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Japanese Economy - Still Looking for a Boost

In this DBRS Morningstar commentary, we discuss Japan's challenging growth outlook at the outset of a spectator-less Olympics and amid ongoing concerns about the Coronavirus Disease (COVID-19) pandemic. Japan's economy has experienced a moderate contraction in comparison to its G-7 peers and has experienced relatively smaller outbreaks, but a slow start to vaccinations may delay Japan's recovery between 3-6 months relative to its peers. Rising COVID-19 infections have prompted the government to impose yet another state of emergency in July, which is expected to extend through the end of the Olympic Games. Meanwhile, Japan's challenges with entrenched low inflation are likely to persist, keeping monetary policy accommodative at least into 2023.

Key highlights include:
• Japan is lagging behind the U.S. and European economic recoveries due to successive waves of the virus in 2021 and its relatively slow start to the vaccination process. Only 21.7% of the total population has been fully vaccinated as of the middle of July. The 2020 Olympics, which start this week, have been significantly scaled down and thus are unlikely to provide any boost the economic recovery.
• While U.S. and Europe are seeing some inflationary pressures associated with increased demand in the service sector, Japan's lagged cyclical recovery, one-off factors and entrenched low inflation expectations have kept inflation subdued. This could potentially change as Japan's economy resumes normal activity, but we view Bank of Japan (BoJ) policy as likely to remain accommodative well into 2023.
• Further delays in the recovery may add to the ultimate fiscal cost associated with pandemic-related measures. The pandemic has resulted in Japan's already high debt ratio rising further from 234.8% of GDP in 2019 to 256.2% in 2020. However, DBRS Morningstar believes Japan’s financial flexibility remains high and that the BoJ’s extraordinary measures help to mitigate risks to the government’s ability to service debt.

”Rising infections, slow progress on vaccinations coupled with spectator less Olympics has delayed Japan’s recovery relative to other G7 economies,” notes Rohini Malkani, Senior Vice President in the Global Sovereign Ratings Group. ”While deficits and debt have increased, Japan’s financial flexibility remains high, mitigating risks to the government’s ability to service debt.”