Japan's stimulus package

Japan's Cabinet approved on 13 December a supplementary budget worth JPY3.2 trillion (USD29.2 billion) for fiscal year 2019, following the Abe administration's announcement on 4 December of JPY13.2 trillion in fiscal spending (totaling JPY26.0 trillion, including private-sector and other outlays). These stimulus measures are likely to mitigate downside risks to the economy and facilitate the ruling coalition passing legislation in 2020.

The initial stimulus package plans to use funds deducted from existing budgets, but the December supplementary budget will require a JPY2.2-trillion (USD20.0 billion) issuance of construction bonds. These will go towards rehabilitation works after Hagibis, the largest typhoon since 1958, hit Japan's Kantō region in October 2019. This coincided with the third delay to increasing Japan's consumption tax from 8 to 10%, which compounded the negative effect on retail sales, production, and other business activities in October. Notably, industrial production fell by 4.5% month on month (m/m) in October. However, IHS Markit assesses that the damage done by the typhoon is likely to lead to replacement demand and construction work in 2020 and beyond. In addition, the government will issue JPY2.3 trillion in special bonds because of lower tax revenues than projected in fiscal year (FY) 2019.The stimulus plans are larger than IHS Markit previously expected because of the damage caused by the typhoon.

The larger-than-expected fiscal stimulus measures are likely to lift Japan's real GDP growth until the end of FY 2021. Specifically, the stimulus measures include JPY5.8-trillion worth of planned rehabilitation works and disaster-prevention projects and JPY4.3-trillion worth of measures to strengthen economic activities after the 2020 Tokyo Olympics. In addition, JPY3.1-trillion worth of packages for supporting for small and medium-sized enterprises, prospective export-oriented businesses, and local communities through adopting innovative technologies will be included.

The large-scale stimulus indicates that the Abe administration is concerned about repercussions on Japan's economy of the trade disputes between China, the European Union, and the United States. Exports have continued to decline because of lower external demand: the China-US trade dispute is reducing exports to those two major trade partners. In October, Japanese exports to China and the US were down 10.3% year on year (y/y) and 11.4% y/y, respectively. Weak exports have reduced industrial production and corporate profits in the manufacturing sector, according to third-quarter 2019 corporations' statistics released by Japan's Ministry of Finance. The coincident indicator of business activity released by the Cabinet Office has been declining through October to 94.8, making further contraction likely.

The Abe administration expects the stimulus plans to boost real GDP by approximately 1.4 percentage points, but IHS Markit assesses this to be optimistic. Large top-down stimulus plans are often eroded by wasteful spending and delays to progress. Specifically, in Japan, public works often face difficulties advancing as planned because of shortages of construction workers and higher costs. IHS Markit estimates that the stimulus package's contribution to Japan's real GDP is likely to be 0.32 percentage point in 2020, 0.16 percentage point in 2021, and 0.24 percentage point in 2022 before the level of government spending (especially on public works) begins to decline. We have revised our real GDP growth forecasts to 0.6% in 2020, 0.7% in 2021, and 0.4% in 2022.

Importantly, a weak economy and larger fiscal expenses are likely to slow fiscal consolidation, indicating that the government is unlikely to meet its target of eliminating the primary balance by FY 2025. Some of the stimulus measures will go to pool budgets for multi-year plans, most likely being spent in FY 2020 and 2021.

Prime Minister Shinzō Abe and his ruling Liberal Democratic Party-Komei Party coalition remain strong after securing a majority of seats in the July 2019 Upper House election. This not only contributes to economic policies, but also indicates that a bill on constitutional revision is more likely to be tabled. Pro-revisionist members hold a super-majority in the Lower House, meaning a proposal to amend the constitution would probably pass through the Diet. Nonetheless, the subsequent referendum is less likely to be successful, especially since Abe and his wife's reputation has been mired by alleged scandals involving altered documents pertaining to the discounted sale of state land to an ultranationalist private-school operator and involving a permit for a veterinary school owned by an associate of Abe's - Abe has repeatedly denied his or his wife's involvement. IHS Markit assesses that an amendment would only likely be approved by voters if it focused on popular measures such as enshrining environmental protection and universal education in the constitution. The Abe administration could attempt to pass these changes first, so that the post-Second World War constitution has been altered already. This would likely occur before attempting at a later date to revise Article 9, which renounces the right to maintain air, land, or sea forces and the right to conflict as a means for resolving international disputes.

Indicators of changing risk environment

Increasing risk

• If further downside risks arise, the Abe administration is likely to introduce additional stimulus measures.
• If the Trump administration in the US decides to increase tariffs on Japanese automobiles and auto parts, despite the US-Japan Trade Agreement signed in September 2019, it would negatively affect this sector and undermine Abe's image as strong leader on the world stage.

Decreasing risk

• If the Japanese government can tighten fiscal consolidation, it will be more likely to attain its target of eliminating the primary balance deficit by FY 2025.
• If the administration is able to resolve the ongoing dispute with South Korea over compensation for victims of forced labor during the colonial period (1910-45), the outlook for firms and sectors affected is likely to improve, specifically manufacturing firms such as Nippon Steel & Sumitomo Metal and the tourism sector.

Posted 06 January 2020 by Harumi Taguchi, Principal Economist, Japan and Pacific Islands, Economics and Country Risk, S&P Global Market Intelligence