Amidst a huge fanfare of euphoria from the press, Japan's GDP expanded by 0.9% quarter on quarter between April and June, or at a 3.7% annualized rate. In doing so it clocked up the first positive growth in five quarters. Many now claim the worst is over is over for Japan, and in terms of the depth of contraction it may well be, but I fear that recovery may be a much more distant prospect than some imagine, and even when it does come may be far more tepid than is being factored in by the consensus. I am not alone in having there doubts. The Financial Times this morning has already begun to qualify its initial response:
"Japan returned to growth in the second quarter after a year of contraction, but economists warned that the recovery remained vulnerable to any faltering in export demand or tightening of the government’s fiscal stimulus spigot........Yet with unemployment still rising and deflationary pressures growing, Japanese Prime Minister Taro Aso acknowledged the world’s second-largest economy was still far from a return to real health. “We are only halfway there,” the prime minister said during a pre-election debate with rival party leaders."As has Bloomberg:
Japan’s 3.7 percent economic expansion last quarter ended the country’s worst postwar recession. The bounce may be as good as it gets. Growth will slow to an annual 2.9 percent pace in the three months ending Sept. 30, according to the median forecast of 10 economists surveyed after yesterday’s gross domestic product report. Falling business investment and rising unemployment may hamper a recovery that has been fueled by $2.2 trillion in emergency spending by governments worldwide.Morgan Stanley analyst Robert Feldman was equally forthright and to the point:
“We have our doubts about the durability of this......There’s isn’t enough demand to get us back on a very strong recovery path. We don’t see a huge downside, but nevertheless the upside is pretty limited.”
Exports, and public investment were the main growth drivers in Japan this quarter, while private consumption remained notably weak. The principal impetus came from exports that jumped 6.6 percent (quarter on quarter), led by demand from China. At home, Taro Aso’s 25 trillion yen ($264 billion) in stimulus helped consumer spending rise 0.8 percent on the quarter and lead government investment to climb 8.1 percent. The figures evidently show hallmark of a worldwide rebound in factory demand (after inventories have been run down) and large-scale economic stimulus measures in Japan. The expansion in exports, benefits from economic stimulus measures, and inventory building are unlikely to continue, and growth will most likely slow again, especially after the last quarter of this year, as their impact fades. Deflation will remain a feature of the Japanese economy and I thus expect the BOJ to maintain its policy of monetary easing into the indefinite future.
Personally I do not expect to see anything resembling a full-fledged recovery in Japan until the second half of 2010, although the present slight expansion phase may well continue through the July to September quarter, and certainly the July PMI suggested this.
Thereafter, however, economic growth is likely to slow through to the end of the fiscal year, and we may well see further quarters of negative growth. The principal reasons for this expectation are:
(1) fading support from economic stimulus measures, especially after the elections, when the deteriorating fiscal situation will need to be addressed.
(2) prospects of a slowdown in economic activity overseas, especially in China, which has become a key customer, and
(3) downward pressure from household spending as employment adjustments have an effect.
Industrial Output Improves
Japanese industrial output rose for the fourth month in a row in June and is expected to keep climbing as manufacturers restart production lines halted during the highpoint of the slump. June industrial production was up 2.4 per cent month-on-month, a rate of increase lower than the revised 5.7 per cent growth recorded for May but still an increase.
It is now obvious that the drastic output cuts of the last quarter of 2008 and first quarter of this year have successfully cleared the excess inventory backlog despite the extraordinary speed at which demand declined. The Industry and Trade Ministry (Meti) reported that inventories were down 1.0 per cent month-on-month in June, while the inventory ratio - which compares inventory to actual shipments and is seen as a leading indicator - was down 9.8 per cent. This the sharp fall in the inventory ratio suggests that the driveing force behind the current production growth has shifted from excessive inventory reduction to responding to overseas and domestic demand fuelled by government stimulus policies across the globe.
July PMI survey data provided further evidence that Japan’s manufacturing sector may continue to sustain the economy into the next quarter. The seasonally adjusted headline Nomura/JMMA Purchasing Managers’ Index (PMI) rose to 50.4 in July, from 48.2 in the previous month, pointing to the first improvement in operating conditions for seventeen months. Although only marginal, growth of the sector was slightly faster than the survey’s historical average.
Manufacturing production increased for the second month running in July, rising at the most marked pace since September 2006. Where an expansion of output was signalled, PMI survey panellists frequently linked this to renewed growth of new orders. It was the first improvement in firms’ order books for seventeen months. Those respondents that reported a rise in new order levels widely attributed this to firmer demand from home and overseas, with export sales rising for the second month in a row. The survey organisers stated that anecdotal evidence suggested improved demand from China was providing the main boost to workloads at manufacturers.
Deflation A Done Deal, And Digging In For A Long Winter
The shortfall in demand is already weighing on prices, making it likely that deflation will once again become entrenched in the economy. Consumer prices plunged a record 1.7 percent in June and yesterday's GDP report showed wages fell a record 4.7 percent from a year earlier. Capital spending, which accounts for about 15 percent of the economy, fell 4.3 percent last quarter. A survey published this month by the Development Bank of Japan showed companies expect to cut fixed investment 9.2 percent this fiscal year. Reductions by manufacturers will be the steepest since 1993.
While the falling energy prices that have been the main driver behind the decline in the consumer price index to date, deepening deflation fuelled by job insecurity and massive manufacturing over-capacity could become a major feature of the Japanese economic environment and effectively undermine the economic recovery process. The fall in "core-core" consumer prices, which exclude both food and energy, accelerated to 0.7 per cent in June, while more recent July price data for urban areas of Tokyo showed a fall of 1.1 per cent.
Unemployment On The Way Up
Japan’s unemployment rate rose to a six-year high in June and consumer prices fell at a record pace, adding to evidence the domestic economy is struggling to recover even as exports start to improve. The jobless rate advanced to 5.4 percent from 5.2 percent in May, the statistics bureau said today in Tokyo, higher than the 5.3 percent median forecast of economists surveyed.
Economists expect the jobless rate to rise to a record 5.8 percent as companies cut costs. Deflation may erode profits even as factory output rebounds, further hampering Japan’s recovery from its deepest postwar recession.
In addition there is the so called "hidden unemployment" problem - employees retained by Japanese companies who are effectively surplus to current needs. A recent study by analysts at Nomura found that when indexing the number of those employed and real GDP to the output peak of Q4 2007 the result showed a considerable gap. Based on a simple calculation and assuming this gap to represent the amount of “hidden underemployment”, they arrive at a figure for “hidden jobless” in Q1 2009 of 4.7m. This is far higher than the June unemployment figure of 3.48m. If the hidden jobless are included together with the registered “unemployed”, they calculate that the unemployment rate would leap from 5.4% to 12.2%.
Consumer Confidence Rises
Japan’s household sentiment rose for a seventh month in July, adding to signs the world’s second- largest economy is edging closer to a recovery. The confidence index climbed to 39.4 from 37.6 in June, the Cabinet Office said today in Tokyo. It has improved every month since tumbling to a record low of 26.2 in December. A number below 50 means pessimists outnumber optimists.
The Economy Watchers index, a survey of barbers, taxi drivers and other small businesses who deal directly with consumers, climbed to 42.4 from 42.2 in June, making for a seventh monthly increase.
Storm Clouds Ahead
So despite the sigh of relief that everyone must have gasped on seeing the growth number for the second quarter, it is obvious that Japan's problems are far from over. Unemployment - with or without the hidden variety - is going to remain a problem, and the consensus view among economists expects the unemployment rate to climb to an unprecedented 5.9 percent by next year. On the other hand real wages continue to fall, sliding by 5.2 percent in June from a year earlier, the fastest decline on record.
And while the Bank of Japan this month announced that economic conditions had “stopped worsening”, it also highlighted doubts about the robustness of recovery by predicting the contraction in the fiscal year would be greater than previously forecast. The BoJ now expects gross domestic product to contract 3.4 per cent in the year to March 2010. Bank of Japan Governor Masaaki Shirakawa stresssed that demand for the country’s products and services may well not gain momentum.
It is now highly likely that the next central bank inflation forecast will predict that deflation will extend into 2011, which will force them to prolong their policy of keeping rates near zero for some considerable time. Shirakawa himself has admitted that prices are falling worldwide because of a dearth of demand and excess supply in the wake of the global economic crisis, adding that it will take “considerable time” before price drops moderate.
On top of this there is continuing political uncertainty. Opinion polls show the ruling Liberal Democratic Party is likely to lose the lower house election to the opposition Democratic Party of Japan, which has never held power before. The DPJ has made considerable promises to the Japanese electorate for spending increases, but it is unclear how they will, in fact react give the very strong constraints on public spending which actually now exist. On thing. however, is certain: if they do win the coming elections they will inherit an economy which even after last quarter’s expansion is still at its 2004 level.