Present And Future Prospects For The Japanese Economy

Economic Developments in Japan and their Impact on Markets…..

Projected real GDP growth in Japan is likely to continue declining in 2016 and 2017. However, beyond 2018 the country’s GDP is expected to grow by over 1% in real terms. Economists are of the opinion that spare capacity remains in the Japanese economy, and growth above the long-run trend of 0.5% is possible. The big challenge in Japan is its ageing population, and in this vein Japan is a laggard behind its other G7 rivals. Since the Japanese culture is inherently anti-immigrant, it will be difficult if not impossible to solve Japan’s ageing population dilemma by the hiring of foreign workers. In terms of markets, investor sentiment remains weak in Japan.

Fortunately, though, the Japanese yen is a safe-haven currency that generates tremendous interest when the Chinese economy is languishing or when European volatility racks markets. We have seen a spike of interest in the Japanese yen in recent times. Only now that the Fed is looking to raise interest rates are we seeing the dollar gaining the ascendancy over the Japanese yen. Recall that the yen appreciated sharply against the USD in 2016, trading below the critical 100:1 level recently. A strong Japanese yen is a bugbear to the Nikkei 225 index. As the yen appreciates, the income potential of listed company’s declines. Since Japan is a major export market, it relies heavily on a weak Japanese yen to drive sales and profitability.

Is a Japanese Yen Overvalued or Undervalued?

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For many years, the JPY was heavily overvalued. This was evident in the early 2000’s when the yen was well below 100:1 to the greenback. A strong Japanese yen is a disincentive to manufacturers who find it difficult to sell their wares to the global economy. This is particularly true since Japan competes with China for much of the export market. A big plus point for Abenomics has been the series of corporate reforms enacted to drive profitability. This has resulted in a much improved Nikkei 225 index which is now at multi-year highs.

Corporate profits in Japan are certainly robust and look likely to remain that way. According to the fiscal policy directives, productivity growth is expected to be 2.2% per annum within several years. But to get there, Japan needs to tackle hard issues such as output per hour with a declining workforce. And this is where Japan lags far behind other G7 countries. As at 2014, GDP per hour was measured 28% lower than the average of other advanced economies. The Japanese yen has appreciated sharply in 2016 as a result of the strong demand for it. Recent USD strength, EUR resilience and GBP strength have helped to ease the exchange rate and make Japanese exports more affordable.

What about Inflation in Japan?

Japan does not have a problem with inflation, it has a problem with the deflation. This is one of the most devastating forces on the Japanese economy because it is characterized by decreasing prices, smaller GDP, slow or absent wage growth and a general shrinking of the economy. In a deflationary economy, the purchase of big-ticket items takes a back seat as market participants prefer to wait for prices to drop further before spending their money. This destroys overall economic activity and wipes out growth.

In July 2016, consumer inflation was reported at -0.4%, and this is precisely why the Bank of Japan is in an unenviable situation when it comes to adopting the right mix of monetary policy stimuli. Between 2000 and 2016, Japanese core inflation has been negative. To counter this, the Bank of Japan is seeking to make money as cheap as possible to drive up the velocity flow of money through the economy and increase inflation rate.

On 30 August 2016, the unemployment rate in Japan dropped to 3% for July. This marks the lowest unemployment rate in the island nation in 21 years and this comes amid one of the most stagnant economic periods in the history of Japan. The reason why this seemingly contradictory economic statistic presents itself is that the Japanese economy is shrinking and the workforce is diminishing. Combined, the number of available jobs and the number of people available to fill them is matched. The prime objective of the Japanese government is boosting GDP growth.

Is the 2% Inflation Objective Reasonable?

For the 3 months through June 2016, GDP growth increased by 0.2% at an annualised rate. The Bank of Japan continues to target a 2% inflation objective, but that appears to be nothing more than a pipe dream at this point in time. The unemployment rate is certainly a feather in the cap for Governor Kuroda, but much work remains. The unemployment rate in June 2016 was 3.1%, and so progress is definitely being made on that front. Earlier in August, the Bank of Japan passed a QE policy worth 28 trillion Japanese yen (equivalent of $275 billion) to stimulate the economy. Where to next, is anybody’s guess, but with Kuroda at the helm you can always expect the unexpected.