BUSINESS AS USUAL: After more than two months of suspended operations, Carlos Ghosn, President of Nissan Motor Co., a major Japanese automaker, on May 17 announced that production would resume at an engine plant in Fukushima (XINHUA/AFP)

Japan's economy has taken the brunt of the beating following a triple disaster, but now the catastrophe's ripples are hitting markets worldwide. Severed links in Japan's logistics and infrastructure have led many manufacturers' electronic component productions to struggle to resume business, placing a burden on the global supply chain. This incident presented both challenges and opportunities to China. Imports and the nuclear power industry will take a blow, but exports will draw on Japan's reconstruction efforts. Yan Kun, a senior researcher with the Chinese Academy of Social Sciences, and Zhang Peng, an associate researcher with the Research Institute for Fiscal Science at the Ministry of Finance, discussed these issues in a recent report. Edited excerpts follow:

The devastating earthquake in Japan and ensuing tsunami will surely deal a heavy blow to the world economy. The crisis is expected to damage the global industrial supply chain since companies around the world rely on Japanese suppliers to meet demands for components. If this crisis cannot be effectively addressed, the international community will start building a new supply chain, leaving Japanese industries marginalized. That is why the Japanese Government must seriously solve the acute problem.

One solution is to accelerate domestic reconstruction and prevent the supply chain disruptions from becoming entrenched. Meanwhile, it is necessary to strengthen investments at home and avoid massive outbound investments.

In another move, the earthquake will have an impact on the carry trade strategy of the Japanese yen, adding to the volatility of international financial markets. Carry trade means borrowing currencies with low-interest rates and using the loans to buy higher-yielding assets elsewhere. A trader using this strategy attempts to capture the difference between the interest rates.

Japan has kept its interest rates under 1 percent since September 1995 while those of other nations lingered around 2-3 percent. As a result, the yen became an important currency for carry trade. But the recent disaster has cast an ominous shadow over the economic and policy prospects of Japan, making a dent to the carry trade strategy. Most importantly, it puts Japanese policymakers in a quandary. In a bid to propel the quake-stricken economy, the Japanese central bank turned to a quantitative easing policy and further lowered the interest rate. This move is set to shore up needs for yen carry trade, leading to torrential capital outflows and cushioning the effect of quantitative easing. In addition, the unstable carry trade will increase uncertainties hanging over the international financial markets and ripple through the global commodities trade and yen trading. But once the status of the yen as a currency of carry trade weakens and no other currency serves as an alternative, asset markets, originally supported by the yen, will suffer a plunge in trade volume and a price free-fall. This may even lead to a financial crisis in many developing countries.

Worse still, fiscal woes are deepening in Japan, which is likely to cause fiscal risks in the United States and rekindle the sovereign debt crisis. As it plans a sizable rebuilding package, Japan is now burdened with mounting public debt, which runs close to 200 percent of its GDP. Moreover, the Japanese Government has made a massive capital infusion into the economy and is likely to tap into the foreign exchange reserves or gold reserves to meet soaring demands for capital. By the end of 2010, Japan's holdings of the U.S. Treasury securities had totaled $886 billion. Once Japan sells off the securities to replenish its reserves, their prices will nose-dive.

In March 2010, the international credit rating agency Moody's lowered the outlook for Japan's government debt to "negative" from "stable," citing concerns that the country's economic and fiscal policies may not prove strong enough to achieve the government's deficit reduction target and contain the inexorable rise in debt, which already is well above levels in other advanced economies.

In April, Standard & Poor's, for the first time, downgraded its credit outlook for the U.S. sovereign debt. This was widely seen as an alarm bell for simmering fiscal risks facing the world.