Japan’s Economy Shrinks 2% in Jan.-March

Japan’s economy shrank by an annualized rate of 2% in the first quarter of this year, according to the Cabinet Office. It was the first drop in two quarters and followed a protracted period in which the country had failed to exit deflation. Private consumption – the backbone of domestic demand – slid 0.7% in inflation-adjusted real terms. Exports also dived, falling by 5%, the first drop in four quarters. Frauds surrounding safety testing at some car makers, which led to stalled production, took a toll on economic growth as did the Noto Peninsula earthquake.

The contraction was worse than the 0.8% drop analysts had feared and casts doubt on the strength of any economic rebound. The country’s GDP exceeded ¥599tn on an annualised nominal basis, which is approaching the target of ¥600tn that was set by former Prime Minister Shinzo Abe’s administration in 2015. Nevertheless, the overall result was prompted by price increases and therefore many people were unable to feel the impact of economic growth.

The extended period of deflation and intermittent growth has made it challenging for the Bank of Japan to achieve its inflation targets. “This is not a good number for Abenomics. The more we see slowing in this economy, the more difficult it is for the Bank of Japan,” said Jesper Koll, CEO of WisdomTree Japan.

In the January-March period, consumers reacted adversely to the fraudulent testing scandals at some automakers, which had an impact on overall private consumption. Growth in financial services may have been behind a rise in stock prices following the government’s announcement of a new tax exemption scheme, Nippon Individual Savings Account, for small-lot investors.

In the aftermath of the Kumamoto earthquake in April followed by heavy rains and flooding in southern Japan, companies are curbing production until supply chains are fully operational. Meanwhile, attempts by Prime Minister Shinzo Abe to defy a long-standing caution against foreign bonds, has led some analysts to suggest that the Japanese are becoming bolder in their investments. The uncertainty following the Brexit vote has not put off investors in Japan from seeking higher yielding debt securities in the UK. The yen-denominated bonds may offer better yields and currency advantage.

Even as the country takes cautious steps in global affairs, the focus is on the Prime Minister’s planned comprehensive economic package that will offer measures such as financing for small and medium-sized firms so as to ensure the country’s long-term economic growth. Public investment has consistently been debated, but the government needs to steer the plan towards measures which will offer the best reforms centered on achieving sustainable growth taking into account international developments.

With US intervention in Asia increasing, Japanese corporates are showing a growing interest in diversifying operations and investing overseas. Sectors such as infrastructure promise strong demand, backed by public-private funding, especially emerging markets such as India. Encouraging innovation and investment across all sectors is crucial, but small start-up firms will need guarantees of financial support in order for their projects to become sustainable over the longer term.

Despite the struggles of Abenomics to date, experts suggest that growth is likely to come from overseas investments, innovation, and increased support of small-scale startup businesses. But in the short-term, deflation is a worry, exports need to improve, and consumer sentiment must be revived. Only then will analysts be able to predict with certainty the direction of the economy

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