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Japan Country Risk Report Q2 2016

Executive Summary
Core Views
Major Forecast Changes
Key Risks
Chapter 1: Economic Outlook
SWOT Analysis
BMI Economic Risk Index
Economic Growth Outlook
Downbeat Growth Outlook Amid Growing External Risks
Our real GDP growth forecast of 0.6% for 2016, compared with consensus expectations of 1.1%, reflects our bearish view on external
demand amid a continued unravelling of the Chinese economy and renewed recession risks in the US, which look set to compound
domestic structural economic woes. That said, lower energy prices pose upside risks to growth, should businesses use windfall profits
to boost investment.
GDP By Expenditure Outlook
TABLE: GDP GROWTH FORECASTS
TABLE: PRIVATE CONSUMPTION FORECASTS
TABLE: GOVERNMENT CONSUMPTION FORECASTS
TABLE: FIXED INVESTMENT FORECASTS
TABLE: NET EXPORTS FORECASTS
Monetary Policy
Latest BoJ Move Adds To Inflationary Potential
The BoJ’s latest monetary policy tweaks mark an incremental easing amid already extremely loose monetary policy in Japan. As debt
continues to be monetised, the money supply will rise, feeding through into higher consumer price inflation following years of stagnating
prices.
Monetary Policy Framework
Fiscal Policy And Public Debt Outlook
Ambitious 2016 Budget Is Little Cause For Cheer
The FY2016 budget intends to narrow Japan's fiscal deficit to 6.6% of GDP, but continued supplementary budgets and weak real GDP
growth suggest this will not be achieved. While total government debt as a share of GDP is stabilising thanks to the Bank of Japan's
policies, the risk of a fiscal crisis in Japan over the coming years remains acute.
Structural Fiscal Position
TABLE: MAIN REVENUE AND EXPENDITURE CATEGORIES
External Trade And Investment Outlook
Terms Of Trade Windfall Boosts Savings But Not Investment
Japan's external accounts have been a major beneficiary of the decline in global energy prices, with the trade account heading back
to balance from a significant deficit and the current account surplus surging. However, this increased surplus partly reflects weakness
in domestic investment as businesses have used the windfall of cheap energy to increase overseas assets rather than domestic
investment, which will prevent a broad-based recovery in the domestic economy.
Outlook On External Position
TABLE: MAIN EXPORT AND IMPORT PARTNERS
TABLE: MAIN IMPORT AND EXPORTS
TABLE: CAPITAL & FINANCIAL ACCOUNT BALANCE
Currency Forecast
JPY: Bullish Case Growing Stronger
The dollar appears to be forming a significant topping pattern against the yen, with potential for significant yen strength over the first few
months of 2016. While there are clearly structural headwinds facing the currency as a result of the huge fiscal deficit and likelihood of
increased debt monetisation, the bullish medium-term case is becoming increasingly visible.
TABLE: BMI CURRENCY FORECAST
Chapter 2: 10-Year Forecast
The Japanese Economy To 2025
Three Barriers To Growth
There are three important factors that stand in the way of Japan achieving anything other than meagre real GDP growth over the coming
decade. These closely related factors suggest to us that real GDP growth will average around 0.7% per annum over the next decade.
A fiscal crisis, which would lead to rapidly rising interest rates, is by far the most salient threat to growth, although it could be argued that
an economic crisis could be a necessary evil to trigger a boost in private sector growth dynamism.
TABLE: LONG-TERM MACROECONOMIC FORECASTS
Chapter 3: Political Outlook
SWOT Analysis
BMI Political Risk Index
Short-Term Political Outlook
July 2016 Upper HouseElection Crucial For Abe
Japan’s July 2016 Upper House elections will be crucial for Prime Minister Shinzo Abe. If the ruling coalition secures a two-thirds majority, it
will press ahead with a controversial constitutional amendment that would further expand Japan’s military profile and de-prioritise
economic reforms.
TABLE: POLITICAL OVERVIEW
Long-Term Political Outlook
Abe And LDP Face Colossal Long-Term Challenges
Prime Minister Shinzo Abe and his Liberal Democratic Party (LDP) are unlikely to deliver a sustainable recovery of the Japanese
economy and address the country’s structural woes. These include a colossal national debt burden, demographic decline, and the loss
of competitiveness of Japan’s key industries. There is a high risk of a fiscal crisis before the end of the 2010s, and the LDP’s eventual
replacement by new political forces.
Chapter 4: Operational Risk
SWOT Analysis
Operational Risk Index
Operational Risk
TABLE: DEVELOPED STATES – LABOUR MARKET RISK
TABLE: DEVELOPED STATES – LOGISTICS RISK
TABLE: DEVELOPED STATES – CRIME AND SECURITY RISK
TABLE: DEVELOPED STATES – TRADE AND INVESTMENT RISK
Chapter 5: BMI Global Macro Outlook
Global Macro Outlook
Unfinished Business In 2016
TABLE: GLOBAL ASSUMPTIONS
TABLE: DEVELOPED STATES, REAL GDP GROWTH, %
TABLE: BMI VERSUS BLOOMBERG CONSENSUS REAL GDP GROWTH FORECASTS, %
TABLE: EMERGING MARKETS, REAL GDP GROWTH, %
TABLE: JAPAN - MACROECONOMIC DATA & FORECASTS

Japan Country Risk Report Q2 2016

Core Views

Our real GDP growth forecast of 0.6% for 2016, compared with consensusexpectations of 1.1%, reflects our bearish view on externaldemand amid a continued unravelling of the Chinese economy andrenewed recession risks in the US, which look set to compound domesticstructural economic woes. Lower energy prices pose upside risks togrowth, should businesses use windfall profits to boost investment.

The Bank of Japan’s latest monetary policy tweaks mark an incrementaleasing amid already extremely loose monetary policy. As debt continuesto be monetised, the money supply will rise, feeding through intohigher consumer price inflation following years of stagnating prices.

The FY2016 budget intends to narrow Japan’s fiscal deficit to 6.6% ofGDP, but continued supplementary budgets and weak GDP growthsuggest this will not be achieved. While total government debt as ashare of GDP is stabilising thanks to the Bank of Japan’s policies, therisk of a fiscal crisis in Japan over the coming years remains acute.

Japan’s external accounts have been a major beneficiary of thedecline in global energy prices, with the trade account heading backto balance from a significant deficit and the current account surplussurging. However, this increased surplus partly reflects weakness indomestic investment as businesses have used the windfall of cheapenergy to increase overseas assets rather than domestic investment,which will prevent a broad-based recovery in the domestic economy.

The dollar appears to be forming a significant topping pattern againstthe yen, with potential for significant yen strength over the first fewmonths of 2016. While there are clearly structural headwinds facingthe currency as a result of the huge fiscal deficit and likelihood of increaseddebt monetisation, the bullish medium-term case is becomingincreasingly visible.

As Japan’s megabanks embark on aggressive sales of their crossshareholdingsin line with the government’s aims of improving corporategovernance, this will provide the dual benefit of improved capitalallocation and increased capital adequacy. Both of these factorssuggest that banking equities will outperform the broader marketover the medium term.

Major Forecast

We have revised our forecast for the Japanese yen stronger due toa number of positive technical and fundamental factors, from fallingoil prices to our expectation of rising global risk aversion and thepotential for the US Federal Reserve to err on the side of caution withregards to interest rate hikes amid slowing US growth momentum.

We now see the yen averaging JPY115.50/USD in 2016, expectingfurther appreciation from the 2015 average of JPY121.04/USD.


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