By Leika Kihara
(Reuters) -The International Monetary Fund (IMF) raised Asia's economic forecast on Tuesday as China's recovery underpinned growth, but warned of risks from persistent inflation and global market volatility driven by Western banking-sector woes.
The reopening of China's economy will be pivotal for the region with the spillover to Asia seen focused on consumption and service-sector demand rather than investment, the IMF said.
"Asia and Pacific will be the most dynamic of the world's major regions in 2023, predominantly driven by the buoyant outlook for China and India," the IMF said its regional economic outlook report.
"As in the rest of the world, domestic demand is expected to remain the largest growth driver across Asia in 2023."
Asia's economy is expected to expand 4.6% this year after a 3.8% increase in 2022, contributing around 70% of global growth, the IMF said, upgrading its forecast by 0.3 of a percentage point from October.
China and India will be key drivers with an expansion of 5.2% and 5.9%, respectively, though growth in the rest of Asia is also expected to bottom out this year, the report said.
But the IMF cut next year's Asian growth forecast by 0.2 of a point to 4.4%, and warned of risks to the outlook such as stickier-than-expected inflation, slowing global demand as well as the impact of U.S. and European banking-sector stress.
"While spillovers to the region from stress in U.S. and European financial sectors have been relatively contained thus far, Asia remains vulnerable to tightening financial conditions and to sudden and disorderly repricing of assets," the IMF said.
And while Asia has strong capital and liquidity buffers to fend off market shocks, the region's highly leveraged corporate and household sectors are "significantly" more exposed to a sharp increase in borrowing costs, it added.
The IMF also urged central banks in Asia - excluding Japan and China - to keep monetary policy tight to bring down inflation, which could remain stubbornly high due in part to robust domestic demand.
"The costs of failing to bring inflation below target are likely to outweigh any benefits from keeping monetary conditions loose," the IMF said.
"Insufficient tightening in the short term would require disproportionately more monetary tightening later to avoid high inflation becoming ingrained, making a larger contraction more likely."
While China will be a key driver of the region's growth, the country's property sector remains a risk that policy makers need to address to ensure an even recovery in the sector, the IMF said.
Recent moves by the government to ease financing to developers had largely benefited bigger developers. Still, regions in China with smaller, weaker players had yet to show signs of a recovery, said Thomas Helbling, deputy director of the Asia and Pacific Department at the IMF.
"While the government's (recent) effort has stablised the market, it should proactively support the restructuring of weaker developers which are still suffering," said Helbling at a media briefing in Hong Kong.
China's policymakers have been trying to stabilise the sector that accounts for a quarter of national GDP after a string of defaults among developers and a slump in home sales.
"For regions with weaker housing markets the recovery has yet taken place. We need further policy measures to limit potential risks," said Helbling.