Earthquake effect on Japanese Economy

Posted in Finance Articles, Total Reads: 6630 , Published on March 20, 2011

Earthquake and subsequent devastating tsunami has left deep scars on Japan.  The economics of natural disaster is very difficult to write as there are thousands of people who have lost their lives. Writing about economics becomes insensitive but unemotional and rational economic facts suggest that this disaster will have significant effect on Japanese economy.  With impending nuclear disaster looming large, the extent of economic damage is uncertain. The Japanese would have to rise together but it wont be easy.

Japan Earthquake's effect on its economy

Japanese economy reeling under the US recession, as of fourth quarter last year was still shrinking. It was expected that Japanese will start growing again by first quarter this year.  With this catastrophe, this recovery will be delayed. The earthquake and tsunami has affected an area which constitutes around 8% of Japanese economy. But there will be ripple effects of this in other parts of the country as well. For example, the loss of electricity generation at several nuclear reactors will dampen activity in oth¬er parts of the country for some time. Nuclear power forms around 25% of the total electricity generation in Japan. Pro¬duction supply-chains and/or transportation of goods and services could also be disrupt¬ed.

In case of manufacturing, for example Toyota, one plant shutting down can have ripple effect across other plants which use those parts. Just in time inventory which originated from Japan could cause problems in future because of low inventories and problems in transportation. Japan exports more than it imports. The demand of goods comes from outside the country. The demand from other countries is not going to drop because of earthquake. So this works in favor of Japanese economy.

Japan’s fiscal situation Is worst among the industrialized nations. The government has a gross debt-to-GDP ratio of 210%, a net debt-to-GDP ratio of 120%, and it is currently running a fiscal deficit of about 8% of GDP.  Approximate cost of reconstruc¬tion will be around US$ 200 billion, which is roughly 3.7% of Japanese GDP. Assuming one fifth of those damages will be covered by insurance companies, this would still leave the Japanese government with a fiscal cost of close to 3% of GDP, which is significant, but should not prompt a fiscal crisis. The impact on the fiscal deficit will be incremental, as not all the reconstruction spending will be done at once. As the country recovers from the shock, stronger economic activity will also translate into rising fiscal receipts. 85% of Japanese debt is held by Japanese citizens. Due to the high personal savings rate, it is the Japanese people that determine the borrowing ca¬pacity of the government. It will be very difficult for Japan to borrow from outside due to exacerbated fiscal situation. Either they will have to sell their investments in US treasuries or they will have to print the money. This may trigger inflation.

The earthquake has had a prominent effect on yen, Japanese currency. The explanation is that Japanese insurance companies are expected to have to sell foreign assets and repatriate funds to pay for the insurance policies. With demand for yen increasing, this will appreciate yen. Hedge funds investment which borrowed yen and invested in higher yielding currencies like AUS$, was a profitable investment as long as rate of appreciation of yen < interest rate in the target currency.  However, the recent crises had hedge funders become wary and start unwinding their technical position. As a result, yen became more expensive, which altered the original yen appreciation < rate of return equation. A positive feedback loop ensues.

Oil prices have dipped as well, but this is after having increased amid the political instability in the Middle East and North Africa. The pullback in oil is a reflection of the fact that Japan is a major oil-importing nation. If economic growth in Japan is weaker-than-anticipated, it supports a lower price for crude.

Lastly, earthquakes tend not to be that devastating in the long run. Confidence is a major driver of economic activity. When consumers and companies get nervous they spend less and that can cause recessions. But earthquakes do not hit consumer confidence because earthquakes are specific events and the scope of the damage is usually known pretty quickly, if not the eventual cost.

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