DIRECTOR'S PERSPECTIVE

by Saruhan Hatipoglu sshatipoglu@beri.com

Is Japan Out of the Danger Zone?

The year was 2001.  Japan was on the verge of economic bankruptcy with little or no growth for almost a decade. The banking industry was in shambles, and consumer confidence was sorely lacking. The global economy seemed to have given up hope for Japan. That was when Junichiro Koizumi was elected head of the LDP and became the prime minister, bringing yet another wave of hope and guarded optimism to the country. But was this only another illusion for the Japanese people? 

Fast forward to 2004.  Today, Japan is showing signs of economic recovery. Real GDP expanded strongly during two consecutive quarters, bringing annual first quarter growth to 4.7%. In addition, the Bank of Japan’s (BoJ) Tankan survey released in July indicated strong business confidence in the economy. In fact, the headline index of sentiment for large manufacturers had its best performance since 1991. The number of companies maintaining a “guarded outlook” was greater than optimistic ones only in the retail and construction industries out of the total of 27 sectors surveyed by the BoJ. The recovery is also having a positive impact on fighting deflationary pressures, one of Japan’s inherent woes. Although an annual price increase is not expected in 2004 (0.4% decrease in the twelve months through May), the extent of deflation will be less, with inflation possibly appearing in 2005. The BoJ is maintaining an accommodative monetary policy to combat deflationary pressures, and kept the discount rate at 0.10% at the June meeting.

Is growth going to be sustained in Japan?  An examination of some statistics calls for caution. For example, the Tankan survey, as optimistic as the results may be, should not be used to compare one time period to another because surveyed companies are not the same. Furthermore, it is true that business confidence is on the rise, but its extent and duration is not yet certain. The stability of consumer confidence is also not yet guaranteed. Soft retail sales (0.5% lower in May from a year earlier) are the best proof of the fragile nature of confidence in the economy.

Second, the main source of economic growth so far is not internal demand but robust export expansion, particularly sales to China. The value of exports expanded 9.8% in May, compared to the 2003 period. Last year, Japan’s exports to China grew by a remarkable 32.3%, reaching ¥4980 billion. This dependence is risky and assumes steady growth in China, a scenario that is now in jeopardy because the government of China is taking measures to slow economic expansion. A hard landing (e.g., growth of 3%-5%) in China has very low probability, but if it occurred, it would spell trouble for the Japanese recovery.

Finally, promise of reform is not entirely fulfilled. Even though much-needed financial reform is taking place, there are other areas that require attention. The public highway corporations, postal savings system and multi-layered domestic distribution are some key issues that Prime Minister Koizumi has not yet adequately addressed and will find difficult to do so. Substantial debt obligations that the country is facing in the middle of a demographic time bomb (public debt is estimated at 160% of GDP) will prevent public officials from adequately tackling long-term structural problems in the country, posing yet another threat to sustained growth.

Conclusion  Much depends on how domestic demand will fare during the remainder of this year and in 2005. Mr. Koizumi’s leadership will help determine that outlook. The upper house elections on 11 July will show how popular Mr. Koizumi and the Liberal Democratic Party (LDP) are in Japan. For market stability and reform policies, continuity is of immense importance to the nation. The outcome of upper house elections will provide a better measure of the likelihood of prosperity. Political continuity will contribute to gains in domestic demand and accelerate the “recovery with reform” approach of Mr. Koizumi. If this policy fails, Japanese recovery will depend on sustained growth in China, which is unlikely to provide the growth engine Japan is desperately seeking in the long term.

Japan: The numbers are encouraging, but the story is more complicated

DIRECTOR'S PERSPECTIVE Last Updated July 2004