Global demand has consistently weakened this year, for multiple reasons, and the risk of recession is rising. If advanced economies were to fall into recession, developing countries in Asia would not be immune to the fallout. Policymakers in the region will need to monitor and carefully navigate a challenging economic environment to keep inflation in check and sustain growth.

WHAT IS A GLOBAL RECESSION AND WHEN WAS THE LAST TIME IT HAPPENED?

Although a global recession has no clear-cut definition, the term can be broadly referred to as a synchronised GDP contraction across many economies in the world, accompanied by a broad decline in various other measures of global economic activity. The world economy has rarely registered an annual contraction. In the post-war period, it happened only during the Global Financial Crisis in 2009 and the Covid-19 pandemic in 2020.

WHAT IS CAUSING THE RISKS OF A GLOBAL RECESSION TO RISE?

The main reasons are the global monetary tightening cycle and possible escalation of the fallout from the invasion.

Central banks in advanced and emerging economies are facing increasing inflation and responding by repeatedly hiking interest rates. Containing inflationary pressures is necessary, but synchronised rate hiking across the world means a global monetary tightening cycle. This increases the negative effects on global liquidity, as simultaneous policy rate hikes in different economies reinforce each other's tightening impact on global financial conditions.

There is a risk that central banks may overdo it, underestimating the impact of their actions on inflation and the contractionary effects on the real economy.

At the same time, risks of an escalation of the economic fallout from the Russian invasion of Ukraine cannot be ruled out. Indeed, the gas leaks discovered on subsea Russian pipelines to Europe in late September and the missiles hitting Poland's territory in mid-November indicate these risks are substantial.

Global oil and, particularly, gas prices are likely to remain elevated—and they may even spike again, which worsens the global inflation outlook.

HOW WOULD A RECESSION IN THE UNITED STATES AND EUROPE AFFECT ASIA?

A recession in the US and the euro area would affect Asia mainly through trade. These two economies absorbed about 29 per cent of the region's merchandise exports in 2021.

The effects are likely to be layered.

First, lower consumer spending in the US and euro area would dampen Asia's export prospects. More open economies—such as the People's Republic of China, the Republic of Korea, and Singapore—would suffer a larger impact.

Next, slower growth in the People's Republic of China—which exports about 30 per cent of its merchandise to the US and Europe—would decrease further the demand for imports from the rest of Asia and create distortions to production chains in the region.

Some developing Asian economies could also be affected via reversals of financial flows. During periods of heightened global uncertainty, investors often look for safe-haven assets, and this can result in substantial capital outflows and currency depreciation in emerging economies. Such a development could fuel imported inflation, stifle consumer and business confidence, and give rise to balance-of-payments and debt-servicing difficulties in economies with weaker macro-fundamentals.

HOW SHOULD POLICYMAKERS IN ASIA RESPOND TO A POSSIBLE GLOBAL RECESSION?

Greater coordination among monetary authorities across the world, as well as clearer communication of their planned tightening path to tame inflation, would make it easier for policymakers to choose the right policy mix

The authors are economists of the Asian Development Bank.