By Wei Hongxu
Since the beginning of this year, Japan’s long-sluggish economy has made significant progress. On the one hand, the longstanding deflationary trend in Japan has continued to improve. The core consumer price index (CPI) excluding fresh food rose 3.2% yoy in May, beating economists’ forecast of 3.1%.
Excluding both fresh food and energy prices, the key CPI rose 4.3% in May, compared to 4.1% in April, and hit a new high since June 1981. It is worth noting that this Index, which is the EU’s most closely watched indicator of inflation The Bank of Japan (BOJ) has exceeded the central bank’s inflation target of 2% for the 14th straight month. On the other hand, the Japanese economy has shown signs of improvement. Japan’s real GDP grew 1.6% on an annualized basis in the first quarter, boosted by higher household and business spending, marking the first positive growth in three quarters. The resurgence in economic growth and inflation has raised optimistic expectations of Japan’s recovery from the ‘lost decades’.
The trend reversal in the Japanese stock market after a prolonged downturn has further boosted market confidence. Under the influence of investors like Warren Buffett, more and more international investors have been turning their attention to the Japanese stock market since this year. Since 2023, the Japanese stock market has been on a steady uptrend, and the Nikkei 225 index recently hit a new high not seen in 30 years. In the real estate market, the country’s Real Estate Economic Institute released average prices for fiscal 2022 on April 18. Prices in Tokyo’s 23 wards rose 17.2% year-on-year to reach JPY98.99 million, setting a new historic high with comparable data since fiscal 1990. The resurgence and rise in asset prices in Japan symbolize the revival of market confidence and expectations.
There are also signs of an accelerated shift in Japanese manufacturing to the industrial sector. In 2022, domestic construction orders in Japan reached a 20-year growth rate year-on-year. Semiconductor companies such as Samsung, TSMC and Micron have made large investments in the country. According to a survey by Nikkei, the planned investment in industrial equipment for fiscal 2023 has exceeded 30 trillion yen for the first time and reached 31.6 trillion yen, representing a growth of 16.9% compared to the actual investment last year. The planned investment in equipment by companies has reached a new high 15 years since the Lehman crisis in 2007. The growth in industrial investment signals optimism about future market demand and is, to some extent, leading to a recovery in the underlying economic driver, growth.
Various signs suggest that the long-established Abenomics economic policies that Japan has pursued, along with the ensuing improvements in new capitalism, have yielded positive results. The Japanese government’s suite of policies aimed at raising workers’ incomes, boosting investment in human capital and encouraging business investment are increasingly showing significant effectiveness, helping the country to emerge from long-term economic stagnation. However, if Japan hopes to fully emerge from the deflation trap and restore normality, it still faces many obstacles.
First, there is the question of whether Japan’s unconventional monetary policy can run smoothly. As inflation continues to rise, the BOJ will soon face a turning point in normalizing its monetary policy. In fact, the Bank of Japan has already started examining the effectiveness of its actions and will also consider the quantitative easing exit strategy. Because of Japan’s longstanding policy of quantitative easing, there has been a divergence in the political cycles of economies in Europe and the United States. As global interest rate differentials widen, the Japanese yen has depreciated several times since last year. The Japanese yen weakened to over 143 yen against the dollar as the Federal Reserve continued its tightening policy. The devaluation of the yen will further push up the prices of imported goods in Japan. If the BOJ initiates the exit from quantitative easing due to meeting its inflation target, this can lead to unpredictable transition risks. This could be one reason why the new BOJ governor is reluctant to clearly signal a change in policy. BOJ Governor Haruhiko Kuroda has previously stated that Japan will eventually have to exit accommodative policy and that it could potentially have an impact on its assets once negative interest rates and yield curve control are ended. As of last year, capital markets have already started preparing for volatility after Japan ended its yield curve control policy, and speculative funds continue to flow into Japan to take advantage of the weakening yen. Against this background, the inflow of international capital could be a factor contributing to the rise of the Japanese stock market. As risks mount, any signs that the central bank is changing policy direction will lead to market turmoil. The stability of the Japanese financial system is not exactly reassuring given the long-term low interest rates. The BOJ must face the risk of avoiding a political lapse that could lead to another crisis in the Japanese economy.
Another challenge is the long-term impediment to growth caused by population aging, for which there is currently no effective solution. One of the main reasons for Japan’s long-term economic stagnation is the changing demographic structure, in particular the increasing aging of the population, which has led to a decline in the labor force and increased stress on the overall population. Unfortunately, this trend has not yet slowed down. According to population estimates by the Ministry of Internal Affairs and Communications of Japan as of September 15, 2022, the total population of Japan decreased by 820,000 year-on-year, while the number of people aged 65 and over reached a record 36.27 million, an increase of 60,000 compared to the previous year. The proportion of the population aged 65 and over in the total population reached 29.1%, the highest level in history. Some analysts point out that a rapid aging of the population can lead to insufficient market demand, an increased tax burden and a negative impact on economic growth due to stagnation in labor force growth.
In addition, the sustainability of Japan’s ongoing economic improvement faces challenges. Some researchers believe that the current upswing in Japan’s economy is due to short-term factors and whether the growth can be sustained remains questionable. Particularly given the unfavorable global economic outlook, the Japanese economy will be impacted by weakening external demand and escalating geopolitical risks. For example, Kyohei Morita, chief economist at Nomura, points out that despite the global economic slowdown, Japan’s decent growth is due to two factors: the post-pandemic restart of the economy, which has triggered pent-up demand, and increased capital spending by companies following a slowdown in the economy Inflation from its 40-year high. However, recent positive economic data from Japan has not completely reassured the market. Morita cautions that sustaining the business investment that fueled economic growth in the first quarter could prove challenging. In addition, researchers from China Merchants Securities note that the competitiveness of Japanese companies is not optimistic after three decades of stagnation. While Japanese companies remain competitive in sectors such as semiconductors, they face increasing pressure and challenges in industries such as automotive, LCDs, photovoltaics and mobile phones. Especially in emerging sectors of the economy, they are usually in a passive position. With falling industrial competitiveness, it can be difficult to maintain market prosperity driven by money and capital factors.
Final conclusion of the analysis:
Despite the positive signs for the Japanese economy and the rare development of the stock market, there are still many challenges to be overcome if Japan is to achieve long-term stable growth and return to normalcy. In particular, the transitional risks associated with political changes could potentially lead to another setback for the country’s economy.
Wei Hongxu is a researcher at ANBOUND
Comments are closed.