Worst-case scenario: stagflation

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The ASEAN+3 Macroeconomic Research Office (AMRO) said on Monday, during its press conference on its ASEAN+3 Regional Economic Outlook 2026 report, that “if the (Middle East) conflict escalates and oil prices stay above $100, the impact would be far worse. Scenario analysis suggests regional growth could fall by 0.3 percentage points, while inflation could rise by 0.8 percentage points, relative to the baseline.”

This would be the worst-case scenario, which AMRO chief economist Dr. Dong He was quick to assure, “We are not predicting a stagflation scenario. That’s not our forecast. The region would still be able to grow and inflation is not, sort of out-of-control scenario. So we don’t see that worst outcome as part of the scenario analysis yet.”

However, according to the AREO 2026 report, “A prolonged conflict would trigger cascading and non-linear effects. Energy shortages would disrupt industrial inputs and spill into petrochemicals, packaging and fertilizers. Costs would then pass into services and food prices, reinforcing inflationary pressure.”

The report said that “as these channels compound, the total impact could exceed the sum of its parts. This is the nature of a persistent supply shock — it does not stay in one lane. Some economies could also face weaker tourism and remittance flows, while renewed trade tensions or a sharper global slowdown would add further strain.”

“These risks are real and should not be understated. But the region confronting them today is structurally different from the one that faced earlier energy shocks,” the AREO report said. “ASEAN+3 today is structurally more resilient. Energy required to produce a unit of GDP has fallen by 20 to 30 percent since 2000. Power systems have diversified, and electric vehicle adoption is accelerating. These changes weaken the transmission from oil prices to growth – though the current shock has exposed gaps that remain.”

The transformation, the report warned, “runs deeper than energy. Over the past two decades, regional production networks have evolved into a dense and sophisticated architecture where the technological capabilities of Japan and Korea, the dynamism of ASEAN and the scale of China reinforce one another.

“On the demand side, ASEAN+3 has emerged as the world’s largest market, accounting for 28 percent of global final demand. The share of value-added exports absorbed within the region has risen to nearly 30 percent, while reliance on the US has declined to around 20 percent.”

According to the report, “Against such a changed structural background, the central policy priority in the short term is to avoid worst-case outcomes such as stagflation.”

Stagflation is defined as an economic condition characterized by slowing economic growth, high unemployment and rising prices (inflation) simultaneously. Named in the 1960s, stagflation shattered long-held economic theories when it emerged during the 1970s oil crisis.

Fiscal policy, the report said, “has a complementary role. Targeted support for vulnerable households and exposed sectors can help cushion the real income shock. What should be avoided are broad-based price suppression measures that could undermine fiscal sustainability. Above all, responses must remain state contingent. The nature and persistence of the shock – not its headline severity – should determine the policy stance.”

It added that “Looking beyond the short-term, the energy shock underscores that the green transition is critical to macroeconomic resilience. Diversifying energy and input sources, accelerating electrification, strengthening strategic reserves and keeping regional trade open are not separate priorities – they are elements of a single resilience strategy.”

Thus, the report stressed, “Deepening regional cooperation remains ASEAN+3’s strongest collective asset. For ASEAN, this means moving beyond trade liberalization to build denser intra-regional investment links and a more balanced, resilient production base.The path ahead will test these foundations in real time. But if policymakers preserve their flexibility, maintain fiscal discipline and continue to deepen the cooperation that underpins the region’s collective strength, ASEAN+3 is well positioned to navigate this shock – and emerge more resilient for what comes next.”

Philippines: Most vulnerable?

At the press conference following the online briefing, AMRO chief economist Dr. Dong He admitted that in ASEAN, “the Philippines is very dependent on oil and gas imported from the Middle East. More than 90 percent comes from that region. So it is a bit more dependent compared with other economies. For example, Singapore has more diversified sources of imports.”

He continued that “in terms of starting position, as I mentioned earlier, some of the economies start from a position of very low inflation. The region as a whole has stable and low inflation. For example, Thailand is quite dependent on oil and gas imports as well, but its inflation was very low last year. So in that sense, it could let prices go up without necessarily reacting from a monetary policy point of view. So from that point of view, they can, on the policy side, there’s some room to react to this inflationary impact.

“In some other economies like the Philippines, inflation is a bit at a higher end of the target range. So maybe policy is a little bit more constrained on that side. So too is Japan. Japan’s inflation is a little higher than the BOJ target. So any further increase might create more pressure from the policy side. So when we analyze the individual impact on individual economies, I think all economies have some vulnerabilities, but as a whole, I think many economies still have a lot of policy space to deal with.”