Export-led recovery continued in Japan

The economy is rebounding from one of its deepest recessions in post-war history [GDP contracted 5.2% in 2009]. The recovery in Japan has gained strength in recent months, fuelled by robust exports and government stimuli: growth accelerated to 5% in Q1 of 2010 as exports increased 30%, due mainly to strong demand from Asia. Despite a decline in disposable household income in 2009, private consumption contributed positively to growth, with spending supported by fiscal stimulus, especially by subsidies on green durable goods that have encouraged this increase in spending.

Along with the recession, unemployment too reached post-war record levels in 2009, peaking at 5.1% of the labour force, but the employment situation has gradually improved and, although still at unacceptably high levels, the jobless rate is expected to improve slightly: to 4.9% in 2010. Deflation has been a persistent problem for the Japanese economy for many years and in 2009 the consumer price index [CPI] fell 1.4%. Deflation continues to be a threat, but there are signs of improvement, with the International Monetary Fund [IMF] predicting a slowdown in deflation in 2010 and 2011.

Payment morality in Japan remains very high: usually buyers will settle their invoices on or before due date. However, because so many Japanese businesses continue to pay diligently right up until the point of entering bankruptcy, punctual payment isnt necessarily indicative of healthy cash flow generation. For many businesses, these punctual payments are possible only because banks have been generous with their funding, leading to a weak and highly leveraged balance sheet.

Outlook for recovery still looks fragile

Our Consensus Economics expects Japans GDP growth for the whole of 2010 to increase 3.2%. But the recovery still looks fragile and the pace of rebound is likely to moderate in the second half of the year as stimulus measures expire and export growth levels off. The strength of the yen against other currencies will further dampen export growth - and may price Japanese export goods out of the market.

Japan's government debt has been steadily rising for the last few years, reaching a record high of 883 trillion yen at the end of the fiscal year 2009 [218% of GDP]. The IMF has forecast that this debt will rise further: to 227% of GDP in 2010 and to 235% of GDP in 2011. While the self-funding nature of Japans sovereign debt sets it apart from many other high debtor nations and the yield provided by this debt suggests that it remains manageable, the increasing trend is not sustainable. The government has indicated its commitment to limiting further increases in debt and reversing the upward trend. Given the limited scope for cutting expenditure, fiscal adjustments will need to rely on new revenue sources and limits on spending growth, which can be achieved through comprehensive tax reforms [such as increasing consumption tax] and by containing non-essential public spending growth.

Standard & Poors warned Japan at the end of January that it would reduce its country rating from AA stable to AA negative outlook if economic data remained weak and medium-term growth is not boosted, especially in the light of the countrys high government debt burden and its weak demographic profile. This threat has now materialized and Japans country rating has been downgraded to AA negative. However, Japans sovereign risk is still rated AA.