- Japan's growth outperformance is primarily driven by exports and tourism-related sectors
- Post-Covid consumption recovery still trails behind
- An instrumental factor shaping these dynamics is the substantial depreciation of the yen
- The assertion that a weak yen has a positive net impact on the economy gains support from data
According to the preliminary estimate released this week, Japan's GDP growth accelerated to 6.0% QoQ saar in 2Q, notably faster than the 3.7% in 1Q. On a YoY basis, the economy maintained a steady expansion of 2.0% in 2Q, mirroring the growth seen in 1Q. Barring an abrupt downturn in 2H, full-year growth appears on track to reach approximately 2%. This signifies a notable acceleration of about 1ppt compared to the previous year, bucking the regional trend of a widespread slowdown.
Drivers of growth outperformance
To identify the driving forces behind Japan's growth outperformance, we conduct a comparative analysis with other North Asian economies, scrutinizing exports, tourism exports, and domestic consumption. Our findings reveal that Japan outperforms most regional counterparts in both exports and tourism-related activities. However, the path to post-Covid consumption recovery trails behind. The yen's substantial depreciation plays an important role in shaping these dynamics.
Exports: Japan’s exports exhibit a slightly better performance compared to regional peers amidst the ongoing global trade downturn. In USD terms, Japan's exports contracted at a single-digit rate of -5.6% YoY during the Jan-Jul period. In contrast, both South Korea and Taiwan experienced double-digit declines of around -15% YoY in their respective exports. China's exports, following an initial robust rebound due to supply-side restoration, declined back to approximately -15% YoY in recent months. The resilience in exports, coupled with the reduction in imports, acted as a primary driving force behind Japan's 2Q GDP, contributing 6.1ppt on a QoQ saar basis.
Japan's diversified exports portfolio, characterized by a relatively small reliance on the electronics sector, underlines its resilience. Electronics constitute just 19% of Japan's total exports, in contrast to China, South Korea, and Taiwan, where the proportion ranges from 30% to 50% (2022 statistics). The electronics sector, impacted by the dissipation of lockdown-driven demand and drastic inventory destocking, has encountered challenges post-Covid. Conversely, the automotive sector, accounting for 17% of Japan's exports, is on a path to recovery, benefiting from supply chain stabilization and the easing of chip shortages.
Furthermore, the yen's substantial depreciation also adds to Japan’s export resilience. The JPY REER has witnessed a cumulative 25% decline since the outset of the pandemic in early 2020. The undervalued yen bolsters the competitiveness of Japan's exports. It also fosters the process of production reshoring, as a rising number of Japanese MNCs rebuild supply chains in the post-pandemic landscape.
Tourism exports: Notably, Japan's tourism exports exhibit a superior performance compared to regional counterparts during the post-Covid reopening. Foreign visitor arrivals in Japan exceeded 2mn in June, surpassing 80% of the pre-pandemic levels recorded in Dec19. This stands in stark contrast to the 40%-60% recovery observed in South Korea and Taiwan.
While China was a dominant source of tourism before Covid, Japan has effectively diversified its tourist sources in the post-pandemic era. Chinese tourists constituted 30% of Japan's total visitor arrivals in 2019, a proportion that dwindled to merely 5% in 1H23. The rest of Asia now contributes a substantial 70% to Japan's visitor arrivals. The synergy of a weaker yen and Japan's enticing tourism resources has bolstered this impressive recovery.
Domestic consumption: On the domestic front, Japan's recovery in consumer spending has followed a relatively slow and gradual path. Private consumption expenditures have largely returned to the pre-pandemic levels recorded in 4Q19, but they remain slightly below the 3Q19 levels preceding the 2019 sales tax hike. Notably, this trajectory lags behind Taiwan, which experienced a V-shaped consumption rebound driven by the release of precautionary savings post-Covid. It also lags behind South Korea, which faces consumption constraints arising from elevated interest rates and declines in property prices. In 2Q, private consumption expenditures acted as a modest drag on Japan's GDP, subtracting 1.1 ppt from the headline growth on a QoQ saar basis.
Japan's ultra-low interest rate environment, appreciating asset prices, improving labor market conditions, and recovering consumer confidence collectively bolster the consumption prospects. However, the primary impediment lies in the surge in inflation. Average CPI inflation soared to 3.5% YoY in 1H23, driven by the yen depreciation and elevated import costs. Although nominal total wages and base wages picked up to 2.6% YoY and 1.5% YoY respectively post the Shunto negotiations, they still failed to adequately offset the inflationary impact. As a result, diminishing real wages have curtailed consumers' purchasing power and dampened consumption.
The adverse effects of yen weakness on consumer spending are also reflected in outbound tourism. As Japan reopens, the number of resident departures has increased, recovering to approximately 40% of the pre-pandemic levels recorded in Dec19. This is, however, far lower than South Korea and Taiwan's recovery rates of 70%-90%.
Implications for forecasts and policies
The robust 1H GDP performance justifies an upward revision of the full-year 2023 growth forecast, from 1.2% to 2.0%. This entails a technical payback of about -1% QoQ saar in 3Q, followed by a projected on-trend growth of 1% in 4Q. On a YoY basis, growth is expected to remain stable at around 2% during 3Q-4Q.
The impressive headline growth, despite varying performances across external and domestic sectors, bolsters the Bank of Japan's assertion that the net impact of a weak yen remains beneficial for the overall economy. Following the Yield Curve Control adjustment in July, the BOJ has embraced a more flexible approach, allowing the 10Y JGB yield to fluctuate between -0.5% and 1.0%. The increased operational flexibility further reinforces our anticipation that the BOJ will maintain the existing YCC policy framework throughout the remainder of the year.
To read the full report, click here to Download the PDF.
