Japan’s Economic Outlook for Fiscal 2022 and 2023 (May 2022)
Economic Research Department Executive Research Fellow Taro Saito
1. Annual decline of 1.0% in January-March 2022
Due to the influence of priority preventative measures, private consumption, especially face-to-face services such as dining out and lodging, decreased slightly by 0.03% from the previous quarter, while the contribution of external demand was significantly reduced by 0.4% from the previous quarter (down 1.7% on an annual basis). Capital investment rose 0.5% from the previous quarter for the second consecutive quarter on the back of high corporate profits, and government consumption rose 0.6%, reflecting the progress of vaccination, although this did not cover the decline in consumption and external demand.
The real GDP growth rate in FY 2021 was 2.1%. Although this was the first positive growth in 3 years, the pace of recovery was extremely slow after the sharp contraction in FY 2020 (- 4.5%).
The Japanese economy registered a record-high annual contraction of 28.2% in the April-June quarter of 2020 due to the impact of the new COVID-19 virus, followed by high growth in the second half of 2020, but repeated contraction and positive growth in 2021. In the United States, real GDP in the April-June quarter of 2021 and that of the Eurozone in the October-December quarter of 2021 exceeded that of the pre-COVID-19 period (October-December 2019), but Japan's real GDP was still 0.7% below that of the pre-COVID-19 period in the January-March quarter of 2022.
The difference in interest rates between Japan and the United States has widened as the FRB has raised its key interest rate to cope with high inflation and Japan has continued its monetary easing policy. The dollar-yen exchange rate and nominal effective exchange rate are at their lowest levels in about 20 years, and the real effective exchange rate is at its weakest level in about 50 years.
The weak yen has both merits and demerits. Advantages of the depreciation of the yen include (1) an increase in exports due to an increase in export volume and export prices through improved price competitiveness, (2) an increase in exports of services, mainly due to inbound tourist demand, and (3) an increase in income received from overseas (in yen terms). On the other hand, there are disadvantages such as (1) the deterioration of corporate profits due to the rise in import costs and (2) the decline in the real purchasing power of households due to the rise in import prices.
We have estimated the export function (real exports) using the real GDP of overseas economies (income factor) and the real effective exchange rate (price factor) as explanatory variables to examine the impact of the depreciation of the yen on exports. We can see that the price elasticity of goods exports has been declining in recent years because the linkage between foreign currency-denominated export prices and exchange rates has been decreasing due to the increase in value added of export items, while the price elasticity of services exports has been rising due to the expansion of inbound demand.
An estimate of the impact of the 10% depreciation of the yen on the external balance shows that the trade balance improved by 3.5 trillion yen in FY 2010, but the improvement in the balance is now 800 billion yen, a significant decrease. [*]1By breakdown, the improvement in the real trade balance shrank from 4 trillion yen in FY 2010 to 2.2 trillion yen, and the deterioration in terms of trade (trade gains and losses) widened from 600 billion yen in FY 2010 to 1.5 trillion yen. On the other hand, exports of services increased by 200 billion yen in FY 2010 and by 800 billion yen now. However, entry restrictions are currently in place as a border measure against the new COVID-19 virus, and unless such immigration restrictions are eased significantly, service exports cannot be expected to benefit from the weak yen.
The primary income balance improved by 2.2 trillion yen compared to 1.4 trillion yen in FY 2010. This is because the primary income balance (income received from overseas minus payments) is larger than in FY 2010 (primary income balance: 13.9 trillion yen in FY 2010 to 21.6 trillion yen in FY 2021), making it easier to benefit from the weaker yen.
Using our macroeconomic model, we estimate the impact of a weaker yen on the corporate and household sectors. A weaker yen leads to an increase in corporate profits and capital investment through an increase in exports. In addition, the rise in import prices due to the depreciation of the yen initially adversely affects personal consumption through the decline in real income due to the rise in consumer prices, but the positive effects of the spread of improvement in corporate profits to employment and wages subsequently outweigh the negative effects, contributing to a boost in personal consumption.
[*]1 Calculated using trade, services, and primary income balance for FY 2021
[*]2 the impact of the secondary income account is excluded
2. Real growth rate is expected to be 2.0% in FY 2022 and 1.7% in FY 2023
With priority preventative measures being ended on March 21st, attendance at retail and entertainment venues highly linked to service consumption picked up and, in Golden Week in May, recovered to levels clearly above those before the COVID-19 pandemic began.
The nominal wage per capita fell sharply in FY 2020 due to the impact of the new COVID-19 virus but has been on an upward trend since the beginning of FY 2021. However, the rise in consumer price inflation has been a depressing factor in real wages.
Nominal employee compensation declined 1.5% in FY 2020 from the previous year, the first decline in 8 years, and then rose by 1.7% in FY 2021. In FY 2022, as the number of employees continues to increase due to the background of the high sense of labor shortages at companies, the nominal compensation of employees is expected to increase by 2.1% from the previous year, reflecting the higher growth in scheduled cash earnings, the higher rate of wage increases in the spring labor offensive compared with the previous year, and the increase in special cash earnings (bonuses), which is closely linked with corporate profits. At the same time, however, the pace of price increases will accelerate, and the growth of real employee compensation is expected to decline significantly from 2.0% in FY 2021 to 0.4% in FY 2022. The growth rate in FY 2023 is expected to rise to 1.8% as the pace of price increases slows.
Under normal circumstances, a decline in real income would directly lead to a slump in consumption. However, in the wake of the COVID-19 crisis, the savings rate was much higher than in normal times due to behavioral restrictions, so consumption will continue to be influenced more by trends in the savings rate than by real income.
The amount of household savings increased sharply to 74.7 trillion yen (seasonally adjusted annualized value) in the April-June quarter of 2020, mainly due to the provision of the special fixed benefits, and then decreased to 28.1 trillion yen in the October-December quarter of 2021. However, it still exceeds the level of the pre-COVID-19 period. This is because the household savings rate has remained higher than usual due to restrictions imposed by the state of emergency, although disposable income has declined significantly from its peak due to the full impact of the special fixed benefits.
The household savings rate rose from 1.4% in FY 2018 to 3.7% in FY 2019 and then jumped to 13.1% in FY 2020. On a quarterly basis, it rose to an extremely high level of 21.9% in the April-June quarter of 2020, and then fell to 9.0% in the October-December quarter of 2021, but the level remains high compared to normal times.
As a result of the accumulation of flow savings, household cash and deposits as stock have also increased significantly. The amount of cash and deposits held by households rose at an annual pace of 10 trillion ~ 20 trillion yen from the pre-COVID-19 period to more than 1,000 trillion yen at the end of 2019, but the pace of increase has accelerated due to an increase in savings resulting from the COVID-19 crisis. The balance of cash and deposits for the quarter from October to December 2021 was approximately 1,085 trillion yen (seasonally adjusted value calculated by the Institute), a deviation of approximately 46 trillion yen from the trend during the pre-COVID-19 period.
[*]3 Household Burden = Estimated based on consumption expenditure in FY 2021 (Family Income and Expenditure Survey, total households) x 2%
[*]4 Excess Savings (Flow) = (Savings in 2021 - (Disposable Income in 2021 + Pension Benefit Adjustment) x Average Savings Rate from 2015 to 2019) ÷ Total Households, Excess Savings (Stock) = Deviation from Trend of Cash and Deposit Balance at End of 2021 ÷ Estimated by Total Households