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The cost of a quake

Tokyo - A triple blow of earthquake, tsunami and one of Japan's worst nuclear accidents is set to damage the world's third-largest economy, possibly more deeply and for longer than initially expected.

Power outages and possible tax rises are likely to hurt companies and households and could outweigh the mild economic aftershock from the 1995 Kobe earthquake, given that oil prices and the yen are stronger and Japan's debt pile is much bigger.

Rolling blackouts started on Monday, affecting businesses and households as the country grapples with its worst crisis since World War Two. More than 1 million people are without water or power, and towns have been wiped off the map.

Already saddled with debt that is double the size of its $5 trillion economy and threatened by credit downgrades, the government is discussing a temporary tax rise to fund relief work.

Nikkei futures extended losses on Monday, even after the Bank of Japan announced an increase in its asset buying programme, falling more than 7% at one stage before closing at 9,460, down 6.98% on the day.

In the cash market, a record 4.88 billion shares changed hands on the Tokyo Stock Exchange's first section as investors dumped shares after a devastating earthquake and tsunami struck northern Japan last Friday.

Japan's central bank pumped a record 15 trillion yen ($182bn) into the financial system on Monday and doubled its asset purchase scheme to buffer the economy from Japan's strongest-ever quake.

"We will take every possible measure, including providing liquidity, to ensure the stability of financial markets and smooth settlements (of business deals)," a bank spokesperson said.

Japan's economic growth is in a better profile than it was when the Kobe quake struck. But many say a noticeable hit to gross domestic product (GDP), which was only just recovering from contraction at the end of 2010, is likely to be felt over the next several months.

"When we talk about natural disasters, you tend to see an initial sharp drop in production... then you tend to have a V-shaped rebound. But initially everyone underestimates the damage," said Michala Marcussen, head of global economics at Societe Generale.

"Power supply is a critical factor. If power production output is damaged in a sustainable fashion, that could have a durable impact on the economy."

Tokyo Electric Power Co said on Sunday it may have to conduct rolling blackouts in winter, in addition to summer.

"The earthquake will bring lots of things to a halt. We are going to see quite a dent on GDP, blackouts will lead to a sharp contraction of production," said Janwillem Acket, group chief economist at Julius Baer.

He estimated the damage would be felt for two quarters, but it was not likely to knock the economy back into recession.

"We know public finances are already weak, much weaker than they were during Kobe. Pressure for emergency tax hikes is there. But I don't think the economy will go back to recession."

Growth impact

Following the 1995 Kobe earthquake, the economy shrank by 2%, followed by a V-shaped recovery. Back then, oil prices were hovering around $17 to $21 a barrel while the yen - key to exporters - was at around 100 per dollar when the quake hit.

Currently with oil prices at near a two-and-a-half year high above $100 and the Japanese currency at a stronger 82 yen per dollar, the impact from these two factors alone will be more adverse.

Japan's GDP shrank by an annualised 1.3% in the fourth quarter. A Reuters poll published before the quake showed it was likely to expand 0.5% in Q1, or about 2% on an annualised basis.

"The Japanese economy is now likely to take longer than we expected to exit its current lull. We had projected an April-June exit but now forecast July-September or possibly October-December," Nomura said in a note to clients.

Nomura expects the largest negative impact on quarterly real GDP growth will emerge in April to June 2011.

"Based on the experience of the Kobe earthquake, we think a V-shaped recovery supported by a rapid upturn in demand driven by government-funded rebuilding work in the affected areas is also unlikely," it said.

Bank of America Merrill Lynch expects the quake-hit areas account for up to 7.8% of Japan's GDP, compared with 12.4% from the regions affected by the Kobe earthquake.

The bank expects the hit to GDP to be at least 0.2 to 0.3 of a percentage point, although a relatively large amount of spare capacity may offset the production loss.

The yen rose sharply following the Kobe earthquake as Japanese companies repatriated capital, a pattern which may gather momentum in the coming week.

More debt

Another obstacle is Japan's fragile debt position, already double the size of its $5 trillion gross domestic product.

BofA Merrill Lynch expects rebuilding cost could be at least 1.0% of GDP, while Nomura expects the size of any extra budget for rebuilding to exceed 3 trillion yen.

Brendan Brown, economist at Mitsubishi UFJ Securities, said it seems plausible that the debt costs could add between 2% to 10% of GDP to its massive public debt load.

This could hit its credit rating again. Japan was downgraded by Standard & Poor's in January given the lack of a plan to fix public finances, and Moody's has warned it may do the same.

Others also suggested the government may tap into its $1 trillion-plus foreign exchange reserves - the world's second-largest - to finance relief work.

"Normally you don't think about using foreign exchange reserves for this, but it's possible," Marcussen said.

 


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