons for this auspicious view. US fiscal policies will boost demand as new accelerated depreciation rules spur capital spending while tax rebates boost consumer spending. Moreover, the burst of capital spending to promote AI projects shows little sign of dissipating.
The biggest threat is the lagged effects of much sharper protectionism
Barring a major political crisis, the global economy will also benefit from relatively low oil prices. At the same time, worldwide financial conditions have eased following last year’s rate cuts by major central banks. With many large economies now having secured trade deals with the US, the uncertainty over trade that depressed capital spending and hiring after April last year should also ease.
Nevertheless, several threats to the global economy are not being given adequate attention.
The most important of these is the lagged effects of much sharper protectionism. The average tariff level in the US has soared, from below 3% in 2024 to around 15% today, delivering a significant shock to the world economy. The damage was not fully evident in 2025 because most tariff hikes kicked in after August. What’s more, many importers initially chose to absorb higher import costs, thereby sparing consumers the pain of higher prices. That is changing as companies are now raising prices.
Over time, the tariffs will impose efficiency losses as well, as companies are less able to utilise the most cost-efficient imports. They will also now have to consider the resilience of supply chains and geopolitical factors rather than just cost and quality. As inefficiencies deepen, economic growth is bound to be affected.
Further shocks
Moreover, there is another trade shock underway – the substantial surge in Chinese exports to the world outside the US. These export surges have impacted domestic producers in many countries, including those in Europe and major Asian trading nations as well as nations such as Brazil, Turkey, and South Africa. It has resulted in a proliferation of tariffs and non-tariff barriers as the importing countries move to protect their domestic industries.
World economic growth is over-reliant on AI-related capital spending
The second vulnerability is the world economy’s excessive reliance on AI-related capital spending to support growth. For many of Asia’s major exporting nations, this boom has led to outsized gains in exports of semiconductors and related electronic components. Although tech businesses paint an upbeat picture of continued expansion in such investments, the funding for such unprecedented levels of capital spending could well dry up as financial markets correct and investors become more sceptical.
Policy response
These concerns are not far from the minds of those shaping monetary and fiscal policies in Asia. Asian central banks eased financial conditions through last year’s rate cuts, and fiscal spending is expected to be the primary means for supporting economic growth in Asia this year.
China’s policymakers have already shown the way, with promises of strong action to raise domestic demand. India’s recent Budget raised capital spending significantly – and it is likely that other countries will follow suit.
Expect more bilateral agreements to liberalise trade
There is also a growing effort within Asia to diversify trade away from the US, with more bilateral agreements to liberalise trade such as the one that India concluded with the EU recently. Another element will be efforts, albeit modest ones, to liberalise imports and restrictions on foreign investment as part of wider reforms to promote economic growth.
In short, Asia will suffer headwinds from the global economy but proactive countercyclical policies should help the region’s economies absorb the shocks.
