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Will deflation spoil Japan's economic recovery?

Posted by: Ian Rowley on June 26, 2009

In recent weeks there have been signs that the worst of Japan’s economic slump is over. Gross domestic product, which plunged at a terrifying pace after the collapse of Lehman Brothers last fall, is expected to grow at a moderate pace this quarter. The stock market is up a third from two-decade lows in March. And, despite plunging global sales, Toyota’s new president Akio Toyoda sounded reasonably upbeat yesterday at a first press conference since taking over from Katsuaki Watanabe on June 23.

But not all the news is rosy. Today, official figures gave the clearest evidence yet that the specter of deflation—something that for years held back Japan’s recovery from its “lost decade”—is hovering over the economy once again. In May, consumer prices excluding food (core cpi, if you prefer the jargon) fell 1.1%. That marked the fastest fall on record. The May plunge, compares to a 0.1% decline in April.

That prices are falling isn’t a huge surprise. Consumer spending has dropped for the last 14 months in a row. And energy prices, which account for about 7% of the CPI weighting, have also weakened. What’s more, as Japan’s exporters have been hit by falling demand, bonuses—a big chunk of annual pay for many Japanese—are taking a battering. Many companies have also introduced temporary wage cuts. No surprise, then, that retailers faced with weak demand, are discounting. “We must carefully watch price movements and manage policy to prevent Japan’s economy from collapsing or persistent price falls that would hold back growth,” Japan’s finance minister Kaoru Yosano said at press conference earlier today.

Still, it’s not all doom and gloom. Jesper Koll, CEO of Tantallon Research Japan in Tokyo, sees little cause for concern despite a seemingly grim core cpi number. Koll says that the price falls can be considered “good deflation” caused by the reduced prices of imported raw materials or growing competition among Japan’s retailers. “If I can buy a T-shirt for 300 yen rather 1,000 yen, then that’s good,” he says. “This is increased productivity and competition.”

For sure, Japan’s Fair Trade Commission seems to be doing its bit to boost competition even if it weighs on the cpi stats. On June 22, it ordered Seven-Eleven Japan, Japan’s biggest convenience store chain, to stop preventing franchise stores from selling bento lunches at discounts when the item are close to their expiration dates. Analysts said that the ruling would promote a bout of price competition between Japan’s ubiquitous combini stores. Koll adds that the CPI figure is only a cause for concern if in the wage declines outstrip price declines in the long term. Expecting a V-shaped recovery, he thinks that can be avoided.

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