Island Row Prompts Fitch Warning on Japanese Firms

Japanese auto and tech companies risk having their credit ratings downgraded if the dispute between Asia’s two biggest economies is prolonged, Fitch Ratings cautioned on Tuesday.

Anti-Japanese protesters are confronted by police as they demonstrate over the disputed Diaoyu Islands, on September 16, 2012 in Shenzhen, China.
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Anti-Japanese protesters are confronted by police as they demonstrate over the disputed Diaoyu Islands, on September 16, 2012 in Shenzhen, China.

The warning came as hundreds of Japanese companies shut their operations across China as violent protests over a territorial dispute between both countries escalated.

Fitch singled out electronics firms Sharp , Panasonicand Sony , as well as automaker Nissan , as firms at greatest risk of a downgrade because they have the highest sales exposure to China among Japanese corporates.

Sharp's sales from China represented 20 percent of its total sales during the year ended March 2012, while Panasonic and Sony derived 13 percent and 9 percent of their global sales, respectively, from the mainland.

Nissan has the greatest exposure, with 26 percent of its revenue attributed to China sales in the same period.

“Japanese companies' sales and reputation with Chinese consumers are likely to be affected, at least in the short term,” Fitch said in the note. “(We) believe that major Japanese auto and technology manufacturers' ratings may come under pressure.”

China and Japan are arguing over the uninhabited islets in the East China Sea, a long-standing dispute that erupted last week when the Japanese government decided to nationalize some of them, buying them from a private Japanese owner.

The move sparked anti-Japanese demonstrations across China over the weekend, which spread to 85 cities by Tuesday. The violent protests have inflicted damage to Japanese factories in the country and led to the boycott of Japanese stores such as Fast Retailing's Uniqlo.

Fitch’s note comes as a further blow to Panasonic and Sharp, both of which are already on negative watch with ‘BBB-‘ ratings.

Shares of Panasonic, Sharp and Nissan, which had to suspend some of their operations due to the protests, fell more than 1 percent on Tuesday. Sony shares managed to end higher.

Not all Japan watchers are as negative about the impact of the dispute on Japan Inc.

Jesper Koll, Managing Director and Head of Japanese Equity Research with JPMorgan Securities Japan, says the factory shutdowns could actually be positive for Japanese companies because it helps them avoid an inventory buildup, he said.

“Given the fact that we are definitely having a sharper-than-expected and longer-than-expected slowdown in China, there are plenty of industries, consumer electronics being one of them, where there are excessive level of inventory,” Koll said on CNBC Asia’s“The Call”on Tuesday. “So ironically, these factory stoppages may not necessarily be a bad thing because they actually speed up the long overdue inventory adjustment.”

He noted that the territorial dispute is something “that can be worked out” even if it is an obstacle to Japan-China ties in the short term, adding that the two countries “depend on each other” and are “linked at the hip.”

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.

By CNBC’s Jean Chua.