Japan Country Forecast

18-Month: LDP Coalition 75%
Five-Year: LDP Coalition 40%
Turmoil Financial Transfer Direct Investment Export Market
18-Month: Low A- A A+
Five-Year: Low A A- A

( ) Indicates change in rating.  *  Indicates forecast of a new regime.

Years Real GDP Growth % Inflation % Current Account ($bn)
2008-2012(AVG) -0.1 -0.2 137.96
2013(F) 1.1 0.4 42.90
2014-2018(F) 1.5 0.9 91.40

Old Wine in a New Bottle

The landmark victory of the DPJ in 2009 promised a fresh start after five decades of the LDP political dominance, but the party failed to live up to expectations, and went down to defeat at an early election that was held in December 2012 against a backdrop of growing economic pessimism.  The LDP’s victory capped a remarkable political comeback for Shinzo Abe, whose short stint as prime minister in 2006-2007 is remembered mostly as a period of deteriorating relations with Japan’s neighbors.

Abe has recast himself as a determined reformer who has staked his political future on ending two decades of economic stagnation.  Dubbed by observers as “Abenomics,” the prime minister’s three-pronged policy program consists of aggressive monetary easing to combat deflation, a fresh fiscal stimulus package to boost economic growth, and reforms designed to encourage private investment and boost the competitiveness of exporters.

In truth, only the last of the three prongs marks a significant departure from the LDP’s traditional approach, and given the LDP’s close links to powerful vested interests, considerable skepticism remains as to Abe’s ability to push through structural reforms.  Moreover, despite a solid mandate and a veto-proof majority in the lower house of the Diet, the window of opportunity will be narrow, as LDP heavyweights will lose whatever appetite for substantial change they may have if, as is likely, the party wins the Senate elections in mid-2013.

Political Weakness Will Limit Progress on Reforms

Industry leaders have complained that Japan is lagging behind other Asian countries in free-trade accords, and the government faces pressure to participate in negotiations for the US-led Trans-Pacific Partnership.  However, Japan’s inclusion implies the elimination of protective barriers, a move that will face strong resistance from agricultural producers, an important component of the LDP’s base.  Abe will probably hold off on the issue until after the Senate elections, and his decision will say much about whether he is genuinely committed to reform.

The $113 billion stimulus package unveiled in January should be enough to ensure positive economic growth in 2013.  However, the government’s forecast that fiscal expansion will boost real GDP growth by two full percentage points will not be borne out in the absence of a significant improvement in export performance, which is unlikely.  Real GDP growth is forecast to come in slightly above 1% this year, while the current account surplus will continue to narrow, the result of a further widening of the trade deficit.

The failure of consumer demand to emerge as a reliable engine of growth will limit the potential for sustained healthy expansion and leave the economy vulnerable to external shocks that impact negatively on the export sector.  Real GDP growth will average just 1.5% per year through 2018, and inflation will remain well under control, averaging less than 1% per year over the same period.

Economic Forecasts for the Three Alternative Regimes

LDP Coalition Divided Government DPJ Coalition
Growth (%) Inflation (%) CACC ($bn) Growth (%) Inflation (%) CACC ($bn) Growth (%) Inflation (%) CACC ($bn)
2013 1.1 0.4 42.90 0.7 0.0 36.40 -0.3 -0.2 24.30
2014-2018 1.5 0.9 91.40 0.9 0.1 65.00 1.0 0.5 76.30

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