Japan Economics

Debt sustainability, early evidence of coronavirus drag

Japan Economics Weekly
Written by Marcel Thieliant

The ratio of Japan’s public debt to GDP will probably keep rising over the coming decades. But with the Bank of Japan set to keep a lid on borrowing costs, it’s hard to make the case that public debt is unsustainable. Meanwhile, there are mounting signs that the coronavirus will become a drag on growth this quarter, consistent with our view that the economy will contract this year.

Bank of Japan will prevent a public debt crisis

In its Article IV report, the IMF this week called Japan’s public debt trajectory “unsustainable” and proposed a further increase in the sales tax from 10% to 15% to reduce fiscal risks. Arguing that the debt trajectory is unsustainable seems a little harsh when the government debt to GDP ratio has stabilised in recent years. (See Chart 1.) The structural narrowing in the budget deficit due to the increase in the sales tax from 5% in 2014 to 10% today was a key driver. So was the return of inflation.

Chart 1: General Government Gross Debt
(% of GDP)

Sources: Refinitiv, Capital Economics

Admittedly, we think that rising social security spending will result in a renewed widening of the budget deficit over the coming decades, perhaps to 4% of GDP by 2050. That means that we expect the ratio of public debt to creep up from just under 240% of GDP now to 280% by then.

But debt sustainability isn’t all about debt levels. Funding costs are important, too. The Bank of Japan has pledged to keep 10-year yields at 0% and is unlikely to tolerate any surge in borrowing costs as this would make it even more difficult hitting its 2% inflation target. What’s more, the government’s debt position looks less precarious once we take its large holdings of financial assets into account. Last year, they were equivalent to 84% of GDP. As such, we aren’t convinced that Japan’s public debt profile is unsustainable.

Disruption to supply chains set to intensify

The 22% drop in Chinese passenger arrivals at Narita airport during this year’s Lunar New Year relative to last year’s provides early evidence that the coronavirus outbreak will result in a sharp fall in tourist arrivals in the first quarter. What’s more, daily air departures in Hong Kong have slumped by another 90% since the holiday, indicating that tourist arrivals from other parts of Asia may dry up too. As such, a 30% drop in tourist arrivals as happened during SARS increasingly looks like a best-case scenario. If the Hong Kong figures are any guide, slumping tourism revenue may knock off as much as 0.6%-pts from GDP this quarter.

The disruption to supply chains seems small so far. Nissan will halt production at its Kyushu plants today and on Monday, but that would only result in 3,000 less cars produced than otherwise – a mere 0.4% of monthly car production across the country. But other manufacturing sectors are more reliant on inputs from China than the car industry. (See here.) And it now seems likely that the disruption to industrial activity in China will drag on well beyond this week. (See here.)

The SARS outbreak didn’t have any visible impact on retail spending or consumer confidence but that probably reflected the fact that there were no infections in Japan. By contrast, there are now 250 coronavirus cases in Japan, including those on a cruise ship quarantined off Yokohama. And Japan today reported the first death from the new virus. That leaves a growing risk that private consumption will come under pressure as well. As such, we reiterate our below-consensus forecast that GDP will shrink by 0.2% this year.

The week ahead

In a busy week for economic data, we’ve pencilled in a sharp fall in GDP in Q4 as consumer spending plunged after October’s sales tax hike. As for the January data, inflation may have weakened a touch while export volumes are likely to have plunged.


Data Previews

GDP (Q4, First Estimate) Mon. 17th Feb.

Forecasts

Time (JST)

Previous

Consensus

Capital Economics

GDP q/q (y/y)

08.50

+0.4% (+1.9%)

-1.0%

-0.7% (+0.9%)

At least it wasn’t as bad as 2014…

GDP almost certainly contracted last quarter. That’s because the rise in the consumption tax from 8% to 10% at the beginning of October dealt a sizeable blow to domestic demand. We think private consumption and fixed investment together knocked 1.5% pts off GDP in Q4.

The 1.8% q/q fall in private consumption we have pencilled would be much smaller than the 4.8% q/q plunge after the previous sales tax hike in April 2014. That partly reflects the success of government countermeasures designed to offset the 2019 hike’s blow to consumer spending. Meanwhile, we think business investment fell 2.3% q/q last quarter. That’s slightly larger than the 1.9% drop in Q2 2014 and reflects plunging capital goods shipments across Q4.

A continued rise in goods exports coupled with falling imports in the wake of the tax hike means net trade is likely to have provided a 0.6%pt counter-boost to GDP last quarter.

Finally, we’ve assumed a 0.2 percentage point boost from inventories. That’s smaller than the boost following the 2014 tax hike but consistent with a smaller drop in consumption. All told, our forecast is for a 0.7% q/q fall in GDP. (See Chart 2.) That would be a much smaller drop than the 1.9% q/q contraction in Q2 2014.

Chart 2: Contributions to Quarterly GDP Growth (%pts)

Sources: Cabinet Office, Capital Economics

Machinery Orders (Dec.) Wed. 19th Feb.

Forecasts

Time (JST)

Previous

Consensus

Capital Economics

“Core” Machinery Orders m/m (y/y)

08.50

+18.0%(+5.3%)

-8.8% (-0.4%)

-10.0%(-0.4%)

Machinery orders probably dropped off again

“Core” machinery orders jumped 18% m/m in November following four straight months of falling orders. (See Chart 3.) That was driven by one large order in the “transport and postal activities” category. And as manufacturing orders remained soft, the November data were in tune with the “decoupling” of manufacturing and non-manufacturing investment over the past year.

Domestic machine tool orders remain weak and dipped lower at the end of the year. That points to a sizeable fall in “core” machinery orders. We have pencilled in a renewed sharp fall in “core” orders in December. But as the data are released after the Q4 GDP figures, December’s machinery orders will largely be old news.

Looking further ahead, we think investment growth will disappoint this year. That forms part of our non-consensus view that the economy is likely to contract in 2020.

Chart 3: “Core” Machinery Orders (Yen Billion)

Sources: Refinitiv

External Trade (Jan.) Wed. 19th Feb.

Forecasts

Time (JST)

Previous

Consensus

Capital Economics

Trade Balance (Yen Billion)

08.50

-155

-1717

-1780

Trade Balance, Seas. Adj. (Yen Billion)

08.50

-102

-591

-720

Exports (y/y)

08.50

(-6.3%)

(-7.1%)

(-6.5%)

Imports (y/y)

08.50

(-4.9%)

(-1.3%)

(0.0%)

Export volumes likely to have plunged

Export values fell by 7.3% y/y in the first 20 days of January. (See Chart 4.) We have pencilled in a 6.5% y/y fall for the month as a whole, suggesting that external demand remained weak at the start of the year. And the weakness of exports in January 2019 means that the annual growth figure is likely to understate the fall in exports last month. In monthly terms, we think both export values and volumes fell around 8%.

Meanwhile, import values dropped just 0.1% y/y in the first 20 days of January following a 4.9% y/y fall in December. Much of that improvement was down to a smaller drag from falling import prices. Overall, we think import values were flat in y/y terms last month. Import volumes probably increased around by 1% m/m. That would point to domestic demand having continued to regain momentum last month following October’s sales tax hike. As such, net trade appears to have been a sizeable drag on GDP growth at the start of 2020.

Chart 4: Trade Values (% y/y)

Sources: Refinitv, Capital Economics

Consumer Prices (Jan.) Fri. 21st Feb.

Forecasts

Time (JST)

Previous

Consensus

Capital Economics

Consumer Prices (y/y)

08.30

(+0.8%)

(+0.7%)

(+0.7%)

Consumer prices excl. fresh food (y/y)

08.30

(+0.7%)

(+0.7%)

(+0.8%)

CPI excl. fresh food & energy (y/y)

08.30

(+0.9%)

(+0.8%)

(+0.8%)

Inflation rate edged down last month

Headline inflation dropped from 1.0% to 0.6% in Tokyo in January. (See Chart 5.) We are expecting a more modest drop in the nationwide headline figure, from 0.8% to 0.7% y/y (0.5% excluding the impact of the tax hike and free childcare).

The headline rate in Tokyo was dragged down by sharp falls in fresh food and electricity & gas inflation. However, petroleum inflation – which has a much higher weighting in the consumer basket outside of the capital – rose from 0.9% to 7.8% in Tokyo last month. That should have resulted in a renewed rise in energy inflation in the nationwide figures.

We expect “core” inflation to have edged down to 0.8%. The Tokyo CPI showed sizeable falls in “reading and recreation” inflation as well as “furniture and household items” inflation.

Chart 5: Headline Inflation (%)

Sources: Refinitiv, Capital Economics


Economic Diary & Forecasts

Upcoming Events and Data Responses

Date

Release/Indicator/Event

Time (JST)

Previous*

Median*

CE Forecasts*

Mon 17th

GDP (Q4, Prov., q/q)

08.50

+0.4%

-1.0%

-0.7% (+0.9%)

GDP Deflator (Q4, Prov.)

08.50

(+0.6%)

(+1.1%)

(+1.1%)

Private Consumption (Q4, Prov., q/q)

08.50

+0.5%

-2.0%

-1.8%

Business Investment (Q4, Prov., q/q)

08.50

+1.8%

-1.6%

-2.3%

Industrial Production (Dec., Fin.)

08.50

+1.3% (-3.0%)p

Tue 18th

No Significant Data Released

Wed 19th

Trade Balance (Jan.)

08.50

-¥155bn

-¥1717bn

-¥1780bn

Trade Balance Adjusted (Jan.)

08.50

-¥101bn

-¥591bn

-¥720bn

Exports (Jan.)

08.50

(-6.3%)

(-7.1%)

(-6.5%)

Imports (Jan.)

08.50

(-4.9%)

(-1.3%)

(0.0%)

Machinery Orders (Dec.)

08.50

+18.0% (+5.3%)

-8.8% (-0.4%)

-10.0%(-0.4%)

Thu 20th

Machine Tool Orders (Jan., Fin.)

15.00

(-35.6%)p

Fri 21st

National CPI (Jan.)

08.30

(+0.8%)

(+0.7%)

(+0.7%)

National CPI Ex-Fresh Food (Jan.)

08.30

(+0.7%)

(+0.7%)

(+0.8%)

National CPI Ex-Fresh Food and Energy (Jan.)

08.30

(+0.9%)

(+0.8%)

(+0.8%)

Manufacturing PMI (Feb., Prov.)

09.30

48.8

48.6

Services PMI (Feb., Prov.)

09.30

51.0

All Industry Activity Index (Dec.)

13.30

+0.9%

+0.3%

+0.3%

Selected future data releases and events

Fri 28th

Tokyo CPI (Feb.)

Labour Market (Jan.)

Retail Sales (Jan.)

Industrial Production (Jan., Prov.)

Vehicle Production (Dec.)

Housing Starts (Jan.)

*m/m(y/y) unless otherwise stated; Japan is 9 hours ahead of GMT.Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts

%q/q(%y/y) unless stated

Latest

Q4 2019

Q1 2020

2019

2020

2021

GDP

+0.4%(+1.9%)

-0.7%(+0.9%)

-0.2%(+0.1%)

(+1.1%)

(-0.2%)

(+0.8%)

Private Consumption

+0.5%(+1.5%)

-1.8%(-0.5%)

+0.1%(-0.6%)

(+0.5%)

(-0.6%)

(+1.9%)

Consumer Prices

(+0.8%)

(+0.5%)

(+0.8%)

(+0.5%)

(+0.6%)

(+0.5%)

Consumer Prices Excl. Tax

(+0.6%)

(+0.3%)

(+0.6%)

(+0.4%)

(+0.4%)

(+0.5%)

Unemployment Rate (%, average)

2.2

2.2

2.4

2.4

2.5

2.5

Policy Rate (%)

-0.10

-0.10

-0.10

-0.10

-0.10

-0.10

Monetary Base, end period (¥ Tr)

517

513

517

513

530

545

10 yr JGB, end period (%)

-0.03

-0.01

0.00

-0.01

0.00

0.00

Nikkei 225, end period

23,643

23,657

24,000

23,657

25,000

26,000

¥/$, end period

109.9

108.6

110

108.6

110

110

¥/Euro, end period

119.1

121.8

118.8

121.8

115.5

115.5

¥/£, end period

143.3

144.1

146.3

144.1

148.5

154.0

Sources: Bloomberg, Thomson Reuters, Capital Economics


Marcel Thieliant, Senior Japan Economist +65 6595 1514, marcel.thieliant@capitaleconomics.com  Tom Learmouth, Japan Economist, +65 6950 5702, tom.learmouth@capitaleconomics.com

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