Asia's developing economies, once home to double-digit growth rates, will see momentum stall over the next two years amid a weak recovery in industrial nations and a slowdown in China, the Asian Development Bank (ADB) warned on Wednesday.
Gross domestic product (GDP) growth for developing Asia is expected at 5.7 percent in 2016 and 2017, decelerating from 5.9 percent in 2015, the bank said in its new 2016 outlook.
The region's outlook is looking increasingly dim with the U.S., euro area and Japan experiencing weak external demand and Beijing concentrating on reforms that are likely to hit its GDP, the ADB said.
Tepid external appetite for manufactured goods and low commodity prices will trim emerging Asia's current account surplus to 2.6 percent of regional GDP this year, from 2.9 percent in 2015, the ADB said.
Moreover, future interest rate hikes by the Federal Reserve and the spread of producer price deflation across Asia also pose risks, the report added.
Major risks
To nobody's surprise, the ADB pins China's structural transition to consumption-led growth, away from exports and investment, as the biggest threat to emerging Asia.
"Simulations estimate that the drop in PRC [People's Republic of China] growth may have shaved as much as 0.3 percentage points from developing Asia's outlook," said the report.
Reduced investment in state-owned industries with excess capacity, part of Beijing's supply-side reform agenda, is expected to moderate GDP growth to 6.5 percent this year, within the government's range of 6.5-7 percent, and to 6.3 percent in 2017.
A sharp slowdown in China, the world's second-largest economy, could have major ramifications.
Global growth could lose nearly 1.8 percentage points while oil prices could plunge 10-25 percent from their current levels, the ADB warned.
The emergence of producer price deflation in countries including the Philippines, Malaysia, India, South Korea, Thailand, and Hong Kong, is also weighing on the region amid a combination of slowing GDP and slumping crude.
China's 48 consecutive months of producer price deflation is also to blame, according to the ADB.
"Deflation in the PRC may be transmitted to its neighbors through lower export prices, especially if the renminbi depreciates," the report noted, referring to widespread market expectations for the Chinese currency to lose ground against the dollar.
The yuan has fallen nearly 5 percent against the dollar since a shock devaluation in August last year.
Policy makers must not ignore the producer price index (PPI) when assessing inflation seeing as a slumping PPI can compound producers' debt burdens and thus restrain investment, inflicting greater damage on the economy than a sliding consumer price index, the ADB said.
Bright spots
The future isn't entirely bleak however. Strength in India and the Association of Southeast Asian Nations (ASEAN) will help balance a slowing China, the ADB pointed out.
India is expected to log 7.4 percent growth in 2016 before accelerating to 7.8 percent next year, while aggregate growth in the 10 ASEAN economies could rise to 4.5 percent in 2016 and 4.8 percent in 2017, led by Indonesia's private investment and infrastructure push.
Productivity is key
Officials must counter the region's slowdown by increasing productivity, explained Shang-Jin Wei, the ADB's chief economist.
Wei notes that Asia's average growth dropped 2 percent between 2008-2014, with 40 percent of that decline due to lower potential growth, i.e. the maximum level of economic output consistent with full employment and stable inflation.
"While altering demographics is not something that can be accomplished within a few years, many developing economies still have tremendous room to use structural reforms to remove distortions in the labor, capital, and land markets, and to improve incentives for private sector investment, all of which lead to higher productivity and therefore higher potential growth."