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Faster Pace of Economic Expansion and a Stronger Yen Yoshihisa Kitai Chief Economist Nippon Steel & Sumikin Research Institute Corporation [Date of Issue: 30/April/2015 No.0242-0969]

Date of Issue: 30/April/2015

Faster Pace of Economic Expansion and a Stronger Yen

Yoshihisa Kitai
Chief Economist
Nippon Steel & Sumikin Research Institute Corporation

The Japanese economy is looking brighter not only in terms of exports but also personal consumption and capital investment, and we may well see the yen recover from over-depreciation.

Optimism has been growing recently over the prospects for the Japanese economy in FY2015. Exports have been picking up since the end of last year, driving a steep rise in production. The effects of yen depreciation finally seem to have linked to an export hike. The spring wage negotiations are producing wage increases at a higher rate than in 2014, albeit only slightly, and forecasts are for somewhere around 2.5 percent. Lower crude oil prices and the bottoming out of the yen's plunge will ensure that the rate of increase in consumer prices drops from around three percent in FY2014 to almost zero in FY2015, while real wages will rise more than two percent and personal consumption will maintain robust growth. Service consumption has begun to grow steadily, fueled by travel, and consumer electronics sales have also recovered. This trend should now widen to automobiles, apparel, food and other products.

Japan’s Indices of Industrial Production Capital investment is also showing signs of picking up again. With the ratio of ordinary profit to sales surpassing historical highs and surplus funds continuing to grow, Japanese companies are finally losing their long reluctance and rolling out long-shelved replacement investment and high-added-value investment. Construction orders in particular have shot up recently, with interest in office buildings particularly strong. Improvements to Tokyo's infrastructure in the lead-up to the 2020 Tokyo Olympics have spurred a large-scale office building construction boom in the capital, while more foreign tourists are encouraging more hotel construction plans. A growth rate of around two percent is therefore almost guaranteed for FY2015, and might even reach close to three percent.

Japanese companies’ profit margins Amidst all this, change is also occurring in the exchange rate trend, which until now has seen the yen heading steadily downward. The FRB's bearish view of US economic prospects and the growing expectation that the federal funds rate rise will be postponed from around June until after fall put the initial brake on the yen's downward trajectory. Next, where Japan's current account was nosing toward deficit in the first half of last year, it is now some 10 trillion yen in the black. Factors behind the growing current account surplus include falling energy imports, a sharp rise in profits received on foreign investments, and more foreign tourists pushing the travel account into the black. With energy imports continuing to fall until around April and export growth solidifying, the current account surplus should reach around 20 trillion yen, approaching a new record high.

Japan’s current account balance Further, even if the FRB does elect to hike rates, with the US budget deficit steadily declining due to the increased revenues accompanying steady economic expansion, and the rate of rise in consumer prices certain to remain low thanks to lower energy prices, long-term interest rates are unlikely to rise very far. Japan's long-term interest rates are of course now so low-0.3-0.4 percent-that they can hardly fall any further. A one percent increase in the long-term interest rate disparity between Japan and the US usually translates into yen depreciation of around 10 yen, but there is little likelihood that US long-term interest rates will rise more than one percent over the coming year, so the yen appreciation effect of Japan's current account surplus expansion should outweigh that greater long-term interest rate disparity.

Circumstances are also increasingly moving the Bank of Japan toward postponing achievement of its two-percent inflation target. At the end of October last year, BOJ Governor Haruhiko Kuroda unexpectedly announced additional monetary easing, but this was somewhat of a tightrope move given the 5-4 split in the board vote. Concern about the possible side effects of additional monetary easing is already spreading among board members, and most of the private sector shares that sentiment. The growing view is that yen depreciation of more than 120 yen would benefit only export companies, impacting adversely on the stable expansion of domestic demand. Export companies too have begun to indicate concern that if yen depreciation artificially inflates profits, it could weaken their corporate constitutions. Where companies assume continued yen depreciation of around 120 yen, they are likely to pull back on their efforts to strengthen international competitiveness.

In addition, excessive yen depreciation is beginning to produce various side effects. For example, foreign investment in Japanese real estate has been skyrocketing since last year, reaching close to the pre-Lehman shock peak. Some reports suggest that 40 percent of real estate transactions in Tokyo involve foreigners. Many of those foreigners are Taiwanese. In Taiwan, the government is strengthening policies designed to constrain soaring real estate prices, while the price of luxury condominiums in Taipei has risen to almost double that of Tokyo, making affluent Taiwanese increasingly interested in Japan's real estate market. As a result, the rate of increase in real estate prices in central Tokyo is now more than 10 percent in some areas. While that rise in real estate prices need cause no immediate concern, there is a strong likelihood that excessively high prices will cause an equally excessive slump. Concern over the prospects for long-term interest rates, which have remained exceedingly low, can also not be ignored. If Japan is to reach the BOJ's two-percent inflation target, the long-term interest rate too will obviously lift to two percent or more. A gradual interest rate increase over a number of years until that two percent is reached would pose no problem, but there is no guarantee that things will go so smoothly.

Given the above situation, it seems highly likely that the two percent inflation target will be bundled vaguely to the back of the shelf, with additional monetary easing abandoned. That would immediately transform the view of the yen of those exchange rate market participants who were operating on the expectation of additional monetary easing. A similar phenomenon occurred in January this year in Switzerland, when the Swiss central bank suddenly abandoned its declared cap of 1.2 Swiss francs to the euro. The Swiss franc immediately shot up to 1 franc to the euro. Short-term exchange rate fluctuations of around 20 percent are not uncommon when central banks suddenly change their financial and exchange policies, as seen in Japan last year and Switzerland this year. That's why around this fall, the second that most people started expecting the BOJ to postpone additional monetary easing, the yen will in all likelihood start strengthening, and financial market turmoil could well result.

With the pace of economic expansion currently picking up, Japan's labor shortfall will inevitably worsen. To combat this, the Japanese government plans to change the system with the aim of boosting the current intake of foreign trainees from around 200,000 by another 200,000. Specifically, the period of stay will be extended from three to five years, more countries will be invited to send trainees, and trainees will be accepted in forestry and nursing for the first time. However, this won't be sufficient to cover the worsening labor shortfall. At the same time, the labor force has swelled by close to 800,000 people over the last year with the addition of older people and women, and there is still room to bring more people from both groups into the labor force. If the hiring ratio of older people aged 65 or above can be lifted by five percent, the labor force could be grown by more than 1.5 million, and by more than 2.5 million if the hiring ratio of women can be similarly raised by five percent. Developing policies for promoting employment of the elderly and middle-aged women is therefore likely to be more effective as a means of dealing with the growing labor shortage than using manual workers from abroad.

(original article : Japanese)
(For the Japanese version of this article)

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