Inflation throttles demand in Japan

Ryoji Chubachi may have a better grasp of economic risk than the honchos running Japan's central bank and finance ministry.

Speaking in Singapore last week, the Sony president voiced concern that Japan, the US and Europe face stagflation, that dreaded combination of weakening growth and quickening inflation.

"This is the reality we are facing," Chubachi told reporters. "Our concern is that consumers' buying power is decreasing. If this situation continues long-term, it would affect Sony."

Chubachi's comments got more attention outside Japan than within Asia's biggest economy. They were, after all, quite off script at a time when Bank of Japan (BoJ) and finance ministry officials are downplaying stagflation worries.

News last Friday that Japan's inflation rate exceeded two per cent for the first time in a decade validated such concerns. The data also served to remind that Japan's private sector senses economic challenges more keenly than do its public officials.

Gross domestic product fell an annualised 2.4 per cent in the second quarter, and global trends augur poorly for a bounce back. In the first month of the third quarter, July, core consumer prices, which exclude fresh food, climbed 2.4 per cent from a year earlier. Call it Japan's 2.4 per cent quandary.

The irony is that the moment Japan dreamed about for years is here: Inflation is replacing deflation. The return of inflation was supposed to improve pricing power for companies and encourage consumers to save less and spend more. It would be better if inflation accelerated amid sound growth. Instead, Japan is recession bound.

Sony is on the front lines of Japan's income-deprived recovery. The longest postwar snapback hasn't fattened pay cheques as expected because of rising competition from China, India and the rest of developing Asia.

It would come as less of a surprise to Chubachi and Sony CEO Howard Stringer that household spending fell 0.5 per cent in July, a fifth monthly decline. Sony's first- quarter profit fell 47 per cent.

Denial may be at play here, too. As the turmoil of 2007 entered 2008, officials denied Japan was vulnerable. They denied the credit-market crisis that began with US subprime loans was a risk to the economy. Now there's denial about a recession.

While Japan mulls a variety of fiscal stimulus options, including tax cuts, its ability to borrow to support growth is limited. Economists were underwhelmed by Prime Minister Yasuo Fukuda's plan to spend about two trillion yen ($18 billion) to stave off recession.

"The government needs to provide steps to encourage spending by companies and households, but no such steps are in the package," says Kyohei Morita, chief economist at Barclays Capital in Tokyo.

The unfocused handouts smack more of politics than economic policy making. Even if BoJ Governor Masaaki Shirakawa wanted to help out, Japan's benchmark rate is 0.5 per cent.

That leaves little fiscal or monetary ammunition to boost domestic demand.

Tightening of credit by banks has caused a flurry of bankruptcies among real estate companies. Urban Corp went into bankruptcy this month with $2.4 billion of debt, the country's biggest failure among publicly traded companies in six years.

Stagflation isn't a risk only for Japan, Europe or the US, but for developing Asia, too. Lim Hng Kiang, Singapore's trade minister, downplayed the danger last week.

"When we look into the external environment in the immediate future, we recognise that it will be more difficult than, say, last year," Lim told reporters. "As to whether we consider conditions going forward to present challenges of stagflation to us, I think the conditions are very different."

That may be a matter of definition. For developing Asia, stagflation-like forces could be at play even if they're not recorded in official data. Even before the most recent food-price scare, hundreds of millions of households were spending half their income on food. These days, they're spending even more, regardless of what headline inflation figures say.

The prevalence of negative real interest rates also is worth noting. Annual inflation rates are higher than borrowing costs in economies including Indonesia, Malaysia, the Philippines and Thailand. That's more a recipe for inflation than stable growth. The world's No 2 economy may indeed be tipping into stagflation. All you need to do is check with the folks at Sony.