Economic Impact of Asian Tsunami Tragedy

Experience Suggests a V-shaped Economic Impact

Previous disasters give us some insight into the likely economic impact of this tragedy. Last year's SARS epidemic, the 2002 Bali Bombing and the Kobe earthquake in Japan almost a decade ago give us some insight into how the economic impact of natural disasters unfolds.

There tends to be a V-shape economic impact - a large dip in economic activity followed by a policy response that tends to involve increased government spending, leading ultimately to economic recovery in a year or so.

Clearly the scale of this disaster is far greater and impacts more countries, but the profile may well be the same; initially, a huge economic setback, followed by a strong policy response and economic recovery.

Direct and Indirect Costs to Hit Growth

The immediate economic impact tends to be direct, with negative effects on consumption and business activity in the regions and sectors affected. The direct economic impact in this case is likely to be concentrated on tourism and fishing in the coastal areas affected.

The wider, indirect impact is harder to predict. For instance, following the Bali bombing there was a wider, negative impact on tourism across Indonesia, but conversely some benefit to tourist sectors in Thailand and Malaysia as tourists changed plans.

After the Kobe earthquake, there was a wider negative impact on business confidence in Japan. Similarly after this disaster there will be a wider negative impact, as tourism and consumer and business confidence is impacted by the scale of the disaster. Not only is tourism important, but also for many countries this is the peak tourist season, compounding the impact.

While the tourist sector is a similar size of both Indonesia's and Sri Lanka's economies, the impact is likely to vary considerably. In Indonesia the main tourist areas of Bali and Lombok are not impacted.

In contrast, the extent of the devastation on Sri Lanka suggests its tourist sector and economy will be hit harder. Given the size of the economies and the scale of the disaster, it is the Maldives and Sri Lanka that are worst affected in economic terms, although all countries will be impacted.

Asia's Bigger Economies to Rebuild Quickly

In recent years, the world economy has shown a remarkable resilience to economic, financial and terrorist shocks. Asia, too, has been resilient, as evident from last year's SARS outbreak. The bigger economies impacted by this disaster will be resilient, while the smaller ones will need more assistance.

Experience suggests the policy response will be key. In Bali, for example, the Indonesian government moved quickly to rebuild the local economy and spent significant amounts in promoting tourism. After Kobe, there was huge infrastructure spending.

Similar experiences have been seen after other natural disasters. Of course, the scale of this disaster is huge in comparison, suggesting the policy response not only needs to be speedy but significant in size. Clearly some economies will be more resilient and governments better able to respond.

The immediate response is of course likely to be humanitarian in focus. The rebuilding of coastal infrastructure will take far more time. It will need effective planning and could be costly. Also, often bottlenecks mean that spending on construction has to be phased.

For the region in general, the rebuilding process will be greatly helped by the current economic and political climate. Following three years of strong growth, the economies of India, Indonesia, Thailand and Malaysia are in a strong position to overcome the tragedy.

For these countries, recent growth has been strong, fiscal positions have improved and external reserves are high. The shock absorber in economic terms is likely to be government fiscal positions. For instance, ahead of the forthcoming general election, the Thai government was already planning huge government spending.

This disaster provides the justification for even more, and concentrated in the coastal regions affected. In India and Indonesia, governments elected earlier this year, will be keen to demonstrate their effectiveness. Moreover, the economic shock may encourage central banks in these countries to delay rate hikes - notably in Thailand and India.

Sri Lanka and the Maldives Face Huge Challenges

In contrast, Sri Lanka and the Maldives face significant difficulty in overcoming the disaster on their own. The timing of the tragedy is particularly bad news for Sri Lanka's economy that was already facing a number of challenges. Its textile manufacturing is already under threat due to the ending of the Multi-Fibre Agreement's quota system as of January 1st, 2005.

Now, the loss of tourism revenues will worsen its deteriorating current account deficit. The government's ability to cope with the disaster will be further hampered by a severe lack of available public funds due to its large budget deficit.

In the Maldives, the problems are potentially more widespread as it wholly derives tax revenue from customs, tourist and property taxation. With its tourist economy in disarray, the Maldives will be heavily dependent upon international aid.

Thankfully, the response from international agencies and governments across the globe has been swift. However, even given that support, the economies of the Maldives and Sri Lanka face severe difficulties adjusting to the sheer scale of the disaster.

National, Regional and Global Response is Key

The policy response to this disaster needs to be simultaneously national, regional and global in nature. It must be national in that governments will be expected to respond with increased spending to address immediate problems and rebuild local infrastructures.

It must be regional in the sense of the need to coordinate in the same way in which many countries cooperated in response to last year's SARS epidemic.

Finally, it must be global in that some of the poorer economies impacted will need greater assistance from outside. The United Nations has already indicated it will launch an immediate aid appeal. Longer term, there may be the need for assistance with infrastructure spending.