Analysis - Japan faces record-long trade deficit, little sign can reverse trend

Reuters

By Tetsushi Kajimoto

TOKYO (Reuters) - Japan is on course for its longest run of trade deficits, effectively marking the end of the nation's decades-long reliance on exports from the likes of electronics giant Sony and automaker Toyota as a driver of growth and income.

Trade figures due on Thursday are likely to show that Japan produced its 14th consecutive deficit in August, matching a 1979-1980 record run during the global oil shock. Economists say the deficits will continue.

When Prime Minister Shinzo Abe's reflationary policies weakened the yen after he took power last December, many economists had anticipated a so-called J-curve effect, where a spike in import costs would over time be more than offset by gains in exports.

But a closer look at trade statistics shows that the currency's 15 percent decline since the beginning of this year has failed to produce the export turnaround needed to bring the trade balance back into the black and there is little indication it will do so in the future, posing new policy challenges.

"I cannot tell when the trade deficit will end," said Norio Miyagawa, a senior economist at Mizuho Securities Research & Consulting Co. "What's worrying more is that Japan's export competitiveness may be waning."

With trade acting as a drag rather than an engine of growth, there is more pressure on Abe to reform the domestic economy. But so far, the structural reform part of the prime minister's "Abenomics" policy agenda has disappointed, unlike his radical monetary easing and fiscal stimulus, which have buoyed the stock market and business mood.

Persistent trade shortfalls are likely to swing the current account to deficit as soon as three years from now, meaning that Japan will start chipping away at its vast pool of domestic savings, increasing the need to start reining-in its ballooning public debt. Ramping up more foreign investment, so far low on the list of priorities of the world's top creditor nation, may also become a necessity.

Abe's policies are designed to revive an economy from years of low-grade deflation and sluggish consumption. The exports industry has been the main base underpinning the economy.

"We're going through the process of reducing our heavy dependence on exports," said Takeshi Minami, chief economist at Norinchukin Research Institute. "But for now, the country has no choice but to depend on exports until it exits deflation and domestic demand plays out more in the economy."

After the 1979-1980 oil shock, Japan bounced back smartly, exporting millions of its cheap, durable and fuel-efficient cars and iconic electronic gadgets such as Sony Corp's Walkman. Today, however, there is no turnaround in sight.

Even though increased fuel imports since the March 2011 Fukushima disaster have been a major drag on trade, restarting all of Japan's nuclear reactors would not bring it back into the black, estimates suggest.

The only one of Japan's 50 reactors in operation was shut for planned maintenance on Sunday, with no firm date for bringing back an energy source that had covered about a third of the country's electricity needs.

Restarting nuclear power would bring Japan more than 3 trillion yen (18.87 billion pounds) in annual savings, RBS Securities estimates, still well short of a trade gap that reached a record 4.8 trillion in the first half of this year alone.

"I think Japan's trade deficit will last forever even if nuclear reactors are restarted," said Hiromichi Shirakawa, chief economist at Credit Suisse.

HOLLOWING OUT

Shirakawa calculates that a 10 percent-or-so fall in the yen's value adds only 1 percent to export volumes over two quarters, half of the effect it had in the period before the global financial crisis.

That is because of the "hollowing out" of Japanese manufacturing as firms shift production and procurement overseas. Years of yen strength contributed to that shift, but the currency's retreat failed to reverse the trend as the desire to move closer to faster growing markets, tariffs, lower taxes and labour costs all played a role.

A Cabinet Office survey of manufacturers showed the share of overseas production of Japanese companies rose to 17.7 percent last year from just over 13 percent a decade ago and is seen reaching 21.3 percent in five years.

Another survey by the trade ministry showed that overseas investment as a share of manufacturers' capital spending has also been climbing, reaching a record 21.5 percent in fiscal 2011/2012 compared with 15.9 percent two years earlier.

"Steps are needed such as corporate tax cuts and promotion of free trade pacts in order to encourage firms to locate their bases at home," Miyagawa said. "Without such efforts, the economy will go into a steady decline," he said.

Japan has started negotiating trade pacts with the European Union and Pacific Rim nations led by the United States, but it continues to debate the merits of cutting corporate taxes that are among the highest in the developed world.

Finance Ministry data shows that while the yen's decline has driven up the yen value of exports, boosting exporters' earnings, it has failed to shore up export volumes which peaked in 2007 and have been in a steady decline since 2010.

That reflects both the declining share of products "Made in Japan" in companies' overseas sales and their reluctance to risk trade tensions by using the yen's weakness to boost market share by cutting overseas prices, analysts say.

While export prices calculated in yen rose 14.3 percent in the year to July, when measured in contract currencies they only declined by 1.5 percent, Bank of Japan data showed this month.

Japanese carmakers are a case in point.

Most, including Toyota Motor Co and Honda Motor Co , have reported a decline in export volumes so far this year, partly because they continue to shift production abroad.

For example, Honda moved the production of its popular CR-V SUV a year ago from its Sayama plant near Tokyo to its North American factory.

Japanese carmakers have also avoided cutting prices for their exports in major overseas markets, partly because of sensitivities in the United States and elsewhere about Japan using the yen's weakening to gain a competitive edge.

Economists say as long as Japanese exporters choose to cash in extra profits rather than aggressively pursuing bigger market share abroad, thus boosting business investments at home and wages, the weak yen will have little effect on economic growth.

"The key for the effects of a weak yen is whether export prices will be reduced and thereby export competitiveness will rise," Masahiko Hashimoto, an economist at Daiwa Institute of Research, said in a research note.

"As long as export volume does not rise markedly, there's no need to boost domestic production, so it won't have much ripple effect on the economy."

(Additional reporting by Yoko Kubota: Editing by Tomasz Janowski and Neil Fullick)

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