Japan quake impact to global economy call for G-20 policy coordination

Asian countries will feel the financial effects of the Tohoku earthquake and tsunami.

Downside risks have increased sharply with the recent barrage of shocks, from nuclear problems triggered by the Japanese earthquake and tsunami to popular uprisings in the Middle East and North Africa. These challenges to the global economy call for stronger policy coordination among the G-20 to prevent further erosion of household and business confidence. At this vulnerable stage of the global recovery, efforts aimed at stabilizing aggregate demand and reducing financial market volatility will cement the expansion and lower the risk of a slide back into recession.

The direct economic impact of the Tohoku disaster on global growth will be small. Japan's contribution to growth in recent years has averaged less than 0.5%, which is disproportionately small compared with its 7% share of global output. For this reason, a near-term contraction in the Japanese economy will subtract little from global GDP growth. The largest impact will be felt in Asia, for it is most exposed to trade with Japan, but even here the hit will be small. Most of the negative effects will come from supply chain disruptions.

The Moody's Analytics post-disaster forecast of 2011 global growth at 3.3% is little changed from that in the prior month. The forecast assumes that Japan will successfully resolve the nuclear crisis, so the global recovery will not be derailed. Despite the blows to the Japanese economy, the world economy can survive such shocks by making adjustments and becoming more adaptable. For example, the setback to nuclear power will eventually put upward pressure on fuel prices and may stimulate more investment in renewable energy technologies.

Asia-Pacific region will suffer most
Moody's Analytics has lowered Japan's near-term growth forecast to around 1%, down from the previous forecast of 1.4%. The disruption to business and industry from rolling electricity shortages and other supply problems will be most acute in the second quarter, but rebuilding is expected to lift growth in the second half of the year.

Because of supply chain disruptions, South Korea and Taiwan will be hit hardest in 2011. Household spending in South Korea also may falter, as consumer sentiment fell to a two-year low in March, weakening domestic demand. In Taiwan, GDP growth is likely to bounce back in 2012; the island economy may benefit from ramped-up production of electronic components previously made in Japan.
Southeast Asian countries such as Thailand, Indonesia, the Philippines and Vietnam that depend on Japanese visitors for a significant share of their tourism revenues will take a short-term hit, but there will be some offset in rising exports of materials used in Japan's recovery and reconstruction work.

Like other trading partners, China will experience near-term supply disruptions from the Japanese disaster, but the dragon economy will not veer from its high-growth path. The more lasting impact will be on the final makeup of China's energy strategy, which includes the quantity of eggs it will finally put in its nuclear basket.

Latin America trades elsewhere
The Moody's Analytics forecast for growth in Latin America is broadly unchanged from the prior month. It is expected to moderate toward its long-term potential rate of 5% in 2011 supported by domestic demand. The direct impact of the Japanese disaster on the region will be very small, as exports to Japan account for only 2.5% of total exports from the region, while imports from Japan account for around 5%. Moreover, Latin America's trade with Japan has been eclipsed by China's larger footprint.

The 2011 GDP forecast for Argentina has been raised by more than a percentage point to 6.5%, as high agricultural prices and near-record harvests are providing the government with much-needed revenue while boosting private consumption and investment. Growth in Brazil will moderate to about 4.5% as the government reins in spending and pares lending to BNDES, the national development bank.

Indirect effects in Europe
The Japanese disaster will have little direct impact on the European outlook. Trade flows are very small: Japan accounts for less than 1.7% of Europe's total imports and around 1% of its total exports. For this reason, the euro zone outlook has not changed appreciably from last month's forecast. GDP growth is expected to hover in the 1.3% to 1.7% range this year and next.

However, the indirect effects promise to be much greater. Already, Japan's nuclear crisis has played a major role in Germany's recent election upset. The ruling coalition's weakened position will increase uncertainty over Germany's handling of the euro zone sovereign debt woes at a time when the crisis is deepening and bond yields of the euro zone's most fiscally troubled countries are rising again.

In France, household consumption spending is expected to remain an important contributor to growth, though it may weaken a little in 2011, as welfare spending has been cut and public sector job losses undermine consumer confidence. Germany's dynamic manufacturing will also continue to be an important driver of euroland growth. Elsewhere in Europe, the switch from a fiscal stimulus to austerity will weigh on aggregate demand. This will further delay the region's return to prerecession output levels.