Japan: Good start to 2014, but uncertainty ahead

Japan: Good start to 2014, but uncertainty ahead

Japan: Good start to 2014, but uncertainty ahead

Asia Pacific Economic Outlook, March 2014

While there are signs that Japan’s economy is breaking free from years of poor growth and deflation, rising external and internal imbalances are a cause for concern.

Japan_photoThe year 2014 has begun with mixed news for Japan. The GDP data for Q4 2013 suggest that Japan’s economy grew at a much slower pace than expected at the end of last year relative to the previous quarter. However, there are signs that the economy is breaking free from years of poor growth and deflation. Real GDP grew 2.7 percent year over year in Q4 2013 and was primarily fueled by domestic demand, as consumer spending and business investment gathered momentum. The latest manufacturing, investment, and employment data indicate that this momentum was sustained in the fourth quarter as well.1

Data indicate economic strengthening

Business orders for machinery increased 9.3 percent year over year, reaching a five-year high in November.This was the fifth-highest percentage increase ever. The increase in orders bodes well for business investment, which has been one of the weak spots in Japan’s economic recovery.

The Ministry of Economy, Trade, and Industry reported a month-on-month rise of 1.1 percent in industrial output in December, which is a relief after a contraction in November.2 According to the government’s employment statistics, the unemployment rate fell to 3.7 percent in December, down from 4 percent in November, and the lowest rate since December 2007.3 The ratio of jobs to applicants improved to 1.03—for every 100 job seekers, there were 103 job offers available. This is the first time since October 2007 that there has been a surplus of available jobs. This bodes well for wage-price inflation, which is crucial for a rise in the overall inflation rate and sustained improvement of consumer spending. A job surplus will further help Prime Minister Shinzo Abe initiate labor and wage reforms, which have been on his agenda.

Housing starts jumped 11 percent year over year in 2013, the highest in more than a decade.

The consumer-price index increased 1.6 percent year over year in December, while the core inflation rate, which excludes prices of food and energy, was 0.7 percent. For all of 2013, the inflation rate went up 0.4 percent, the first annual rise since 2008. The Bank of Japan (BOJ) is aiming for an inflation rate of 2 percent as the level necessary to overcome deflationary pressures. While the rise of the inflation rate is slow, and it will likely take time to reach that target, progress is in a desirable direction.

Japan’s housing market has also shown signs of a sustained recovery. Housing starts jumped 11 percent year over year in 2013, the highest in more than a decade. In December alone, housing starts rose 18 percent from a year before, up for consecutive 16 months. Sales of new condominiums rose to a six-year high. However, most of this growth has been in the sales of new homes last year; sales of existing homes have been slow so far.

Corporate earnings improved in Q4 2013, cheering investors. Some of the largest corporates reported strong profits. The stock market, which had slumped in January from its peak, climbed up. Strong US data also improved market confidence.

Concerns about fiscal and current account imbalance

Net exports, a traditional driver of Japan’s economic growth, remained sluggish in Q4 2013 despite strong growth in exports supported by a weak domestic currency. The benefits of the cheap Japanese yen for the export-driven economy were offset by a steady rise in energy imports post the tsunami of 2011. Nuclear energy has been one of the biggest sources of energy for the country; the tsunami forced some nuclear plants to shut down, which resulted in increased dependence on energy imports. This, in addition to weakness in the yen, has been driving up import bills. The current account balance has been steadily falling since Q3 2011 post the tsunami. In Q4 2013, it reported a deficit of -0.3 percent of GDP, for the first time since the early 1980s, due to rising trade imbalance and a falling income balance. Moreover, it is now expected that the deficit will likely continue for some time. Japan has to import much more energy to replace dormant nuclear power plants. Additionally, easy monetary policies will keep the currency weak, putting further pressure on import bills.

The imbalance in the external deficit is cause for concern since the fiscal deficit has been rising because of government stimulus programs. Japan has the highest debt-to-GDP ratio among developed nations (over 200 percent of GDP), and rising external and internal imbalances may increase the economy’s susceptibility to external shocks.

Investor concerns

The government has undertaken a few initiatives to implement reforms, which are likely to strengthen economic growth, correct fiscal imbalances, and improve sentiments. One such reform is the plan to raise the sales tax from 5 to 8 percent, in order to improve the government’s financial situation and limit debt levels. However, it is feared that this could impact both consumer spending, which is yet to sustain momentum, and growth, which is still premature. It has even been widely debated that the growth figures that suggest a strong recovery in recent quarters might be a result of a rush in demand before a sales tax increase planned for April. If that is true, Japan may see growth slide in Q2 2014.

There is growing concern over how the BOJ’s exit from its asset purchase policy will affect the economy. According to its recent monetary policy statement, the BOJ will purchase Japanese government bonds (JGBs) so that their outstanding amount will increase at an annual pace of about 50 trillion yen.4 At the same time, the government plans to issue bonds worth 155 trillion yen to investors starting this April.5 Thus the BOJ will be financing a large proportion of the budget deficit. This implies that when the BOJ starts to slow asset purchasing, there will be lower demand for government bonds, causing bond yields to rise substantially. A rise in rates can derail the fiscal balance further. Moreover, higher bond yields would raise capital costs, leading to a drop in investment and thus adversely affecting economic growth. Although the BOJ has not yet indicated any intentions of tapering its asset purchase, the associated risks concern investors.

Falling real wages, which declined in 2013 almost to their record low of 2009, are the other concern. With rising prices and an impending tax increase, consumers will soon find it difficult to sustain consumer spending. For Abenomics to have a sustainable impact, corporate profits must lead to higher pay. Abe has been pressing corporations to raise pay, but without much success so far.

Uncertainty ahead

Economic growth in Japan responded positively to Abenomics, that is, to fiscal and monetary stimulus. Most likely, growth will be sustained in the next couple of quarters as well. However, the economy may see uncertainty in the new fiscal year (which begins in April 2014) after the sales tax increase. But more importantly, the rising risks and uncertainty may weigh on growth. Abe has a lot more to do: address Japan’s dismal productivity, provide more employment to the female workforce, and incentivize corporates to raise wages, among others. Whether or not Abenomics maintains the growth on a sustainable basis is something only time will tell.


View all endnotes
  1. GDP numbers had not been published at the time of this writing.
  2. Ministry of Economy, Trade, and Industry, “Indices of industrial production (Jan. 2008 – Dec. 2013),” updated January 31, 2014, http://www.meti.go.jp/english/statistics/tyo/iip/b2010_result-2.html.
  3. Statistics Bureau, Ministry of Internal Affairs and Communication, “Labour force survey: Monthly results, December 2013,” released January 21, 2014, http://www.stat.go.jp/english/data/roudou/results/month/index.htm.
  4. Bank of Japan, “Statement on monetary policy,” January 22, 2014, https://www.boj.or.jp/en/announcements/release_2014/k140122a.pdf.
  5. Japan Ministry of Finance, “Market issuance plan by JGB types,” December 24, 2013, http://www.mof.go.jp/english/jgbs/debt_management/plan/e20131224calendar.pdf.


Dr. Rumki Majumdar

Dr. Rumki Majumdar is a macroeconomist and a manager at Deloitte Research, Deloitte Services LP.

Asia Pacific Economic Outlook, March 2014: Japan
Illustrations by Jessica McCourt (Cover), Stephanie Dalton Cowan (Japan)