OECD Economic Outlook, Volume 2023 Issue 2

Japan

Real GDP growth is projected at 1.0% in 2024 and 1.2% in 2025, mainly driven by domestic demand. Private consumption will be supported by pent-up demand, stronger wage growth and the new economic package. Government subsidies for green and digital investment and high corporate profits will boost business investment, despite higher uncertainty. Headline inflation is projected to moderate but remain around 2% as wage growth gains momentum in 2024-25.

Record high gross government debt, at 246% of GDP in 2022, calls for a detailed and credible medium-term fiscal consolidation strategy, with further gradual increases in the consumption tax rate and measures to control spending. Structural reforms to boost employment and productivity are also key to put the public finances back on a sustainable trajectory and address demographic headwinds. Continued flexibility in the conduct of yield curve control and a gradual modest increase in the short-term policy interest rate are warranted, based on OECD projections of sustained inflation and wage growth.

Domestic demand has slowed

Following robust growth in the first half of 2023, real GDP contracted by 0.5% in the third quarter. High uncertainty and inflation weighed on private consumption and investment. Headline consumer price inflation stood at 3.3% in October, reflecting decreasing energy prices and the extension of government energy subsidies. Corporate short-term inflation expectations fell slightly to 2.5% for the near term and 2.2% for three years ahead. Nominal wages have been trending up and are expected to gain momentum as the strong result of the Shunto wage negotiations (3.6% wage growth) spreads to SMEs.

Japan: Activity and labour market indicators

1. Nominal wages are total cash earnings per employee. Real wages are nominal wages deflated by the consumer price index excluding imputed rent.

Source: OECD Economic Outlook 114 database; Ministry of Internal Affairs and Communications; and OECD calculations.

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Japan: Demand, output and prices

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Japan: Inflation and fiscal indicators

Source: Ministry of Internal Affairs and Communications; OECD Economic Outlook 114 database; and OECD calculations.

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In late October, yields on 10‑year Japanese government bonds peaked at around 0.9% and the yen depreciated sharply, but pressures subsequently abated somewhat. Despite rising in September, business confidence in manufacturing remains well below that of the non-manufacturing sector. Corporate profits continue to increase and firms’ investment plans remained strong in the Bank of Japan’s September Tankan Survey, with large firms projecting a 13.6% increase in nominal capital expenditure in FY 2023. Buoyant automobile exports were offset by high service imports in the third quarter. The number of inbound tourists slightly surpassed 2019 levels in October, although the recovery in tourists from China is sluggish at only 35% of pre-pandemic levels.

Macroeconomic support is projected to gradually decrease

The new economic package announced in November includes measures to moderate the impact of high prices and support medium-term investment in several areas, such as economic security, green and digital transformation, and education. It includes cash handouts to low-income households and temporary cuts to income and residential taxes, which will cost JPY 1.1 trillion (0.2% of GDP) and around JPY 4 trillion, respectively. The current subsidies to cushion the impact of higher fuel oil, electricity and city gas prices are also extended until April 2024, with those for electricity and city gas to continue at reduced rates from May 2024. The related supplementary budget, which also includes expenditures expected to be implemented over multiple years, will be around JPY 13.1 trillion in FY 2023 (2.3% of GDP). The OECD projections assume that the subsidies will remain in place until the end of 2024, albeit gradually declining over time, alongside an annual increase in defence spending of around JPY 1 trillion in 2024-25. Fiscal support is projected to decline with the end of pandemic-related measures and the gradual decline in price subsidies in 2024 and the phase-out of subsidies in 2025. The gross public debt-to-GDP ratio is projected to remain high at 243.8% in 2025.

The short-term policy interest rate remains unchanged at -0.1%, but the conduct of yield curve control has been modified twice in 2023. With the second adjustment in late October, the Bank of Japan shifted to an upper bound of 1% for the yield target of 0% for 10-year Japanese government bonds and stated that the upper bound will serve as a reference, with yields controlled mainly through large-scale Japanese government bond purchases and market operations. Such adjustments to further increase flexibility should be continued. OECD projections of sustained inflation around 2%, increasing wage growth and a closing of the output gap imply a gradual increase in the policy rate is warranted, starting from early 2024. However, if the positive wage-inflation cycle gets underway more slowly than projected, the Bank of Japan is likely to wait for longer before raising interest rates.

Growth will moderate in 2024-25

GDP growth is projected at 1.0% in 2024 and 1.2% in 2025, as the positive contribution of net exports declines. Private consumption will be supported by rising wages and the new economic package. Business investment will grow, supported by government subsidies and high corporate profits. Public investment in large-scale projects will support growth in 2024. The labour market will remain tight, contributing to higher wage growth in 2024-25. Headline consumer price inflation is projected to increase to over 2% by the end of 2025 as government subsidies end, the output gap closes and wage growth gains momentum.

A key source of uncertainty is the impact of rising import price inflation due to the yen’s depreciation and renewed energy price increases. Weaker-than-expected external demand, including a sharper slowdown in China, and further supply chain disruptions due to geopolitical tensions, would lower growth. Persistent cost pressures and further monetary policy tightening in other advanced economies could create pressures on the monetary policy framework, necessitating abrupt changes. On the upside, further depreciation of the yen could strengthen price competitiveness of exports, including inbound tourism.

Securing fiscal sustainability is key

Rebuilding fiscal buffers and ensuring debt sustainability should be prioritised, in the context of increasing debt service risks associated with a possible rise in long-term interest rates. Prolonged price caps should be phased out. These add to fiscal sustainability challenges and could reduce incentives to shift to renewables and lower energy demand by distorting market signals. Overreliance on supplementary budgets and contingency reserve funds lowers the transparency of fiscal projections and targets. Announcing the concrete revenue and expenditure measures needed for medium-term fiscal consolidation would boost the credibility and sustainability of fiscal policy. Population ageing will raise fiscal pressures, with national projections of an increase of around JPY 17 trillion (2.7% of projected GDP in 2025) in health, long-term care and pension expenditures between FY 2024 and 2040. Raising the pension eligibility age beyond the target of 65, in line with rising life expectancy, would help raise the employment of older persons and reduce fiscal costs. Expanding social security coverage for non-standard workers and enhancing vocational training and education could boost labour productivity and labour supply. Continuing Work Style reforms, including equal pay for equal work and flexible work arrangements, and improving child-care provision, would promote female employment and reduce Japan’s large gender wage gap. Lowering barriers to foreign workers and foreign direct investment would also help. Faster progress with the digital and green transformation is also needed. Enhancing energy security and lowering dependence on fossil fuels requires stepping up the promotion of research, development and deployment of clean energy technologies, including renewable energy, and encouraging greater energy efficiency.