Japan economy grappling with traction even with policy efforts

Performance has been weaker than other advanced economies.

Recent preliminary data showed that Japan’s GDP expanded an annualized 1.7% quarter-on-quarter in January-March in real, inflation-adjusted terms.

According to a research note from Moody’s Investors Service, despite the increase, output actually contracted slightly year-on-year, adding to evidence that the economy is struggling to gain traction.

Sustained low output growth would impair Japan’s economic strength, and hinder the government’s ability to meet its fiscal targets, a credit negative.
GDP growth and inflation have fallen short of official targets in the past year, despite ongoing policy efforts. In the last budget, the government estimated a 1.2% increase in real GDP in the year ending March 2016 (fiscal 2015), higher than the actual outcome of 0.8%.

It also expected a 2.7% increase in nominal GDP, which came in at 2.2%. Moody’s Investors Service expects this trend to endure: it forecasts real GDP to grow 0.4% in calendar 2016, much lower than the government’s budget projection of 1.7% for fiscal 2016.

Here’s more from Moody’s Investors Service:

Japan’s economic performance has also been weaker than that of other advanced economies in recent years. This trend is likely to continue as the US (Aaa stable) shows signs of picking up on robust job growth and European economies benefit from recovering domestic demand. We already assess Japan’s economic strength as lower than other large advanced economies, despite similar levels of wealth, size and diversification.

Despite the Bank of Japan’s monetary easing, disbursements from the government’s supplementary budget and reform to the corporate governance code in mid-2015, the trend in private capital investment has yet to revive. Against the backdrop of a weak global economic environment and uncertainty in financial markets, Japanese corporates remain cautious about investing domestically, as the first quarter’s 5.3% annualized quarter-on-quarter decline in private nonresidential investment reflects. Weakness in private capital investment is an important factor hampering the government’s efforts to generate sustainable GDP growth.

Even the positive aspects of the GDP report, including a return to an expansion in both household consumption and exports, are likely to prove temporary in the face of mounting headwinds. Although it is too early to assess the impact of the government’s negative interest rate policy, the yen’s recent strengthening against the dollar (see Exhibit 3) seems likely to offset any potential economic benefits by undermining export competitiveness and corporate profitability, and also fueling deflationary pressures. Delays to manufacturing production following the Kyushu earthquakes in April may also contribute to near-term weakness.

Notwithstanding the relatively robust GDP outturn in the first quarter, pressure on corporate profitability from the stronger yen, and continued lackluster wage growth could weigh on tax receipts in coming quarters. Generating economic growth is an important plank in the government’s fiscal consolidation programme. As well as indicating reduced economic strength, sustained low growth is likely to undermine fiscal reforms.

The broad weakening in domestic demand and inflation has weighed on nominal GDP growth and, in turn, hinders the government’s ability to meet its fiscal targets, such as that of a primary deficit of 1.0% of GDP by 2018.

We believe that this could well prompt the government to reexamine its current fiscal stance. Against the backdrop of multi-year highs in revenue collection as a share of GDP, this could include a possible delay to the consumption tax hike. At present, expenditure restraint is the primary driver of deficit consolidation.