Japan’s economic contraction is worse than expected

Output of the world's third largest economy shrank an annual 28.1% from the previous quarter

A man walks by an electronic stock board of a securities firm in Tokyo, Monday, Sept. 7, 2020. Asian stock markets were mixed Monday after Wall Street turned in its biggest weekly decline in more than two months.(AP Photo/Koji Sasahara)

Japan confirmed the scale of its record economic contraction last quarter with figures that were slightly worse than first estimated, highlighting the enormous challenge facing the country as the ruling party officially kicks off its campaign for a new leader.

Gross domestic product shrank at an annualised pace of 28.1 per cent from the previous quarter in the three months through June, according to revised data from the Cabinet Office.

While the overall figure was largely in line with a first estimate, the data indicated business investment was more than three times weaker than first thought. The figures also showed stockpiles of unsold goods building up, adding to signs that the world’s third-largest economy is heading for a slow recovery.

Confirmation of Japan’s biggest GDP slide in records going back to 1955 comes as the Liberal Democratic Party prepares to pick a new prime minister to replace Shinzo Abe, whose resignation last month for health reasons shocked the country. Mr Abe’s most likely successor, longtime aide Yoshihide Suga, faces the tough balancing act of trying to contain the virus while restoring economic activity.

"The next prime minister will have to set coronavirus measures as the first priority," said economist Masaki Kuwahara at Nomura Securities. “The economy should see a double-digit rebound, but the recovery pace will be slow.”

The leadership contest formally started Tuesday, with the vote set for September 14. The party will then use its majority in parliament to install the winner as the next prime minister on Sept. 16.

Mr Suga, the current chief cabinet secretary, would be a continuity pick. He wants to stick to the Abenomics path that includes massive monetary stimulus and a flexible spending approach, but says he would also take more action if needed to save jobs.

Among the key decisions for the new leader will be when and how aggressively to switch from emergency lifeline support for businesses and households toward stimulating the economy.

A separate report Tuesday showed declines in household spending steepening in July, falling 7.6 per cent below last year’s level as consumers cut back on travel and eating out amid a spike in virus cases, an indication of the difficulty of expanding activity without setting back the recovery.

Wages fell for a fourth month in July compared with the previous year, adding to the downward pressure on consumption.

"An increase in infections remains a possibility. If that happens we’ll see another standstill in service-related consumption and the need for further spending measures," said Hiroaki Muto, economist at Sumitomo Life Insurance. "They’ll likely add stimulus at the same time as accepting some level of increase in cases."

The new leader will have up to 9.5 trillion yen (Dh326 billion / $89 bn) of budgeted reserves to draw on if more measures are needed. A weaker-than-expected recovery could fan speculation about another extra budget.

Analysts see GDP rebounding about 13 per cent this quarter, a big jump, but not enough to make up for three straight quarters of contraction. Bloomberg Economics argues the economy may never regain its pre-pandemic size because handling the crisis will be the priority for the new leader, further delaying critical reforms needed before Japan’s shrinking population causes a longer-term shrinking of the economy.

Currently, BOJ officials see little need for the central bank to take further policy action at its meeting next week because financial markets are stable and companies have access to credit, people familiar with the matter said.

"Going forward, spending is likely to remain under pressure, given a range of negatives, from the virus to weak wages and concerns about jobs," said Bloomberg’s economist Yuki Masujima. "A slow recovery in the economy will be a headache for Prime Minister Shinzo Abe’s successor, even as the Bank of Japan continues to put a prop under corporate Japan."