What Will Prompt Economic Recovery?(Nov 2012)

◆Economic outlook revised sharply downward: In light of the first preliminary Jul-Sep 2012 GDP report (Cabinet Office), we have revised our economic growth outlook sharply downward. We now forecast real GDP growth of +0.7% y/y for FY12 (previous forecast: +1.8%) and +0.9% for FY13 (+1.2%).

◆What will prompt economic recovery?: With the worsening of foreign economies, it is highly probable that Japan’s economy peaked in March 2012 and has slipped into recession. In this report, we examine past recoveries of the Japanese economy to elucidate conditions for a future recovery. A review of past periods when Japan’s economy recovered reveals that since the 1990s the driving force of recoveries has clearly shifted from fiscal and monetary measures to exports. In the current downturn, it is highly probable that the growth of exports, such as through the recovery of foreign economies, will trigger the bottoming out of Japan’s economy. Despite the existence of downside risks, as our main scenario we believe that Japan’s economy will follow a path of gradual recovery in 2013 and beyond, supported by three factors: (1) pickup of the US and Chinese economies, (2) reconstruction demand related to the Great East Japan Earthquake, and (3) further monetary easing by the Bank of Japan (BOJ).

◆How should the future direction of the world economy be understood?: The key to anticipating the direction of the world economy is the degree to which sluggish domestic demand in Europe, the US, and other advanced economies will be offset by the policy responses of emerging economies. We therefore undertook a quantitative simulation of the world economy with (1) domestic demand in advanced economies and (2) the policy responses of emerging economies serving as exogenous variables. Our simulation indicates that emerging economies aggressively implementing fiscal and monetary measures has the potential of offsetting to some degree sluggish domestic demand in advanced economies. However, should multiple risk factors materialize at the same time, such as further deepening of the European sovereign debt crisis and the US fiscal cliff, the policy responses of emerging economies alone would not be sufficient to support the world economy.

◆Risks facing Japan’s economy: Risks that will need to be borne in mind for Japan’s economy are: (1) any deepening of the European sovereign debt crisis, (2) worsening of Japan-China relations, (3) the US fiscal cliff, (4) a surge in crude oil prices stemming from geopolitical risk, and (5) further appreciation of the yen.