Commentary |
4 April 2020

How the virus could stagger Asia's giants

COVID-19 looks set to hit the emerging world hard. For Australia, what happens in India and Indonesia could be most consequential. Originally published in the Australian Financial Review.

Roland Rajah
Roland Rajah

COVID-19 looks set to hit the emerging world hard. For Australia, what happens in India and Indonesia could be most consequential.

The rise of these two Asian giants is central to Australia’s nascent Indo Pacific hopes to counterbalance and diversify away from China’s strategic and economic predominance.

Right now, however, it is India and Indonesia that look to be in trouble while China is doing better.

China appears, for now, to have beaten back the virus while its economic recovery is making headway – even if this remains fraught and far from the V-shaped recovery first hoped for.

India and Indonesia face a more perilous outlook.

The fear is COVID-19 could mercilessly lay bare the reality that, for all their rising economic heft, both remain very much developing countries. Health systems are weak and risk being quickly overwhelmed by the virus. Especially if it spreads within dense slums and poorer areas in major cities or to rural villages with limited access to proper water and sanitation.

Lockdowns, social distancing, and personal hygiene efforts could have much less success slowing the virus. Poverty and informal employment also mean lockdowns – the most extreme solution – are difficult to sustain before people might struggle to survive, or revolt. Ramping up healthcare and social safety nets is critical but an enormous task that could test both countries to the brink.

With some hope, relatively warm climates and youthful populations will help limit the human toll.

If the potential severity of the health crisis is not bad enough, pre-existing fragilities greatly magnify the risk of deep and prolonged economic crises in both countries.

Indonesia has already been one of the hardest hit by the flood of investors fleeing emerging markets. More than US$10 billion has left since late January and in the past month the rupiah has collapsed by 15% – putting it in a similar camp to Mexico, Russia, Brazil, and South Africa (all facing serious problems).

Indonesia’s vulnerability is its reliance on capital inflows and evaporating commodity demand, combined with US$410 billion in external debt, mostly in US dollars. Adding a failure to control the virus would create an even more dangerous cocktail – prompting capital outflows to accelerate and deepening a vicious cycle of falling growth, a plunging exchange rate, and ballooning debt.

India’s problems are more domestic. Its financial system is already a mess and struggling with over US$130 billion in nonperforming loans. Before COVID-19 scared people back into their homes, there was violent social unrest over the central government’s divisive Hindu nationalist policies. Heading into the current crisis, growth was already decelerating fast.

Adding COVID-19 on top will not only cause economic activity to plummet but also heap damage onto an already impaired banking system – accelerating India’s own vicious cycle of collapsing growth, mounting bad loans, and drying up credit to the real economy.

Policymakers in both countries will struggle to provide the kind economic relief packages other major economies are pursuing. India’s consolidated budget deficit was already going to be over 7% of GDP before the virus struck. Indonesia had a much better starting point. But its reliance on commodities and foreign financing, along with the rupiah’s vulnerability, complicate its options.

So far India and Indonesia have announced relatively timid fiscal packages, at just 0.9% and 2.8% of GDP respectively. Central banks have cut interest rates but refrained from going too far too fast to protect their currencies.

Much is uncertain. Bolder policy efforts will surely come. Yet, even an optimistic scenario could see India and Indonesia mired in the economic fallout of COVID-19 for years, especially as corporates and banks grapple with bankruptcies and damaged balance sheets. Financial crises of some magnitude could easily ensue, magnifying the economic and social costs.

What can Australia do?

Indonesia currently looks more vulnerable than India. But both are far too large for Australia to play the decisive role.

The opposite fear that China might instead single-handedly play the role of financial saviour is also unrealistic – its hard currency reserves are not the war chest they once were and must be preserved given the risks China itself faces.

A new US Federal Reserve facility allowing foreign central banks to exchange US treasuries for dollars will help with short-term liquidity. But it can’t solve the fundamental financing problem.

What else? Australia could consider a scaled-up version of the US$5 billion World Bank led ‘standby loan’ facility we joined in 2009 to backstop Indonesia’s access to global capital markets. Having Japan join again while adding America, South Korea and China could yield some serious heft.

Even that might not be enough. And if India and others need help too, the challenge becomes vastly more difficult. The only real solution is beefing up the International Monetary Fund, World Bank, and other multilateral development banks.

The G20 is apparently formulating a plan. They need to deliver soon. And big.