Saturday, August 10, 2013

What is causing the summer economic slump in Japan?

As discussed previously (see post), Japan's recent economic momentum has weakened. With the economy rebounding strongly earlier in the year, many had hoped growth will accelerate. But the industrial production pullback in June did not turn out to be simply an aberration and other reports started signaling a slowdown in economic activity. As the service PMI data shows (below), the slowdown is not dramatic but is certainly noticeable.

Japan service sector PMI (source: Markit)

There is only so much that the massive monetary stimulus was able to accomplish before sentiment turned sour again.
Reuters: - Japan's service sector sentiment index fell to 52.3 in July, a government survey showed, down for the fourth straight month, a sign that feel-good effects on consumers from government's reflationary policies are moderating.

The Cabinet Office survey of workers such as taxi drivers, hotel workers and restaurant staff -- called "economy watchers" [chart below] for their proximity to consumer and retail trends -- showed their confidence about current economic conditions was down from 53.0 in June.

Source: Bloomberg

And yesterday we saw this loss of momentum reflected in the Japanese consumer confidence inducators.

Source: Cabinet Office

What's causing this sudden summer slump? Here are a few thoughts.

1. The Japanese remain uneasy with the growing government debt problem (see story of quadrillion yen), which is not helping with corporate and consumer sentiment. Elaine Kurtenbach of the he Associated Press put it quite well:
CTV: - A central concern is a potential loss of confidence in Japan's ability to service its debt, given that repaying just the interest on government bonds is consuming a growing share of limited tax revenues. Japan's parlous fiscal situation is compounded by surging health and welfare costs from the fast-expanding share of elderly in the population. Rising inflation would inevitably push interest rates on government bonds higher, adding to the burden.
2. The looming sales tax hike (which is meant to address the above) remains a major risk to spending and growth, as the debate about its impact continues (see story).
GS: - The decision to raise the consumption tax was agreed among three parties, and it is almost an international commitment from Japan. If the Abe administration decides to change its tax hike plans, it runs the risk of losing its credibility. We see that the Abe administration will opt to raise the consumption tax rate as planned. However, we still recommend caution as we see some market confusion ahead of the final decision in late September to early October.
3. While economists tend to think that inflation is quite healthy for Japan after years of deflationary pressures, it may be difficult for the consumer to adapt to the new regime. Wages have been declining for some time (see discussion), which is less of a problem when prices are falling.  It becomes a problem when prices rise and are combined with the new sales tax.

Source: ISI Group

This change could be particularly difficult without any substantial labor reforms that would allow wages to keep up with rising prices (maintain real wage stability). BOJ's target of 2% inflation could prove to be a painful adjustment for the Japanese consumer. This adjustment may already be making its way through the economy, reflected by weaker economic indicators.
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