Japan

Ongoing economic recovery after a period of stagnation

Japan's economic growth slowed in late 2023 and early 2024 as pent-up demand weakened, while temporary factors such as the Noto Peninsula earthquake on New Year's Eve and the suspension of automaker shipments for certain brands also led to supply-side constraints. The positive momentum in the first half of 2023 stemming from further lifting of Covid restrictions quickly reversed. The main drag was a noticeable slowdown in private consumption, a primary demand component accounting for about 55% of GDP, due not just to a fading of the reopening recovery but also to falling real wages against a backdrop of elevated inflation and yen weakness. Inflationary pressures, which lasted for three years, eased recently with the moderation of global fuel prices. But headline inflation growth has remained above the central bank's target as import prices rose due to a weaker yen.

However, after traversing a period of stagnation, recent developments suggest that the Japanese economy may have moved out of the doldrums. Encouraging prospects were seen in consumer spending recovery, with private consumption showing positive growth in the second quarter 2024 after falling sequentially for four consecutive quarters. This came against the backdrop of significant wage hikes achieved in the annual spring negotiations, which rose 5.3% year-over-year at the largest companies and far exceeded the Bank of Japon’s core inflation forecast (2.5% for FY24). Furthermore, it looks likely to rebound further on the back of improving real wages growth, which finally turned positive in June 2024 after almost two years of declines due to a combination of nominal wage hikes and easing inflationary pressure because of yen appreciation. In addition, fiscal measures to alleviate rising costs of living should also help to mitigate the squeeze on households’ purchasing power. Meanwhile, strong domestic demand for renewables, digitalisation and labour-saving investment still underpinned gross capital formation, although the pace in 2024 has slowed from the strong uptick in 2023.

Looking to 2025, we expect the Japanese economy to continue to recover, with growth in consumer spending driven by improving purchasing power, rising corporate capex as companies push ahead with reducing labour requirements and digitalisation. That said, the improving domestic situation may be partially offset by weaker export momentum due to a slowdown in the US economy and sluggish economic recovery in China. While shipments to emerging economies excluding China have remained firm amid the ongoing global electronics upcycle, those to the US and Europe have been declining due to weaker auto shipments. Exports to China have also softened due to slowing demand for electric machinery.

Current account continues to improve

Japan's current account surplus has improved further recently, as an increase in the primary income surplus more than offset the drag of a widening trade deficit. While goods exports improved on back of shipments of cars and chipmaking machines, imports grew faster as a weaker currency pushed up import bills. Meanwhile, rising costs of buying foreign-made software, digital tools and other business services weighed on the services account even though the net balance of travel-related services hit a record surplus. On the positive side, primary income surpluses have also risen to record highs recently, helped by higher coupon income from foreign bond holdings due to rising overseas interest rates, and higher yen dividend income due to a weaker yen.

The FY24 budget request is 112.6 trillion yen (18.3% of GDP), slightly lower than the FY23 combined budget of 114.4 trillion yen (20.0% of GDP). Although this is the first budget cut in 12 years, it is nonetheless the second-highest budget on record, exceeding 110 trillion yen for the second consecutive year. When the central bank raised interest rates from their current near-zero levels and abandoned government bond yield control, financing costs became higher, while total debt service increased by 7% from last year and increased from 22% to 24% of total expenditure. Social security spending still accounts for nearly a third of total spending to cope with an ageing population and declining birth rates. It is worth noting that Japan further expanded defence spending by 17% to 7.9 trillion yen (1.3% of GDP) which is marginally closer to its five-year plan to double defence spending to 2% of GDP by 2027 to respond to growing security challenges posed by neighbouring North Korea and China.

While the initial budget represents a mild fiscal consolidation effort, the final public spending is likely to be higher because the government has historically released a supplementary budget every year since 2009, usually in the third or fourth quarter. Meanwhile, the FY25 budget request totals 117.6 trillion yen, exceeding the originally requested and approved FY24 budgets of 112.6 trillion yen and 114.4 trillion yen, respectively. The increase, as usual, centres around social security costs due to the country's aging population and military buildup efforts. The increase in debt servicing costs also assumes an increase in Japanese government (JGB) bond interest rates to 2.1% from 1.9% in the FY24 budget. The Ministry of Finance will examine these proposals to draw up a draft budget, expected by the end of the year. Continued government borrowing is expected to push outstanding long-term debt levels to 1,279 trillion yen (USD 10 trillion), or about 224% of Japan's GDP. However, the broad domestic investor base (more than 90% of long-term public debt is domestically owned) should continue to support the government's financing capabilities.

Gradual path of monetary policy normalisation

Since the start of 2024, the Bank of Japan (BOJ) has taken increased measures toward returning to an orthodox monetary policy framework. The initiatives come amid growing confidence in the sustainability of inflation, with core CPI (excluding fresh food), the BOJ's preferred key inflation gauge, having remained above 2% since April 2022. At the March monetary policy meeting, the BOJ officially scrapped the negative interest rate policy (NIRP) and yield curve control (YCC) mechanisms. The unsecured overnight lending rate is set as the main policy rate. A target range of 0% to 0.1% was set in March of this year before being raised further to around 0.25% in July. The reference interest rate for the 1.0% cap on the 10-year Japanese government bond yield was dropped and the BOJ announced in July that it would gradually reduce the scale of government bond purchases, aiming to halve the purchase scale to 3 trillion yen per month by the first quarter of 2026, from 6 trillion currently.

With inflation expected to remain above target in 2025 (2.1%) and close to target in 2026 (1.9%), the central bank is likely to continue its policy to gradually normalise its monetary policy. While this is not our core scenario, risks could emerge if the BOJ sharply accelerates short-term interest-rate hikes on upside surprises for inflation, which could destabilise a domestic business environment long accustomed to very low borrowing rates, increase the government's debt payment pressure and undermine financial stability.

Risks of political instability rise as Japan’s long-ruling party loses its majority

Former Liberal Democratic Party (LDP) Secretary-General Shigeru Ishiba was elected resident of the ruling party and became Japan's new Prime Minister in October 2024. He succeeded Prime Minister Kishida, who chose not to seek re-election, and said he would take responsibility for the LDP's fundraising scandal to show voters the possibility of change in the LDP. The incoming government's economic policies are unlikely to change significantly from those of the former administration that promoted wage increases and job market fluidity. Ishiba’s growth strategies emphasise wealth redistribution and rural revitalisation. He also respects the BOJ’s independence but leans towards an overall easing stance to end deflation. On the fiscal front, Ishiba advocates fiscal discipline in preparation for emergencies and advocates raising investment income and corporate taxes to increase revenue. For foreign policy, he proposes to strengthen defence capabilities by creating an “Asian version of NATO” and to share US nuclear weapons in the region. This could strengthen the alliance with the US and possibly allies such as South Korea. Such a military alliance might be perceived as anti-Chinese, but Ishiba also advocates for a more diplomatic approach to stabilise Sino-Japanese relations given their durably close trade and investment ties.

Having said that, the new administration will now have to find a way to retain power given that the ruling LDP-Komeito coalition lost its majority in the Lower House election. Ishiba, resolved to building political momentum on his consistently high approval ratings, decided to dissolve the Lower House shortly after taking office, but his call for a snap election backfired. In the 27 October election, the ruling coalition won a total of 215 seats, falling short of the 233 seats needed for a simple majority in the 465-seat chamber, a first since 2009. Accordingly, upcoming political negotiations will add a layer of instability to Japan's political situation. To maintain Ishiba government's policy agenda to a certain extent, the LDP-Komeito alliance can still form a minority government without expanding the alliance. However, that requires the cooperation of opposition parties on a policy-by-policy basis, which thwarts the government's ability to implement policies and raises the risk of a short-lived administration.

Presumably, the LDP-Komeito coalition can also explore to expand the alliance, but this requires greater compromises from the Ishida government to maintain the alliance. Potential new coalition partners include the Japan Innovation Party (38 seats) and the Democratic Party for the People (28 seats), the third and fourth largest parties in the Lower House. Unlike Ishiba’s preference for fiscal consolidation, both these two smaller parties have called for consumption tax cuts and lower gasoline taxes. This means that either party joining the governing coalition could make fiscal policy more expansionary and exacerbate risks to fiscal sustainability. At the same time, the main opposition Constitutional Democratic Party of Japan (CDP), which gained 50 seats in the election to 148, also intends to form a new government with parties other than LDP and Komeito. The CDP’s agenda doesn’t fundamentally differ from that of LDP, but calls for restoring the middle class via wage hikes, as opposed to an emphasis on cash handouts to low-income groups by the LDP. However, given the difficulty the CDP faces in forming a multi-party coalition, the likelihood of a complete change of government under a non-LDP Komeito leadership is slim. But should it unexpectedly materialise, it will bring greater political uncertainty to Japan.

Payment

Japan has ratified the International Conventions of June 1930 on Bills of Exchange and Promissory Notes, and of March 1931 on Cheques. As a result, the validity of these instruments in Japan is subject to the same rules as in Europe.

The bill of exchange (kawase tegata) and the much more widely used promissory note (yakusoku tegata), when unpaid, allow creditors to initiate debt recovery proceedings via a fast-track procedure, subject to certain conditions. Although the fast-track procedure also applies to cheques (kogitte), their use is far less common for everyday transactions.

Clearing houses (tegata kokanjo) play an important role in the collective processing of the money supply arising from these instruments. The penalties for payment default act as a powerful deterrent: a debtor who fails twice in a period of six months to honour a bill of exchange, promissory note, or cheque collectable in Japan is subsequently barred for a period of two years from undertaking business-related banking transactions (current account, loans) with financial establishments attached to the clearing house. In other words, the debtor is reduced to a de facto state of insolvency.

These two measures normally result in the calling in of any bank loans granted to the debtor.

Bank transfers (furikomi), sometimes guaranteed by a standby letter of credit, have become significantly more common throughout the economy over recent decades thanks to widespread use of electronic systems in Japanese banking circles. Various highly automated interbank transfer systems are also available for local or international payments, like the Foreign Exchange Yen Clearing System (FXYCS, operated by the Tokyo Bankers Association) and the BOJ-NET Funds Transfer System (operated by the Bank of Japan). Payment made via the Internet site of the client’s bank is also increasingly common.

Debt Collection

In principle, to avoid certain disreputable practices employed in the past by specialised companies, only lawyers (bengoshi) may undertake debt collection. However, a 1998 law established the profession of “servicer” to foster debt securitisation and facilitate collection of non-performing loans (NPL debts) held by financial institutions. Servicers are debt collection companies licensed by the Ministry of Justice to provide collections services, but only for certain types of debt: bank loans, loans by designated institutions, loans contracted under leasing arrangements, credit card repayments, and so on.

Amicable phase

A settlement is always preferable, so as to avoid a lengthy and costly legal procedure. This involves obtaining, where possible, a signature from the debtor on a notarised deed that includes a forced-execution clause, which, in the event of continued default, is directly enforceable without requiring a prior court judgement.

The standard practice is for the creditor to send the debtor a recorded delivery letter with acknowledgement of receipt (naïyo shomeï), the content of which must be written in Japanese characters and certified by the post office.

As of 1 April 2020, statute of limitation period has changed.

For the debts accrued after 1 April , the statute of limitation period of the debts is 5 years from the date of the knowledge of the creditor of the collectability of the debts and 10 years from the date of the accrual of the debts in accordance with Article 166(1) of the Civil Code revised and informed as of 1 April 2020.

Legal proceedings

Fast-track proceedings

Summary proceedings, intended to allow creditors to obtain a ruling on payment (tokusoku tetsuzuki), apply to uncontested monetary claims and effectively facilitate obtaining a court order to pay (shiharaï meireï) from the judge within approximately six months.

If the debtor contests the order within two weeks of service of notice, the case is transferred to ordinary proceedings.

Ordinary proceedings

Ordinary proceedings are brought before the Summary Court (kan-i saibansho) for claims under JPY 1,400, and before the District Court (chiho saibansho) for claims above this amount. Those proceedings, partly written (with submission of arguments and exchanges of type of evidence) and partly oral (with respective hearings of the parties and their witnesses) can take from one to three years as a result of the succession of hearings. These proceedings generate significant legal costs.

The distinctive feature of the Japanese legal system is the emphasis given to civil mediation (minji chôtei). Under court supervision, a panel of mediators – usually comprised of a judge and two neutral assessors – attempts to reach, by mutual concessions of the parties, an agreement on civil and commercial disputes.

In practice, litigants often settle the case at this stage of the procedure, before a judgment is delivered. While avoiding lengthy and costly legal proceedings, any transaction obtained through such mediation becomes enforceable once approved by the court.

0

Enforcement of a Legal Decision

A court judgment is enforceable if no appeal is lodged within two weeks. If the debtor does not comply with the decision, compulsory measures can be ordered through an execution against Real Property (an Examination Court issues a commencement order for a compulsory auction) or an execution against a claim (a compulsory execution is commenced through an order of?seizure).

Japanese law provides for an exequatur procedure in order for foreign awards to be recognised and enforced. The court will verify several elements, such as whether the parties benefited from a due process of law, or if enforcement will be incompatible with Japanese public policy. Furthermore, if the issuing country does not have a reciprocal recognition and enforcement treaty with Japan, the decision will not be enforced by domestic courts.

Insolvency Proceedings

Restructuring

There are two types of restructuring proceedings. The first of these is corporate reorganisation proceedings (kaisha kosei), which are typically used in complex insolvency cases involving stock companies. They come with the mandatory appointment of a reorganisation trustee by the court and with a stay against enforcement by both secured and unsecured creditors. The court typically appoints a third-party bengoshi with substantial experience in restructuring cases.

The second of these is civil rehabilitation proceedings (minji saisei), which are used to rehabilitate companies of almost any size and type. The debtor-in-possession (DIP) administers the rehabilitation under supervision of a court-appointed supervisor. Enforcement by secured creditors is not stayed in principle. The debtor must enter into settlement agreements with secured creditors in order to continue using the relevant collateral to conduct their business.

Winding up proceedings

There are two winding up proceedings. In bankruptcy proceedings (hasan), the court appoints a lawyer as trustee to administer the proceedings. Enforcement by secured creditors is not stayed; rather, they can freely exercise their claims outside of the bankruptcy proceedings. The trustee will usually attempt to sell secured collateral with the agreement of the secured creditors and contribute a percentage of the sales proceeds to the estate. The debtor’s estate is distributed to creditors in accordance with prescribed statutory priorities without any need for voting by the creditors.

The second, special liquidation (tokubetsu seisan), is used for stock companies. A liquidator is appointed by either a debtor’s shareholders or the court. Distributor of the debtor’s estate to creditors has to be approved by creditors with claims to two-thirds or more of the total debt or by way of settlement. This procedure is used when the debtor’s shareholders are confident that they will obtain creditors’ cooperation for the liquidation process, and wish to control the liquidation process without involvement of a trustee.

0

Last updated:November 2024