Japan's triple economic shock

15 June 2020

By Sayuri Shirai, Keio University

This article first appeared on the East Asia Forum

Japan’s economy has experienced three consecutive shocks over the past year-and-a-half. The first shock struck Japan in early 2019 when the US–China trade war and slowing economic growth adversely affected Japan’s manufacturing sector. This economic effect was exacerbated by a second demand shock caused by the consumption tax hike from 8 to 10 per cent on 1 October 2019. Just as Japan’s economy was recovering, a third shock caused by COVID-19 dealt the most severe blow, plunging Japan into a full-blown recession.

COVID-19 forced a one-year postponement of the 2020 Tokyo Summer Olympics. The 2020 target for foreign visitors was set ambitiously at 40 million. Hosting the games in 2020 and low interest rates resulted in nationwide city development projects. Real estate prices and the Real Estate Investment Trusts (REIT) index rose steadily by promoting foreign capital inflows. Domestic banks increased loans to the real estate sector relative to other sectors and invested in REITs.

While tourism, construction and real estate development helped to offset declining manufacturing activities in 2019, some potential risks emerged — economic growth now depends on construction, real estate development and inbound tourists.

Before the pandemic, there was concern that Japan might fall into a recession triggered by a decline in real estate prices after the Olympics. Most construction projects were completed at the start of 2020 and some real estate prices were overvalued because of oversupply. The COVID-19 pandemic is accelerating this problem.

Since February 2020, some businesses in the accommodation, restaurant and retail sectors have entered bankruptcy. The REIT index has dropped substantially — economic and social activities are likely to pick up only moderately from June, once the emergency period is over. But the recovery process will be slow for Japan due to public concerns over COVID-19 containment and the limited availability of tests. Bankruptcies will rise and bank loans will transform into non-performing loans as economic suffering continues.

Japan’s economic growth contracted for two consecutive quarters at an annualised rate of –7.3 per cent for the fourth quarter of 2019 and –3.4 per cent for the first quarter of 2020, compared with the previous quarter. Growth for the second quarter is expected to deteriorate by a further –20 per cent.

Compared with the United States and Europe, the Japanese government’s actions have been slow even though the amount of support is comparable. The government announced an economic package in early April 2020 amounting to around 21 per cent of nominal GDP.

The package is primarily comprised of deferred tax and social security payments, and the provision of subsidised loans and guarantees on bank loans. Wage support for firms maintaining employment is covered in the package, but complicated applications and the slow approval process have discouraged many firms from applying. The package includes cash transfers to firms and individuals of about 3 per cent of nominal GDP. Additional cash support is likely to be needed for affected firms.

The government initially wanted to provide cash to targeted households (US$2800 per household) but it has switched to providing cash to all individuals (US$935 per person) as complaints emerged about the complicated eligibility requirements. This is why the passage of the relevant bill was delayed at the Diet until the end of April 2020. The crisis has revealed inadequate e-government services together with a lack of ID numbers issued to the general public that are linked with payroll, taxes, and social security services.

The BOJ’s response to COVID-19 is limited compared with those of its US and EU counterparts. In mid-March 2020, a temporary liquidity operation was initiated by the BOJ to commercial banks at 0 per cent interest with maturity within a year (most only three months) by loosening the collateral requirement until September 2020. But the BOJ lowered the lending rate by a mere 10 basis points and did not provide interest subsidies on lending rates. In contrast, the European Central Bank provided three-year loans to banks with substantial interest subsidies.

The BOJ increased purchases of corporate bonds and commercial papers moderately, mainly to support large firms. Many large firms already have cash and deposits and issue such bonds and notes for precautionary reasons.

The impact of these purchases on overall corporate financing conditions is limited since the market sizes are relatively small — about 11 per cent of nominal GDP in total — compared with bank loans to the corporate sector amounting to 60 per cent of nominal GDP. The BOJ increased the amount of stock exchange trade fund (ETF) purchases, but the impact on the household sector is limited since households’ stock holdings account for only 10 per cent of total financial assets.

The BOJ’s balance sheet rose by a mere 5 per cent after early March 2020. The increase was largely a result of providing US dollar liquidity to banks through borrowing from the Federal Reserve. While this may help large banks with exposures to foreign markets, it is largely unrelated to many local banks and credit unions.

At the end of April, the BOJ expanded its purchase amount of corporate bonds and commercial papers. The temporary liquidity operation expanded eligible collateral and eligible financial institutions, but these measures appear insufficient to promote an increase in banks’ lending to small firms affected by the COVID-19 crisis. In response to criticism that not enough support is given to smaller firms, the BOJ held an emergency meeting in May to implement a new loan program for banks that extent credit to smaller firms with small interest subsidies. While this is a welcome step, the limited actions of the BOJ clearly reflect the limited room left for monetary accommodation after the continuation of monetary easing since 2013. It may also reflect the BOJ’s unwillingness to take greater risks, since it is already bearing high risk through substantial purchases of stock ETFs.

COVID-19 is testing the government and the BOJ and demanding they be more innovative and flexible in order to provide much-needed support to the economy.

Sayuri Shirai is Professor at Keio University and a former policy board member of the Bank of Japan.

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