With Kishida’s Resignation, Japan Brings More Economic Uncertainties to Asia in a U.S. Election Year

Following two significant interventions, a disastrous fall and the subsequent unnatural recovery, the Japanese economy has finally attracted the scrutiny it deserves. For the better part of 2023 and the first half of 2024, many observers have been quick to praise Japanese economic recovery, particularly with the Japanese stock surging over 20% from January to June this year, peaking at its highest level in 33 years. But yet, contrary to these arguments, unfortunately, Japan is not back. While observers have failed to address the structural weaknesses lurking beneath the surface, they should also pay more attention to the mounting uncertainties that could further worsen Japan’s economy and put at risk the economic and financial stability of Asia and the rest of the world. Now, with the resignation of Prime Minister Fumio Kishida, whose departure at the end of September could very likely coincide with a U.S. Federal Reserve (the Fed) rate cut, China, South Korea and ASEAN countries should work together to address the region’s political and economic hazards and prepare for more market turbulence in a U.S. election year.

The false narrative of Japanese economic resurgence has been largely fueled by stock market performance on paper. Indeed, the Nikkei 225 has performed well. Yet the rise has been driven nearly by domestic factors, specifically the Bank of Japan (BOJ)’s aggressive negative interest rate policies, which aimed to push domestic savings into the stock market. However, this artificial inflation of asset prices has not successfully attracted foreign investment, which is the key to keep the rise consistent. Indeed, demand for the Japanese yen has been consistently weak, and the Japanese currency depreciated by nearly 25% over the past two years, with the exchange rate holding around 147 yen/dollar, its weakest point since the early 1990s. And as foreign investors refuse to rush in, the Japanese yen went below 160 yen/dollar in recent months. This disparity between the stock market high-score and an F-score in the currency market underlines the fragility of Japan’s economic foundation.

The corporate performance across Japan is also telling a troubling story. The end of COVID-related aid has triggered a wave of bankruptcy in 2023, with over 9,000 companies possessing liabilities over 10 million yen (or USD 60,000). The outlook for 2024 is even bleaker, with expectations that bankruptcy cases involving 10 million yen or more liabilities will surpass 10,000 this year. What’s worse, the construction and wholesale industry suffered the most among all, as they reported the highest increase in bankruptcy in 2023. Such negative impact will put further doubts on the sustainability of the Japanese economy given the fundamental role that construction and wholesale play in a healthy economy.

Meanwhile, the Japanese people are yet to show confidence in the economy despite seemingly optimistic indicators on paper. While the Japanese consumer price index remains stably below 3% over the past three months, the figure is disconnected from what the Japanese people seem to feel on the ground. Real wages have been declining for the record-breaking 26 months, as inflation has consistently outpaced wage growth, leading to subdued consumption and a sense of financial strain among consumers. A recent survey indicated that over 60% of Japanese households feel financially strained due to rising costs of essential goods. This disconnection could suggest unidentified structural risks hidden underneath the previous optimistic reports of figure-driven analyses.

The Asian economies should be aware of the risks of Japan’s economic future especially given the close interconnections among the world’s most vigorous economies. Japanese companies, flush with hot cash during the negative interest rate period, aggressively pursued mergers and acquisitions (M&A) throughout Southeast Asia. From 2020 to 2023, Japanese firms invested over USD 50 million in Southeast Asia. As Japan exits its negative interest rate policy, however, more of the capital that once flowed out to developed and emerging markets will likely return home, strengthening the yen. While this may offer short- to medium-term relief for Japan, it creates significant external account and macroeconomic challenges for emerging Asian countries that have become increasingly dependent on Japanese investment.

This repatriation of Japanese funds could destabilize financial markets across ASEAN countries, triggering broader economic disruptions. This situation puts China in a particularly challenging position. As the largest economy in the region, China cannot afford to be a passive observer, especially as its top leaders view ASEAN countries as important partners to achieve a prosperous and sustainable future. Beijing, Tokyo, and Seoul, during their 9th trilateral summit, also jointly called for deeper regional cooperation to enhance regional financial safety. The potential convergence of a Fed rate cut and Japan’s leadership transition at the end of September presents a high-risk scenario. Historically, similar rate cuts during risk periods have driven capital back to the U.S., weakening other currencies and destabilizing markets globally. With the added uncertainties of the upcoming U.S. election—which has already begun to trigger market turbulence—the risks are imminent. Given these risks, it is crucial for China and its regional partners to strengthen mechanisms like the Chiang Mai Initiative Multilateralization (CMIM) to guard against financial shocks and stabilize regional economies. The CMIM, which currently holds a USD 240 billion pool for addressing short-term liquidity problems, could play a pivotal role in mitigating potential adverse effects on neighboring economies as Japan’s central bank and Japanese market players recalibrate their monetary policy and financial strategies, respectively.

Regarding Japan, it must become more proactive in addressing its public finances, given its significant role as an economic and policy player in Asia. Whoever succeeds Kishida in September should put economic sustainability high on the policy agenda. Long-term issues such as Japan’s ballooning national debt, exacerbated by foreseeable interest rate rises, and stagnant real wages demand urgent attention. A failure to get its economic house in order could result in significant disruptions, with cascading ramifications across the region, especially when uncertainties pile up in a US election year.