Japan, World's Third Largest Economy, In The Stranglehold Of A Recession

The weak economic data that Japan posted on Monday suggests that the third largest economy in the world could see a contraction in its GDP growth in the third quarter of this year in the wake of a decline in its second-quarter growth pace and an increased reliance on government support, David Rea, a Japan economist at Capital Economics, stated in a research note on Monday.

Flaccid Growth

According to figures released on Monday, Japan's core machinery orders -- a leading and relatively reliable indicator of business investments and capital formation in the country -- slid 14.8 percent in May, from the previous month, to their lowest level in two years.

Japan's second-quarter GDP growth is 1.2 percent -- 20 basis points above analysts' initial estimate of 1 percent. While some analysts believe that Japan is turning around, many others are pessimistic about the effects of a rising Yen, a gaping trade deficit and Japan's mounting debt levels on the country's future prospects. May's fall in capital spending follows a 2.1 percent drop in non-residential investment growth in the first quarter. The stranglehold on new investments in corporate Japan would weigh down heavily on overall GDP growth.

We may not have a technical recession yet, Rea said in an interview from London. But it is quite a bumpy ride for GDP growth in Japan.

Gloomy Trade Balance

Following a trade shortfall of ¥11 billion ($139 million) with the EU in April, its largest deficit with Europe in three decades, Japan's current account surplus -- the difference between the country's income from foreign sources and its non-investment-related foreign payment obligations -- shrank 62.6 percent to ¥215.1 billion ($2.7 billion) in May from the year before. That was far below than the ¥511 billion surplus that economists were expecting, according to a report by Dow Jones Newswires.

A surplus in the current account shrank substantially due to an expansion in its trade and service deficit as well as a contraction in investment income surplus from a year earlier, the ministry said.

Exports are struggling as an offshoot of a rising Yen and the ricocheting effects from the euro debt crisis. Meanwhile, mounting energy and natural gas import bills are widening the chasm in the country's trade balance.

A key reason for Japan's skyrocketing energy bills is its shift from nuclear power to liquefied natural gas, following an atomic crisis at a Fukushima Daiichi plant last year. While that may be a misfortune for Japan, the U.S. might stand to gain from it, some trade experts say.

Replacing nuclear power with oil and gas may be helpful to the U.S. by increasing American demand for liquefied natural gas and creating jobs in the shell gas sector, said Robert E. Scott, director of trade and manufacturing policy research at the Economic Policy Institute in Washington, D.C.

A Gaping Fiscal Famine

Tokyo is encumbered with pressures to scale down Japan's burgeoning debt, which currently stands at about $14 trillion -- a level that is nearly as much as what the U.S. government records. 

After Fitch downgraded Japan's sovereign credit in May this year, economists have been saying that the country's debt will be far worse than that of some European nations including Italy and Greece.

The possibility of steep borrowing costs and rising yields on Japanese government bonds, as a result of the country's mounting debts, is also making investors more cautious about the prospect of investing in Japan.

Tokyo is embarking on a move to overhaul its public finances, with Prime Minister Yoshihiko Noda backing a push to double sales tax countrywide. Christine Lagarde, managing director of the International Monetary Fund, lavished praises on Mr. Noda's plan.

Rising Yen

The Yen might currently be trading lower amid dismal economic readings. But the trend is temporary, economists say.  

The value of the Yen is expected to strengthen in the long term. As the Euro debt crisis escalates, investors will develop an aversion to high-risk assets and move to safe havens like Japan, David Rea said. That possibility is now priming the Japanese government for a further rise in the value of the Yen -- another occurrence that could hurt Japanese exports.

Consumer Confidence on a Slide

Against a backdrop of an aging population, shrinking domestic markets and deteriorating business conditions, an increasing level of pessimism plagues Japan's people. According to an Economy Watchers' Survey, which polled over 2000 job-holders, consumer sentiment dropped from 47.2 in May to 43.8 in June, its lowest in a year.

Growing uncertainty with regard to job prospects in the country is likely to weaken consumer spending and lead to a more acute retrenchment of workers than what analysts are current expecting.

With ripple effects from a deflationary threat in China and interest-rate cuts in China and Europe cascading over Japan, there are expectations that the country's central bank may be the next in line to unveil fresh monetary easing measures.