In the Tsunami's Wake

March 1, 2005 Topic: Economics Regions: Asia Tags: Baltic SeaDebtFinancial CrisisAsian TigersEuro

In the Tsunami's Wake

Mini Teaser: It was a human tragedy, but not an economic disaster.

by Author(s): Anjalika Bardalai

It would have been reasonable, upon hearing the news of the earthquake-induced tsunami that devastated South and Southeast Asia on December 26, to wonder at the unfairness of disasters so often striking those countries that are least equipped to deal with them. Bangladesh and China are flood prone; severe earthquakes have recently struck Central America, Turkey, India, Algeria, Afghanistan and Iran. Although Southeast Asia has been spared dramatic floods, cyclones or earthquakes in the past several years, the region suffered prior to the tsunami from multiple occurrences of avian flu, outbreaks of Severe Acute Respiratory Syndrome (SARS) and devastating terrorist attacks.

The strongest immediate impact of the tsunami will of course be felt in the staggering numbers of people lost: at least 160,000 in Indonesia, 31,000 in Sri Lanka, 10,000 in India and 5,000 in Thailand, according to the government figures available in mid-January. One could easily imagine that the indescribable human tragedy would be compounded by an economic one: A country like Indonesia that has slowly struggled to rebuild its economy after the regional financial crisis of 1997-98 suddenly sees years of effort undone in the space of a single day. Natural disasters are profoundly humbling in their ability to take lives and leave survivors utterly impotent--but their effect on economics is far more restricted. Good governance, planning and intervention can ensure that survivors do not suffer economically as well as emotionally. In this case, it is largely the generosity of rich countries that will ensure that, however the humanitarian crisis plays out, the economic damage from this disaster will be relatively short lived. To be effective, foreign assistance will have to be nuanced. Rich countries' offers of loans, grants and debt suspensions will vary by country, since the nations affected by the tsunami have vastly different economies.

For Sri Lanka, whose economy (much smaller than that of Indonesia, Thailand or India) would have had an extremely difficult time absorbing the impact of the disaster, direct aid is critical. Its government was already running a budget deficit of more than 8 percent of GDP before the tsunami. Were the financial responsibility for reconstruction to rest with it, the country would almost certainly face a prolonged fiscal crisis. In addition to a loan program for 2005-06 offered by the Asian Development Bank in November 2004, Sri Lanka has accepted tens of millions of dollars in donations and loans. Most of that country's estimated $1.5 billion reconstruction cost will come from this external aid.

In addition to direct aid, the provision of debt suspension will also limit the timeframe for economic disruption. The Paris Club of creditor nations offered countries affected by the tsunami a three-month moratorium on debt payments. This may be extended to one year, based on further assessments of the damage. As both Sri Lanka and Indonesia were facing large debt-service obligations in 2005, the move had the potential to save their governments hundreds of millions of dollars this year.

The main danger, as with the extension of loans, is that countries benefiting now from the suspension of debt will face larger payments in the future. Indonesia's government, in an unusual display of prudence, made it clear that it was mindful that the rest of the world would form opinions of the country's standing and stability--and thus its attractiveness as a destination for foreign investment--based on how it reacted to the offer of debt suspension. Towards the end of January, Economic Minister Aburizal Bakrie made the surprise announcement that Indonesia would not accept the offer of the debt freeze and would continue to pay off its debts on schedule.

Sri Lanka, on the other hand, not only embraced the Paris Club's offer, but indicated that it would simply prefer that its debts be written off altogether. An aide to President Chandrika Kumaratunga said, "We are not looking at numbers at the moment. We are talking about principle. The principle here is that there is a significant capital cost for reconstruction." Though the Paris Club is unlikely to accept Sri Lanka's proposal, even a suspension of the island's debt will allow government funds that might be destined for debt repayment to be used instead for reconstruction and humanitarian aid--seriously reducing the possibility of a tsunami-induced economic shock in the country.

The issue of direct aid is more complex in Indonesia, however. To be sure, the promised foreign assistance totaling $5.1 billion (in grants and soft loans) will be crucial not only in offsetting reconstruction costs, which the government has estimated at $4.5 billion, but in providing some budgetary support. Indeed, it is possible that Indonesia may be able to post a small budget surplus in 2005 on the basis of foreign aid, after running deficits for eight consecutive years.

Yet the sheer volume of incoming foreign aid is likely to present special challenges over the longer term. In a country that had been taking slow but important steps towards economic and fiscal reform, the sudden inflow of money may tempt government officials to delay further reform measures or to relax its oversight of the country's fiscal position. This would, of course, present substantial dangers to the economy over the longer term. Early indications are that Indonesia is showing itself to be a model of responsibility. In rejecting the offer of debt suspension, for example, it also liberalized banking regulations to free up more money for infrastructure development. Yet there remains a caveat: In a country that Transparency International ranks the twelfth most-corrupt country in a survey of 133, the possibility that executives and officials might simply pocket this well-allocated money is very real.

The challenges are compounded by the fact that some two-thirds of the promised foreign aid to Indonesia took the form of loans, not grants. These loans, while certainly necessary and welcome in the short term, will merely increase the government's debt obligations down the road--no small consideration in a country whose foreign debt was equivalent to some 55 percent of GDP even before the tsunami. These same issues are likely to present themselves in Sri Lanka (which also had foreign debt equivalent to about 55 percent of GDP prior to the tsunami), although there the need for structural reform is less acute.

Thailand, however, will be far less reliant on foreign aid for the simple reason that donors will be less generous with it than with other nations affected by the tsunami. With a much larger economy than either Indonesia or Sri Lanka, and a much wealthier society, Thailand was bound to see much smaller inflows of aid than its neighbors. In any event, the government, buoyed by strong economic growth over the past several years--and likely courting nationalist sentiment ahead of elections scheduled for early February--has not expressed much interest in foreign aid, preferring to demonstrate its self-reliance. It too refused the offer of debt suspension, and the government will bear much of the estimated $330 million in damages itself. It has so far committed $1.5 billion for reconstruction and disaster relief, authorized an emergency soft-loan program, and granted tax breaks to businesses in the affected areas. It has also proposed some indirect assistance in the form of tax breaks in foreign markets for Thai products. Prime Minister Thaksin Shinawatra claimed that several countries have already agreed to temporarily restore Thailand's GSP (Generalized System of Preferences) status, which had been revoked in 2001.

India too, with an estimated $1.5 billion in damage, has rejected most foreign aid. Its nationalist pride is largely warranted--the country's strong and relatively diverse economy can absorb the impact of the tsunami far more easily than its neighbors. India's major industries, such as agriculture, manufacturing and information technology, were untouched by the disaster. In addition, the two states most affected by the waves, Andhra Pradesh and Tamil Nadu, are among the wealthiest and best-governed in India, so rehabilitation and reconstruction efforts should be well managed and efficient.

The countries affected by the tsunami should thank fate as much as their generous foreign donors for ensuring that the economic damage wrought by the disaster will be limited in duration. If anything about such devastation can be considered fortunate, it is that the urban business and industrial centers in the nations affected were left mostly unscathed. Not only did that limit the already staggering number of deaths--one has only to imagine how much higher the death toll would have been had Jakarta or Bangkok or Bombay taken a direct hit--but it ensured that the economic price exacted will be far smaller than if these countries' major industries--oil and gas in Indonesia, tea plantations in Sri Lanka--had been destroyed. Industries and areas that were affected are small contributors to the macroeconomy: Fishing comprises just about 2 percent of Thailand's GDP and 3 percent of Sri Lanka's, for example, and the Indonesian province of Aceh, which suffered the greatest impact, contributes just 4 percent of the country's GDP (almost all of which is generated by a liquefied natural gas plant, which emerged undamaged). Even tourism, which will suffer while beach resorts are rebuilt, accounts for just 4.6 percent of GDP in Sri Lanka. Tourism will not be affected in Indonesia, since that country's resorts were completely unaffected.

Essay Types: Essay