Whither Japan’s Economy?: In this report we examine the following: (1) US-China Trade War, (2) The Heat Wave Effect, (3) The Impact of Unpaid Overtime, (4) What Happened to Fiscal Reconstruction?, and (5) US-Japan Risk from the Viewpoint of Money Flow(No. 198)[Summary]

◆Japan’s economy is in a temporary lull, with a gradual slowdown seen throughout FY2019: In light of the 1st preliminary Apr-Jun 2018 GDP release we have revised our economic growth outlook. We now forecast real GDP growth of +1.0% in comparison with the previous year for FY18, and +0.8% in comparison with the previous year for FY19. Our assessment of Japan’s economy remains unchanged. The economy is now in a temporary lull, with the positive factors which came together in FY17 now in the process of falling away. We expect Japan’s economy to continue slowing down for some time, and then move toward an extremely moderate growth pattern.

◆Reassessment of US-China Trade War and its Effects on the Global Economy: Using the DIR macro model, the estimated effects on the US and Chinese real economies due to additional US-China tariff measures is not expected to be devastating. On the other hand, neither can it be ignored. Downward pressure on GDP in the two countries is expected to be -0.25% for China, and -0.29% for the US. Meanwhile, impact on the global economy according to IMF estimates is seen at -0.10%. For Japan, the moment of truth will arrive at the trade negotiations on automobiles. If a tariff of 20% is imposed on imports of Japanese automobiles to the US, the tariff cost to Japanese motor vehicles and parts could grow to 1.7 trillion yen or more.

◆The Heat Wave Effect – A Bottom-Up Approach: In predicting the short-term momentum of personal consumption, we must take into considerations the effects of Japan’s recent heat wave in addition to other factors. According to the DIR estimate, for each 1°C increase in average temperature in comparison with the previous year, nominal household consumption expenditure is raised by 100 billion yen, as is expected to be the case for the Jul-Sep period.

◆The Impact of Unpaid Overtime on Japan’s Economy: We estimated the impact of the unique Japanese phenomenon of “service overtime” (unpaid or voluntary overtime) on Japan’s economy using the DIR macro model. Then we estimated what the impact would be on corporate income if service overtime were reduced. While a negative effect was detected in the short-term, in the mid to long-term it actually would have a positive effect. As for the breakdown by industry, “service overtime” is on the high side in those industries which have low productivity. These industries also tend to have a high rate of employee retention. Assuming that there is more employment mobility, we estimated what the impact of increased turnover in labor would be on industries with a lot of unpaid overtime, and we found that productivity would improve by around 2.0%. It would be a plus to the macro economy in the mid to long-term if the extent to which corporations with low productivity can depend on unpaid overtime is gradually limited.

◆Fiscal Reconstruction – An Impossible Dream?: In June 2018 the government pushed back its target to reach fiscal sustainability (primary balance in the black at both national and local levels) from the original target of FY2020 to FY2025. Even the new target date will not be easy to achieve considering the current structure of revenue and expenditure on both the national and local levels, as well as the fact that a high economic growth rate would be required to get back in the black by then. We also performed an international comparison to see where Japan stands in its deficit situation, while at the same time analyzing national and local public budgets to find what the mid to long-term prospects might be. According to the baseline cases used by DIR and the Cabinet Office, the amount by which Japan’s primary balance will be in the red by FY2025 comes to -9.7 trillion yen (DIR) and -8.1 trillion yen (Cabinet Office). Getting the public budget back in the black will require improving the balance of payments by increasing the consumption tax by 4%pt or more. The road to fiscal health is a difficult one.

◆Looking for Risk in US-Japan Money Flows: In the US just before the global financial crisis of 2008, and in Japan during its bubble period (1985-1990), there was a rapid increase in debt held by financial institutions, households, and corporations. In both cases a financial crisis was triggered when the economic bubble burst, and both countries fell into recession. During the IT bubble in the US, assets grew, while expansion of debt was not very prominent. Because of this fact a financial crisis was avoided after the IT bubble burst, and the recession which followed was limited to the short-term. The current situation has more in common with the IT bubble than with the global financial crisis of 2008, or Japan’s economic bubble. There is a good possibility that the value of risk assets will fall, but we are of the opinion that risk of a financial crisis occurring is limited.

◆BOJ’s monetary policy: We expect the BOJ to maintain current monetary policy for the time being. Considering the policy introduced in September 2016 to permanently battle deflation, the issue is expected to be creating a more flexible inflation target.

Our assumptions
◆Public works spending is expected to decrease in FY18 to -0.4%, then return to growth in FY19 at +1.6%.
◆Average exchange rate of Y110.7/$ in FY18, and Y111.3/$ in FY19.
◆US real GDP growth of +2.8% in CY18, and +2.5% in CY19.