Outcomes of the G7 summit and the future of Sino-Japanese relations

Robert Xiao, Beijing director

It’s hard to believe that we are about to enter June, which means that nearly half this year has already passed. Over the past few weeks, we have been reviewing and assessing China’s economic performance. This week, I will combine our latest analysis from the EIU and share with you our outlook on the global economy. Additionally, I will look back at the 2023 Group of Seven (G7) summit and discuss the future trajectory of Sino-Japanese relations and the trade landscape related to it. I hope this information will provide useful guidance for your strategic and business planning.

First, with the global economy proving resilient so far in 2023, the EIU has raised its forecast for global GDP growth to 2.2% for this year. It’s worth noting, however, that this brighter outlook still represents a slowdown. The war is affecting the global economy via higher commodity prices, supply-chain disruptions, and Russia’s weaponisation of energy supplies. This situation will persist throughout 2023 (and probably beyond), as we expect the war to become a protracted conflict with no clear resolution. The economic impact of the war is felt especially strongly in Germany and central Europe, where energy-intensive industries will struggle to remain competitive. Owing to its reliance on private consumption, the UK economy is being disproportionately hit by the cost-of-living crisis, and we expect it to be one of the few economies in the region (together with Germany) to only narrowly avoid a recession in 2023. In the US, we expect annual growth to slow sharply this year, to 1%, as the pace of consumer spending becomes unsustainable in the face of high inflation and a steep rise in interest rates.

Second, we expect global commodity prices to continue easing from their 2022 peaks this year, but to remain well above pre-war levels. However, China’s reversal of its zero-covid policy will put upward pressure on oil prices, which we expect to remain above US$75/barrel in the medium term. An EU ban on seaborne Russian oil imports (since late 2022), China’s reopening (in early 2023), and the decision by OPEC+ members in April to cut production will all exacerbate market tightness. We expect European gas prices to ease gradually in 2023-24 but to remain above 2019 levels, weighing on households and businesses. The possible tightening of Western sanctions (for instance on refined Russian oil) will fuel price volatility.

Furthermore, we expect global inflation, an issue of concern to many, to ease slightly, from an estimated 9.2% in 2022 to 7.2% in 2023. High global commodity prices, continued supply-chain disruptions from the war in Ukraine, and, in some parts of the world, the still-strong US dollar will keep annual inflation well above 2019 levels. However, we expect inflation to lose some momentum as global demand softens and commodity prices ease back from their 2022 peaks. We expect central banks to maintain their aggressive policy stance in an effort to bring inflation under control, even as global growth slows. Interest rates in most major economies will peak by mid-2023, and in most cases will remain there until 2024.

It should be noted that the foregoing predictions are based on reasonable assessments of many exogenous factors. Several potential scenarios could derail our forecasts. The most noteworthy of these include: an escalation of the war in Ukraine (there is little prospect for an end to the war this year or next); social unrest arising from high inflation (especially given that high levels of public indebtedness constrain emerging countries’ room for manoeuvre to mitigate the impact on households); an escalation of tensions around Taiwan (following China’s frequent military manoeuvres around the island); financial contagion following the collapse since March of three US regional banks and turmoil at a Swiss banking giant Credit Suisse; the emergence of a new variant of covid-19 (or of another highly infectious disease) that is especially aggressive; and extreme weather events that further fuel global inflation. If one (or several) of these scenarios were to materialise, a global recession this year or next would be likely.

Turning to the recent G7 summit. The 2023 G7 summit was held in Hiroshima, Japan on May 19-21. A joint Communiqué issued by the member states during the summit addressed a number of matters. The members pledged closer coordination on deterrence and response to economic coercion; agreed to cooperate on enhancing economic resilience and security; reiterated their support for Ukraine in its war against Russia; and proclaimed a commitment to nuclear disarmament. Although the joint Communiqué issued by the leaders of the G7 countries expresses a desire to build “constructive and stable” relations with China, and emphasises an approach of de-risking rather than decoupling, the general sentiment is gloomy regarding the direction of relations. Moreover, the Communiqué highlights tensions across the Taiwan Strait, human rights issues in Tibet and Xinjiang, and China’s handling of Hong Kong in its sections pertaining to regional affairs. Japan’s leading role in such talks will be viewed unfavourably by China, which considers these domestic affairs and opposes any foreign intervention.

“We are taking concrete steps to…coordinate our approach to economic resilience and economic security that is based on diversifying and deepening partnerships and de-risking, not de-coupling.”

We therefore believe that relations with China have entered a new stage in which Japan’s focus has shifted from promoting economic ties to risk management. Despite recurring discord over disputed territories around the Senkaku/Diaoyu islands and interpretations of Japan’s colonial history, Japan has prioritised trade and investment in its engagement with China over the past decades. However, China’s growing economic and military power, increasingly assertive foreign policy approach aimed at gaining an economic and strategic edge, and the challenges it poses to existing rules and norms have changed the mindset of Japanese leadership.

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Although we do not expect military conflict between the two countries in our forecast period (2023-27), friction between China and Japan over trade and other economic dealings will become more frequent. Recognising this, the Japanese government will focus on managing risk by reducing economic reliance on China, strengthening cooperation with Western allies, and avoiding military confrontations with China over disputed territories. The first test will come in July, as Japan plans to impose restrictions on 23 items used in the semiconductor manufacturing process as part of a coordinated move with the US and the Netherlands to restrict China’s access to advanced semiconductors. Exports of these 23 items to countries outside 42 designated friendly destinations will require individual permission, which in practice will severely curb China’s ability to acquire chipmaking tools and materials from Japan.

We expect China to respond with restrictions on certain segments of Japanese trade and investment in China, with automotive, electronics, and entertainment being most vulnerable. Direct flights between the countries could also be restricted when bilateral tensions flare up. There is an additional risk of self-organised consumer boycotts against Japanese goods and companies within China, influenced by public opinion that is increasingly unfriendly to Japan, although violent mass protests and vandalism are unlikely.