GDP grew by 0.5% q/q in Q3, slower than in the previous quarters but still well above potential. The excellent performance is based on very loose macro-economic policies and households bringing purchases forwards. In that respect, it is borrowing from tomorrow’s growth. The current favourable economic climate should be used to implement the growth strategy.
The Japanese economy remained very dynamic in the third quarter. GDP grew by 0.5% q/q, which was slower than in the preceding two quarters (around 1%), but well above potential growth estimated at around 0.25% (annual rate). Entrepreneurs have been reporting shrinking excess capacity. In some sectors, such as construction, production is close to capacity.
The excellent performance of Japan can be attributed to two factors. First, the government has embarked on a very loose fiscal policy. In January, it launched a fiscal stimulus plan, which is now being implemented. Government investment increased by 6.5% in Q3 after 4.8% in the preceding quarter. It contributed 0.4 point to overall GDP growth.
Second the anticipation of a three-point VAT hike in April 2014 prompted household to advance their purchases. (The hike was confirmed in early October.) The effect was clearly noticeable in the first half of the year, when consumption, also supported by rising stock prices, increased by around 0.5% q/q. In Q3, consumption was maintained at a relatively elevated level. Moreover, house purchases were stimulated. In Q3, residential investment increased by 2.7%, which contributed 0.1 point to growth.
The disappointment came from exports. Thanks to the depreciation of the yen – by end September the currency had shed more than 25% of its value against the US dollar compared to a year earlier – Japanese industry had gained competitiveness. In particular in the first half of the year, exports had increased rapidly by around 3.5% q/q. However, in Q3, it contracted by 0.1%. This was due to the sluggishness of world trade. In particular, imports by the emerging economies contracted. According to the CPB trade monitor, imports by emerging Asia, an important market for Japanese exporters, were 1.9% lower in the period June-August from the preceding three months. This was partly compensated by stronger demand from the US and the euro area -- both increased by around 1.75%. As imports continued to rise strongly (+2.2% in Q3), the contribution of net trade was –0.5 point.
The good performance of the Japanese economy is based on increased public borrowing and bringing purchases forward. In that respect it is taking away from tomorrow’s growth when government and to a lesser extent households have to consolidate their balance sheets. The big backlash will come after the VAT hike in April. We expect GDP to contract by more than 1% in Q2 2014.
The government will limit the contraction in Q2 2014 by launching a new fiscal stimulus package, which pushes fiscal consolidation further out. The government’s objective is to achieve a zero primary balance by 2020. A fiscal consolidation plan will be published before the end of the year. An important element will be the increase of the Japanese growth potential. The government would be wise to use the current favourable economic climate to implement the growth strategy.