Japan: Worse before better

Another coronavirus strain has been found in Japan and the number of corona cases is increasing again rapidly, although fortunately the number of deaths remains comparatively low (figure 1). As a consequence, the government has declared a ‘state of emergency’ for Tokyo and its three neighboring prefectures as of 8 January and the expectation is that the state of emergency will be expanded to more prefectures (including Osaka and Kyoto) in the coming days.

Essentially that means these regions will be in a ‘soft lockdown’, with restrictions on sporting and cultural events, the (voluntary) closure of restaurants after 8 pm, encouragement for people to work from home and avoid going out unless needed. Schools, however, will remain open.

Overall, these containment measures are a little more strict than they were during the first wave of coronavirus infections in May 2020 (figure 2). The economic effects will not be quite as severe as more businesses and consumers have somewhat adapted to living around containment measures (such as ordering more products online) and since coronavirus vaccines (of which Japan has bought enough to vaccinate its entire population) provide some light at the end of the tunnel.

Nevertheless, it seems likely that Q1 GDP growth in Japan will be hit quite severely as Tokyo alone represents 19% of the Japanese economy and the new measures will stay in place for at least one month (and possibly much longer since containment are still relatively loose compared to other countries). We think Q1 GDP might actually contract by 2.6% y/y (-1% q/q). Consequently, we have also revised our full year estimate downwards to 2.5% for 2021 (from 2.9%).

Japan’s government has approved a new fiscal stimulus package to fight the economic effects of the coronavirus. This third package totals JPY 73.6 trillion (14% of Japan’s GDP) consisting of JPY 40 trillion in direct spending and JPY 33.6 trillion in loans and guarantees. The package will be used (among others) to improve the ability of Japan’s health system to accommodate more coronavirus patients, provide financial support to distressed businesses, accelerate the adoption of digital technology and promote green energy technology.

Prime Minister Suga said the new package would give a direct boost to GDP of 3.6%, although he did not indicate over which time period. That seems optimistic. Most of the package consists of loans and guarantees, which will only stimulate the economy if banks actually lend that money out. Moreover, half of the new stimulus package was already present in the previous two stimulus packages, so the actual amount of new spending is not as big as it seems at first sight.

At its latest meeting on 17 and 18 December 2020 the BoJ decided to extend the duration of its additional purchases of commercial paper (CP) and corporate bonds by 6 months, until the end of September 2021. The BoJ also increased the limit of such purchases to JPY 20 trillion (from JPY 15 trillion) and gave itself some leeway in how much each of the two assets it can buy (that was previously capped at JPY 7.5 trillion of additional purchases per asset class).

The BoJ also extended the duration, by 6 months, of its Special Program, which is meant to help struggling firms (mainly SMEs) get financing amidst the corona crisis. In addition, the BoJ removed the cap of JPY 100 billion that each Japanese financial institution can lend to a single firm.

In its Summary of Opinions, the BoJ mentioned that it needs to “”assess its strategy, tools and communication” to achieve its 2% inflation target. That might foreshadow more unconventional monetary policy measures down the road. We don’t yet know what that will look like, although yield control will most likely remain. We will know more in March when the BoJ presents the findings of its assessment.

Even more monetary stimulus is still possible. Core inflation continues to be negative in Japan (figure 3) posing the risk of a deflationary spiral and the Yen continues to strengthen against the USD (figure 4). One of the triggers for more monetary stimulus (next to weaker inflation and a stronger Yen) could be additional fiscal stimulus, seeing how the BoJ has previously mentioned the need to coordinate monetary and fiscal stimulus.