Snapshot

Coronavirus to hit already reeling Japanese economy


It was always going to be bad, the question was just how bad.

The Japanese economy contracted by 1.6% quarter-on-quarter. This was driven by large contractions in consumption and investment and follows October’s raise in Value-Added-Tax (VAT) from 8% to 10%.

This fall in Japan’s GDP was almost double the magnitude that was expected by economists. Investors were also clearly caught off guard, with the Japan’s TOPIX index selling off by around 1% on the news.

Countermeasures unsuccessful

Despite large countermeasures to the tax change this time around, the last VAT hike in 2014 remains the best comparison for investors thinking about this GDP print.

When taking into account that the magnitude of the hike was smaller in 2019 than 2014, the scale of contraction is fairly in line with 2014.

This shows that countermeasures taken this time around did not work, which will disappoint Japanese authorities.

Moreover, we now know that the lack of a surge in demand in the third quarter reflects poor domestic demand, rather than the success of measures meant to smooth demand ahead of the tax change.

Coronavirus to weigh on 2020 outlook

Due to the knock-on effect that this has on the growth outlook for 2020, Japanese economists will have to slash forecasts for this year by around 0.5 percentage points.

The resulting 2020 growth story for Japan will depend on the recovery from here given the negative effects of the coronavirus.

Japan is particularly vulnerable to the virus relative to its developed market peers, reflecting not only its location but the importance of China for tourism, exports and its supply chains.

Ultimately the severe contraction in the economy at the end of 2019 elevates recession risk and underscores Japan’s poor starting point to battle virus-related impediments.

No imminent policy response

Authorities were already concerned about the longer term growth outlook, announcing a fiscal stimulus package in December – worth 1.8% GDP over 2020 and 2021.

Although the Japanese government could easily draw up another package, authorities will instead likely closely monitor how well the data recovers in the first quarter, alongside the downside risks from the coronavirus.

For the Bank of Japan, investors should expect some more comments from Governor Kuroda highlighting that the central bank could ease if needed.

The poor growth data clearly raises the chances of a rate cut this year, but given this would have limited impact and hurt the financial sector, the central bank is more likely to keep rates unchanged.