Korea-Japan conflict likely to reduce Japan’s GDP by no more than 0.1 pct this year, says Capital Economics

The tensions between Korea and Japan are unlikely to end anytime soon. That suggests that tourist arrivals may fall further and Koreans will continue to boycott Japanese consumer goods. However, Japan’s shipments to Korea are dominated by intermediate products and those exports have fallen less sharply. The conflict is expected to reduce Japan’s GDP by no more than 0.1 percent this year, according to the latest research report from Capital Economics.

Net exports knocked off 0.2 percentage points from quarterly GDP growth in the third quarter. While goods exports edged up, the 4.6 percent q/q plunge in services exports marked the largest fall since 2012.

One reason is the escalating conflict between Japan and Korea, which is hitting trade in both goods and services. While tourist arrivals from other regions climbed to a record high in Q3, those from Korea slumped 38 percent q/q. As a result, the “exports of travel services” component of GDP plunged 10.5 percent q/q, the largest fall since the Great East Japan Earthquake.

Tourist arrivals from Korea fell by another 13 percent m/m in October. But with arrivals now low in absolute terms, the drag on overall tourist arrivals should start to become a little less severe in the fourth quarter.

Even if Korean arrivals keep falling by around 10 percent in both November and December, it is estimated that they will drag down overall arrivals by 7 percent in Q4 compared to 8 percent in Q3. What’s more, Korean tourists spend only half as much when they visit Japan as the average tourist, the report added.

The long-standing conflict between Japan and Korea over wartime reparations escalated further this year when Japan placed restrictions on obscure chemical products that together accounted for just 0.05 percent of Japan’s total exports.

Korean consumers have boycotted Japanese products. Japan’s exports to Korea have fallen to a three-year low even as those to other countries have started to stabilise. Food exports have halved while shipments of transport equipment have fallen a third.

Exports of other manufactured goods as well as machinery have fallen by around 10 percent. The only sector that has bucked the trend is electrical machinery, which may be a sign that the inventory cycle in the semiconductor industry has turned around.

There are no signs that the conflict will end anytime soon. Korea decided in August to end an intelligence-sharing agreement with Japan. Sunday’s talks between the country’s foreign ministers to salvage the deal ahead of its expiry on Friday have proved unfruitful.

"Given that Korea still accounts for nearly 7 percent of Japan’s exports, that’s a significant risk for Japanese exporters. Again though, the overall impact on the economy will be small. Even if exports to Korea fall by another 5 percent m/m in both November and December, the cumulative drag would only be around JPY130 billion this year, or 0.03 percent of GDP," Capital Economics further commented in the report.