Japan catastrophe poses economic threats and opportunities for Lanka – Heraymila Securities

Heraymila Securities Ltd. yesterday opined that the recent devastating earthquake and tsunami in Japan poses economic threats and opportunities for Sri Lanka.

The stock broking firm said that the unfortunate catastrophe will have minimal immediate impact on Sri Lanka though there are several near and medium impacts.

In a brief economic analysis of the 11 March Japanese tsunami, Heraymila said the human and economic costs are still being counted, but are likely to be large.

“The direct impact of the Japanese natural disaster on the Sri Lanka economy should be small. Only about 2% of exports are to Japan and around 2% of tourists are from Japan,” it said.

“However, Japan is a generous donor, accounting for around two-thirds of total donations. This could weigh on donor‐reliant industries, such as project financing banks, infrastructure projects, etc. There are also indirect impacts on commodity prices and potential risks to global demand. These are not yet clear,” Heraymila added.

Here are some of the excerpts from the analysis of Heraymila Securities:

In the near term, a large sell‐off in Japan and Asian equities could weigh on Sri Lankan equities. Especially if foreign funds divert to now attractively priced Japanese equities, rather than richly priced Sri Lankan equities.

Investors should focus on portfolio diversification and seek expert advice to reduce portfolio risk exposure should the sell‐off persist.

In our view, the key consequences of the Japanese earthquake will be:

1) Heightened short term risk aversion, impacting on financial markets and commodities

2) Near term disruption of exports from Japan, particularly hi‐tech products

3) Possible impact on Japanese aid to Sri Lanka

4) Increased medium term demand for building products

5) Longer term increase in demand for non‐nuclear energy sources

Heightened risk aversion has led to a significant equities sell‐off in Japan and around Asia. This held the initial risk of contagion to Sri Lanka. Now that Japanese equities look over‐sold, foreign funds may be diverted there, instead of Sri Lanka.

Concerns about global growth and risk‐off trades have also impacted on commodity prices more generally. This may be a headwind for plantations companies, but a positive for others who rely on commodity inputs, such as oil (e.g. transportation) and metals (e.g. cable manufacturers). Net, the impact of lower commodity prices, if sustained, should be positive.

The JPY is likely to strengthen in the term, as capital outflows slow and funds flow in for insurance and reinsurance. This could make imports from Japan more expensive (e.g. for cars) in the near term, although we expect this to reverse over the medium term.Some industrial production will be particularly for cars, memory chips and LCD panels. However, there is production capacity in other regions within Asia, which will likely to respond to already higher market price signals.

The total impact is difficult to gauge, as the production chain is long and complex.

Medium term impact

In the medium term, there will be demand for construction materials as the devastated areas are rebuilt. This could add to construction sector inflation, including affecting demand for commodities such as cement, logs, timber, steel and copper.

Some media reports have suggested that “Japan is the single largest donor to Sri Lanka providing about two‐thirds of the total donor contribution.” This could have serious implications for economic growth in Sri Lanka, particularly in areas that aid would have helped (infrastructure, north and east, etc).

In the medium term the JPY could depreciate if the reconstruction and rehabilitation following the Tsunami is funded out of further increases in government debt (already running at 200% of GDP). This would reduce the cost of imports (particularly cars and electronics) from Japan.

Long term impact

The local and international experience following natural disasters is optimistic. Like Sri Lanka following the 2004 tsunami, we are optimistic that Japan will bounce back. The human and psychological scars will take time to heal, but economies are resilient and tend to bounce back to old trends over a period of five to 10 years.

There could be a longer term impact on for non‐nuclear power generation, following the still evolving nuclear power station failures in Japan. This could reduce the demand for nuclear power, in favour of renewable and thermal (gas/coal/diesel) electricity generation. This could increase costs for fuel and generation capacity over the next decade or so.

Sri Lanka has an urgent need for more power generation capacity; increases in global demand for thermal power generation capacity may require a closer scrutiny of its longer term power generation plans and increase exposure to renewable sources.