By Anthony Rowley
Until recently, it seemed that Japan had achieved what many had come to believe was impossible – shrugging off the decade-long after effects of its notorious bubble economy, and re-emerging as a locomotive of the Asian and global economies. Some more bullish analysts were jubilant: “Best since the bubble” – and in some ways even better – declared Richard Jerram, chief economist at Macquarie Securities in Tokyo, as Japan's economy entered its 32nd month of recovery.
Others were even more optimistic: visiting Tokyo in June, IMF Managing Director Rodrigo Rato declared that Japan was “leaving behind many years of slow or even negative growth”. This was largely thanks to economic reforms being pursued by the Japanese government – from which “Europe could learn”, he suggested. Then, in August, the IMF upgraded its forecast for Japanese real economic growth in 2004 to 4.5% from 3.4%.
The Japanese government also revised upward its own forecast, albeit to only 3.5%. All seemed to be going well: exports were robust, domestic demand was showing strength, unemployment was falling, corporate confidence in Japan was at its highest in years, and industrial efficiency and productivity were also rising.
Warning signs
Forward indicators were looking good too – although one was lagging badly. That was Tokyo's Nikkei 225 stock average, which after an impressive leap of 50% in less than 12 months, began losing momentum a few months ago and then went into retreat. Various reasons were advanced to explain the market's stubborn refusal to support the view that Japan's economy is headed for a strong 2004 and 2005. One was that investor action had shifted from large cap stocks to smaller firms that do not influence the Nikkei 225.
But recently it has begun to look as though the market knew something that many economists did not. The first warning came with the shock announcement that Japan's real GDP growth in the second quarter of 2004 had skidded to just 1.7% at an annualized rate compared to 6.1% on an annualized basis in the first quarter.
Economists such as Jerram sought to shrug off the slowdown by blaming the quality of the GDP data, but it became less easy to be sanguine as the unemployment rate jumped again to 4.9% in July from 4.6% in June (after several months of falling joblessness). In addition, industrial output slumped. What had appeared to be a short growth adjustment began to look more serious, and the R word – recession – began to be whispered around again among analysts and even among Japanese government officials.
Critical period
The next few months will be critical. Key to what is happening will be the third quarter GDP figures. If these prove to be poor once again, and if there is also a reversal of the quite dramatic rise in Japanese corporate sentiment over the past year or two, as is looking increasingly likely, then the pessimists' case will begin to appear more solid.
One authoritative voice of caution is that of Haruhiko Kuroda, former vice minister for international affairs at the Japanese ministry of finance and more recently a special adviser to Prime Minister Junichiro Koizumi. Kuroda (who will succeed Tadao Chino as president of the Asian Development Bank early next year) warned at the beginning of September that the consumer spending that has helped to spur Japan's economy of late would soon begin to slow again.
Kuroda also warned, more ominously, that deflation would continue to dog Japan's economy. “Japan's deflation is very persistent and difficult to eradicate,” he said, adding that dealing with this must be the “most important macroeconomic objective” for policy-makers.
Ironically, deflation has helped to make Japan's GDP data look good in recent times. Just as nominal growth is normally trimmed back when adjusted for inflation (to show real growth), so an adjustment for deflation has the opposite effect by boosting real growth. At first sight this does not appear important in Japan's case as consumer price deflation is running only at around 0.1% to 0.2% a year. But the broad “deflator” of all costs in the economy is running at 2.6%, and that has a big impact on real growth.
Some analysts, such as Jeffrey Young, chief economist at Nikko Citigroup in Tokyo, have been consistently cautious about the durability of Japan's economic recovery. They have pointed to the fact that the drop in unemployment (until July) was due mainly to what Young calls a “whopping” number of people who have dropped out of the labour force and given up the search for jobs. And they have also noted that increases in consumption have been financed not by rising income but by a rundown in personal savings, which they say is unsustainable.
Young suggests too that the dramatic improvement in Japanese corporate profits in recent times is about to disappear as slowing sales meet rising costs of oil and other inputs. The Nikkei stock average, which has slumped back to 11,000 after pushing a high of over 12,000 earlier this year, appears to believe him. The slowdown in corporate sales appears to reflect the moderation of growth in the US and China, as well as a growing mood of caution among Japanese domestic consumers.