Japan: Slow liftoff Global Economic Outlook, Q3 2015

The economy is having trouble taking off; areas of concern include slowing exports, consumer and industrial sectors, and retail sales. First-quarter GDP growth provides hints on the path of the economy.

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The Japanese economy is having trouble taking off. Observers note several areas of concern:

  • The Bank of Japan’s policy of quantitative easing (large purchases of government bonds) has substantially suppressed the value of the Japanese yen, but exports have not surged, as hoped. The exchange rate is now roughly 125 yen per US dollar, with the yen down about 20 percent from a year ago—the yen’s lowest value in 13 years. Yet rather than exports shooting up, the government reports, May exports rose only 2.4 percent from a year earlier, slower than April’s 8.0 percent increase. Indeed, exports declined 2.7 percent from April to May. Moreover, export volume (exports adjusted for price changes) actually fell 3.8 percent in May from a year earlier. Many attributed the slowdown in exports, in part, to the weakness of the Chinese economy: May exports to China were up only 1.1 percent from a year earlier. In contrast, exports to the United States rose 7.4 percent from a year earlier, though this still represented a substantial slowdown from the prior month. Also, imports fell 8.7 percent in May from a year earlier, indicating weak domestic demand in the Japanese economy. The weakness of trade is likely to have a chilling effect on business investment; it also bodes poorly for economic growth in the second quarter.1
  • Likewise, Japan’s consumer and industrial sectors provide cause for concern. The government reported that, compared with a year earlier, in April, consumer spending declined 1.3 percent, industrial production fell 0.1 percent, and core consumer prices remained unchanged. Plus, although unemployment declined, that was entirely due to a sharp drop in labor force participation. Despite a highly aggressive quantitative easing program and a sharp drop in the yen’s value, inflation has not yet rebounded. The governor of the Bank of Japan attributes the low inflation to the impact of lower energy prices; he sees this as temporary and expects to see a pickup in inflation.2 In addition, overall demand in the economy remains very weak, as consumer purchasing power stagnates while businesses remain reluctant to invest. The International Monetary Fund says that Japan needs a new set of reform-oriented policies and should not simply rely on a lower yen to boost exports.3
  • As for the consumer, retail sales in Japan rose 5.0 percent in April vs. a year earlier. This number sounds strong but actually reflects last year’s plunging retail sales following a national sales tax boost. In fact, retail sales remain relatively weak. Moreover, sales were up only 0.4 percent from March to April on a seasonally adjusted basis, suggesting that retail spending has nearly stalled. The government reports that spending on big-ticket items remains weak, indicating that the sales tax rise continues to negatively influence such spending. That increase caused last year’s recession, and so far the rebound has been disappointing. The government hopes that corporations will pass strong profits on to workers in the form of higher wages, thus boosting spending, but this has not yet happened.
The government hopes that corporations will pass strong profits on to workers in the form of higher wages, thus boosting spending, but this has not yet happened.

Evidence from the first quarter

First-quarter GDP growth provides hints about the path of Japan’s economy. The economy actually grew strongly in the first quarter, with real GDP rising at an annualized rate of 2.4 percent—far better than the 1.6 percent growth in the Eurozone or the decline in output in the United States. However, much of Japan’s growth stemmed from an accumulation of inventories; when this is excluded, real GDP grew at a rate of only 0.7 percent. Moreover, the massive growth of inventories in the first quarter means that businesses may not boost production much in the second quarter. This bodes poorly for second-quarter growth. Thus, although Japan came out of recession in the fourth quarter of last year, growth since has been relatively anemic.

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The government’s GDP report contained positive and negative elements. Consumer spending and nonresidential investment both grew at a moderate rate of 1.4 percent, while residential investment soared 7.5 percent. Government spending grew modestly, even as government investment declined sharply. Interestingly, although exports grew at a blistering rate of 9.9 percent, imports grew even faster at a rate of 12.0 percent, meaning that net exports actually made a substantial negative contribution to GDP growth. This report suggests that the drop in the yen’s value initially paid dividends in terms of export competitiveness. Domestic demand, though, remains relatively weak, and the modest increase in business investment—the first rise in four quarters—is nevertheless disappointing.4

Another positive element concerns corporate profitability, which the yen’s sharp drop has boosted: For the fiscal year that ended in March, 30 percent of large publicly traded companies reported record profits—the highest percentage since 2006—and total profits were up 6.7 percent from the previous year, hitting a record volume. The companies that did especially well, benefiting from the cheap yen, were those with substantial export sales or overseas operations, as well as industrial companies, boosted by falling oil prices. On the other hand, rising import prices and weak domestic demand hurt many domestically oriented nonmanufacturing companies. The rise in overall profitability has led to a surge in dividend payments to shareholders, and the question now is whether strong profitability will boost investment, which, lately, has been relatively weak. The government also continues to hope that companies will elect to boost compensation, thereby stimulating increased consumer spending.