Japan's Economic Outlook for 2014(Dec 2013)

◆Economic outlook revised: In light of the second preliminary Jul-Sep GDP release (Cabinet Office), we have revised our economic growth outlook. We now forecast real GDP growth of +2.5% y/y for FY13 (previous forecast: +2.6%) and +1.0% for FY14 (+1.0%). We have revised our economic outlook downward in view of the economic growth rate for Jul-Sep 2013 coming in lower than anticipated and factoring in the annual revision of FY11 and FY12 GDP, released along with the second preliminary 3Q 2013 GDP report.

◆Japan’s Economic Outlook for 2014: After hitting bottom in November 2012, Japan’s economy has entered a recovery phase. We believe it will continue to expand steadily supported by (1) increases in exports based on the backs of the US economic recovery, (2) ongoing depreciation of the yen and the rise in stock prices supported by the BOJ’s monetary easing, and (3) economic stimulus measures to offset the effects of the consumption tax hike. Risks that will need to be kept in mind regarding the Japanese economy are: (1) turbulence in emerging economies, (2) China’s shadow banking problem, (3) a reigniting of the European sovereign debt crisis, and (4) a surge in crude oil prices stemming from geopolitical risk.

◆Will a virtuous circle actually take hold in Japan’s economy as intended by the government?: In this report, we analyze whether or not the virtuous circle that the government targets will actually occur. First, from a wage perspective, an increase in wages will have a positive impact on non-manufacturing sector. In particular, higher contractual cash earnings will invigorate personal consumption, centering on durable goods. However for the virtuous circle to be sustained, a key issue will be whether or not the increase in wages can be passed through to output prices. Second, from a capex perspective, a tax cut for capital investments could invoke more such investments in the future. However, given Japan’s sluggish capacity utilization rate, the ability of capex to recover will likely to be weak. The moderate downtrend of capex’s production inducement coefficient in recent years is also a matter of concern. The capex trend is greatly influenced by growth expectations. Hence, increasing the growth expectations of companies through measures such as cutting the corporation tax and drastic deregulation is the true path towards the recovery of capex. Finally, we examine the effects of corporation tax cut and present a quantitative simulation of economic trends.