Tokyo’s attempts to bring back fiscal restraint may be hampered by a fresh leadership contest, since choosing the ruling party’s new leader this month runs the risk of calling an early parliamentary election. This also applies to the next prime minister.

The Bank of Japan is moving away from its stimulus programme that has lasted for ten years, as evidenced by the record 117.6 trillion yen (USD 811.93 billion) in budget requests. This implies that the government is no longer able to depend on extremely low borrowing costs and on the central bank to essentially finance debt.

As per the finance ministry, the assumed interest rate is expected to rise from 1.9% to 2.1% for the year beginning in April 2024. This would increase debt-servicing costs for interest payments and debt redemption, which will reach 28.9 trillion yen from 27 trillion yen for the current year.

“An economic package likely to be compiled under the next prime minister, including whether to extend energy subsidies, will show the new leader’s stance on fiscal discipline,” Hideo Kumano, chief economist at Dai-ichi Life Research Institute, said.

The minister of digital transformation and a candidate for the position, Kono Taro, called the current fiscal situation an “emergency situation” and stated that Japan needs to restore fiscal discipline.

Takayuki Kobayashi, another contender, announced that he would introduce a new package to help alleviate the burden of growing costs.

“The economy should be prioritised over finance,” he said.

Another candidate, Toshimitsu Motegi, declared that he would support a large stimulus package to guarantee the economy keeps improving.

“With a looming lower house election ahead, calls for more spending could grow,” Saisuke Sakai, senior economist at Mizuho Research and Technologies, said.

A failure to streamline spending would make it difficult to achieve a primary budget surplus, he added.

Meanwhile, in some good news for the country, its services activities expanded further in August 2024, helped by overseas sales as it gained an edge despite the darkening global outlook, according to a private sector survey.

The final Au Jibun Bank Services Purchasing Managers’ Index (PMI) came in at 53.7, unchanged from the initial reading and above the 50.0 line, separating expansion from contraction for the second month in a row. The headline figure was aligned with July’s reading, but service companies saw a slowdown in new business growth compared to the previous month.

However, export sales rebounded from a contraction in July to the largest rise in three months, supporting overall service-sector business.

The manufacturing sector, on the other hand, contrasted a different picture as it witnessed its poorest exports in five months due to weak demand in China, South Korea, and other major markets.

As per the government data, Japan’s export growth was below expectations in July 2024, underlining growing risks of further deceleration due to a stronger yen and softer conditions.

Weak global demand is clouding the prospect for the Asian country’s sustainable economic growth, while the Bank of Japan policy tightening has promised more rate hikes if the economy and inflation match up to its forecasts.

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However, its official currency yen reached its 32-year low against the dollar. The crucial factors behind these are the widening interest rate gaps between the US and Japan, along with the latter’s trade and current account deficit.

Japan’s history of low inflation
Despite its destruction in the Second World War, Japan in 1960 had a per capita GDP of around USD 8600, about one-third of the US. The same figure touched the USD 35000 mark by 1988 and surpassed the US on this front.

The average per capita growth in Japan was 5.2% in 1988 alone. However, after the 1989 Tokyo stock market crash and the 1992 asset price bubble burst, the US overtook the Asian country in terms of per capita income and it widened further. As per the 2018 stats, the US per capita income was USD 55,000, while Japan’s was USD 49,000. The Asian country’s average per capita GDP growth figure from 1998-2018 was only 0.76%.

However, one noticeable thing about Japan is its consistently low inflation. In the 1980s, it was at 2.5%, came down to 1.2% by the 1990s and in the early 2000s, became deflation, averaging from -0.2% to 0.5% in 2019. During COVID, the parameter turned negative again.

It rose from 0.1% in 2021 to 2.6% in 2022. Also, from 1992 to 2021, consumer goods prices rose only by 6% in Japan as against the nearly 80-90% ones in the UK and US.

Roles of Abenomics and wage rule behind low inflation
In 2012, after coming into power for the second time, late Japanese PM Shinzo Abe came up with “Abenomics”. It was about increasing the country’s money supply, boosting government spending, and infusing the essence of competitiveness in the economy.

From 2013-2018, Japan’s monetary base expanded through government-backed easing. It was done to disrupt the prolonged strong yen and deflationary recession that haunted Japan from 1993 to 2013 beginning.

The beneficiaries of the monetary policy easing were large exporting companies and the wealthy as they reduced wages and raised the consumption tax. There was no increase in average household incomes, affecting consumer behavior.

During COVID, the government spent large amounts of capital to keep the economy running. It used only a small amount of money on the household support front. With prices remaining moderate and no wage hike, Japan lowered the risk of severe inflation back then.

Japan’s average wage rate ratio has remained the same since 1992. As per the data of the Organization for Economic Cooperation and Development (OECD), the Asian country’s average annual individual income is ranked 24th out of 35 nations. Among G7 members, it is the second lowest.

With food and energy prices rising in 2022 and not the average salaries, an average Japanese household can find meeting its daily ends very difficult.

As per the Focus Economics report, the weak domestic demand is related to low wages. Over a third of all jobs are either part-time or contracted ones, with the labor unions focussed more on the job security front.

However, with inflation severely affecting the best of economies in the world right now, this pattern may change in the coming days as either the business leaders will have to effect some salary raise for their staffers or the unions will have to toughen their stance on the matter to ensure that the basic salary scale is matching the positive inflation metrics or in the best case, outpacing the latter.

While the nation opted for the gradual easing of pandemic curbs, resulting in slower economic recovery and a delayed yet significant post-COVID demand increase, as explained by Yasumune Kano from policy think tank Chatham House, these moves will only hold back the arrival of global inflation, instead of completely avoiding it.

Bank of Japan’s love affair with negative interest rates
The Bank of Japan has a monetary policy different from that of the US or UK. For the Bank of Japan, it’s all about going after monetary policy easing as opposed to the western counterparts, whose primary weapon against inflation is aggressive rate hikes. The Japanese central bank has the distinction of being the only major financial institution with a negative interest rate policy.

A Moneycontrol report perfectly sums up the BoJ’s situation. It has this constant juggling act between low inflation and deflation. From negative interest rates to large-scale stimulus, it tried everything. While the inflation rate stayed on the negative scale during COVID, it became positive in September 2021 and rose to the 2008 level of 2.5%. The bank’s short-term policy rate remains at an ultra-low level. It eyes buying of bonds and keeps the 10-year interest rates in that area at zero percent.

Talking about deflation, it’s a phenomenon where people ‘believe’ that consumer products will get cheaper as time passes by and stall the consumption behavior growth. The overall economy slows down due to poor demand. While all the other central banks raise policy rates to lower aggregate prices, Japan’s deflation scenario calls for increasing aggregate prices.

Bank of Japan Governor Haruhiko Kuroda recently justified his bank’s policy stance by citing three reasons. First is the country’s slow recovery from COVID, second has been poor Gross National Product (sum total of all Japanese nationals’ incomes, excluding the non-citizens living in the country) growth. As against the 2021 GDP growth of 2.5%, Japan’s GNP was around 0.6%. And the final factor cited by him was high energy prices.

As per a recent study, the rising inflation in Japan is due to the external supply factor, compared to the United States, where the same ratio is nearing 9% due to higher demand and lower supply.

When the interest rate or the cost of borrowing money goes down, the citizens spend more. In Japan, it’s completely the opposite. As per Bloomberg, the interest rate in the Asian country has been at -0.1% since 2016. The same rate, since 1995, never crossed the 0.5% mark.

The report also cites Japan’s aging population behind this low consumer demand and this factor is helping inflation to remain low. This section of the population is keeping more money at hand as the savings policies don’t offer lucrative returns due to the negative interest rates.

During an interaction with International Finance, Professor Robert Dekle, faculty member of the economics department of the University of South California, said, “The high costs will raise Japanese producer costs and they will raise their prices, hurting consumer demand and GDP. If the country is worried about the weak yen, it will have to raise interest rates. But the weak yen has benefits like promoting exports and tourism as well, and shifting demand to Japanese products. Whether the weak yen on the net will hurt Japan is an open question.”

Talking about the Bank of Japan’s distinction of sticking with the formula of easing monetary policies and whether that will help the country to fight inflation this time around, Professor Robert Dekle said, “The inflation rate is still low, and the economy is still weak, so Japan will try to muddle through with the low interest rates, despite the weak yen.”

“No, the higher minimum wages will worsen inflation by raising wages and producer costs,” he replied, when asked about the Japanese government’s plan about introducing a ‘Minimum Wage Hike’ policy.

Japan’s tight state controls to deal with price rises
Along with the Bank of Japan’s monetary policy easing stance, Japan is also known for its government control to limit consumer goods and services price volatilities.

Electricity and natural gas prices follow the gradual revision process and the utility providers go for long-term supply contracts. They only pay a yearly premium to ensure price stability, petrol prices have been subsidized recently.

While the world is suffering due to the surge in wheat prices, thanks to the Ukraine war, Japan is immune from its side effects as the product is imported by a government entity that follows the principle of fixing a six-month uniform market resale price range. Japan imports mainly from the US, Canada, and Australia. In 2022 June, this import cost exceeded the resale price, effecting a subsidy-kind of situation for the domestic consumers.

While Japan may go for a bigger and more prominent “bread and noodle subsidy” as the Ukraine conflict rages on, the slow lifting of COVID curbs also ensures that the post-pandemic demand increase will keep the country’s inflation down for some more months. Still, there is a shift towards sustained inflation for Japan’s economy and the “cost of living” emerged as an issue during the recently concluded House of Councilors election.

The Bank of Japan said that future debates on its monetary policy will revolve around short-term interest rate hikes and the central bank’s balance sheet health. So, it needs to be seen whether the Asian powerhouse goes for an economic policy change and if it happens, how drastic it will be.

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The surge in inflation was fuelled primarily by rising food prices and the dissipation of previous mobile charge cuts. The economists think that Japan’s price rises will speed to the central bank’s 2% objective in the coming months.

Takumi Tsunoda, senior economist at Shinkin Central Bank Research Institute said that the nationwide inflation may rise to 2% in April-June. He also added that inflation may not keep accelerating further as the pace of the energy price is slowing.

The increase in the Tokyo core consumer price index (CPI) was quicker than the median market prediction of 1.8%, followed by a 0.8% rise in March. The index excludes fresh food, which is a variable factor but includes energy goods.

In the overall reading, Tokyo’s CPI climbed 2.5% in April from the previous year, the sharpest rate of inflation since October 2014. The report indicated that the fading effect of last year’s mobile fee reduction pushed up the total CPI by 0.80 points, while non-fresh food costs pushed it up by 0.17 points.

According to a government official, to-go sushi packages, hamburgers and bread saw the biggest price hikes among food items in April. Also because of the government’s fuel subsidy schemes to cut gasoline and other energy expenses, energy prices in Tokyo grew 24.6% year-on-year in April, slower than in March. Posting the first increase since March, the core CPI in Tokyo excluding fresh food and energy items rose 0.8% in April.

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The BoJ’s preferred measure of core CPI, excluding fresh food, rose 0.2% in March, still a long way from the BoJ’s FY2017 forecast of 1.4%. That said, the April Tokyo CPI was slightly better than expected, unlike in the previous two releases, although the pace of inflation still remains slow.

On the other hand, the labour market report confirmed tight conditions in March, with the unemployment rate staying the lowest level since the mid-1990s. Industrial production fell more than expected in March, but mainly due to the volatility of the series while corporates expect a sharp rise in production in April.

All said, the Japanese economy continues to face the issue of tight job market conditions and better activity not translating into underlying price rises. The recent  round of annual wage negotiations provides little support for this transmission, with wage growth likely to decelerate for the second straight month.

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