Three months into 2023, the macroeconomic outlook for South Asia presents a balance of good and bad news. To start with the good news, global energy prices, and thus fertilizer prices, have fallen from their peaks, which has eased domestic inflationary pressures, reduced import bills, and reversed some of the large terms-of-trade losses during the past year. China’s economy has reopened, reducing disruptions in global value chains and boosting global production potential. Services exports, both tourism and business services, have continued to recover strongly. In Maldives, tourism now exceeds pre-pandemic levels, as tourism from China has increased sharply in recent months. In India, the services sector is the fastest-growing sector, together with the construction sector, which has been boosted by new government priorities. And lastly, most South Asian countries have finally started fiscal consolidation by reducing inefficient subsidies, raising tax revenues, and tightening expenditures. In Bangladesh and Sri Lanka, fiscal consolidation is supported by recently agreed IMF programs, while negotiations in Pakistan are ongoing.
However, these positive developments only mitigate the negative impact of intensified pressures on the balance of payments and the financial sector. Rising global interest rates have caused capital outflows from South Asia, putting downward pressure on the value of their currencies. Uncertainty in global financial markets, with recent bank runs on a few regional banks in the United States and Europe, has the potential to exacerbate imbalances in South Asia’s financial markets. Countries in South Asia with latent non-performing loans following forbearance measures during the COVID-19 pandemic are more vulnerable to spillovers from volatile global financial markets. Loan moratorium programs during the pandemic have delayed the recognition of distressed assets. But non-performing loan ratios have started rising, for example in Bangladesh due to high import costs and weak regulatory enforcement, and in Sri Lanka due to rising rates and increased macroeconomic uncertainties. Increased borrowing by the government from domestic banks has crowded out private credit in Pakistan, while rising sovereign-bank linkages in Maldives, Pakistan and Sri Lanka have further increased the financial sector’s vulnerability.
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