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demand. Our US economics team expects the stimulus to boost growth in H2 CY17 and likely CY18. Japan should be a big winner from stronger US growth, given its high exposure to the US economy in terms of exports and corporate profits (Chart 22 and Chart 23). On the negative side, aggressive protectionist trade measures, if implemented, would depress US growth and global trade further. If combined with a stronger yen, Japan’s economy would be hit hard.

Chart 22: Japan's export exposure (% of total gross and value-added exports*)
[Bar Chart showing USA, CHN, KOR, TWN, GER]
Gross exports
Value-added basis
Source: OECD

Chart 23: Breakdown of Japan exports to US by commodity, 2015
[Pie Chart]
6%
7%
22%
14%
39%
12%
Chemicals
Manufactured goods
Machinery
Electrical Machinery
Transport equipment
Others
Source: BofA Merrill Lynch Global Research, MoF

Base case: “benign Trump” scenario
For the moment, we are assuming limited positive and negative policy changes. Our US team expects uncertainty to cause a modest slowing of growth in the first half of next year, but this will be more than offset by fiscal stimulus in the second half and into 2018. But the size of the fiscal expansion will likely be smaller than promised, and the introduction of modest protectionist measures means that the boost to global trade will essentially be zero. Table 1 shows the impact on growth under two scenarios, based on different assumptions for global trade and FX. Under the upside case, Japan’s GDP could rebound towards 2%, as the economy benefits from a combination of stronger global trade and a weak currency. Under a downside “protectionist” scenario, 2017 growth would slow to around zero and would most likely tip Japan back into deflation.

Table 1: Sensitivity of Japan's growth to global trade and foreign exchange rate
(Assumptions) Baseline Case 1 - Upside Case 2 - Downside
Global trade 0.0% 3.0% -10.0%
% JPY appreciation (*) -7.0% -10.0% 10.0%

(Simulation results) Change (Contribution) Change (Contribution) Change (Contribution)
(**) (**) (**)
Real GDP impact 0.2ppt — 0.9ppt — -1.4ppt —
Consumption 0.0% (0.02ppt) 0.3% (0.15ppt) -0.8% (-0.44ppt)
Capex 1.9% (0.26ppt) 2.9% (0.40ppt) -3.2% (-0.44ppt)
Net Exports — (0.00ppt) — (0.30ppt) — (-0.23ppt)
Source: BofA Merrill Lynch Global Research, CAO, MoF, IMF
(*) Rate of appreciation of Japanese yen in terms of effective exchange rate
(**) Contributions to the change in real GDP

Political impact of a Trump administration
For Japan, the impact of Trump’s election goes beyond economic issues. It also impacts defense spending and regional trade arrangements.

Military self-reliance and budget choices
Trump has made it clear that he wants allies of the US to shoulder a greater share of the defense burden. There is a lot of uncertainty as to how far Trump will go to re-define the US-Japan alliance. Despite his criticism, Japan already pays about 75% of US military hosting costs. However, it seems fair to assume that Japan will be expected to

Bank of America Merrill Lynch
Japan Economics Viewpoint | 18 November 2016
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