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Outlook for the Japanese Economy in 2010-11
— Growing downward pressure; reactionary downturn in consumer spending to bring deceleration in FY 2011 —

November 17, 2010

Overview

The Japanese economy has been softening since the summer and the decline has been particularly clear in mining and manufacturing output. The major cause of this decline is a sharp fall in car sales following the termination of the subsidized vehicle scrappage program. Exports, which until now have been the driving force behind the economy, have also peaked. Domestic demand has yet to see a real recovery and remains sluggish. Owing to the fragility of domestic demand, the decline in the pulling power of consumer durables and exports is likely to be a cause of economic weakness.

Three factors are set to exert a downward pressure on the economy:

(1) Exports
Shipments to Europe and the United States have continued to grow until now but are likely to weaken as the economic pulling power of both public and private sectors declines. The growth of shipments to the newly industrialized countries has also been slowing and there is little hope of rapid recovery as the benefits of economic stimulus measures will be tailing off and production adjustments continuing in electronics and other industries.

(2) The strong yen
The appreciation of the yen will impact on the Japanese economy in three areas: (i) prices, (ii) sales volume and corporate behavior.
(i) Prices: exporters will see their sales fall owing to foreign exchange losses, while importers will see their costs fall owing to foreign exchange gains. In macro terms, since foreign exchange gains will exceed losses, the net impact will be positive. The impact of a 10% rise in the value of the yen against the dollar will be the equivalent of ¥1 trillion a year.
(ii) Sales volume: by undermining the price-competitiveness of Japanese products, a strong yen will exert downward pressure on export volume and upward pressure on import volume. Even if current exchange rates are maintained, the strength of the yen is set to cause a 0.2% fall in real GDP in fiscal 2011. Given the intensifying competition from Korean and Taiwanese companies, among others, it is possible that the negative impact will be still greater.
(iii) Corporate behavior: the strength of the yen will reinforce the tendency of businesses to seek to cut costs. In the medium-to-long term, manufacturing industry is likely to speed up the shift of production overseas, leading to a decline in domestic capital investment and employment.
Overall, the negative effects in the medium-to-long term will outweigh the short-term benefits and the appreciation of the yen will have a negative impact on the Japanese economy.

(3) Effects of policy measures
Sales of TV sets are likely to see a reactionary fall in early 2011. Ahead of the switch to digital terrestrial broadcasting, some 2.5 years’ worth of demand for TV sets is likely to be brought forward. For this reason, it is likely that the reactionary slump in sales following the switch to digital terrestrial broadcasting will be severe and that the ensuing stagnation will be prolonged. The economic stimulus measures put forward since September 9 are likely to be of limited benefit to the economy.

Domestic demand is unlikely to be strong enough to absorb these downward pressures and drive the economy forward. Since Japan still has a GDP gap of nearly 4%, the deflationary trend will be prolonged and, as the sentiment of over-employment and over-capacity is still strong in the business sector, a significant improvement in capital investment and employment conditions is unlikely.

The continued stagnation of exports, the reactionary declines following the end of economic stimulus measures, and the weakness of the recovery in domestic demand mean that the Japanese economy is likely to continue treading water in the short term. In early 2011 in particular, the negative impact as the benefits of measures to stimulate consumer spending tail off will exert strong downward pressure on real GDP. There is a risk that signs of economic deceleration will strengthen.

Given that the major cause of the growth of the GDP gap is the slump in the business sector and that a revitalization of the business sector is essential for employment growth, measures aimed at the business sector are clearly the key priority.

For more information on the content of this report, please contact Hideki Matsumura, the Japan Research Institute, Limited.

E-mail:matsumura.hideki@jri.co.jp

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