Japan has been stuck in an economic malaise for more than a decade. Recently, the policies of Prime Minister Shinzo Abe—Abenomics—have provided a cyclical boost to the economy, but many challenges lie ahead that could increase volatility in global markets.
Japan’s economy gained traction throughout 2013, fueled by monetary and fiscal stimulus. One of the goals of these policies is to end the deflation that the Japanese have had for many years. It’s been somewhat successful; we’ve seen prices go up. So far, though, inflation has been driven more by the weakening currency and by rising energy prices.
Issue: declining real wages
The wages of Japanese workers have remained flat on a nominal basis. But when you factor in the rise in inflation, wages have actually gotten worse on a real, or inflation-adjusted, basis. This has not put the Japanese consumer on particularly strong footing. What we’re worried about in the near term is the April consumption tax hike that’s going to hit. It’s a clear risk to the outlook, and we think it’s going to test the sustainability of Japan’s cyclical upturn. It risks sending a demand shock that could resonate throughout the rest of Asia.
Issue: record high government debt
At the same time, Japan’s government debt levels continue to rise to record highs, and they are now the highest in the world, at around 230% of GDP. This is increasingly burdensome for the government budget.
The gross financing needs of the government budget deficit, as well as existing debt, are now about 58% of GDP in 2014. That's more than twice as much as most other advanced economies that have high debt levels. So, Japan really faces the need for substantial fiscal reforms ahead.
Issue: no savings cushion
For the past few decades, Japan has enjoyed a vast pool of domestic savings that has allowed it to finance rising debt levels. Now, however, that internal savings cushion has disappeared: Japan’s households have a negative savings rate.
Japan is no longer a net saver on an external basis, either. For the first time in more than three decades, Japan does not have a current account surplus, and the upshot of this is that the trade deficit they have today is the largest one in recent memory. So, Japan’s savings cushion has dwindled and is going to make financing these high debt levels increasingly problematic.
Issue: currency volatility
Our outlook, then, is that policymakers are going to respond to these challenges by providing even greater monetary easing. Monetary authorities in Japan have already employed quantitative easing. They've been buying government bonds and other securities. That has helped stabilize interest rates at low levels, despite the fact that interest rates in the United States have gone up over the past year, and the interest rates of Japan and the U.S. tend to track each other.
However, monetary easing could really put more downward pressure on the yen, and that has the potential to provoke greater volatility in global currency markets.
In conclusion, Japan has the potential to be a source of near-term and medium-term volatility for both the global economy and global capital markets.
- Stay up to date on news and markets in Japan.
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