Japan: Obstacles to recovery

Japan: Obstacles to recovery

Japan: Obstacles to recovery

Global Economic Outlook, Q2 2014

The Japanese economy is emitting mixed signals, punctuated by fears concerning a tax increase and its potentially damaging impact on economic growth.

Japan_spot1A weak fourth quarter

The Japanese government’s latest estimate is that the economy grew at an annual rate of only 0.7 percent in the fourth quarter, a very weak reading. The earlier estimate was growth of 0.9 percent. Weak export growth meant that Japan had its largest current account deficit on record. Business capital spending was also weaker in the fourth quarter than previously estimated. The uncertainty about the potential impact of the upcoming tax increase is likely hurting business willingness to take risks. Many analysts expect a strong first quarter of 2014 in anticipation of the April 1 tax increase. This is expected to be followed by a sharp decline in GDP in the second quarter.

Many analysts expect a strong first quarter of 2014 in anticipation of the April 1 tax increase. This is expected to be followed by a sharp decline in GDP in the second quarter.

First-quarter hopes

As for the first quarter, there is a mix of data so far. Japan’s exports were up 9.8 percent in February versus a year earlier, which was weaker than market expectations. In part, the weakness may have reflected weak demand in the United States during a period of very bad weather. Still, investors were concerned that exports are not doing better. There had been hope that a robust export sector might play a role in offsetting the negative impact of the April tax increase. After taking inflation into account, the volume of exports was up only 5.4 percent. It had been hoped that the sharp drop in the value of the Japanese yen would have helped to boost export growth. However, a weaker currency only helps if exporters reduce their prices. Evidently this is not happening to the degree expected. In addition, the government reports that imports were up 9.0 percent, more than anticipated. A weaker yen does cause an increase in import prices, which could have a negative impact on consumer spending. On the other hand, a weaker yen helps to boost inflation, one of the government’s goals.

As for Japan’s critical manufacturing sector, the purchasing manager’s index for the first two months of 2014 was strong, suggesting that the sector continues to grow at a robust pace. The government reported that industrial production increased 4.0 percent from December to January, the biggest one-month increase in three years and a good deal faster than most analysts expected. There were other favorable indicators. The government reported that household spending increased 1.1 percent from December to January. Retail sales increased 4.4 percent in January versus a year earlier, the fastest January increase since 1980. It is widely expected that, because of the tax increase in April, economic activity will ultimately plummet in the second quarter after surging in the first. The data suggest that GDP may have increased rapidly in the first quarter, despite the slowdown in export growth. The main uncertainty is how much of a decline will take place in the second quarter, and how much the government can do to limit the damage.

On the other hand, one worrisome sign is that the purchasing manager’s index for the nonmanufacturing services sector fell into negative territory in February, indicating that the broad services sector may have stopped growing altogether.

Confidence in inflation

Meanwhile, Bank of Japan (BOJ) Governor Haruhiko Kuroda said that he remains confident that Japan is moving in the direction of 2.0 percent inflation.1 Indeed, the government reported that consumer prices excluding volatile food prices were up 1.3 percent in January versus a year earlier. While below the BOJ target of 2.0 percent, this rise is clear progress from the deflation that existed just a year ago. Kuroda also expressed confidence that, following a brief disruption from the tax increase in April, the economy will continue to grow at a strong pace. However, he noted that the BOJ will adjust policy if necessary.2 Many analysts are more worried about the tax increase than Kuroda appears to be. Indeed, there had been speculation as to whether the BOJ would take more aggressive actions, yet in March the BOJ announced that it will continue its program of asset purchases at a constant pace, leading to a rise in the value of the yen. A survey found that 73 percent of economists believe that the BOJ will indeed boost the pace of asset purchases later this year. Kuroda said, “We will adjust policy without hesitation if achieving 2 percent inflation becomes problematic or if smooth progress isn’t made toward the goal.” He also indicated that he is not concerned about the slow pace of export growth, saying that this was due to temporary factors.3

What next?

What can be expected of the Japanese economy in the wake of the large tax increase that went into effect on April 1? The second quarter is expected to involve a sharp drop in GDP—that is a given. The real question concerns what follows: Will the economy bounce back? Will fiscal and monetary policy be sufficient for Japan to avoid another recession?

It is too early to answer these questions with any certainty, but there are a number of factors that will play a role in determining growth for the remainder of the year.

First, a rise in wages would help. So far, wages have stagnated even as prices have risen. This concerns the government. It means that the real purchasing power of wages is declining, which bodes ill for consumer spending. It could be that businesses have held back on wage increases prior to the tax increase. If wages are boosted in the coming year, it would go a long way toward reviving consumer spending.

Second, the rest of the world matters. If the European, American, and Chinese economies do well, it will boost Japanese export growth. Although Japan is attempting to move away from export dependence, trade remains a critical element in success.

Third, much will depend on the policy reaction to the tax increase. If the BOJ becomes more aggressive in response to faltering spending, it would be helpful.

Finally, much will depend on the attitude of business. And that, in turn, could depend on the government’s commitment to implementing the third arrow of Abenomics: deregulation. If the government announces significant regulatory reforms by the summer, it could have a big positive impact on business investment.

If the government announces significant regulatory reforms by the summer, it could have a big positive impact on business investment.


View all endnotes
  1. Stanley White, “BOJ’s Kuroda: High chance BOJ to meet its inflation target,” Reuters, March 20, 2014, http://www.reuters.com/article/2014/03/20/us-japan-economy-boj-kuroda-idUSBREA2J0CC20140320.
  2. Leika Kihara, “BOJ Kuroda repeats vow to adjust policy when needed,” Reuters, April 16, 2014, http://www.reuters.com/article/2014/04/17/japan-economy-boj-idUST9N0N603Z20140417.
  3. Ibid.


Dr. Ira Kalish

Dr. Ira Kalish is chief global  economist of Deloitte Touche Tohmatsu Limited.

Japan: Obstacles to recovery
Cover Image by Jessica McCourt (Cover), Maria Corte Maidagan (Japan)