Atradius Country ReportJapan – May 2011 Tokyo

Yokohama

Osaka

Sapporo

The economic impact of the earthquake and tsunami

Zero GDP growth expected in 2011

Japan’s recent disaster, which left some 26,000 people dead or missing, was a bigger blow to the country’s economy than had been anticipated. The Japanese government estimates that the cost of rebuilding will be US$ 309 billi-on, with direct damage accounting for 3-5 % of GDP. Further expense is expected because of disruption to supply chains and to power supplies, both of which have disrupted production as well as lessening consumer confidence and household spending.

In May this year, growth forecasts have again been revised downwards, and Japan may experience recession in Q1 and Q2 of 2011 due to a sharp decrease in net exports, as output from energy-intensive industries such as steel, automotives and electronics falls while imports, especially of fuel to replace lost nuclear supplies, are expected to increase. According to a preliminary estimate by the Japanese Cabinet Office released on May 19th, GDP shrank 0.9 % on the previous quarter in Q1 of 2011, with consumer spending down 0.6 % (private consumption accounts for almost 60 % of the Japanese economy). Net exports subtracted 0.2 % from GDP.

However, reconstruction efforts in Q2 and Q3 should drive positive output growth in the second half of the year, together with a revival in exports to meet the backlog of orders. Overall, Consensus Forecasts expects zero GDP growth this year (before the devastation, the forecast was for 1.4 % growth) followed by 2.8 % in 2012, thanks to the effects of further reconstruction and improved output.

Source: Consensus Forecasts (Survey date May 9, 2011)

Not surprisingly, the indications are that output declined in March 2011, with government reports showing a record 15.3 % month-on-month drop in industrial production, while exports contracted 2.3 %. Although manufacturers have forecast a solid rebound in industrial production - with estimated growth of 3.9 % in April and 2.7 % in May - many weaknesses remain, as evidenced by the continuing monthly slippage in the Purchase Managers´ Index: down to 45.7 in April, after already falling from 52.9 in February to 46.4 in March. With power shortages and supply chains interruptions, Japanese industrial production will suffer in 2011 after its recovery in 2010 (see next chart).

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10

5

0

-5

-102008 2009 2010 2011* 2012*

(% change on previous year)

GDP growth

*forecast

-1.2 -6.3

0.0 2.83.9

Source: Consensus Forecasts (Survey date May 9, 2011)

Household spending plunged 8.5 % year-on-year in March, while retail spending stood at its lowest point for 13 years (7.8 % month-on-month) and consumer confidence also fell steeply: according to the Japanese Cabinet Of-fice, the consumer confidence index decreased to 33.1 in April 2011, down from 38.6 in March. While the unemplo-yment rate was unchanged at a better-than-expected 4.6 %, the data may have been skewed as it was impossible to collect information from the Miyagi, Fukushima and Iwate prefectures: those areas in northern Japan worst affected by the earthquake. Overall private consumption is expected to decrease 0.7 % in 2011 and to pick up again in 2012 (see chart below).

Source: Consensus Forecasts (Survey date May 9, 2011)

Fiscal and monetary measures

Immediately after the disaster, the Bank of Japan (the country’s central bank) injected over US$ 700 billion into the market to ensure sufficient liquidity, doubled the size of its asset-purchase fund and unveiled a one-year lending programme, including an emergency lending programme for banks in the devastated north-eastern areas. In March, the G7 countries came together in an unprecedented move to stem a further appreciation of the yen, partly caused by speculation that Japanese investors would repatriate assets to pay for reconstruction. A strong yen would have the effect of damaging the competiveness of Japanese exporters. In April the central bank also announced a US$ 12 billion credit facility programme for lenders in the north-east, and in early May the Japanese parliament passed a 4 trillion yen (US$ 49 billion) extra budget: likely to be the first of several packages for reconstruction and to support businesses hit by the disaster.

4

2

0

-2

-42008 2009 2010 2011* 2012*

(% change on previous year)

Private consumption

*forecast

-0.7-2.0

1.21.9

-0.7

20

10

0

-10

-20

-302008 2009 2010 2011* 2012*

(% change on previous year)

Industrial production

*forecast

-3.4

-21.8

-4.0

8.5

16.6

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It is expected that the Bank of Japan will ease monetary policy further to bolster the economy, as disruption from supply chains and power shortages has been worse than anticipated. This soft monetary policy, together with en-ergy price increases and rising demand, will put upward pressure on inflation, which is now expected to increase by 0.4 % in 2011, compared to expectations before the disaster of a 0.3 % drop (see chart below).

*forecast

Source: Consensus Forecasts (Survey date May 9, 2011

Future downside risks

Additional downside risks include a strengthened yen, high commodity prices - which squeeze real spending and profits - and further nuclear fallout. The economy’s deterioration makes it harder for the government to sustain confidence in Japan’s government debt, such that Standard & Poor’s has downgraded its outlook for the nation’s AA- local-currency credit rating from ‘stable’ to ‘negative’. This highlights starkly the challenge that the govern-ment faces: financing rebuilding and supporting a recovery without adding to the world’s biggest public debt burden. Rating companies are concerned that politicians may fail to forge a consensus to tackle a public debt that now equals around 200% of GDP. Increasing taxes would relieve the fiscal deficit, but could also dampen demand just when the economy is at its weakest.

The impact on domestic industries

Electronics/ICT and automotive

Many production plants have been directly and/or indirectly affected, by damage caused by the tsunami or by a shortage of vital parts and components. The main impact of the disaster on these sectors, all of which are important to the Japanese economy, is disruption to supply chains - especially for electronic components such as batteries and semiconductors - delaying production of cars, auto parts and consumer electronics. As an example, production of the Apple IPad 2 is expected to be affected, as its batteries are sourced from Japan. In just the nine days following the earthquake, technology sales in Japan dropped by 35 %.

Year-on-year, car sales decreased by 37 % in March and 51 % in April. Toyota, Honda and Nissan, Japan’s three lar-gest carmakers, all reported a sharp drop in domestic output in March. Toyota’s output in Japan fell 60 % year-on-year, to 129,491 vehicles, while Honda reported a 63 % decline, to 35,000 units. Toyota’s domestic sales dropped 46 % in March and 69 % in April, and it is estimated that, up to the end of April, the carmaker lost 300,000 units of production in Japan and 100,000 overseas due to shutdowns and shortage of electronic parts, rubber and plastics. However, in May Toyota revised its expectation for a recovery in both domestic and overseas production to begin in June, rather than its earlier forecast of July, and for global production to return to normal in November/December this year. Nissan expects a return to normality even earlier: by October.

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4

2

0

-2

-4

2008 2009 2010 2011* 2012*

(% change on previous year)

Consumer prices

1.4

-0.7

0.20.4

-1.4

Food and agriculture sector

These sectors have been hit hard as, with the food radiation scares that followed the disaster, several countries - including the US, Australia and some in South East Asia - banned the import of food products, including milk and dairy products; fruits and vegetables; seafood and meat, from the affected prefectures of Fukushima, Ibaraki, To-chigi and Gunma. Like other industries, the Japanese food industry has been hit by power disruptions. Production levels at Meiji Holdings Co., Japan‘s leading producer of dairy products, declined to 50 % of pre-earthquake levels, mainly because of the rolling power blackouts in the Tokyo area. The operator of the 7-Eleven chain of convenience stores in Japan announced that its net income will fall by some 22 % in this financial year as a result of the earth-quake and subsequent nuclear disaster.

The insolvency environment

Source: Global Insight, Atradius ERD

Source: Global Insight, Atradius ERD

For the time being, we still expect corporate insolvencies in Japan to increase 5 % year-on-year in 2011 after a 13.9 % decrease in 2010. However, we cannot discount the possibility of a higher number of business failures, as the damage done by the earthquake and the tsunami has been compounded by infrastructure damage and the rolling power blackouts that have contributed to supply chain disruptions. We see upside risks for the second and third quarters of 2011, when we would expect any credit constraints to show their full effect.

Source: Global Insight, Atradius ERD Japanese business insolvencies (year-on-year change) Siehe excel chart *forecast Source: Global Insight, Atradius ERD

(1 year trailing sum of insolvency counts based on monthly data)

Insolvency trends: Japan

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0

5,000

10,000

15,000

20,000

% change

2006

1.9 %

13,245

2007

6.4 %

14,091

2008

11.0 %

15,646

2009

-1.1 %

2010

-13.9 %

13,322

2011*

5.0 %

13,988

(year-on-year change)

Japanese business insolvencies

0

5,000

10,000

15,000

20,000

*forecast

15,480

Impact on the global economy

Limited impact on consumer electronics companies

Although Japan’s share of global trade has declined in recent years (to 4.5 %), it plays a critical role in the global supply chain of the hi-tech electronic and automotive industries. The disaster has therefore led to a reduction in the global output of some products, with Toyota announcing a five day suspension of production in its North American plants in April, Honda halving production at its UK plant, and Nissan suspending UK production for three days at the end of April due to a shortfall of parts from Japan.

Supply shortfalls could, in principle, pose an upside risk to global inflation, but so far the knock-on effects on glo-bal manufacturing are muted.

Japanese consumer electronics companies are likely to suffer limited direct impact from the effects of the earthqua-ke and tsunami. While the top four companies - Panasonic, Sharp, Sony and Pioneer - have faced disruptions due to damage at some factories, rolling electrical power outages and delays procuring parts and materials, they do not appear to have suffered serious damage. None of those four has suffered enormous damage to the manufacturing bases of its core businesses and each has geographical diversity in both production and sales which will reduce the impact of the disaster.

A different picture for the ICT sector

However, the picture is different for the Information and Communication Technology (ICT) sector. The semicon-ductor industry was hit hard by the earthquake and tsunami, with damage to both manufacturing facilities and the transportation infrastructure needed for the inward shipment of supplies and the export of finished products. It may be the second half of 2011 before semiconductor production fully resumes in Japan, with disruption to worldwi-de supply as Japan is a major component in the global semiconductor manufacturing process. iSuppli, a market research firm for the electronics/ICT industry, reported that the disaster is currently putting a squeeze on 25 % of the worldwide production of silicon wafers used to make computer chips. Some of this has been offset by increased production by South Korean firms, such as Samsung and Hynix, but nevertheless there is no doubt that supply has fallen following the earthquake. With demand remaining stable or increasing, prices are set to rise and this will put pressure on margins - and ultimately may lead to a rise in the price of electronics/ICT goods.

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