Japan Economic Focus Q2 2016
The Japanese economy has been struggling in recent months and this has been reflected in poor equity market performance. In the last calendar year for instance, the Nikkei 225 Index is down 13.5%. The economy is flirting once more with renewed deflation and we expect the Bank of Japan to undertake further policy measures to boost activity. For instance, the March Tankan survey showed weaker inflation expectations than in December 2015, both in the corporate sector and in domestic households. Indeed the Central Bank noted that capital expenditure plans had also been reduced in the wake of the slowdown in emerging economies. The form of easing will likely be through an increase in the pace of purchases in its 80 trillion yen in annual bond purchases by around 5-10 trillion yen.
Very weak inflation is also an outgrowth of a tumbling economy that is teetering on the verge of recession. Japan’s GDP contracted 1.1% annually in the fourth quarter of 2015. That was the second time the economy contracted in three quarters. With Japanese factory output plunging in February, a technical recession – defined as back-to-back quarters of contraction – is certainly possible in the first quarter. The most recent Purchasing Managers Index data showed the steepest decline in activity since January 2013.
Forecasts for full-year growth show that the Japanese economy is set to improve marginally later this year. The International Monetary Fund pegged Japan’s GDP growth at 1% in 2016, however this may prove to be a struggle in reality. They also argued that Japan should adopt a target for wages growth, lift pay in the public sector and raise the minimum wage as part of efforts to boost incomes and spending in the economy. It will be interesting to see the full impact of the recent Kyushu earthquake on wider economic developments.
The exposure to a slowing Chinese economy has also proved to be negative with Japan having five times the economic exposure to China than the US economy has and double that of Continental Europe. This of course can be a double edged sword, with Japan remaining the most leveraged play on global GDP recovery.
The trauma of long term stagnation is entrenched in Japan. This experience of long term stagnation – two decades – has made firms very conservative in distributing higher wages and against increasing dividends and investing in real assets because of worries that the Japanese economy might fall into another stagnation. The country has been struggling with poor demographics for some time but investors more recently have started to fret about the overall debt levels in the economy.
Zero interest rates have disguised the underlying danger posed by Japan’s public debt, likely to reach 250% of GDP this year and spiralling upwards on an unsustainable trajectory. The primary budget deficit stands at 4.5% of GDP and analysts have estimated that real interest rates need to be at -1.5% in order for the Government to balance the books. If they run out of local investors to fund the debt, some observers believe that they will have to turn to external sources or inflate their way out of the situation. The Central Bank already own 34.5% of the government bond market as of February, and this is expected to reach 50% by 2017.
Japanese officials admit privately that a key purpose of ‘Abenomics’ is to soak up the debt and avert a funding crisis as the big pension funds and life insurers retreat from the market. The other unstated goal is to raise nominal GDP growth to 5% in order to ‘bend down’ the trajectory of the debt ratio, a task easier said than done. There has also started to develop a sense of domestic unrest concerning Abenomics. The weakness of the Yen and the deeply unpopular sales tax are seen as two major problems. With food self-sufficiency only running at 39%, the currency movements have driven up import prices with food alone accounting for 80% of domestic inflation.
The Central Bank is likely to push back the timing for the achievement of the 2% price stability target. They will also set out the new growth strategy which is characterised by its identification of 10 specific sectors that are expected to grow, such as artificial intelligence, health care, the environment and energy. Creating added value totaling 30 trillion yen (S$364 billion) through the “4th industrial revolution” in which productivity would be enhanced dramatically via information and telecommunications technology, and expanding the market size of health care and medicine from 16 trillion yen to 26 trillion yen – by amply incorporating these numerical targets into the growth strategy, the government aims to realise a nominal gross domestic product of 600 trillion yen by 2020.
Any lack of policy action generally causes the Yen to strengthen and this will act as a headwind for the domestic equity market. The current earnings season is highlighting the concerns of exporters such as Canon and Toyota regarding the currency.