Japan

The Japanese economy has been a slow performer among peers, with its GDP growing on average by +0.5% over 2000-2019 and +1.2% over 2010-2019, a moderate pace compared to other advanced economies or the Asia-Pacific region. Real GDP contracted by -4.2% in 2020, and was followed by a mild recovery, with growth of just +2.8% in 2021, followed by a modest +1.1% in 2022, even though Covid-19 constraints ended in that year. In 2023, growth picked up to an estimated +1.7%, bringing real GDP back to its 2019 level. GDP likely contracted by -0.2% in 2024, and we expected a recovery of +1.2% in 2025 and +1.1% in 2026. The contraction in 2024 was mainly due to lower private consumption in the context of high costs of living. Improvements going into 2025 will be supported by rising wages and easing inflation, and government measures (such as tax cuts and oil price regulation). Fundamentals for Japanese exports are bright (especially for electronic goods), but their performance risks being capped by the more protectionist US trade policy. Over the longer term, Japan should return to its pre-pandemic, structurally low growth rate of below +1% per year. On the one hand, the medium-term economic performance will be supported by more dynamic global and domestic demand, higher public investment as well as a competitive environment. On the other hand, labor shortages caused by an aging population will curtail Japan’s growth prospects.

Inflationary pressures were scarce in Japan until recently. Headline consumer price inflation averaged 0.5% over 2010-2019, including three deflationary years. Inflation accelerated to an average of 2.5% in 2022 (although well below the global rate of 8.2%). In 2023, inflation came in at around 3.3% – a 30-year high in Japan (while global inflation decreased to 6.2%). Against this backdrop, in March 2024, the Bank of Japan, (BoJ, the central bank) exited negative interest rates, which had been in place since 2016, and raised further its policy rate in July 2024 and January 2025. Quantitative easing was also scaled back. We expect inflation to decelerate and come down to 1.8% in 2025 (after above 2.5% likely in 2024) and 1.9% in 2026.

Fiscal policy had been eased significantly during the height of the Covid-19 crisis and we expect the government to continue to support household incomes and encourage rising wages and workforce training in the next few years. On the corporate side, the government will keep incentivizing efforts towards digitalization and innovation (especially when it comes to semiconductors and the green transition).  However, Japan’s neighbors in the Asia-Pacific region will pose strong competitive obstacles to the country’s development in the semiconductor industry.

Japan’s business environment is relatively well-positioned in our assessment of 185 economies, rated in the best range in the majority of the sub-components, although it seems to be slightly deteriorating. The 2023 Heritage Foundation’s Index of Economic Freedom survey assigns Japan rank 31 out of around 185 economies, reflecting particularly good scores with regards to property rights, judicial effectiveness, government integrity and monetary freedom, while there remains room for improvement regarding government spending, and fiscal health receives an alarmingly low score. Meanwhile, the World Bank Institute’s annual Worldwide Governance Indicators surveys suggest that the regulatory and legal frameworks are business friendly and the level of corruption is low. Our proprietary Environmental Sustainability Index puts Japan at rank 83 out of 210 economies, reflecting strengths in energy use per GDP, water stress and CO2 emissions per GDP, but weaknesses in terms of the recycling rate and renewable electricity output.

Japan's political stability has seen deterioration in recent years, with an increased risk of returning to frequent changes in government leadership. Prime Minister Shigeru Ishiba’s Liberal Democratic Party (LDP) registered a relatively weak victory in the snap election for the lower house of parliament in October 2024. In total, the LDP lost 68 seats and the ruling coalition (LDP and Komeito) now forms a minority government with 220 of the 465 seats at the lower house. At the same time, the main political rivals of the Constitutional Democratic Party saw a significant gain in the number of seats won, bringing their total to 148 (up from 96 seats previously). This weakened position, along with Ishiba’s unpopularity with other members of the LDP, could lead to a push for his resignation. A lot depend on the outcome of the upcoming upper-house election in July 2025.