Impact of political and economic crisis in Europe on emerging South Asian countries

Published On: August 16, 2022 08:22 PM NPT By: Laurent Bracqbien

South Asian countries are suffering the consequences of a tense and unstable global economic situation, with multiple causes, including the war in Ukraine. The soaring inflation widens budget deficits and empties the coffers of the countries in the region, often already very dependent on the outside for their oil and food supplies. If, in the face of inflation, global actions are beneficial in the short term, they threaten the independence of certain countries and unsettle governments, shown by the examples of Nepal and Sri Lanka.

As the COVID-19 crisis continued to weigh on Asian countries, including China, the first half of 2022 was marked by a gloomy and uncertain global economic situation(1), as well as risks of degradation that have materialized, related to the combination of several factors.

The war in Ukraine has erupted and intensified, with a significant impact on the price of energy and food that could last over the long term(2). Pandemic disruptions and sanctions against Russia create challenges in global supply chains that weigh on economic activity. Furthermore, the tightening of financial conditions is greater than expected. On June 15, the Federal Reserve System (Fed) raised its key interest rates by three-quarters of a percentage point, which is the largest increase since 1994(3). Borrowing on world markets is now more expensive and economic austerity is gaining ground.

In South Asia, the impact of these events is visible in economic and political terms, especially for emerging and developing countries. Record inflation hits all countries in the region and threatens the post-pandemic economic recovery(4). For emerging countries, there is also a flight of capital which accentuates the economic and political risks.

In Nepal, a country heavily dependent on imports, mainly because of its geography, the trade deficit is abysmal. The country imports more than 40 percent of its consumption needs and 100 percent of its fuel needs(5). In 2021, it had already reached €14 million(6) (46% of GDP) and the first figures for 2022 suggest that it will widen even further this year, which will lead to the rapid melting of foreign exchange reserves.

In this context, foreign influences are increasingly being felt. In particular, the United States has a powerful lever for action in the region, thanks to the Millennium Challenge Corporation (MCC), a $500 million grant that finances infrastructure projects which Nepal fears will be reduced by war. Thus, at the United Nations General Assembly, the American resolution against the Russian invasion in Ukraine has found the support of the Nepali ally, affirming that territorial integrity was a “sacrosanct” principle.

In Sri Lanka, the President fled the country on July 13th on a military plane to the Maldives(7), against a backdrop of unprecedented economic and political crisis, and a state of emergency has been declared. The island nation, which has been suffering for several months from an unprecedented shortage of basic necessities (medicines, food, energy), and its 22 million inhabitants, suffer from runaway inflation and prolonged power cuts. The main food, rice, saw its production drop by half last year. The new crop was affected by fertilizer shortages, due to the lack of foreign currency which has stopped imports of many products including fertilizers.

For the first time in its history, the government has been preparing its people for austerity measures to get help from the International Monetary Fund (IMF) since last spring. An economic crisis that quickly turned into a social and political crisis: for months, demonstrators have been camping outside the presidential seat in Colombo to demand the resignation of the President, whom they accuse of mismanagement. Could this scenario be repeated elsewhere in South Asia and affect other emerging economies weakened by the consequences of the war in Ukraine?

Some analysts are already anticipating such a scenario. “In the next 18 months, we are going to have, all over the emerging world, extremely difficult situations linked to the explosion of inflation, especially in the late-run regimes, which will result in economic crisis, becoming social and political crisis,” says Jean-Joseph Boillot(8), specialist in the Indian economy and advisor for emerging countries at the IRIS (Institut de Relations Internationales et Stratégiques, based in Paris).

Due to the critical inflationary situation in which we find ourselves, the short-term urgency for South Asian central banks is to lower inflation and protect the most vulnerable (food, fuel) through a determined fiscal policy, which also requires a trust that some governments have lost. To regain room for maneuver, the support of global financial institutions (such as the IMF) is undoubtedly essential and will make it possible to carry out this effort. But in the long term, this situation is also, for some countries, an opportunity to develop their strategy of influence in South Asia. This is the case with the United States, in exchange for financial assistance, or even with Russia, in exchange for its raw materials. As often during a crisis, economics and politics go hand in hand.

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