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
- Trade agreement with the EU and Transpacific Partnership (December 2018)
- Regional trade agreement (RCEP) with neighboring countries
- Excellent corporate payment behavior
- Difficulty in consolidating public finances and ending deflationary pressures
- Reduction of the workforce and low immigration contribution, increasing share of precarious workers
- Low growth potential, low productivity of SMEs
- Still insufficient female labor participation, lack of child care
- Aging population, risk of jeopardizing the social security system
Fragile recovery amid headwinds
The economy is set to recover in 2021, amid persistent headwinds. The country was hit by a third wave of infections in late October 2020, with no sign of abating at the time of writing (January 2021), and the government was considering declaring a second state of emergency after the first one declared in April. This situation is likely to continue weighing on domestic consumption (56% of GDP) and tourism (8% of GDP), as restrictions on the movement of people are likely to be tightened again. This will in turn exacerbate deflationary pressures. On the external front, exports (18% of GDP) have been under downward pressure due to the trade tensions between the U.S. and China, to which Japan is exposed via supply chains links, further compounded by the COVID-19 outbreak. External demand has been mostly relying on the recovery of China (the largest trade partner), which absorbs up to 18% of total exports, although the margin of improvement started to decline in Q3 2020 as shipments of chip-making equipment to China dropped. Consequently, weak domestic and external demand is set to weigh on private investment (17% of GDP), as industries are looking to cut expenditures on plants and machinery.
Public debt load balloons up
The current account surplus, which narrowed in 2020, should rebound in 2021 on the back of a recovery in the merchandise trade surplus and a decrease in the services deficit. Imports should remain muted, as the new wave of infections is likely to continue weighing on domestic demand. Export growth (transport equipment, construction, and manufacturing equipment, electronics, specialty chemicals, optics, etc.) is set to recover, albeit softly, driven by the revival of Chinese demand, while global demand should slowly mend as Japan’s other trade partners are still grappling with COVID-19 infections. Furthermore, the ongoing trade disputes with South Korea (7% of total exports) since 2019 and the related exports curbs on semiconductor parts should also continue to be a burden. Additionally, the current account failed to capture inflows on the services front (3.5% of GDP in 2019) due to a collapse in tourism in 2020, as borders have remained closed for international tourists. That said if the situation improves thanks to vaccination campaigns, and with the Tokyo 2020 Olympics postponed to 2021, the current account should find additional support there. The primary income, which reflects returns on Japanese investments made overseas and usually contributes the most to the current account surplus, eroded in 2020 as the global crisis affected profits.
The fiscal deficit is expected to narrow in the fiscal year starting in April 2021, after three large stimulus packages (two in April 2020, one in December, accounting for USD 3 trillion or two-thirds of the GDP) weighed on FY 2020 (with the fiscal impact representing 14% of GDP). These packages are meant to support employment, consumer spending and to ensure business continuity through subsidies and cash handouts. Even though the budget drafted for FY 2021 will increase to USD 1 trillion, as it will partly fund the December 2020 stimulus package worth USD 700 billion, it may not reflect Japan’s final spending for FY2021 given that the country is still grappling with COVID-19 infections and might unveil additional extra budgets to support the recovery.
Stable domestic politics vs. tensed international relations
Prince Naruhito became the 126th emperor of Japan in May 2019. Japan’s new prime minister, Yoshihide Suga, will maintain policy continuity after Shinzo Abe, former prime minister and president of the ruling Liberal Democratic Party (LDP), ended his final three-year term prematurely due to health reasons in September 2020. Prime Minister Suga will most likely focus on the fight against COVID-19 in the first place, to restore economic confidence as soon as possible - before the next House of Councilors (Upper house) elections in July 2022 - in order to secure LDP seats. On the international front, Japan’s relationship remains delicate with China, over its expanding influence throughout Asia, and South Korea. With the latter, the dispute over the compensation for forced Korean labor during Japan’s colonial rule is the issue at the heart of diplomatic and economic disputes between the two countries. Nevertheless, South Korea announced that it would not leave the General Security of Military Information Agreement (GSOMIA), the strategic military information exchange agreement it shares with Japan. Both sides have agreed to hold talks over Japan’s export dominance on three chemical products critical to the manufacturing of semiconductors and displays by South Korea.