MACRO REPORT Japan Economy Update March 2015 Key Insights Monica Defend Head of Global Asset Allocation Research Alessia Berardi Senior Economist Global Asset Allocation Research Also contributing Riccardo Soggiu Senior Economist, Central Banks Global Asset Allocation Research Abenomics: The winter Diet is currently underway (26 Jan 24 Jun). The recent resignation of the Farm Minister Nishikawa has put the schedule of the Diet at some risk, starting with a possible delay in approving the Budget Law. Nishikawa is the third Minister to resign since the Cabinet reshuffled last September; the previous Minister Hayashi has been re-appointed. The agriculture sector is in the spotlight because of further developments related to the Trans Pacific Program and the tight conditions that will be required as part of any deal. Economic Outlook: Japan was technically out of recession in Q4 2014. However, in real terms, the country closed the 2014 Calendar Year with flat economic growth. On the basis of the new data set, we confirm a mild recovery going forward: CY 2015/2016 at 0.6% YoY and 1.1% YoY respectively. Between the second and the third quarters of 2015, the Core Inflation rate will likely touch bottom around zero, before increasing again towards 1.0% in the forecasting horizon. In our view, there is a not negligible probability of seeing some negative figures for inflation in the short term. Monetary Policy: Our main case is that the Bank of Japan (BoJ) will not intervene further in 2015, as it will look at inflation dynamics over the medium-to-longer term rather than on a short term basis. The risk to our main case of further intervention is not low, at 30% probability, and the timing associated with that risk is towards the end of the year, when the BoJ will reassess a proper economic outlook for 2016. Macro Pulse ECONOMIC CONDITIONS STABILITY CONDITIONS Poor Good Poor Good Japan was out of the technical recession in Q4 2014. No further easing is the main case. Budget Law is under consideration. Zero inflation shortly. Japan Population is aging and the immigration trend is virtually non-existent. Structural reforms are struggling. A third Minister (Farm) appointed in the Cabinet reshuffle has resigned. New Pension Fund allocations increase appetite for riskier and foreign assets. Labour Market efficiency is the weakest contributor to the country s competitiveness. Source: Pioneer Investments. Data as of February 27, 2015. 1
Economic Conditions: Mild Recovery Expected Growth & Economic Trends On the 16th of February, the Japanese Cabinet Office released the Preliminary figure for Japan s Q4 2014 GDP at 2.2% QoQ ann. rate, vs. Pioneer expectations at 1.9% and Consensus at 3.7%. According to the Preliminary figure, with a decent increase in GDP, as in our main case. However, in real terms, the country closed the 2014 Calendar Year with flat economic growth. On the basis of the new data set, 0.6% and 1.1% YoY, respectively. 2017 GDP will be slower, if the Japanese Government follows through in the implementation of the Consumption Tax hike (from 8% to 10%) delayed from this year. Figure 1. JAPAN GDP Contributions 6,0 4,0 2,0 0,0-2,0-4,0-6,0-8,0 Pers. Cons. Exp. Investments Gov. Cons. Exp. Net Trade Inv. Changes GDP Source: Japan Cabinet Office, Datastream, Pioneer Investments, as of December 2014. We do not expect robust performance on the private consumption side: household demand will remain quite muted. Indeed, on one hand, wages have only just turned up in real terms, after the strong hit caused by the spike of the inflation rate; on the other hand, the labor market is tight and remains supportive of the private consumption recovery. After spiking up in December 2014, the Scheduled Cash Earnings (Nominal Wages) grew by 0.4% YoY, a not negligible rate of growth, coming after 3 years of negative growth. Once again, the upcoming spring wage negotiations will be pivotal. 2
(%YoY) Japan Macro Report March 2015 Figure 2. JAPAN Wages 3,0 2,0 1,0 0,0-1,0-2,0-3,0 Consumption tax hike -4,0 gen-07 dic-07 nov-08 ott-09 set-10 ago-11 lug-12 giu-13 mag-14 Contractual Cash Earnings Real Wages Source: Japan Cabinet Office, Datastream, Pioneer Investments, as of December 2014. Non-Residential Fixed Investments in CY 2014 averaged around 4% of annual growth, a more than decent yearly rate of growth for Capex. They started the year with a stellar +10.5% YoY in Q1 2014, riding the wave of high corporate confidence based on the results of 2013 and the frontloading of expenditures due to the Consumption Tax. However, Capex collapsed to a meagre 0.6% YoY in Q4 2014. Industrial Production recovered during Q4 and Earnings season has been good as well; we expect that Capex will keep growing going forward. The most recent figures for Corporate Profitability and Diffusion (like the Tankan index) are supportive of our outlook. Corporate Japan has a JPYUSD at 104 as the main case. Trade statistics at the end of 2014 and in January 2015 showed a narrowing trade deficit because of the recovery of Japan s principal trading partners, such as the US. According to our expectations, in 2015, the contribution of Net Exports to GDP growth will be positive and higher than in 2014. In our view, Core Inflation (BoJ s target) will remain well above zero and above the 2.0% target (thanks to the Consumption Tax hike in April 2014) until April 2015, when the base effect will likely fade. According to our expectations, between the second and the third quarters of 2015 the Core Inflation rate will touch bottom, before increasing again towards 1.0% in the forecasting horizon. The bottom that we expect to see is at zero positive in the best scenario (in December, the Core Inflation rate without the impact of the Consumption tax was at 0.5% YoY). Indeed, there is a not negligible chance of seeing some negative figures for inflation in the short term. 3
Figure 3. JAPAN Core Inflation 4,0 3,5 3,0 2,5 2,0 1,5 1,0 0,5 0,0-0,5 BoJ Target 2% -1,0 01/01/2012 01/07/2012 01/01/2013 01/07/2013 01/01/2014 01/07/2014 Source: Japan Cabinet Office, Datastream, Pioneer Investments, as of December 2014. In comparison with the macroeconomic outlook released by the BoJ in January, we expect much more muted growth in FY 2015 (Pioneer 1.2% vs. BoJ 2.1% YoY) and a much lower Inflation rate in 2016, when the BoJ is targeting 2.0% YoY (Pioneer 1.0% vs BoJ 2.2% YoY). Figure 4. Macroeconomic Outlook Real GDP Core CPI Ex-Consumption Tax Hikes BOJ Pioneer BOJ Pioneer BOJ FY 2014-0.5-0.8 2.9 3.0 0.9 FY 2015 2.1 1.2 1.0 0.7 FY 2016 1.6 1.2 2.2 1.0 Source: BoJ, Pioneer Investments. Data as of February, 27 2015. Consumption Tax Impact Economic Policies Monetary Policy The 2% inflation target has become a medium term target, with the BoJ no longer vowing to reach it within 2 years. The BoJ in February indicated that it will continue its QQE (Quantitative and Qualitative Easing) policy until stable 2% inflation is maintained. It highlighted that Japan s economy has continued its moderate recovery trend and noted that exports and production have been picking up. CPI was described as likely to slow for the time being on the drop in energy prices but they highlighted that inflation expectations are rising from a longer term view. It vowed to watch risks and to adjust policy as appropriate going forward. The vote to maintain the current policy obtained an 8 to 1 majority. Speaking at the press conference after the meeting, President Kuroda stated that there is no need for further policy action at this point but reiterated that the BoJ won t hesitate to take policy action if needed. He also reiterated that the BoJ is committed to reaching the 2% inflation target as soon as possible and indicated 4
that a virtuous cycle is taking place in Japan s economy and that the CPI target is likely to be reached in FY2015 (which starts in April). The next interest rate setting meeting is on March 17. Our main case is that the BoJ will not intervene further in 2015, as it is looking at inflation dynamics over the medium-to-longer term rather than on a short term basis. The risk to our main case of further intervention is not low, at 30% probability, and the timing associated with that risk is towards the end of the year, when the BoJ will reassess a proper economic outlook for 2016. Fiscal Policy The Budget submitted by the Ministry of Finance at the beginning of January is currently under consideration in the Diet (to be approved by the end of March). Although the Consumption Tax hike has been delayed to the 2017, the targets under the Medium-Term Fiscal plan (August 2013) have been confirmed in the current Budget: - The Government aims to halve the primary deficit of the national and local governments to GDP ratio (-3.3%) from the ratio in FY2010 (-6.6%) - The Government aims to achieve a primary surplus by FY2020 he Government will seek to steadily reduce the public debt to GDP ratio The Budget plans to reduce the Bond Dependency Ratio 1 to 38.3% in FY 2015 from 43% in FY 2014. That reduction is made possible by increased revenues from the Consumption Tax hike in April 2014. According to some local sources, a new set of measures in terms of fiscal consolidation is under analysis. On top of that, it s worth noting that fiscal consolidation can more easily be initiated when the economy is on a clear and solid reflation path. A broad framework revising the taxation system has to be implemented, with the objective of incentivizing the reflation path as well as improving the budget deficit. Stability Conditions: Fiscal Consolidation Needed Politics The winter Diet is currently underway (26 Jan 24 Jun). The recent resignation of the Farm Minister Nishikawa has put the schedule of the Diet at some risk, beginning with a possible delay in approving the Budget Law. Nishikawa is the third Minister to resign since the Cabinet reshuffled last September; the previous Minister Hayashi has been re-appointed. The agriculture sector is in the spotlight because of further developments related to the Trans Pacific Program and the tight conditions that will be required as part of any deal. 1 The Bond Dependency Ratio is defined as the ratio between new public bond issuance and general account expenditures. 5
In our view, regional elections in mid-april will be interesting in providing an assessment of the approval level for Abe s Cabinet. 2015 Triggers and Risks Triggers Further JPY depreciation going forward could push Exports to further support economic growth through Net Exports contribution. A more convincing implementation of economic measures by the Cabinet, following December s election victory, could boost potential GDP growth in coming years. Risks A weak posture with respect to growth strategies without any effort on fiscal consolidation could push the country towards default. Higher-than-expected interest rates could offset efforts put in place by the BoJ and the Cabinet to revive the economy, pushing the country s debt to default. Notwithstanding the elections held in December, Abe s Cabinet appears less strong after three resignations in six months. 6
Macroeconomic Forecast Japan 2012 2013 2014 2015E 2016E 2017E 2014 2015E 2016E Macroeconomic Forecasts Q1 Q2 Q3 Q4 Q1E Q2E Q3E Q4E Q1E Q2E Q3E Q4E GDP & Components % QoQ Annualized % QoQ Annualized % QoQ Annualized GDP 1.8 1.6 0.0 0.6 1.1 0.6 5.5-6.7-2.3 2.2 1.6 1.5 1.2 1.5 0.8 1.0 0.9 1.1 Personal Consumption Expenditures 2.4 2.1-1.3-0.0 1.0 0.2 9.1-18.8 1.0 1.1 1.6 1.5 1.3 1.2 0.6 0.7 1.3 1.0 Government Consumption Expenditures 1.7 2.9 1.0-0.2-0.1 0.4-2.8 2.0 2.2 0.4-0.8-1.6-1.2-0.4 0.4 0.4-0.4 Residential Investments 3.2 8.7-4.6-4.5 4.0 2.7 10.0-35.4-25.1-4.8 3.1 3.1 5.3 4.1 3.6 4.4 4.7 1.2 Non- Residential Investments 3.8 0.6 3.9 0.9 3.4 1.9 26.0-18.5-0.6 0.4 0.9 6.9 2.7 4.2 4.0 2.1 2.3 3.0 Total Internal Demand (YoY%) Total Consumption + Fixed Investments+Inventories 2.6 1.9 0.0-0.2 1.1 0.6 3.3-0.3-1.5-1.4-3.0 0.2 1.0 1.0 1.3 1.1 1.1 1.1 Final Internal Demand (YoY%) Total Consumption + Fixed Investments 2.4 2.2-0.2-0.1 1.1 0.6 4.0-1.2-1.7-1.7-3.4 0.9 1.0 1.2 1.2 1.1 1.1 1.1 Exports 0.0 1.6 8.2 3.1 2.6 2.0 28.8-1.3 6.2 11.4 1.2-3.5 4.4 3.7 2.6 3.8 0.4 2.3 Imports 5.4 3.1 7.3 0.6 3.0 1.8 30.3-19.7 4.2 5.3 2.3-3.6 3.5 3.0 4.8 3.5 2.0 2.6 GDP Contributions Net trade - 0.7-0.2 0.3 0.4-0.0 0.1 Inventories changes 0.2-0.4-0.1 0.3 0.0 - Economic Trend % YoY % YoY % YoY Industrial Production 0.3-0.5 2.1 0.8 3.8 1.1 8.4 2.6-1.1-1.3-3.3-0.1 3.0 3.6 3.7 5.0 3.9 2.4 Corporate Profits 8.7 20.2 7.3 1.6 12.5 5.9 20.2 4.5 7.6-3.3-4.6-3.7 6.4 8.2 13.3 15.5 9.5 11.7 Employees' Compensations 0.9 0.6-1.0 0.6 0.7 0.8-0.5-1.9-0.8-0.6-0.5 1.5 1.1 0.5 0.6 0.6 0.6 1.2 Corporate Goods Prices Index -0.9 1.3 3.2-1.2 1.3 1.7 2.0 4.3 4.0 2.4 0.8-1.9-2.4-1.1 0.7 1.1 1.8 1.8 Consumer Prices Index -0.1 0.4 2.6 1.0 0.6 1.3 1.3 3.4 3.2 2.7 2.9 0.2 0.2 0.6 0.4 0.7 0.7 0.7 Unemployment Rate 4.3 4.0 3.6 3.5 3.4 3.4 3.6 3.6 3.6 3.5 3.5 3.5 3.5 3.4 3.4 3.4 3.4 3.4 M2+CD 2.5 3.6 3.4 2.9 2.8 3.2 4.0 3.3 3.0 3.4 3.3 2.8 3.1 2.5 2.5 2.7 2.9 3.1 Update as of February 27, 2015; for time series with higher frequency (monthly or daily) than quarterly, we consider the quarterly average; in Italic exogenous variables; GDP components on quarterly frequency are %Q/Q annualized rates; all other figures, if not otherwise specified, are %Y/Y. Important Information Unless otherwise stated, all information contained in this document is from Pioneer Investments and is as of February 27, 2015. The views expressed regarding market and economic trends are those of the author and not necessarily Pioneer Investments, and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading on behalf of any Pioneer Investment product. There is no guarantee that market forecasts discussed will be realized or that these trends will continue. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested. This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any service. Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies. Date of First Use: March 4, 2015. Follow us on: www.pioneerinvestments.com 7 0147_0215