Author: Max Tomlin

While snap elections did not always result in the instigator’s desired outcome in 2017, Japan’s own did just that. The unexpected call for parliamentary elections made in September by long-standing Prime Minister Shinzo Abe was timed perfectly. Despite notable successes during Abe’s time in power, several pressing issues still remain deeply problematic for the Japanese economy and people, not least the threat of demographic catastrophe. With such concerns permeating the social consciousness, in the week prior to Abe’s announcement, Yuriko Koike, former Minister of Defence and leader of the newly created Hope Party, stepped into the limelight. The charismatic candidate offered an alternative to mainstream politics in Japan and quickly garnered support, particularly among the country’s youth.

But this wasn’t another surprise power shift as that witnessed in the UK; Abe didn’t just win, he won by a landslide. With more than two thirds of 465 seats in Japan’s House of Representatives, the Liberal Democratic Party (LDP) held a majority even without its coalition partner, Komeito. With Komeito in tow, Abe now has a supermajority in parliament and has what he has long desired: the capacity to change Japan’s pacifist constitution. More importantly, the results revealed on October 22 were a massive boon for his eponymous economic stimulus package, known as Abenomics.

Monetary arrow
Instigated soon after Abe’s re-election in December 2012, Abenomics was created to revitalise the Japanese economy and lure it out of a two-decade-long mode of deflation. The programme consists of a three-pronged approach: monetary policy, fiscal stimulus and structural reforms.

investors are pouring in from around the globe to take advantage of japan’s under-valued stock market

The first arrow involves an unparalleled quantitative easing (QE) programme by the Bank of Japan (BOJ), which, to the surprise of many, has become all the more aggressive. The BOJ first started dabbling with QE back in 2001, when it began over-capitalising commercial banks to prompt them to lend more at less risk. Though this initial QE programme, QE1, was marked a failure and came to an end in 2006, a second, more vigorous programme (QE2) began in 2013 when the central bank started buying JPY 7.5trn ($66.7bn) of long-term government bonds each month.

BOJ Governor Haruhiko Kuroda stunned global financial markets once again in October 2014 when the central bank increased its yearly long-term bond purchases from JPY 50trn ($445bn) to JPY 80trn ($650bn). At the same time, it also tripled both exchange-traded funds purchases and real estate investment trust purchases to JPY 3trn ($26.7bn) and JPY 90bn ($801m) respectively.

Though it took several attempts, Japan’s QE programme, which is now the longest-running in the world, managed to reduce real interest rates and provide a much-needed boost to spending and investment. It has also found currency success: according to the London Capital Group, by mid-2015, the yen had depreciated by over 35 percent on traded weighted basis, while the USD/JPY exchange rate had leapt from below 80 to over 125. Consequently, a cheaper yen has fuelled export growth by making Japanese manufacturers more competitive.

The country’s stock market, meanwhile, has investors pouring in from around the globe in the hope of taking advantage of one of the most under-valued markets among the biggest economies. “Growth [in the stock market] has been much stronger than anyone would have expected four or five years ago, and like elsewhere, extended growth, low rates and low volatility are very equities-friendly,” explained Steven Englander, Head of Research and Strategy at Hong Kong-based Rafiki Capital Management.

John Vail, Chief Global Strategist and Head of the Investment Strategy Group at Nikko Asset Management, agreed: “Japanese economic and corporate profit growth are more geared to global economic reflation than other developed countries. This was shown by [the Q3 2017] results season that exceeded expectations more than I have ever seen in my 30 years of covering Japan. Profit and sales growth were the best among developed economies, as was the surprise factor relative to consensus.” Also playing a positive role in the Nikkei Stock Exchange’s recent performance is the government’s pro-market stance, mounting investor confidence and improving corporate governance.

Negative for positive
After three years of buying JPY 80trn ($712bn) in assets annually, the central bank had acquired almost one third of Japan’s bond market, but the target inflation rate of two percent had still not been met. Furthermore, instability in the global economy was threatening to undo what the BOJ had achieved thus far, in terms of higher stock prices and a weaker yen. Subsequently, in January 2016, the BOJ stunned international markets by introducing negative interest rates in the country for the first time, joining Sweden, Switzerland and Denmark in an attempt to encourage lending.

Despite the limited impact of the negative interest rate policy, which is coupled with concerns about the profitability of Japanese banks, the monetary stimulus arrow of Abenomics has seen the greatest success of the three. Englander explained that this comes down to both timing and sequencing: “The timing issue is that monetary policy works a lot quicker than structural policy, particularly through the impact on asset markets. The yen falls quickly, equity markets rally, then rates spill over into housing and construction, etc.”

He continued: “The sequencing problem is that you need lower interest rates to offset fiscal drag. So trying to narrow the deficit when you have little room to go on rates is paddling uphill. That will have to wait until inflation is higher and there is room for real rates to absorb some of the impact. Unexpectedly, and they claim unintentionally, the BOJ balance sheet is accomplishing fiscal consolidation for them.”

Phase two
As another means to kick-start the economy, Abe’s fiscal programme started in 2013 with Japan’s second-biggest stimulus package on record, encompassing recovery measures reaching JPY 20.2trn ($210bn), of which JPY 10.3trn ($116bn) was direct government spending.

The regime focused on developing the country’s infrastructure, particularly tunnels, bridges and earthquake-resistant roads. Governmental expenditure has since expanded, with a further JPY 5.5trn ($48.9bn) in April 2014, and another JPY 3.5trn ($31.1bn) after the elections in December 2014.

Japan’s QE programme reduced interest rates and has provided a boost to spending

Despite continued spending, in 2016, calls for greater fiscal stimulus grew. Kuroda himself spoke out in favour of a more robust fiscal policy in order to reinforce the efforts of the central bank, explaining that monetary policy alone could not eliminate deflation – in stark contrast to previous arguments made by the governor. “Synergy effects are produced when a government proactively carries out fiscal spending while a central bank provides accommodative financial conditions,” he said at the time, according to Reuters.

And so, in October 2016, the Japanese Parliament approved an additional JPY 3.287trn ($31.94bn) in the budget for the fiscal year ending March 2017, bringing annual spending to more than JPY 100trn ($890bn). In addition to the extra funding being funnelled into transportation infrastructure and places prone to natural disasters, the tourism industry also received a boost in a bid to entice more visitors to the 2020 Tokyo Olympics.

According to The Japan Times, in August 2017, budget requests for fiscal year 2018 reached JPY 101trn ($913bn), topping the one trillion mark for the fourth year in a row. Spending on social programmes in particular is expected to increase by JPY 630bn ($5.6bn) from fiscal year 2017, which is linked to the third, but more elusive arrow of Abenomics – structural reforms.

Structural delays
While Abe’s first two arrows have enjoyed some success, particularly in terms of the value of the yen and GDP growth, many argue that structural reforms have received the least attention of Abe’s three-pronged approach.

“The most problematic was always going to be the ambition to achieve structural reforms to address the longer-term future of the economy, and to encourage innovation and competition. Much of this entails significant social and institutional change, which is invariably a slow process,” said Janet Hunter, a professor specialising in Japanese economics at the London School of Economics and Political Science.

She continued: “I don’t think that anyone expected rapid results. Incremental change has been taking place, perhaps more than one thinks, but there is very limited evidence of dramatic change. However, the policies of fiscal and monetary stimulus may have been coming up against their limits. The massive government debt, now more than 240 percent of GDP (completely unprecedented in industrial economies), is moving into uncharted territory and although it has been sustained so far – partly because most of the debt is held internally, much of it by the BOJ – the government needs to increase its revenue, which it hopes to do by introducing a higher rate of consumption tax in 2019 (already postponed twice). But for the long term, it is structural reforms that they want to focus on, and this is emphasised in particular by the demographic problem of a declining population and ageing.”

Japan’s QE programme reduced interest rates and has provided a boost to spending

Englander too argued that there has been significant structural change, but it is less obvious due to its slow pace. He explained: “Structural policy is almost certainly slower and the efficiency gains take much longer to emerge. However, they have gotten participation rates in the 15-to-64 age group well above US levels and increasing sharply – which is a great accomplishment given their demographic skew. This has been important in maintaining growth well beyond what most would have thought possible a couple of years ago.”

Let’s get to work
A major triumph of Abenomics has been the ongoing reduction in Japan’s unemployment rate. By 2017, the level had dropped to 2.8 percent – an incredible 22-year low. What’s more, figures released by Japan’s health ministry show that 97.6 percent of university graduates who pursued employment in spring 2017 found jobs by April 1, marking the highest ratio since records began in 1997 – something that again demonstrates the sector’s recovery under Abe. While such figures are the stuff of dreams for any government, in Japan they are linked with an extremely tight jobs market and stagnant wages. Indeed, in 2016, according to The Japan Times, workers received their first year-on-year net wage gains in six years.

When asked why wages are not rising in spite of a high demand for labour across the country, Vail explained: “Corporate executives are told to boost profits, so they don’t offer more than what is required. If employees leave for higher-paying jobs or make strong requests to management, this would incentivise management to raise wages. [However], Japanese employees are usually too loyal and risk-averse to attempt such. [Although], the wealth effect of higher equity and property prices should stimulate consumer spending and economic growth.”

The well-publicised issue of a rapidly ageing population is a major contributor to Japan’s labour shortage, but there are other factors involved, which could benefit from structural reforms. For one, making it easier for immigrant workers to enter the country would help, yet there is a reluctance to do so formally.

Tapping into the female workforce is an area that has received greater efforts, but despite this, the female labour force participation rate has yet to show the increases hoped for. Hunter explained: “There may be a number of reasons for this, including the fact that many women just don’t want to cope with the working conditions of their male counterparts, particularly those with more career prospects; the fact that many large corporations remain particularly conservative and women don’t have the same opportunities; and the fact that so many institutions, including family taxation and the operation of schools, are built around the idea of a married woman being a full-time wife and mother.”

The issue of a rapidly ageing population is a major contributor to Japan’s labour shortage

To counter the issue (while also encouraging parents to have bigger families), during his campaign last year, Abe made the eye-wateringly expensive pledge to provide free kindergarten and day care for children between the ages of three and five, promising further support for those below three for low-income families. However, according to Hunter: “Building more nursery capacity will only go a very limited way toward addressing this problem.” Moreover, the actual cost of Abe’s new policy has not yet been shared, leading many to question its feasibility.

Furthermore, there is the issue of Japan’s low level of productivity, which – despite Japan’s world-renowned technological prowess – is the lowest of the G7 countries. Hunter argued that boosting productivity could be one way to help the labour shortage problem, but doing so will not be simple. “[It] means changing many long-standing working customs and practices, and not just introducing new technology,” Hunter noted.

Sluggish consumers
Despite the rallying of the stock market and rising business confidence, consumers in Japan remain cautious. Englander believes this is also down to demographics: “Older people are very cautious on spending out of wealth. They prefer steady fixed income streams.” He continued: “Real wages are still not increasing as quickly as policymakers would want. Despite the social transition in Japan, traditional savings habits have not died out.”

As such, though interest rates for savers are low, consumer demand and spending are still disappointing, while household savings rates are also very low compared with historical levels. Hunter told World Finance: “One of the reasons why increases in the consumption tax have been deferred is that it could undermine consumer spending still further, and there is thus a tension between the government’s need to increase its revenue and its desire to increase consumer confidence. Unless they can come up with clear reasons why consumer spending has not recovered, then it is difficult to deal with the problem. Obviously the distribution of spending power is one potential problem. Many of Japan’s savings are with the older generation. On the one hand, they do have more time and leisure to spend money. On the other, they don’t necessarily want to, and they may only spend it in certain ways.”

Vail agreed that an increase in the Consumer Price Index (CPI) would be detrimental: “I think it is nearly impossible to durably raise the official CPI to two percent on a sustained level without creating a very strong housing market throughout the urban areas of the country (which is quite difficult). Excluding rent, the CPI is not very low (one percent YoY in September 2017 and accelerating upward), and is likely the appropriate rate for its economy. If Japan cuts its two percent target to one percent, then forex markets will put upward pressure on the yen, which is highly undesirable.”

More structural
The end of Governor Haruhiko Kuroda’s term at the BOJ is fast approaching, due in April 2018; whether he will stay for another term is still unknown at the time of writing. One possible replacement is Japan’s ambassador to Switzerland, Etsuro Honda, who, like Kuroda, is regarded as being dovish. Other potential candidates come from within the BOJ, namely Hiroshi Nakaso and Masayoshi Amamiya who, some argue, could take different approaches to Kuroda if given the helm.

Japan’s level of productivity is the lowest of the G7 countries

When asked what he expects, Englander explained that a continuation of the status quo is likely – with or without Kuroda. “You have to give him credit for being so single-minded in pursuit of stimulus and adjusting the policy stance after negative rates proved to be so ineffective as stimulus. The recent election should be taken as an endorsement of Abenomics and Kurodonomics, so his successor is likely to be in the same mould. I doubt that Abe would want to take any risk that a successor is seen as unwinding the policy, as confidence in Abenomics is now at a high point.” He added: “The question for Kuroda or his successor is how to gently ease the BOJ away from negative rates without generating the kind of [US dollar or euro] rally that occurred when they gave indications of a policy shift.”

In conjunction, Abe’s third arrow requires a rejuvenated focus. As Englander and Hunter both explained, structural reforms were always going to be the hardest arrow to tackle, and also the lengthiest in terms of producing change. But in order to continue boosting the economy, they are absolutely crucial – now more so than ever. “The key challenge is to identify those structural flaws that most inhibit productivity growth and efficiency and target those,” Englander added.

In addition to boosting productivity, considerable changes within the labour market are required, which include promoting labour mobility, closing gaps between working conditions and pay, and increasing wage pressure. Meanwhile, more robust reforms to boost the female labour participation rate, encourage part-time work and make it easier for immigrants to enter the market are all essential in addressing the issues catalysed by Japan’s shrinking population.

As daunting and difficult a task as structural reform is, if Abenomics has proved anything, it’s that the unprecedented – even the unthinkable – can and will be implemented in the process of reinvigorating the Japanese economy and avoiding recession. Now, with renewed support for his sometimes-controversial stimulus programme, it is full-throttle for Japan’s prime minister, as Abe attempts to bring the economic glory days back to Japan.