A Japanese domino effect?

The tragic natural disasters and nuclear accidents that have struck Japan are being viewed by some as a potential catalyst for a double-dip recession, but as Mike Taylor writes, the commentators may be fearing fear itself.

The almost ephemeral nature of the uncertainty that has marked investor sentiment over the past 18 months has gained real substance as a result of a combination of global factors: the revolutionary movement in Libya and elsewhere in the Middle East, and the Japan earthquake, resultant tsunami and consequent nuclear accidents.

Taken individually, each of the events is sufficient to generate significant investor caution. Taken together, the events have given rise to suggestions that markets are about to experience the second downturn of the ‘double-dip’ recession that has been prophesised by some commentators for most of the past 18 months.

But while events in the Middle East represent a highly fluid unknown, it is the natural disasters that have struck Japan which represent the major focus for investors.

Notwithstanding the challenges that have confronted the Japanese policymakers over the past two decades, it remains a significant economic power accounting for 6 per cent of global gross domestic product (GDP).

Thus, if the combined effect of the earthquake, tsunami and nuclear accidents is a significant disruption to the Japanese economy, flow-on effects to the global economy will be unavoidable – with significant trading partners such as Australia standing to be more affected than others.

At the time of writing, six days after the earthquake, tsunamis and nuclear accidents, the scale of events remains an unknown quantity for Australian economists and analysts. While they could make a judgement about the likely impact of the natural disasters, the extent of the nuclear events remains a worrying unknown.

However the underlying view of most Australian analysts and economists is that the events in Japan, while devastating in humanitarian terms, will not necessarily become the catalyst for the long-feared double dip recession.

Senior lecturer in economics at RMIT, Dr Steven Kates, said there was no question that the events in Japan would create a dip resulting from a significant hole in production, but this needed to be weighed against the replacement activity that would then be generated.

“The impact of events in Japan are significant and the impact on GDP is undeniable,” he said.

For their part, analysts at Credit Suisse have preferred to downplay the long-run global impacts of events in Japan, preferring to weigh the impact of the past week’s events against the known consequences of the 1995 Kobe earthquake, which is regarded as having had a more dramatic impact on Japanese manufacturing infrastructure.

On that basis, the Credit Suisse analysts said they believed the total cost would be half of that of the Kobe earthquake, or around 3 per cent of GDP.

This compared to the analysis issued by ratings agency Standard & Poor’s (S&P), which predicted greater consequences than those experienced after Kobe because of the unpredictable effects of a nuclear crisis.

“Credit quality could still deteriorate for companies that escaped direct earthquake damage if electricity shortages and other challenges are prolonged,” according to S&P.

S&P global chief economist David Wyss told reporters and analysts last week the crisis over the stricken nuclear plant was the biggest uncertainty facing Japan and the global economy at the moment.

“The impact of the earthquake and tsunami, I think we have a pretty good handle [on them] ... We know how those things affect the economy,” he said.

But he added: “The nuclear issue we have never seen before on this type of scale in a very heavily developed populated region.”

Wyss said it was “way too early to tell on this one because we don’t know what is going to happen with the nuclear [situation]”.

Nomura Australia Limited has also sought to use the 1995 Kobe earthquake as a yardstick but has predicted that, given the extensive damage to road networks, power plants and other infrastructure over a wide area, the short-term economic impact will be greater.

“At first glance, the Australian economy may appear to be particularly vulnerable to a hindered Japan,” the Nomura analysis said.

“After China, Japan is Australia’s second-largest export market, taking 19.5 per cent of total merchandise exports in the seven months to January 2011.

“Australia also has its biggest bilateral trade surplus with Japan,” the analysis said. “What makes Australia far less vulnerable than the aggregate trade numbers imply is the degree of concentration in export categories more likely to benefit over time, and even in the very early stages, as Japan copes and then recovers from the tragedy.”

However, what the Nomura analysis does highlight is the likelihood that Japanese investment may level off this year.

It said investment links between Australia and Japan are significant, with $31.6 billion of Australian investment in Japan and $102 billion of Japanese investment in Australia in 2009.

“Japanese investment in Australia may level off through 2011, or even suffer some mild repatriation,” the Nomura analysis said.

“But any negative influence on the economy is likely to be offset by a rather weaker Australian dollar.”

Fidelity Investment Management head of Japanese equities, Steve Seneque pointed out the tragic disaster had come at a key turning point for the Japanese economy.

“While the post-Lehman recovery entered a temporary lull in the second half of 2010, economic growth was widely expected to reaccelerate this year as global activity picked up,” he said.

“Although the external environment is likely to remain supportive, the disruption to domestic activity will inevitably delay Japan’s recovery.

“On the other hand, increases in government spending and substantial relief efforts are likely to provide a boost to construction and capital investment,” Seneque said. “This could help to drive a recovery in the economy over the mid term.”