SINGAPORE, March 11, 2020 – Despite continued weakness in exports amid a global slowdown, the Japanese economy has remained resilient, underpinned by sustained domestic demand, according to the 2019 Annual Consultation Report on Japan published by the ASEAN+3 Macroeconomic Research Office (AMRO) today. The report was prepared based on AMRO’s Annual Consultation Visit to the country in November 2019 and data available as of December 27, 2019.

The Japanese economy is projected to expand by 1.0 percent in FY2019 before slowing to 0.6 percent in FY2020.[1] Japan’s services sector—with solid capex investment and strong inbound tourism—provides some support to the economy against weaker external demand. Meanwhile, Consumer Price Index (CPI) inflation – excluding fresh food – is expected to be around 0.6 percent in FY2019 and 0.5 percent in FY2020 (excluding the effect of the consumption tax hike and policies concerning the provision of free education), well below the Bank of Japan’s 2 percent target.

Japan’s external position remains strong with a sizable current account surplus. The major source of the surplus has shifted from goods trade surplus to interest and dividend incomes earned from Japan’s large overseas investments. The financial account has observed outflows, driven by residents’ outward investments in search of higher returns.

The financial system remains sound although financial institutions are struggling with low profitability. However, the ultra-low interest rate environment has squeezed banks’ net interest margins, exerting downward pressure on profitability, especially that of regional banks which depend mostly on domestic lending.

The fiscal deficit narrowed from 3.3 percent in FY2015 to 2.2 percent in FY2018, owing to higher growth in tax revenues, sustained expenditure discipline and low debt service burden. Going forward, driven by the new fiscal stimulus package, the fiscal deficit is projected to widen significantly to 3.2 percent in FY2019 before narrowing slightly to 3.0 percent in FY2020.

The Japanese economy is confronted with downside risks in the near term, mainly from external factors. These include a sharper-than-expected slowdown in China and the global economy, and a re-escalation of the U.S.-China trade tensions.

The effects of the consumption tax hike in October 2019 on private consumption are expected to be less severe than those of the 2014 tax hike, thanks to the government’s countermeasures such as cashless payment promotion program, premium vouchers for low-income and child-rearing households, and tax reductions for housing purchases. However, there is still a risk of prolonged weakness in private consumption.

Fiscal authorities should step up efforts toward improving fiscal sustainability. The offsetting measures against the tax hike should be tapered as planned so that the additional tax revenue can be used to improve the fiscal balance. Ongoing efforts on expenditure reforms should be strengthened by curbing public spending on non-essential projects.

The current easy monetary policy stance should be maintained to support growth and counter disinflationary pressures, and the Bank of Japan should be ready to ease further in the event of a sharp economic downturn amid external headwinds. However, from a longer-term perspective, the authorities should be mindful of the possibility that the policy space under the quantitative and qualitative monetary easing policy could become progressively limited over time.

Structural reforms should be pursued in a comprehensive manner to enhance the economy’s growth potential and address the challenges of an aging population. Further corporate governance reforms are necessary to improve management efficiency and transparency to attract more investors. To cope with the labor shortage, the effective utilization and development of human resources need to be strengthened by implementing work-style reforms, employing robotics and automation, and embracing more foreign workers.

[1] AMRO’s growth projection does not reflect potential impacts of the COVID-19 outbreak.

About AMRO and AMRO’s Annual Consultation Report:

The ASEAN+3 Macroeconomic Research Office (AMRO) is an international organization established to contribute towards securing macroeconomic and financial stability of the ASEAN+3 region, which includes 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.

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