Andrew Marshall

Economic Impact Of Terror Attacks Often Short-Term

Singapore. If the suicide bombers who targeted two luxury hotels in Jakarta this year hoped their attacks would strike a significant long-term blow against Indonesia’s economy, the reaction of financial markets suggests they were wrong.

Economic warfare is at the heart of the tactics of terrorism. A few militants with primitive and low-cost weaponry can cause economic destruction that reverberates far beyond the physical damage they inflict, impacting whole industries and countries.

But the overwhelming evidence from militant attacks over recent decades is that the impact is almost always temporary.

In the long run, economies and markets are remarkably resilient.

From the hijacked airliner attacks in the United States on Sept. 11, 2001, to the suicide blasts at nightclubs in Bali in 2002 and the Madrid and London train bombings of 2004 and 2005, markets have reacted in a highly consistent pattern.

Domestic equities, bonds and the local currency suffer a knee-jerk sell-off. Risk appetite drops sharply and there is a swift flight to quality, with investors seeking the sanctuary of US Treasuries, and sometimes selected commodities and gold.

But within weeks — and usually days — asset prices recover. In the first trading session after the 2002 Bali bombings, the Jakarta stock market plunged more than 10 percent and the rupiah dived 3.7 percent. But within 24 days, stocks were back at pre-attack levels, and the rupiah recovered within 5 weeks.

Subsequent bombings in Indonesia had far less impact even in terms of short-run reaction. After the hotel blasts in July, stocks sank 2.7 percent but ended trade just 0.6 percent down.

So what are the lessons for investors and risk managers?

Firstly, the initial market impact from terror attacks is likely to be overdone and to unwind over subsequent days.

The reasons can be found in human nature — behavioral economists have shown that people tend to be naturally risk averse and prone to panic and a herd mentality in the face of uncertainty and danger.

For bold investors, asset price weakness in the wake of militant attacks is a buying opportunity.

Second, once the initial panic eases, investors take a more rational look at the medium-term economic impact.

The direct economic impact in terms of physical damage and loss of human capital is much less of an issue than the question of whether the attacks have spill-over consequences that magnify their cost.

Thirdly, the micro-impact of attacks can be more serious than the macro. While economies are resilient, sectors such as airlines, tourism and insurance are much more vulnerable. Portfolio diversification can reduce this risk.

Finally, the extent to which attacks have a long-term market impact on industries and countries depends on whether they cause investors to re-evaluate their long-term risk assessments.

The 2002 Bali bombings fundamentally changed perceptions of Indonesian risk for investors and tourists. Later attacks had less impact because the higher risk level was already priced in.

In the Southeast Asian context, this means that even if militants in Indonesia or the Philippines are able to launch new attacks, the risk for portfolio investors is limited. A much more significant issue would be if the risk profile of other countries in the region changed dramatically.

Thailand, Singapore and Malaysia are key flash points — the risks that militants launch damaging attacks on major economic or tourist targets is widely regarded as low, but the long-term economic impact would be disproportionately high.

For Indonesia and the Philippines, many of the risks are on the upside — if either country can demonstrate it is making sustained progress on reducing the threat from terrorism, country risk ratings will be revised in a favorable direction.

However, this does not make Indonesian or Philippine markets immune from negative terrorism risk.

Indonesia has been a highly bullish story for investors this year due to improved economic and political stability, and expectations that President Susilo Bambang Yudhoyono, newly returned for a second term, will pursue much needed market-friendly reforms and crack down on graft.

But risk analysts worry that Indonesia’s progress is highly dependent on Yudhoyono’s personal power and popular support. He has no obvious successor who would have the power base and determination to maintain stability and continue reforms.

After the July bombings, police said they had foiled a plot by militants to launch a suicide minibus attack on the president near his residence.

Were such an attack ever to succeed, it would profoundly impact Indonesia’s future.

Reuters

Your View

See Result