Japan’s economy has continued its recovery in the past weeks but remains dependent on stimulus efforts to revive the local economy and its exports, which are mainly manufacturing based, an area that depends on the development of the global economy and which is showing signs of a slow-down.
While growth is one issue in the Japanese economy, the fiscal balance is another one. In comparison to other major OECD economies, Japan has so far not addressed this issue as aggressively as other economies, due certainly in part to the triple disaster of last year. In the meantime, the government has started to tackle the issue by planning to double the consumption tax; further measures are expected to follow in the future. With an ageing population, the highest debt burden of all major OECD economies and despite the needed recovery efforts after last year’s events by far, it is certainly a sensible area that needs to be sorted out as long as it possible to do so without the pressures from capital markets.
There is a plan to increase the consumption tax to 8% by 2014 and to 10% by 2015, from currently 5%. But even with the rise in consumption tax, the gross debt-to-GDP measure is forecast to stand at a stunning 292% in 2016, according to an estimate that has been undertaken by Credit Suisse.
To find new sources of revenue, therefore, should be expected to be a key issue for the future. Additional sovereign funding needs will probably hold back next year’s expansion, after this year’s focus moves away from providing support for the economic recovery. The current global slowdown and demographic developments will potentially make it challenging to find the right balance. However, it should be noted that to raise the tax in the current environment might turn out to be a risky move. In 1997, the last time the tax was increased, it led to a recession and a slump in retail sales and to a steep decline in central government tax revenues.
Another sensitive area — and consequence of last year’s events — is the shut-down of the nuclear facilities in Japan, which have provided more than a third of electricity to the country. There is currently a popular mistrust of nuclear energy and it remains to be seen how this will develop.
Only one reactor has been re-started recently, but this is considered to be an exception; no additional nuclear energy supply should be expected in the near future. Currently, the shortage of electricity is compensated via imports of fossil fuels for burning to generate electricity.
This is not only more expensive, given that the nuclear infrastructure had been providing relatively cheap energy after the expensive installation costs had been absorbed, but it is also a burden to the economy, which has been facing a yearly trade deficit, a phenomenon not known for more than two decades. Trade surpluses had been an important source of funding for the economy and, hence, the trade deficit has become the source of its largest fiscal deficits. It is not expected that the country will return to its nuclear facilities anytime soon, which in the short-term will also have a negative impact on the economy.
The pattern of a monthly trade deficit promptly started in March of 2011, when the country was hit by the tragic events. The April 2011 gap was the highest at 697 billion yen, but the most recent May number was again at almost the same level at 657 billion yen. This comes despite a relative successful development in exports, which increased by 10.0% y-o-y in May on a non-seasonally adjusted base and by 8.0% in April.
Industrial production is also holding up well, but the momentum seems to fade with a yearly rise of 3.4% in May compared to a 12.9% rise in April. Retail trade has slowed down slightly as well, from a 5.9% y-o-y rise in April to a 3.6% increase in May. The slowing momentum becomes even more evident when reviewing the recent manufacturing order numbers which declined by 7.1% in May, after a rise of 9.2% in April. This yearly comparison translates into a monthly change of an even greater magnitude of -14.8, compared to an increase of 5.7% in April.
Interestingly, it is domestic demand that has fallen sharply by 23.0% m-o-m, compared to foreign demand, which was at around the same level in May as it was in April at 0.3%. This will need further close monitoring as the latest Tankan survey signaled improving manufacturing data. The large manufacturer business conditions diffusion index improved from -4 in the March Tankan to -1.
This is the first improvement in large manufacturer business conditions in three quarters. The outlook for large manufacturers is also for continued improvement to an index of 1; and despite some disparity between industries, manufacturing conditions are reported to be solid overall. The more positive momentum of the Tankan index is contrary to the lead indicator of the purchase manufacturing index (PMI), provided by Markit. The June composite PMI fell below 50 for the first time since November of last year to stand at 49.1. Both the manufacturing and the services sector are forecast to decline with an index level of 49.9 and 49.3, respectively.
The momentum in the 1H12 has been solid, especially when compared to the previous year. This higher than expected momentum has supported a lifting of this year’s growth forecast to 2.5% compared to last month’s forecast of 2.0%. However the slow-down in the global economy, combined with the need to tackle the fiscal situation and the expected slowdown in domestic demand, is expected to drag the expansion again to lower levels in the next year to around historical averages to stand at 1.2%.