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Rising yen poses debt challenge for East Asian economies

By Yazad Darasha A post-quake appreciation in the Japanese yen poses a challenge for debt management as about 25 per cent of East Asia's long-term debt is denominated in yen.

A mere 1 per cent appreciation in the Japanese yen would translate into about a $1 billion increase in annual debt servicing cost on yen-denominated assets held by East Asia's developing nations, according to the World Bank.

The yen witnessed strong appreciation (chart the yen) against the dollar after the earthquake and resultant tsunami created havoc and is threatening a further disaster at the nation's nuclear power plants.

The devastating earthquake set off expectations that companies will repatriate yen to help pay for rebuilding efforts. Traders betting that insurers with exposure to Japan and companies based in the country would soon need to buy large quantities of yen to cover damages and pay out insurance claims drove the yen up to 78.4600 to the US dollar on March 16.

A stronger yen is also being seen as a threat to Japan's exporters, who fear that profit margins will be squeezed as input costs rise.

While it is still too early to assess the extent of the damage and how much money may be needed to rebuild parts of the country that were destroyed by the earthquake and the tsunami it triggered, a portfolio manager at a London-based hedge fund told Zawya Dow Jones that "the net impact is probably negative for dollar/yen."

About one-fourth of East Asia's long-term debt is denominated in yen, ranging from about 8 per cent in China to about 60 per cent in Thailand. These nations will see a corresponding increase in debt-servicing costs if the yen rises dramatically.

According to World Bank, Japan's real GDP growth will slow, but the slowdown will likely be temporary, and growth should start picking up after mid-2011 as reconstruction efforts get under way.

In its East Asia and Pacific Economic Update released on Sunday, the Bank said that while it is still too early for a full assessment, Japan's past experience suggests an accelerated reconstruction effort, and the short-term impact on the economies of developing East Asia is likely to be limited.

The report, titled Securing the Present, Shaping the Future, was finalized in the weeks prior to the disaster in Japan. In new research prepared since the quake and tsunami struck Japan, the World Bank provides preliminary analysis on the implications for the region with a focus on trade and finance.

However, the analysis points to uncertainties and ongoing challenges posed by the unfolding situation involving nuclear reactors in Japan.

"Clearly given Japan's importance in East Asia, the tragic events unfolding will be felt in the region. But it's far too early to give an accurate assessment of the likely damages," said Vikram Nehru, World Bank Chief Economist for the East Asia and Pacific region.

"At this stage, we expect the economic impact of this disaster on the East Asian region to be fairly short-lived. In the immediate future the biggest impact will be in terms of trade and finance. We expect growth in Japan will pick up as reconstruction efforts accelerate."

On trade, if the Kobe earthquake of 1995 is to serve as a historical guide, Japan's trade slowed only for a few quarters; Japanese imports recovered fully within a year and exports rebounded to 85 per cent of pre-quake levels.

But this time around, disruption to production networks, especially in automotive and electronics industries, could continue to pose problems.

The impact of the earthquake and tsunami will shave as much as 0.2 per cent off global GDP growth, according to a worst-case scenario proposed by Credit Suisse. This means taking about $150 billion off the table this year.

Japan accounts for about 6 per cent of the world's GDP and is now the third largest country globally. It was overtaken by China, which became the second-largest economy in the world at the end of 2010.

"So if Japanese GDP falls by say 3 per cent as a consequence of the earthquake - and this is triple the economists' worst-case estimate - this would take about 0.2 per cent off global GDP growth, which is projected to be 4.5 per cent this year)," Credit Suisse analysts said in an investor note on Wednesday.

"Our economics team believes that total cost will be around 3 per cent of GDP (half that of the Kobe quake), directly and indirectly - and, in a worst-case scenario, will take 1 per cent off the projected 2011 GDP growth (central case 0.2 per cent)," the institution said.

© Zawya 2011