Japanese Economy Shakes Off Long Downturn
Nippon Steel & Sumikin Research Institute Corporation
Japan's exports to resource-rich countries began a steep downward slide in early 2015 even as consumer confidence declined, pushing the economy into a prolonged slump. Now, with exports picking up and consumers feeling more optimistic, the second half of 2016 should see a gradual recovery.
Export stall and slumping investment
A downturn that continued for almost a year from the spring of 2015 saw the Japanese economy slide into what could be described as a slight recession from the end of 2015 into the spring of 2016. While shrinking exports were the main cause of the downturn, it was sluggish personal consumption that kept the economy from recovering.
Starting with trends in the export volume index, this dropped 2.7 percent year-on-year for FY2015. On a quarterly basis, it slumped heavily for two consecutive quarters-down 11.7 percent at an annualized rate on the previous quarter in the second quarter of 2015 and 7.7 percent in the third-but has since leveled out, rising 1.9 percent in the fourth quarter of 2015 and 0.6 percent in the first quarter of 2016. By region, in FY2015 the figures were well down for exports to resource-rich countries-38.2 percent year-on-year for Russia, 20.7 percent for Africa, and 9.4 percent for Latin America-with the worldwide slump in resource-related investment that accompanied plunging primary product prices clearly exerting a negative impact on Japanese exports. The 4.5 percent drop in the volume of exports to the US too was influenced by the decline in resource-related investment, while the 2.7 percent decline in exports to China reflected the slowing pace of Chinese economic expansion. By product, general machinery dropped a particularly hefty 6.5 percent due to its close connection to resource-related investment.
Looking back on the situation in early 2015, further yen depreciation from the end of 2014 (102.9 JPY/USD in August 2014'119.4 JPY/USD in December) and the gradual recovery sustained in the US and elsewhere in the developed world made it seem certain that export volume would lift several percent in FY2015, so the slump which actually occurred was an unforeseen negative for the Japanese economy that fiscal year.
Weak exports caused capital investment too to flatten, particularly in the manufacturing industry. The rate of increase in real capital investment on a GDP basis in FY2015 was a meagre 2.0 percent year-on-year, while the slowdown in construction investment that arose from various causes also impacted negatively on capital investment. The floor area of non-residential construction starts, which is a key construction investment index, fell 4.6 percent from 52.6 million m² in FY2014 to 50.2 million m² in FY2015. At the same time, private construction orders, housing included, rose 7.9 percent from 8.9 trillion yen in FY2014 to 9.6 trillion yen in FY2015.
What has caused this disconnect between orders and new construction starts? The first factor is the longer preparation time required by the increased scale of construction orders. Large-scale office buildings often take more than a year from order to start. The second reason is the shortage of construction workers. The jump in public works investment following the Great East Japan Earthquake shifted construction workers in that direction, while the total number of construction workers has also dropped from around six million in the early 2000s to around five million today, making it difficult for construction companies to cope with the increase in orders. Thirdly, the ongoing rise in construction costs has delayed starts on received orders.
Dwindling consumer confidence
Personal consumption has also been increasingly sluggish. FY2015 employee compensation lifted 1.7 percent due to greater employment (albeit primarily among temp workers) and an upturn in wages (albeit gradual). Nominal personal consumption, however, fell 0.5 percent year-on-year. Consumption growth tends to undercut income growth when declining consumer confidence dampens the propensity to consume. The primary reason is the rise in food prices. The food price index created based on actual sales trends in food supermarkets began shifting upward as of mid-2015, topping one percent in early 2016. Food manufacturers who held off from raising prices in FY2014 because of the consumption tax hike began transferring the higher costs incurred through factors such as yen depreciation to food prices as of FY2015, pushing up the unit price. Higher food prices prompt many consumers to begin economizing.
Second, the elderly have become aware of falling pension benefit payments. To ensure that sufficient funds are available to pay pensions into the future, the government had planned to gradually lower pension benefit payments in real terms. However, because it was simultaneously decided to avoid lowering the nominal level to the greatest possible extent, many nominal pension payments were left untouched as Japan continued to struggle with deflation. Because the rate of increase in consumer prices remained positive for three consecutive years from 2013 to 2015, there was an across-the-board reduction in pension payment levels in real terms. With their pension benefits shrinking, elderly people have naturally begun to reduce their consumption.
Third, sluggish stock prices have curtailed luxury consumption, and this too has acted negatively on personal consumption. Stock prices began rising at the end of 2012, returning to the 20,000 yen mark in April 2015. However, the strong yen and instability in international financial markets since August have pulled them back within the 15,000-17,000 yen range in 2016. Capital gains from rising stock prices were boosting sales of big-ticket items in department stores and elsewhere, but with those prices now dropping, big-ticket sales have been falling away as of summer 2015.
Fourth, there is strong concern that the introduction of negative interest rates is reducing consumer confidence. The Bank of Japan launched its negative interest rate policy in January 2016 when its targeted two percent price-rise failed to materialize. Interest rates fell even further, including minus 0.3 percent for 10-year JGBs. Left with limited investment options, Japanese consumers, who manage most of their financial assets through deposits, have been forced to watch their interest income decline. The BOJ is hoping that the introduction of negative interest rates will shift investment from deposits to stocks and real assets, but there is a strong possibility that consumers are simply curbing their spending to make up for the reduced interest income.
The Japanese economy picks up
While the Japanese economy has accordingly remained flat, it should head toward a gradual recovery from the second half of 2016 into 2017. Factors behind the improvement will include, firstly, an export turnaround. Exports to Russia and Latin America have already ceased their downward plunge and bottomed out, and exports to the US are also on the rise. While exports to the Near and Middle East continue to dwindle, increases in other regions may cover these. Reshoring by car manufacturers will also boost car exports by around 10 percent.
Second, personal consumption will also break out its slump. Faced with a serious ongoing labor shortage, companies will have no choice but to continue expanding their payrolls and gradually increasing wages. Food prices are also beginning to settle, and the benefits of low primary product prices and the strong yen should continue for a while. While there is nothing immediate that can be done about negative interest rates and lower pension payment levels, a growing number of positive signs should boost consumer confidence. The May decision to delay a further consumption tax hike might not be great for Japan's finances, but it will certainly impact positively on personal consumption.
Third, construction investment will finally pick up thanks to a range of factors: the construction of major office buildings moving from preparation into actual construction; public works investment associated with the Great East Japan Earthquake coming to an end; medical care- and logistics-related construction finally bottoming out; and the rise in construction costs flattening and allowing construction companies to make a start on their projects.
While the Chinese economy will continue to merit attention, the above factors should see the Japanese economy achieve a certain amount of growth from the second half of 2016 into 2017. With the UK voting in its June 23 referendum to leave the European Union, both sides face some tricky negotiations, while it is also still possible that the UK will choose to stay in the EU. The major reasons that the British public opted to leave were: (a) concern about the future of the EU given political integration without financial integration; and (b) dissatisfaction at the growing disparities at home created by economic policies that prioritize market mechanisms. It is unlikely that the UK's departure from the EU will cause demand to shrink to any great extent, and in the short term the impa7ct on the Japanese economy and the global economy should be slight, but concern over the EU's future and growing disparities worldwide will certainly cast a cloud over both the economy and society over the medium to long term.
(29 June 2016)
(original article : Japanese)