Japan in freefall

At some point in our lives, we have imagined the feeling of a freefall…..it is discomforting. And now, we have the world’s second largest economy in the state of a freefall. So let’s all brace for the thud, before we hear the big ouch!

Japan’s GDP slumped by an astounding 3.3% for the quarter ending December 31, 2008, which amounts to nearly 13% per annum. This is much higher than the shrinkage rates in the US and Europe of 1% and 1.5% respectively in the quarter under comparison. The Japanese economy is projected to shrink at an annualized rate of 9.6% in the first quarter of 2009, though only time will tell if this will be higher or lower. The key reason for Japan’s state of affairs is its overdependence on exports, which have taken a bad hit due a slum in demand from UAS, Europe and China for the nation’s autos and electronic products. Exports fell a whopping 13.6% in the last quarter of 2008. Besides a slump in demand from other nations, the other key reason for shrinking exports is the appreciation in the Japanese Yen. The Yen besides being a preferred hedge, has also appreciated due to massive unwinding of carry trade, where investors had borrowed in Japan at low interest rates and converted it into foreign currencies and invested it in high yielding markets. With risk aversion setting in, investors sold off these investments and brought the money back to Japan and converted into the Yen, which increased its demand and made it appreciate. A higher Yen makes Japan’s exports more expensive, leading to dwindling exports.

Japanese companies are slashing jobs by tens of thousands, leading to weakened internal demand and consequently adding to economic contraction. While other nations have announced massive stimulus packages, Japan proposed a small package of $111 billion last year. However, political dynamics have not allowed the stimulus package to be approved by the Japanese parliament and matters seem to be getting worse for the nation. In comparison, China has a $560 billion stimulus package in the offing and the US, a second package of $789 billion. Even if Japan manages to pass its paltry stimulus package, it may be too little and too late.

The export led economic shock has led to a massive drop in Japan’s industrial production. Industrial output by the end of February is expected to come down to 1987 levels. Japan had built up its economic prowess around exports, when its share in GDP rose from 10.6% to 16.5% between 2002and 2008. With, a slump in global demand, Japan’s strength seems to have turned into its biggest weakness and threatens to set it back by several years.

Japan is also afflicted by the low interest rate syndrome. Having had near zero interest rates for a prolonged period, the Japanese central bank has very little room to maneuver its monetary policy lever. Uncertainty and risk aversion is leading consumers and companies to hoard cash resulting in lower spending and investment, adding to Japan’s negative spiral.  It appears that Japan needs to go all out to announce and implement a massive fiscal stimulus package in order to break the fall and turn back its economy.

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