Summary
At this stage, it is difficult to assess the economic impact of the 11 March earthquake in north eastern Japan. Assuming the same proportional cost of rebuilding relative to that region’s GDP contribution as in the Great Hanshin earthquake of 1995 (also known as the Kobe earthquake), the cost would be around 1% of Japan’s GDP, or USD 60bn. In terms of energy release, this earthquake was almost 2,000 times stronger than Kobe, but as the Sendai region is significantly different in structure to Kobe, this initial cost is an approximation.
The Bank of Japan (BoJ) has already stepped in to provide liquidity support; we believe it will continue to do so. USD-JPY moved lower on Friday in anticipation of repatriation flows, particularly from insurance companies, but we expect the BoJ to be vigilant in preventing a sustained appreciation of the Japanese yen (JPY), especially so close to its all-time low of 79.75.
While rebuilding costs will add to Japan’s government debt, at around 200% of GDP, a further 1% burden is unlikely to materially change the country’s debt dynamics, especially as not all costs will be borne by the government. The rise in JGB yields from the end of Q3-2010 to today, if sustained, would have the same impact in a single year than this one-off cost.
We expect jet fuel and gasoil to be under increased pressure, and have revised our forecasts higher. Japan is a significant refinery market, and while South Korea can step in to fill the shortfall, its refineries are already

running at around 90% capacity.
Agriculture prices had already been trending downwards, and we believe this should be broadly sustained. However, Japan is the largest global importer of corn, representing 18% of global trade. Japanese stocks of corn and soybeans were already low, while those of rice were higher; it is not yet known whether agriculture stores were affected. Longer-term, rice production could be affected by the level of salt water, but with the planting season not due until May and salt-resistant varietals an option, the effect on rice is unclear.
The regional impact is unlikely to be significant, given both the structure of Asia ex-Japan economies compared with 1995 and Japan’s smaller role. However, Japanese positioning in currencies such as the Australian dollar(AUD) and Brazilian real (BRL) is high via investment trusts.
Economic impact
Given the scale of the devastation, the near-term impact on Japan’s economy should not be underestimated. That being said, Japan’s economy has the ability to cope, and it will rebound. The boost from reconstruction will be huge. More worrying will be the cost of the reconstruction, as this will shed further doubt on the country’s fiscal position. There may also be some impact on energy markets, given Japan’s role as a refiner; we provide some initial estimates in this report. While there will be wider questions linked to nuclear energy safety, it would be premature to suggest that this will fundamentally change nuclear plans in Japan or elsewhere, or energy demand. The scale of the disaster and future recovery spending is likely to underpin prices of certain foods and a number of raw materials; again, we detail the impact on rice, corn, wheat and soybeans. Notwithstanding these price effects, the wider impact on the world economy should be manageable.
The economic impact on Japan– A V-shaped effect
The immediate impact on Japan may be stagflationary: negative for growth, with upward pressure on prices of items in short supply, such food and possibly materials needed for reconstruction. The scale of the devastation means that the affected region may take years to recover fully, as major reconstruction will be required and some of the agricultural areas will need to be repopulated. This will not easy for a country with a rapidly ageing population.
Although this was a massive earthquake, there are, unfortunately, many examples of previous natural disasters to draw upon, even in Japan. The impact on growth is invariably a V-shape. Initially there is a blow to growth, resulting in the downward leg of the V. Output is hit, spending is affected and confidence can often be damped. This impact is not always proportionate to the magnitude of the event, but depends more on where it hits. Chile, for instance, has had major earthquakes, but usually in remote areas that have small populations and little economic impact. The area hit by this earthquake and the resultant tsunami is smaller as a proportion of Japanese GDP than the area affected by the Great Hanshin earthquake, but it has caused major devastation, including loss of life and casualties. The negative impact on domestic confidence could be sizeable.
The impact of a disaster depends upon the region affected
Japan’s previous major quake was the January 1995 7.2-magnitude Great Hanshin quake, centred around the Kobe region – a far more important industrial region than the one hit by the latest disaster. The Great Hanshin quake impacted Hyogo, which includes Kobe, Osaka and Kyoto; they currently account for 14.4% of Japan’s GDP.
Although the region affected this time is less important economically, a wider area has been devastated.. Thus, the lessons from 1995 might be more related to the timing than the overall impact of the quake. To give credit to the Japanese authorities, their initial assessment of the cost of the Kobe quake turned out to be remarkably accurate. It is now estimated to have cost USD 102.5bn. The official figures, released just weeks after the quake, estimated that the cost would reach USD 8.8bn in lost output and USD 97.8bn in reconstruction and restoration, and that this investment would add 0.6% to GDP in the year after the quake and 0.1% in the year after that. This assessment highlights the eventual growth rebound after the initial setback and damages. The cost arises from the need to finance capital and public investment.
The latest disaster has hit the eastern part of the Tohuku region hard, particularly the prefectures of Iwate, Miyasi and Fukushima, which collectively contribute about 4% of Japan’s economic activity. Ibaraki, where output has also been affected, adds a further 2.2%. Sendai, the city that has received most of the media attention (population: 1mn), is the capital of Miyagi and is an agricultural area. Thus, as important as the region is, it is not central to Japan’s economic success. While it will take time to assess the full damage from this natural disaster, much of what was there has been wiped out completely. This points to a huge reconstruction cost, plus the challenge of repopulating the farming regions involved.
Japanese industrial firms work on low inventories and efficient supply chains. Thus, there is always the risk of disruptions to supply chains. These should become apparent quite quickly, but are expected to be limited. The biggest challenge for many firms may be power shortages, although this problem is more likely to affect regions away from the industrial centres. There is still much uncertainty.
Rising prices
Natural disasters elsewhere have had an impact on some – but not all– prices. A good example is tourist prices. For instance, after the December 2004 tsunami hit Indonesia, tourists who had already booked tended to travel, but those planning six months or so ahead might have been deterred from booking, depressing holiday and travel prices. But in time, these also recovered, reinforcing the idea of a V-shaped effect. For Japan, the effect on tourism will be small. But there is likely to be a price effect, largely for items impacted by the quake and for resources in short supply during reconstruction. Given the impact of the quake and tsunami on the agricultural area, the price of many food items (see detail below) could be affected. During the reconstruction phase, prices of materials needed for rebuilding could also be hit. This impact could be profound.
Policy response and the JPY
The policy response has already included the central bank ensuring sufficient liquidity to overcome any near-term problems. The damage to the economy and further pressure on the government deficit should be JPYnegative. However, the initial market expectation may well be of JPY appreciation as domestic investors and funds that may have been more likely to invest offshore show their patriotism by keeping money at home. Insurers that hold huge amounts of overseas assets may be forced to repatriate to pay for claims and costs as a result of the disaster – even though many see Japan as an underinsured nation in areas such as property. The last thing Japan needs is a stronger currency; the economy will need solid export performance, especially with domestic demand likely to suffer near-term. Thus, the authorities are likely to intervene to ensure JPY stability. The main focus, though, is likely to be on fiscal policy and the cost of the disaster. Japan’s recent ratings outlook downgrade by Moody’s met with a mixed price response, as its large public debt is accompanied by large private savings. There is no doubt there will be a further temporary increase in debt. But this can be financed, and relative to the debt stock, this is a relatively small burden to absorb. Yields are likely to stay low, especially as the BoJ has the capacity to step up its asset purchase programme further.
The impact on the rest of the world
Economies often have to cope with external shocks. For instance, in the wake of the financial crisis, global trade suffered. The economic and financial impact of this earthquake will largely be felt in Japan. The impact elsewhere will depend on how the disaster impacts prices of international goods – particularly given recent foodprice and energy inflation. There will also be a focus on financial flows, given Japan’s status as the world’s thirdlargest economy and one of the biggest private-sector savers.
In recent weeks, some commodities have been under downward pressure in anticipation of further monetary tightening by China. The likely scale of Japan’s rebuilding, particularly of regional infrastructure, is likely to offset that effect now.
The recent rise in oil prices has added to recession risks in the West and to inflation concerns in the East. One result of this earthquake has been damage to some of Japan’s nuclear energy facilities. In the wake of past energy shocks, Japan sensibly (given its industrial growth) moved towards greater energy efficiency and diversified energy uses. One consequence of this was growth in its domestic nuclear energy capability. It has 55 nuclear power stations that provide one-third of its domestic energy. In recent years, Japan has delayed some planned nuclear plants because of the need to include new earthquake-resistant technology. Japan is at the cutting edge of earthquake-proof construction, as anyone who has been in a tower block in Tokyo during a quake can testify; the buildings sway, but maintain their integrity. Some of the damage in the wake of the 1995 quake arose from older highways that were incapable of withstanding such shifts. Nuclear plants are generally located on the coast, particularly in Japan given the country’s mountainous topography. Thus, wherever an offshore quake hits, there is a risk.
While the quake has resulted in blackouts, it is still unknown how long energy production will be reduced. If this persists, the economic impact could spread from immediate reconstruction costs to lower overall output levels across a broader part of the economy. This might lead to increased demand for non-nuclear energy, specifically oil. Japan has strategic stockpiles which could be used. Japan is the third-largest consumer of oil behind the US and China. It consumes just over 4 million barrels per day (mbd). Last year, global oil demand was 86.7mbd, with emerging economies accounting for 41.6mbd and advanced economies making up the rest. The earthquake could push up demand for energy imports, despite an initial negative effect, but this is hard to quantify.
Not only does Japan import all of its energy needs, it also re-exports a proportion of what it refines. As the refinery fires highlight, some of these facilities are likely to be closed for some time. This may impact not only the quantity of overall oil demand, but also demand for specific petroleum products, as we explain in more detail below.
A disaster can also have unexpected consequences. For instance, will this event detract from Tokyo’s attraction as a financial centre? Will it improve China-Japan relations, given the positive tone of China’s official response? How will it influence other countries’ nuclear policies? China has already suggested that its own plans will be unaffected. China has 13 nuclear reactors and 27 more planned; none are located in its main earthquake zone. Then there is the impact on Japanese politics, which has been unstable in recent years; how the government responds to this disaster could have a big bearing on the future.
20 years ago in the markets, there were periodic bouts of pessimism towards Japanese Government Bonds(JGBs) based on the view that a Tokyo earthquake was inevitable, and that the country would not be able to afford it. Another Tokyo earthquake has been expected since the 8.3-magnitude quake in 1923. The JGB market, like other world markets, can cope with this quake. But a future Tokyo quake, if it were to happen, would be a different matter. The markets have often overlooked Japan in recent years, yet the economy is still at the cutting edge in many areas – such as in research, design and development – and has shown itself to be capable of rebounding from disasters in the past. We hope and believe it will do so this time.
(Author: Chief Economist and Group Head of Global Research at Standard Chartered Bank)