The sky-high yen and global economic downturn will likely continue to exert downward pressure on the economy in 2012, but domestic demand linked to postdisaster reconstruction work is expected to underpin growth.
Japan is stepping up its austerity measures, including preparations for raising the consumption tax as early as in 2013, amid increasing concern that any delay in fiscal rehabilitation could in the long term cause the bond market to collapse in a similar manner to eurozone nations.
The Bank of Japan, which has little room to lower its key interest rate from the current zero to 0.1 percent range, may lack alternative options to boost economic growth, although expanding its asset-purchase program could be an option.
Japan’s economy is increasingly feeling the negative impact of Europe’s sovereign debt crisis. The trade balance was in the red for the second straight month in November due to slower shipments of auto and electronic parts to other Asian economies, which build products for export to Europe, where consumer sentiment has been dented.
The yen, meanwhile, has risen 7 percent in effective terms since May, according to the Organization for Economic Cooperation and Development, putting more pressure on exporters. A strong yen pares manufacturers’ overseas profits when repatriated.
Against this backdrop, it’s not surprising that business sentiment among large manufacturers, such as Sony Corp. and Toyota Motor Corp., declined faster than expected in December from three months earlier, according to the BOJ’s “tankan” sentiment survey.
Corporate appetite for fresh capital spending also weakened over the same period, the survey showed.
“We cannot count on external demand to support the economy in the first half of 2012,” said Ryutaro Kono, chief economist at BNP Paribas Securities (Japan) Ltd. But domestic demand linked to reconstruction work in the northeast after the March 11 disasters “should help Japan avoid negative growth,” he added.
The government estimates that the economy will grow a real 2.2 percent in fiscal 2012, which starts April 1, spurred by strong domestic demand.
But there are downside risks to this scenario, and an economic recovery depends to a large extent on how successful European leaders are in taming the long-running eurozone debt crisis. If they fail to resolve the continent’s debt woes, demand for Japanese products will fail to pick up, weakening exports and prolonging Japan’s economic downturn.
But economic growth is not the only issue Prime Minister Yoshihiko Noda urgently needs to address. He also faces the more fundamental problem of restoring the country’s fiscal health, which is the worst among major developed economies.
The OECD has projected that Japan’s gross government debt will approach 230 percent of its gross domestic product in 2013, far higher than that of Greece or Italy, which respectively sparked and deepened the eurozone crisis.
Public finances have steadily deteriorated as the population has aged, swelling social security costs. Noda says he wants to win the public’s approval for his administration’s plan to double the consumption tax rate in stages to 10 percent by the mid-2010s, up from the current 5 percent, to raise additional money to fund welfare services.
The government and Noda’s ruling Democratic Party of Japan are considering a plan to start raising the tax as early as October 2013, but even some DPJ lawmakers are urging the prime minister not to rush to make a decision before the potentially negative economic impact is thoroughly examined.
But something will need to give, as Standard & Poor’s and Moody’s Investors Services — the world’s two leading credit rating agencies — have already cast doubt on the credibility of Japan’s public finances. Both agencies downgraded their ratings for Japanese government bonds in 2011, and say they are closely watching to see if the government can compile a credible and sustainable fiscal reform plan next year.
However, the fiscal mire Japan finds itself in is not comparable to that faced by eurozone states. More than 90 percent of JGBs are held by domestic investors, ensuring Japan has a far higher degree of stability and security than the troubled European nations do. The EU’s concerns over members’ deteriorating external balances have prompted many foreign investors to ditch government-issued debt.
Demand from domestic institutional investors at JGB auctions in Tokyo has remained steady, in fact. But analysts warn that if the government’s measures fail to assure the markets about the country’s long-term fiscal health, their confidence in the bonds will quickly fade.
“We cannot deny the possibility that hesitation by only one such stable buyer could easily spread among the others,” said Hiromichi Shirakawa, chief economist at Credit Suisse in Japan.
After the March 11 disasters, some ruling DPJ lawmakers publicly urged the BOJ to underwrite JGBs and help finance reconstruction work in Tohoku. But the central bank’s governor, Masaaki Shirakawa, rejected the request on the grounds that if the BOJ started funding government projects, the level of inflation could spiral out of control.
But the BOJ will have to come up with its own response in terms of policies the bank can use to stimulate growth in 2012.
Analysts say the only option the BOJ has left is to expand its asset-purchase program, currently capped at ¥55 trillion, if downside risks intensify.