Boston, MA -- (ReleaseWire) -- 09/20/2012 -- Core Views The Japanese economy contracted an estimated 0.7% in 2011, and we expect growth to continue to come under threat as volatility in the external environment translates to swings in domestic economic activity. There have been few signs of any improvement in private consumption, and we therefore maintain our real GDP growth forecasts of 1.4% for 2012 and 2013. The massive changes in Japan's current account dynamics continue to push the country's current account balance towards zero and into the red beyond 2018. However, we believe that import levels will grow at a much slower pace as the power situation in Japan stabilises. As a result, we believe the country will run a smaller goods balance deficit of 0.1% of GDP in 2012 (compared with 0.3% in 2011), and a current account surplus of 2.1%. Long-term household savings rates will continue to decline as a progressively ageing society and a shift towards lower-paying contract (non-regular) employment forces more Japanese households to consume a greater proportion of their income. Consequently, this is likely to place significant downward pressure on Japan's net international investment position, although a shift from positive to negative territory will most likely take more than 30 years. While post-earthquake reconstruction is expected to result in higher loan demand in the short term, we believe the longer-term impact will be muted as Japanese economic expansion remains anaemic. Moreover, we believe earthquake assistance will result in further increases in lenders' bond holdings, leading to greater industry exposure to mounting public debt risks. Major Forecast Changes We have lowered our longer-term forecast for the core expenditure items (such as social security) for Japan's fiscal budget from 3.0% to 2.0% from 2013 and beyond in light of renewed efforts by the government to trim spending in these areas. We have further lowered our tax revenue growth projections for 2012 and 2013 as we expect renewed weakness in the economy to affect tax receipts. Key Risks To Outlook The main risk to Japan's economy comes from a fiscal crisis which could result from the increase in debt issuance that will likely be needed to fund reconstruction efforts. While the bond markets remain underpinned for now, the possibility of a failed bond auction cannot be discounted given the huge debt burden of the central government. Another major risk to our economic outlook is another collapse in external demand as was seen during the height of the global financial crisis. This would come at the worst possible time for the Japanese economy, which is suffering from negative domestic demand growth. While unconventional quantitative easing, including the purchase of risk assets such as exchange-traded funds and real estate investment trusts, may help to stem deflation over the next few quarters or even years, the risk of a sudden onset of hyperinflation over the longer term has increased considerably.
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