A Collective Sigh of Relief - Deloitte

More documents

Recommendations

Info

Global Economic Outlook 2nd Quarter 2012 JAPAN 30 Japan: New risk factors by Dr. Ira Kalish Worrying about trade and debt For some time, pundits have bemoaned the fact that Japan’s sovereign debt is roughly 200 percent of GDP, which is widely viewed as an unsustainable number that puts Japan at risk of a financial crisis. However, other observers remain unalarmed because Japan runs a current account surplus. In other words, Japan saves so much that the savings exceeds the funds needed to service government debt and fund domestic investment. There is still money left over to lend to or invest in the rest of the world. Thus, Japan’s massive government debt should not be viewed as a problem because of its formidable savings. Yet, that is only true as long as Japan runs a current account surplus. That assumption is now being brought into question. In January, Japan ran a trade deficit. The current account balance is the trade balance plus net interest payments. Those interest payments are so large that Japan still had a current account surplus in January. Yet, the fact that Japan ran a trade deficit raised eyebrows. If continued, it could ultimately lead to a current account deficit. If that were to happen, servicing the large sovereign debt could be problematic. If markets perceived that to be so, they could push up the yield on Japanese government bonds, further exacerbating the problem of bringing the debt to a sustainable level. Why did Japan run a trade deficit? The main reason is that, following the earthquake, most of Japan’s nuclear power plants were idled. Thus, Japan had to import massive quantities of oil and natural gas in order to generate electricity, so the import bill rose. At the same time, a high valued yen conspired with weak demand in Europe to cause exports to falter. Moreover, rising oil prices could worsen the situation. The good news is that there was a trade surplus in February. Still, the stage is not yet set for a sustained improvement in the trade balance. Aggressive monetary policy One of the problems for exporters has been the high valued yen. However, in recent months, the yen has declined somewhat, thereby boosting the competitiveness of exports. This shift was mainly due to a change in monetary policy. The Bank of Japan (BoJ) has implemented two rounds of asset purchases (often known as quantitative easing), the second of which was announced in February and involved 10 trillion yen ($130 billion). The effect of this was to boost liquidity, boost expectations of inflation, and put downward pressure on the yen. Indeed, the yen fell from roughly 77 yen per dollar to 83 yen per dollar. Now there is talk of another round of asset purchases. There are two reasons for this. First, inflation remains close to zero even though the BoJ set an explicit inflation target of 1.0 percent. While the program of asset purchases ended deflation and created a bit of inflation, it may not be sufficient. Second, there is concern that the yen could bounce back as long as the Japanese currency is seen as a safe asset in a world of risk. Further financial market stress in Europe or a stumbling of the U.S. economy could cause the yen to shoot up. Fiscal issues Meanwhile, the Japanese government is determined to put Japan on a sustainable fiscal path. Japan faces several problems. First, the debt is already very large and higher bond yields would make the situation worse. Second, Japan’s economy has grown very slowly, thereby generating modest revenue gains. Third, deflation meant that incomes were declining or stagnant at best, thus suppressing government revenue. Finally, the aging population means that future spending on pensions and health is likely to increase substantially. Many observers worry that, without a plan to create fiscal probity, Japan could face a serious crisis in the not-too-distant future.
The solution, according to Prime Minister Noda, rests in raising the sales tax from the current 5 percent to 10 percent by 2015. This plan has become hugely unpopular, and it is not clear that it will pass the Parliament. If it doesn’t pass, confidence could be undermined, leading to higher bond yields. If it does pass, however, the effect on growth could be negative. Thus, Japan is caught between a rock and a hard place. Moreover, failure to pass Noda’s legislation would be indicative of a larger problem of political gridlock. This means that passage of other reformoriented legislation would be less likely. Growth outlook Given the fiscal, trade, and energy situations, one could be forgiven for expecting poor economic performance. However, the reality is likely to be somewhat different — at least in the short run. There are a number of factors that should boost growth in the coming year. That would be welcome, given that Japan’s economy shrank by 0.9 percent in 2011. Moreover, GDP declined in the fourth quarter at an annual rate of 2.3 percent. That was largely due to a decline in inventories and a drop in exports. The latter was due to the temporary effect on Japanese supply chains emanating from the floods in Thailand. The Japan good news is that the factors hurting growth in the fourth quarter were temporary. In 2012, growth should resume for several reasons. First, Japan’s government is expected to continue to spend massively on reconstruction, thereby boosting domestic demand. Second, the Thai floods are over, and supply chains have resumed. Third, the aggressive monetary policy has suppressed the yen, which should help export competitiveness. Fourth, the aggressive monetary policy has also boosted expectations of inflation, which have the effect of cutting real interest rates. This should help boost credit demand. Fifth, higher inflation could stimulate consumers to spend more. Sixth, following the depletion of inventories in the fourth quarter, businesses are likely to engage in inventory rebuilding in early 2012. Finally, the rest of the world is not doing as badly as previously expected. This should help to stabilize exports. Thus, a reasonable expectation for 2012 is that the Japanese economy will grow between 1.0 and 2.0 percent, inflation will be positive, and the yen will not resume its appreciation. Geographies 31
Page 1 and 2: A Deloitte Research publication | 2
Page 3 and 4: iorating situation. Siddharth concl
Page 5 and 6: 32 34 36 40 32 Brazil: Worried abou
Page 7 and 8: Figure 1. Use of ECB's deposit faci
Page 9 and 10: Figure 2. Economic Sentiment Indica
Page 11 and 12: competitiveness is based on product
Page 13 and 14: USA Geographies 13
Page 15 and 16: Figure 3. Average price of regular
Page 17 and 18: Figure 5. Equally weighted coincide
Page 19 and 20: Energy prices and consumer behavior
Page 21 and 22: Longer term Recovery overseas will
Page 23 and 24: UK Geographies 23
Page 25 and 26: hardly been eliminated. From the hi
Page 27 and 28: India Geographies 27
Page 29: At a time when the government can i
Page 33 and 34: grew, but at a slower rate than in
Page 35 and 36: that if the price of oil were to de
Page 37 and 38: A step in the right direction Indon
Page 39 and 40: Persistent challenges Pervasive cor
Page 41 and 42: India’s recent economic interest
Page 43 and 44: Trade patterns of the future: Wakin
Page 45 and 46: Yield curves (as on April 6, 2012)*
Page 47 and 48: Contact information Global Economic

A Collective Sigh of Relief - Deloitte

Create successful ePaper yourself

Delete template?

Save as template?