Why the Japanese Economy Is Falling Again and What Will Happen to It Next
Japan’s economy suddenly went into recession: the historical fall of the yen undermined the country’s recovery from the pandemic. The economy is now in a vulnerable position, given the risks of a global recession, rising inflation and the threat of new anti-COVID measures
The Japanese economy, the third largest in the world, unexpectedly showed a fall in July-September after nine months of steady growth. Despite the easing of covid restrictions, the country’s GDP was negatively affected by the depreciation of the national currency, rising prices for goods and services, as well as the risks of a global recession.
The economy contracted by 1.2% in annual terms (analysts had expected growth of 1.1%), falling compared to the previous three-month period amounted to 0.3% instead of the projected growth of 0.3%.
“The decline was unexpected,” said Atsushi Takeda, chief economist at the Itochu Economic Research Institute, adding that the biggest impact was higher-than-expected import prices.
The weakening of the yen led to a record trade deficit for Japan. In the first half of the fiscal year, from April to September, the value of imports rose by almost 45% due to the sharp rise in fuel prices. The value of exports rose by just under 20%.
However, Stefan Angrik, senior economist at Moody’s Analytics, called the foreign trade picture “oddly good news,” explaining that the rise in imports in the third quarter suggests that “Japan’s belated recovery from COVID-19 is gaining momentum: businesses and households are starting to spend.”
Recovery of domestic consumption
In the third quarter, private consumption, a major component of the Japanese economy, rose 0.3% from the previous quarter. Japanese consumers were freed from travel restrictions this summer for the first time since the pandemic began in 2020. The recovery in household spending, however, was held back by rising prices during this period.
After decades without significant price increases, Japanese businesses and households are forced to contend with inflation driven by disrupted global supply chains, rising food and energy prices, and a depreciating yen. Consumer price growth in September was 3% year on year - this low figure compared to inflation in other regions came as a shock to Japan, accustomed to price stability.
Although domestic consumption remains below pre-pandemic levels, Shinichiro Kobayashi, chief economist at Mitsubishi UFJ Research & Consulting, said Japan’s ongoing adjustment to the new, post-COVID realities, as well as opening borders to tourists and a massive government stimulus package to compensate the effects of inflation are likely to support a recovery in domestic consumption going forward.
Fumio Kishida’s government has budgeted an additional ¥29 trillion ($206.45 billion) to support households and mitigate the effects of inflation on them.
How the depreciation of the yen affected GDP growth
The yen, like other Asian currencies, has fallen sharply against the dollar over the past year and hit a 32-year low. As of Monday, November 14, the Japanese currency has fallen in price against the dollar by 21.5% since the beginning of the year.
“When the yen falls so quickly, companies are in a difficult position: they are suffering from rising costs of importing materials and cannot easily shift the costs of exports - with the economy of other countries slowing down,” said Harumi Taguchi, chief economist at S&P Global Market intelligence.
Economists attribute the depreciation to the decision of the Central Bank of Japan to keep interest rates low. According to experts, the difference in rates that formed after the start of the cycle of increase by the Fed (since March, the federal funds rate rose from near-zero to 3.75-4%), led to a sell-off of yen-denominated assets, as investors redirected capital to the US market is looking for higher returns.
The Central Bank of Japan is of the opinion that the economy recovering from the pandemic needs monetary stimulus, and wage growth should be more pronounced in order to make the current cost inflation sustainable and favorable for the economy.
Unlike most countries, Japan has suffered from chronic deflation for a long time, and bank chief Haruhiko Kuroda has spent the past decade trying to start a cycle of inflation and growth.
Most economists do not expect any change in monetary policy until the end of Kuroda’s term.
On the back of asset outflows driven by the weak yen, Japan recorded a record trading loss of ¥19.7 trillion in July-September.
A cheaper currency provides some benefits to Japanese exporters and corporations with a large share of income from abroad, as their products become more accessible to foreign consumers and demand for them increases.
However, the benefits from cheaper exports turned out to be less significant compared to the losses from higher import prices. While exports rose 1.9% from the previous three months, imports rose 5.2% as rising energy costs and a weak yen pushed the price of goods entering Japan higher. The higher import bill led to lower net exports, resulting in a 0.7 percentage point decline in GDP.
What will happen to the Japanese economy next?
The weakness of the Japanese economy may be short-term, some experts say. According to Shinichiro Kobayashi, the unexpected drop in GDP was largely due to the sharp rise in prices for imported services and the economy is likely to return to growth next quarter.
Taro Saito, senior economist at the NLI Research Institute, takes the same position. “The contraction this quarter is a one-time thing, and we think there will be growth again in October-December,” he told AFP. “Both individual consumption and corporate investment remain high. The government campaign to support tourism across the country is also likely to help boost consumption,” Saito added.
Darren Tei, Japan economist at Capital Economics, also expects the economy to pick up in the fourth quarter as inbound tourism picks up and the trade deficit narrows. He emphasizes, however, that a new wave of COVID-19 and rising inflation could prove to be deterrents.
An even more accurate upbeat forecast comes from Daiwa Securities economist Mari Iwashita. In her opinion, the country’s economy will grow by 4.4% year on year between October and December - mainly due to a significant recovery in household spending.
In the long term, the picture is more ambiguous. Despite the weak yen, the demand for export products may well decline due to the global economic downturn. With the global economy teetering on the brink of recession, the risks for Japan are also growing: Economics Minister Shigeyuki Goto said that a global recession could hit the country’s households and businesses.
Darren Tey predicts a difficult 2023 for Japan. “As for 2023, Japan will be drawn into a moderate recession in the first half of the year due to the global downturn, which will affect exports and business investment,” he said.
A slowdown in the global economy, triggered by monetary tightening, China’s zero-tolerance policy for COVID-19 and geopolitical uncertainty, will have a negative impact, according to UBS economists Masamichi Adachi and Go Kurihara.
“On top of these factors, pressure from a shrinking and aging population and low medium- and long-term growth expectations cannot be ignored,” they added.