Japan’s Economy is finally seeing some light of hope as the economy is showing some impressive sign of post pandemic recovery. In this Article we discuss Japan’s economy and monetary policy followed by IMF and OECD’s economic outlook.

Economy and Monetary Policy

As of the second quarter 2023, Japan’s real GDP surpassed its pre-pandemic peak by increasing to 1.2% compared to the first quarter. The main contribution to the growth came from the external sector. Export growth was supported by a weakening yen and in return helped to reduce the import. However, the domestic demand still remain sluggish while there is a fear looming of high inflation.

On November 6, 2023, Japan’s Governor UEDA Kazuo, made Speech at a Meeting with Business Leaders in Nagoya, where he stated that “Japan’s economy has recovered moderately. It is likely to continue recovering, and in the latest Outlook Report, the Bank projects that the economy will grow at a relatively high rate of 2.0 percent for fiscal 2023 and then continue growing at a rate of around 1 percent for fiscal 2024 and 2025, which is somewhat above its potential growth rate”

There is a proactive approach in terms of prices and wage setting in Japanese firms. This shows that there is a growing potential of meeting the Central Bank’s 2% inflation target. In the latest Outlook Report, the Central Bank projects that the Consumer Price Index (CPI) Inflation for all items excluding fresh food will remain high at 2.8 percent for fiscal year of 2023 and 2024. Whereas for the Fiscal Year 2025 it will be at 1.7 percent.

Source: Speech at a Meeting with Business Leaders, Bank of Japan.

According to the Outlook for Economic Activity and Prices (October 2023), the consumer price Index (CPI, all items minus fresh food) is likely to be above 2 percent in the fiscal year 2024. This price increase will be due to increase in the past import prices (including of energy and grains) and also effect of the recent rise in crude oil prices.

The rate of increase in the CPI is projected for the fiscal year 2025 is to decelerate owing to dissipation of these effects. By the end of the projection period, the CPI inflation is likely to increase slowly towards price stability target. And also the output gap turns positive and as medium to long-term inflation expectations along with wage growth will increase.

On Monday (i.e. 6^th November 2023), the Central Bank – The Bank of Japan (BoJ), announced its monetary policy in that it stated “The Bank will continue to allow 10-year Japan’s Government Bond (JGB) yields to fluctuate in the range of around plus and minus 0.5 percentage points from the target level, while it will conduct yield curve control with greater flexibility, regarding the upper and lower bounds of the range as references, not as rigid limits, in its market operations….”

The BoJ has also decided to let long-term government yields exceed the previous 1.0% ceiling under yield curve control. It also stated in its monetary policy statement that there will be no upper or lower range or any rigid limits in its market operations. With rise in a 10-year yields reflects the fundamentals of economic conditions.

With the materialisation of pent-up demand Japan’s economy is expected to continue recover moderately – at least for time being. As the virtuous cycle of income and spending increases then Japan’s economy is forecasted to grow above its potential growth rate.

IMF and OECD Economic Outlook

IMF’s Outlook on Japan

According to IMF Japan’s economy recovery was driven by domestic demand along with a weaker global economy that drives external demand. Real GDP increased by 1.1 percent in 2022 – this is below the level of 2019 (on an Annual Basis). Japan’s Private investment recovered along with the recovery of its private consumption which led the economy recovery.

Japans Industrial production has strongly recovered in summer as its supply chain constraints and its lockdowns are removed. Headline Inflation has been above 2 percent (year on year) since April; mainly driven by external factors including lagged effects of higher commodity prices and yen depreciation.

Due to a sharp rise in the value of commodity imports the current account surplus has narrowed to 2.1 percent of GDP in 2022. With capital adequacy ratios above regulatory requirements the banking sector remains resilient. However, the interest and credit risks are increased.

IMF forecasts that the economic recover to continue in the near term with its pent-up demand, border reopening, policy supports and supply chain improvements. The Growth is expected to increase to 1.3 percent in 2023 – this will be mainly due to private consumption and fixed investment.

IMF projects that the output gap to close this year. As supply side constraints ease exports will increase along with inbound tourist’s arrivals. IMF also forecasts that inflation to rise further due to delayed effect of yen depreciation and border reopening before it declines again. With the adoption of the Fiscal package in October 2022, the primary fiscal deficit will stay elevated in 2023. Due to lower commodity prices and inbound tourism, the current account surplus is projected to bounce to an average of 2.9 percent of GDP in 2023. The major macroeconomic challenge is an aging and declining population.

IMF highlighted five down side risks to growth and they are i) deepening geo economic fragmentation and geopolitical tensions; ii) an abrupt slowdown of the global economy; iii) commodity price volatility; iv) natural disasters and v) cyber threats.

OECD Economic Outlook

OECD in its June Economic Outlook stated that GDP growth is estimated at 1.3% for the year 2023 and 1.1% for the year 2024 which is mainly driven by domestic demand. Government subsidies (particularly for green and digital investment) will boost investments despite higher uncertainty. OECD expects the labour market to remain tight with the unemployment rate to edge down to 2.4 in 2024.

It highlighted that downside risks as supply chain disruptions, weaker than expected external demand along with abrupt change in monetary and financial conditions. High level of public debt may lead to loss of confidence in Japan’s fiscal sustainability, which could destabilise the financial sector as well as the real economy with large spillovers to the world.

Conclusion – My Perspective

The Japanese economy is recovering, at least for time being, with pent-up demands and increase in fixed investment. The main concerns for Japan’s economic growth story will be increase in interest rates, inflation expectations as well as geo-political tensions.

Japanese economy recovery is also attributed to reopening of the economy (with reopening borders), supply chain improvements. However, the future growth prospects entirely depends on its policy framework (including both fiscal and monetary policy). The effectiveness of policy framework is entirely depends on the Central Bank’s stance, wage growth and domestic demand.