Some Japanese firms like Panasonic and Canon shut down factories in China on Monday after violent protests over a territorial dispute. But regional strategists say the disruption to business will be short-lived as the two trade partners cannot afford to let the situation get out of hand.
Japan’s decision to buy disputed East China Sea islands from a private Japanese owner has led to angry mob attacks over the weekend against Japanese businesses in China.
The dispute over the islands - called the Senkaku by Japan and the Diaoyu by China - intensified last week when China sent six surveillance ships to the area in response to Japan's purchase.
“The dispute is clearly serious. But temporary factory closures are not the same as permanent closures. Local (Chinese) governments will also be wary of the impact for exports, jobs, and tax revenues as a result of factory closures,” Ben Simpfendorfer, Managing Director of Silk Road Associates, an investment consultancy specializing in China, told CNBC.
He added that the real fallout should be assessed “over months, not days.”
China is Japan's largest trading partner, with bilateral trade in 2011 growing 14.3 percent to a record $345 billion, according to Chinese government data, and both countries are seeking to increase trade with each other as demand from the United States and Europe continues to weaken.
The two nations are “hugely interdependent,” says Nicholas Smith, Director of CLSA in Tokyo. “Neither can afford the damage this spat has caused. Wage rates have been growing at 20 percent a year in China, and economic growth is faltering. The Japanese may well use these riots as an excuse to redirect their investment to other parts of Asia where the costs are lower.”
Japan’s Nissan Motor said earlier this month that sales in China had been affected owing to the brewing tensions between the two countries. CEO Carlos Ghosn also told CNBC last week that the dispute was “worrying” and that the firm was doing all it could to “lobby” for a resolution.
On Monday U.S. Defense Secretary Leon Panetta, who is on a visit to Tokyo, called upon the two nations to resolve their dispute. Japanese Foreign Minister Koichiro Gemba also said Japan was seeking to keep a lid on the dispute. Meanwhile, China said it would protect Japanese citizens and properties.
But if the dispute was to worsen, Graham Bibby, CEO of Richmond Asset Management in Hong Kong, says China would have the upper hand.
“I just look at the economics behind it and a lot of the manufacturing from Japan relies on rare earths and most of the rare earths they get are from China,” Bibby told CNBC. “And the last time this sort of squabble came up, China said no more rare earths so no more Toyotas and no more smartphones. So at the end of the day, they’ve got the upper hand.”
In 2010, China temporarily stopped exports of rare earths used in high-tech manufacturing to Japan after it arrested a fishing boat captain whose trawler collided with two Japanese patrol boats off the same islands.
—By CNBC’s Jean Chua.