Japan has confounded expectations to post its longest economic expansion since 2006, with upbeat consumers and businesses seen extending the winning streak. However, there is still plenty of work to do before policymakers start popping champagne corks over Abenomics’ apparent success.
Preliminary figures released Monday showed the world’s third-largest economy grew at an annualized rate of 4 percent in the April-June quarter, outperforming economists’ expectations for a 2.5 percent rise. The expansion was the sixth straight quarter of growth and the biggest increase since the March quarter of 2015.
In nominal terms, gross domestic product (GDP) grew by 1.1 percent from the previous quarter, for an annualized growth rate of 4.6 percent.
According to Japan’s Cabinet Office, the main driver was domestic demand, which increased by a brisk 1.3 percent from the previous quarter. Private consumption expanded by 0.9 percent, its fastest growth rate in more than three years, as shoppers spent more money dining out and buying durable goods.
Business investment surged by 2.4 percent, doubling the median economists’ estimate, in the fastest expansion since 2014 amid strong growth for construction equipment and software.
Government spending also contributed to spring’s growth spurt, with public demand rising by 1.3 percent in the quarter.
Yet it was not all good news, with exports contracting by 0.5 percent while imports increased by 1.4 percent, in the first negative quarter for trade in a year.
“The engines of consumer spending and capital expenditure both fired well in the second quarter, and that’s why domestic demand was so strong,” Hidenobu Tokuda, senior economist at Mizuho Research Institute, told Reuters.
“The pace of growth may moderate slightly, but we are still in recovery mode. This is a positive development for inflation.”
Frustrating policymakers, inflation has lagged behind the general economic recovery despite the tightest labor market in decades. Price pressures have remained subdued, with the domestic demand deflator only gaining 0.4 percent, well below the Bank of Japan’s (BoJ’s) 2 percent target.
Since launching its ultra-easy money policy in April 2013, the BoJ has been forced to push back the time frame for achieving its inflation target by six times, partly due to sluggish consumer spending. However, the latest data suggest the nation’s millions of consumers are finally loosening the purse strings on the back of higher wages and ultra-low unemployment.
Japan’s jobless rate fell to 2.8 percent in June, the lowest level in 23 years, while the job to applicant ratio stood at 1.51, its highest level since 1974.
“We are in this transition phase and we have just begun to see more convincing evidence that domestic demand is finally picking up,” Kathy Matsui, chief Japan strategist at Goldman Sachs, told Bloomberg TV. “I don’t think that consumption would’ve been this strong had we not seen wages at least pick up to some degree.”
Structural Turnaround
WisdomTree Japan’s Jesper Koll pointed to rising wages, improved housing demand and the return of corporate “animal spirits” as evidencing a structural turnaround.
“The April-June GDP report suggests that the Japanese economy has entered into a sweet spot, with growth accelerating and broadening into all components of domestic demand. While the 4 percent annualized GDP growth rate marks peak slingshot acceleration, the details of the report fully verify our thesis that Japan has entered a self-sustaining domestic demand-led up-cycle,” he said in a report released Monday.
Evidence of higher wages was shown in the worker compensation data, with a strong 2.6 percent rise in the quarter pushing the absolute amount of wages paid back to levels last seen in fiscal 1999.
According to the Tokyo-based economist, the uptrend in workers’ pay is structural, with demographic changes forcing a structural shift from part-time to full-time employment and steady upward pressure on wages and incomes.
“While for the past two decades, excess employment put downward pressure on wages and forced headwinds against consumption, Japan’s labor shortages are now becoming reliable tailwinds for domestic demand,” he said.
Consumer spending outpaced the growth in workers compensation in the June quarter, marking the first drop in the savings rate in more than three years, and indicating greater confidence in the sustainability of the improved labor market. This was backed up by improved residential investment, which rose for the sixth straight quarter, suggesting a structural shift toward higher household formation, Koll argued.
For businesses, the return of animal spirits was evidenced by the eighth straight rise in private capital expenditure (capex), with demand drivers including a switch toward electric vehicles and the need for improved productivity in the services sector.
“The combination of record-low interest rates and record-high corporate cash balances suggests no financial limits for added capex. If at all, the general rise in the rate of return on invested capital suggests it increasingly pays to invest,” Koll said.
Yet the noted Japan bull suggested policymakers had little room for complacency, given an expected dip in government spending and the dangers of a stronger exchange rate for exports.
“We maintain our view that the new Abe Cabinet is likely to present added ease of fiscal policy, with a supplementary budget of around 5 trillion Japanese yen ($45 billion) likely to be presented by October. For monetary policy, we expect no change from the BoJ – the sweet spot in growth is anchored in steady productivity gains and, more importantly, inflation remains more of a theoretical conundrum rather than a real-world threat,” he added.
Koll predicted real GDP growth of 2 to 2.5 percent over 2018-19, although he warned that sustained yen appreciation could threaten to put Japan back into deflationary territory.
Marcel Thieliant, senior Japan economist at Capital Economics, reiterated his firm’s forecast of a 1.5 percent GDP increase in 2017, helped by another rise in the third quarter that would mark the longest expansion since the turn of the century.
However, the London-based consultancy expects the Japanese economy to slow next year to just a 1 percent expansion as external demand cools. With the boost from higher energy prices seen fading by year-end, “monetary policy tightening remains a long way off despite strong economic activity,” Thieliant said Monday.
According to Japan’s Nikkei daily, an average of 15 private-sector economists have predicted real GDP growth of 1.8 percent for the fiscal year ending in March 2018, which would mark the fastest pace since fiscal 2013 and not far off the government’s 2 percent target.
Yet risks include the possibility of sluggish wages growth, reduced exports to China following fall’s party congress, and geopolitical issues such as the North Korean crisis driving the yen higher due to its “safe haven” status.
Reforms Urged
“If you ask me whether private consumption has fully recovered, I would say it still lacks strength in some areas, which will need to be followed with policy,” Economy Minister Toshimitsu Motegi told reporters.
“We’ll make sure that the domestic demand-led recovery continues. What is needed is supply-side reform. We’ll focus our efforts on human resource investment, improvement in productivity, and new growth strategies.”
Support for such efforts has come from the International Monetary Fund (IMF), which has urged greater reform amid structural headwinds.
In its latest “World Economic Outlook Update,” the IMF predicted Japan’s GDP would expand by 1.3 percent this year on the back of stronger private consumption, investment and exports, yet it predicted a slide back to just 0.6 percent growth in 2018.
The Washington-based organization’s latest report on Japan released July 31 suggested that the nation’s economy was growing above potential, with a broader and more balanced expansion than in 2015. However, “labor shortages are evident, wage growth remains weak, and inflation is stubbornly low,” presenting risks to medium-term growth, it warned.
“Looking at population dynamics and the projected steady decline in the labor force, Japan will need to make labor more efficient and more inclusive — by, for example, bringing more women into the work force in regular (full-time) positions and on an equal pay for an equal work basis,” the IMF’s Todd Schneider said.
“This means, among other things, labor contract reform, elimination of disincentives to full-time and regular work, and more availability of childcare and elder-care. Many of these issues are covered in the government’s Work Style Reform plan, but could be accelerated.”
According to Schneider, such reforms could improve resource allocation while increasing wage pressures, helping to facilitate Abenomics’ reflationary goals.
He also called for Tokyo to implement its planned consumption tax hike, which has been twice delayed, amid high gross public debt at an estimated 240 percent of GDP and with increasing demands on the public purse from an aging population.
Japanese Prime Minister Shinzo Abe has pledged to raise the consumption tax rate to 10 percent from 8 percent in October 2019, after having originally planned the hike in 2015. He has cited as reasons the need to achieve a primary balance surplus by fiscal 2020 and to curb public debt.
The IMF’s Schneider suggests Japan’s consumption tax rate is low compared to its peers, with a high efficiency of tax collection pointing to large revenue gains. He said a consumption tax hike would be preferable to higher income taxes, since “working incomes are essential to household consumption,” while a consumption tax spreads the burden “across all age cohorts.”
He also called for other fiscal measures such as higher inheritance and property taxes along with asset taxes, to further supplement revenue gains from the consumption tax hike.
Yet previous sales tax increases have pushed the economy into recession, with policymakers overestimating consumers’ willingness to accept price rises following two decades of deflationary expectations.
Despite becoming the nation’s third-longest serving postwar leader in May, Abe’s ability to implement further fiscal and structural reforms has come under challenge recently. A dive in approval ratings due to political scandals and controversy over constitutional reform saw Abe forced into a cabinet reshuffle, amid speculation over his political longevity following his party’s losses in the Tokyo assembly election.
However, a subsequent rebound in the Abe Cabinet’s approval rating to over 44 percent, up nearly 9 percentage point since mid-July, and weakness among opposition parties has sparked speculation of a snap election in October 2017.
With the next lower house poll not due before the end of next year, Abe still has time on his side to ensure the recent economic revival proves sustainable. Putting the economy first and constitutional reform second would be a good starting point, should he wish to achieve a lasting legacy.