Vaccines to hasten recovery despite third virus wave - Capital Economics
Japan Economics

Vaccines to hasten recovery despite third virus wave

Japan Economic Outlook
Written by Marcel Thieliant

Japan is battling a third virus wave and is a laggard in the global vaccine rollout race. Even so, we expect economic activity to return to pre-virus levels in the second half of this year as vaccines become widely available. Our forecast that GDP growth will average 3.7% this year and 2.3% next year is well above the analyst consensus.

  • Overview – Japan is battling a third virus wave and is a laggard in the global vaccine rollout race. Even so, we expect economic activity to return to pre-virus levels in the second half of this year as vaccines become widely available. Our forecast that GDP growth will average 3.7% this year and 2.3% next year is well above the analyst consensus.
  • Domestic Demand – The third virus wave will result in a renewed fall in consumer spending in Q1. However, consumption should rebound from Q2 as vaccines become available and we expect it to rise by 2.5% this year. Business investment has lagged the recovery in consumption and we think it will rise by a smaller 1%.
  • External Demand –Exports of services should start to rebound from the middle of the year as travel resumes. But with goods exports now around pre-virus levels, the recovery in overall exports is set to slow. By contrast, imports should continue to recover as domestic demand rebounds.
  • Labour Market – Even by Japanese standards, the labour market has been surprisingly resilient during the coronavirus crisis. With the labour force now back at pre-virus levels and employment rebounding, we think that the unemployment rate has already peaked. We expect it to fall from 2.9% now to 2.7% by the end of this year and to 2.4% by end-2022.
  • Prices – Inflation has held up reasonably well during the coronavirus crisis. With energy prices recovering, it’s likely to be positive across most of this year. We expect both headline and core inflation to stabilise at around +0.3% next year.
  • Monetary & Fiscal Policy – Fiscal policy will remain loose this year, though premature tightening poses some downside risks next year. Meanwhile, we don’t expect the Bank of Japan’s policy review in March to result in major changes.
  • Long-term Outlook – We are optimistic that the pandemic will not prevent productivity growth from accelerating over coming decades. But due to the shrinking population, trend GDP growth will remain broadly unchanged at around 1%. Meanwhile, we expect inflation to remain very subdued.

Key Forecasts Table

Key Japan Forecasts

% y/y

2020

2021

2022

Annual

(unless otherwise stated)

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

2020

2021

2022

 

Demand

 

 

 

 

GDP (% q/q)

-0.5

-8.3

5.3

2.3

0.2

1.3

0.6

0.6

0.8

0.3

0.3

0.4

GDP (% y/y)

-2.1

-10.3

-5.7

-1.8

-1.0

9.3

4.4

2.7

3.2

2.3

2.0

1.7

-5.0

3.7

2.3

Consumption

-2.8

-11.3

-7.2

-3.1

-3.9

7.4

3.7

3.5

6.1

4.3

3.4

3.1

-6.1

2.5

4.2

Private Fixed Investment

-2.5

-7.3

-10.9

-6.1

-5.1

0.5

4.6

4.6

4.1

4.0

3.7

3.4

-6.7

1.1

3.8

– Non-Residential

-2.1

-7.9

-11.0

-5.7

-5.4

1.3

4.8

4.8

4.1

4.1

4.0

3.8

-6.7

1.2

4.0

– Residential

-4.0

-5.0

-10.5

-7.9

-3.4

-2.9

4.1

4.1

4.1

3.5

2.7

1.9

-6.8

0.4

3.1

Government Expenditure

1.7

1.9

3.4

3.7

5.7

6.0

3.8

2.9

0.8

-0.9

-1.9

-2.4

2.7

4.6

-1.1

Domestic Demand

-1.8

-7.2

-5.3

-1.8

-1.7

5.4

3.9

3.5

4.2

2.7

2.0

1.6

-4.0

2.7

2.6

Exports

-5.7

-21.8

-15.9

-8.3

-1.8

20.1

13.7

6.1

6.5

6.3

5.7

4.5

-12.9

8.9

5.7

Imports

-3.6

-4.0

-13.3

-8.7

-5.7

-3.2

10.3

10.9

12.0

8.7

5.6

3.9

-7.4

2.8

7.4

Labour Market

Employment

0.5

-1.1

-1.1

-1.0

-0.4

1.5

1.3

0.8

0.7

0.6

0.6

0.6

-0.7

0.8

0.6

Unemployment Rate (%)

2.4

2.8

3.0

3.0

2.9

2.8

2.8

2.7

2.6

2.5

2.4

2.4

2.8

2.8

2.5

Labour Cash Earnings

0.6

-1.7

-1.2

-3.2

-0.5

-0.2

0.7

1.2

0.4

0.9

0.8

1.3

-1.6

0.4

0.8

Consumer Prices

Total

0.5

0.1

0.2

-0.9

-0.6

-0.4

0.1

0.4

0.3

0.3

0.2

0.1

0.0

-0.1

0.2

Total (Excl. tax)

0.2

-0.3

-0.1

-0.9

-0.6

-0.4

0.1

0.4

0.3

0.3

0.2

0.1

-0.3

-0.1

0.2

Excl. Fresh Food & Energy

0.7

0.3

0.1

-0.3

-0.1

-0.3

0.2

0.2

0.3

0.2

0.2

0.2

0.2

0.0

0.3

Excl. Fresh Food, Energy & Tax

0.5

0.1

-0.2

-0.3

-0.1

-0.3

0.2

0.2

0.3

0.2

0.2

0.2

0.0

0.0

0.3

Markets (end period)

BoJ Policy Rate (%)

-0.10

-0.10

-0.10

-0.10

-0.10

-0.10

-0.10

-0.10

-0.10

-0.10

-0.10

-0.10

-0.10

-0.10

-0.10

Monetary Base (Yen Trillion)

518

540

585

611

627

643

659

675

688

700

713

725

611

675

725

10 Year JGB Yield (%)

-0.07

0.00

0.03

0.03

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.00

0.03

0.00

0.00

Yen/Dollar

109

108

106

104

103

102

101

100

99

98

96

95

104

100

95

 

Other

Current Account (% of GDP)

3.6

1.5

3.0

3.6

2.9

1.6

1.2

1.0

1.2

0.7

0.4

0.0

2.9

1.7

0.6

Budget Balance (% of GDP)

-12.4

-9.0

-8.0

Government Debt (% of GDP)

258

260

264

Sources: Refinitiv, Capital Economics


Overview

Third wave to slow recovery for now, but vaccines to fasten it again

  • Japan is battling a third virus wave and is a laggard in the global rollout of vaccines. Even so, we expect economic activity to return to pre-virus levels in the second half of this year as vaccines become widely available. Our forecast that GDP growth will average 3.7% this year and 2.3% next year is well above the analyst consensus.
  • Japan’s third virus wave has continued to intensify, with the number of new infections, deaths and severe cases reaching fresh record highs. (See Chart 1.) The government has now declared a state of emergency in the Greater Tokyo area and will probably declare one in the Kansai region this week. (See Chart 2.) Those prefectures account of nearly half of GDP and the state of emergency may be extended nationwide before long as other regions aren’t faring much better. (See Chart 3.)
  • However, the restrictions are mild: restaurants, department stores and entertainment venues only have to shorten operating hours a bit. Schools remain open. Restrictions in virus hotspots will probably be tightened further.
  • We’ve pencilled in a 1.5% q/q drop in consumer spending in Q1. This would be much smaller than the 8.3% q/q slump in Q2 2020 but the measures announced so far are less draconian than those in the first state of emergency and the starting point for consumption is already depressed.
  • In fact, we still expect rising investment and exports to result in a further increase in GDP this quarter. Indeed, surveys suggest that business investment should rebound soon. (See Chart 4.)
  • Looking further ahead, Japan is lagging other countries in terms of the rollout of a vaccine. As things stand, vaccinations will only start by the end of February. What’s more, the share of Japanese willing to get vaccinated is low by global standards. (See Chart 5.)
  • Even so, we suspect that most medical workers and the elderly will have been inoculated by the middle of the year. With PM Suga keen on reopening the economy, we expect the bulk of restrictions on activity as well as voluntary social distancing to come to an end. Our forecast that GDP will return to pre-virus levels by Q3 2020 would mean that Japan doesn’t recover as rapidly as the US but outpaces the euro-zone. (See Chart 6.)
  • The labour market has proved more resilient than we had anticipated. The restrictions imposed to rein in the latest virus wave could result in a small decline in employment. But with the labour force participation rate now close to pre-virus levels, we expect the unemployment rate to settle at 3% rather than our previous forecast of 3.5%. (See Chart 7.)
  • The decline in consumer prices has remained moderate in light of the huge slump in activity. With the labour market set to start tightening again soon and energy prices picking up, inflation should turn positive again. (See Chart 8.) But in contrast to the US, where we expect inflation to rise well above pre-virus levels, price gains will remain muted. That underpins our view that the yen will strengthen from 104 against the dollar now to 95 by end-2022.
  • The Bank of Japan has pledged another review of its monetary policy settings at its March meeting, but the Bank has ruled out changes to its negative interest rate policy. We suspect policymakers will only tinker at the margins.

Overview Charts

Chart 1: New Coronavirus Infections & Severe Cases

Chart 2: New Coronavirus Cases Per Million People
(7-day Ave.)

Chart 3: Hospital Beds Occupied by Covid-19 Patients (% of total)

Chart 4: Business Investment (% y/y)

Chart 5: Share of people willing to get vaccinated against Covid-19 (%)

Chart 6: Real GDP (Q4 2019 = 100)

Chart 7: Unemployment Rate (%)

Chart 8: Consumer Prices (Excl. tax, % y/y)

Sources: Refinitiv, CEIC, MHLW, Ipsos, Capital Economics


Domestic Demand

Renewed drop in consumption to reverse as vaccines are rolled out

  • The third virus wave will result in a renewed fall in consumer spending in Q1. However, consumption should rebound from Q2 as vaccines become available and we expect it to rise by 2.5% in total this year. Business investment has lagged the recovery in consumption: we think it will rise by 1%.
  • Consumer spending rebounded by 5.1% q/q in Q3, but the recovery has been highly uneven. While spending on goods was just 1% below pre-virus levels, spending on services was still down more than 8%. (See Chart 9.)
  • At first glance, the drop in retail sales in November seems to reflect increased caution due to the third virus wave. But the fact that the number of domestic hotel guests kept rising suggests otherwise. (See Chart 10.) And the services PMI was steady in December.
  • However, mobility started to drop in earnest at the start of the new year not only in the Greater Tokyo Area but in Osaka and Aichi, too. (See Chart 11.) And the suspension of the Go to Travel campaign should weigh on leisure spending.
  • The modest restrictions imposed so far are unlikely to rein in the surge in new infections and will probably have to be tightened. Even so, we suspect that the drag on consumption won’t be as large as during the first state of emergency.
  • The experience from other countries that have imposed second lockdowns is that consumers are less likely to cut spending. And given that services consumption is still subdued, we estimate that even in a worst-case scenario where spending fell all the way to Q2 levels it would decline by 6% instead of the 8.3% plunge in Q2.
  • With vaccines set to be rolled out from late-February, we expect most restrictions on economic activity to be phased out by the middle of the year. And with voluntary social distancing no longer required, we expect consumer spending to return to pre-virus levels by Q3 2020.
  • One upside risk is that households spend the savings they accumulated during the lockdown. While disposable income fell in Q3 as households no longer received the ¥100,000 transfer payments paid to every resident, the household savings rate remained high. (See Chart 12.) And the 5% y/y rise in households’ holdings of currency and deposits in Q3 marks the strongest increase since the mid-1990. But with consumer confidence still subdued, we suspect that the windfall will be saved rather than spent. (See Chart 13.)
  • Non-residential investment fell at a slower pace in Q3 and we think now think that it will rebound in Q4. Admittedly, the weakness in non-residential building orders suggests that the resilience in private non-dwellings investment may not last. (See Chart 14.) But the surge in machinery orders and capital goods shipments suggests that spending on machinery and transport equipment is already on the mend. (See Chart 15.)
  • Housing completions have slumped even though housing starts have held up. (See Chart 16.) We’ve pencilled in a 1% rise in residential investment this year.

Domestic Demand Charts

Chart 9: Real Consumer Spending (Q4 2019 = 100)

Chart 10: Domestic Hotel Guests & Retail Sales

Chart 11: Apple Maps Routing Request (13th Jan. = 100)

Chart 12: Household Disposable Income & Spending (Yen tn, Annualised)

Chart 13: Consumer Confidence

Chart 14: Non-Dwelling Construction Orders & Non-Dwelling Construction Investment (Yen tn)

Chart 15: Investment

Chart 16: New Housing Starts & Completions

Sources: Refinitiv, Apple, Capital Economics


External Demand

Recovery in exports has largely run its course

  • Exports of services should start to rebound from the middle of the year as travel resumes. But with goods exports now around pre-virus levels, the recovery in overall exports is set to slow. By contrast, imports should continue to recover as domestic demand rebounds.
  • Estimates by the Bank of Japan show that goods exports have continued to rise rapidly in recent months. While Japan’s exports continue to lag China’s, they have caught up with Korea’s. (See Chart 17.) The recovery has been led by IT-related and intermediate goods, but the mainstays of Japanese manufacturing – cars and machinery – are now back at pre-virus levels, too. (See Chart 18.)
  • However, our own estimates suggest that export volumes have yet to return to pre-virus levels. And business surveys paint a mixed picture. The export climate index, a weighted average of the PMIs of Japan’s trading partners, suggests that the recovery in export volumes has a bit further to run. (See Chart 19.) By contrast, the drop in “new export orders” in December’s manufacturing PMI suggests that the recovery will soon run out of steam. (See Chart 20.)
  • Our view is that the global rollout of a vaccine will not bode particularly well for goods exports. After all, restrictions imposed to prevent the spread of the virus have resulted in a shift of consumer spending from services to goods. As those restrictions are eased, spending should shift back to services.
  • Indeed, it’s striking that Japan’s exports to the EU and Asia excluding China have fallen only marginally over the past year while those to the US have risen. After all, we estimate that GDP in those destinations was still well below pre-virus levels in Q4. By contrast, Japan’s exports to China haven’t risen much faster than China’s GDP over the past year. (See Chart 21.) The upshot is that the recovery in goods exports will slow sharply this year even as global GDP bounces back.
  • Exports of services fell further in Q3 and were a whopping 30% below pre-virus levels. While they now have started to rebound, the recovery will gather pace once vaccines are available in Japan and elsewhere and global travel resumes. We believe they could return to pre-virus levels by the end of our forecast horizon. (See Chart 22.)
  • The recovery in import volumes has been muted and the restrictions imposed to battle the third virus wave suggest this will remain the case for now. But with retail sales and industrial production close to pre-virus levels, the recovery in energy, intermediate products and consumption goods imports has further to run. And while business investment has lagged the recovery in consumption, capital goods imports should gradually rebound too. (See Chart 23.) We’ve pencilled in a 2.8% rise in import volumes this year.
  • The surge in exports should have lifted the current account surplus to a three-year high at the end of last year. However, we expect the surplus to fall towards 0% of GDP by end-2022. (See Chart 24.) The rebound in import volumes and higher crude oil prices will push the trade balance into deficit. And the stronger yen will diminish the surplus in the primary income balance.

External Demand Charts

Chart 17: Goods Export Volumes
(Calendar Year 2019 = 100)

Chart 18: Export Volumes by Product
(Calendar Year 2019 = 100)

Chart 19: PMI Export Climate Index & Export Volumes

Chart 20: PMI New Export Orders
& Export Volumes

Chart 21: Japan’s Export Volumes by Destination & GDP
(%-Change Between Q4 2019 and Q4 2020)

Chart 22: Export Volumes (Calendar Year 2019 = 100)

Chart 23: Import Volumes (Calendar Year 2019 = 100, 3M Ave.)

Chart 24: Current Account Balance (4Q Sum, % of GDP)

Sources: Refinitiv, Markit, CEIC, Capital Economics


Labour Market

Extra-tight labour market to return

  • Even by Japanese standards, the labour market has been surprisingly resilient during the coronavirus crisis. With the labour force now back at pre-virus levels and employment rebounding, we think that the unemployment rate has already peaked. We expect it to fall from 2.9% now to 2.7% by the end of this year and to 2.4% by end-2022.
  • The rapid recovery in the participation rate is evidence that nearly all those that left the labour force during the lockdown have either found new jobs or are actively looking for work again. (Chart 25.) Given that the labour force is already at pre-virus levels, we don’t expect it to rise much further this year.
  • Employment has only recovered half of the plunge suffered during the April-May nationwide state of emergency, so still has lost ground to make up. (See Chart 26.) We think it will rise 0.8% this year after a 0.7% fall in 2020. Indeed, our composite measure of employment conditions suggests that employment growth will continue to recover rapidly over the coming months. (See Chart 27.)
  • It’s possible that the second state of emergency will result in a small decline in employment this quarter. However, the government’s employment adjustment subsidy scheme should allow hard-hit firms to temporarily furlough rather than lay off their workers. Most firms that furloughed workers in the spring had to wait at least three months to be reimbursed by the government for paying those workers a leave allowance. (See Chart 28.) But receiving the support is more straightforward for repeat applications, so most firms would likely receive the subsidies faster this time.
  • Either way, employment should rebound further over the coming quarters as vaccines become available and restrictions on activity are eased. All told, we expect employment growth to consistently outpace labour force growth, which will gradually push down the unemployment rate.
  • The jobless rate only rose from 2.4% in February to a peak of 3.1% in October, far smaller than the 1.7%-point rise during the Global Financial Crisis. Both the job-to-applicant ratio and Q4 Tankan are consistent with the jobless rate rising further. But more important than their level is that they have both begun to signal a tightening of labour market conditions. (See Chart 29.)
  • Slumping overtime pay and bonus payments have resulted in a sharp fall in overall wages. (See Chart 30.) But regular earnings have held up. A tightening labour market should lift regular wage growth to 0.5% by 2022.
  • The recovery in overtime pay may stall for now as the services sector faces near term headwinds from tightening coronavirus restrictions. Overtime hours in the hard-hit accommodations and food & drink sectors were still roughly a quarter down on pre-virus levels in November. But they should resume their recovery later in the year once vaccinations allow those sectors to follow the manufacturing sector back towards full health. (See Chart 31.)
  • And while overall wage growth probably weakened much further in December due to a sharp fall in end-of-year bonuses, growth in both bonuses and contracted wages should now be recovering strongly. (See Chart 32.) We expect overall wage growth to turn positive later this year.

Labour Market Charts

Chart 25: Participation Rate
(%)

Chart 26: Labour Force & Employment
(Quarterly, Millions)

Chart 27: Composite Employment Survey
& Employment

Chart 28: Furloughed Workers & Employment Adjustment Subsidies Paid Out (Monthly)

Chart 29: Labour Market Tightness
& Unemployment Rate

Chart 30: Labour Cash Earnings (% y/y)

Chart 31: Overtime Hours per Employee (% y/y)

Chart 32: Labour Cash Earnings (% y/y)

Sources: Refinitiv, MHLW, Markit, Capital Economics


Prices

Weak but positive inflation on horizon

  • Inflation has held up well reasonably well during the coronavirus crisis. With energy prices recovering, it’s likely to be positive across most of this year. We expect both headline and core inflation to stabilise at around +0.3% next year.
  • Headline inflation has weakened significantly in recent months, largely due to a slump in energy prices. (See Chart 33.) To be sure, underlying inflation has also turned negative. But once we strip out temporary distortions from the recent domestic travel subsidies underlying inflation has remained positive.
  • The artificial drag from the Go To Travel campaign should temporarily be lifted. Go To has been halted nationwide for the two weeks ending 11th January though we expect that to be extended to at least end-February given the surge in infections. Those government subsidies – which cover 35% of domestic travel expenses – have been knocking 0.4%pts off headline inflation since they were launched in late-July.
  • We expect petroleum prices to recover to $60 per barrel by the end of this year before falling to $55 by end-2022. As such, headline inflation should turn positive before long. The recovery in crude oil prices has already started to boost petroleum inflation. (See Chart 34.) It will soon start to boost electricity and gas inflation, too.
  • Part of the reason underlying inflation hasn’t plunged as it did in 2009 is that the yen hasn’t strengthened much. As such, import prices of consumer goods aren’t falling any more sharply than they were before the pandemic. And while we expect the yen to strengthen to 95 against the US dollar by end-2022 from 103 now, that won’t be enough to put much downward pressure on goods inflation. (See Chart 35.)
  • Admittedly, the earlier plunge in the Bank of Japan’s measure of the output gap suggests that “core” inflation could yet weaken further. (See Chart 36.) But the key point is that – partly due to social distancing guidelines depressing supply – firms aren’t slashing prices in response to the slump in demand.
  • Both manufacturing and non-manufacturing firms had reported only a modest rise in spare capacity given the huge slump in GDP and have begun to report that capacity is diminishing again. (Chart 37.) And with the unemployment rate set to soon start falling back towards the cyclical low of 2.2% reached in late-2019, we expect firms to start reporting capacity shortages again later this year. That will put upwards pressure on input and output prices. Indeed, our composite measure of output prices dipped in December but is still consistent with underlying inflation recovering to zero over the coming months. (See Chart 38.)
  • Over the medium term, there are upside risks to inflation due to the continued surge in the money supply. But those risks are smaller than in other advanced economies. An expansion in the money supply has the greatest potential to stoke inflation when it ends up in the hands of households. Households’ money holdings were only up 5% y/y in Q3. Corporate holdings have surged, but firms are more likely to favour topping up their cash reserves or distributing dividends over wage hikes so they’re unlikely to drive higher inflation. (See Chart 39.)
  • Indeed, while 5-year inflation expectations recovered a little in the latest Tankan, they remained weak by past standards. (See Chart 40.) We expect inflation to remain well below the BoJ’s 2% target, though concerns over financial stability will prevent the Bank from responding with additional rate cuts.

Prices Charts

Chart 33: Nationwide CPI
(Exc. Tax & Free Childcare, % y/y)

Chart 34: Oil Prices
& CPI Petroleum

Chart 35: Yen/Dollar & Import Prices
of Consumer Goods (% y/y)

Chart 36: Output Gap & Core Inflation
(Exc. Tax & Free Childcare, % y/y)

Chart 37: Tankan
Production Capacity

Chart 38: Composite Output Prices
& Underlying Inflation

Chart 39: Money Holdings (% y/y)

Chart 40: Tankan 5-Year Inflation Expectations

Sources: Refinitiv, Statistics Bureau, BoJ, CE


Monetary & Fiscal Policy

Fiscal policy to remain loose, BoJ to stay the course

  • Fiscal policy will remain loose this year, though premature tightening poses some downside risks next year. Meanwhile, we don’t expect the Bank of Japan’s policy review in March to result in major changes.
  • Tax revenues slumped during the state of emergency as firms made use of tax deferrals. Revenue has been very close to last year’s levels in recent months even though economic activity was still much weaker, which suggests that firms have started to pay back deferred taxes. (See Chart 41.) The government expects tax revenue to rebound from ¥55tn in the fiscal year that ends in March to ¥57.5 in fiscal year 2021, but our more optimistic forecasts for GDP growth suggest the tax intake could be higher. (See Chart 42.)
  • The government passed another ¥21.8tn supplementary budget in early December, which means that budgeted central government spending will hit nearly ¥170tn in the current fiscal year. Even allowing for the modest rise in regular budget spending in FY2021, that suggests that fiscal policy will be tightened sharply this year. (See Chart 43.)
  • In reality though, fiscal policy is set to remain loose. For a start, the latest supplementary budget will only be approved by the Diet this month and most of that spending will take place over the coming months even if it is accounted in the FY2020 budget. What’s more, we suspect that the government will pass at least one large supplementary budget for FY2021, although perhaps only in December.
  • Some tightening in fiscal policy has already happened. Indeed, the budget deficit narrowed sharply in Q3 as the ¥100,000 cash handouts were no longer paid. (See Chart 44.) As such, we’ve revised down our estimate of the budget deficit in 2020 from 13% of GDP to 12%. We expect the shortfall to narrow to 9% this year. (See Chart 45.)
  • The surge in the budget deficit coupled with shrinking output may have lifted the ratio of government debt to GDP from 235% of GDP to 262% of GDP last year. But with output rebounding strongly we expect the ratio to remain broadly stable even as the budget deficit remains high. (See Chart 46.)
  • The Bank of Japan’s assets have risen at a record pace in recent months. The widening gap with the monetary base reflects soaring government deposits. (See Chart 47.) The Bank will probably slow the expansion in its balance sheet as economic activity continues to recover.
  • The Bank pledged in December that it will conduct another review of its monetary policy settings in March. It explicitly ruled out changes to its negative interest rate policy. Instead, the assessment will focus on “yield curve control management” and the Bank’s asset purchases.
  • One concern is that the share of ETFs owned by the Bank surged to nearly 80% in March, though it has fallen again as the Bank has cut its purchases sharply. (See Chart 48.) The Bank bought the least ETFs in five years at the start of this year and the strong rebound in risk appetite suggests those purchases could be abandoned altogether. By contrast, we see little scope for the Bank to lift super-long yields as demanded by Board member Suzuki. After all, the Bank’s purchases of super-long government bonds are already very low.

Monetary & Fiscal Policy Charts

Chart 41: Central Government Tax Revenue (Yen tn)

Chart 42: Nominal GDP & Tax Revenue (Yen tn)

Chart 43: Central Government Spending
(Fiscal Years, Yen tn)

Chart 44: General Government Budget Balance
(% of GDP)

Chart 45: General Government Budget Balance
(As % of GDP)

Chart 46: Gross General Government Debt
(As a % of GDP)

Chart 47: Monetary Base & BoJ’s JGB Holdings
(Annual Change, ¥tn)

Chart 48: Share of ETFs Owned by Bank of Japan
(% of total outstanding)

Sources: CEIC, Refinitiv, MoF, Tokyo Stock Exchange, Capital Economics


Long-term Outlook

Stronger productivity growth to offset shrinking population

  • We are optimistic that the pandemic will not prevent productivity growth from accelerating over coming decades. But due to the shrinking population, trend GDP growth will remain broadly unchanged at around 1%. Meanwhile, we expect inflation to remain very subdued.
  • The pandemic will have brought net migration to a near-standstill this year and we only expect it to return to pre-virus levels by 2024. After that, the population will shrink at an accelerating pace. (See Chart 49.)
  • The drop in the labour force participation rate during last year’s state of emergency has already completely unwound and we expect it to rise a little further over the coming years. But it won’t be long before the ageing of the population will start to become a drag. (See Chart 50.)
  • Before the pandemic, we were optimistic about the long-term outlook for productivity growth as the potential from existing ICT technology hasn’t been fully exploited yet. We also think that there will be a second wave of advances linked to technology and robotics.
  • We think that the pandemic will trigger a permanent shift towards working from home. This could boost the labour force participation rate of the elderly and women as Japanese workers have the longest commutes among G7 countries. (See Chart 51.) And it could spur productivity gains further as it forces firms to adopt more ICT technology. It could also deal a death blow to the outdated hanko system which requires documents to be manually stamped.
  • Japan has fallen behind Korea, Singapore and Germany in terms of the use of industrial robots. The pandemic could give adoption another boost as robots don’t catch coronaviruses.
  • One downside risk is that the recent surge in loan guarantees could keep unproductive zombie firms artificially live. However, the stock of credit-guaranteed loans isn’t any larger than it was after the GFC. (See Chart 52.) And given that the share of zombie firms in Japan is much lower than in many other rich economies, this probably isn’t a main reason why productivity growth has been weak in recent years.
  • All told, we stick to our forecast that productivity growth will accelerate towards 2% by 2050. However, that tailwind will be offset by the shrinking of the workforce and GDP growth should settle around 1%.
  • Inflation didn’t rise much as capacity shortages started to build before the pandemic and didn’t weaken much in the wake of the downturn. The expansion in the BoJ’s balance sheet has dwarfed the increase in the early stages of Quantitative and Qualitative Easing and the resulting surge in the money supply growth presents some near-term upside risks. Over the long-term though, we expect inflation to settle around 0.5% as the output gap closes.
  • The fallout from the pandemic will push the budget deficit to 12% of GDP this year. We think it could take a decade for the shortfall to narrow to pre-virus levels. And it may widen again thereafter as the ageing of the population lifts social security spending. The ratio of public debt to GDP could surpass 300% in the 2040s, but this is unlikely to trigger a public debt crisis as the Bank of Japan will keep borrowing costs very low.

Long-term Outlook Charts

Chart 49: Annual Change in Population (‘000)

Chart 50: Labour Force Participation Rate (%)

Chart 51: Average Time Spent Commuting to Work
(15-64 years old, minutes)

Chart 52: Credit Guarantees Outstanding (% of GDP)

Sources: Refinitiv, OECD, United Nations, JFG, Capital Economics

Key Forecasts (% y/y, Averages, unless otherwise stated)

2006-2010

2011-2015

2016-2020

2021-2025

2026-2030

2031-2050

Real GDP

0.0

1.1

-0.3

2.1

0.8

0.7

Real consumption

0.4

0.6

-1.1

2.3

0.8

0.7

Productivity

0.2

0.7

-1.2

2.0

1.4

1.7

Employment

-0.2

0.3

0.8

0.1

-0.6

-0.9

Unemployment rate (%, end of period)

4.4

3.0

2.8

2.5

2.5

2.7

Wages

-0.8

-1.0

0.6

0.2

1.4

1.7

Inflation (%)

-0.3

-0.2

0.9

0.2

0.5

0.5

Policy interest rate (%)

0.1

0.1

-0.1

-0.1

-0.1

-0.1

Ten-year government bond yield (%)

1.1

0.3

0.0

0.0

0.0

0.0

Government budget balance (% of GDP)

-6.0

-8.5

-4.4

-7.9

-4.7

-3.5

Gross government debt (% of GDP, end of period)

208

231

258

275

287

315

Current account (% of GDP)

3.2

2.5

2.7

2.0

1.3

1.1

Exchange rate (¥ per US$, end of period)

82

120

110

102

86

58

Nominal GDP ($bn)

6,204

4,469

4,904

5,664

6,907

11,898

Population (millions)

128

127

126

123

120

106

Sources: Refinitiv, Capital Economics


Marcel Thieliant, Senior Japan Economist, marcel.thieliant@capitaleconomics.com
Tom Learmouth, Japan Economist, tom.learmouth@capitaleconomics.com
Mark Williams, Chief Asia Economist, mark.williams@capitaleconomics.com