Japan’s economy set for reverse V-shaped growth in 2023

Japan’s strong economic recovery in Q2’23, thanks to a stellar performance of the external sector, was welcome news overall. Japan’s economy surprised with a 1.5% expansion from the previous quarter in April-June, according to data released by the Cabinet Office on August 15th. This growth was much stronger than EIU’s expectation of a 0.2% sequential increase, and marked the strongest quarterly expansion in two and half years. Real GDP growth in the first quarter of this year was also revised up to 0.9% quarter on quarter, from the previous official estimate of 0.7%.

In the wake of the strong economic performance in the first half of this year, we will revise up our 2023 GDP growth forecast from 1.3% to about 2%. However, we expect weakening economic growth in the second half of 2023, as elevated consumer prices will exert a greater drag on consumer spending and external demand remains feeble.

Time for Japanese exporters to shine

The strong headline growth figure in April-June was flattered by an unusually strong external sector performance, which is unlikely to be repeated in the upcoming quarters. Real exports of goods and services increased by 3.2% sequentially in the second quarter, largely reversing a 3.8% decline in January-March. A weak yen played a big role in bolstering export performance, as it made Japanese goods and services cheaper for overseas purchasers.

However, the yen further depreciated by 8.8% against the US dollar from end-March to end-June as continuing monetary policy tightening in the US widened the bilateral interest rate differentials, to the yen’s disadvantage.

Combined with resilient US consumer demand in the first half of this year, the yen’s depreciation created a favourable environment for Japanese exporters. Japanese carmakers stood out as beneficiaries of this opportunity, as a result of extraordinarily strong demand for passenger cars in the US and an end to the shortages of automotive semiconductors, which had previously dampened automotive production in Japan.

Additionally, Japan’s services exports received a further boost from the return of foreign visitors. Japan reopened its border to international travellers last October. By end-June the number of international arrivals had recovered to 72% of the level in 2019. Moreover, spending per person among foreign visitors has been boosted by favourable exchange rates and the relatively mild inflation in Japan, which have kept price levels low. As direct purchases by non-residents are counted as services exports, this rebound in foreign visitors and their consumption has been a major factor behind the consistently strong increases in real services exports since mid‑2022.

The positive showing of the external sector masked softening domestic demand.

Private consumption, which accounts for over half of total GDP, decreased by 0.5% from the previous quarter in April-June. As consumer prices continue to rise at an unusually fast pace in Japan’s context, households are under growing pressure to tighten their purse strings. The cutback on discretionary spending was evident in a 3.3% quarter-on-quarter decline in durable goods consumption, marking its weakest level in a year.

The receding enthusiasm for new purchases was also reflected in a declining interest in foreign produce. Japan’s imports of goods and services decreased by 4.3% sequentially; this magnitude of decline was last seen in the third quarter of 2020, when the country was mired in a pandemic-induced state of emergency. Conversely, the slide in imports represents a positive contribution to overall GDP growth, as it augments the impact of net exports to the headline growth figure.

No signs of charging dynamism were shown in other GDP components consisting of domestic demand. Government consumption has remained largely flat over the past year as fiscal support for low-income households and small businesses has been phased out. An ongoing recovery in business investment slowed notably in the second quarter as rising input and labour costs ate into the corporate budget for capital investment. Meanwhile, inventory levels rose for the eighth consecutive quarter. The continuing build-up of private-sector inventories represents another worrying signal of slowing economic activity, as demand is insufficient to absorb production.

Growth will pick up in 2024 after a brief slowdown in late 2023

Economic growth in Japan is set to slow in the second half of this year amid softening domestic demand. Sluggish private consumption will not tick up until households see solid evidence of stabilising prices in the market. The increase in the headline consumer price index is unlikely to return to the 1-2% range until mid-2024 amid sticky core inflation and tight labour market conditions, which supports workers’ demands for greater wage growth. As consumer price inflation (excluding fresh food and energy) continued to rise to a 42-year high of 4.3% in June, showing no signs of peaking, consumer spending will remain under pressure in the remainder of the year.

The economy will continue to expand in 2024 as a result of a combination of positive trends: easing inflation will strengthen consumer spending; the anticipated full recovery of foreign visitor numbers will extend growth in services exports; and accelerating economic expansion in the US and the EU will lift demand for Japanese goods. Despite a slow and uneven start to its post-pandemic recovery, Japan’s economy is on track to achieve steady expansion in the coming years.

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