Japan: Risk Assessment
Country Risk Rating
Business Climate Rating
- Privileged location in a dynamic region
- Very high level of national savings rate (around 23% of GDP)
- Public debt is 90% owned by local investors
- Advanced technology products and diversified industrial sector
- Difficulty of consolidating public finances and bringing an end to deflation
- Reduction of the workforce; increasing share of precarious workers
- Political instability
- Low productivity of SMEs
Cyclical Recovery will Slow in 2018
Growth remained robust in 2018, but it is expected that it will taper down in 2019. This will be due to structural headwinds, as cyclical tailwinds begin to phase out. The economy suffered from a devastating earthquake, typhoons, and severe floods in 2018. Export growth has started to decline in line with a global slowdown and risks related to the trade war between the United States and China. Private consumption picked up in 2018, favoured by higher real wages, with total cash earnings jumping to 3.6% YOY in June: the fastest pace of increase since 1997. However, private consumption will slow in 2019. Wage growth in 2018 was related to temporarily higher inflation expectations and a tight labour market: the unemployment rate stood at 2.3% in September, the lowest level since June 1994. However, wage growth is scheduled to slow, constrained by companies’ sticky deflationary mind-sets and rigidities in the labour market (lifetime employment system). Employees are unlikely to increase their spending enduringly if they believe payments are one-off. Moreover, a sales tax hike is currently scheduled for the second half of 2019, which will drag on domestic demand. In turn, weak domestic demand will exacerbate deflationary pressures. There was modest pickup in headline inflation in 2018, but this can be traced back to higher import prices, notably oil. Consumer price inflation is expected to remain significantly below the Bank of Japan’s (BoJ) 2% target going into 2019. Private investment will likely remain sluggish as investors wait to see signs of a real pickup in domestic demand. This caveat notwithstanding, corporate profits, cash reserves, and liquidity conditions remain favourable. BoJ will likely keep its ultra-accommodative monetary policies in place throughout 2019 and 2020, which will continue to sustain economic momentum.
Consolidation of public finances remains challenging
The fiscal deficit is expected to widen further in 2019, with the main factors driving this deterioration being ongoing fiscal policy stimuli, as well as reconstruction work following devastating floods in southwestern Japan in June and typhoon Jebi in September 2018. Infrastructure investments ahead of the Tokyo 2020 Olympic Games will also add to budgetary pressures. These are a constant in Japan, but the space for further stimuli is rapidly depleting, as social spending already weighs significantly on the state budget: Japan’s debt service burden represents 25% of GDP. Moreover, there is no easy way to boost state revenues. The government decided to postpone the next VAT hike (from 8% to 10%) until October 2019, which should help boost revenues post-2020, even if private consumption will likely decline in the short-term. Front-loading ahead of October is possible, which would exert upside pressure on GDP in the third quarter. However, the Japanese economy entered a recession in the quarters following the last sales tax hike in 2014 – a scenario which could repeat itself again in the fourth quarter of 2019. The current account is expected to remain in surplus, but this will narrow going into 2019 and 2020. The yen has remained weak against the dollar relative to 2017 levels, which played a role in boosting exports. However, the currency is expected to appreciate in 2019, worsening the terms of trade. Export growth is also set to decline due to slower global demand. Moreover, exports may be impacted by the US-China trade war, as Japan is exposed via supply-chain links. The current account surplus will also benefit from inflows on the services front, as a result of the rise of tourism. The economy has benefitted from higher tourism revenues, led by Chinese tourists. This trend could slow if the yen appreciates significantly relative to the yuan.
LDP faces challenges despite majority
Prime Minister Shizo Abe won a snap election on October 2017. However, despite his Liberal Democratic Party (LDP) managing to secure a majority, reforms have been slow to materialize. This includes reforms to unlock labor productivity under the “Third Arrow of Abenomics”, as well as constitutional reforms that would allow Japan to increase military spending to 3% of GDP for defensive. Although higher military spending can contribute to GDP growth, in Japan’s case it could clash with other social spending in the context of existing budgetary pressures. Prime Minister Abe has also stated that he is keen to revive the Trans-Pacific Partnership, signaling a diversification away from strategic dependence on the United States, and towards a more multinational approach. On May 2018, the trade ministers of the countries that signed the original deal – excluding the United States – met to revive the pact. Japan is simultaneously working on a bilateral trade agreement with the United States. Japan has also recently signed a commercial agreement with the EU.