Japanese Q2 GDP misses consensus forecasts


The Japanese economy grew less than expected in the second quarter of 2013 according to the Cabinet Office. Consensus forecasts for Q2 annualized growth were at 3.6% but actual growth came in at 2.6%.

This a rather large miss, but perhaps more than anything reflects that analysts and economists at investment banks are getting slightly carried away with excitement over the improvement in the economy.

There is no doubt that the economy is improving. 2.6% is still a very healthy GDP growth rate, and it far exceeds that of most countries in the world. However, anything less than this would have been disappointing, since the Japanese economy is being stimulated quite aggressively through both fiscal and monetary means via the Abenomics program that we have explained in some detail here.

Using quarterly Cabinet Office data (seasonally adjusted), we have put together a few charts to highlight what we think are the key points from today’s GDP figures.

Firstly, the overall trend in GDP looks reasonably healthy on the face of it:

GDP - Q2

What is driving the recent growth seems to be mainly private consumption, which is exactly what Abenomics is aiming for, at least as a first stage:

GDP - Q2 a

There has been some concern that the observed growth in consumption has been partly the result of consumers moving forward their expenditure in order to avoid the controversial consumption tax hike that we have discussed here.

However, it does appear that there is more to the story than that. Notice how consumption seemed to roll over in early/mid 2012, only to pick up again in late 2012 and early 2013. This seems to hint at consumers reacting to Abenomics even before the results became evident. In other words, the average Japanese consumer clearly bought into the idea that Japan was capable of turning the corner through implementation of Abenomics, and this in conjunction with the rapidly rising equity market in late 2012 (caused by largely speculative foreign investor inflows, as well as the dramatic effect on corporate profits caused by the falling Yen, which in turn was a result of the BoJ aggressive QE program), clearly caused consumers to loosen their purse strings. Finally, there was (and still is) a quite concerted effort in most of the Japanese media to encourage the idea that Japan is turning the corner, and with that message being drummed home every day to the average consumer through TV and newspapers, there is no doubt that this would have had a positive impact on people’s spending patterns.

Consumption 1

This is all very positive, but as NipponMarketBlog has pointed out in the past, unless wage inflation takes hold now that consumer price inflation seems to be turning positive (see our piece here), there is a real risk that the bounce in consumption that we have observed so far, may well fizzle out.

In the absence of further growth in consumption, the other two major components of GDP that have the potential to take over and thus maintain positive growth for the economy as a whole, are government spending and private investment (particularly corporate investment). Unfortunately, given the Japanese government’s dismal fiscal situation (see our piece here), continuing with public sector spending (and thus also deficits to the tune currently 10% of GDP) is simply not sustainable for more than a couple of years. In other words, private investment has to take over as the driver of continued growth. There is also the risk of so-called ‘moral hazard’ from too much public spending (see out piece here).

Sadly, for the moment at least, there seems to be limited scope for an increase in corporate spending. The Q2 GDP figures reveal that private non-residential investment actually fell 4.5% YoY, which is quite an unpleasant surprise, especially considering the very large jump in corporate profits being reported at the moment (in the order of 100% YoY across the companies listed on the TSE).

GDP - Q2 b

Clearly, the fall in the Yen and the resultant increase in corporate profits has not yet persuaded companies to invest in new equipment. The government is mulling over a plan to incentivise companies to increase investments through tax breaks, but one has to wonder how effective that is going to be, for the simple reason that corporate Japan has been flush with cash for years and so presumably would already have increased their investment spending if they had deemed it necessary or beneficial to do so. The fact that this has not happened, seems to indicate to NipponMarketBlog that from a business management point of view there simply is not currently a perceived requirement to increase investment, and no amount of tax breaks are going to change that – at least not in a meaningful way.

So why have companies not invested more given that the Japanese economy is picking up? There could be several reasons for this. Firstly, corporate Japan is inherently very conservative, and one does not usually see large scale investments unless there is an obvious opportunity presenting itself. Secondly, corporate Japan has suffered from overcapacity in many sub-sectors (which is partly the reason for the prolonged period of deflation), and so the economic rationale for further investments is tenuous at best. Secondly, could it be that corporate Japan as a whole is still not buying in to Abenomics, possibly because they realize that they growth in profits that they have already experienced is to a large extent the result of the accounting effect of a weaker yen?

Industrial Production

Either way, it is NipponMarketBlog’s view that the government will struggle to materially affect any meaningful change in corporate capital spending behavior, especially if they now begin to find themselves under pressure to increase employee salaries and bonuses because of inflation beginning to turn positive.

Any decision on the part of corporate Japan to increase spending has to come from within, and it has to be the result of decisions about returns on invested capital, which in turn will be based on confidence in the sustainability of the domestic recovery and the strength of the global economy. Time will tell whether corporate Japan eventually steps up and starts investing again, but there is no doubt that without an increase in investment, Japan’s apparent revitalization could be at risk of failing.

Finally, we present the view of the level-headed HSBC strategist Garry Evans, who appeared on Bloomberg TV and among other things discusses the idea of a very incremental increase in the consumption tax, which NipponMarketBlog finds an infinitely more sensible idea than the currently proposed two-stage doubling next year from 5% to 10%. The last thing the government would want at this point in time is to risk derailing the recovery in consumption by slapping the consumers with a higher sales tax that may well decrease their propensity to spend, especially if wages do not keep up with increases in prices.


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