Challenges Remain For Normalization Of Japanese Economy – Analysis


By Wei Hongxu

Since the beginning of this year, the long-stagnant Japanese economy has shown substantial progress. On one hand, the long-standing deflationary trend in Japan has continued to improve. The core Consumer Price Index (CPI), excluding fresh food, increased by 3.2% year-on-year in May, surpassing economists’ predictions of 3.1%.

When excluding both fresh food and energy prices, the crucial CPI rose by 4.3% in May compared to April’s 4.1%, reaching a new high since June 1981. It is worth noting that this index, which is the most closely watched inflation indicator by the Bank of Japan (BOJ), has exceeded the central bank’s 2% inflation target for 14 consecutive months. On the other hand, the Japanese economy has shown signs of improvement. Supported by increased household and corporate spending, Japan’s real GDP grew by 1.6% on an annualized basis in the first quarter, marking the first positive growth in three quarters. The resurgence in economic growth and inflation has raised optimistic expectations of Japan’s recovery from the “lost decades.”

The turnaround in the Japanese stock market after a prolonged slump has further boosted market confidence. Since this year, with the influence of investors like Warren Buffett, an increasing number of international investors have begun to pay attention to the Japanese stock market. Since 2023, the Japanese stock market has been consistently rising, and the Nikkei 225 index recently reached a new high not seen in 30 years. In the real estate market, the Real Estate Economic Institute of the country announced on April 18 the average prices for the fiscal year 2022. The prices in Tokyo’s 23 wards increased by 17.2% compared to the previous year, reaching JPY 98.99 million, setting a new historical high with comparable data since the fiscal year 1990. The resurgence and ascent of asset prices in Japan symbolize the revival of market confidence and anticipation.

There are also signs of accelerated reshoring in Japanese manufacturing in the industrial sector. In 2022, domestic construction orders in Japan reached a 20-year high in year-on-year growth rate. Semiconductor companies such as Samsung, TSMC, and Micron have made large-scale investments in the country. According to a survey by Nikkei, the planned investment in industrial equipment for the fiscal year 2023 has exceeded JPY 30 trillion for the first time, reaching JPY 31.6 trillion, representing a growth of 16.9% compared to the previous year’s actual investment. The planned investment in equipment by businesses has reached a new high after 15 years since the pre-Lehman crisis in 2007. The growth in industrial investment signifies optimism for future market demand and to some extent brings about a recovery in the intrinsic driving force of economic growth.

Various indications suggest that the economic policies of Abenomics, which Japan has been implementing for a long time, along with the subsequent improvements in New Capitalism, have yielded positive results. The Japanese government’s series of policies aimed at increasing employee income, enhancing human capital investment, and encouraging corporate investment are increasingly demonstrating significant effectiveness, helping the country to break free from its long-standing economic stagnation. However, if Japan hopes to completely overcome the deflationary trap and restore normalcy, it still faces many obstacles.

Firstly, there is the question of whether Japan’s unconventional monetary policy can be smoothly phased out. With inflation continuing to rise, the BOJ will soon face a turning point in normalizing its monetary policy. In fact, the Japanese central bank has already started studying the effectiveness of its policies and will also consider the exit strategy for quantitative easing. Due to Japan’s long-standing quantitative easing policy, it has experienced a divergence in policy cycles from economies in Europe and the United States. As global interest rate differentials widen, the Japanese yen has depreciated multiple times since last year. With the Federal Reserve persisting with its tightening policy, the Japanese yen weakened beyond 143 yen against the dollar. The depreciation of the yen will further push up the prices of imported goods in Japan. If the BOJ initiates the exit from quantitative easing due to achieving its inflation target, it may bring about unpredictable transition risks. This may be one factor why the new BOJ governor is hesitant to clearly indicate a policy shift. BOJ Governor Haruhiko Kuroda has previously stated that Japan will need to exit accommodative policies at some point, and once negative interest rates and yield curve control end, it may have spillover impacts on its assets. Since last year, capital markets have already begun preparing for the volatility after Japan ends its yield curve control policy, and speculative funds have continued to flow into Japan, preparing to take advantage of the weakening yen. The inflow of international capital against this backdrop may be one factor contributing to the rise in the Japanese stock market. With risks accumulating, any signs of the central bank changing its policy direction will bring about market turbulence. The stability of Japan’s financial system is not reassuring under long-term low-interest rates. The BOJ needs to confront the risk of avoiding a policy derailment that could bring a crisis back to the Japanese economy.

Another challenge is the long-term growth constraint posed by population aging, for which there is currently no effective solution. One of the significant reasons for Japan’s long-standing economic stagnation lies in the changing demographic structure, particularly the deepening of population aging, which has resulted in a decline in the labor force and an increased burden on the general population. Unfortunately, this trend has yet to be alleviated. According to population estimates released by the Japanese Ministry of Internal Affairs and Communications, as of September 15, 2022, Japan’s total population decreased by 820,000 compared to the previous year, while the number of people aged 65 and above reached a record high of 36.27 million, an increase of 60,000 compared to the previous year. The proportion of the population aged 65 and above in the total population reached 29.1%, reaching the highest level in history. Some analysts point out that severe population aging can lead to insufficient market demand, increased fiscal burdens, and negative impacts on economic growth due to stagnation in the growth of the labor force.

Furthermore, the sustainability of Japan’s ongoing economic improvement also faces challenges. Some researchers believe that the current upturn in the Japanese economy is driven by short-term factors, and whether the growth can be sustained remains questionable. Particularly in the face of unfavorable global economic prospects, Japan’s economy is constrained by weakening external demand and escalating geopolitical risks. For example, Nomura’s Chief Economist, Kyohei Morita, suggests that despite the global economic downturn, Japan’s decent growth can be attributed to two factors: the restart of the economy after the pandemic, which has unleashed pent-up demand, and increased capital expenditure by companies following a decline in inflation from its 40-year high. However, recent positive economic data from Japan has not completely reassured the market. Morita points out that sustaining the corporate investment that drove first-quarter economic growth may prove challenging. Additionally, researchers from China Merchants Securities note that after three decades of stagnation, the competitiveness of Japanese companies is not optimistic. While Japanese companies remain competitive in sectors such as semiconductors, they face increasing pressure and challenges in industries such as automobiles, LCDs, photovoltaics, and mobile phones. Especially in emerging economic sectors, they are mostly in a passive position. Market prosperity driven by monetary and capital factors may be difficult to sustain amid declining industrial competitiveness.

Final analysis conclusion:

Despite the positive signs in the Japanese economy and the rare performance of the stock market, there are still many challenges to overcome if Japan aims to achieve long-term stable growth and return to a path of normalcy. In particular, the transition risks associated with policy changes could potentially setback the country’s economy once again.

Wei Hongxu is a researcher at ANBOUND


Anbound Consulting (Anbound) is an independent Think Tank with the headquarter based in Beijing. Established in 1993, Anbound specializes in public policy research, and enjoys a professional reputation in the areas of strategic forecasting, policy solutions and risk analysis. Anbound's research findings are widely recognized and create a deep interest within public media, academics and experts who are also providing consulting service to the State Council of China.

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