Japan’s economy contracts amid US tariff strains, India poised to overtake

Japan’s economy contracted unexpectedly in the first quarter of 2025, signalling a fragile recovery. The contraction, which marks the first since 2024, has been attributed to a drop in exports, flat consumer spending, and the looming impact of trade tensions with the US, including tariffs imposed by President Donald Trump.

According to preliminary data from the Cabinet Office, Japan’s real GDP contracted an annualised 0.7 per cent in the January-March period, far worse than the median forecast of a 0.3 per cent drop.

This decline follows a robust 2.4 per cent expansion in the previous quarter, highlighting the vulnerability of the export-heavy economy. With private consumption, which accounts for more than half of the economy, stagnating and net exports contributing negatively to growth, Japan’s economic outlook appears increasingly uncertain.

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US tariffs deepen challenges

The contraction in Japan’s economy comes as the country faces mounting challenges from trade tensions with the US, particularly following Trump’s sweeping tariff measures. In March, the US imposed a 25 per cent duty on steel and aluminium imports, followed by tariffs on automobiles and other Japanese goods in April. These measures are expected to weigh heavily on Japan’s export-driven industries, notably the automotive sector, which is a cornerstone of its economic growth.

Japanese automakers, such as Toyota and Honda, have already signalled that the tariffs are affecting their profitability. Honda recently revised its profit forecast for the fiscal year, and Toyota followed suit. The tariffs could cost Japan’s automotive sector an estimated ¥2 trillion ($13.7 billion) in operating profits for the current financial year, prompting concerns about the broader impact on Japan’s economy.

Despite these challenges, Japan has signalled that it is prepared to hold out for a better trade deal with the United States. Prime Minister Shigeru Ishiba has made it a priority to negotiate with the US over tariff exemptions. However, the outcome of these talks remains uncertain as the negotiators have yet to reach a breakthrough, and the pressure is mounting on Japan’s leadership to secure a favourable deal.

As Japan’s economy faces significant headwinds, much of the focus is now on the negotiations with the US over trade tariffs. Japan’s economy minister, Ryosei Akazawa, and finance minister, Katsunobu Kato, have already held several rounds of talks with US officials, but significant hurdles remain.

Japan’s starting position is the elimination of all new tariffs, including those on automotive and steel imports, which have been particularly damaging to its largest industries. The question now is whether Japan can win exemptions from these tariffs through continued negotiations or whether it will be forced to accept a deal that could further hamper its economic recovery.

While the US and China have recently negotiated a temporary truce, Japan has not yet made substantial progress in its talks with Washington, leaving the country’s economic future hanging in the balance.

India’s rising economic power

While Japan grapples with economic contraction, India is on a different trajectory. With a large and youthful population, a growing manufacturing base, and increasing digital transformation, India has almost closed the economic gap with Japan.

This shift will soon propel India into the position of the world’s fourth-largest economy, as Japan’s economic challenges deepen. Experts suggest that, with Japan’s economy slowing and India continuing its growth trajectory, India may soon surpass Japan in terms of total GDP.

Although the United Nations has reduced India’s 2025 growth forecast to 6.3 per cent, experts still predict that India’s economic ascent will continue, potentially shifting the global rankings in the coming years.

The future of Japan’s economy

Japan’s economic vulnerability, coupled with its slowing domestic demand, has raised questions about its ability to withstand the impacts of external trade pressures, particularly in light of India’s growing economic influence. While Japan’s policymakers face pressure to stimulate growth through fiscal measures or interest rate cuts, they are constrained by political considerations and weak demand.

For Japan, the road ahead is fraught with uncertainty. The ongoing trade challenges, combined with stagnant domestic consumption and global trade disruptions, threaten to undermine the nation’s ability to maintain its position as a global economic power. Meanwhile, India’s continued rise suggests that Japan may soon face new competition for its spot in the top tier of the world’s largest economies.

As Japan grapples with these challenges, the global economic landscape is set to undergo a transformation. The balance of power may soon shift, with countries like India emerging as stronger players in the global economy, while Japan’s future hangs in the balance amid ongoing trade tensions and internal stagnation.