September 30, 2015, 13:30 JST

Japan in recession this summer

The chances are that the Japanese economy had a negative growth in the July-September quarter. According to the official report published on September 30, the industrial production in August fell by 0.5% month on month after a seasonal adjustment, following the 0.8% decline in July. While we are yet to know what happened in September, production plans published by manufacturers suggest that September will see only a very marginal 0.1% expansion in their production. That puts the July-September quarter well on the negative growth path from the April-June quarter.  

note: The forecast for September is according to the production plans surveyed by METI.

Industrial production is of course only a part of the economy, accounting for roughly 20% of it. Service activities such as communication, retailing and finance account for much larger portion. However, in Japan, manufacturing tended to have a very high correlation with the overall economic activities. In the last 15 years, there were 20 quarters where industrial production saw negative quarter growth. In 17 out of these 20 quarters, the overall economic activities were also negative. If the Japanese economy follows such historical norm, Japan is having a recession, defined as two consecutive quarters of negative growth, in 2015. Assuming manufacturers follow their production plan of +0.1% in September, the industrial production in the July-September quarter would show a sizable negative growth of -1.1%.  

note: July-September quarterly growth assumes our projection, +0.1% month on month, for September.

It could be argued that having a technical recession is no big deal for Japan. With the severe declining trend in the work-age population in Japan, the potential growth of Japan is now estimated to be virtually zero. The growth in Japan can easily dip into the negative territory whenever a moderately negative shock hits Japan. Indeed, it sure does not feel like a recession in Japan. Corporate profits just recorded the historical high in the April-June quarter, both in terms of its level and the profit margin. The unemployment rate in Japan remains at record low. 

It will still be more than a month before the official estimate for the July-September GDP is released and there are chances that Japan could escape the marking of a recession. Private consumption seems to have done OK this summer. According to the retail sales report also published on September 30, retail sales in Japan grew by 1.4% in July and stayed level in August. And we are yet to have little solid data on what happened to the economy in September. Having said that, the unusually low temperature in early September probably damaged the private consumption in September, and the corporate capital expenditure does not seem to have done well in the quarter, judging from machinery orders data. The official preliminary estimate for the July-September GDP is now scheduled to be published in November 16, and we will probably have a good idea on its result by early November. 

In our view, the difference between a mildly positive growth, say +0.2% and a mildly negative growth, say -0.2%, is within in a statistical noise and should not matter. However, it probably has an important implication for the public policy management. The government official will probably blame the weakness in the global economy, in particular in China as a cause for recession, but they should admit that the domestic demand is not robust enough to offset the weak external demand. The private consumption growth in 2015 will most likely be negative, and the Japanese companies are continuing to sit on their pile of cash, and if anything, spending their cash in acquiring assets overseas, rather than investing in their domestic facilities. 

In terms of policy responses, the immediate big question is whether the BoJ will implement an additional easing. In our view, the news that Japan is probably going through a technical recession will definitely increase the chance of a monetary easing. An easing by the BoJ as early as in October is conceivable, although not probable. We do not think the news of a probable technical recession will push the BoJ into additional easing though. In the press conference after the BoJ policy meeting scheduled next week, the governor Kuroda is bound to be asked what he thinks of the likelihood of the recession in 2015. He will probably say it is still uncertain, and even if it does, what matters is the future outlook and the outlook of the economy still remains positive, not requiring an immediate stimulus by the BoJ.

What could change such passive attitude of the BoJ? A further slide in the stock market could be an important element. By the close of September 29, Japanese stocks have lost about 20% of its value since its high in 2015. Another element is the exchange rate. USD/JPY is still hovering around 120, surprisingly unaffected by the turbulence in the stock market in the past 2 months. In our view, the BoJ is probably reluctant to push the yen down from the current level, but if yen is to start to appreciate, say break above 110, the BoJ should perceive it as a risk that could derail the Japanese economy. Political pressure is another. Prime Minsiter Abe is facing an Upper House election, and he will find it hard to justify his policies if the economy is turning south. For now, we do not think the governor can muster the majority votes in the BoJ policy board to decide to ease, given how difficult it was in October 2014, but economic and financial development in the next few months could tip the balance. In our view, if the BoJ is to ease in the near terms, we think it will increase its asset purchase of equity ETF and REIT, and maintain its JGB purchase unchanged.