Japan drops to fifth-largest economy, falls behind India and Germany in two years

According to the International Monetary Fund, Japan will drop to the world’s fifth-largest economy in 2026, falling behind India and marking another decline in the Asian nation’s economic standing.

The anticipated shift comes as Tokyo grapples with a shrinking population and puts added pressure on Prime Minister Sanae Takaichi to deliver results from her upcoming growth plan, scheduled for release this summer. Economic experts say the country needs to boost productivity and focus on sectors with strong growth prospects.

Recent government figures showed Japan’s economy contracted during the three months from July through September, the first such decline in six quarters. The downturn came partly from reduced exports as President Donald Trump implemented higher tariffs on Japanese goods.

Looking ahead to 2026, economists predict the Japanese economy will get back on track with modest growth once uncertainty around US trade policies settles following a bilateral agreement between the two nations.

The Organisation for Economic Cooperation and Development said Japan’s economy will grow by 0.9% this year. The projected growth comes from Takaichi’s expansive monetary policies and increased consumer spending driven by higher real income for households.

Yen weakness and China tensions pose major risks

However, Yusuke Koshiyama, a senior economist at Mizuho Research & Technologies, pointed to two serious concerns hanging over the economy: a weakening yen and deteriorating relations with China.

The Japanese currency has faced downward pressure as investors worry about the country’s fiscal stability. These concerns stem from Takaichi’s plans for increased government spending, which include financial relief for households dealing with rising prices.

Koshiyama warned that a weaker yen drives up the cost of imported goods and pushes inflation higher. “There is no denying the risk of an intensifying stagflation phase – meaning high inflation amid low growth – if inflationary pressure from the yen’s depreciation offsets the effects of measures against rising prices,” he said.

Relations between Japan and China have grown tense recently after Takaichi suggested in November that Tokyo might intervene if Beijing attacked Taiwan.

Beijing has encouraged Chinese citizens to skip trips to Japan, which could hurt the country’s tourism sector.

Falling global rankings highlight productivity concerns

The IMF’s October global economic outlook showed Japan falling behind India when comparing countries by nominal GDP measured in US dollars. This comes just two years after Germany overtook Japan in the rankings.

Shinichiro Kobayashi, a principal economist at Mitsubishi UFJ Research and Consulting, acknowledged the ranking drop mainly reflects the yen’s weakness. Still, he said a lower position “would directly lead to a decline in Japan’s influence in global trade, the global economy and world politics”.

“The fundamental issue is that productivity has not risen, despite past administrations seeking to raise it through various growth strategies,” Kobayashi said.

Attention is now focused on the new growth plan that Takaichi’s administration will unveil this summer as she works to strengthen the economy through public and private investment.

Operating under her motto of “responsible and proactive public finances”, Takaichi has identified 17 key sectors for government support. The list includes shipbuilding, artificial intelligence and semiconductors.

Economists call for broader growth focus

Hideo Kumano, executive chief economist at Daiichi Life Research Institute, believes Takaichi’s plan misses several areas with strong growth potential. He specifically mentioned tourism, efforts to reduce carbon emissions, robotics and self-driving vehicle technology.

“It would be desirable for the Takaichi administration to revise the contents gradually and flexibly,” Kumano said.

Takahide Kiuchi, executive economist at Nomura Research Institute, urged Takaichi’s government to tackle the falling birth rate as part of its growth plan.

“Companies will become pessimistic about the potential growth of the Japanese market, where the decline in population is set to accelerate, and curb domestic investment, which will lower labour productivity,” Kiuchi said.

He warned that aggressive government spending through more bond sales, like the upcoming stimulus package, will leave fewer resources for future generations and eventually slow economic activity, reducing Japan’s potential for growth.

“Demonstrating a commitment to medium- and long-term financial consolidation will stem declining growth expectations among domestic companies and prevent a further erosion of Japan’s economic presence, which will serve as one of the key growth strategies,” he said.

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