Trade policy review report by the secretariat

2  ECONOMIC ENVIRONMENT

2.1  Recent Economic Developments

1.1.  At the time of its 12^th TPR in 2013, Japan was recovering from the earthquake and tsunami of 2011 which resulted in sharp declines in private consumption and stock-building, and widespread supply chain disruptions affecting production across the country, particularly in export led sectors such as automobiles and electronics. Production had also been affected by the shutdown of nuclear power plants following the accident in Fukushima in 2011. Moreover, Japan confronted other key challenges, notably very high public debt, rapidly aging population, and nearly two decades of deflation and low growth.¹

1.2.  Since then, Japan has been implementing an ambitious reform programme to overcome deflation and revitalize the economy. The programme consists of a "three arrows strategy"²: monetary easing, flexible fiscal policy, and structural reforms (section 1.3).

1.3.  Regarding monetary policy, on 22 January 2013 the government and the Bank of Japan (BOJ) released a joint-statement, where BOJ set a 2% price-stability target to be achieved at the earliest possible time.³ On 4 April 2013, BOJ introduced "Quantitative and Qualitative Monetary Easing" which included increasing the monetary base by some ¥60-70 trillion per year mainly through the purchase of Japanese government bonds.⁴ As a result, BOJ has now become the single biggest holder of Japanese government bonds (JGBs) underscoring the scale of its monetary easing programme.⁵ On 31 October 2014, BOJ announced it will expand the monetary base each year by some ¥80 trillion (from ¥60-70 trillion) in a further effort to achieve the 2% inflation target.⁶

1.4.  On the fiscal side, the strategy has involved short-term economic stimulus combined with medium-term measures aimed at achieving fiscal consolidation. In early 2013, a fiscal package of ¥10.3 trillion (some US$100 billion or about 2% of GDP) was adopted.⁷ In December 2013, an extra fiscal stimulant of ¥5.5 trillion (US$53.4 billion or about 1% of GDP) was approved to mitigate the downside risks to the economy of the consumption tax rate increase from 5% to 8% applied as of 1 April 2014.⁸ This was the first increase in the consumption tax in 17 years and the first step in a two-stage boost that is set to take the tax rate to 10% in April 2017.⁹ The consumption tax, levied on goods and services transactions, is the largest component of indirect taxes, contributing 20.7% to total tax revenue in FY2013. The 8% consumption tax rate consists of the national consumption tax (6.3%) and a local consumption tax (1.7%).

1.5.  Japan also aims to halve by FY2015 the primary deficit of central and local governments as compared to that of FY2010, and to achieve a primary surplus by FY2020. Thereafter Japan will seek to reduce the public debt-to-GDP ratio (estimated at about 240% of GDP in 2013). According to the IMF, the fiscal measures adopted by Japan are a welcome step but a concrete medium-term fiscal consolidation strategy beyond 2015 is needed otherwise the public debt-to-GDP ratio would again begin to rise after 2019.¹⁰

1.6.  Regarding the exchange rate of the yen, a nominal depreciation against the U.S. dollar of about 22% took place in 2013 (Table 1.1), reflecting several factors such as the new monetary framework, a reversal of the yen's safe haven status, and a structural weakening of Japan's trade balance given higher energy imports (section 1.2.1). Between January-November 2014, the nominal exchange rate of the yen also depreciated against the U.S. dollar.¹¹

Table 1.1 Selected macroeconomic indicators, 2009-13

	2009	2010	2011	2012	2013
	(% change, unless otherwise indicated)
National accounts
Real GDP	-5.5	4.7	-0.5	1.5	1.5
Final domestic demand	-4.0	2.9	0.4	2.3	1.8
Private consumption	-0.7	2.8	0.3	2.0	2.0
Government consumption	2.3	1.9	1.2	1.7	2.0
Gross fixed capital formation	-10.6	-0.2	1.4	3.4	2.6
Exports of goods and services	-24.2	24.4	-0.4	-0.2	1.6
Imports of goods and services	-15.7	11.1	5.9	5.3	3.4
Exports of goods and services (% of GDP)^a	12.7	15.2	15.1	14.7	16.2
Imports of goods and services (% of GDP)^a	12.3	14.0	16.0	16.7	19.1
Employment	-1.5	-0.3	-0.1	-0.3	0.7
Unemployment rate (annual average)	5.1	5.0	4.6	4.3	4.0
Household disposable income (% change)	-1.1	0.5	-0.1	-0.1	..
Prices and interest rates
Consumer prices (CPI) (average; % change)	-1.3	-0.7	-0.3	0.0	0.4
GDP deflator (% change)	-0.5	-2.2	-1.9	-0.9	-0.6
Basic discount rate and basic loan rate (%)	0.3	0.3	0.3	0.3	0.3
Exchange rate (annual average, ¥ per US$)	93.5	87.8	79.8	79.8	97.6
	(% of GDP)
Fiscal balance
Revenue	29.6	29.6	30.8	31.2	31.7
Expenditure	40.0	38.9	40.6	39.9	40.0
Balance	-10.4	-9.3	-9.8	-8.7	-8.3
Primary balance	-9.9	-8.6	-9.0	-7.8	-7.6
Excluding social security	-9.3	-8.2	-9.0	-8.0	-7.6
Government debt, gross	210.2	216.0	2,229.8	237.3	243.4
Saving and investment
National saving (gross)	22.2	22.3	22.4	21.9	..
Domestic investment (gross)	19.7	19.8	20.2	20.8	21.0
Current account	2.9	4.0	2.2	1.0	0.7
Goods	1.1	2.0	-0.1	-0.9	-1.8
Exports	10.9	13.3	13.4	13.1	14.2
Imports	9.7	11.4	13.4	14.0	16.0
Services	-0.7	-0.6	-0.6	-0.9	-0.7
Primary income	2.7	2.8	3.1	3.0	3.4
Secondary income	-0.2	-0.2	-0.2	-0.2	-0.2
Capital account	-0.1	-0.1	0.0	0.0	-0.2
Financial account	3.4	4.6	2.8	1.0	-0.3
Direct investment	1.2	1.3	2.0	2.0	2.7
Portfolio investment	4.4	2.7	-2.7	0.7	-5.3
Financial derivatives (other than reserves)	-0.2	-0.2	-0.3	0.1	1.2
Reserve assets	0.5	0.8	2.9	-0.6	0.8

.. Not available.

a Percentage distribution in annual nominal GDP.

Source: IMF (2014), Japan – 2014 Article IV Consultation – Staff Report, Country Report No. 14/236. Viewed at: https://www.imf.org/external/pubs/ft/scr/2014/cr14236.pdf; and information provided by the Japanese authorities.

1.7.  In 2013, the Japanese economy grew by 1.5% (the same as in 2012) supported by strong industrial production, retail sales, and consumer spending. Expenditure on rebuilding the physical infrastructure also helped.¹² For 2014 and 2015, the IMF expects Japan's real GDP growth to be 0.9% and 0.8%, respectively, as fiscal stimulus winds down.¹³ On 31 October 2014, BOJ halved its forecast for economic growth for FY2014 to 0.5%.¹⁴ The consumption tax increase had a negative effect on domestic demand which together with weak capital spending and big cuts in inventories caused the economy to shrink by 7.3% and 1.9% in the second and third quarters of 2014, respectively.

1.8.  In 2013, Japan had an annual average inflation rate of 0.4% (zero in 2012) supported by BOJ's accommodative monetary policy stance. For 2014, the IMF expects an average inflation rate of 2.7%, i.e. somewhat above the 2% target, mainly as a result of the consumption tax increase. Nonetheless, underlying inflation (excluding the consumption tax increase) is expected to be 1.1% in 2014. For 2015, the IMF expects inflation of 2%.¹⁵ Following additional monetary easing, BOJ expects to meet its 2% inflation target in or around FY2015.¹⁶

1.9.  Japan's current account surplus decreased during the review period from US$127.1 billion in 2011 to US$33.2 billion in 2013 (Table 1.2), reflecting a narrowing of the gap between gross national savings and gross domestic investment (Table 1.1). This decline is mainly the consequence of the trade deficits recorded since 2011, the longest period since comparable records began in the 1970s (section 1.2.1). For 2014 and 2015, respectively, the IMF expects current account surpluses of 1% and 1.1% of GDP.¹⁷

Table 1.2 Balance of payments, 2009-13

(US$ billion)

	2009	2010	2011	2012	2013
Current account	145.4	217.9	127.1	58.7	33.2
Goods	57.6	108.6	-4.1	-53.6	-90.0
Exports	547.0	735.0	789.7	776.9	696.0
Imports	489.4	626.4	793.8	830.5	786.0
Services	-34.9	-33.7	-38.2	-50.6	-35.7
Credit	121.0	131.3	137.6	134.2	135.4
Transport	31.6	39.0	38.4	40.2	39.6
Travel	10.3	13.2	11.0	14.6	15.2
Other	79.1	79.1	88.3	79.5	80.7
Debit	155.9	165.0	175.8	184.8	171.1
Transport	40.6	46.5	49.5	55.4	47.0
Travel	25.2	27.9	27.2	27.9	21.9
Other	90.2	90.6	99.1	101.5	102.3
Primary income	135.2	155.4	183.4	177.2	169.1
Secondary income	-12.4	-12.5	-13.9	-14.4	-10.2
Capital account	-5.0	-5.0	0.4	-1.0	-7.6
Credit	1.1	0.9	7.5	6.0	1.2
Debit	6.1	5.8	7.1	7.0	8.8
Financial account	173.2	254.1	165.9	61.6	-16.7
Direct investment	61.3	71.4	116.8	119.1	133.6
Portfolio investment	219.4	151.2	-162.1	40.4	-261.5
Financial derivatives	-10.2	-11.7	-16.9	7.4	57.0
Other investment	-124.4	-0.1	55.2	-67.0	14.6
Reserve assets	27.0	43.3	172.9	-38.3	39.5
Net errors and omissions	32.7	41.1	38.5	3.9	-42.3

Source: Information provided by the Japanese authorities.