Japan Hits a New Era of Growth

Jul 17, 2023

A rise in the country's nominal GDP after a long period of flatlining offers opportunity for investors.

Key Takeaways

  • Japan's nominal GDP growth may approach 5% this year.

  • Stock prices are likely to benefit, as should employee compensation, corporate earnings and tax revenue. 

  • A new national “grand strategy” could bring changes to Japan’s energy, agriculture, health care, technology and education sectors.

Asia is emerging as a destination for investors seeking opportunity amid a slowing global economy – and Japan, in particular, is expected to be a regional standout.  


The world’s third-largest economy has managed to emerge from deflation without runaway inflation, and capital expenditure from the private sector is rising. But perhaps most significantly, Japan’s nominal gross domestic product (GDP), which measures output at current prices, is rebounding.  


“This marks a momentous change for Japan after economic growth has languished in negligible or negative ranges for years,” says Morgan Stanley’s Chief Japan Economist Takeshi Yamaguchi. 


Meanwhile, the government and business are working to secure political autonomy, supply-chain security and economic prosperity through faster technology adoption; a more flexible, mobile and skill-based labor market; better governance; and fiscal sustainability. 


Japan's shift to solid nominal growth is important for equity market returns, and Tokyo's TOPIX index could increase by 7% from today's levels. Here’s what investors need to know. 


Japan’s Growth Outlook 

While discussions of economic growth usually focus on real growth, Japan is unique in that both nominal and real growth rates are important. Nominal GDP growth covers price changes for the entire economy and is the sum of real GDP growth, which is forecast to reach 1.1% for 2023 and 2024, and domestic inflation. 


This real growth will be accompanied by moderate domestic inflation and improvement in the difference between export prices and import prices. Consequently, Morgan Stanley Research expects Japan's nominal GDP growth to approach 5% in 2023, its highest since 1991, The nominal growth trend should then shift up above 2% over the medium term after this temporary surge.   


The higher nominal growth trend in Japan implies simultaneous growth for employee compensation and corporate earnings, a large increase in tax revenue and potentially positive effects on asset prices, says Yamaguchi. 


What Japan’s Growth Could Mean for Stocks 

“In the era of higher nominal GDP we expect Japanese stocks to outperform, driven by five factors,” says Asia and Emerging Market Equity Strategist Daniel Blake. 


  • Faster revenue growth: Sales for companies focused on the domestic market should see some acceleration alongside nominal GDP as they increase prices and/or sales volume.  


  • Improved profit margins: Operating profit margins should benefit as companies can adjust their product mix more easily and pass through increases in input costs to final prices. Increased sales should offset companies’ fixed costs, even for those sectors with limited pricing power, such as department stores, and food and beverage.  


  • Central bank normalization: Despite the return to inflation, the Bank of Japan is unlikely to start raising interest rates soon, and economists expect the central bank to have loosened its anti-deflation measures by the second half of 2024. These moves could be neutral or even positive for stocks.  


  • Investor shift to equities: Japan's households are generally conservative in their investment portfolios, partly as a result of the longstanding lack of inflation. The combination of a new inflation tax and higher nominal returns on equities, alongside planned capital market overhauls, could lift domestic ownership of risk assets, including Japanese equities.  


  • Higher valuations: A comparison of Asian and emerging equity markets based on price-to-book ratio and return on equity found that the MSCI Japan index would be trading around 25% above current valuations, driven in part by higher nominal growth expectations. 


The Grand Strategy in Focus 

Japan’s era of nominal growth coincides with a national “grand strategy,” which Prime Minister Fumio Kishida has called a “new form of capitalism.” The aspirations are national security and economic prosperity, despite adverse demographics trends at home and geopolitics abroad. “This is expected to bring big changes, especially to sectors such as energy, agriculture, health care, artificial intelligence, technology and education,” says Robert Alan Feldman, Senior Advisor at Morgan Stanley MUFG Securities. “The resulting transformation of these industries and of existing economic structures could boost economic sustainability and raise income for both capital and labor.”  


Historically, Japan’s national security relied on military or diplomatic power, while economic or financial power brought economic prosperity.  However, geopolitical shifts now mean both capabilities contribute for both aspirations, making it all the more important for public and private sector capabilities to work together, says Feldman. 


To achieve its aspirations, Japan must move quickly and decisively in four areas.  


  • Faster technology diffusion: Economic transformation depends on the rapid diffusion of technology, a four-part process that includes recognizing the problem, developing a technological solution, building consensus to use the technology and quick implementation. The Japanese government and companies have excelled at the first two, while lagging behind on the others because of siloed social structure and bottom-up decision making. Gaining ground on decision-making and action will require leadership from the top and efficient organizational processes.  


  • Greater labor market liquidity: New technology cannot spread without a workforce that is able to adapt. Companies will need to invest in reskilling the labor force.  


  • Better public and private governance: The private sector has made great progress in corporate governance, but still needs more attention to financial efficiency and flexibility of both business portfolios and internal procedures. The public sector needs better internal information sharing and faster decision procedures. 


  • Fiscal rebalancing: The government could reduce costs by using technology in traditional spending areas, including medical, pensions and welfare, and changing rules in others, such as raising the age at which workers can receive pensions. Technology-based cost reductions would reduce the need for tax hikes. 


Japan has already made some headway on a number of the key elements in the grand strategy, such as corporate governance and technology diffusion. However, labor markets, national governance and fiscal reform have been slower to advance.  


"Room for improvement is quite substantial and suggests that investor attention to the progress of Japan's emerging grand strategy is warranted," says Feldman. 


For an in-depth look at Japan’s prospects for growth, ask your Morgan Stanley representative or Financial Advisor for the full reports, “Japan’s New Grand Strategy” (June 11, 2023) and “Momentous Shift in Japan’s Nominal GDP path,” (June 11, 2023). 

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