Japan

Briefing Notes for the Launch in Tokyo, March 2009

Impact: the return of recession

  • Japan’s economy contracted after growth of 2.4% in 2007. Business investment and export demand plunged, and consumer confidence and private consumption deteriorated. The economy contracted by 3.3% on 4th quarter 2008 on quarter-to-quarter basis, reducing the annual growth rate to -0.7% in 2008.
  • The global financial crisis appeared to have limited impact during 2007, yet it had already begun to erode business confidence at the end of 2007, reinforcing the deterioration of business investment during 2008.
  • Private investment, which suffered a major setback in 2007, made some recovery during 2008, but fell again towards the end of the year reflecting the falling consumer confidence.
  • Increased production costs, particularly due to the surge in commodity prices, as well as falling demand, squeezed profits in the business sector. Corporate profit plunged by annual rate of 22.4% in the third quarter of 2008 – the largest fall in 7 years.
  • Household consumption weakened in the absence of consumer confidence and income growth. In addition to sluggish wage growth, surge in oil prices pushed up consumer price during 2008, reducing the real income. Labour market condition eased and unemployment rate crept up as recession deepened and firms start cutting labour force, particularly part-time workers. Unemployment and sluggish wage growth further dampened consumer confidence and failed to support private consumption

Inflation

  • Corporate price inflation, which tracks changes in wholesale prices, recorded a hike of more than 7% in the third quarter 2008, reflecting the high price of oil and commodities.
  • Corporate price inflation pushed up the consumer price to 1.4% in 2008, which is about 10 year high for Japan.
  • Falling oil price in the second half of 2008 and recession brought back the concern on deflation which haunted Japan for a decade.

External sector

  • The fall of U.S. export demand was partly offset by the solid demand from the other parts of the world at the beginning of 2008.
  • The recession in U.S. and Europe reduced their demand for Asian products, which eventually led to a significant reduction in Asia’s demand on Japanese export products. As the demand from Europe and Asian economies fell, export begun to shrink (in yen term) in the second quarter of 2008, recording a contraction by 26.5% in November 2008.
  • Trade surplus plunged. Together with an increase in imports, trade surplus shrank as much as 67% in 2008, largest fall in history.
  • Fall of demand from Asian countries have significant impact on Japan’s export growth, as almost half of Japan's exports are directed to Asia. In particular, as of 2008, around 20% of Japan’s export went to China and Hong Kong, China, In dollar term, export contracted at annual rate of 15% in November, of which almost half is attributable to the contraction of the demand from Asia.

Policy responses

  • The deepening global downturn led macroeconomic policies of the three economies in one direction: supporting domestic demand and ensuring liquidity in the financial sector. The budget balance is expected to worsen in all these economies. Their weakening economies will limit revenue growth and increase the need for fiscal expenditure.
  • Public debt stood at 170% of GDP in 2008. While budget deficit narrowed in recent years, fiscal consolidation was put on hold. The proposed budget for fiscal year 2009 indicates an increase of expenditure by 7%. The deteriorating economic outlook has led the Government to make economic recovery a priority over fiscal consolidation for the time being.
  • The government announced plans for economic stimulus package of approximately 75 trillion yen in total, consisting of 12 trillion yen (about 2% of GDP) fiscal measures and 63 trillion yen financial measures within the two supplementary budgets for fiscal year 2008 and the budget for fiscal year 2009. The package embraces three components; assistance for consumers, assistance to small and medium enterprises, and revitalizing regional economies.
  • The Bank of Japan cut the target for the overnight call rate in October 2008, from 0.5% to 0.3%. After the U.S. Federal Reserve Bank cut its target for the federal funds rate to between zero and 0.25%, the Bank cut its target rate to 0.1% in December.
  • The past experience of extremely accommodative monetary policy cast doubt on the effectiveness of the rate cut to prevent a credit crunch, and the BOJ explored other measures to ensure liquidity for the corporate sector, especially small and medium-sized businesses.
  • To encourage banks to maintain funding for the corporate sector, the BOJ relaxed requirements for BOJ’s loans to banks (so that banks could get loans with lower-rated corporate debts as collateral). It also announced other non-traditional measures such as purchase of corporate bonds and commercial paper to reduce corporate financing costs.

Outlook

  • Recession is expected to continue in the coming year as external demand deteriorates and private demand weaken further. The economy contracted by 0.7% in 2008 and is expected to contract by 2.5% in 2009.
  • Inflation rate is estimated to fall from 1.4% in 2008 to -0.2% in 2009, raising concern on the return of deflationary pressure.
  • Medium term policy challenges mount – fiscal consolidation and reform of social welfare system. With fast aging population, it is a daunting task to restructure social safety net which is sustainable, resilient to large shocks and protect vulnerable groups.