Japan has long been seen as the “sick man of Asia”, and the March 11 disasters knocked the country’s economy back into intensive care. But as both the US and Europe teeter once more on the brink of recession the Japanese economy is starting to look surprisingly healthy in contrast.
“It’s a kind of negative beauty contest – Japan looks least bad of the trio at the moment, and that is why the yen has surged against the dollar and the euro of late,” says Japan’s former ‘Mr Yen’ Eisuke Sakakibara.
“The Japanese economy is at least recovering – it has certainly hit bottom – but for the US and European economies we don’t know where the bottom is,” Sakakibara, a former vice finance minister for international affairs, tells Emerging Markets.
But the prognosis is far from a clean bill of health.
Japan’s economy contracted in the final quarter of 2010 even before the massive earthquake and tsunami struck in March, and by the end of June it had been in recession for three consecutive quarters. The most optimistic forecasts see real GDP recording zero or negative growth in calendar 2011 before rebounding to 2.5% growth in 2012.
September brought yet another change of prime minister in Japan following the resignation of Naoto Kan, the fifth Japanese political leader to quit in the space of as many years. He was succeeded by former finance minister Yoshihiko Noda, a fiscal hawk like his newly appointed finance minister, Jun Azumi. But there is a limit to what they can do to repair Japan’s battered public finances in the face of a weak economy. Likewise, their determination to battle the strong yen is likely to be undermined by the fact that both the dollar and the euro are weak, says Sakakibara.
An OECD (Organization for Economic Cooperation and Development) projection in July suggested that Japan’s GDP could contract by up to 1% in 2011, while the IMF has suggested a 0.7% shrinkage. Investment bank Goldman Sachs estimated shortly after the March 11 earthquake and tsunami that the contraction in 2011 could be as severe as 3%.
The initial impact was severe: first quarter GDP slumped 3.5% on an annualized basis, even though the disasters affected only one month of that period. But by the second quarter, the contraction had slowed to 1.3%, and the hope is that some expansion will show through in the third quarter.
“Some kind of recovery will probably be seen to have occurred from summer, but the question is how strong the recovery will be,” says Sakakibara. He says he does not expect Japan to suffer the kind of downturn that is increasingly likely in the US and Europe.
Recovery is to some extent underwritten by reconstruction work along hundreds of kilometres of Japan’s earthquake and tsunami-ravaged north-east (Pacific) coast that will begin in earnest this autumn and is scheduled to last for several years. Former economics minister Kaoru Yosano has put the cost at ¥10–15 trillion ($460–690 billion) or 2–3% of Japan’s GDP, although other estimates say 4% is more likely.
The Japanese central government will bear the brunt of this spending, but there is still uncertainty over how it will be financed. A couple of supplementary budgets for fiscal 2011 already passed will cover the initial costs such as waste clearance, temporary housing and compensation payments, but the lion’s share has yet to be financed.
POWER PROBLEMS
Apart from the strong yen, which hit a new post-war record high (in nominal terms) of ¥75.95/$ towards the end of August, the threat of electric power shortages in Japan, arising directly and indirectly out of the Fukushima nuclear crisis, looks set to persist for a long time.
For an energy-intensive economy that converts imported raw materials into high valued-added capital and consumer goods exports, power shortages are very bad news. Industrial output slumped after the March 11 disasters, because of physical damage to factories, and this has been exacerbated by electricity shortages.
The crippling of the huge Fukushima complex itself was bad enough, but it has resulted in no fewer than 35 of Japan’s total 54 reactors scattered around the country (which collectively supply some 30% of the nation’s electric power) being idled pending special “stress tests”.
Nuclear power has become a political football in Japan with former prime minister Naoto Kan, backed by 70% of polled voters, calling for its phasing out, while business lobbies such as the Federation of Economic Organizations (Keidanren) are demanding an early restart of idled nuclear plants.
Keidanren and individual business leaders claim that companies, both large and small, could desert Japan en masse, adding to the hollowing out of the country’s industrial base, if they face the threat of electric power shortages at the same time as battling with yen strength or endaka.
“If we completely abandon nuclear power generation, most industries would lose competitiveness and leave Japan,” says Masakazu Toyoda, chairman of the semi-government Institute of Energy Economics in Tokyo. Japanese banks report, meanwhile, that increasing numbers of firms are asking for help in implementing relocation strategies overseas.
Japan has been able to avoid power cuts during a very hot summer this year only by staggering industrial production and by energy-saving economies by business and household sectors. But there is no assurance that it can get through the winter or even next summer without more severe outages.
CURRENCY CURSE
At least the solution to the electric power dilemma lies in Japan’s own hands. But Japanese authorities feel impotent in the face of a yen surge prompted by the perceived relative strength of Japan’s economy and the simultaneous weakness of the dollar and the euro.
This has happened at about the worst time for Japan, just when external demand from recession-poised western economies and even from still-robust China shows signs of weakening. “When the dollar went to $76 after the earthquake in March, this was like another tsunami crashing against our economy,” is the way Prime Minister Noda has put it.
Japanese authorities intervened in currency markets in March and then again in early August (spending in total more than ¥3 trillion on dollar buying), but while this managed to nudge the yen down to around ¥80, the relief was short lived. Further interventions appeared imminent.
Japan’s former vice finance minister for international affairs, Takehiko Nakao, promised a “measured approach” to intervention in the currency market, implying a series of repeated interventions rather than one big bang. But Sakakibara says the best this can do is to buy time.
Intervention is effective, Sakakibara suggests, “only when you intervene persistently and when you have an agreement from other parties, but now Europeans have protested against yen intervention and the Americans don’t like it. So in a situation like this intervention is useless.
“My expectation is that the US economy will be weak and may hit a double dip [recession]. The European crisis is spreading, so both the euro and the dollar are very weak. That implies that the yen will strengthen. I would not be surprised if the rate went into levels of the upper ¥60s/$.”
Even so, the yen is still not as strong in inflation-adjusted terms as it was in 1995 when it hit its previous all-time high. “Given relative price movements in the US and Japan, ¥80/$ today is something like ¥100/$ 15 years ago,” says Sakakibara. “So it’s not yet a crisis. But I might add that the world economy as a whole is in crisis, and Japan will be hit by that.”