The Japanese economy appears to have entered a recessionary phase. In the third quarter, Japan’s GDP declined 0.9 percent over the previous quarter. This represents an annualized decline of 3.5 percent, and the economy may also contract in Q4 2012. A dip in exports to Europe was accompanied by weaker exports to Asian economies in Q3 2012. Consumer spending, which accounts for over 50 percent of Japan’s GDP, experienced its second consecutive quarterly drop. Furthermore, capital spending slipped for the first time since mid-2009. However, a faltering economy is only part of the story. The central bank’s monetary stance and political transitions will likely attract more attention in the coming months. The possibility of a change in political leadership following the general election in December is heightening policy uncertainty.
The main factor contributing to GDP contraction was a drop in exports. Net exports shaved nearly 0.8 percent from GDP in Q3 2012 as nominal exports ebbed in 10 of the past 13 months. October marked the fifth consecutive monthly decline wherein exports dropped by 6.9 percent. Meanwhile, higher demand for fuel has increased the import bill, and Japan’s trade deficit has remained in negative territory. Territorial disputes with China have made matters worse. In October, sales of Japanese-brand passenger cars were down 38.2 percent over the previous month and down a staggering 59.4 percent year-over-year. However, trade ministers from China, Japan, and South Korea have initiated discussions for a trilateral free-trade agreement. The talks, if successful, will likely create one of the world’s biggest free-trade zones.
The Japanese government lowered its view of the economy for the fourth consecutive month. Weak corporate spending was one of the main factors for the downward assessment. The government is also pessimistic about bankruptcies, the employment situation, and corporate profitability—especially among manufacturers. In addition, domestic demand could lose momentum, which does not bode well for private consumption.
The Democratic Party of Japan is likely to lose its majority to the opposition Liberal Democratic Party (LDP) in the general election scheduled for December 16, and Shinzo Abe may become the country’s new prime minister. Mr. Abe has promised additional stimulus to revive the economy, and he called for an even more aggressive monetary intervention by the central bank. Some experts believe that Mr. Abe’s stance on reforming the Bank of Japan (BoJ) law to make the central bank more accountable to the government could impinge on the independence of the central bank. While changes to the BoJ law will be difficult to implement, the next government will nominate up to three new members of the nine-member board of governors, including a replacement for the current governor. As a result, the LDP could exert significant influence on future monetary policy.
While monetary policy could play a major role in Japan’s recovery, the central bank has not been able to deliver on its targets.
Meanwhile, the BoJ decided to keep its monetary policy unchanged in its meeting on November 20. Interest rates were held at between 0 and 0.1 percent, and the size of the asset purchase program was not increased. After two consecutive months of easing, the BoJ’s monetary stance was in line with expectations. Moreover, the BoJ might face increased political pressure to adopt aggressive monetary expansion, following the general election in December. As a result, the central bank might have preferred to hold back on its limited policy options during this meeting. The BoJ has expanded its monetary stimulus four times this year by increasing the size of its asset purchase program to $1.2 trillion.
While monetary policy could play a major role in Japan’s recovery, the central bank has not been able to deliver on its targets. Japan continues to face a deflationary environment, and the BoJ’s target of 1 percent inflation is unlikely to be achieved this year. Moreover, the BoJ remains weary to the risk of a rise in the value of the yen amid unlimited quantitative easing by the US Federal Reserve. Yet, much of the onus of supporting the economy might fall on the BoJ.