In this report we examine three issues facing Japan's economy: (1) The effects of cheap oil, (2) The return of capex spending to domestic investments, and (3) Is the Euro Zone Headed Toward Japanization?(No. 184)

◆Main economic scenario for Japan: In light of the 1^st preliminary Oct-Dec GDP release (Cabinet Office), we have revised our economic growth outlook. We now forecast real GDP growth of -0.9% in comparison with the previous year for FY14 (-0.5% in the previous forecast) and +1.9% in comparison with the previous year for FY15 (+1.8% in the previous forecast). In this report we have added our outlook for FY16 as well, with real GDP growth rate seen at +1.8% in comparison with the previous year. As we have indicated in our previous outlook, Japan’s economy is now seen as having entered a recession since having peaked in January 2014. However, the downtrend appears to have ended fairly quickly as of around August. We expect Japan’s economy to gradually recover due to the following factors: (1) Continuation of the virtuous circle brought on by Abenomics, and (2) The gradual firming up of exports centering on the US.

◆Three issues facing Japan’s economy: In this report we examine the following three issues facing Japan’s economy. (1) The effects of cheap oil, (2) The return of capex spending to domestic investments, and (3) Is the Euro Zone headed toward Japanization?

◆Issue (1) The effects of cheap oil on Japan’s economy: The sudden collapse of the price of crude oil in the summer of 2014 is expected to benefit both households and corporations, while giving a push to Japan’s overall economic situation. Household purchasing should increase due to falling prices, while the increase in real wages should improve confidence, leading to improvements in personal consumption. As for the corporate sector, lower costs will be a factor in pushing up earnings, and this is expected to encourage increases in capex spending and higher wages. According to a simulation we ran using a macro model, lower crude oil prices since the summer of 2014 will give a boost to real GDP figures for fiscal years 2014-16 as follows: FY14 +0.20%, FY15 +0.50%, and FY16 +0.41%.

◆Issue (2) The return of capex spending to domestic investments: As the yen has become increasingly weak in recent years, some manufacturers are returning production facilities back to domestic locations from their former overseas operations. This new phenomenon has gotten a lot of media coverage of late. Calculating the ratio of overseas capex spending using a regression model, we predict that it will begin to decline in FY2014 and beyond. Results of a survey sent out to corporations shows similar results. The manufacturing industry plans on cutting back on its overseas capex spending during the FY2014 year. As the effects of Abenomics gradually appear in the future, more capex spending is expected to return to domestic investments after a series of years where investment in overseas production facilities became excessive due to the high yen.

◆Issue (3) Is the Euro Zone headed toward Japanization?: In comparing the economies of the Euro Zone and Japan, we see that each has positive and negative factors. Overall, the Euro Zone still has room for additional policy moves, and if they can learn from Japan’s lost decades, with government and the ECB cooperating to come up with the appropriate policies, they will be able to avoid falling into a long-term structural recession. However, the Euro Zone has one structural defect – they have a unified monetary policy, but have not combined the fiscal policies of the various countries. The biggest danger for the Euro Zone at this time is the possibility that the populism spreading in some member countries could become a fatal hindrance to attempts to free themselves from their predicament.

◆Four risk factors facing Japan’s economy: Risks factors for the Japanese economy are: (1) The Triple Weaknesses – a weak bond market, weak yen, and weak stock market stemming from the postponement of the additional consumption tax hike, (2) China’s shadow banking problem, (3) tumult in the economies of emerging nations in response to the US exit strategy, and (4) a worldwide decline in stock values due to geopolitical risk.

◆BOJ’s monetary policy: Our current outlook is that it will be difficult for the BOJ to reach its target growth rate in consumer price of 2% by the original deadline. We expect additional monetary easing measures by the BOJ to take place at the beginning of fall in 2015, but the timing of monetary easing could come much earlier than that.

【Our assumptions】
◆Public works spending will grow by +5.1% in FY14, then decline by -5.3% in FY15, and is expected to decline again in FY16 by -3.5%. An additional consumption tax hike is now planned for April 2017.
◆Average exchange rate of Y109.9/$ in FY14, Y120.0/$ in FY15, and Y120.0/$ in FY16.
◆US real GDP growth of +3.0% in CY15 and +2.7% in CY16.