Japan quietly reflates, buying time for reckoning with debt

[TOKYO] Hidden beneath the headlines about Japan's continual failure to reach its inflation target is a quiet reflation of its economy.

It took almost two decades, but Japan finally notched a record for the size of its economy in 2016, one of the most significant signs yet that Prime Minister Shinzo Abe's reflation policies have had an impact on underlying fundamentals.

Despite population declines on the order of more than a quarter million people a year, and in face of muted productivity gains, Japan's nominal gross domestic product totalled 537 trillion yen (S$6.67 trillion) last year, government data showed Monday. Last year was the first time that nominal GDP, which is unadjusted for price changes, hit a record since 1997.

The good news: domestic demand contributed to the gains, with business investment outpacing the GDP rise, and both consumption and government spending playing their part. The bad news: most of the increase came from exports climbing more than imports. That could be a problem because of US President Donald Trump's protectionist moves and his concerns about Japan's exchange-rate policy.

"The cheap yen since the start of Abenomics has really been a tailwind for the recent movements," said Hiroaki Muto, chief economist at Tokai Tokyo Research Center. "I don't think it would have crossed this point" without that, he said of nominal GDP.

If the BOJ decided to keep its balance sheet big, that would leave Japan with much more room to address debt.

The expansion has given a bigger denominator for Japan's debt-to-GDP ratio, offering more time to address reining in public-sector leverage that's a legacy of decades of stagnation and fiscal stimulus. The extra cushion is all the more important should the Bank of Japan, which now holds almost 40 per cent of Japanese government debt, decide that it needs to shrink its balance sheet - as its US counterpart is planning.

For now, the outlook is for continued gains in nominal GDP, which is the calculation that matters for corporate, government and household incomes. Exports are projected to outpace imports again for January, and price increases are forecast to pick up after being held down by commodity prices in recent years.

Also under-appreciated is how Japan's government has succeeded in tightening its belt in recent years. In 2010, a previous administration set a goal of halving the primary budget deficit, which excludes debt-servicing costs, from the equivalent of 6.3 per cent of GDP.

In a rare win for fiscal targeting, the gap in 2015 was 3 per cent. While it widened this year with fiscal stimulus packages, the government - under its optimistic "economic revival" scenario for growth - sees it at 1.4 per cent for 2020.

The key for policy makers will be to avoid complacency, said Mr Muto: "if you think it'll be all right, reforms will fall into retreat." In particular, Abe - who some project to remain in power until 2020 - will need to take on social-security reforms, he said, given the swelling funding shortfall that looms as Japanese people age.

BLOOMBERG