Japan braces for more inflation amid Ukraine crisis

Russia’s invasion of Ukraine has further worsened the outlook for global inflation, with the crisis already causing oil prices to soar — and economists say it may spike further.

The further rise in energy costs is expected to hurt the Japanese economy, which has already begun to feel the effects of the existing inflation wave after decades of deflation and flat prices.

Japanese companies are normally reluctant to pass extra costs on to consumers, but recent rises in commodity prices have forced many firms to break that habit.

Costs of everyday goods ranging from pasta to soy sauce and gasoline have been increasing for the past several months.

Russia’s invasion of Ukraine will only escalate this trend, thereby increasing the burden on Japanese firms and households, some economists say.

“The impact on households is inevitable…. (Rising oil prices) will be reflected in products, such as gasoline and kerosene, and electricity prices for sure,” said Shunsuke Kobayashi, chief economist at Mizuho Securities.

As the rise in oil prices will push up transportation costs, a slew of wholesalers and retailers will likely raise prices as well, he added.

Even if some companies choose to shoulder the soaring costs by themselves, it will hurt their profits and eventually impact employees’ salaries.

“No matter what route it takes, the increase in energy costs will hit households,” Kobayashi said.

On Thursday, global benchmark Brent crude rose above $105 (about ¥12,100) a barrel, while U.S. West Texas Intermediate (WTI) crude at one point topped $100 a barrel, both hitting their highest levels since 2014.

In a report released Monday, Kobayashi estimated that Japan’s import costs would increase by ¥7.8 trillion if the average WTI price remains at $95 this year, compared with $65 last year.

In that case, it would slash gross domestic product by 1.8% and companies’ operating profit by about ¥5.5 trillion, while households would take a ¥3.5 trillion hit.

The report was released before Russia’s military operation, and Kobayashi said it is now more uncertain how oil prices will fluctuate going forward.

Crude oil imports from Russia accounted for 3.6% of Japan’s total last year, while the figure was 8.8% for liquefied natural gas. Economic sanctions could further disrupt the balance of supply and demand, with the latter already outstripping the former, thereby affecting energy prices.

Ken Kobayashi, who chairs Japan Foreign Trade Council Inc., a Tokyo-based research body, said that inflation stemming from higher oil and LNG prices is one of the most serious risks facing the Japanese economy.

After the average cost of a liter of gasoline exceeded ¥170 on Jan. 21 for the first time in more than 13 years, the government began providing subsidies to oil wholesalers to cushion the impact of the climbing oil prices

Despite the financial assistance, the average price of gasoline nationwide rose for seven straight weeks. According to the Agency for Natural Resources and Energy, the average price stood at ¥172 as of Monday, a ¥0.6 increase from the previous week.

The government is offering subsidies to oil wholesalers if the price exceeds ¥170. But because the subsidy limit is set at ¥5 per liter, the program is already unable to keep the price below ¥170 because of the rapid rise in crude oil prices.

Speaking at a news conference on Friday morning, Prime Minister Fumio Kishida said the government will “substantially” bolster the subsidy program to curtail the increase in gasoline prices. He also mentioned possible measures to prevent a rapid rise of electricity and gas rates.

“As for the rises in crude oil and fuel costs, we will strive to curb the adverse impact on people’s lives and business activities, keeping it to a minimum,” Kishida said.

The prime minister added that relevant ministers will hold a meeting and swiftly compile measures to tackle the issue.

The ruling Liberal Democratic Party is calling for the subsidy limit to be raised to over ¥25 per liter, while some major opposition parties are urging the government to enact a temporary gasoline tax cut of ¥25 per liter.

A tax cut can be implemented if the average price of regular gasoline remains above ¥160 for three consecutive months. But enacting it would require a legal amendment, as the policy has been frozen since 2011 in an effort to secure tax revenue for the reconstruction of the Tohoku region following the Great East Japan Earthquake.

Kishida has said the government will look into additional measures, including the tax cut. But he has also pointed out that the move would come with some potential downsides, as it is expected it would diminish tax revenue and make consumers hesitant to buy gasoline before the price drop, which would impact logistics.

Options to curb surging oil prices in the short term are basically limited to fiscal measures, Kobayashi of Mizuho Securities said, adding that the tax reduction would be more effective because the subsidy program will not guarantee that major wholesalers will actually cut prices.

Apart from oil, Russia is the world’s largest exporter of wheat. Although Japan does not directly import wheat from Russia, sanctions against Moscow could boost demand for wheat from other markets, pushing up prices globally. Ukraine is also a major wheat exporter and it’s uncertain what the crisis there could mean for its exports.

In addition, Russia is a major producer of palladium, which is used to make exhaust gas from vehicles less harmful. As imports of the metal from Russia account for about 35% of Japan’s total, automakers’ production could be affected if Moscow retaliates by limiting exports.

Worsening matters, concerns over soaring inflation come at a time when Japan is looking to resuscitate its sluggish economy following the peak of its sixth wave of COVID-19.

Information from Kyodo added