Japan’s Economy Contracts 7.8 Percent, Worst Decline on Record

TOKYO — Japan’s economy shrank 7.8 percent in the second quarter of the year, its worst performance on record, as the coronavirus pandemic ground economic activity to a near halt in April and May.

The nosedive in output in the three months — an annualized drop of 27.8 percent — was the third straight quarter of contraction for Japan, the world’s third-largest economy after the United States and China. It followed a 0.6 percent decline in the first quarter of 2020, or an annualized decrease of 2.2 percent, the country’s government said on Monday.

It is the largest decrease since 1955, when the Japanese government began to use gross domestic product as a measure of its economy.

Already weakened by a tax increase, slowing demand from China and a series of natural disasters last fall, Japan’s economy became the first among major nations to officially fall into recession when the pandemic hit, causing exports to plunge and effectively obliterating the country’s tourism sector.

“The pandemic’s total impact on the economy up to this point is almost the same as the 2008 financial crisis,” said Michinori Naruse, an economist at the Japan Research Institute.

But with the financial crisis, “things got worse slowly,” he said. “This time, they got bad all at once.”

The slowdown in Japan, while crippling, was not as severe as the 9.5 percent drop by the United States in the second quarter, which erased almost five years of growth. Britain, whose economy has taken the hardest hit from the pandemic in Europe, fared even worse, with the government reporting a staggering 20.4 percent quarterly decline last week.

And there are signs that the worst pain may be over in Japan. The country racked up most of its economic damage in April and May, when Prime Minister Shinzo Abe declared a national emergency in an effort to check a slow but steady rise in coronavirus infections.

While Japan never went on full lockdown — the authorities do not have the legal power to force people to stay home — economic activity still decreased significantly as workers and consumers chose to stay in.

But by late in the second quarter, the full effects of an economic stimulus package worth around 40 percent of the country’s G.D.P., including cash handouts and zero-interest loans, began to be felt.

The stimulus helped keep unemployment and bankruptcies low. And while companies furloughed millions of workers, government subsidies, combined with a super-tight labor market, ensured that workers would have a job to return to when the emergency lifted.

“We had a huge hit in April and May, but the economy bottomed out in May, and in June we actually had a pretty sizable rebound,” said Izumi Devalier, chief Japan economist at Bank of America Merrill Lynch.

That rebound was largely driven by the end of the country’s national emergency in late May, when workers began to head back to offices and consumers back to stores, bolstered by government subsidy checks.

“We had this mechanical sort of reopening rebound in June as people started going out and spending again,” Ms. Devalier said. “The cash handouts basically hit from late May to June, so just when the economy reopened, people had cash to spend.”

That translated into a sharp increase in retail sales in June. Industrial production and exports were also up. And the country’s unemployment rate dropped, dipping one-tenth of a percentage point to 2.8 percent during the same month, according to government data.

Those numbers are reason to believe that, despite the grim quarterly report, “Japan will come out of this better than most people think,” said Nicholas Smith, a Japan analyst at CLSA, an investment group.

Japanese companies are cash rich, he said, adding that their “cushion is going to be very, very useful” as the country rides out the pandemic.

What’s more, “banks have a lot of dry powder,” and “there’s not a problem in getting a loan if you need it.”

Whether Japan is in a position to take advantage of those factors will depend in part on how it handles the virus. As of mid-August, the signals are mixed.

So far, the country has avoided the worst of the pandemic. It has reported just over 1,100 deaths from the virus, far fewer than its peer economies.

In June, heartened by low virus numbers, the national government began a campaign to encourage domestic travel in hopes of reinvigorating local tourism and the moribund service economy.

But infections began to rise again in July, quickly outpacing the growth in the lead-up to the earlier national emergency and provoking widespread criticism of the government for easing its control measures too early.

Even as the case numbers have risen, Mr. Abe said in early August that the country’s economy could not afford a second national emergency and that he would do everything in his power to avoid one.

Still, the governors of Okinawa and the central Japanese prefecture of Aichi have declared emergencies on their own, putting pressure on the central government to act. In Tokyo, which has regularly reported more than 200 new cases a day for the past month, the government has asked restaurants and bars to close by 10 p.m.

That has made consumers nervous and “stalled the improvement in services spending” that was seen in June, said Ms. Devalier of Bank of America Merrill Lynch. She added that “the rebound in the third quarter risks being quite weak.”

“Corporates and consumers have the ability to withstand short-term shocks,” she said, but “the longer we stay below normal, the longer we stay deeply below normal, there are going to be second-order effects that will lead to an even more sluggish recovery.”

That is bad news for most of corporate Japan, which anticipates that profits will sink as much as 36 percent during the fiscal year that ends next March, according to an analysis of publicly listed companies’ earnings projections carried out by the Japanese financial paper Nikkei Shimbun.

Even under the best-case scenario, the road to good economic health is likely to be a long one, said Taro Saito, an economist at the NLI Research Institute.

While the uncertainty surrounding the virus makes it difficult to predict the future, he said it would take at least three years for Japan’s economy to return to pre-pandemic levels.

“We may have gotten out of the worst period,” he said, “but we are still a long way from so-called normal.”

Hisako Ueno contributed reporting.