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Asia Pacific Economic Outlook, January 2013

GDP growth is disappointing, but the new prime minister, Shinzo Abe, has outlined an economic revival strategy based on an aggressive monetary policy, infrastructure outlays, and more debt financing.

Japan City LifeWhile the Japanese economy has been relatively weak in recent months, expectations pertaining to its performance have increased considerably since Shinzo Abe became the country’s prime minister in December 2012. Mr. Abe outlined an economic revival strategy focused on an aggressive monetary policy, increased infrastructure outlays, and additional debt financing. Meanwhile, the Japanese economy is estimated to have contracted at an annualized rate of 0.3–0.5 percent during the last quarter of 2012.  However, leading indicators suggest that growth will likely accelerate, and current projections suggest 2.2–2.5 percent GDP growth in 2013.

Japan’s current account recorded its second consecutive monthly deficit in December 2012—a trend that does not augur well for an export-dependent economy. Japan’s current account surplus declined a staggering 50.8 percent in 2012 from the previous year, recording its lowest level in over three decades. The yen’s rising value and weak external demand took a toll on the country’s exports. Furthermore, a dispute with China over island ownership was a drag on outbound shipments to China. On the other hand, imports rose 4.5 percent because suspended operations at Japanese nuclear power plants resulted in an uptick in LNG imports.

However, the outlook for exports is improving. Market participants expect that Mr. Abe’s government will successfully decrease the yen’s value. In fact, the yen has experienced considerable depreciation after the Liberal Democratic Party’s (LDP) victory in the general election in December. Furthermore, the Bank of Japan’s (BoJ) governor announced that he will leave his post three weeks before his term expires. While this gives the government an opportunity to nominate a candidate who might support its policy agenda, some experts believe that government influence in the appointment of a governor could compromise the central bank’s independence. The appointment of the new governor and the subsequent transition is unlikely to be smooth, and it may depend on cooperation between the ruling LDP and its main opposition—the Democratic Party of Japan.

However, the outlook for exports is improving. Market participants expect that Mr. Abe’s government will successfully decrease the yen’s value.

The yen’s recent weakening is good news for Japanese exporters; many of them have already made upward revisions to their profit projections. A weaker currency could also result in higher inflation as component and raw material costs will likely escalate. This may also help the central bank achieve its ambitious inflation target. Yet, a significant devaluation of the yen could result in criticism from other nations and challenges pertaining to currency diplomacy. Furthermore, the central bank is unlikely to meet its inflation target through currency depreciation alone, and it will likely have to look at other policy options including a substantial expansion of its quantitative easing program and perhaps a sizeable increase in wage rates.

Meanwhile, several leading indicators suggest a modest revival of the economy. Japan’s benchmark composite index marked its first increase in nine months in December 2012. Furthermore, the index of coincident indicators such as industrial output, retail sales, and new job offers stood at 92.7, up 2.5 points from November 2012. Core machinery orders unexpectedly rose 2.8 percent in December, marking a third consecutive monthly gain. Orders rose 2 percent in Q4 2012 and suggest that capital spending will likely increase in the coming months. In addition, the average daily balance of lending by Japanese banks rose 1.3 percent in January from a year ago, up for the 15th consecutive month, and Japan’s service sector sentiment index registered an increase. The overall trajectory of the economy coupled with a weak yen and strong stock market appreciation have boosted both consumer and business sentiment. If the government succeeds in implementing reforms and the central bank pushes for an even more aggressive monetary policy, Japan’s economy could surprise on the upside.

Cover Image by Stephanie Dalton