This Time Might Be Different
It’s not just Tokyo hotels that are finding it tough. Blackouts, aftershocks, nuclear fears and a general mood of restraint are conspiring to create an economic impact that's likely considerably greater than originally believed.
On Wednesday, the Cabinet downgraded its outlook for the economy, the first such move in six months. Its regular survey of industry, conducted in late March, showed a record drop in confidence, to the lowest point since early 2009. A regular Reuters survey has shown similar results. Comments by government ministers suggest that the government is forecasting—hoping for—a short shock to the economy, followed by a strong rebound later in the year. That's generally what happens following a major natural disaster, and it's the path that Japan followed after the Kobe earthquake in 1995.
There are grounds, however, to argue that this time might be different. First, the crisis isn't over. How quickly can the situation at the nuclear power plant in Fukushima be brought under control? TEPCO remains unable to provide any kind of timeline. How bad will the blackouts be during summer? Keidanren, Japan’s leading business association, is trying to get the government to accept voluntary power cuts, rather than the mandatory outages planned. Will there be more damaging aftershocks? That's the forecast.
Second, Japan faces a much more constrained fiscal situation than it did in 1995. Under the circumstances, efforts to reduce the public debt—usually stated as more than 200 percent of GDP—will be put aside for the time being. There's a strong argument that Japan’s debt crisis is overrated, and certainly the ultimate risk is of inflation, not default, but at some point political pressure will return for both the government and the Bank of Japan (BOJ) to rein in the debt.
BOJ officials have pointed out that Japan has an ample surplus of savings to pay for reconstruction. This is certainly true, but those savings are in the private sector. To be mobilized for rebuilding and fiscal stimulus it needs to made available to the government, which can be done through either higher tax or higher debt. Neither option is appealing. Tokyo may be able to pass a special tax to pay for reconstruction—a draft bill prepared by the ruling Democratic Party of Japan has this and other options on the table—but raising income or consumption (sales) taxes would be fatal to efforts to stimulate a battered economy and may ultimately result in lower tax revenues. That’s what happened when the consumption tax was last raised, in 1997.
The main worry with the use of additional debt is that even with an average interest rate on its outstanding debt of just 1.5 percent, interest payments already account for 25 percent of the Japanese government’s tax revenues. This is one reason why the BOJ is so reluctant to directly monetize the debt—the fear that this could trigger inflation expectations, a rise in bond yields, and a crushing interest payment burden for the government.
Reining in debt while trying to kick-start the economy is the central economic dilemma for the Japanese government, and I’ll have more to say about a possible solution in a piece on Monday.
Third, the Japanese economy was already very fragile even before the earthquake, with the endemic problem of falling population and weakening demand. The natural momentum in Japan is now towards contraction, not growth.
In normal times, the Japanese business year moves in fairly predictable cycles. For the vast majority of Japanese companies, the fiscal year ends on March 31, and March is generally a flurry of last-minute orders and activity. Early April often brings a brief lull, with many companies inducting new recruits, executing reshuffles, or digesting acquisitions, which are often timed for April 1.
For workers, thoughts often begin to turn to the upcoming Golden Week holidays, a set of consecutive public holidays that start at the end of April and run through the first week of May. In Tokyo, where everybody is from somewhere else, Golden Week often means a return to hometowns. That idea will be particularly appealing this year, with Tokyoite nerves somewhat frayed by the constant aftershocks.
Given the circumstances this year, it's very likely that companies will hunker down in April and wait until after Golden Week before making spending decisions. In my own (admittedly very unscientific) survey of clients and associates, that is the strong impression they are getting. The retail and hospitality sectors will be suffering badly, and trying to survive. Manufacturers will be focused on fixing disrupted supply chains. Many other companies will be poised, with a wait-and-see attitude. In short, April is going to be dismal.
What happens after that first week in May very much depends on the tenor of the news reports. For the government to get its wish of a short shock followed by a sharp recovery, a best-case scenario is required: progress in Fukushima, with no more alarming contamination reports; a workable arrangement for the power cuts; convincing government announcements on economic stimulus with a credible plan for eventual fiscal reform; and significant progress in fixing supply chains.
That’s a lot of ifs, but it may not be as difficult to achieve as it sounds. Radiation levels outside Fukushima are trending downwards, and in Tokyo they have returned to normal range. There have been no further contamination alerts. Power outages during summer, when demand peaks, could perhaps be alleviated through means such as extending and staggering summer holidays. The government apparently has a comprehensive bill to be tabled in early May. And early reports suggest that many companies are making good progress in restoring their capabilities.
So Japan may exit summer with its economy bruised but still standing. Of course, the risks are very much on the downside, such as a damaging aftershock, a setback at Fukushima, a slowdown overseas, or delays in getting supply chains restored.
Longer term, the two central economic debates in Japan will resume: how to pay down the public debt without strangling growth, and whether to open the economy or continue to protect the primary and tertiary sectors. But even in the very best-case scenario, the disaster and its aftermath will lend additional urgency to these questions.
James Pach is the publisher of The Diplomat and the founder of Trans-Asia Inc., a Tokyo-based translation and investor relations company.
On Wednesday, the Cabinet downgraded its outlook for the economy, the first such move in six months. Its regular survey of industry, conducted in late March, showed a record drop in confidence, to the lowest point since early 2009. A regular Reuters survey has shown similar results. Comments by government ministers suggest that the government is forecasting—hoping for—a short shock to the economy, followed by a strong rebound later in the year. That's generally what happens following a major natural disaster, and it's the path that Japan followed after the Kobe earthquake in 1995.
There are grounds, however, to argue that this time might be different. First, the crisis isn't over. How quickly can the situation at the nuclear power plant in Fukushima be brought under control? TEPCO remains unable to provide any kind of timeline. How bad will the blackouts be during summer? Keidanren, Japan’s leading business association, is trying to get the government to accept voluntary power cuts, rather than the mandatory outages planned. Will there be more damaging aftershocks? That's the forecast.
Second, Japan faces a much more constrained fiscal situation than it did in 1995. Under the circumstances, efforts to reduce the public debt—usually stated as more than 200 percent of GDP—will be put aside for the time being. There's a strong argument that Japan’s debt crisis is overrated, and certainly the ultimate risk is of inflation, not default, but at some point political pressure will return for both the government and the Bank of Japan (BOJ) to rein in the debt.
BOJ officials have pointed out that Japan has an ample surplus of savings to pay for reconstruction. This is certainly true, but those savings are in the private sector. To be mobilized for rebuilding and fiscal stimulus it needs to made available to the government, which can be done through either higher tax or higher debt. Neither option is appealing. Tokyo may be able to pass a special tax to pay for reconstruction—a draft bill prepared by the ruling Democratic Party of Japan has this and other options on the table—but raising income or consumption (sales) taxes would be fatal to efforts to stimulate a battered economy and may ultimately result in lower tax revenues. That’s what happened when the consumption tax was last raised, in 1997.
The main worry with the use of additional debt is that even with an average interest rate on its outstanding debt of just 1.5 percent, interest payments already account for 25 percent of the Japanese government’s tax revenues. This is one reason why the BOJ is so reluctant to directly monetize the debt—the fear that this could trigger inflation expectations, a rise in bond yields, and a crushing interest payment burden for the government.
Reining in debt while trying to kick-start the economy is the central economic dilemma for the Japanese government, and I’ll have more to say about a possible solution in a piece on Monday.
Third, the Japanese economy was already very fragile even before the earthquake, with the endemic problem of falling population and weakening demand. The natural momentum in Japan is now towards contraction, not growth.
In normal times, the Japanese business year moves in fairly predictable cycles. For the vast majority of Japanese companies, the fiscal year ends on March 31, and March is generally a flurry of last-minute orders and activity. Early April often brings a brief lull, with many companies inducting new recruits, executing reshuffles, or digesting acquisitions, which are often timed for April 1.
For workers, thoughts often begin to turn to the upcoming Golden Week holidays, a set of consecutive public holidays that start at the end of April and run through the first week of May. In Tokyo, where everybody is from somewhere else, Golden Week often means a return to hometowns. That idea will be particularly appealing this year, with Tokyoite nerves somewhat frayed by the constant aftershocks.
Given the circumstances this year, it's very likely that companies will hunker down in April and wait until after Golden Week before making spending decisions. In my own (admittedly very unscientific) survey of clients and associates, that is the strong impression they are getting. The retail and hospitality sectors will be suffering badly, and trying to survive. Manufacturers will be focused on fixing disrupted supply chains. Many other companies will be poised, with a wait-and-see attitude. In short, April is going to be dismal.
What happens after that first week in May very much depends on the tenor of the news reports. For the government to get its wish of a short shock followed by a sharp recovery, a best-case scenario is required: progress in Fukushima, with no more alarming contamination reports; a workable arrangement for the power cuts; convincing government announcements on economic stimulus with a credible plan for eventual fiscal reform; and significant progress in fixing supply chains.
That’s a lot of ifs, but it may not be as difficult to achieve as it sounds. Radiation levels outside Fukushima are trending downwards, and in Tokyo they have returned to normal range. There have been no further contamination alerts. Power outages during summer, when demand peaks, could perhaps be alleviated through means such as extending and staggering summer holidays. The government apparently has a comprehensive bill to be tabled in early May. And early reports suggest that many companies are making good progress in restoring their capabilities.
So Japan may exit summer with its economy bruised but still standing. Of course, the risks are very much on the downside, such as a damaging aftershock, a setback at Fukushima, a slowdown overseas, or delays in getting supply chains restored.
Longer term, the two central economic debates in Japan will resume: how to pay down the public debt without strangling growth, and whether to open the economy or continue to protect the primary and tertiary sectors. But even in the very best-case scenario, the disaster and its aftermath will lend additional urgency to these questions.
James Pach is the publisher of The Diplomat and the founder of Trans-Asia Inc., a Tokyo-based translation and investor relations company.
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