Japan macro outlook: Sheltered for now - bumpy road ahead

Demand has been remarkably resilient in Japan despite the weaker global economy. Another record fiscal budget and the Olympics should keep the economy growing in 2020. In 2021, the economy will have to find support abroad to keep growing. We expect GDP growth to decline from 1.0% in 2019 to 0.5% in 2020 and 2021.

The VAT hike poses an immediate risk to domestic demand. A supplementary fiscal budget for the reconstruction from typhoon Hagibis should take the edge off, though.

Looking a little further ahead, escalation of the global trade war is the key risk for Japan, as it hits the economy in two ways: on declining demand for Japanese goods and a deterioration of competitiveness on the back of yen appreciation.

We expect further easing of economic policy will come from the fiscal side, whereas the Bank of Japan will keep its policy largely unchanged through 2020 and 2021 and stick to fine-tuning.

Solid economy despite weaker global demand

The economy has been robust during 2019 despite several headwinds. Domestic demand has been the primary growth driver on the back of decent household consumption and investments and an accommodative fiscal stance. Under difficult circumstances, exports have weakened and were down around JPY100bn y/y in September with US, China, ASEAN and also the smaller trading partner South Korea, where exports have been weak since the bilateral trade spat began earlier this year. The strong yen has been a key reason for this.

As of 1 October, Japan entered troubled, although not uncharted, territory, when VAT was raised from 8-10%. The last time VAT was hiked the economy went straight into recession. This time the government has taken several measures to mitigate the shock to private demand. Among other things, it has excluded groceries from the tax hike and for a limited time, cashless transactions to small and medium retailers are subject to a 2% refund. The general expectation of the Bank of Japan (BoJ) and the government has been that the impact would be far less severe this time. However, we saw a big spike in September retail sales followed by a huge plunge in October, indicating that people are reacting quite strongly to the VAT hike. The October typhoon Hagibis probably also benefitted by keeping people at home, though.

Olympics and public spending will support growth

Despite stagnating wages, the increasingly tight labour market has boosted total wage income. We expect a significant correction in consumption in Q4 due to the VAT hike and, looking ahead, we see scope for a limited pick-up in consumption. Consumers are cautious and once the impact of the VAT hike has settled, we expect private consumption to grow slowly. Massive public debt forces households to save.

2020 will be the year for the Tokyo Olympics and it will likely have a significant economic impact. According to a BoJ research paper (Economic Impact of the Tokyo 2020 Olympic Games) GDP has been affected already since the nomination of Tokyo back in 2013. To begin with, it was primarily investment, but tourism has also benefitted from the Olympics, even years before the actual games. Whatever the reason, tourism in Japan has exploded since the nomination in 2013, with the number of arrivals at 31.2 million in 2018 compared with 10.4 million in 2013. However, recently Japan has seen a large fall in the number of tourists, primarily driven by a decline in the number of South Korean visitors in the wake of the intensified trade spat between the two countries, see box.

In 2020, the impact of the Olympics is going to peak, as 920,000 spectators are expected (by the organizers) to visit Tokyo per day and the BoJ expects the total contribution to GDP of the Olympics to add approximately JPY8trn to GDP in 2020, equivalent to 1.5% of GDP (just 0.2%-points more than in 2019, though). Investment in particular is going to wane as the Olympic boost disappears, but also because businesses assess that their production capacity has increased during 2019. That said, an increasing labour shortage will support the incentive to invest

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