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Japan’s Current Account– Its Status & Future

By Norihiro Yamaguchi

Foreword
Japan marked two consecutive months of current account deficit
last winter. Given that this economy has enjoyed, or sometimes evenbe criticized for, a stable current account surplus over decades with
only a few exceptions, two months of deficit attracted considerable
attention in financial markets and business talks. Will the current
account deficit continue? What implications does it have for the
economy? Does it mean Japanese economic deterioration? This
article provides an analysis of the developments in the current
account, forecasts from both cyclical/short-term and structural/longterm views, and finally considers the implications.

Structure of Japan’s Current AccountAuthorNorihiro Yamaguchi

structurally negative, but negligible.
This primary income-led current account surplus structure is quite
unique to Japan. For many other major economies, the largest
component in the current account is usually the trade balance. For
instance, the United States has a current account deficit led by alarge deficit in goods trade. The United Kingdom enjoys a sizable
service account surplus, while a large goods trade deficit leads it to a
current account deficit. For the Eurozone and China, goods trade
surpluses drive their current account surplus.

Two Successive Months of Current Account Deficit
However, Japan’s stable current account surplus seems to be at a
crossroads recently (Chart 2). The current account balance inJanuary was -1.2 trillion yen, the second consecutive month of being
in deficit after a -0.3 trillion-yen deficit in December 2021. Since it
was the first time for Japan’s current account to mark a deficit for
two consecutive months since 2014, it attracted attention in theforeign exchange market and served as one of the fundamentals forthe yen’s depreciation.

The current account records the balance of economic transactions
between one economy and others in terms of goods, services, andinvestment. The current account balance is more comprehensive
than the goods trade balance. The current account is the sum of thebalance of goods trade, the service trade balance, and the balancesof primary and secondary income.
The goods trade account refers to net exports (i.e.,
CHART 1
exports minus imports) of goods such as machinery,Japanese current account balance,
vehicles, and commodities. The service trade balance isannualthe net balance of transport, travel, and other services
Yen, Trillions
such as intellectual property use charges,
Goods trade
Services trade40
telecommunications, and financial services. The primaryPrimary income
Secondary income
income balance consists of net investment income fromCurrent account balance
direct and portfolio investment activities, while the30
secondary income balance reflects current transfers freeof charge, such as ODAs and remittances.
20
Japan has had a long history of current accountsurpluses, but its driver has changed over time (Chart 1).
10
Until the early 2000s, the main driver of Japan’s current
account surplus was the surplus in goods trade. However,0since the early 2010s, the primary income surplus has
been exclusively supporting the current account surplus,-10
whereas the trade account has basically been balanced.
The service trade account has marked a deficit-20
continuously throughout the period, but its deficit size had
2000
2005
2010
2015
2020
been trending smaller until the Covid-19 era. The
Source: Ministry of Finance, Bank of Japan, Haver Analytics
contribution from the secondary income balance is also
https://www.jef.or.jp/journal/

Japan SPOTLIGHT • September / October 2022

21

The breakdown shows that the surplus in primary income was notenough to cover the deficit in the goods and service trade balances.
The goods trade deficit expanded, with a significant increase inimports and stagnant exports. On the import side, the import valueof commodities rose sharply due to soaring global commodity
prices. Imports of pharmaceuticals also increased, amid vaccinationneeds. On the other hand, a recovery in exports has been delayedwith the continuing supply-chain disruptions, particularly in the auto
sector. For service trade, evaporation of inbound tourists amid
Covid-19 has been causing service exports to deteriorate.
In February, though, a current account surplus returned and has
continued until the most recent data in May. A seasonal decline infossil fuel import volumes contributed favourably, and theimprovement in primary income receipts is helping to support theoverall account.

shipping, which represents about 20% of Japan’s exports, to recover.
Additionally, service exports are unlikely to recover strongly either.
Although the government has reopened Japan’s borders tointernational tourism since June, capping the entry number at
20,000 people per day means that the number of visitors will stay atless than a quarter of that in pre-Covid 2019 at the maximum. Also,
even if the government were to eliminate the cap, given that strict
restrictions are likely to continue in mainland China, and tourists
from there represented 30% of total international tourists and 37%
of total international tourist consumption (both in 2019), a fullrecovery will not take place till China drastically changes its policy.

Is the J-Curve Effect Still There?

Furthermore, in terms of the balance of trade in goods, the impactof the recent massive depreciation of the yen will not be negligible,
Goods Trade Account Likely to Stay Negative
given the size of the movement. Although it is true that the tradein Coming Months
balance or current account balance could influence the foreignexchange market in turn, I will narrow the argument down to the
Against this backdrop, the goods trade balance is highly likely toimpact from the foreign exchange market on the trade account given
stay in deficit in the coming months. The largest driver will continuethat the exchange market moves more complexly.
to be soaring commodity prices. Crude oil prices have been
In the foreign exchange market, the yen has been depreciating
fluctuating recently, reflecting factors such as the lockdowns in
rapidly against the dollar, against the backdrop of the massive
China, Russian supplies, and the economic outlook in developed
increase in commodity prices since Russia’s invasion of Ukraine,
economies, but they have remained high at around $100/bbl. On the
widened US/Japan interest rate differentials, and the difference inexport side, given the continued impact of supply-chain disruptions
economic and monetary policy outlook between Japan and otherand the downward revisions in auto manufacturers’ production plansdeveloped economies. The yen depreciated to a 24-year low of 135
over the summer, it will take some more months for vehicle
to the dollar in June, whereas it was around 115 in February. The yen
has also depreciated against other main currencies, andthe nominal effective exchange rate of the yen, which is its
CHART 2
trade-weighted value against other currencies, saw aJapanese current account balance,
significant decline of around 10% during this period.
monthly
In the theory of the J-curve effect in international
Yen, Trillions
economics, currency depreciation is thought to work
Goods trade
Services trade
4
asymmetrically to the trade account over time, just like thePrimary income
Secondary income
shape of “J”. On the export side, currency depreciation
Current account balance
3
contributes to an increase in export volumes throughenhancing export competitiveness by allowing export
2
companies to cut prices denominated in foreign
currencies. Given that it takes a while for businesses to1change the prices of their products after currency
depreciation, this effect of enhancing exports emerges0with lags. On the other hand, on the import side, import-1
prices in one’s own currency inflate immediately. As aresult, the impact from currency depreciation on the trade-2
balance changes over time, from initial worsening(increase in import prices) to eventual improvement-3(improvement in export volumes).
2021/01
2021/052021/092022/01
2022/05
However, it is arguable whether the J-curve effect still
Source: Ministry of Finance, Bank of Japan, Haver Analytics
exists in Japan. As businesses have already shifted to
22 Japan SPOTLIGHT • September / October 2022

overseas production from exporting products, except for high-value
products, clearly the path through from yen depreciation to export
prices is smaller than before. As a result, it is hard to imagine thatongoing yen depreciation will lead to a significant increase in export
volumes even with lags.

Stable Primary Income to Support Current AccountHowever, I do not believe that Japan has already turned into an
economy with a permanent current account deficit structure.
First, it is too early to say that the large deficit in goods trade will
persist. In commodity markets, it seems that the situation
surrounding the war in Ukraine has already been priced in largely.
This implies that it will take additional news for commodities toincrease further from now. The increase in medical imports and theslump in auto exports due to supply-chain disruptions are temporary
factors, although it could take several more months for them tonormalize.
Second, as argued in the previous section, what matters most inJapan’s current account recently is the primary income accountrather than the trade account. Therefore, it is necessary to have alook at this less-familiar component of the current account.
The source of Japan’s primary income used to be exclusively
portfolio investment income, mainly from foreign bonds held byfinancial institutions (Chart 3). Since the 2010s, however, direct
investment income has grown as manufacturers enhanced overseas
production and non-manufacturers also increased overseas
business. As a result, direct investment income and portfolio
investment income now each account for about half of the total

investment income.
The increase in the amount of assets has contributed to the recent
surge in direct investment income. Although portfolio investment
assets are still larger than direct investments, direct investment
assets tripled over the past 10 years. Indeed, according to UNCTAD,
Japan’s direct investment outflow was the largest in the world in2018 and 2019 and was third largest in 2020 after China andLuxembourg, whereas it ranked just 13th in 2000.
Another source of strong direct investment income is its
structurally high rate of returns. The return from direct investments
has been around 6%-8% recently, whereas the portfolio investment’s
return is trending downward, to below 3%, partially reflecting the
low interest rate trends in developed economies. Direct investment
returns are high in investments in Asia. Although there are notable
short-term risks such as the economic slowdown in China, stableprimary income surpluses will support the overall current account,supported by economic developments in emerging Asia.
In addition, when it comes to the primary income account, it
seems that the yen’s depreciation is firmly contributing to an
improvement in the balance. The primary income surplus for March
was a record-high 3.3 trillion yen and April/May was also a robust
2.4-2.5 trillion yen.

Savings-Investment Balance Determines Current
Account

In the long run, the current account balance is thought to be
determined by the macro savings-investment balance. If an economy
has national savings larger than its investments (net savings /financial surplus), it implies that it has a structural current
account surplus, as the overseas sector for the economy
CHART 3is in financial deficit and vice versa.
Main components of net primary income
Japan has structural net savings in the household andYen, Trillions
corporate sectors which are larger than the net
14
investments in the government sector (Chart 4).
Direct investment income
Portfolio investment income
Fluctuations in 2020 and 2021 were notable in that the12
deficit in the government sector expanded significantly
due to direct payment programs to households. However,10
as this deficit was simply covered by an increase inhousehold savings following the worst of the pandemic,8
its impact was largely netted out. Looking ahead, it islikely that net savings in households and companies will6
cover the net investment in the government sector, as has
4been the case in past years.
The most important factor in the outlook for Japan’s
2savings-investment balance is the sustainability of thehousehold sector’s excess savings. Generally, the aging of0society is thought to lower savings, as the presence of
2000
2005
2010
2015
2020
retired households who withdraw savings for
Source: Ministry of Finance, Bank of Japan, Haver Analytics
consumption increases. In the real world, however, itJapan SPOTLIGHT • September / October 2022

23

CHART 4

Savings-Investment balance (positive if
net saver)Households

Financial institution

Yen, Trillions

Overseas (rhs)60
40

Non-financial corporations
General government

Yen, Trillions inverted

-60
-40

Japan’s parliamentary democracy, whichever the rulingparties are. The fiscal measures in response to the Covid19 crisis will be withdrawn gradually, but it is not realistic
to expect that fiscal consolidation will progresssignificantly anytime soon, particularly with sustained
expansion in social security expenditures.

Theoretical View of the Current Account& Macroeconomy

Traditionally, the development stage theory of Geoffrey
Crowther famously provides a theoretical framework00connecting economic growth and the structure of balanceof payments. According to this theory, the balance of-20
20
payments, including the current account, shifts in theorder of (1) immature debtor, (2) matured debtor, (3) debt
-40
40
reducer, (4) immature creditor, (5) matured creditor, and(6) asset liquidator, depending on the country’s stage of
-60
60
2005
2009
2013
2017
2021
economic development, just like a human life cycle.
Looking at the current account balance, an economy
Source: Bank of Japan
experiences a current account deficit at the stage of (1),(2), and (6), whereas it enjoys a current account surplus
could work conversely through an increase in the middle-age
when it is at (3), (4), and (5) stages. At the initial stage of economic
generation who aggressively save anticipating retirement, while thedevelopment, a country starts with a current account deficit because
younger generation, who invest more in residential property,
it imports more goods from overseas than it exports as its
declines.
manufacturing ability is limited, and it relies on foreign capital for
Moreover, there would be a non-negligible impact from thedomestic financing needs.
improvement in life expectancy and an increase in precautionary
Subsequently, as its trade balance improves with enhanced export
savings due to fears over the sustainability of the social security
competitiveness, the current account deficit decreases. Once allsystem. In fact, net savings of Japanese households, both indebts are repaid, not only the trade balance but also the primary
absolute terms and as a percentage of GDP, were larger in the 2010s,
income balance turns into a surplus. This is when its current accountwhen the aging of Japanese society progressed, than in the 2000s.
surplus reaches its peak. Thereafter, as export competitivenessThe impact of aging on the balance might not be as large as it
gradually declines, the trade balance deficit increases again, andappears.
eventually the trade balance deficit exceeds the primary income
The corporate sector, the other source of net savings, is alsobalance surplus, and the current account turns into a deficit.
unlikely to turn toward net investment anytime soon. Theoretically,
Based on this theory, by simply looking at what happened during
free enterprises in a market economy are the ones that conduct
last winter, Japan seems to be shifting from the matured creditor
capital investments by raising outside funds, and they are often
stage (5) to asset liquidator (6) in that its trade account deficit istreated as net investors. However, in Japan, facing balance sheet
becoming larger than the primary income balance surplus. Based on
adjustment pressure after the collapse of the bubble economy, thethis theory, the shift in the development stage is irreversible; once
financial crisis in the 1990s and secular stagnation thereafter,
Japan turns into a current account deficit, it will persist in the future.
companies have kept investments within their cash flows. The
Such an argument was widely made in 2012-2013 when Japan saw
corporate sector is now structurally over-savvy. Furthermore, it isthree consecutive months of current deficit, and today.
highly likely that the importance of maintaining cash has been
But it won’t be that easy in the real world. In fact, Harutoshi Oda
recognized again by business managers with the Covid-19 turmoil.
(“A Contemplation on the Development of the International Payment
Additionally, with no change in expectations of continued secular low
Pattern of Crowther”, Fukuyama Daigaku keizaigaku ronshu, 2009)
growth in domestic demand, it is unlikely that companies will rapidly
points out that many developed economies did not follow this theory
shift to net investments.
in practice. According to this paper, some economies (Australia, New
On the other hand, structural net investments in the government
Zealand, and Spain) maintained a current account deficit for a longsector will continue, given that fiscal consolidation is unlikely undertime, and others (Canada, Italy, Portugal, and Sweden) go back and20

24 Japan SPOTLIGHT • September / October 2022

-20

forth between a current account surplus and deficit, rather thanshifting as the life cycle goes on.
Particularly, it points out that current account balances of nonindustrial export-oriented economies, such as resource richeconomies or financial economies, typically do not follow the patternof development stage theory. It would be more accurate to say thatdevelopment stage theory is just a guideline. Although Japan has
followed the development stage theory largely, it does notnecessarily mean that it will continue to do so in the future. To givean example, the existence of a non-negligible services trade income
from inbound tourists is not clearly treated in the theory. The size of
travel income has little to do with the economic development stage.
In fact, from the view of the savings-investment balance, it can besaid that economies in secular stagnation due to society aging run acurrent account surplus. In the context of secular stagnation, it is
widely argued that an increase in life expectancy and a decline infertility lead to higher net savings through a higher working-age
savings requirement and lower demand for housing investment,
respectively. Besides, under secular stagnation, companies find it
difficult to find investment opportunities as the domestic market
shrinks. These domestic excess savings are eventually “exported” toforeign economies via capital outflows. This implies that the aging of
the population can boost savings and could lead to a current accountsurplus.
An Oxford Economics’ global analysis based on demographic
change and wealth accumulation also found that the negative impact
from demographics on Japan’s current account surplus is limited,even at a horizon of 2050. It appears that there is considerable time
for Japan to become a permanent current account deficit economy,leaving aside some short-term fluctuation.

Implications of Structural Current Account Deficit
So far, we have looked at the structural forces of the current
account and found that it is unlikely that the Japanese current
account deficit will persist structurally. However, suppose that Japan
eventually turns into a chronic current account deficit economy atsome point; what kind of problems will emerge?
For an economy with a fixed exchange rate and limited exporting
ability, the current account deficit could be a policy constraint. At thetime when Japan adopted a fixed exchange rate system, thisconstraint was famously quoted as the balance of payments ceiling.
The point of this argument is that a widening current account deficit
leads to increased pressure for currency depreciation with anincrease in cash outflows, and the authorities need to conduct
currency intervention by buying the domestic currency to maintainthe fixed rate. Thus, when the economy grows due to an increase indomestic demand, the authorities need to tighten it adversely inorder to reduce its current account deficit beforehand, as if thecurrent account deficit were the ceiling for growth.

However, now that Japan has moved to a floating exchange rate
regime, there is little need to directly correct the current accountdeficit immediately. Although the current account balance sometimes
attracts attention in the foreign exchange market, as earlier this year,
it is not the single factor that determines the exchange rate. In a
floating rate regime, there are many other factors which influenceexchange rates: price differences, interest rate differences, andmarket confidence, to name a few.
In fact, as we saw at the beginning, there is little relationshipbetween the current account balance and economic growth inadvanced economies. The US and the UK have structural current
account deficits, but their growth rates are higher than that of Japan.
Even if an economy has an entrenched current account deficit, it canbe said to not matter a lot as long as it is stable and sustainable.
Rather, if current account surpluses are driven by domestic excess
savings, then current account surpluses can be evaluated as areflection of sluggish domestic demand, in other words, secularstagnation.
Having said that, though the implications of current accountdeficits for economic growth would not be significant, it does notmean they are entirely without caveats. For an economy withinsufficient savings in the government, current account deficits canbecome a financing constraint for the government as it means thatdomestic private savings are smaller than the government’s
financing needs. For Japan, in turn, it will mean an increased foreign
presence in the Japanese government bond market, whereas now
foreign investors represent a limited share of 13.6%.
An increase in foreign holdings will mean a change in the structureof the Japanese government bond market. In this regard, Sotaro
Kankawa (“Investment Behavior of Foreign Investors in the JGB
Market”, Bank of Japan Working Paper Series, 2020) points out that
foreign investors behave differently from domestic investors in thebond market. Particularly, they tend to reduce bond purchases
during periods of heightened global market uncertainty, whereas
such a tendency is not seen among domestic investors. The
increased presence of foreign investors could potentially increase
volatility in Japanese government bond interest yields, i.e., thegovernment’s financing costs, which could be problematic given thelarge size of Japan’s debts which have already surpassed 250% of
the size of its GDP.

Norihiro Yamaguchi is a senior economist at Oxford Economics. He is covering
Japanese macroeconomic research and forecasting. He holds a Master’s degree inpublic policy from the University of Chicago, and a Bachelor’s degree in
economics from the University of Tokyo.

Japan SPOTLIGHT • September / October 202225