OECD Economic Outlook, Volume 2020 Issue 1

Japan

In 2020, Japan is on course to experience its deepest recession of the post-war era, with at best a modest recovery in 2021. Economic activity has plummeted in the first half of 2020, reflecting the impact of incrementally stepped-up confinement measures and lower external demand. Large‑scale fiscal support and the gradual lifting of the confinement measures will help to partially reverse the collapse but, in the event of a second outbreak later in the year, re-confinement would impart another economic blow. GDP is expected to fall by 6% in 2020 in the single‑hit scenario and by 7¼ per cent in the double‑hit scenario. Headline inflation is projected to turn negative in 2020, reflecting considerable economic slack and a fall in energy prices.

The government has launched a range of measures to support households and protect businesses and employment, including cash handouts to households, increased subsidies for special paid leave, rent subsidies, deferrals of tax and social insurance premiums, and emergency loans and credit guarantees. While reopening of the economy should proceed step by step, following effective safety and distancing protocols, it may require extending some of the temporary measures, focusing on those facing prolonged economic hardship.

Soft confinement measures have been stepped up

Japan’s first COVID‑19 case was confirmed on 16 January 2020, but the daily number of confirmed cases started to rise significantly only in late March, with community infections, and accelerated in April. It has since shown signs of peaking. The death toll has been very limited so far despite the very high share of the elderly population.

Japan: Business sentiment and labour market

1. The diffusion indices show the share of firms responding they found business conditions good minus the share of firms that reported bad business conditions. The numbers for 2020Q2 are based on forecasts by firms.

Source: Ministry of Internal Affairs and Communications; Ministry of Health, Labour and Welfare; and Bank of Japan.

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Japan: Demand, output and prices (double-hit scenario)

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Japan: Two scenarios of real GDP and two scenarios of inflation

1. Headline inflation, excluding the effect of the October 2019 consumption tax hike based on the government estimate.

Source: OECD Economic Outlook 107 Database; and Ministry of Internal Affairs and Communications.

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Japan: Demand, output and prices (single-hit scenario)

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Confinement measures have been largely on a voluntary basis but have been stepped up over time. The government asked for the cancellation of large‑scale events and gatherings from late February and for the closing of all public schools except universities from early March. Following stay‑at‑home requests in several prefectures, a state of emergency was declared from 7 April to 6 May and then until 31 May. It first covered the seven most affected prefectures but was soon extended nationwide. It enabled prefectural governors to order school closures, restrict the use of public facilities, request non‑essential businesses to close, and take forcible actions, including using private lands and buildings to build temporary hospitals. The state of emergency was lifted before schedule on 25 May, and steps have been outlined to relax the restrictions on economic activity. International travel bans have also been in place since February.

Economic activity has plummeted

The pandemic has affected most economic activities, albeit unevenly. Tourism, accommodation, restaurants and personal services including leisure activities are hardest hit, reflecting the impacts of both voluntary restraints and a de facto ban on inbound tourism. While sales of essential products have remained solid, those of department stores have more than halved. The Bank of Japan March Tankan Survey showed business sentiment in the manufacturing sector at its lowest level in a decade. Despite the limited impact on unemployment so far, the job‑openings‑to‑applicants ratio has been declining, reflecting a fall in job offers rapidly spreading across both manufacturing and non-manufacturing sectors.

The government has provided unprecedented support to the economy

In early April, the government launched a wide range of measures to support households and protect businesses and employment. Additional government spending of 4.7% of GDP is enshrined in the first FY 2020 supplementary budget to finance the measures, including cash handouts of JPY 100 thousand (around USD 1 000) to every resident as well as cash transfers to heavily affected business owners (0.4% of GDP). The government also eased the criteria for the Employment Adjustment Subsidy, which provides firms with financial support to cover the cost of special paid leaves due to temporary closures, and raised the subsidy between April and June for those that do not dismiss workers. In late May, the government announced a second FY 2020 supplementary budget of 5.8% of GDP, with measures including additional cash benefits targeted at single-parent households, a rent subsidy to help heavily affected firms, and further enhancement of the subsidy for special paid leaves. Together with off‑budget measures, including deferrals of tax and social insurance premiums and emergency loans and credit guarantees, total support amounts to an unprecedented 42.2% of GDP. The supplementary budgets not only provide a range of subsidies to accelerate growth in the recovery stage, including through promoting tourism, digital transformation and supply‑chain relocations, but also set aside a contingency fund of 2.1% of GDP. The double‑hit scenario assumes that the contingency fund will be fully utilised to cope with a second outbreak.

The Bank of Japan has sought to ensure adequate financing of the economy to maintain financial system stability through the enhanced purchases of various assets, including exchange traded funds, commercial paper and corporate bonds, and the introduction of a new operation to provide loans against private debt as collateral at a 0% interest rate. It also decided to purchase enough Japanese government bonds (JGBs) to keep the 10‑year JGB yields at around 0%. The Financial Services Agency reaffirmed that banks can draw on their regulatory capital and liquidity buffers as needed to support lenders affected by the pandemic. The projections assume that this highly accommodative policy stance will be unchanged through 2021.

The recovery will be moderate

With the stay‑at‑home requests and closure of non‑essential businesses under the state of emergency implemented in full between mid‑April and mid‑May 2020, private consumption is estimated to have dropped by around a quarter during this period. Reopening of non‑essential businesses, which has begun in less affected regions since late May, is assumed to continue gradually. In the double‑hit scenario, voluntary restraints are assumed to be fully reinstated during October, followed by gradual easing.

GDP is estimated to have plunged in the second quarter of 2020, led by private consumption. External demand has also fallen sharply, reflecting the global recession. The double-hit scenario entails another short‑term blow to the economy in late 2020. The sharp fall in demand coupled with heightened uncertainty will hold back housing and business investments as well. Consequently, GDP is projected to decline by 6% in 2020 in the single‑hit scenario and by 7¼ per cent in the double‑hit scenario. The subsidies for special paid leave are expected to limit the rise of unemployment but at the cost of a significant reduction of workers’ earnings. Economic activity has started to pick up in late May, but slowly, as the easing of confinement measures proceeds gradually while purchasing power suffers from lower income, notwithstanding government cash handouts. The double‑hit scenario assumes the phased reopening of the economy to be set back in October. As the fiscal boost is assumed to be rolled back in 2021, the recovery is projected to remain moderate and unemployment will stay at a higher level, even though private consumption and service exports will be buoyed by the Tokyo Olympic Games, now rescheduled to summer 2021. Ample slack in the economy will see inflation turn negative. The double‑hit scenario also entails more severe long‑term consequences for potential growth through lower investment and lower labour force participation, particularly of women and the elderly, due to long‑lasting higher unemployment.

The recovery could be stronger than projected if severe labour shortages arising from demographic change spur investment and labour force participation more than foreseen. Japan’s unprecedentedly high level of public debt is projected to rise even further due to the large‑scale fiscal boost. It remains a key risk: a loss of confidence in Japan’s fiscal sustainability could destabilise the financial sector and the real economy, with large negative spillovers for the world economy.

A gradual reopening process may require additional policy support

The government has taken forceful measures to alleviate the negative impacts of the pandemic and to support the economy. Step‑by‑step reopening of economic activity should be allowed subject to safety and distancing protocols, prioritising businesses with lower risks of infections in the workplace and for customers. Appropriate implementation of the supplementary budgets will be key, as gradual reopening may require the government to extend and enhance the temporary measures with a focus on businesses and workers subject to prolonged hardships, including extended business closure. Policies in the recovery stage should promote flexible working styles through use of digital technology and help reduce renewable energy generation costs by strengthening competition in electricity markets, which can facilitate distancing and supply‑chain relocations as well. While the impact on debt service of any additional fiscal costs can be mitigated by the central bank’s current yield curve control policy, restoring fiscal sustainability will continue to require a detailed and concrete consolidation programme.