China key to Japan's recovery

Japanese Prime Minister Shinzo Abe's Yasukuni Shrine visit has dealt a blow to the recovering trade between the world's second and third largest economies. According to the Chinese Ministry of Commerce on Tuesday, China-Japan trade in 2013 reached $312.55 billion, a 5.1 percent year-on-year drop. While China's exports to Japan decreased by 0.9 percent to $150.28 billion, its imports from Japan were $162.28 billion, witnessing a drastic 8.7 percent decrease.

Besides other factors, Abe's hawkish policies have played a big role in the trade decline, which will eventually curb Abe's efforts to revive Japan's economy.

Abe has implemented a bold economic policy, known as "Abenomics", after he was sworn in as the prime minister for the second time in late 2012. Abenomics is believed to have helped the Japanese economy expand at a revised annual rate of 4.1 percent and 3.8 percent in the first and second quarters of 2013. But the growth in the third quarter dropped to a revised rate of 1.1 percent, down from the initial reading of 1.9 percent, creating worries over the effectiveness of Abenomics in sustaining Japan's growth momentum.

Japan's core consumer price index reading, which excludes the volatile fresh food prices, jumped slightly above zero in September and rose to a five-year high of 1.2 percent year-on-year in November. The country also has overcome its years-long deflation thanks to factors such as higher prices of energy and imported goods, as well as imported inflation that has moved from upstream to downstream industries all the way to the final product. So Japan's inflation is likely to stay above 1 percent in the coming months and its upward momentum will depend on the depreciation of the yen.

The yen has already weakened - it was 100 to 105 against the US dollar in December. If it drops further in the first half of 2014 and approaches the 110-to-1 mark against the dollar, Japan could have a 1.5 percent year-on-year increase in inflation by the middle of 2014 and hit the 2 percent mark by the end of the year.

According to the Japanese Ministry of Finance, the country's exports in November 2013 increased by 18.4 percent year-on-year, the ninth consecutive increase last year. The items that saw the biggest export gain include automobiles, general machinery, electronic and electrical goods, and chemical products. Transport equipment exports, for example, grew by 25.6 percent in November, and while their supply to the United States and the European Union grew by 30.5 percent and 20.8 percent, they recorded a 150 percent increase in the Chinese market.

The sale of Japanese automobiles, too, rebounded in the world's biggest vehicle market even amid the territorial row between China and Japan. In December, Toyota registered a 19.4 percent year-on-year increase in sales, which followed the 40.7 percent year-on-year rise in November.

Therefore, Japan's economic recovery, fueled by the depreciation of the yen and growing external demand, can be attributed to an increase in its exports. Although the strong export performance has not caused Japan's record-high trade deficit to shrink, the country is projected to achieve that later this year. However, it is not expected to see a trade surplus anytime soon.

Abenomics has so far caused the yen to depreciate and has kept Japan on course to fending off deflation and stimulating external demand, but that does not mean it can also succeed in facilitating economic growth. The deduction in corporate tax has not prompted Japanese companies to increase investment, because many of them are still burdened with overcapacity.

As for domestic demand, private consumption in Japan increased for the fourth straight quarter. But this momentum cannot be sustained because the Japanese government's plan to raise sales tax in 2014 forced people to make a last-minute dash to buy houses last year. Besides, the rise in salaries aimed at spurring domestic consumption will increase labor cost per unit of output, which will be bad for export competitiveness, unless the yen continues to depreciate. And the continuation of the super-easy monetary policy is certainly not helpful given the spillover effect of the depreciation of the yen.

Japan will also find it harder to increase its exports because of the barriers it faces in the negotiations for the Trans-Pacific Partnership and the China-Japan-Republic of Korea trilateral free trade agreement. True, Japan's stock market staged its biggest rally in 2013, boosting corporate confidence. But it continues to have its share of skeptics, with many considering the rapid move in the equity market as a flash in the pan.

To bolster the economy this year, the Abe administration worked out an economic stimulus package worth about 5.6 trillion yen ($53.75 billion) in December, which is estimated to rate the economic growth rate by 1.1 percent. If Japan focuses on increasing public investment in the coming months, it probably will be able to maintain a good growth momentum in the first half of the year. The growth rate, however, may drop in the second half, which could prompt Tokyo to renew its economic stimulus package.

The biggest risk facing the Japanese economy this year is that the 10-year US Treasuries yield has strayed above 3 percent after Washington decided to scale back its third round of quantitative easing, putting upward pressure on the Japanese government's bond yield. But an aggressive rise in bond yields will only increase Japan's financial burden.

China's economic growth and increasing domestic demand are boosting Japan's economic recovery by stimulating imports from Japan. But Tokyo's hard stance against Beijing on the political and diplomatic fronts could force China to change its economic policy toward Japan. And that would not be good news for Japan amid its struggle for economic recovery.

The author is deputy director of the department of Chinese trade studies at the Chinese Academy of International Trade and Economic Cooperation, affiliated to the Ministry of Commerce.