Japan's Economic Green Shoots Could Wither Fast

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Yuriko Nako / Reuters

Job-seekers rest on a bench at a job fair held for graduates in Tokyo November 15, 2008

Japan's hard-hit economy this week got a double dose of mildly good news. According to official figures released June 29, Japanese industrial output jumped nearly 6% in May, matching the largest monthly increase since 1953. And on July 1, the much-watched tankan survey, which measures sentiment among Japan's largest manufacturers, improved for the first time in two-and-a-half years, indicating confidence in the country's economic prospects is starting to grow.

But while it may be true that Japan has seen the depths of its worst postwar recession, economists say things are still far from good — and a "double-dip" recession is an increasingly likely outcome. "It will take several years, not one or two years, before Japan's output gap, or economic slack, disappears," says JPMorgan chief economist Masaaki Kanno. "Deflation and high unemployment will last for a long time. The question is whether the economy will continue to grow for several years without having the double dip."

Analysts had anticipated some improvement in business confidence in the quarterly tankan survey results released by Japan's central bank. However, the survey, which polls 1,215 large manufacturers as well as thousands of other businesses, indicated companies remain more pessimistic than optimistic and are still reluctant to make capital investments. According to Kanno, the results confirm "the upside momentum is getting stronger, but the level of the economic activities is still very low." Japan's unemployment rate rose for the fourth straight month to 5.2% in May, up from 5.0% in April. Job availability is at a record low, with only 44 jobs available per 100 job seekers. The last time unemployment reached 5.2% was in Sept. 2003.

And while industrial output in the world's second-largest economy jumped 5.9% in May — the third consecutive month-to-month increase — output remains down nearly 30% compared with May, 2008. "Currently, the recovery is boosted by global destocking and the government economic-stimulus measures," says Hiromichi Shirakawa, chief economist at Credit Suisse in Tokyo. "If [those] fade away, it's possible for the [economy] to go down again."

Kanno stressed that to avoid a double-dip recession, it's critical that the government gets the timing right when it begins to reverse loose fiscal and monetary policies as the economy improves. For example, raising interest rates — now effectively zero — too quickly could nip a recovery in the bud. "We need to be careful about the response of the market and the economy to the expected government's and central bank's exit policy," says Kanno. "Normalization policy may trigger the next downturn."

The risk could be reduced if U.S. consumer demand for Japanese products began to strengthen, or if the government introduced additional stimulus spending. Due to budget constraints, says Shirakawa, the latter is unlikely. Japan currently spends 4% of GDP, an unusually high ratio for a developed country, to service its burgeoning debt. But a pickup in consumption is possible, he says. The savings rate in the U.S. has increased in the past few months, and consumers may be feeling more confident that they can now spend a little more. That could provide some relief to Japan's battered export sector; Japanese exports in April were down 39% on a year-over-year basis, the worst drop registered among major economies. Shirakawa says he expects demand will be "so-so" through the end of the year. But he added that "a sustained recovery of consumer demand doesn't seem that likely."