Japan is likely to suffer a temporary economic hit from Friday’s devastating earthquake and tsunami and then enjoy a boost from reconstruction, but the cost of rebuilding will worsen its already worryingly high public debt burden.
While few expect the damage to exceed that of the Kobe earthquake in 1995, when the economy shrank by 2 percent before rebounding even further, the concern is that Japan’s economy is much weaker today. It is also weighed down by the largest public debt among advanced economies, double the size of its US$5 trillion GDP.
Additionally, some economists said the scale of the disaster and its consequences remained far from clear, especially after an explosion on Saturday at a nuclear power plant damaged by the quake that has caused some radiation leakage.
“Not since the Cold War have I been asked to think about the economic consequences of a nuclear explosion in a densely populated area in a modern industrial economy,” said Carl Weinberg, chief economist at High Frequency Economics. “I don’t relish that task.”
However, most analysts said that while Japan’s economy may now not return to growth in the first quarter, it will pull through later this year.
As for the world economy, Japan is not a major engine of global growth so the disaster poses less of a risk to other countries than soaring oil prices caused by turmoil in the Middle East and North Africa.
“The global economy will be fine,” said Stephen Stanley, chief economist at Pierpont Securities in Stamford, Connecticut.
“After an initial decline in GDP growth, [Japan’s] economic activity will rise, driven by reconstruction,” said Mohamed El-Erian, who helps oversee more than US$1.1 trillion in investments at PIMCO.
Japan might see GDP expand by more than 3 percent in annualized terms over the next three quarters if the pattern seen from the smaller magnitude 7.2 Kobe earthquake in 1995 is anything to go by, analysts said.
Friday’s quake, which sent a tsunami surging through coastal towns and cities, was centered around the northeastern city of Sendai in a region that is home to auto manufacturing and semiconductor factories.
Japan’s economy was struggling before the disaster. Its GDP shrank by an annualized 1.3 percent in the fourth quarter of last year. A Reuters poll published before the quake showed economists expected GDP to resume growing in the first quarter, expanding by 0.5 percent from the previous quarter.
One of the most worrying impacts of the earthquake will be Japan’s already fragile debt position.
“The timing of the disaster could not have been much worse,” Capital Economics said in a research note.
“A large part of the reconstruction costs will probably have to be met by local authorities and ultimately by central government, which is already struggling to bring public debt under control,” it said.
Brendan Brown, economist at Mitsubishi UFJ Securities, said it “seems plausible” that the debt costs could add between 2 percent to 10 percent of GDP to its massive public debt load.
If public debt grows more than 5 percent, “there would be the speculation as to whether the Japanese government would dip into its massive holdings of foreign exchange reserves and, say, sell US T-bonds rather than issuing huge additional quantities of JGBs,” Brown said.
It is unimaginable that Japan would restructure its debt, but investors might expect higher inflation and a weaker yen as ways to help it to cope with its debt burden, he said.
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. Moody’s has warned it may soon cut Japan’s ratings if the government fails to control its ballooning debt.
The yen, which jumped more than 1 percent to ￥81.87 to the US dollar following the quake on Friday, will likely gain further in the following days, depending on the size of repatriations from insurers and other companies.
The Bank of Japan was scheduled to offer several trillion yen [tens of billions of US dollars] to money markets today, in an emergency operation aimed at ensuring market stability and the smooth settlement of funds, Jiji news agency said, which could take pressure off the currency.
“We expect that the foreign exchange market will take its cues from the immediate monetary and fiscal response,” Citigroup analysts said in report.
Another intervention by the bank in the currency market to curb the strong yen is also a possibility, said Mansoor Mohi-uddin, head of foreign exchange strategy at UBS Macro Research.
“We don’t expect USD/JPY to break through 80,” he said in a research note. “Instead we think the Ministry of Finance would follow up its action of September last year by instructing the Bank of Japan to intervene in the currency markets again.”
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