SINGAPORE, March 09, 2022 – The Japanese economy should grow at a faster 2.9 percent in 2022 after a moderate 1.7 percent recovery in 2021 from the economic effects of COVID-19 restrictions. These conclusions are highlighted in the 2021 Annual Consultation Report on Japan published by the ASEAN+3 Macroeconomic Research Office (AMRO) today. The report was produced based on AMRO’s Virtual Annual Consultation Visit to Japan, and data and information available up to February 18, 2022.

Recent developments and outlook

The Japanese economy experienced a gradual and bumpy recovery at 1.7 percent in 2021, after being severely battered by the COVID-19 pandemic in 2020. In 2021, private consumption exhibited highly volatile movements in tandem with recurrent waves of COVID-19 infections. Business investment was weak, dragged down by global supply chain disruptions. Exports grew rapidly on strong external demand in H1, before slowing in H2. Looking forward, the economy should grow faster at 2.9 percent in 2022, reflecting pent-up private consumption and business investment.

Consumer price inflation weakened in 2021 on the back of a decline in prices of services. Looking ahead, consumer prices (less fresh food) will likely rise modestly by 0.7 percent in 2022.

The external position has stayed strong, supported by continued large primary income surplus. In 2021, the current account surplus amounted to 2.8 percent of GDP.

Financial conditions have been accommodative on the back of strong financial and liquidity support from the government and the Bank of Japan (BOJ) since the outbreak of the pandemic.

The budget deficit widened sharply in fiscal 2020, as a result of massive stimulus packages in response to the pandemic. For fiscal 2021, the government announced its largest initial budget of JPY106.6 trillion, equivalent to about 20 percent of GDP, although the budget deficit will likely shrink from 11.0 percent of GDP in fiscal 2020 to 8.6 percent of GDP in fiscal 2021. By contrast, government debt should rise further from 249 percent of GDP in fiscal 2020 to 258 percent of GDP in fiscal 2021.

Risks, vulnerabilities, and challenges

 The Japanese economy is confronted with several near-term risks, including the recurrence of COVID-19 infections and supply chain disruptions, and structural challenges.

Any recurrent waves of the COVID-19 infection will have significant impact on economic activities at home and abroad. Sustained global supply chain disruptions and bottlenecks will adversely affect Japanese manufacturers’ production and exports. A prolonged pandemic would also have adverse effects on financial institutions, in particular on regional banks, in the form of deteriorating asset quality and lower profitability. A premature unwinding of the government’s special lending programs for small and medium-sized enterprises, before the pandemic comes well under control, could put upward pressure on firm bankruptcies.

Structural challenges include weakening fiscal discipline, side effects from prolonged monetary easing, the declining profitability of regional banks, and demographic drag from population aging and low fertility rates.

Policy recommendations

Fiscal policy should remain supportive of the economy in the short term, with targeted measures to hard-hit sectors, backed by a credible medium-term fiscal consolidation plan. Rather than provide universal supports to all households, it is more critical to roll out well-targeted spending measures for vulnerable households and hard-hit businesses in the services sector to enhance the efficacy of the stimulus packages, given the tight fiscal situation. In this regard, the overall size of the supplementary budget for fiscal 2021 is exceptionally large, given the anticipated economic recovery. In terms of the composition, it is commendable to allocate a significant share of the supplementary budget to the hard-hit sectors, although it still contains some elements of universal supports, such as cash handouts to households with children.

At the same time, the government should begin preparing for a new medium-term fiscal consolidation plan to ensure long-term fiscal sustainability. Given the snowballing demand for government spending as well as rising social security expenditure, oversight of the budget and the government’s compliance with medium- to long-term fiscal targets need to be enhanced to curb Japan’s government debt, which is equivalent to about 250 percent of GDP, and is ranked highest in the world. Japan could consider setting up an independent fiscal institution with a mandate to assess fiscal policy and performance. Moreover, the medium-term fiscal consolidation plan should prioritize containing social security expenditure, while raising tax revenues in the post-pandemic period.

The easy monetary policy stance should be maintained to support growth and counter deflationary pressures. If there are adverse economic and financial impacts due to resurgence of COVID-19 infection, the BOJ could implement further easing measures to support the economy. Weakness in the price of services, while due to transitory factors, warrants closer monitoring of potential spillovers to general price levels.

The BOJ’s inflation-overshooting commitment remains appropriate as it provides assurance to the markets that the monetary policy stance will remain easy until the current low consumer price inflation is above the 2 percent price stability target in a stable manner. However, the feasibility of achieving the 2 percent target is still highly uncertain in the near term. From a medium- to long-term perspective, the BOJ should continue to consider policy options to ensure a gradual and orderly unwinding of the current prolonged easy monetary policy stance under the normal market conditions.

Comprehensive structural reforms should be quickened to address Japan’s long-term challenges. Digitalization should be accelerated, in particular, to address challenges posed by the pandemic. To enhance productivity, the government should strive to create a conducive environment where Japanese corporates are encouraged to increase investment in digital transformation and the green economy. Policy support to address climate change should continue, to enhance economic resilience against natural disasters and achieve a green society. Comprehensive healthcare reforms should be undertaken in a timely fashion to enhance Japan’s social and economic resilience.

To cope with structural labor shortages, embracing female, elderly, and foreign workers should be further encouraged. Strengthening work-style reforms, increasing job mobility and teleworking, employing robotics and automation, and using big data, can all contribute to enhancing productivity growth.

About AMRO

The ASEAN+3 Macroeconomic Research Office (AMRO) is an international organization established to contribute toward securing macroeconomic and financial stability of the ASEAN+3 region, comprising 10 members of the Association of Southeast Asian Nations (ASEAN) and China; Hong Kong, China; Japan; and Korea. AMRO’s mandate is to conduct macroeconomic surveillance, support the implementation of the regional financial arrangement, the Chiang Mai Initiative Multilateralisation (CMIM), and provide technical assistance to the members.

About AMRO’s Annual Consultation Report

The Annual Consultation Report was prepared in fulfillment of AMRO’s mandate. AMRO is committed to monitoring, analyzing and reporting to its members on their macroeconomic status and financial soundness. AMRO also helps identify relevant risks and vulnerabilities, and assists members, if requested, in the timely formulation of policy recommendations to mitigate such risks.