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Japan’s Q2 2014 GDP contracted by -1.7% in Q2, -6.8% on an annualised basis. This was the worst fall since March 2011, leading some commentators to suggest that Abenomics – Japan’s economic experiment – is failing. Domestic demand fell by 10.5% (q-o-q, annualised) led by a sharp fall in private consumption (-18.7%), private capital investment (-9.7%) and housing (-35.5%), despite higher demand from the public sector and increased net exports. However, the headline figures are in line with market expectations. The Nikkei and Yen both took these figures in their stride.

So why did this occur?

Japan’s consumption tax (VAT) increased in April from 5% to 8%. In order to avoid the tax rise, households brought forward purchases, especially of expensive items. As a result, expenditure on durable goods increased by 63.3% (q-o-q annualised rate) in Q1 and subsequently fell by 56.8% in Q2. Offshoring by industry means that the weaker yen under Abe has yet to translate into improved exports. This all resulted in Q1 GDP increasing 6.1% ( annualised, and lower than initial estimates of 6.7%) and the drop.

Key commentators here are unperturbed. The Chief Economist of the Daiwa Research Institute expects ‘the economy to rebound positively in Q3 and to continue on an upward trend thereafter’. Consensus estimates predict that Q3 GDP will come in at 4.1% (q-o-q annualised), followed by 1.9% in Q4 and 1.6% in Q1 2015. Recent economic data confirms this optimistic view for Q3 GDP with new car sales increasing in July for the first time in several months. Consumer confidence has also been increasing for the past few months.

Economic Minister Amari also echoed this optimistic scenario stating that in his view the economy ‘is likely to continue on moderate recovery going forward’.

Abenomics to date

The first two arrows of Abenomics (monetary easing and fiscal policy) have led many to conclude that Japan has ended its long period of deflation. June core inflation (CPI) is currently 1.3% (excluding fresh food and the impact of the tax rise). This is the 13th consecutive positive figure. When Abe took office, it was -0.2%. Unemployment has also fallen to 3.7% (close to full employment) and Japan’s output gap has closed.

However, household income in Japan has not kept pace with higher inflation and taxation so that the benefits of economic recovery are not yet apparent. Japan’s potential growth rate needs to improve through structural reforms to ensure its economy continues to grow. The rate is currently under 1% and needs to increase to 2% .

Looking ahead, the next major economic decisions are:

whether to increase VAT again in October 2015. This will be dependent on the Q3 2014 GDP figure but Credit Swiss’s Chief Economist has stated ‘Rebounding GDP growth makes the second VAT hike take place as scheduled’;
when to restart Japan’s nuclear reactors. Once that occurs, it will boost Japanese GDP and reduce its imports of LNG; and
how to finance lower corporation tax from current rate of 35% to between 20-30% over the next few years.

Comment

The sharp fall in GDP will attract headlines but this is heavily distorted by the VAT increase. It should not distract from the successes that Abenomics has had to date or the opportunities offered by a growing Japanese economy

The Bank of Japan (BOJ) remains confident that they will reach their 2% inflation target in 2015.

Disclaimer

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Japan: recent economic developments and the role of abenomics

This research and analysis was withdrawn on 3 August 2016

This publication was archived on 4 July 2016