GDP Q2 2007 Downward Revisions

"Is Japan Heading for a Recession?" Claus asks us in his last post, and the answer looking at the latest set of GDP revisions may well be yes.

Japan’s economy shrank more sharply than expected in the second quarter, and revised growth domestic product data released today show an annualised contraction of 1.2 per cent. In general we had been expecting a downward revision following evidence last week that capital spending, a big driver of growth, had slowed sharply. But the fall of 0.3 per cent in quarter-on-quarter terms against a preliminary estimate of 0.1 per cent growth was deeper than even we expected.

The reversal from annualised growth of 0.5 per cent to a decline of 1.2 per cent in the second quarter is explained almost entirely by a change in the assessment of capital spending. Preliminary data indicated that this had grown at an annualised rate of 4.9 per cent, but this figure has now been revised down to a contraction of 4.8 per cent.

This kind of data has lead JPMorgan to revise down its estimate for annual growth in the year to end-March 2007 from above 2 per cent to 1.6 per cent. Even more to the point they now expect the central bank to refrain from a rate rise until at least next year, with the implication that there would be minimum a one-year gap between quarter-point rate increases. And this is at the earliest!

Anyway, here's the revised chart.




My personal feeling is that the Japanese expansion has been steadily losing momentum since the end of 2005. Exceptional global conditions in the last quarter of 2006 gave a hefty push to Japanese exports, and, as a consequence, to capital spending (domestic consumer demand has hardly budged). Since I doubt in the current environment that these global conditions will be reproduced this autumn (indeed, the opposite may hold if the US now goes into recession) I am not anticipating a recurrence of what happened in Q4 2007. It remains to be seen, at a global level, how much of the expansion which took place during the back end of 2006 was really sustainable (on Eastern Europe, which was an important part of the picture I certainly have my doubts) and how much was an "excess" which is now in the process of being corrected. Only time will tell. But in the meantime I am certainly not forecasting any further rate hikes from the BoJ, either in what remains of this year, or during as far forward as we can see into 2008.

Is Japan Heading for a Recession?

By Claus Vistesen

While financial markets are gazing firmly towards the US economy shadowing Ben Bernanke's every word and gesture for a hint of future rate decisions economic fundamentals in Japan are trending firmly and steadily downwards into worrisome territory. At this point however the headline chosen for this entry might still seem rather alarmist but given the nature of lag of economic data relative to the present time I don't think that this question is entirely worthless to entertain. In this light, this entry should be seen as a small update relative to the large review and preview note on Japan posted recently here at GEM. This entry consequently gathers data from recent entries at Alpha.Sources as well as Japan Economy Watch to bring our readers fully up to date with the economic situation in Japan.

Let us begin with some simple charts which plots Japanese GDP in quarters as well as annually since 1995 so that we can get an idea of where were are. Based on the quarterly measures it is of course impossible to discern a trend but as we turn to the annual figures we can see how Japan indeed is currently enjoying what seems to be a persistent positive trend in GDP from 2001 and onwards. Yet, if we look at quarterly figures we can see that Japan in Q2 2007 was seriously flirting with the dreaded 0% mark (quarterly!) and with the recent revision of corporate capex we might even be looking at a contraction. This does not of course indicate that Japan is heading for a recession but it means that we are likely to enter a period where Japan very well could be flirting with the probability.

Moving further I present a quick extension of the short-term charts on prices and domestic consumption presented in the previous Japan note. As we can see, the trend continues with stagnating domestic demand as well as continuos and persistent deflation. Note in particular the core-of-core rate which slumped to -0.5%. Regarding household consumption the trend has been trending steadily down towards stagnation after beginning 2007 on a bright note.

Finally and before I leave you I want to note two further aspects of the Japanese economy. The first relates to the much debated issues surrounding industrial production; Edward provides the relevant data and commentary here. It is still too early to say anything but it clearly seems that industrial production, while it has somehow abated on the back of the peak in Q4 2006, still is situated on a high ground relative to the beginning of 2006; the latest incoming data point show how industrial slipped slightly in July with -0.4% drop on a seasonally adjusted basis. As I have stressed before the gauge for industrial production is intimately related to the evolution of the trade surplus and in this context the mounting and lingering uncertainty surrounding the US and indeed global economy represents a notable downside from the point of view of corporate capex. In fact, if the recent downward revision of corporate capex is a sign of things to come we could be looking at a correction of industrial production which could fare well into H2 of 2007. This call is of course perfectly falsifiable since the future monthly readings will tell us what to expect. I don't quite think it is safe to lay out this rather bearish forecast but a second monthly decline in August would indicate, I think, that industrial production very well could begin to correct in the quarters to come. The second and thus final aspect I feel the need to note is the general tendency on the labour market where tightening continues alongside the trend of falling wages, something which of course runs counter to what we learn from economic textbooks. In stead of moving into a detailed assessment at this point I am taking a shortcut by pointing towards the recent analysis provided by Edward over at JEW.

Conclusively, the following bullit points sums up the current trends in the Japanese economy all of them intimately related to the ageing of Japan's population as well as the ongoing turmoil in financial markets.

• Don't expect the BOJ to raise anytime soon. Of course and in terms of invesment decisions the traditional disclaimers apply but I honestly have a hard time seeing how the BOJ can justify a raise in this context even if Fukui is determined to finish his term on a sound footing whatever that means.

• Japan remains well entrenched in deflation and even though headline inflation (which in this case include food) is set to nudge up we should be looking at the underlying trend which is generated from domestic Japanese activity and thus the core-of-core index.

• Domestic consumption remains depressed. This does not mean that we are witnessing a secular decline but rather that the trend is low and overall negative. Increasingly, we also need to realize that whatever terms we apply to the current trend of domestic demand it does not conform with the idea of an economy being driven by internal dynamics.

• Regarding cyclical indicators downside risks seems to have emerged regarding the external demand for Japanese goods and thus also industrial production and more general corporate capex. The main culprit here is of course the mounting uncertainty surrounding the strength of the US economy and with industrial production currently sitting on a high plateau Japanese growth rates are particularly sensitive at this point given the de-facto reliance on corporate investment as a derivative of net exports.

• Japan's labour market continue to defy conventional textbook wisdom as the ever declining unemployment rate fails to spur wage inflation. In fact, wages are now clearly set on a lingering downward trend on an aggregate basis. In order to come to grips with this fact and thus also in order to align expectations with reality we need to take a long hard look at Japan's population structure. I know this is indeed one of the recurring tedious claims of mine but it is equally as tedious to see how the discourse is not budging; even if this is not entirely true but there is still some distance to travel I would say.

Japan July 2007 Wages

Japanese monthly wages, including overtime pay and bonuses, dropped 1.9 percent in July, the eighth monthly decline and the fastest pace in three years according to the Labor Ministry in Tokyo today.



This development in Japanese wages is by no means new, as can be seen from this chart for annual changes over the last 4 years. In fact total earnings went down in both 2003 and 2004:

Comment

The failure of Japan's strengthening job market to translate into higher pay is hindering growth in consumer spending, which accounts for more than a half of the economy. That leaves the nation reliant on exports at a time when a U.S. housing recession is threatening global growth.

``Falling wages could jeopardize the recovery in consumer spending, leaving Japan more dependent on foreign demand,'' said Yoshiki Shinke, chief economist at Dai-Ichi Life Research Institute in Tokyo, before the report was released.

One reason average wages have slipped since December is the replacement of retiring baby boomers with younger, cheaper employees. Another is the increased hiring of part-time workers, whose pay is on average less half that of full-timers, Shinke said.

Average pay fell about 10 percent between 1997 and 2005. One in three Japanese workers is a part-timer today, compared with one in five a decade ago.
Bloomberg

Investment In Plant and Equipment Q2 2007

Corporate investment in Japan declined in the second quarter of 2007 following a sharp fall in spending in the predominantly domestically focused non-manufacturing sector. According to data released by the Ministry of Finance in Tokyo today, capital spending sank 4.9 percent in the three months ended June 30 after advancing 13.6 percent in the first quarter. Here's the chart.


We can also see that this was the lowest reading since Q2 2005, and gives us some indication of one of the factors responsible for slow Q2 GDP growth, although it does seem that there is some possibility that the Q2 data may now need to be revised downwards. The big question, of course, is what is happening during Q3. But do note this quote in Bloomberg from Hiroaki Muto - senior economist at Sumitomo Mitsui Asset Management in Tokyo - ``We can't rule out the possibility that the economy shrank last quarter, though such a dip would be temporary. "

So in fact, the longest Japanese expansion in recent history may have already ended.

Comment

The report may hinder the Bank of Japan's case that the economy is strong enough for it to raise the key overnight call rate in two weeks. Companies may pare investment even more in the coming months if the U.S. housing crisis curbs demand in Japan's largest export market.

``The U.S. housing recession is a risk factor and may slow foreign demand,'' said Naoki Iizuka, senior economist at Mizuho Securities Co. in Tokyo. ``It is too early to conclude that capital spending will be a problem for the Japanese economy,'' he said, adding that a change to the sample used by the finance ministry may have distorted the reading.
Bloomberg