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Japan rebuilds

The initial response to the Japanes tsunami saw markets fall but the country is bouncing back

As Japan slowly comes to terms with the devastation and tragic loss of life caused by the recent earthquake and tsunami, investors are also starting to take stock. The clean-up operation has started in earnest.

The short-term implications will be significant. Activity in the economy will slow as factories, suppliers and businesses are either closed or have their operations disrupted. Problems at Japan’s nuclear plants are also causing major power shortages, stymieing the recovery effort. The threat of a meltdown also has citizens and politicians on tenterhooks.

Markets suffered as investors fled for safe havens, notably US government bonds. The Nikkei index shed 20 per cent in the first few days of the markets reopening.

But the situation will turn around over the medium to long term. Japan is one of the best equipped and most well prepared countries to deal with such a disaster.

Extensive reconstruction work will soon be under way, boosting the building industry. Infrastructure, including roads, ports and railways, will be replaced.
History offers some perspective. After the 1995 Kobe earthquake, production across the country dipped by around 2.5 per cent. This quickly rebounded, so much so that the overall impact on GDP for that year was barely perceptible in the quarterly data.

Our initial estimate is that Japan’s GDP growth will be down this year from its forecast 1.5 per cent to 0.7 per cent but will rise in 2012 from the previously predicted 1.7 per cent to 2.1 per cent as the country rebuilds. A further boost in 2013 is also probable.

As for consumer prices, we are likely to see them rise immediately due to supply disruptions and increase in the months to come as the reconstruction process adds to demand and activity.

What are the implications for the global economy?

We think they will be minimal, as the recovery is expected to continue at a fairly robust pace. Countries such as South Korea and Germany could benefit as they boost their exports to fill the gap left by Japanese companies.

The market’s fall in the wake of the disaster, while dramatic, seems like a reasonable response and does not indicate a major loss of investor confidence.

After the 1995 quake, Japanese equities fell by 25 per cent over six months but this was because stocks were extremely high to start with and so more susceptible to a dramatic fall. We do not expect a repeat of this situation in 2011. At the time of writing, the Nikkei had recovered around half of its losses.

As for bond investors, the Bank of Japan has pumped a massive amount of money into the market by purchasing government debt and other assets. This has meant bond prices have gone up and yields have gone down. Such a major cash injection has calmed market jitters somewhat.

Thereafter, we expect yields to climb as the rebuilding effort adds to the govern-ment’s already high level of debt.

Where do we go from here? We have to respond to events as they unfold. There may be more difficult days ahead for equity markets. But short-term ups and downs are part and parcel of investing. If equity prices fall, then valuations become more attractive and the case for buying will strengthen.

Richard Dingwall-Smith is chief economist at Scottish Widows Investment Partnership


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