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Tuesday, March 15, 2011

Why Japan’s calamity can hurt the global economy and stock markets

There is an English proverb: Misfortune never comes alone. In Japan’s case, misfortune seems to be coming in droves. Before the stoic and resilient people from the island country could recover from the horrendous calamity of the massive earthquake and devastating tsunami, the explosions and radiation leaks from the ageing Fukushima nuclear power plant has sent shock waves through the entire global economy.

Oil prices dipped on the assumption that demand from Japan will diminish as the economic growth may stall while the nation reconstructs the severe damage to life and property. Japan is the third largest oil consumer in the world, and there may be a drop in demand in the near term.

But global demand for oil may increase. Many countries, including the USA, depend on oil for their energy requirements – unlike India where coal-fired power generation is the norm. The US-India civilian nuclear treaty was supposed to be a win-win agreement for both. New nuclear power plants built with US technology was supposed to alleviate India’s perennial power shortage, and boost the demand for US-made equipment and consultancy services. The crisis in Japan’s nuclear power plant, built with equipment and technology from the US giant General Electric, will now put nuclear power as an alternative energy source on the back burner.

Japan also happens to be a large market for luxury goods, with more than 10% of world sales. Any further slowdown of an already slowing Japanese economy will seriously affect the businesses of luxury goods makers the world over. Many of these luxury goods – whether Gucci bags or parts for BMW cars – are actually manufactured in Asian countries.

With the Japanese Nikkei index taking a beating, investors are likely to pull out of Japanese funds that invest in global stock markets to cover their losses. As per a CNBC report, more than US $7 Billion has been invested by Japanese funds in Indian markets – and that is less than 20% of their total investments in emerging markets as a whole. The Sensex dropped 18% when FIIs recently pulled out US $2 Billion. Any Japanese withdrawal can cause a much bigger correction. Already, European indices have felt the heat.

Many Indian companies have built up their Japanese bases over a long period of time. Infosys and TCS are among them. There is talk of repatriation of Indian employees. It remains to be seen what effect that may have on the bottom lines of Indian companies.

Unlike the rise in oil prices, which every one expects to moderate in the near term as the unrest in North Africa and the Middle East gets quelled with firm hands, the crisis in Japan isn’t going to end soon. A melt-down in a nuclear reactor in a populated area can have serious long-term repercussions. Operations of many global companies will be disrupted because of damaged roads and ports, and shutdown of manufacturing facilities.

Indian investors need not sell in a panic. Corrections due to ‘black swan’ events, like the one in Japan, provide buying opportunities. Be patient and stay prepared for a deeper correction.

1 comment:

Carry Trader said...

BOJ has expanded the QE program to 10T Yen to aid the recovery. However it needs to be signficantly bigger to have a meaningful impact.

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