International | May 31 2006
By Chris Shaw (Tokyo)
Following a March quarter GDP growth figure that showed a slowing in its economy, the World Bank and others have revised down their forecasts for growth in Japan while retaining a positive overall outlook.
GDP in the quarter came in at 1.9%, which while above consensus estimates of 1.1% means annual growth for the year to March was around 3%, down from the 4.3% rate in the October-December quarter.
As a result the World Bank now expects the economy to grow at 2.8% this year, a result the same as last year, before slowing to 2.1% in 2007 and 1.8% in 2008. In contrast, the IMF estimates growth this year will be 2.75% and 2% next year.
Morgan Stanley has not changed its estimate for 2007 of 2.3%, though it has lowered its forecast for this year to 2.9%. It sees little chance of a significant slowdown, as it expects wages growth and rising productivity and fixed capital investments to support growth in the economy overall.
Credit Suisse agrees, suggesting there is little chance the current increase in volatility in global markets will have a significant impact on Japan’s economic recovery. It supports its view by pointing out personal consumption expenditure was stronger than expected, which is having flow through benefits for the broader economy.
Again Morgan Stanley agrees as it sees the economy’s growth drivers shifting to domestic demand in the private sector, meaning there is less reliance on exports. At the same time, the broker acknowledges there is the potential for growth to slow if the correction in asset markets globally continues.
Also important for ongoing growth in the broker’s view is the improved strength in the Japanese banking sector, which it argues provides a more stable base for the economy overall and particularly with the prospect of higher interest rates leading many to suggest the yen carry trade will be unwound.
The market is factoring in an increase in rates in coming months, with current economic data tending to support such a view. As DBS points out, the last few months have shown the inflationary outlook is positive and while increases in the CPI are likely to be modest it does imply negative real rates given the current zero interest rate policy.
As such a situation can impact on investment and savings decisions and inflationary expectations the BOJ is unlikely to allow such a situation to persist longer-term.
In DBS’s view the BOJ is about half-way through its process of removing excess liquidity from the banking system, so no increase in rates is likely prior to this being completed. It has brought forward its timing for an increase to August from September, though it suggests any increase will be modest given the uncertain political environment in coming months thanks to the upcoming retirement of Prime Minister Koizumi.
Morgan Stanley has a similar timetable, tipping an initial increase in rates for the September quarter based on its expectation of core inflation of 0.5% year-on-year in the June quarter and an average of 0.4% for the year. It does suggest any move in rates will follow a measured approach, the broker favouring increases of 0.25% every six months rather than every quarter as the market is currently expecting. Also supporting such a timetable for a rate change is the fact the next survey of business confidence, known as the Tankan, is due in early July, giving the BOJ time to assess additional data before it meets.
The broker’s analyst Robert Feldman suggests the move to change rates is a judgement call based on the outlook for unit labour costs (ULC).
In Feldman’s view wages are subject to upward pressure from the tighter labour market and downward pressure from post-retirement hiring of less skilled workers, while productivity faces upside risk from further restructuring, globalisation and technology and downside from the exhaustion of excess capacity
While Feldman is more optimistic on the outlook for both than is the BOJ, he suggests there is the potential for damage to be done to the economy if the bank gets its judgement wrong and continues to lift rates even if there is no sign of sustainable increase in ULCs.
Looking forward, Credit Suisse suggests fiscal restructuring remains a key to the health of the economy, particularly given the large debt position and the upcoming increase in social security costs as baby boomers retire in coming years.
The broker suggests therefore the government will shift to a focus on inflation, which in the broker’s view can be addressed through either an increase in the consumption tax or via monetary reflation, with an inflation target of about 3%.
Achieving such a target suggests much work needs to be done to ensure ongoing growth in the economy, as Morgan Stanley is forecasting CPI of 0.4% this year and 0.2% next year, the fall in part reflecting the likelihood of a stronger yen offsetting the impact of higher oil and primary product prices. As a result, the broker has delayed its expectation of a positive reading on the GDP deflator until the June quarter next year, having previously expected such an outcome by the December quarter this year.
The combination of higher inflation and higher interest rates has seen the yen strengthen significantly in the last few months, with further gains considered likely given Japan appears to be commencing a policy of higher rates at the same time as interest rate increases in the US appear to be coming to a close.
The strengthening yen has caused some alarm in terms of corporate earnings, as most companies have based their results for the year on an exchange rate of about 110 yen to the US dollar. The broker is somewhat less concerned provided the rate of any further appreciation is not too fast, as it suggests overall the economy is better placed to withstand such external shocks than has been the case in recent years.
The bottom line is the Japanese economy should continue to grow and this will be good for global growth, but with growth unlikely to be sustainable at rates much above 2% it is more a case of steady as she goes rather than having to strap yourself in for a wild ride.
