After three “lost decades”, Japan may finally be regaining its economic footing. But for how long?
In 2009, Hoover Institution Fellow Michael Auslin referred to Japan as the “sick man of Asia” in an article for Foreign Policy. Having once been the pre-eminent power in East Asia and the architect of an iconic economic miracle, Japan was seemingly stuck in a black hole of anaemic growth. Once regarded as a contender to replace American economic hegemony, questions were asked about whether Japan would have sufficient economic firepower to maintain its pivotal role as a great power in the Asia Pacific regional order.
Yet ironically, the waning of the traumatic Covid-19 pandemic has seen Japan experience something of a reprieve from its economic doldrums. In 2Q2023, Japan experienced 6% q-o-q economic growth, soundly beating market expectations of 3.1% q-o-q expansion. This marked its third consecutive quarter of growth, as it notched 3.7% q-o-q expansion in 1Q2023 and 0.2% in 4Q2023. DBS predicts Japan’s full-year growth to reach 2% this year.
Bank of Singapore chief economist Mansoor Mohi-uddin notes that Japan’s nominal GDP hit an all-time high at JPY600 trillion ($5.7 trillion) in 2Q2023. “We think nominal GDP will stay on its new uptrend now,” he says, noting that typically near-zero or negative inflation, fingered for sapping the economic vitality of the country, has now hit four-decade highs owing to the twin shocks of Covid-19 and the war in Ukraine. The Bank of Japan (BOJ) is maintaining sub-zero rates in a sea of rate hikes to bring inflation to around 2%. As of July 2023, BOJ expects inflation, which has averaged 0.3% since the bursting of Japan’s bubble economy in 1992, to hit 2.6% in FY2023 and 1.9% in FY2024.
Investors have naturally been jubilant. As of June 2023, the Nikkei was up 30% year-to-date while Topix gained 24% to reach a three-decade peak. “Our investment committee recently turned overweight on Japanese equities among global equity markets in our foundation asset allocation,” notes Abhilash Narayan, senior investment strategist at Standard Chartered in May.
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“Investors are rediscovering Japan. Inflows into the country’s equity market from non-domestic investors are the strongest they’ve been in a decade,” says Luca Paolini, chief strategist at Pictet Asset Management, as he upgrades his call on Japanese equities to overweight from neutral based on a strong Japanese economy and changes to domestic investment rules.
Mohi-uddin concurs. “We thus recommend investors stay overweight Japan’s equities. The return of inflation and nominal GDP growth will support domestic firms’ profits and revenues after Japan’s three lost decades,” he says in an Aug 24 economic research report.
Even Warren Buffett has turned into a Tokyo bull. The Oracle of Omaha has increased his holdings of Japan’s top-five trading firms, prompting what UOB calls “a sudden inflow of US$7.83 billion [$10.4 billion] in just five days”. Berkshire Hathaway’s average holdings of Itochu, Marubeni, Mitsubishi Corp, Mitsui & Co and Sumitomo are at least 8.5%. “We’re not done [with Japan],” Buffett told Berkshire Hathaway stakeholders at its annual meeting in May.
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Echoing the sentiments, Masashi Akutsu and Tony Lin over at Bank of America observe that it was Japan’s pivot to inflation that was the greatest common area of interest among foreign investors. “Many of them now think that this presents an opportunity for a structural change,” state the analysts in their Sept 15 note.
However, they warn that foreign investors are not yet fully “confident” that inflation can be sustained and whether that will ensure corporate reforms.
Yet, it can also be interpreted that there is more room to grow as more investors warm up to this investment theme. “In other words, there is room for a substantial influx of funds if inflation proves sustained and corporates reform.
“A recent phenomenon is the large number of investors who had been out of Japanese stocks for a long time or are getting into them for the first time. Building positions take time,” they add.
Good times here again?
Much of the Japanese recovery stems from its delayed Covid-19 recovery, with its last remaining travel requirements for citizens dispensed with on April 29. Pent-up demand has seen consumer spending roaring, with retail sales up 7.3% y-o-y in May. Japanese workers are also enjoying higher wages and big fat bonuses. Spring labour-management discussions saw
Japan’s average summer bonus reach JPY903,397 — the sixth highest level on record — and monthly wages growing by the largest amount in 31 years.
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Higher consumption is also supported by BOJ’s commitment to ultra-easy monetary policy. The central bank shocked markets in July when it hinted that it would “loosen” its yield curve control policy which targeted a 0% yield on Japanese 10-year government bonds. This led to equities and government bond prices falling over fears of possible monetary policy tightening. BOJ has since sought to reassure markets that a change in monetary policy is still some ways off.
“We do not have an exit from monetary easing in mind,” says BOJ deputy governor Shinichi Uchida in a speech at a meeting with local leaders in Chiba prefecture on Aug 2. “The downside risk of missing a chance to achieve the 2% target due to a hasty revision to monetary easing currently outweighs the upside risk of the inflation rate continuing to exceed 2%,” he adds, referring to BOJ’s 2% inflation target.
“We think that underlying inflation is still a bit below our target,” echoes BOJ governor Kazuo Ueda at the Jackson Hole Economic Symposium, an exclusive meeting of central bankers organised by the US Federal Reserve in Wyoming.
A June report by Bridgewater Associates notes that BOJ is “appropriately cautious” about shifting its “very easy” monetary policy stance despite achieving “inflation at target, roughly normal levels of economic activity, and close to normal pricing of assets in relation to cash”. The presence of global risks and the lack of major international pressures outside of restoring normalcy to the Japanese government bond market, it notes, makes it prudent for BOJ to avoid deviating from its current monetary policy stance.
“The resilience of Japanese activity, combined with a weak yen, is helping to feed strong EPS momentum. Japanese corporates had a very good earnings season with far more firms beating analyst expectations than is typical,” says Daniel Grosvenor, director of equity strategy at Oxford Economics. He sees this momentum likely to continue into 2H2023 and has accordingly reiterated the firm’s “overweight” stance on Japanese equities.
False dawn?
Yet, there is some concern that the green shoots of economic revival may prove to be a false dawn. An Economist Intelligence Unit (EIU) report on Aug 16 anticipates “reverse-v-shaped” growth in the Land of the Rising Sun, warning that strong economic momentum is unlikely to persist into 2H2023 as private consumption subsides.
“We expect Japan’s economy to cool in the second half of 2023, as domestic demand will be weighed down by persistent inflation while exports of goods will trend down amid slowing economic momentum in the US and China,” says Fei Xue, senior analyst, Asia, at the EIU. He sees growth in Japan picking up again in 2024 as these negative factors recede.
Antonio Fatas, professor of economics at Insead, agrees. “Some of the growth is cyclical (recovery from the pandemic), like in other countries. That is likely to end soon (like in other countries),” he tells The Edge Singapore.
Another source of possible gloom, however, is the possibility that BOJ may tighten monetary policy in January 2024. While BOJ maintains that its ultra-easy monetary policy will remain for the present, its move to loosen yield curve control may be a prelude to possible tightening next year. Reuters reports that economists see policy “unwinding” taking place by July 2024 latest.
BOJ board member Naoki Tamura foresees that the Japanese economy will reach BOJ’s 2% interest rate target by early 2024, which would pave the way for a possible rate hike. “Removing the negative rate would naturally be one of the options,” Tamura, who is viewed as a fiscal hawk, told reporters in a speech to local business leaders in Kushiro, Hokkaido, on Aug 30.
In the medium-term however, Syetarn Hansakul, senior analyst at the EIU, is optimistic that the end of deflation will be a boost for sustainable growth in Japan. Xue expects growth to be steady and moderate at an average annual rate of 1.1% during 2023–2027.
“The end of deflation is positive for sustainable growth, although we expect growth to stay modest at just above 1%. Households will be enticed to spend now rather than defer their spending as in the past, waiting for prices to drop,” Hansakul tells The Edge Singapore.
Fatas, however, argues that there was never really a problem with Japan to begin with. “There was a talk about the ‘lost decades’ of Japan after 1995 that was unfair. Japan always did relatively well, in some cases better than other advanced economies, when it came to productivity growth,” Fatas tells The Edge Singapore. Slow growth, he argues, stems from Japan’s ageing population given that its workforce could not grow as fast as those of other economies.
Fatas credits policies pursued under Abenomics — a suite of sweeping reforms under late former prime minister Abe Shinzo — for increasing the work of the labour force and productivity levels. These include ultra-easy monetary policy, increased government spending, and structural reforms. While Japan has ranked last in terms of productivity among G7 countries for five decades straight as of 2022, its productivity growth ranks second in the G7 from 2020–2022 at a CAGR of 3.3%
“This [labour productivity growth] may partly reflect the acceleration in technology investments by Japanese corporates on foot of the digital transformation initiative promoted by the authorities since 2018 to combat Japan’s demographic challenge,” says Dong Chen, head of Asia macroeconomic research at Pictet Wealth Management.
The long road to prosperity
Nevertheless, Japan’s road to renewed prosperity remains paved with adversity. EIU’s Xue also sees several mid- to long-term constraints hindering Japan’s growth prospects. Strained trade relations with China, persistent demographic ageing, and a low-inflation mindset are likely to exert a drag on the growth prospects of Asian economies like Japan.
“The slowdown in China will take some wind out of Asia’s medium-term growth prospect,” says Hansakul. She predicts that the continued bifurcation of regional supply chains will raise production costs for regional firms. As a major Apac economy, Japan is likely to be caught in the crossfire. Slowing growth rates in China, Fatas adds, could lead to both external and internal sources of volatility that could trigger regional instability.
Pictet’s Chen is more optimistic that supply chain diversion will benefit the Japanese economy. Japan’s status as a US ally and strength in several high-tech sectors suggest that it would be able to enjoy long-term advantages as the US and its allies quit China. The Japanese government has also provided generous funding for semiconductors, starting a JPY774 billion special fund in 2021 to support cutting-edge chip manufacturing.
“External shocks due to the pandemic and the Russia-Ukraine war seem to have led to real changes in corporations’ price- and wage-setting behaviour, which may support a more sustained inflation outlook in Japan,” says Chen. He notes that JPY400 million is reportedly being allocated to the construction of a new TSMC semiconductor plant in Japan.
It also remains to be seen, however, how sustainable Japanese consumer consumption will be. Consumption-driven growth has previously been impeded by anaemic wage growth, consequently worsening deflation. Japanese Prime Minister Fumio Kishida has promised to roll out a “new capitalism” that emphasises higher wages, labour market flexibility, and increased government spending on green and digital transformation. Its goal is to drive growth and resolve social problems.
“The new form of capitalism initiative by the Kishida government to achieve faster wage growth in the private sector seeks to support consumption and defeat deflation in a sustainable manner but it is only in its early stage and its success is not yet assured,” says Hansakul.
A key headache for the Japanese government will be the persistent challenge of an ageing population, which Hansakul believes will be difficult to reverse. Despite attempts by the Japanese government to introduce fiscal stimulus to encourage young people to have more children, this alone is insufficient to defuse Japan’s demographic time bomb. A punishing work culture and financial stresses may discourage couples from childbirth.
“Our nation is on the cusp of whether it can maintain its societal functions,” Kishida said during a policy speech in the Japanese diet in January. “It is now or never when it comes to policies regarding births and child-rearing — it is an issue that simply cannot wait any longer,” he added.
In the meantime, the Japanese government has sought to increase the size of its workforce by increasing female participation rates and raising the retirement age to make up for the shortfall. The employment rate for Japanese women, for instance, has increased steadily from 47.1% in 2013 to 53% in 2022. But Fatas of Insead notes that the “easy solutions” for growing the Japanese workforce have already been exploited.
“Productivity is where there is room to continue growing as long as Japan is able to continue closing the productivity gap it has with other countries. Reform in certain sectors (mostly services) can help maintain that momentum,” he says.
