Japan emerges from slump

As general election looms, polticians take heart from 6.3 per cent increase in exports

Having endured her most brutal downturn since the Great Depression of the 1930s, Japan ended five consecutive quarters of decline between April and June this year.

The economy grew by 0.9 per cent in the second quarter, a shade below expectations. Japan thus follows Germany and France in being one of the first advanced economies to emerge from recession.

However, such was the sheer drop suffered by Japan's economy before the recovery that second-quarter output was still 6.4 per cent lower than it was at the same point last year.

Observers agreed that whichever party wins the country's elections on 30 August, the challenges it will face remain immense. Having endured two decades of stagnation, and faced with an ageing population, few believe Japan will find it easy to recover her past economic prowess.

Much the same factors that drove Japan down were responsible for her bouncing back in the second quarter. In particular, exports of manufactured goods have recovered with the recent revival in world trade, which collapsed during 2008. Japanese exports have been through an unprecedentedly torrid time. In some months the nation recorded a trade deficit, which was unheard of for half a century.

Exports fell at an annualised rate of 60 per cent during the fourth quarter of 2008 and the first quarter of 2009, resulting in a sharp contraction in output. An appreciation of the yen by 31 per cent over the same period, partly because of the end of the "carry trade" – in which investors borrowed low-yielding currencies and lent high-yielding ones – also contributed to the trade-led contraction and hit corporate profitability. But exports rose by 6.3 per cent between April and June, the first quarterly increase since January 2008, and made the largest positive contribution to growth.

The substantial fiscal and monetary stimulus in major Japanese markets such as the US and China was also a factor that boosted overseas demand for Japanese goods. A return to profit for major players such as the car maker Toyota, which announced its first loss since 1950 in the first half of this year, should follow.

Stimulus measures enacted by the current Liberal Democrat government also helped to push gross domestic product into positive territory. A series of one-off payments to families helped to drive private consumption higher for the first time in more than a year. Yet the scale of Japan's budget deficit and her total national debt – which is scheduled to reach 200 per cent of GDP before long – will constrain any future special measures, say bodies such as the International Monetary Fund and Organisation for Economic Co-operation and Development.

Even so, the opposition Democratic Party of Japan, which is leading in the opinion polls, has promised a further fiscal boost of 3.5 per cent of GDP over the next two years, on top of the 4.7 per cent already implemented. There are also doubts about the effectiveness of the Bank of Japan's near-zero interest rate regime and modest programme of credit easing through buying commercial paper and corporate bonds.

Kyohei Morita, chief Japan economist at Barclays Capital, said: "The Japanese economy has pulled out of recession but has yet to break free of its dependence on the overseas economy and domestic stimulus measures. In this context, it looks likely to face its next test in January to March 2010, when the current economic stimulus measures run their course."

Apart from exports and government stimulus packages, economists fear Japan may slump back into a classic deflationary cycle, as she did in the "lost decade" of the 1990s. Private capital investment and the housing market are especially weak points in the domestic economy. Rising unemployment, fear of debt and depressed wages are all hampering progress.

Grant Lewis, an analyst at Daiwa Securities, said: "The economy will remain vulnerable to any hiccups in the recovery in global demand. Deflation, meanwhile, looks set to intensify on the back of the enormous amount of spare capacity in the economy but, with the economy now growing again, albeit thanks to the outside world, the Bank of Japan will now feel it has done all it needs to."