As the death toll mounted to more than 40,000 and an estimated 5 million were left homeless from the Sichuan province earthquake, Chinese companies began totaling the natural disaster’s financial price tag.

Despite the massive loss of life, economists predict the overall economic impact will be comparatively less significant, largely because the area hit hardest has no big industry presence, while its agricultural contribution to the state’s production is less than 1 percent of both crops sown and pork production. Sichuan is China’s largest pork-producing province, accounting for about 10 percent of national output.

Also, the area hit is home to around 5 million people, a number relatively small compared to the total population of the state, 81 million.

Although there will be a small dent in the country’s economic growth in the second quarter, reconstruction activity will pick up during the third and fourth quarters, bringing stronger growth and higher-fixed asset investments.

Overall, we don’t expect this human tragedy to have a severely negative economic impact on China’s growth or inflation.

More than 20 Shanghai-listed companies issued loss estimates as a direct result of the quake, and stocks continue to drop as the death toll rises. Agricultural Bank of China--the nation’s largest rural lender--predicts it will see at least an $850 million rise in bad loans, which is a considerable setback for the worst-performing of China’s four biggest banks.

According to government estimates, total businesses losses amount to more than $9.5 billion. More than 14,000 businesses were affected, and damage to private property is estimated to equal much more.

Sichuan Changhong--a large electronic appliances manufacturer in the city of Mianyang, near the quake’s epicenter--was forced to stop production after the initial tremor. But it’s ramped up facilities in other areas of the country to make up for the shortfall. And Petrochina, China’s largest oil company based on assets, estimated initial losses totaling $255 million, a mere fraction of its net profits.

Moody’s reported that the poverty of the mountainous region worst-hit by the earthquake, coupled with the low penetration of insurance coverage in China, indicates the impact on the country’s financial sector would be slight. Analysts reported early estimates of total property loss ranging from $10 billion to $20 billion.

However, insured losses have been estimated at a small percentage of this cost because insurance penetration in the area is so low and most Chinese property and casual (P&C) policies don’t cover earthquakes. The Sichuan province accounts for less than 5 percent of total premiums for China’s 10 leading insurers.

CICC, a Beijing-based investment bank, calculated that profit growth for China’s larger banks will slow by 1 to 2 percentage points. However, it also reported that the impact on smaller banks will be minor. The burden is likely to fall on Agricultural Bank of China, which is planning to list on the Shanghai stock Exchange later this year, because the majority of its loan book is concentrated in rural areas.

Inflation and Long-Term Growth

The quake has intensified concerns about rising prices in China, where headline inflation rates are already at 11-year highs of more than 8 percent. Beijing ordered price freezes in the Sichuan province, but greater inflationary pressure is already obvious in surrounding provinces.

Although the province accounts for approximately 7 percent of China’s agricultural output, the areas worst hit are mainly mountainous regions that account for less than 1 percent of the nation’s total. Inflationary pressure will rise around the quake zone because of transportation issues, but it’s doubtful to spread countrywide.

China’s inflation has been rising because of higher food prices, a trend we expect to continue long term, although an easing in prices should occur as production adjusts to demand. The main idea to note is that inflation will be structurally higher in China, and Asia in general, going forward because of the institutionalization of wage stability and earnings increases.

Specifically, the new labor law that China passed gives more rights to workers and ensures higher--and more sustainable--wages, while increasing the employer’s responsibility regarding insurance.

All these changes aim to make workers feel more comfortable about their future, allowing for increased spending of their discretionary impact. As urban centers also provide better health services--a big expense for the rural Chinese--this will increase consumption even more and keep inflation at elevated levels.

On the other hand, sustainable, higher food prices will be a big positive for the poorer rural population because it will provide great stimulus for the rural economy, which also fits well with the government’s plans to expand economic growth to more rural areas of the country where the majority of the population resides. Avoiding social instability is the main goal for Chinese leaders because it implements a gradualist approach to Chinese economic change.

On the investment side, we continue to favor companies that are exposed to the retail domestic demand story as well as energy and infrastructure plays. For more information on the latter and our favorite infrastructure company in China, see GE, 13 March 2008, Asia’s Railroad to Riches.