Japan

The Japanese economy has been a slow performer among peers, with GDP growing on average by +0.8% over 2000-2019 and +1.2% over 2010-2019, a moderate pace compared to other advanced economies or the Asia-Pacific region. Real GDP contracted by -4.3% in 2020, and was followed by a mild recovery, with growth of just +2.3% in 2021, followed by a modest +0.9% in 2022, even though Covid-19 constraints ended in that year. In 2023, growth picked up to an estimated +1.8%, bringing real GDP back to its 2019 level. We expect GDP growth to moderate to +0.2% in 2024, and then rebound moderately to +1.2% in 2025. The projected slowdown in GDP growth is mainly due to lower private consumption. Improvements going into 2025 will be supported by rising wages and government measures (such as tax cuts and the oil-price regulation). In addition, as external demand is expected to rise (especially for electronic goods), exports are forecast to increase (and have already done so since the beginning of 2024). Over the longer term, Japan should return to its pre-pandemic, structurally low growth rate of below +1% per year. On the one hand, the medium-term economic performance will be supported by a more dynamic global and domestic demand, higher public investment as well as a competitive environment. On the other hand, labor shortages caused by an ageing population will curtail Japan’s growth prospects.

Inflationary pressures were scarce in Japan until recently. Headline consumer price inflation averaged 0.5% over 2010-2019, including three deflationary years. Inflation accelerated to an average of 2.5% in 2022 (although well below the global rate of 8.2%). In 2023, inflation came in at around 3% – a 30-year high in Japan (while global inflation decreased to 6.2%). Against this backdrop, in March 2024, the Bank of Japan, (BoJ, the central bank) ended the era of negative interest rates that had been in place since 2016. Quantitative easing was also scaled back. We expect inflation to decelerate and come down to 2.6% in 2024 and 1.8% in 2025. Such a divergence in Japan’s policy rate path with the US puts pressure on the currency, with the JPY depreciating against the USD (JPY132:USD1 in Q1 2023, JPY149:USD1 in Q4 2023, JPY158:USD1 in Q2 2024). The JPY depreciation may slow in the rest of 2024 as the Fed is expected to start cutting rates from September.

Fiscal policy had been eased significantly during the height of the Covid-19 crisis and we expect the government to continue to support household income and encourage rising wages and workforce training in the next few years. On the corporate side, the government will keep incentivizing efforts towards digitalization and innovation (especially when it comes to semiconductors and the green transition).  However, Japan’s neighbors in the Asia-Pacific region will pose strong competitive obstacles to the country’s development in the semiconductor industry.

Japan’s business environment is relatively well-positioned in our assessment of 185 economies, rated in the best range in the majority of the sub-components, although it seems to be slightly deteriorating. The 2023 Heritage Foundation’s Index of Economic Freedom survey assigns Japan rank 38 out of around 180 economies, reflecting particularly good scores with regards to property rights, judicial effectiveness, government integrity and monetary freedom, while there remains room for improvement regarding government spending and fiscal health receives an alarmingly low score. Meanwhile, the World Bank Institute’s annual Worldwide Governance Indicators surveys suggest that the regulatory and legal frameworks are business-friendly and the level of corruption is low. Our proprietary Environmental Sustainability Index puts Japan at rank 83 out of 210 economies, reflecting strengths in energy use per GDP, water stress and CO2 emissions per GDP, but weaknesses in terms of the recycling rate and renewable electricity output.

Japan's political stability rests on the dominance of the Liberal Democratic Party (LDP). Internal LDP dynamics, including factional debates and cooperation with the junior coalition partner, Komeito, shape policy more than opposition scrutiny. However, recent funding scandals have rocked the LDP, eroding the popularity of the party and its Prime Minister and leading to a by-elections defeat in April 2024. The LDP will hold an internal leadership election in September 2024, which could risk seeing current prime minister Kishida Fumio getting replaced. However, the LDP still has a strong majority in parliament, and the liberal and left-wing opposition, marked by successive defeats and a lack of reform ideas, struggles to challenge the LDP. Therefore, the latter is likely to remain in power after the October 2025 general election. A victory would pave the way to political stability in the medium term.