Asia caution needed after quake

Jason Hepner, investment director for global strategy at Standard Life Investments, examines Asia’s near term outlook.

For many years Asia has been an important hub of global growth, driven in large part by the impressive performance of China and India. Over the medium to long term, it is highly likely that Asia will still command a growth premium over most other regions. However, in the near term the prospect of slower growth is just one of the important uncertainties facing the region’s largest economies.

Our analysis must begin with Japan, still the world’s third largest economy having recently ceded second place to China. The Tohuko Pacific earthquake and subsequent tsunami represent the largest disaster affecting Japan since World War Two. The Kobe earthquake in 1995 registered a magnitude of only 7.3 magnitude versus 9.0 for this most recent earthquake. It is likely to have a materially negative impact on Japan’s GDP for several quarters, although it should spur a more prolonged period of construction activity looking further out, say over the next one to two years.

Disaster impact

The impact of the disaster remains uncertain. As Japan struggles to contain the fallout from their nuclear power facilities, it looks likely that there will be major disruption to energy supplies for some time to come. Japan has hitherto been dependent on nuclear for around 35% of its electricity production, and the area affected by the earthquake and tsunami is estimated to account for some 20% of this.

In the immediate aftermath, there will be demand for other sources of energy such as oil, gas and coal. Looking further out, the world may well see a trend away from favouring nuclear as a core option, and more towards LNG and renewable energy. This in turn may elevate energy prices, hampering growth and affecting inflation and monetary policy across Asia.

Much will depend on the Japanese policy response. As far as monetary policy is concerned, we have already seen a range of measures from the Bank of Japan to keep the system flush with liquidity and hence prevent a jamming up of financial markets. Quantitative easing has been expanded, in addition to large scale repo operations.

As with any country, the exact impact of quantitative easing is uncertain, even in a climate of relative stability, let alone in the present extremely difficult and complex scenario. A further variable will be the extent of fiscal support package. A large scale fiscal package is clearly necessary; however one must bear in mind that Japan is already some way down the rankings in terms of debt sustainability.