Doubts on IMF estimate

It looks like the IMF (or everybody else except me?) underestimates the severity of damage to Japan's economy due to the earthquake and its aftermath. It's appropriate that the IMF has downgraded its 2011 growth forecast of Japan's economy. But the problem is how much. They initially claimed that the country grows 1.6% in 2011, but has changed it to 1.4%, which means they only slashed 0.2 percentage points.

The International Monetary Fund has cut its forecast of Japan's economic growth due to the country's devastating earthquake and tsunami.

Japan's economy should grow by 1.4 percent this year, down 0.2 percentage points from its pre-quake outlook, the IMF said in a report on the global economic outlook. It cited damage to factories, power outages and other disruptions from the March 11 quake and tsunami, which are believed to have killed more than 25,000 people.

The Washington-based IMF also expressed confidence in Japan's ability to recover, raising its forecast for next year's growth to 2.1 percent, up 0.3 percentage points from its earlier estimate.

The IMF said its forecast assumes that power shortages and an unfolding nuclear crisis triggered by the tsunami are resolved in a few months. It was released just hours before Japanese authorities raised the severity level of the nuclear crisis to rank it on par with the 1986 Chernobyl disaster. It was unclear what impact that change might have on the economic impact of the crisis.

Estimates of damage to Japan's capital stock are 3 to 5 percent of gross domestic product, or roughly twice that suffered due to the 1995 Kobe earthquake, the IMF said.

"This figure, however, does not account for the effects of possible power shortages and ongoing risks associated with the crisis at the Fukushima Daiichi nuclear power plant," the report said.

The Japanese government has estimated the cost could reach $309 billion, making it the most expensive natural disaster on record.

The IMF cautioned that once reconstruction is under way, Tokyo needs to focus on reining in public spending and its spiraling debt. Japan's government debt is over 200 percent of GDP and the Fund said that could climb to nearly 230 percent this year.

"While the immediate concern in Japan should be to support reconstruction, measures that support a reduction of its high public debt ratio over the medium term need to be specified to maintain the strong confidence of its investor base," the report said.

By the way, I have a problem in the AP report quoted above. It says

Estimates of damage to Japan's capital stock are 3 to 5 percent of gross domestic product, or roughly twice that suffered due to the 1995 Kobe earthquake, the IMF said.

It's correct. The IMF says so. But it's a little bit different. According to the original IMF report,

Official estimates of the damage to the capital stock are about 3 to 5 percent of GDP, roughly twice that of the 1995 Kobe earthquake.

In this context, "Official" doesn't mean "IMF official". It implies "Japanese official". In fact, Japanese government estimated the damage at 1.6 to 2.5 trillion yen in late March (in Japanese), which is roughly the same as 3 to 5% of GDP. It's doubtful that the IMF assessed on their own.

Anyway, my question is: if the damage amounts to 3-5% of GDP, be it from the IMF or Japan, why did the IMF cut only 0.2 percentage points from the previous estimate? Do they forecast the V-shaped recovery in the latter half of the year?

I don't know how they calculate their estimation, but the anecdote abounds on the lingering disruption of production among Japanese makers like here and here. Uncertainty would likely redefine the coming moment.

Portugal surrenders

We've just found another victim. His name is Portugal. Portugal gave up its own efforts to solve the financial chaos and asked the EU for help. Portugal is the third country following Greece and Ireland to call on a bailout after the Lehman crisis.

Portugal asked for a bailout Wednesday to relieve its crushing debt, joining Greece and Ireland by becoming the third European nation to ask for outside help amid a bruising European financial crisis.

Prime Minister Jose Socrates went on national television to announce that Portugal must take international assistance to save its rapidly deteriorating economy, after months of insisting that he would do everything possible to avoid a bailout.

Socrates said his caretaker government asked "for financial help, to ensure financing for our country, for our financial system and for our economy."

He did not say how much Portugal would seek, but analysts have predicted Portugal will need up to €80 billion ($114 billion). That amount is bearable for Europe's finances unless other nations — notably Spain — end up asking for help.

So, who's next? Among PIIGS countries, Greece is down, Ireland is down, and this time Portugal is down. Only two countries are left: Spain and Italy.

Among those two countries, Italy is one of the G7 countries, and looks like too big to be overwhelmed by market forces, though its government debt to GDP is the highest in Europe.

The yield spread between Italy's and Germany's bond, the measurement of markets' jitters, hasn't widened so much unlike other eurozone peripheral countries. Italy may have some time until it's exposed to brutal market forces. But before dealing with a debt issue, it's urgent for Italy to do something to this guy.

I bet Spain is the weakest link in the eurozone. Spain's banking sector is burdened with a huge amount of bad loans as a result of the burst of the housing bubble. Let's make a rough estimation. Given the trend line of total credit to GDP ratio between 1996 and 2005, the country is estimated to shoulder as much dud loans as 10% of GDP in 2010.

Though the country's government debt to GDP is much less than Germany, Spain is vulnerable in terms of economic growth, which makes it more complicated to pay back. It contracted 0.1% last year, while other countries including Italy grew handsomely. It is one of the three countries in the eurozone which contracted in 2010. The other countries are Greece and Ireland. The EU predicts a subdued growth for the country this year. Spain has a definite lack of growth strategy.

Risk scenario for Japan

One thing that I think curious is overreaction on radiation issues across the US, which dropped two nuclear bombs in Japan. They claim that nuclear bombs helped hasten the end of war so that millions of lives, be they Americans or Japanese, would have been saved.

Many wise readers would hopefully realize how ridiculous it is, though I'm afraid that there are still not so wise people out there. For those Americans, it looks like OK to contaminate other countries with radiation, but things are completely different if radiation flows in their country, namely the US. If radiation helped millions of lives, why don't you come up in Japan and swim off the coast of Fukushima with your favorite animals like dolphins or whales? Those animals are asking for help in the radiation-rich sea, saying "Help me, please!" Hey, Greenpeace or Sea Shepherd or whatever, jump into the sea off Fukushima and help them!

For those people, this would be appropriate.

Well, ... let's take a look at the resilience of Japan's economy. I mostly agree with an article on the post-quake Japan's economy by Charles Dumas in the FT.

He says:

What is true is that the effects of the disasters will boost demand in the latter part of this year as reconstruction gets under way as well as clearly having cut into productive capacities to some degree.

…

A weakening of the yen should add to demand and raise the possibility of inflation.

…

The effects of the disasters for the next year, therefore, involve a clear and desirable tightening of the domestic Japanese demand/supply balance, plus some improvement of net exports demand. It seems much more likely than not that GDP will be higher in the second half of 2011 and early 2012, rather than lower, as a result. It is possible this could lead to a virtuous circle, driven by stronger demand.

As he notes, the yen is clearly weakening, which makes it possible to advance exports.

And, it seems that rebound in industrial production is likely after the big earthquake: Japan in 1995, and Chile in 2010.

Especially, construction could see the most acute rebound after the quake, which was, in fact, the case with the Kobe earthquake in 1995.

So, if you're, at least, in the construction business, Mr. Trump would likely say:

But the problem is how much the economy rebounds. We understand that economic activity bounces back soon after the quake, but is there anything else that is missing in the context, Mr. Dumas?

Yes, that's electricity.

As I wrote the other day, there is a very strong connection between electricity and economic activity. If electricity is cut by a significant amount, it could possibly discourage the business to produce more.

Japanese officials are reported to consider to cut electricity consumption by one-quarter this summer in Tokyo.

Japan's trade ministry is considering ordering big industrial electricity users in Tokyo Electric Power Co's service area to cut their peak summer power consumption by 25 percent, a ministry official said, as efforts mount to avert crippling summer blackouts.

This could be a big risk scenario for the Japanese economy, even taking into account a weak yen and huge reconstruction demand.

Fukushima, Godzilla, and the economy

Fukushima disaster has shown no sings of abating so far. Worse, radioactive water is leaking into the sea from the nuclear plants.

Tokyo Electric Power Co. or TEPCO, which operates Fukushima nuclear plants, is trying in vain to stem the flow by pouring concrete or sawdust into the contaminated pool. Japanese officials indicated that it takes a few months to quell the situation. So, radioactive water could keep on flowing into the sea for at least a few months, which might be enough to nurture Godzilla. It could not be so late for us to see real Godzilla come up from the sea, and deal a fatal blow to stupid human creation.

... and the story changes completely from here.

The markets completely shrugged off a report on Japan's industrial production, which advanced 0.4% in February from January. Analysts expected a slight drop. Also, the latest Tankan survey of the Bank of Japan, which captured business sentiment in March, had no impact on the markets at all, though it showed a sign of improvement from the previous quarter at least before the quake.

Despite of the markets' negligence, those figures indicate that Japan was on the course of robust economic recovery just before the quake. Unfortunately, the world has taken so dramatic a turn after the quake that the pre-quake figures have no meaning at all for now. The dull reaction in the markets is quite understandable given that everybody is seeking to gauge the impact of the quake on the economy.

It's too early to fully evaluate the post-quake economy at this point because there are few sources available at hand other than awful tsunami scenes which ravaged the region, but let me guess a little bit.

According to a Reuters report, Japan's manufacturing plummeted in March.

Japanese manufacturing activity slumped to a two-year low in March and posted its steepest monthly decline on record as a devastating earthquake and tsunami disrupted supply chains and production operations, a survey showed on Thursday.

The Markit/JMMA Japan Manufacturing Purchasing Managers Index (PMI) fell to a seasonally adjusted 46.4 in March, the lowest since April 2009 and down from February's 52.9.

The data provided one of the first quantitative assessments of the severe damage to production from the March 11 quake and tsunami in northeast Japan, which triggered a nuclear safety crisis and widespread power shortages.

…

The survey, conducted between March 11 and March 25, received only two-thirds of its average number of responses.

I don't know this index so well, but we have to note that it plunged 12% in March from February. It could be staggering if this decline applies to the closely watched Index of Industrial Production. In the Kobe earthquake, which occurred in 17 January, 1995, the Index of Industrial Production dropped only 3% from the previous month. Given that car sales in February 2009, when the index recorded the biggest drop of 8.6% so far since it began in 1978, plummeted 32.4% from the previous year, a double-digit decline in the index looks like inevitable this March, when car sales saw an astonishing fall of 37%.

Today, the BoJ has released the March Tankan survey, which divided the diffusion index by the pre- and post-quake. Obviously, the diffusion index deteriorated after the quake across the board, but not so much as compared to the past.

There are two possible reasons.

First, middle- or small-sized firms in crippled Tohoku area couldn't respond to the survey. Some companies were totally washed away by the tsunami, leaving no workplaces behind. So, the response could be limited to the areas which mostly exclude Tohoku. Second, people might still have difficulty of grabbing what has happened. So, damage would not have been fully felt across the country. We might have to wait to see how deep damage is until the next survey is released in June.

Tough time goes on.

Dire prospect for the post-quake Japan

I have had a tough time for a while. It's not the earthquake per se, though it has a major impact upon everything around me. I was or have been sick, which has nothing to do with the quake. It was difficult to continue blogging. That's it.

By the way, there are many stupid reactions on radiation in the world. For example, the news headlines, especially those of overseas media, tend to focus on radiation threat from damaged Fukushima nuclear power plants. I watched news on MSNBC, and a newscaster was hysterically yelling the concern of possible spread of radiation to the US. Google on Japan's news, and you'll find only those on radiation. Huh? It is so exaggerated that I lost any interests in watching. It's just absurd.

Foreigners, rushing to exit from Japan for fear of radiation, are quite laughable. I heard a news on a Californian jogging with a mask to keep from radiation. It's absolutely silly. Local Fukushima people have been proved not to be exposed to too much radiation to be harmful to health. Why should a Californian prepare for radiation when those living in a place 5500 miles away have no health problems?

I also found it funny to see China's salt panic. It looks like that Chinese food is contaminated more by their wastes than radiation from Japan.

The world should be relaxed and calm down.

Anyway, let's see what effects the quake has on Japan's economy.

Three major regions devastated by the quake, Iwate, Miyagi, and Fukushima, account for only 4% of Japan's GDP. So, it might appear to have little mark on overall economic activity. But there is a problem: Fukushima nuclear power plants, which are situated in Fukushima but operated by Tokyo Electric Power Company or TEPCO, supply electricity not to Fukushima or other devastated regions but to Tokyo and its surrounding areas, which account for 40% of GDP.

Fukushima nuclear power plants have generated about 20% of total electricity by TEPCO. What happens to the economy when those plants don't work?

Due to the power shortage, TEPCO has imposed rolling blackouts (or planned blackouts) in the Kanto district, which includes Tokyo and the other metropolitan cities. TEPCO is now desperate to gather any power to fill the demand-supply gap even by reactivating outdated thermal power plants and buying electricity from a steel company.

Despite of that, though, the probability has been increasing that even though the current rolling blackouts are supposed to end till April, there will be a huge demand-supply gap in electricity this summer. The Ministry of Economy, Trade and Industry (the former MITI), has estimated that one-fourth of demand won't be met.

Some companies like Toyota, Sony, or Toshiba have no choices but to halt a part of production plants due to severe damage by the earthquake. TEPCO's rolling blackouts also make any businesses harder to do in the Kanto district. Tohoku Electric Power Company, which provides energy to the quake-hit area, is also planning to impose the power cuts in their district, though having not done it so far because demand is still low in the region.

The power shortage may spread to the other regions. In fact, Kyushu Electric Power Company has decided to postpone the operation of two nuclear power plants now under suspension, which makes it possible to set out blackouts in the Kyushu region this summer. Hokuriku Electric Power Company is also reported to delay reopening two nuclear plants.

Electricity consumption is positively correlated to production. So, it's inevitable that production falls if electricity is cut.

How much production would be lost if the current power shortages keep on, say, until the end of this year? The coefficient of correlation between electricity consumption and GDP is 0.98, so I assume that there is a one-to-one relation between the two. Given Fukushima creates 20% of total electricity by TEPCO, and the Kanto area, where TEPCO operates, accounts for 40% of Japan's GDP, production might decrease 8% (=0.2 times 0.4) if there is no alternative to Fukushima's energy.

This figure could be worse if the other areas like Kyushu start planned blackouts.

This would cast a really dark shadow over the course of Japan's economy given that its debt has already surpassed 200% of GDP.

That's why I couldn't be optimistic on the country's economy.

The Rise and (Everlasting?) Fall of Japan's Manufacturing

An interesting statistics has just been released by the JEITA(Japan Electronics and Information Technology Industries Association), whose objective is, according to them, "to promote the healthy manufacturing, international trade and consumption of electronics products and components in order to contribute to the overall development of the electronics and information technology (IT) industries, and thereby further Japan's economic development and cultural prosperity".

Don't understand? In essence, it's a group of Japan's electronics firms like Sony, Panasonic, or Toshiba.

What's interesting here is that Japan's imports of high-tech consumer products are, according to JEITA's latest release, supposed to exceed its exports last year, the first time since the statistics began in 2000.

This kind of story like "Japan is losing in manufacturing" isn't new unfortunately, but the current report looks like more revealing in the sense that the country has had to respond to domestic demand of its thought-to-be-dominant staples by import.

Some may think of this phenomenon as tentative, taking into account that the demand for TV rose sharply last year due to the government subsidies. Companies are in a rush to transfer their factories into other countries, especially Asia, to cut costs and circumvent rising yen, so the rise of imports seems inevitable.

In fact, looking at the component of consumer electronics, the trade balance of video equipments including TV declined precipitously in 2010, while audio equipments like radio have kept in favor of import since 2001. It's the government policy, not the country's competitive edge, some may think so.

"Made in Japan" products are, however, going to be much scarcer in the markets. Look at the other electrical products. According to the JEMA, another electrical industry group, the imports of home electrical appliance has surpassed exports since 2001. So, refrigerators, hair dryers, or microwaves that you find in Japan are likely to originate in the other countries, even if the company's brand is Hitachi or Panasonic.

Some Chinese come to Japan for "Made in Japan" products, which they think are superior to "Made in China" in quality. It generally ends up buying more Chinese products, though.

Can companies benefit from offshoring production? I don't think so. Japanese firms have already lost the share of their once-dominant products like semiconductor or LCD panel to their Asian competitors. Given shrinking domestic markets, they are in a hurry to switch into "overseas production, overseas sale", but up until now nothing has emerged to stop the tide of losing battle in the markets.

Basically, it's doubtful to succeed in the business in low-income countries by high-income countries. Products made in or by high-income countries should be costlier than those made in or by low-income countries. Can consumers in low-income countries afford to buy those expensive products? Some may buy it, but sales are supposed to be disappointing given the thin layer of the high-income class in low-income countries.

Japan is fighting in an unfavorable ground.

Hard Time for New Zealand

It would be very hard to see how New Zealand's economy goes after the terrible earthquake that hit the country last month. At least for now, nearly 150 people died, and 200 people are still missing. Though the 6.3 magnitude is lower than the previous 7.1 in September 2010, the current earthquake has claimed more death tolls so far.

Nonetheless, the New Zealand's markets have relatively been calm. For instance, the benchmark stock index NZX 50 lost 1.5% to a twenty-day low just after the earthquake. It looks like that the disaster pulled the trigger of outpouring from the stock market, but it's mostly due to the concerns on the Middle East, the same as the other major indexes like S&P500 or Nikkei 225, rather than the earthquake itself.

Moreover, the bond market, the benchmark of "flight to safety", didn't budge even amid the turmoil. The yields of New Zealand's 10-yr government bond lowered on weekends somewhat, but it's, as is the same with the stock market, because of the Middle East.

The foreign exchange market, on the contrary, showed a different picture from the other two. The New Zealand dollar declined to a two-month low of 74.57 US cents last week, according to the Reserve Bank of New Zealand. The fund escaped the country for fear of a terrible shock, though it returned a little bit after Standard & Poor's confirmed that the nation's ratings aren't "immediately affected" by the earthquake.

One of the key elements for New Zealand's growth is government expenditure. The country's budget deficit relative to GDP is still below the OECD average. So, the government can afford to underpin the economy through budget expansion, especially for reconstruction, in the aftermath of the devastating earthquake.

The country would also have to rely on external demand to shore up the economy, given that it's uncertain how private demand, especially household consumption, rebounds after two consecutive shocks: Lehman and earthquake. New Zealand's exports have a nearly 30% share in GDP. That share isn't high compared to export machine countries like Germany or China, but it's still bigger than the UK or Australia.

The merchandise terms of trade rose to a 35-yr high last quarter. This environment would bode well for the country's exports.