Japan: Risk Assessment
Country Risk Rating
Business Climate Rating
- Privileged location in a dynamic region
- Very high level of national savings (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
Japan benefitted from a combination of cyclical factors in 2017, enabling it to reach a higher than anticipated level of growth. However, the economy is still subject to structural headwinds, which are set to come into force again in 2018 and lead to a slowdown in activity. GDP grew robustly in 2017, driven by foreign trade, a surge in the industrial production, and – to a lesser extent – fiscal stimulus, but private consumption remains lackluster, as real wages have not expanded – despite a tight labor market, with the unemployment rate sitting at 2.8% in April its lowest level since June 1994. Wage growth has been constrained by Japanese companies’ sticky deflationary mind-set, which has resulted in insufficient efforts to redistribute profits. The structure of Japan’s labor market, which features rigid permanent contracts as well as a growing number of temporary workers, has also played a role in keeping wages and productivity depressed.
Domestic demand has played a muted role in boosting inflation. The modest pickup in inflation can be traced back to higher import prices – led by commodities – as well as a weaker yen. However, consumer price inflation remains below the Bank of Japan’s (BoJ) 2% target. Private investment will likely remain sluggish as investors wait to see signs of a real pickup in domestic demand. Notwithstanding this caveat, corporate profits, liquidity, and financial conditions are still favorable.
Going forwards, the Tokyo Olympics and an extension of BoJ’s ultra-accommodative monetary policies will continue to sustain economic momentum.
Consolidation of Public Finances Remains a Crucial Issue
2017 saw a widening fiscal deficit in 2017, due to ongoing policy stimulus, the rebuilding of infrastructure after a series of natural disasters, and construction ahead of the Tokyo 2020 Olympic Games. However, there is less room to implement further fiscal stimulus going forwards: the increase in social spending significantly weighs on the state budget while revenues are insufficient. However, the government decided to postpone the next VAT rise (from 8% to 10%) until October 2019 for fear that another rate hike would cripple consumption. With a debt service burden representing 25% of GDP, the current trajectory of the debt accumulation does not appear sustainable, especially as costs continue to increase with the ageing population (health expenditure) and the 2020 Olympics (investment expenditure).
The current account is expected to remain in surplus in 2018. The yen has remained weak against the dollar, which has played a role in boosting exports in 2017. Robust demand from developed markets, a stabilization of the Chinese economy, and a pickup in global commodity prices, have also facilitated the increase in exports since the last quarter of 2016. However, this is not expected to continue considering the slowing demand from Japan’s main trading partners (China, the United States and Eurozone countries) and signs of commodity price weakness. Imports are expected to increase as households adjust to the expectations of another sales tax hike in 2019. The trade balance is expected to remain slightly in surplus. The services account will continue its consolidation as a result of the rise of tourism – Chinese tourists, in particular and the income balance, which will remain significant.
Abe Wins a Majority, Clearing the Path for Reforms
Prime Minister Shinzo Abe took advantage of favorable cyclical conditions and called a snap election on October 2017, stating he was seeking a fresh mandate amid threats from North Korea. As expected, his Liberal Democratic Party (LDP) managed to secure a majority, which gives him ample room to forge ahead with economic reforms, and reform Article 9 of Japan’s pacifist constitution. The goal would be to increase military spending to 3% of GDP for defensive purposes. Prime Minister Abe has also stated that he is keen to revive the TPP, and on May 21st, trade ministers representing 11 of the 12 signatories met to revive the pact. Japan also wants to maintain close relations with the US so as to avoid being isolated in Asia, and is working on a bilateral trade agreement.
The North Korean threat continues to linger, posing a real security threat. The Korean neighbor has continued to forge ahead with its nuclear program, despite reprimand from the international community. On August and September 2017, it flew ballistic missiles over Hokkaido, prompting Japanese authorities to sound alerts. Although global markets have so far heavily discounted the likelihood of a war with North Korea, a deterioration of investor sentiment could lead to the return of risk-off modes, triggering inflows into safe-haven assets such as the yen with a risk of derailing the rebound in exports and impacting the profits of Japanese conglomerates.