Will the Japanese economy recover?

The magnitude of the Sendai earthquake and its subsequent human tragedy was worse than anyone could expect. And as news arrived of the scale of the calamity, so fears for Japan’s economy have surged.

The earthquake hit just as international interest in Japanese equities was beginning to pick up after years in the doldrums. Bill O’Neill, chief investment officer, EMEA at Merrill Lynch Wealth Management, says its tactical indicators were signalling that Japan should be overweight in international equity portfolios, based on earnings momentum, risk and liquidity.

In January, the Tokyo-based managers of the Franklin Templeton Japan Fund wrote: “We have recently seen multiple sources of economic data suggesting that Japan’s economy might once again be in a recovery phase. We believe the production index in January 2011 might exceed the level recorded in May 2010.”

But it looks as if recovery is set for further delays. Sendai is just the latest earthquake to hit Japan. The Great Hanshin- Kobe earthquake in 1995 saw the Topix index fall by 22% in subsequent months in what was, at that time, still a major global equity market, as compared with 10% of equity benchmarks it represents today. Analysts point out that Sendai’s 8.9 magnitude quake was 300 times stronger than the one in Kobe, which cost ¥9.9trn, or 2% of GDP, in direct damage. Goldman Sachs has estimated the damage caused by the Sendai quake could amount to 4% of GDP.

In contrast to 1995, the Bank of Japan moved quickly to inject ¥15trn ($185bn) to provide liquidity and stability to financial markets, which would only add to Japan’s debt pile, which is already double the size of its $5trn economy. The central bank followed up with an additional ¥3trn, and promised to double a ¥5trn asset purchase scheme. Its key rate was left at between zero and 0.1%.

Economists see Japan’s growth being hit in the first half of this year, but benefiting in the second half from the reconstruction effort. Despite this, Japan faces a huge financing challenge, with public debt already the industrialised world’s biggest at about 200% of GDP. The nation’s credit rating was recently reduced due to concerns that not enough is being done to tackle the debt mountain.

 

 

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