The announcement that India will overtake Japan in nominal gross domestic product in dollar terms in 2025 has shocked Tokyo. Until 2010, Japan had been home to the world's undisputed second-largest economy, but it's now on the brink of slipping to fifth place.

In estimates released in late April, the International Monetary Fund indicated that India's nominal GDP will reach $4.34 trillion (€4.03 trillion) in 2025, surpassing Japan's $4.31 trillion. The timing of India's surge into fourth place comes one year earlier than the IMF's last estimate, due in large part to the weakness of the Japanese yen.

Japan's decline in the global economic standings follows the government's confirmation that the nation had slipped behind Germany in 2023. The shock at India likely surpassing Japan next year is comparable to 2010, when a buoyant China replaced Japan as the world's second-largest economy.

"For Japan, this is a very big concern — but few people are talking about it openly because it is embarrassing and very difficult to solve," said Martin Schulz, chief policy economist for Fujitsu's Global Market Intelligence Unit.

Implementing 'Abenomics'

The problems the nation faced were recognized by Shinzo Abe when he became prime minister in 2012 and announced sweeping plans dubbed "Abenomics" to lift Japanese growth, Schulz said.

And while two of the "three arrows" of the policy — monetary easing by the Bank of Japan and fiscal stimulus through government spending — enjoyed a good degree of success, the third arrow, structural reforms, fell short.

"The whole idea of Abenomics was to drive growth at businesses, but structural reforms were also needed to push productivity," said Schulz. "But that is very hard to do in a country that is aging and where there is resistance to change [and] to digitalization, and people who have been in positions for a long time simply prefer the old ways."

As elsewhere, the COVID-19 pandemic and Russia's war in Ukraine have had an impact on Japan's economy that is still being felt. But other indicators point to a more acute problem.

The Organization for Economic Cooperation and Development heaped new pressure on Tokyo with the May 2 release of its latest report on the outlook for global economic growth.

While the OECD has predicted growth of 3.1% for the world as a whole, up from 2.9% in its February report, and has forecast that both the US and China will outpace previous predictions, the Paris-based organization cut Japan's likely growth from the 1% it had projected three months earlier to just 0.5%.

Developed nations vs. emerging markets

Some of Japan's economic malaise can be linked to the three "lost decades" of stagnant economic growth, said Naomi Fink, global strategist and managing director of Nikko Asset Management in Tokyo.

"Both the US and Japan are developed markets and cannot be expected to grow as quickly as emerging markets, such as China and India, where the middle class is occupying an increasing share of GDP, infrastructure remains to be built, and in sum, a whole lot of capital has yet to be mobilized," she told DW.

"It's altogether normal for developed countries to grow more slowly than emerging markets — they have less growing to do before they hit a growth equilibrium, they typically have aging populations, even with a degree of inward migration," she added.

The key for future growth in Japan, she said, would be investing in productivity growth — technology, human capital, improvements in business processes — as population growth would not remain the primary driver of economic expansion.

Japan could not match India's investment in infrastructure and a rapidly growing middle class, Fink added, while Germany had surpassed Japan primarily on the precipitous drop of the yen against the euro over the last 12 years — a decline of 40% that put the real exchange rate effectively at a 50-year low.

Yen is greatest challenge

The feeble yen is arguably the Japanese government's greatest challenge at the moment, said Schulz, as indicated by two apparent market interventions in April that were an attempt to bolster the currency.

"The yen is becoming a major problem and while in the past if governments did nothing it would bounce back, that is not happening this time," he said. Market intervention has been "futile," he underlined, and will remain that way for as long as interest rates remain static.

The solution, he pointed out, is for the Bank of Japan to adopt a tighter monetary policy and for the nation to focus on improving productivity.

'Cautious optimism'

Fink is also cautiously optimistic that improvements might be on the horizon.

"I expect Japan to clear its low bar of potential growth, but we cannot expect developed economies to grow as rapidly as developing economies," she said. "I think the main goal for Japan is not to achieve nominal growth at all costs but to conquer deflation for good and increase its currently low potential growth."

A number of initiatives that have already been implemented — altering corporate governance practices, encouraging greater labor participation to reduce the pressures of shortages of skilled labor and "fashioning policies to help burnish human capital" — will pay off, she said.

"There are already some good signs that this is happening," she added, pointing to companies' investment behavior in response to labor shortfalls, particularly in the form of wage increases this spring, "which may show some positive spillover into the rest of the economy."

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Edited by: Srinivas Mazumdaru