The economic data for the first half of 2013 suggest that Japan’s economy is growing at a considerably stronger pace than before. Domestic demand, exports, and the government’s fiscal and monetary stimulus packages are helping the economy grow at a fairly healthy rate. However, the recent setback in the stock market rally and the latest weaker-than-expected monthly economic data show that the economy is vulnerable to shocks. So are consumer and business confidence, which have played an important role in boosting economic growth so far. This economic vulnerability, along with rising public debt and declining working population, underlines the challenges the government faces as it tries to revive the country’s economy.
Growing but highly vulnerable
The monthly data releases in Q2 2013 suggest healthy economic growth. But, at the same time, the data also reveal a very mixed picture about the growth’s sustainability. For instance, retail sales, industrial output, housing starts, and the investment climate witnessed a strong rebound in May. Steep currency depreciation, due to the new massive monetary policy stimulus in April, helped exports grow. Japanese manufacturing activity, measured by the manufacturing purchasing managers’ index, rose at the fastest pace in more than two years, from 51.5 in May to 52.3 in June, while the index for new orders rose from 53.1 in May to 54.7 the following month. The Bank of Japan’s Tankan survey of business sentiments for large enterprises in Q2 2013 indicated a significant improvement over previous quarters, far exceeding the forecast numbers.1 The sentiments in large enterprises in the manufacturing sector rose to their highest level—and became positive—for the first time in two years, indicating a favorable business environment. The Bank of Japan’s announcement of monetary stimulus in April has helped contain the steep fall in consumer price inflation and raise inflation expectations. In a survey by the Bank of Japan, the number of respondents who expect prices to rise by more than 2 percent increased 15 percentage points, to around 60 percent, since Shinzo Abe became the prime minister in December. Since the impact of monetary policy on prices comes with a lag, prices are expected to trend up by the end of 2013.
On the other hand, some of the monthly releases indicate that the growth is inconsistent and may even be susceptible to sudden shocks. The average growth of monthly household consumption spending fell to -0.6 percent during April–May from its rapid pace of 2.1 percent in Q1 2013. After a positive average growth of 2.8 percent month on month in the first two months of Q2 2013, the industrial output index fell by 3.3 percent in June. The growth in the equity market, which shot up by more than 50 percent since December 2012, came to a sudden halt in late May and early June. The statement by the US Federal Reserve that it might scale back its bond purchases later this year led the equity index to plunge, while the Japanese yen rose against the US dollar to a two-month high. Equity index has been falling since then, while the yen continues to appreciate against the US dollar. In addition, financial market volatility has led to uncertainty about whether the Bank of Japan will reverse its course of monetary easing. The Bank of Japan opted not to provide additional monetary stimulus in the June monetary policy meeting, sending mixed signals to investors worldwide.
That said, it is beyond doubt that Abe’s economic policies have improved economic activities and sentiments, and the recent poorer-than-expected monthly data may not be an immediate concern. But the vulnerability of the economy cannot be overlooked. Japan has the highest debt-to-GDP ratio among developed nations, and government deficits are still high. High public debt and the fiscal imbalance will continue to worry investors, increasing the economy’s susceptibility to external shocks.
Abe’s win also means that the government can now go ahead with economic reforms, which might be painful in the short term but will likely help the economy sustain growth in the long term.
The significance of Abe’s recent win
Abe’s government has adopted a series of aggressive measures to boost domestic demand and raise inflation since he was elected in December 2012. The recent victory in the parliament’s upper-house election this month has given him a stronger mandate to continue with his economic policies, often termed “Abenomics,” to revive the world’s third-biggest economy. Abe’s win also means that the government can now go ahead with economic reforms, which might be painful in the short term but will likely help the economy sustain growth in the long term.
However, enacting the reforms will not be easy. One of the most challenging reforms is expected to be the fiscal tightening that is planned for next year. There is rising concern that sales tax increases next year may derail a nascent economic recovery and impact consumer spending, which has recently witnessed a turnaround. However, it is Abe’s reform agenda that made him popular and gain support in the upper-house election, so retreating from reforms may result in the loss of people’s confidence. The tax hike that is expected to be effective from 2014 is likely to be the first important step toward repairing Japan’s financial situation, which in turn will likely pave the way to sustainable growth. But the tax hike may also harm growth and inflation prospects in the near term, dampening hope that the economy can overcome 15-year-old deflation and stagnated growth. It will be a tough choice, and whether or not the progress will be sustainable will entirely depend on the government’s stand on the proposed reform agenda.
- Bank of Japan, Tankan Business Condition Index: 157th short-term economic survey of enterprises in Japan, June 2013, http://www.boj.or.jp/en/statistics/tk/gaiyo/2011/tka1306.pdf.