The mood has changed in Japan. Growth momentum was lower than expected in the second quarter and the first quarter was revised down. The GDP growth target of 2% does not seem to be reached.
Why is it important?
The scheme Shinzo Abe has put in place can be read as follows: First let GDP jumps on a strong trajectory. 2% GDP is the trend expected. With this solid trend it is possible to adjust public finances, to stabilize them and at the end to reduce the Public Debt to GDP ratio and makes it sustainable in the long run.
This is clear but Mr. Abe wants to do that very rapidly. He expects to start public finances rebalancing during the next fiscal year that will start in April 2014. VAT rate will be up by 3% from 5 to 8% and government expenditures will be reduced.
But to be able to start next spring the current GDP momentum must be strong and this is not the case yet.
Two things must be added to improve the situation
1 – Productive investment has to increase. For the last 6 quarters since the beginning of 2012 it has dropped. We know that change in business cycle is usually conditioned by change in investment. (see chart 3 below). For the moment companies’ have not been totally convinced by the government strategy and do not follow the impulse coming from public investment. It’s upsetting as the Tankan survey on July the 1st gave positive insights for investment. Nevertheless we have to wait the GDP second publication as important information will be added and this could change the conclusion.
If companies have not been totally convinced, households have followed Abe impetus. As it can be seen on chart 2 consumers’ expenditures have been strong in Q1 and Q2. Nevertheless we will have to be very attentive to consumers’ behavior as confidence has faltered in June and July. Chart 4 shows that households’ mind changed radically last December after Abe’s election. Since last June there is a change and we will have to be attentive to this issue as one important move from the government in the coming months will be a increase in VAT rate.
2 – The second important issue is structural reforms. Proposals still lack of precision and of a calendar. The main point here is to change the way to run the economy: Change on labor contracts to ease the adjustment of the economy, change in women’s role on the labor market, immigration and TPP (Trans-Pacific Partnership (free trade agreement in Asia-Pacific)) are the main reforms expected. There are supposed to allow a 2 % growth in the long run. But precisions on the measure and on the calendar are expected. Everyone has to have time to prepare these changes.  This is not the case yet.

The main point must be: how to boost growth in order to be able to follow Abe’s program. The first impact of the Abenomics has been positive but there is a need for relay on investment and on structural reforms to be able to jump on the second step of Abe’s program. If growth is not high enough there will be no stabilization in public finances nor reduction of the public deficit.
The issue is important and the momentum could decide of the success or of the failure of the program. Remember that in 1997 a hike in VAT rate led to a recession. That’s a point that is currently discussed as consumers’ expenditures are currently the main source of growth.
Abe has to convince companies to increase investment and to be more precise on its structural reforms in order to change expectations and at the end to boost trend growth.

Technical details
GDP growth was 2.6% in Q2 (annual rate) after 3.1% in Q1 (revised down from 4.1%). Compared to Q2 2012 GDP is up by 0.9%. Carry over growth for 2013 at the end of the second quarter is just 1.1%. To converge to 2% growth on average for 2013 then Q3 and Q4 growth should be 4.9% (annual rate). We expect GDP growth to be close to 1.6%
Chart 1 shows the GDP profile in level. GDP is almost back to its pre-crisis level (first half of 2008). It is still 0.1% below this level, this is marginal.
On Chart 2 GDP growth contributions give an important role to consumption and to exports. We see the importance of VAT change and we can still have question on the impact of the Yen devaluation, will it last?
On Chart 3 is shown investment contribution to GDP growth by type of investment. Public investment is supposed to trigger private productive investment; this is not the case yet.
On Chart 4 is shown consumer confidence which has faltered in June and July. This can be a case of concern if this continues.

Chart 1 – GDP profile
Chart 2 – Contributions to GDP Quarterly Growth
Chart 3 – Investment Contributions to GDP Growth
Chart 4 – Consumer Confidence index