Japan’s trade deal with the US is good news but pressure might not be over

Japanese policy makers must have been relieved to see the tariff negotiation with the US reaching an agreement on July 23rd, especially given the state of disarray after the poor results at the Upper House elections for the ruling party (LDP) last weekend.Reaching a deal with the US was extremely important as the US is Japan’s largest trading partner and increasingly. The most affected sectors were autos, machinery and electronics, among others (Chart 1) and the risk was as much as 25% reciprocal tariffs.The final outcome, 15% tariffs rather than 25%, has been received rather positively by the market, also because it covers autos (which were at risk of higher sector tariffs) without any quota imposed. On the negative side, tariffs on steel and aluminum were left unchanged at 50%, which fell short of the Japanese government’s expectations but constitutes a very small share of exports.Although the final tariffs are clearly lower than feared, this is still a negative shock for Japan as the effective tariff rate for Japanese exports into the US will be much higher than what it was in 2024, 3.3%, which is estimated to reduce Japan’s GDP growth by as much as -0.5%.  The fact that the Yen is currently more than 10% weaker than the equilibrium level* of USDJPY=130.1 also offers some respite.Japan’s offer so as to see tariffs be reduced, has been a combination of market access for US companies and investment pledges into the US. On the former, Japan will buy more agricultural products from the US but at the expense of other countries as the Japanese government doesn’t intend to lower tariffs or to increase the minimum access for rice specified by the WTO. On the latter, under the Japan Investment America Initiative, the Japanese government will support companies to invest in the US. Financial support, up to USD 550 billion, will be offered by the Japan Bank for International Cooperation (JBIC) and the Nippon Export and Investment Insurance (NEXI). Japanese companies are expected to support the development of supply chains in semiconductors and pharmaceuticals, thereby, reducing the US dependence on China.Whether the above measures will solve the structural problem of Japan’s large trade surplus with the US is yet to be seen (Chart 2). Japan could still be requested to increase imports on defense equipment and energy where the government has more control. In other words, while the trade deal between Japan and the US is good news, it might not be a final settlement, especially since it might not reduce Japan’s large bilateral surplus with the US.* Breakeven level for profitability according to a company survey in FY24 by the Cabinet Office.