MNI ANALYSIS: N.Korea Risk To Linger; Limited Japan Eco Impact

--U.S. Trade Policy Likely to Have Bigger Economic Impact On Japan

By Max Sato

     TOKYO (MNI) - With no easy solution in sight, and with the U.S. unlikely to

initiate a first strike, North Korea's nuclear ambitions will linger as a

long-term geopolitical risk for the Japanese economy, even though financial

market worries about a possible conflict could well fade, economists told MNI.

     For the Asian and Japanese economies, U.S. trade policy and more mundane

factors like weather patterns will be more important factors for the near-term

outlook.

     A diplomatic solution under which Pyongyang would give up its nuclear

weapons program in exchange for a lifting of economic sanctions is unlikely to

occur anytime soon due to China's unwillingness to take all possible steps to

pressure the Pyongyang government, analysts said.

     Earlier this year, there was good international coordination in enacting

additional economic sanctions against North Korea but China has not taken all

the steps it could, such as cutting off its supply of crude oil to the North, to

push the Pyongyang government to the bargaining table, said Hidehiko Mukoyama,

senior economist on Asia at Japan Research Institute.

     In addition, China has openly opposed the deployment of the U.S. THAAD

anti-missile defense system in South Korea, punishing Seoul with economic

sanctions in retaliation and so giving comfort to the North.

     "There is diplomatic foot-dragging between Japan and the U.S., China and

Russia, and with South Korea, a development North Korea wanted to see," he said.

"North Korea is not going to give up its nuclear weapons development."

     "I think the U.S. will send an envoy to Pyongyang and the two countries

will start some kind of dialogue," Mukoyama predicted. "But that won't break the

impasse. The North Korean risk will continue to exist."

     Mizuho Research Institute senior economist Hidenobu Tokuda said that while

tensions have increased, the nature of the North Korean risk has not changed

since April when he wrote that it would drag on without a clear solution.

     The North Korean nuclear risk index, which Tokuda compiles based on the

number of references to Pyongyang's nuclear threat in Japanese newspapers,

tentatively hit a record high of 555 in August (through Aug. 16), up from 257 in

July and 479 at the time of the previous missile crisis in April.

     "I calculated the August index last week in the wake of heightened tensions

but things have calmed since then, so the August average will probably be lower

than the historical high of 516 hit in July 1994, when the death of Kim Il-sung

caused leadership uncertainty and triggered the first Korean nuclear crisis," he

said.

     The index level of 100 shows long-term stability in the North Korean risk.

It dates to 1993. In recent years, a rise in the index has coincided with a rise

in the yen as investors who had borrowed yen at super-low interest rates covered

their yen short positions in reaction to news of a higher geopolitical risk.

     "The Japanese economy is expected to recover moderately but a military

conflict would be a clear dampener," Tokuda said. "However, the U.S. is unlikely

to strike North Korea first. The uncertainty over the Korean Peninsula will be

prolonged even if the concern about the issue fades in financial markets."

     China and North Korea have close economic ties, JRI's Mukoyama pointed out.

Some southeast Asian countries also have close relations with North Korea, which

sends workers to the region to earn foreign currency, he said.

     "North Korea does not have funds or technology so it gives China mining

rights for iron ore and other natural resources in exchange for foreign

currency. China also imports cheap North Korean workers for its factories,"

Mukoyama said.

     "They are so closely interdependent that China cannot engage in

full-fledged economic sanctions against North Korea."

     An international black market for North Korean arms earns Pyongyang enough

cash that international sanctions may not work, he added.

     There is no Japanese trade issue linked directly to the North Korean risk.

Japanese supplies of electronic parts and chip-making machinery to South Korea

have not been disrupted.

     However, from a broader trade viewpoint, there may be a more obvious change

in supply chain networks that would affect Asia.

     As part of the on-going review of the North American Free Trade Agreement,

Washington is insisting on more local content in cars and trucks sold in the

United States. If such rules are adopted, Japanese automakers may have to move

some of their Mexican production to the U.S., Mukoyama said.

     "South Korean and Taiwan firms are also expected to expand their local

production in the U.S.," he said.

     And if the U.S. tightens its sanctions on firms doing business with

Pyongyang, some Chinese banks and firms will be affected, he said. This, in

turn, could have knock-on effects for the regional economy.

     So far, the Japanese public's economic sentiment has been little affected,

even though the country is exposed to the constant risk of North Korean missiles

striking its territory.

     The Economy Watchers' sentiment survey showed current sentiment regarding

"Korea" recovered to a neutral position of 50.0 in June from 43.8 in May and

stayed at 50.0 in July. The index on the outlook regarding "Korea" also picked

up to 46.4 in July from 45.0 in June and 45.8 in May.

     In August, reports of escalated tensions involving North Korea -- with U.S.

President Donald Trump threatening 'fire and fury' if Pyongyang continued its

threats -- prompted brief safe-haven buying of the yen but financial markets

have been relatively stable.

     Unless the yen appreciates sharply beyond Y105 and causes concerns about

exporter profits, job security and wage growth, this geopolitical risk may not

affect Watchers' sentiment this month, either. That gauge is influenced more

strongly by more mundane factors, such as local weather.

     "Compared to the sentiment-shaking events last year, including Brexit and

the U.S. presidential election, the current situation is in a lull," said

Cabinet Office director of regional economies Masahiko Tsutsumi, who oversees

the compilation of the monthly Economy Watchers' Survey.

     However, were the North Korean situation to worsen, Watchers' sentiment

would be affected by the impact on the yen exchange rate, the stock market and

commodity prices, he said.

     "In the first stage, participants in the financial and capital markets will

react to a heightened geopolitical risk, leading to an appreciation of the yen

or a rise in gasoline prices," he said. "In the second stage, Watchers will

assess the impact of a higher yen, lower share prices or higher commodities

prices."

     "Watchers react to realistic news and events that directly affect their

production and sales. They don't react to every single missile launch," Tsutsumi

said.

     "We still have time before the survey period of Aug. 25 to Aug. 31, so

developments around the joint U.S.-South Korean military exercise this week may

affect sentiment."

     The results of the August Watchers' Survey are due on Sept. 8.

     In July the Economy Watchers sentiment index for the current economic

climate posted the first month-on-month drop in four months, down 0.3 point at

49.7 on a seasonally adjusted basis after rising sharply by 1.4 points in June.

But the level remained relatively high in the current recovery phase.

--MNI Tokyo Bureau; tel: +81 90-4670-5309; email: max.sato@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

[TOPICS: M$A$$$,M$J$$$,MC$$$$,MT$$$$,MX$$$$,MGJ$$$]