Goldman sees no earthquake impact on Japan’s GDP | FT Alphaville

Goldman sees no earthquake impact on Japan’s GDP

Proving that not even a natural catastrophe and a potential nuclear meltdown can dent Goldman’s unerring global financial optimism — Goldman Sachs has published a Q&A concerning the potential economic effects of Friday’s quake and tsunamis.

From economists Chiwoong Lee and Naohiko Baba, with our highlights:

Q1: What are the biggest differences between the March 11 and [1995] Hanshin earthquakes?

A1: The biggest difference is the widespread power outages this time.

Production is being halted due to power outages and voluntary power cutbacks by large customers. The longer this continues, the greater the impact on production will be. We estimate that if power outages continue until end-April, they would lower GDP growth by 0.5 pp, while outages to end-June would lower growth by 0.8 pp. We are still forecasting GDP growth of 1.2% in 2011. We are not revising our forecast at this juncture, but note the potential impact of continued power outages and the high level of uncertainty with regard to other factors (see Q6 below).

Q2: What are total damages from the earthquake likely to be?

A2: We estimate the damages will be around ¥16 trillion, surpassing the ¥10 trillion total from the Hanshin earthquake.

This total damage estimate refers to damage to the physical stock—buildings, production facilities, and the like. For the impact on GDP, a flow concept that reflects economic activity over a given period of time, see question 4.

Q3: How will the losses be covered?

A3: Recovering from the losses will take time, and we expect long-term financing from both the public and private sectors.

In response to the Hanshin earthquake, ¥1 trillion in reconstruction outlays were included in an FY1994 supplementary budget (formed end-February 1995 by the central government), with ¥800 bn in special government bonds issued to finance this. Earthquake-related government outlays over the five years after the earthquake totalled ¥5.0 trillion. We expect reconstruction and financing to take quite a while this time as well. Our insurance sector analyst Philippa Rogers estimates that insurance companies have relatively little direct earthquake exposure, at just 3% of industry written premiums (see March 13 Japan: Insurance: Property & Casualty: First Take: Initial thoughts on earthquake impact for P&C).

Q4: What impact will earthquake damages have on GDP?

A4: No direct impact will be seen in GDP data.

Damages from the earthquake do not have a direct impact on GDP, which is a flow concept that measures added value. Instead, they will impact capital, through damage to existing facilities, in a stock concept. The GDP impact is indirect rather than direct, including the impact on capex and personal consumption from reconstruction demand. For more details, see page 4 “Box: Stocks and Flow – Earthquake impact on GDP” in the March 15 Japan Economics Analyst.

As a result, real GDP movement differs from recurring profit movement. As seen from the Hanshin earthquake, the decline in fixed-asset value due to the earthquake leads to real GDP growth, but recurring profits are dragged down by losses and do not grow as much as real GDP (see Exhibit 1).

Q5: What kind of CPI movement can be expected after the earthquake?

A5: We expect a sharp fall in the area immediately affected by the earthquake, which might cause some decline in the national index.

After falling sharply after the earthquake, Hyogo Prefecture’s CPI stayed close to zero inflation for almost a year. This was consistent with local personal consumption, and can be explained as deflationary pressure from diminished consumption activity (demand) outweighing inflationary pressure from supply shortages. The breakout shows that price decline extended widely but was led by food. A similar pattern seems likely this time. The national CPI declined after the earthquake but did not move very much. This time the disaster area is larger and effects extend to greater Tokyo, so there could be stronger deflationary pressure on the national CPI than in 1995 …

Q6: What risks lie ahead for the economy?

A6: The greatest risk is nuclear plant developments. We divide this risk into (1) the duration of power outages and (2) deterioration in corporate and consumer sentiment.

Industrial production will decline commensurately with any extension of power outages beyond the original expectation (termination at end-April). At the same time, the longer nuclear power issues persist, the more likely firms will defer or abandon production and capex plans and the more likely consumers will put off durables purchases and travel. The production impact from power outages is not difficult to estimate (see Q1) whereas the spending impact from deterioration in sentiment is very hard to gauge. Protracted nuclear plant problems would likely affect foreign tourist numbers as well, potentially hitting the transport and travel industries hard.

Q7: How do macro conditions differ now from those at the time of the Hanshin earthquake?

A7: Comparison is difficult because the March 11 earthquake occurred during a recovery after a large falloff triggered by the financial crisis.

Looking at individual areas, however, we can say the following. (1) Personal consumption: The impact of the eco-point program is beginning to fade and with the program fueling stronger-than-expected growth in consumption up to this time, we think there is likely to be less growth in demand related to the earthquake than after the Hanshin earthquake. (2) Exports: A recovery was taking place at the time of both the Hanshin and March 11 earthquakes. (3) Capex: Capex trends are also similar, with capex improving at the time of both earthquakes, and we think capex is likely to continue growing on reconstruction demand. (4) Housing: Growth in housing construction demand was beginning to decline in 1995, while housing demand was beginning to pick up before the March 11 earthquake due partly to the housing eco-point program…

To summarize, consumption was slightly weaker this time than when the Hanshin earthquake occurred. However, similar improvement was taking place in exports, capex demand was similar, and housing demand was slightly stronger this time. Taking all of these trends into account, we think macro conditions now do not have any clearly positive or negative implications for GDP growth.

Q8: How did the BOJ respond to the earthquake?

A8: The BOJ responded very swiftly with a massive supply of liquidity and an expansion of its asset purchase program.

On Monday, March 14, the BOJ conducted its largest-ever same-day liquidity supply operations, totaling ¥15 trillion, in order to ensure stable and smooth functioning of the financial and payments systems. It has continued to provide ample liquidity since then also. It also moved up the start of the March 14 monetary policy meeting and decided to expand its asset purchase program by ¥5 trillion, to ¥40 trillion. The main component was an increase in commercial paper/corporate bond purchases, and we think this suggests that it largely aims to provide support for companies with lower credit ratings, where fund demand is strong, and to ensure an uninterrupted flow of liquidity. Overall, we think the BOJ is doing its utmost in terms of both the scale and speed of its response (see Exhibits 5-6).

In the event of further deterioration in corporate/consumer sentiment and economic conditions, we think the BOJ will hold special monetary policy meetings and expand the asset purchase program even further. In addition, we think it will come up with a new lending program to assist economic reconstruction once the scale of the damages grows clearer.

Q9: What about the government’s response?

A9: There are many aspects to the government’s response, but we expect it to take a resolute stance against speculative activity on the currency market aimed at exploiting the disaster.

The government has clearly indicated that it plans to forestall any speculative activity aimed at driving the yen higher to capitalize on yen appreciation resulting from the repatriation of funds by Japanese institutional investors in response to the earthquake.

Q10: What has been the response of foreign investors?

A10: Risk aversion has increased and equities have been sold off. However, based on experience after the 1995 Hanshin earthquake, many foreign investors may see a recovery scenario for the Japanese economy in the medium term.

Frequently cited reasons for recovery expectations are (1) Japan is used to earthquakes and therefore relatively well prepared, (2) recovery has been comparatively fast in the past, including the 1995 Hanshin earthquake, and (3) Japan is an orderly country with relatively low risk of social disorder. However, a not insignificant number of investors see increased fiscal concerns for the long term due to the likely high cost of restoration (government aid).

To be fair, the economists seem to be indicating a 0.5 per cent decrease in the second-quarter based on current forecasts for power outages, but no (or insignificant) impact over the course of the year. They’re keeping their 1.2 per cent 2011 forecast.

Still most other banks seem to have revised that 2011 full-year figure down.

Related links:
Economists’ estimate of Japan quake impact – Reuters factbox
Impact of earthquakes, natural disasters on economic growth in Japan – Reuters