Japan's GDP and Economic Trend – Weathering the Gloom?
Martin Schulz
Research Fellow
May 16, 2008 (Friday)
Japan's economy is currently at the crossroads. After a long but slow expansion from 2002, the economy now seems at risk of slipping into recession. Friday's quarterly GDP data will therefore draw quite a bit more attention than usual.
Indeed, already during 2007, about half of the 1.4% annual GDP growth came from external demand and booming exports. A U.S. recession and a slowing world economy are therefore weighing on everybody's minds. Many analysts, including Goldman Sachs, already saw Japan's economy in recession early this year. Adding to the gloom, the cautious earnings announcement of Toyota Motor, the poster child of Japan's recovery, came as a shock – especially after the U.S. bellwether General Electric had already disappointed before. It is not the fact that Toyota forecast a 30% drop in operating profit for the fiscal year 2008, which still seems mild during a global downturn and an explosion of input costs. It is Toyota's North American operations', the profit engine for the company, where operating profit of 160 billion yen during the second quarter of 2007 was falling to an operating loss of 12.4 billion yen for the first quarter of 2008. So even Toyota, with its innovative and efficient product lineup, does not seem to be "subprime proof".
But, so far real growth has been weathering such gloom. Already the last quarter of 2007 has turned out surprisingly strong, with annualized GDP growth of 3.5%. Both external and domestic demand had been up, with corporations continuing to invest, consumers opening their purse strings another little bit, and demand from Europe picking up where U.S. consumers left. The first quarter of 2008 will most likely have been driven by the same momentum. GDP is likely to be up by 0.6%, or 2.5% annualized. Driving forces are strong overseas demand, especially from Europe (with an increase of more than 4%), contributing half of quarterly growth (0.3%), and surprisingly resilient consumer demand (+0.7%), which contributes the most to the domestic half of demand. Corporate investment seems to be flat while production significantly cooled only during March. Even the negative factors that are weighing on GDP growth are not entirely bad. Public investment remains on a downward trend – with forward contracts indicating a further slowdown – and even government consumption did not contribute to growth. Together the public sector might have shaved a full 0.1% from GDP growth. Overall, however, such restraint should help to recover at least a little confidence in Japan's public sector, which had clearly fallen into a policy deadlock after the "Koizumi-Reforms" had faded. Similarly, imports have likely increased by 2%, which reduces the external balance, but shows that demand in Japan remains resilient and able to deal with the rising input costs.
What to make of these differing trends? Unfortunately, the outlook does not seem to be as positive. External demand for Japan's products remained so strong – despite a slowing U.S. and a strong Yen – because the Yen has initially been appreciating Japan's exports, rather than slowing them (a so-called J-Curve effect). Furthermore, Europe has not yet felt the brunt of the U.S. recession, while East Asia has been flooded by U.S. Dollars. Domestically, companies have only just started to cut back on production and bonuses, but they clearly intend to continue to do so as long as the international environment does not recover. Additionally, the leap year has been inflating consumption figures, and the small recovery in housing investment and construction has not been due to additional demand. Construction only turned positive because of increasing construction permissions after last year's disastrous introduction of new housing safety standards that brought construction almost to a standstill. Still, the biggest worries are weighing on Japan's major exporters who have been building up their production networks throughout East Asia so successfully. Production at these companies has clearly been slowing at the end of the quarter. This is because a squeeze in profitability from cost-push inflation will likely get worse because of a slowdown in East-Asia when inflation fighting policies and a stronger Yen are kicking in. The bottom line is that the economy remained stronger than expected. But we are rather looking at a strong LAST quarter of a resilient fiscal year 2007, than at a strong FIRST quarter of a promising calendar year 2008. The outlook for fiscal 2008 therefore remains on the weak side of forecasts at about 1.2%.
Finally, however, it seems to be necessary to note that the actual situation might indeed be better than the gloomy mood and the results of our short-term analysis. Japan does not seem to slip into a home-grown recession, again. Resilient consumer demand, careful corporate planning (including inventory levels), continued public budget restructuring, and very low core inflation are certainly not a recipe for growth. But they clearly show that Japan's fundamentals have improved over the latest business cycle. Furthermore, while exporters will certainly take a hit, many companies continue to report strong demand for their products and, in particular, services. Continued restructuring is clearly paying off for these companies while prospects for strong demand in sectors such as IT services have not faded in Asia. So while there won't be any decoupling from U.S. demand (and from the U.S. Dollar) for the time being, Japan has now become a part of East Asia’s huge economy. With this, companies have already brought their production costs under control and now venture into developing new markets and attractive services with growing demand.
