Could the Bali bombs stall global economic recovery?

The bombing outrage in Indonesia has awakened fears that a global campaign of terror could derail a recovery for the world's economy.

Analysts have started to count the economic cost of the terrorist attacks in Bali amid speculation that the doubtless devastating impact on the Asian nation's economy could ripple across the Pacific, and perhaps even further.

What effects will the bombs have on financial stability and economic growth? Will world markets suffer if Indonesia collapses; and will consumer and business confidence crumble in the wake of a renewed terror campaign?

In terms of economic activity, the rebound in growth had already started to splutter and this latest shock will do little to boost confidence. Kenneth Rogoff, the chief economist at the International Monetary Fund, said: "One can think of there being a terror tax on the global economy." He warned of a repeat of the aftermath of the 11 September attacks last year, which triggered a jump in insurance, security and protection costs. "It's plausible that the economic effects on growth next year in the region will be limited," he added. "But that outcome is of course sensitive to how the security situation evolves, how policy responds and above all what the effects are on business and consumer confidence, domestically and in the rest of the world."

Meanwhile, share prices across the region suffered another volatile trading day after falling sharply on Monday. Indonesian shares failed to make up much of the 12 per cent lost the previous day while markets in the Philippines and Malaysia closed lower. On the currency markets Indonesia's central bank intervened to prop up the rupiah after Monday's 4 per cent fall, while the Singapore dollar, Thai bhat and Philippine peso all fell. The strains on South-east Asia's financial markets prompted flashbacks to 1997 when those Asia nations became the first victims of the financial crisis that came within a whisker of bringing down the entire global economy. But this time there was little sign of any domino-effect sweeping the world, where most markets continued to mount a solid recovery on the back of growing optimism that the worst is over for the world economy.

There was wide agreement that the bomb blasts would have a severe impact on the Indonesian economy. Analysts said tourism and foreign investment would be hit as fun-seekers and profit-hunters sought safer destinations. Caroline Bain, the senior Asian economist for the Economist Intelligence Unit (EIU) in London, said: "It takes Bali out of action for a couple of years and could wreck its position as a tourist destination."

The 4 million tourists who arrive every year provide 6 per cent of Indonesia's foreign exchange earnings, of which the majority comes from Bali. Tourism revenue fell 18 per cent in dollar terms in 1998, when Indonesia was racked by political infighting. Foreign direct investment (FDI) has dried up in the wake of the Asia crisis, ethnic and political infighting and the fall of President Suharto in 1998. Indonesia's FDI fell 11 per cent between January and September to $5.4bn (£3.5bn) over the same period last year.

Meanwhile, 40 million of the 210 million population are unemployed, inflation is running at 10 per cent and the government had bet on a solid rise in economic growth to fund budget plans. The EIU had forecast a rise in FDI next year, bringing in much-needed overseas capital, but Ms Bain said investors would be wary of committing cash "for some time to come".

The country is labouring under a foreign debt burden of about $130bn – equivalent to its entire annual economic output – making it vulnerable to sudden economic shocks. Mahathir Mohamad, the Prime Minister of neighbouring Malaysia, warned the outrages would scare foreign investors away from the whole of South-east Asia.

"It will affect the investment climate because people feel now more insecure," he said.

Ms Bain said that a shortage of foreign cash would increase worries over Indonesia's debts. This in turn could drive the rupiah down further, exacerbating the existing inflation problem and forcing the central bank to put up interest rates. The rupiah has fallen 3.2 per cent in October, the worst performance among global currencies.

Julian Jessop, a global economist at Standard Chartered bank, said while the bombs would impact on the local economy, it was unlikely to trigger a global reaction.

"People will still look for places where production costs are cheap and, while it is inappropriate to talk of winners or losers, they are simply more likely to look at countries like China and Vietnam," he said.

Ms Bain said contagion from Indonesia's economic woes was likely to be limited to countries such as Thailand that also depended on tourism. Few Asian countries had Indonesia's debt problem, she added.

However she warned a longer-term concern would be that Indonesia could find itself isolated from the global community if it failed to tackle Islamic terrorism within its borders. "The US has turned a blind eye so far but if the government does not give the right response then it could jeopardise its relationship with the IMF and they could be looking at default," she said.

If Indonesia defaulted on its debts to western creditors that could lead to a repeat of the emerging crisis triggered by Argentina's decision to default on its debts. So far that looks unlikely with the IMF and the World Bank pledging support for the Indonesian government.