Notwithstanding a stream of negative news in recent times such as a shrinking output and falling business confidence, Japan's central bank has struck a more positive tone about the country's economic outlook.
The Bank of Japan (BOJ), after concluding its last policy meeting of the year on Friday, December 19, said that the nation's exports were showing signs of a rebound and private consumption remained "resilient."
Furthermore, the bank announced that it will continue its monetary stimulus program of printing money and buying government bonds in a bid to achieve its inflation target of 2 percent in 2015. "We're making steady progress in shaking off the public's deflationary mindset," BOJ Governor Haruhiko Kuroda was quoted as saying by news agencies.
But a slump in the price of crude - which dropped nearly 50 percent since June this year to around $55 a barrel - has made the BOJ's attempts to boost inflation a difficult task, even though it has helped cut Japan's trade deficit.
The bank's outlook for the economy comes days after the Liberal Democratic Party (LDP) of Japan's Prime Minister Shinzo Abe and its coalition partner, Komeito, won a snap parliamentary election. The vote was called by Abe to seek a fresh mandate for his economic reform program, dubbed "Abenomics," consisting of a combination of monetary, fiscal and structural policies.
Path to recovery?
Abe campaigned under the slogan "This is the only way to economy recovery," and the Japanese public was ready to agree, said Kristin Surak, senior lecturer in Japanese Politics at SOAS, University of London. "After 25 years of little growth, people want to see the economy restarted, and even as Abenomics sputters, many hope that strong government action will start paying off," she underlined.
Abe argues that his proposed reforms are required to boost growth and raise inflation in the world's third largest economy, which has been struggling from a lack of growth for a long time.
Japan's economic output contracted in the previous two quarters, with GDP shrinking at an annualized rate of 1.9 percent in the July to September period, after dropping 1.7 percent during the three months before that. Analysts believe the decision to hike sales tax from 5 percent to 8 percent in April this year to be the reason behind the contraction.
Although a second tax increase had originally been planned for next year, Abe decided to postpone it to 2017. Marcel Thieliant, Japan economist at UK-based economic research consultancy Capital Economics, says that the direct impact of PM Abe's decision to delay the hike is to boost the outlook for growth and also for underlying inflation, though headline inflation will of course be lower.
"However, if we are right that the yen will decline to 140 against the US dollar by end-2015, import prices will rise further and both real wage growth and consumer spending are likely to stay subdued," the expert noted.
Furthermore, real wages in Japan have declined about 2.8 percent over the past year. The economy also continues to face many key challenges such as high public debt - nearly 240 percent of the GDP -, and ageing population. As part of his efforts to overcome the problems and revive the nation's economy, Abe was able to implement fiscal and monetary stimulus measures relatively easier, and these policies had some success.
Japanese firms have increasingly shifted their production to low-cost, high- growth countries in Southeast Asia
BOJ's quantitative easing (QE), for instance, has led to a depreciation of the yen, and many believe that this fall in the value of the currency has raised Japan's export competitiveness and corporate profitability.
But Thieliant told DW that a weaker yen does not have a major impact on exports, as most of them are invoiced in foreign currency. "Hopefully, the recent weakness of the economy will serve as a wake-up call to policymakers that monetary easing alone is not enough to lift economic growth," the expert added.
The country's manufacturing sector has also weakened significantly over the past years as Japanese firms increasingly shifted their production to low-cost, high-growth countries in Southeast Asia and beyond. Rajiv Biswas, Asia-Pacific Chief Economist at analytics firm IHS, told DW that while Japan's manufacturing has received some boost from yen depreciation, the country will also "need to diversify its exports and increase the competitiveness in service areas such as tourism and financial services."
Biswas warns that unless significant structural reforms are implemented, Japan will face "a policy dilemma whereby the country will become highly dependent on continued BOJ QE policies with no exit strategy."
Economist Thieliant pointed out that disagreements have already emerged within the central bank about the course of monetary policy. "At least one member thinks that continuing with quantitative and qualitative easing for too long may create the perception that the BOJ is monetizing government debt - a perception that would gain credibility if attempts to establish a "sustainable fiscal structure were abandoned," the expert said.
However, despite Abe's talk of the need for structural reforms, there has been little progress so far on this front. Even after the election victory, Abe is likely to struggle to secure political backing for many of his reforms ranging from trade liberalization to the opening up of the labor market, say experts.
For instance, although the PM is an eager proponent of the Trans-Pacific Partnership (TPP) free trade deal, it faces significant hurdles as "it is unpopular in rural areas, which benefit from agricultural protections, and farmers are reluctant to see tariffs drop to zero," analyst Surak pointed out.
Another issue confronting Japan is its ageing and a declining population, which is expected to drop to about 87 million by 2060 from the current 127 million. Nevertheless, Japanese society remains "very conservative and issues such as increasing foreign worker immigration to improve Japan's demographics are politically unpopular," stressed Biswas.
"Even though other advanced countries such as the US, Germany, Canada and Singapore have used such immigration policies to manage their workforce demographics, any attempt at such reforms in Japan would face a political backlash from the Japanese electorate," he added.