By Dr. Ganeshan Wignaraja

Developing Asia (hereafter Asia) is famous for engineering V-shaped recoveries following the 1997 Asian financial crisis and the 2008 global financial crisis as well as emerging as a key engine of global growth. The severity of the COVID-19 pandemic has sparked concerns about whether global growth will be V, U, L or I shaped and what it means for Asia.

China, the initial epicentre of COVID-19, accounts for 17.3% of global cases while lagging South Asia has 0.5% (26 March 2020). The rapid transmission of the infection is linked to globalization of the world economy and the advent of global travel. It has triggered a public health emergency and an unexpected economic shock. Stock markets across Asia have tumbled and China-centred global supply chains are collapsing. Travel bans and lockdowns have disrupted daily life. Unemployment and income inequality are rising.

Asia grew at 5.6% in 2019 and in January 2020 the IMF projected that this figure would uptick to 5.8% in 2020. It is premature to assess the full economic impact of COVID-19 on Asia as economic data is lacking and forecasting models are not adequately specified to analyse the disruption from the pandemic. The IMF will update its forecasts during the virtually held Spring Meetings in mid-April 2020.

Projections made in a study on the medium-term outlook on Asia’s growth and the prospects for middle income countries are being updated using leading indicators (e.g. the manufacturing purchasing managers index) in an attempt to predict significant changes in economic activity. Preliminary research suggests two economic scenarios for Asia and world with the depth of downturn depending on the effectiveness in containing the pandemic.

Scenario 1: a short outbreak and a limited economic impact on Asia. The spread of COVID-19 in Asia is checked within a few months through lockdowns, social distancing, virus testing, quarantine and medical treatment. A vaccine is available ahead of schedule. Asia’s growth could be in the range of 4.0-4.5% in 2020. This is above expected global growth of 2.3-2.5%. An upturn in Asia could be likely in 2021. Nonetheless, Asia would fall into recession as defined as two consecutive quarters of decline in a country's real gross domestic product (GDP).

Scenario 2: A long outbreak and a prolonged economic impact on Asia. COVID-19 continues to spread rapidly in Asia, the interventions are partially successful in containing the infection, another virus season could start with new mutations and vaccine development takes longer than expected. The decline in Asia’s growth may be in the range of 2.0-2.5% in 2020 and remain sluggish in 2021. This is worse than the bottoming of Asian growth to 2.8% in 1997 during the global financial crisis. Meanwhile, global growth could slip to 1.0-1.5% in 2020. This would constitute a lengthy recession.

As the pandemic is fast moving with the epicentre spreading from China to Europe, an L-shaped Scenario 2 seems more likely than V-shaped Scenario 1. Amid such a bleak outlook, central banks in Asia have cut interest rates and are buying assets to support financial markets. Governments are also undertaking fiscal stimulus and welfare measures.

Looking at Asian debt dynamics helps to grasp why they are intervening. IMF technical work in the early 2000s conservatively suggested prudential benchmarks on public debt of a debt to GDP ratio of 60% for developed economies and a debt to GDP ratio of 40% for developing economies. While not officially endorsed by the IMF, it was thought that breaching these benchmarks would threaten fiscal sustainability.

With a government debt to GDP ratio of 58.8% in 2019, Asia has exceeded the benchmark for developing countries and is approaching that for developed economies. China’s government debt to GDP ratio of 60.9% in 2019 is argued to significantly understate the total debt to GDP ratio of 303% when corporate and household debt are included. The pandemic has led to concerns about high debt in state-owned enterprises and corporates held in a fragile shadow banking system. South Asia’s government debt to GDP ratio of 66.5% in 2019 also exceeded IMF benchmarks with outliers Pakistan and Sri Lanka at about 80%. Interestingly, there is little evidence of a Chinese ‘debt trap’ due to commercial borrowing for infrastructure projects at least in the case of Sri Lanka. Graduation from concessional aid has left Sri Lanka more dependent on commercial borrowing from international capital markets. The pandemic has left indebted South Asian economies facing a triple whammy of rising borrowing costs, falling commodity prices and declining tourism receipts. This has put pressure on limited foreign exchange reserves and increased the risk of debt distress in South Asia.

The current COVID-19 trajectory points to a scenario of a long outbreak and a prolonged economic impact on Asia. Policy makers should upscale health interventions as well as loosen monetary and fiscal policy to save lives and mitigate a deep recession. In doing so, the risk of a debt shock needs to be factored into the policy calculus.

Dr. Ganeshan Wignaraja is the Executive Director of the Lakshman Kadirgamar Institute of International Relations and Strategic Studies (LKI) in Sri Lanka. The views expressed here are solely those of the author and not be attributed to the LKI or its Board of Management.