Japan may outperform next year, but structural challenges continue to limit its potential.
The Japanese have a reputation for being punctual, especially in their high-speed train network. Stalled by stagnation, however, the growth train never really left the station over the past three decades. Even during the pandemic, while western economies reaped benefits from economic reopening, Japan played catch up. However, things are starting to change with the Japanese economy looking better placed than most of its advanced peers entering 2023.
The Japanese economy is expected to outperform in our base case. A recovery in consumption, led by pent-up demand and savings, will underpin growth. While demand for goods and services has grown strongly, there is room for the latter to recover further; other developed markets have shown greater increases in spending as they exited lockdowns. The recently announced ¥29 trillion ($200 billion) stimulus package aimed at buffering higher commodity prices and the weaker yen will help to suppress the squeeze on real incomes and provide a boost to growth.
The outlook for exports, an important source of revenue for the economy, isn’t particularly bright. Recession in major western economies coupled with worsening terms of trade will weigh on demand for Japanese goods. Increasing friction with China will pressure Japanese supply chains. That said, the country’s important auto industry, accounting for one-fifth of goods exports, should mitigate the negative shocks from the global slowdown. After five consecutive years of contraction, auto production is expected to bounce back in 2023 as semiconductor shortages recede.
"Though positive when compared to likely recessions in the West, growth will remain uninspiring owing to Japan’s structural woes."
Just when the world is hoping to put inflation in the rear-view mirror, Japan is starting to see signs of more durable inflationary pressures. The eye-watering levels seen in other advanced nations are unlikely to spread to Japan, not an entirely bad outcome for an economy that has long struggled to defeat deflation. While inflation will remain well above the deflationary zone throughout 2023, it is unlikely to be sustained around the 2% target.
Firms are passing on higher costs to consumers, but wages are not moving in tandem, despite a shrinking labor force and persistent worker shortages. According to the Bank of Japan (BoJ), wage growth of around 3% or higher (a rate not seen in three decades) will be required to sustain inflation at the 2% central bank target. Japanese employees rarely switch jobs, and its large employers still provide long-term job security and set wages based on seniority rather than performance. Inflation expectations also continue to fall short of the central bank’s target.
"The Japanese economy is expected to outperform in our base case."
As a result, the BoJ remains the only major central bank with negative policy rates. With little sign of sustained underlying inflation or a wage-price spiral, we expect the BoJ to maintain current policy rates under the yield curve control framework next year, even under a new governor. The policy divergence with the Federal Reserve will keep the yen under pressure, prompting interventions by authorities in the near term.
Though positive when compared to likely recessions in the West, growth will remain uninspiring owing to Japan’s structural woes. Abenomics reforms, such as measures designed to increase women’s labor force participation, are yielding results, but these are modest offsets to the country’s demographic deficit. Japan may outperform in 2023, but its long-term underperformance will likely be sustained.
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