I. Interpretation of the Q4 Outturn
Japan’s production and exports have collapsed in recent months. Real GDP fell by 12.1 percent SAAR in Q4/2008, with net exports contributing about 10 percentage points to this decline. Japan’s performance was the worst among the G-7 countries, although the output drop was even deeper in the newly industrialized economies (NIEs) such as Korea and Taiwan Province of China (Figure 1A). Export and industrial production data for January indicate further declines.
Figure 1.Japan: Dissecting the Q4 Export Collapse
Most of the drop in Japan’s exports was caused by a sharp retrenchment in overseas demand for motor vehicles, information technology (IT), and capital goods (Figure 1B), as firms and consumers cut their investment and durable goods spending in response to the global credit crunch2 and extraordinary uncertainties about the outlook. In particular, data on motor vehicle registrations point to a collapse of car sales in a number of economies (Figure 1C). As a result, Japan’s car exports fell by 65 percent since September 2008, with shipments to the United States plunging almost 75 percent (Figure 1D).
The comparison of Q4 GDP outturns among selected countries suggests that economies with a greater share of advanced manufacturing such as IT goods and autos in GDP have tended to experience sharper output declines than their peers (see also Figure 1E). Japan’s woes were further exacerbated by its large trade exposure to emerging Asia, especially the NIEs (Figure 1F), in which growth has slowed sharply—for all the same reasons as in Japan. In addition, the yen has appreciated by about 30 percent in real effective terms since August (notably, the Korean won depreciated by about 60 percent against the yen over this period). More broadly, the export component of Japanese manufacturing exports is unusually high (and the import component is unusually low), which makes the manufacturing value added and net exports very sensitive to global demand shocks.3
Q4 GDP Growth vs. Share of Advanced Manufacturing in GDP
Sources: CEIC; Haver Analytics; OECD; and IMF staff estimates.
Note: For the definition of advanced manufacturing, see Figure 1.
Worsening financial conditions also contributed to the poor Q4 GDP outturn by weakening Japan’s domestic demand, especially business investment. Stricter lending standards, together with high interest rate spreads and significant stock market declines, have tightened financial conditions to levels last seen during the banking crisis of the 1990s.
Japan: The Financial Conditions Index
Source: IMF staff estimates.
II. Implications of Inventory Adjustment
Production is likely to continue plunging during Q1/2009. The January data point to a further sharp drop in industrial output (by 10 percent m-o-m) and exports (16 percent m-o-m) bringing the total output loss to almost 30 percent since September. Another 8 percent m-o-m decline in industrial production is expected for February, although the Ministry of Economy, Trade, and Industry (METI) production survey envisages a roughly 3 percent production increase in March (Figure 2A).
Figure 2.Japan: Inventory Adjustment Poses a Downside Risk To Growth
The ongoing inventory adjustment, however, presents a downside risk to this scenario. The drop-off in shipments has been so severe that domestic inventories have been rising despite drastic production cuts, especially in the IT sector (Figures 2B and 2C). While producers in most sectors began reducing their inventory holdings in January, the inventory target may be well below the pre-crisis levels since shipments are unlikely to recover anytime soon and many manufacturers need to boost their cash balances as working capital finances remain tight. Corporations are therefore likely to continue reducing inventories in the coming months to bring down their inventory-shipment ratios, with negative implications for production. From this perspective, the METI production survey results for February and March could prove optimistic since the survey implies a relatively small production cut in the electronics industry where the buildup of inventories has been most significant.
Inventories built up in export markets are adding to the downward pressure on production. Indeed, export demand could continue falling for some time as overseas wholesalers and retailers work off their own elevated inventory levels. Data on U.S. inventories of motor vehicles available through December 2008 point to a glut of cars at both wholesale and retail levels (Figure 2D). Indeed, the January shipments of Japanese cars to the United States turned out to be particularly weak. Given the evidence of inventory buildups in other export destinations (Figure 2E), the overseas inventory adjustment poses a short-term downside risk unless final demand recovers quickly.
When will the production and inventory adjustment be over? During the 2001 recession, industrial production started recovering about 5 months after the peak of the inventory cycle (Figure 2F). By analogy, one could expect a bottom in industrial production around May 2009. However, since the global environment is expected to remain weak 4 and the Japanese economy faces headwinds from tight domestic financial conditions, the production adjustment could take longer during this recession.