Average Real GDP Growth in Japan Over the Next 5 Years (2020-2024)
I wrote this piece for a prediction market as part of the debate on the topic. Since that discussion is in a walled garden, I thought I’d share I drop it here to share it with you, gentle reader.
Health of the Economy Entering the COVID-19 Period
As we headed towards the end of 2019 and in early 2020, the Japanese economy experienced headwinds from a variety of sources:
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US-China trade war. This had led to a softening in demand for Japanese manufactured goods in 2019, especially from China. Indeed, exports to China, Japan’s largest trading partner, fell consistently throughout 2019. For instance, by the middle of the year, demand for semiconductor manufacturing equipment fell by 31.5% yoy, car parts by 35% yoy and electronic parts by 19% yoy. Both the US and China are Japan’s largest trading partners accounting for more than 40% of exports.
The above was masked by strong domestic consumption, the growth of tourism (and correspondingly the service sector), and local business capex. Indeed Japan showed 3 consecutive quarters of growth leading up to the 4th quarter in 2019. Then things hit the skids because of Abe’s 2nd tax hike.
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In October 2019 the national sales tax was hiked from 8% to 10%. This had predictable effects. The run up to that date showed significant increase in domestic consumption (3.5% in August and 7.3% in September), especially for large ticket items, followed by a slump (fall of 13.7% in October) after the new tax rate came into effect. This spike and collapse followed a similar pattern to the 2014 tax hike, which took 5 months to recover.
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Global economic slowdown. In March 2019 the US yield curve started to invert and by August the inversion had deepened indicating a risk of recession. The US accounts for slightly more in exports than China (21% in 2019); Germany’s economy showed contraction and China’s growth slowed. In fact, Japan shipped $705.7 bn of goods in 2019 but that was a 4.4% decline from 2018.
Against this backdrop (and battering from Typhoon Hagibis) as we entered 2020, Japan was in fact in technical recession.
COVID-19 Effects
The May 20th PMI survey by IHS Markit showed that Japan suffered from one of the steepest declines in manufacturing and services sentiment among the G4 nations.
Real GDP fell 0.6% in Q1 (qoq) following a fall of 1.9% in Q4 2019.
The effect was due in large part to the reduction in demand for Japanese manufactured goods, the closure of manufacturing facilities, more inefficient supply chains, the collapse of tourism (in which the Chinese play a large role) and consumer spending curtailed by the emergency declaration.
Manufacturing
While we do not yet have statistics for June, overseas machine orders have improved slightly in May from April although the numbers are still far in the red. The nadir was in April at a 21.6% fall from March while May’s decline was 18.5%. The government forecast for overseas machine orders for the 2nd quarter is -13.7% q-o-q.
Production lines for automobiles remain closed in many regions (see the Japanese Cabinet’s Economy Watchers Survey of May 2020)
All this is consistent with the manufacturing output and manufacturing PMI which shows that this sector is still in the depths of the slow down (in comparison to the service sector below). The PMI shows that, while off its lows, Japanese manufacturers are holding off non-urgent capex, apocryphally in anticipation of a second wave of infection (according to Takeshi Minami, chief economist at Norinchukin Research Institute).
Capex is an important component in Japan as the population ages and investment in technology and automation is made to offset a shortage in labour. Big firms in Japan are expected to increase capex this fiscal year (end March 2021) by 3.2% according to the Bank of Japan’s quarterly survey published in early July.
Services
The June 2020 statistics point to a significant recovery in the services sector. Services PMI (IHS Markit, au Jibon Bank at the end of June in a “flash” survey showed services jumped from a low of 26.5 in May to 42.3 (still off the 50 mark but a significant headway).
Easing of restrictions in late May led to the recovery in the sector, compared to the manufacturing sector, demonstrating the difference in inertia between the 2 sectors.
Nonetheless, the precipitous fall in tourism, which is a major driver in services growth, has not recovered. In particular, the Golden Week, which is the busiest season for travel and hospitality, was curtailed because of the emergency declaration.
I suspect most of the improvement in sentiment is because of pent up local demand. It is possible that over the next few months some tourist expenditure from overseas tourists could be replaced by a portion of Japanese who usually travel overseas for their vacation. But sentiment may fall again as we enter the autumn if we see another significant spike in infections.
Interestingly, employment in the services sector has stabilised after 3 months of job losses.
Consumer Spending
The Japanese consumer is an important component of Japanese GDP. Japanese consumer sentiment in April was the lowest in the Cabinet Office’s published records going back to 1983. It has recovered a few points since but is still around the level of the worst periods of the Great Financial Crisis. The easing of restrictions in May has not resulted a significant change in household sentiment reflecting the uncertainties of the path of the resolution of the pandemic and the economy.
Exports
Exports, already suffering from a slowing global economy, fell precipitously since January. Latest data in May showed exports continued to fall (28.3% m-o-m!). The biggest component is car exports which in May was -65.4% compared to the year before.
Real GDP Forecast
Japan’s real GDP (in Yen terms) has grown on average 1.3% from 2010-2019. In the Great Financial Crisis, GDP fell 5.4% in 2009 (yoy). It took 4 years to recover to 2007 levels (2013). This crisis will be a much larger drag on Japan’s economy.
The softness of the global economy as we entered 2020, combined with the effects of the trade war between the US and China and the tax hike had already exerted downward pressure. COVID-19 added a collapse in global demand for Japanese manufactured goods, and devastated tourism (during a planned Olympic year).
The consensus is that Japan’s economy has shrunk by between 13% and more than 20% in the quarter just ended on an annualised basis. (Data release imminent).
Abe’s government approved a 117 trillion Yen (20% of GDP) stimulus package in April followed by the latest package of equivalent size in May 2017. At the same time in May he announced the end of the emergency declaration to allow the economy to re-start. We have seen the effect of the latter on services and services PMI.
The aid is designed to push liquidity into the economy by boosting loans and investments via government-linked lenders to counter the effects of the shutdowns. It will allow companies to keep paying rent and protect jobs. In addition, the aid is also aimed towards subsidising local governments and helping the healthcare system. The aid looks to be designed to cushion the blow delivered by the pandemic, to prevent irreparable damage to the participants of the economy rather than to be fiscally stimulating.
At the same time the Bank of Japan has indicated (in a rare joint conference with the Government), that it will protect the yield curve.
We are starting to see some recovery in the service sector due to pent up demand, but tourism continues to languish. There is a likelihood that the Olympics could be postponed another year if the safety of crowds cannot be established by next May. Assuming a muted Olympics, I expect some recovery in the services sector but not a bounce back to pre-COVID-19 levels by the end of 2021.
For manufacturing and exports, in 2021 the combination of pent-up demand for local capex and low energy prices in the early part of that year, plus a recovery in China and Korea and, tentatively, the US (remember US and China account for 40% of exports) will lead to a growth in manufacturing. Thereafter GDP growth will be slower once the backlog has been worked through as the world’s economies regain their footing.
My assumptions also include a relatively strong Yen vs the USD and CNY, and that Brent crude remains below $60 in 2021.
Hence I predict a fall of over 5% in GDP for 2020 but a growth of around 3% in 2021, followed by a slower climb from 2022 as the world slowly recovers. Given current information, my model shows a 0.7% average (mean) real GDP growth in Japan from 2020-2024. However, that will likely change once we have a reading on 2Q GDP.