Japan Economics Viewpoint
Ready for ignition
18 November 2016
Consensus underestimating GDP and inflation
We are upbeat on Japan’s outlook and think consensus is underestimating the strength
of medium-term GDP and inflation. We expect growth of 1.4% in CY2017 and 1.2% in
CY2018, well above consensus of just 0.8% growth next year. For the first time in four
years both monetary and fiscal policy are supporting growth. The combination of
modestly higher commodity prices, a weaker yen, and a tightening output gap should
drive Japan-style core inflation to 1.0% in CY2017, and 1.4% in CY2018. We expect the
BoJ to keep its rate targets unchanged for the foreseeable future as inflation moves in
the right direction.
Fiscal and monetary policy realigning
For years Japan has oscillated between loose and tight fiscal policy. Japanese
policymakers now seem to be on the same page and we see little risk of another policy
error. If anything, we see upside risks from greater fiscal stimulus via a third
supplementary budget or a relatively aggressive FY17 ordinary budget. Meanwhile, the
BoJ’s new interest-pegging regime ensures that financial conditions will become
increasingly stimulatory as inflation rises.
Economics
Japan
Izumi Devalier
Japan Economist
Merrill Lynch (Japan)
+81 3 6225 6257
izumi.devalier@baml.com
2017 – a year of recovering domestic demand
We think the economy is heading towards a cyclical sweet spot and see a broad-based
recovery in domestic demand. Specifically, 1) consumption is poised to rebound as the
saving rate peaks; 2) capex should accelerate in response to the improving demand
outlook, deepening supply-side constraints, and “low-for-longer” real rates; and 3)
increased efforts by policymakers to accelerate income redistribution could push up the
velocity of money at the margin, helping to reflate the economy.
Unauthorized redistribution of this report is prohibited. This report is intended for amanda.ens@baml.com
Biggest risk factor: US policy uncertainty
External developments pose the greatest risk to our forecasts, chief among them US
policy uncertainty. The downside scenario for Japan is a combination of rising US
protectionism, sliding global trade, and a stronger yen, which could reduce 2017 growth
to zero. The Trump presidency may increase pressure on Japan to achieve greater
military self-reliance, boosting defense spending. There will also be greater incentives to
deepen economic and trade linkages with key regional players, such as China and Russia.
Chart 1: We think consensus is underestimating the strength of medium-term GDP and inflation
2.0
1.5
1.0
0.5
0.0
-0.5
Real GDP %YoY
0.7
0.6
1.4
Source: BofA Merrill Lynch forecasts, Bloomberg
1.2
0.8 0.7
CY16 CY17 CY18 CY16 CY17 CY18
BofA Merrill Lynch does and seeks to do business with issuers covered in its research reports. As a
result, investors should be aware that the firm may have a conflict of interest that could affect the
objectivity of this report. Investors should consider this report as only a single factor in making
their investment decision.
Refer to important disclosures on page 13 to 14. 11686430
Timestamp: 17 November 2016 03:00PM EST
CPI ex fresh food %YoY
-0.3
-0.3
1.0
BofAML Consensus (Bloomberg, as of 15 Nov 2016)
0.4
1.4
0.6
Escape from zero
The Q3 CY16 GDP print confirms our view that Japan has at last emerged from the de
facto zero-growth trap of the past few years. Growth accelerated to an aboveconsensus
2.2% q-o-q saar, after a 0.7% rise in Q2 CY16 and 2.1% rise in Q1 CY16. We
expect a moderation in Q4 CY16, but underlying growth will remain firmly in the 1.0-
1.5% range. We are currently tracking CY2016 growth of 0.7%, a modest improvement
from 0.6% in CY2015, though the switch to a new GDP standard 1 next month raises
uncertainty around our forecasts.
Upturn in exports to be sustained through Q3 CY17
The recent recovery has been driven by a fading consumption tax shock and stronger
exports. The downturn in the global industrial cycle in 2014-16 hurt Japan, but
manufacturing activity bottomed out early this year and is now modestly expanding
(Chart 2). The OECD leading indicator continues to signal a synchronized pick-up in
global growth (Chart 3). The domestic inventory cycle also points to production gains
ahead (Chart 4). For Japanese exporters, the improvement in demand has been most
visible for Europe (Chart 5). US and Chinese demand will likely follow, though the
mainland’s structural shift to services implies only a modest acceleration. We expect the
current up-cycle in global exports to be sustained through Q3 CY17 – possibly longer
depending on developments in the US (more on this later). The combination of stronger
external demand and a weaker currency should shore up business confidence, especially
among manufacturers, and lay the foundations of Japan’s recovery.
Chart 2: Industrial activity has bottomed out
Index 2010=100 3mma sa
110
105
100
95
90
85
2010 2011 2012 2013 2014 2015 2016 2017
IP Real exports
Source: BofA Merrill Lynch Global Research, METI, BoJ
Chart 3: OECD leading indicator points to modest global expansion
8
6
4
2
0
-2
-4
-6
2000 2002 2004 2006 2008 2010 2012 2014 2016
OECD global leading indicator, %YoY (LHS)
Japan real exports, %YoY (RHS)
Source: BofA Merrill Lynch Global Research, OECD, BoJ
50
30
10
-10
-30
-50
Chart 4: The shipment-inventory cycle points to production gains ahead
Shipments %YoY
10
5
0
-5
-10
Mar 2013
Source: BofA Merrill Lynch Global Research, METI
Sep 2016
-10 -5 0 5 10
Inventories %YoY
Chart 5: Japan's real exports by destination, 3mma %YoY
50
40
30
20
10
0
-10
-20
2010 2011 2012 2013 2014 2015 2016
N. America EU China
Source: BofA Merrill Lynch Global Research, BoJ
1
Japan will switch to SNA2008 methodology, starting with the release of revised Q3 CY16
GDP due 8 December 2016.
2 Japan Economics Viewpoint | 18 November 2016
Automatic easing
Policy headwinds are also abating: for the first time since 2013, both fiscal and
monetary policy are poised to turn stimulatory in 2017.
Monetary policy: BoJ pegs to zero
The BoJ’s transition to yield-curve targeting ensures that real yields will drop as inflation
picks up, implying that financial conditions will turn increasingly loose as the recovery
progresses. There are good reasons to be cautiously optimistic: after all, despite a triple
whammy of weak domestic demand, weak commodity prices, and a stronger yen,
Japanese inflation measures are showing early signs of bottoming out (Chart 6).
We expect Japan-style core inflation (CPI ex fresh food) to trough in Q4 CY16, after
which it should accelerate relatively quickly in the first two quarters of 2017 in response
to 1) a recovery in crude oil prices, 2) a weaker yen (we assume USDJPY rebounds to
120 by the end of the year), and 3) stronger wage growth. This also implies stronger
core-core inflation (CPI ex food & energy). We are bullish on all three factors and see
CY17 core inflation running at an above-consensus 1.0% and 1.4% in CY18.
This is still short of the central bank’s 2% target (Chart 7). But we believe there will be
little pressure to lower rates further, especially against the backdrop of a weakening yen
and rising global yields. More broadly, things are moving in the right direction for the
BoJ. The private sector has been steadily re-leveraging, albeit gradually. Meanwhile,
labor markets continue to tighten and wage growth is slowly improving: the 4-quarter
moving average for hourly wages is now up to 1.2% y-o-y (Chart 8). With the labor
market for lower-cost part-time workers nearing saturation, growth in higher-quality,
full-time jobs is picking up (Chart 9). We expect a moderation in employment gains and
faster wage growth ahead.
Chart 6: Produce and consumer price inflation (ex-tax effect)
4
2
0
-2
-4
-6
2011 2012 2013 2014 2015 2016
Corporate goods prices %YoY (LHS)
Headline CPI %YoY (LHS)
Corporate service prices %YoY (RHS)
Source: BofA Merrill Lynch Global Research, MIA
1.0
0.5
0.0
-0.5
-1.0
-1.5
Chart 7: Japan-style core inflation (CPI ex fresh food) forecasts (FY basis)
2.0
1.0
0.0
-1.0
-2.0
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
BoJ BofAML Consensus Target
Source: BofA Merrill Lynch Global Research, BoJ, JCER *Consensus is JCER ESP survey
Chart 8: Wage growth is picking up on the back of tight labor markets
2
1
0
-1
-2
-3
2000 2002 2004 2006 2008 2010 2012 2014 2016
Chart 9: Full-time job growth is accelerating
3.0
Abenomics
2.0
1.0
0.0
-1.0
-2.0
-3.0
2000 2002 2004 2006 2008 2010 2012 2014 2016
Hourly wages, %YoY 4qtr ma
US-style core inflation (ex-tax), %YoY 4qtr ma
Source: BofA Merrill Lynch Global Research, MHLW, MIA
Part-time, ppt contribution
Total employment, %YoY
Source: BofA Merrill Lynch Global Research, MIA
Full-time, ppt contribution
Japan Economics Viewpoint | 18 November 2016 3
Fiscal policy: turning looser In FY17
Fiscal policy is undergoing an equally important shift. In August, the Cabinet approved
an economic stimulus package totaling JPY28trn (roughly 5.5% of GDP). Though “real
water” government spending is a comparatively modest JPY7.5trn (1.5% of GDP), this is
enough to put the fiscal impulse back in expansionary territory, after three years of
tightening (Chart 10). The stimulus measures, which are centered on public investment
and cash transfers to households, should boost CY2017 GDP by 0.5ppt. Public
construction orders are already rebounding as the government front-loaded public
infrastructure spending (Chart 11). Meanwhile, the next stage of the consumption tax
increase has been postponed until October 2019.
Chart 10: After 3 years of tightening, fiscal policy to turn loose in FY17
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
Source: BofA Merrill Lynch Global Research, IMF, CAO
To be clear, we are not talking about massive shifts in the fiscal stance here—the
Ministry of Finance remains very much opposed to expanding the deficit and Prime
Minister Abe has yet to abandon the government’s long-standing goal of balancing the
primary balance by FY2020.
However, there is a growing consensus among Japanese policymakers that premature
fiscal tightening is counter-productive for reflation efforts, especially when monetary
policy is stretched. Even BoJ Governor Kuroda, who initially underplayed the risks from
2014 fiscal tightening, has recently acknowledged that loose monetary and fiscal
policies will have a “synergistic effect.” The upshot is that the risk of another policy
error is low, in our view. If anything, we see upside risks from greater fiscal stimulus in
the form of a third supplementary budget or relatively aggressive FY17 ordinary budget.
We would not rule out further delays to the October 2019 consumption tax hike, either.
Chart 11: Public investment is poised to pick up in the months ahead
30
20
10
0
-10
Forecasts
FY10 FY11 FY12 FY13 FY14 FY15 f FY16 f FY17 f
Fiscal impulse (change in cyclically-adjusted primary balance), % GDP
-20
2010 2011 2012 2013 2014 2015 2016
Public construction orders received %YoY 3mma
Public construction orders completed %YoY 3mma
Contractionary
Expansionary
Source: BofA Merrill Lynch Global Research, MITI
4 Japan Economics Viewpoint | 18 November 2016
2017: a good year for domestic demand
Policy tailwinds are only one pillar of our call for Japan’s outperformance in 2017. We
also believe the stars are aligning for an organic improvement in domestic demand,
which would support the current recovery: the economy is firing on all cylinders for the
first time since 2013, and growth should accelerate to 1.4% in CY2017, followed by
1.2% expansion in CY2018 (Chart 12).
We see three catalysts: a consumer comeback, stronger capex, and a shift in income
away from high-saving corporations in favour of higher-spending households and
stockholders.
Chart 12: Steady improvement in growth, led by domestic demand
3.0
2.0
1.0
0.0
-1.0
BofAMLForecasts
-2.0
2011 2012 2013 2014 2015 2016 2017 2018
Private demand Public demand Net exports Real GDP growth %YoY
Source: BofA Merrill Lynch forecasts, CAO
1. Consumer comeback
Households have been the noticeable laggard in the current recovery and the main
reason why Japan’s economy has barely grown since the 2014 consumption tax hike.
This is not for a lack of income growth: real employee compensation (wages +
employment) has staged an impressive recovery of late, rising 1.2% in CY15, and an
estimated 1.9% in CY16 (Chart 13).
One explanation is that private consumption is simply being underestimated in demandside
GDP statistics: researchers at the Bank of Japan recently produced experimental
supply-side estimates of GDP that were significantly higher than existing expenditureside
statistics. 2 We find the BoJ research interesting and agree that Japanese
consumption statistics are beset by data quality issues. But this alone cannot account
for the consumption slump. We think two factors are equally to blame for depressed
household spending: 1) a squeeze on disposable income from higher taxes and social
security contributions; and 2) a surge in the saving rate (Chart 14).
Calling Japan right in 2017 is largely about correctly forecasting whether these two
trends will reverse. We see several reasons for optimism. First, we expect real employee
compensation to accelerate further, driven by a continued pick-up in per capita wages.
The call on the saving rate is admittedly trickier. But having surpassed the 2006 highs,
we think it is unlikely to surge further, given that consumer confidence is improving and
income growth is firming. FY17 tax reforms are also likely to support household
sentiment at the margin: for example, discussions are underway about enlarging tax cuts
for second-earners who work part-time. Overall, we expect private consumption to rise
1.0% in CY17, adding 0.6ppt to growth.
Should the saving rate stabilize, as we expect, consumption should again start rising in
tandem with compensation. Investors should not have to wait long to get some visibility
around these trends. We expect the saving rate to peak in Q4 CY16 and consumption to
rise strongly from this quarter.
2
Link to the research paper (in Japanese only):
https://www.boj.or.jp/research/wps_rev/wps_2016/data/wp16j09.pdf
Japan Economics Viewpoint | 18 November 2016 5
Chart 13: Real labor income and private consumption
Chart 14: Workers' saving rate at all-time high
270
265
260
255
250
245
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
330
320
310
300
290
280
22
20
18
16
14
12
10
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2012
2015
Real employee compensation, JPY trn saar (LHS)
Private consumption, JPY trn saar (RHS)
Saving rate of workers' households, % 4qtr ma
Source: BofA Merrill Lynch Global Research, CAO
Source: BofA Merrill Lynch Global Research, MIA
2. Capex revival
We also see a fundamental case for higher capital spending. Borrowing rates are very
low and will fall further in real terms as inflation rises. Stronger growth and improved
confidence should also encourage higher capex. And deepening supply-side constraints
offer a strong incentive for Japan Inc. to accelerate productivity-enhancing capex,
ensuring that this expansion is durable.
For these reasons, we think that the impulse of capital expenditures will likely be higher
in the non-manufacturing sector, where capacity utilization rates are higher, and labor
shortages (and hence wage pressures) are more acute (Chart 15 and Chart 16).
Chart 15: Capacity utilization rates by sector
Chart 16: Labor shortages by sector
-10
Insufficient
-40
Insufficient
0
-20
10
0
20
20
30
Excess
40
2003 2005 2006 2007 2008 2010 2011 2012 2013 2015 2016
BoJ Tankan production capacity - manufacturing, DI
BoJ Tankan production capacity - non-manufacturing, DI
Source: BofA Merrill Lynch Global Research, BoJ
40
Excess
60
2003 2005 2006 2007 2008 2010 2011 2012 2013 2015 2016
BoJ Tankan employment conditions - manufacturing, DI
BoJ Tankan employment conditions - non-manufacturing, DI
Source: BofA Merrill Lynch Global Research, BoJ
Chart 17 shows the ratio of personnel costs to sales, using MoF corporate survey data.
The ratio is particularly high for lodging & accommodations (23%), eating & drinking
services (27%), medical, healthcare & welfare (37%) and education & learning support
(37%). Somewhat surprisingly, personnel expenses are fairly restrained in retail. But this
is partly due to the relatively heavy reliance on lower-cost part-time workers. Given the
rapid growth in part-timers’ wages, such cost savings is likely to become increasingly
difficult to maintain.
6 Japan Economics Viewpoint | 18 November 2016
Chart 17: Personnel costs to sales, % ratio 4qtr ma (as of Apr-Jun 2016)
40
35
30
25
20
15
10
5
0
Source: BofA Merrill Lynch Global Research, MoF
Analysis by METI suggests that many of these non-manufacturing industries have the
scope to raise productivity. Wholesale/retail, utilities, and eating & accommodation have
particularly low levels of productivity relative to the US (Chart 18). We think the solution
is to boost capex, especially in ICT and automation. More broadly, an acceleration in
capex is needed if we are to see a pick-up in productivity and sustained profits. Though
we are by no means in the late stages of the profit cycle, the trend clearly points to
higher wage costs going forward, requiring proactive efficiency-enhancing investment
by corporates. Bottom-up data capex data for MSCI Japan also suggest that the
investment cycle has troughed and will pick up next year as earnings momentum
improves (Chart 19).
Chart 18: Japan's labor productivity relative to the US: services is low
Chart 19: Capex – YoY change in Japan vs Global Earnings Revisions
(2003-07)
140
120
100
80
60
40
20
0
Source: BofA Merrill Lynch Global Research, METI
3. Policy priorities and redistribution
We think an increase in government pressure on corporations could speed up income
redistribution at the margin, ensuring that money circulates to those sectors and agents
with a higher propensity to consume. Elevated corporate savings remain a focal point
for the government. Cabinet Office officials have used the concept of the “cash-out
ratio” 3 to highlight the creaky transmission from corporate profits to spending. Chart 20
# stocks upgraded / # downgraded
1.8
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
90 92 94 96 98 00 02 04 06 08 10 12 14 16
Global Earnings Revision Ratio (LHS)
Source: BofA Merrill Lynch Global Quantitative Strategy
30%
20%
10%
0%
-10%
-20%
-30%
MSCI Japan capex %YoY (RHS)
Japan CAPEX (YoY Chg)
3
The idea of the “cash-out” ratio was first raised by private sector representatives of the Council on
Fiscal and Economic Policy. The measure is defined as cash out / cash and deposits. The numerator
includes capex, personnel expenses, R&D, dividends, and changes in equity investments in related
companies. The denominator includes cash and deposits, and securities, short-term lending, and
investment securities classified under liquid assets. Since we are restricted to Ministry of Finance
Corporate survey data, our version of the “cash-out ratio” is defined as capex + personnel costs +
dividends / cash and liquid assets.
Japan Economics Viewpoint | 18 November 2016 7
shows that this measure has been on a steady downtrend, with the numbers particularly
low for large corporates.
So far, the government’s approach has relied more on carrots than sticks, with Prime
Minister Abe using a combination of moral suasion and sweeteners to encourage firms
to disgorge profits. The pattern has continued as we approach FY2017. For example,
local media have reported that the government is considering offering corporate tax
breaks to SMEs that raise wages, in light of more modest wage growth at SMEs.
Discussions are also underway in the Prime Minister’s office about reforming working
practices with the immediate focus on “Equal Pay for Equal work (EPEW)”—i.e. reducing
the wage gap between regular and non-regular employees.
But the issue is contentious from both a capital and labour perspective. And considering
the time it will likely take for related legislation to pass in the Diet, we think the lack of
compliance mechanisms may mean that the immediate impact of EPEW will be limited.
Instead, the debate seems to have shifted towards limiting excessive and unproductive
overtime work. This is low-hanging fruit that does not address the issue of Japan’s
labour market rigidities, which are at the heart of the problem of suppressed wages and
weak household spending power.
That said, there are signs that the government’s patience is wearing thin and that the
Prime Minister is increasingly leaning towards direct intervention. For example, the
government has already delivered a minimum wage hike in FY2016 and plans to take the
national average up to JPY1,000 by 2020 via yearly hikes of 3%. These policy changes
should offer small tailwinds for the recovery in private consumption. We also think the
debate over a possible retained earnings tax is unlikely to go away. We are sceptical it
will be introduced in this year’s tax reforms. However, the government’s escalating war
on corporates hoarding cash is likely to lead to a continued rise in dividend payouts and
share buybacks (Chart 21).
Chart 20: Firms' cash-out ratio*, % 4qtr ma
40%
30%
20%
10%
Chart 21: Dividends and share buybacks by Japanese firms (TSE 1st
section listed)
(JPY trn)
20
15
10
5
0%
1980 1985 1990 1995 2000 2005 2010 2015
All firm sizes Large firms Small firms
0
Dividend
Share buyback
Source: BofA Merrill Lynch Global Research, MoF *The cash-out ratio is defined as personnel
expenses, capex, and dividend payouts as a share of cash and liquid asset balances
Source: Nikkei Astra, BofA Merrill Lynch Global Research
Note: FY2016 dividend is companies' guidance. FY2016 share buyback is estimated by annualizing
the YTD numbers as of November 2016
Risk factors: largely from overseas
A key risk to our 2017 outlook on the domestic side may be weaker-than-expected
growth in real labor income, or a continued surge in the household saving rate, which
would constrain consumption.
However, we think the biggest risks in either direction stem from abroad. Specifically,
we see higher uncertainty over global trade, risk sentiment, and FX as a result of
political transitions in the US and Eurozone. We consider multiple policy scenarios under
a Trump presidency.
Trump’s campaign promises have mixed implications for Japan. On a positive note
deregulation, tax cuts, and aggressive infrastructure spending could boost US aggregate
8 Japan Economics Viewpoint | 18 November 2016
demand. Our US economics team expects the stimulus to boost growth in H2 CY17 and
likely CY18. Japan should be a big winner from stronger US growth, given its high
exposure to the US economy in terms of exports and corporate profits (Chart 22 and
Chart 23). On the negative side, aggressive protectionist trade measures, if
implemented, would depress US growth and global trade further. If combined with a
stronger yen, Japan’s economy would be hit hard.
Chart 22: Japan's export exposure (% of total gross and value-added
exports*)
30
25
20
15
10
5
0
Source: OECD
USA CHN KOR TWN GER
Gross exports
Value-added basis
Chart 23: Breakdown of Japan exports to US by commodity, 2015
6% 7%
12%
22%
39%
14%
Chemicals Manufactured goods Machinery
Electrical Machinery Transport equipment Others
Source: BofA Merrill Lynch Global Research, MoF
Base case: “benign Trump” scenario
For the moment, we are assuming limited positive and negative policy changes. Our US
team expects uncertainty to cause a modest slowing of growth in the first half of next
year, but this will be more than offset by fiscal stimulus in the second half and into
2018. But the size of the fiscal expansion will likely be smaller than promised, and the
introduction of modest protectionist measures means that the boost to global trade will
essentially be zero. Table 1 shows the impact on growth under two scenarios, based on
different assumptions for global trade and FX. Under the upside case, Japan’s GDP could
rebound towards 2%, as the economy benefits from a combination of stronger global
trade and a weak currency. Under a downside “protectionist” scenario, 2017 growth
would slow to around zero and would most likely tip Japan back into deflation.
Table 1: Sensitivity of Japan's growth to global trade and foreign exchange rate
(Assumptions) Baseline Case 1 - Upside Case 2 - Downside
Global trade 0.0% 3.0% -10.0%
% JPY appreciation (*) -7.0% -10.0% 10.0%
(Simulation results) Change (Contribution) Change (Contribution) Change (Contribution)
(**) (**) (**)
Real GDP impact 0.2ppt - 0.9ppt - -1.4ppt -
Consumption 0.0% (0.02ppt) 0.3% (0.15ppt) -0.8% (-0.44ppt)
Capex 1.9% (0.26ppt) 2.9% (0.40ppt) -3.2% (-0.44ppt)
Net Exports - (0.00ppt) - (0.30ppt) - (-0.23ppt)
Source: BofA Merrill Lynch Global Research, CAO, MoF, IMF
(*) Rate of appreciation of Japanese yen in terms of effective exchange rate
(**) Contributions to the change in real GDP
Political impact of a Trump administration
For Japan, the impact of Trump’s election goes beyond economic issues. It also impacts
defense spending and regional trade arrangements.
Military self-reliance and budget choices
Trump has made it clear that he wants allies of the US to shoulder a greater share of
the defense burden. There is a lot of uncertainty as to how far Trump will go to redefine
the US-Japan alliance. Despite his criticism, Japan already pays about 75% of US
military hosting costs. However, it seems fair to assume that Japan will be expected to
Japan Economics Viewpoint | 18 November 2016 9
increase its defense spending. Under Prime Minister Abe, the defense budget has
expanded by 7% but has been kept at roughly 1% of GDP, in keeping with historical
guidelines. This is small by international standards and more likely than not will rise in
the coming years (Chart 24). The composition of spending is also likely to shift from
operating costs towards procurement, which is currently a very small part of the budget
(Chart 25).
Chart 24: Military spending % of GDP as of 2015—Japan's is low by int'l
standards
6
5
4
Chart 25: Breakdown of Japan's defense-related expenditures
100%
50%
3
2
1
0
JP UK AU CH FR KR US RU
Source: BofA Merrill Lynch Global Research, World Bank
0%
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
JP R&D, facility development, maintenance etc.
JP procurement of equipment
JP personnel and food provisions
U.S.Forces Japan-related cost
Source: BofA Merrill Lynch Global Research, Ministry of Defense
TPP and trade policy: potential for linkages with other regional players
Trump and his aides have made it clear that they consider the Trans Pacific Partnership
(TPP) to be a “bad deal.” Media have reported that President Obama is not considering
pushing the deal through a lame duck Congress. This means the deal is likely dead in its
current form.
While negative for Japan, the expected withdrawal of the US from TPP could spur new
arrangements with regional partners. One potential positive is the prospect of improved
economic and trade linkages with other key players in the region, including Russia and
even China. Three upcoming events are worth monitoring closely (Table 2): first, the 19-
20 November APEC Summit in Lima, Peru, where we are likely to see vigorous
discussions on the future of the TPP as well as further progress on the Regional
Comprehensive Economic Partnership (RCEP); second, the 15 December Abe-Putin
Summit, in Yamaguchi prefecture; and third a potential trilateral summit between Japan,
China, and Korea, which onshore media now say is being scheduled for 19-20 December,
though it may not happen given the unfolding leadership upheaval in Korea.
Bullish bottom line – don’t underestimate the recovery
We are optimistic on Japan and think the acceleration in GDP and inflation in 2017 will
be much stronger than consensus expects. For the first time since 2013, fiscal and
monetary policy will be lined up in the same expansionary direction. The global export
cycle has turned and is now tracking modest expansion. Meanwhile, the headwinds to
domestic demand are finally turning into tailwinds. Unlike in the past, we think the risks
of a policy error are low. Assuming that external risks are kept at bay, we think Japan will
surprise with the strength of its recovery.
10 Japan Economics Viewpoint | 18 November 2016
Table 2: Calendar of political events
Date
2016
Sep 26 - Nov 30 (to be extended)
Nov 15
Nov 17
Nov 19-20
Dec 8
Dec 15-16
Dec 24
Event
Extraordinary Diet session (supplementary budget, TPP, tax-hike delay, casino bill)
Japan-Russia trade officials meet (Tokyo)
Abe, Trump meet in New York
Abe, Putin meet at APEC (progress on territorial issue a key public concern)
Jul-Sep GDP 2nd preliminary (change to 2008SNA)
Outline of FY2017 Tax Reform to be released
Russia's Putin to visit Abe in Yamaguchi prefecture
Cabinet to compile FY17 budget
2017
Ordinary Diet session (Jan)
LDP annual convention (Mar 5)
Tokyo parliamentary election (summer)
2018 and later
Source: BofA Merrill Lynch Global Research
Governor Kuroda's term ends (Apr)
2018
Abe's second term as LDP President ends (Sep)
Lower House election if no snap election before (Dec)
Nationwide local elections (spring)
2019
Upper house election (summer)
Consumption tax hike (Oct)
2020 Tokyo Olympics
2021 LDP Presidential term ends
Japan Economics Viewpoint | 18 November 2016 11
Table 3: Economic forecast summary
Calendar Year Fiscal Year Quarterly
2015 2016 2017 2018 2015 2016 2017 2018 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18
(A) (F) (F) (F) (A) (F) (F) (F) (A) (F) (F) (F) (F) (F) (F)
Real GDP (%,qoq ann.) 0.6 0.7 1.4 1.2 0.9 1.1 1.4 1.2 2.2 0.3 2.1 1.5 1.0 2.4 -0.1
Private Consumption (%,qoq ann.) -1.2 0.4 1.0 1.2 -0.1 0.6 1.1 1.3 0.2 1.0 1.2 1.0 1.4 1.4 0.8
Private Capex (%,qoq ann.) 1.6 0.6 1.7 3.2 2.1 0.7 2.4 2.9 0.1 5.0 -0.8 1.4 2.5 7.0 3.1
Private Resid. Investment (%,qoq ann.) -2.5 5.3 0.3 1.1 2.4 6.4 -1.3 1.7 9.6 -2.0 -2.0 -3.9 -5.9 6.1 1.6
Government Consumption (%,qoq ann.) 1.2 1.6 0.8 1.0 1.6 1.1 0.9 1.1 1.7 0.8 0.6 1.2 0.8 0.8 0.8
Public Investment (%,qoq ann.) -2.5 -1.5 3.1 -2.1 -2.7 0.9 1.4 -0.7 -2.7 1.6 8.2 14.8 -11.5 -7.8 -3.9
Exports of Goods & Services (%,qoq ann.) 2.8 -0.3 5.3 3.1 0.4 0.9 5.8 2.3 8.1 4.5 4.5 5.9 11.0 4.6 -3.0
Imports of Goods & Services (%,qoq ann.) 0.4 -1.3 3.9 1.8 0.0 -0.4 4.3 1.4 -2.4 9.0 2.0 4.6 11.8 -1.9 -1.6
Contribution points
Domestic Demand (%,yoy) 0.2 0.5 1.2 0.9 0.8 0.8 1.1 1.0 0.2 1.1 1.7 1.2 1.1 1.3 0.2
Net Exports (%,yoy) 0.4 0.2 0.3 0.2 0.1 0.2 0.3 0.2 2.0 -0.8 0.4 0.2 -0.1 1.1 -0.3
Industrial Production (%,qoq) 1.4 0.7 -0.6 1.6 2.5 1.4 -0.9
(%,yoy) -1.2 -0.8 3.5 3.6 -1.4 0.4 4.2 3.0 0.4 1.2 1.7 3.1 4.2 4.9 4.6
Nationwide BOJ-style Core CPI (%,yoy) 0.5 -0.3 1.0 1.4 0.0 -0.1 1.2 1.4 -0.5 -0.1 0.7 0.7 1.3 1.4 1.4
Nationwide US-style Core CPI (%,yoy) 1.0 0.4 0.4 1.1 0.6 0.3 0.6 1.3 0.2 0.1 0.2 0.2 0.5 0.7 0.9
Unemployment Rate (%) 3.4 3.1 2.9 2.7 3.3 3.1 2.8 2.6 3.1 3.0 3.0 2.9 2.9 2.8 2.8
BoJ ST interest rate target (End of period) -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1 -0.1
BoJ LT interest rate target (End of period) n/a 0.0 0.0 0.0 n/a 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Yen/$ (End of period) 120.2 108.0 120.0 115.0 112.6 112.0 115.0 115.0 101.4 108.0 112.0 115.0 117.0 120.0 115.0
Yen/Euro (End of period) 130.6 116.6 126.0 121.0 128.1 117.6 124.0 121.0 113.9 116.6 117.6 117.3 119.3 126.0 124.0
Note: We may revise our forecasts once additional data become available.
Sources: BoJ, MoF, ESRI of Cabinet Office(EPA), MPMHAPT(MCA), METI(MITI), Ministry of Land, Infrastructure and Transport and BofA Merrill Lynch Global Research estimates.
12 Japan Economics Viewpoint | 18 November 2016
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14 Japan Economics Viewpoint | 18 November 2016