The contraction in Japanese economic activity in Q312 highlights a weak near-term economic outlook, according to Fitch Ratings. Forward-looking indicators give little scope for optimism regarding fourth quarter performance, and Fitch says that it is likely to trim its 2012 growth forecast from 2.1% when it updates its global economic outlook next month.
Japanese gross domestic product (GDP) shrank at an annualised rate of 3.5% in July-September – the first quarterly contraction since Q411. A 5% quarter-on-quarter fall in exports contributed to the decline, driven in part by the impact of the Diaoyu/Senkaku territorial dispute with China on exports, alongside falls in private consumption and private capital investment. GDP estimates can be revised heavily in the second release, but the overall picture of contraction is unlikely to change, says the credit ratings agency (CRA).
A further contraction in Q412 seems possible, which would technically take Japan into recession. Export performance has traditionally been a fair guide to the next quarter’s investment. September saw the sharpest quarter-on-quarter drop in industrial production (-6.6%) since Q109, barring the aftermath of March 2011’s Great East Japan Earthquake. The Cabinet Office’s composite leading indicator has also weakened at the sharpest pace since Q109 (again, excluding the earthquake period), and consumer confidence fell in October. The recent fresh monetary stimulus from the Bank of Japan (BoJ) may help growth recover if it succeeds in weakening the yen for a sustained period, although this has not happened after other recent episodes of monetary stimulus.
A key near-term domestic threat to the economy has been the failure to pass legislation authorising Japanese government bond (JGB) issuance for deficit financing. Fresh discussions in the Diet began last week, and press reports said that the ruling Democratic Party of Japan (DPJ) and the two main opposition parties had agreed to pass the bill. In an extreme case, failure to pass the bill could have prevented deficit spending worth about 8% of GDP.
External risks to Japan’s heavily export-dependent economy abound, however. The dispute with China could continue to damage exports to Japan’s biggest trading partner. Meanwhile, the eurozone crisis and the US fiscal cliff, which Fitch considers the single biggest threat to the global economy, may also weigh on the economy.
Japan’s sovereign credit profile is under pressure from high and rising government indebtedness. The CRA downgraded Japan’s long-term foreign and local-currency issuer default ratings (IDRs) to A+ with a negative outlook in May, and these ratings incorporate an expectation of weak GDP growth – both real and nominal. A formal move back into recession in Q412 would not in itself be a negative rating trigger.
The central issue for Japan’s sovereign rating remains fiscal policy, and the leisurely pace of fiscal consolidation under the current plans. The Fiscal Management Strategy adopted in June 2010 is subject to political risk, and Prime Minister Yoshihiko Noda has promised to call a national election “soon” to secure opposition support for elements of the programme. New elections would be key to determining how fiscal policy develops. Further political volatility would increase Fitch’s concerns about the ability of the Japanese political system to deliver policies geared toward fiscal sustainability.
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