Rising sun or false dawn?
Japan has seen some spectacular shifts since Shinzo Abe became prime minister in December 2012. Corporate profits are up, the stock market has rocketed and the yen has weakened considerably. Perhaps most dramatic of all is the shift towards inflation. Consumer prices have started to rise after being in negative territory for most of the time since the late 1990s.
Trickier to discern, is whether what quickly became known as ‘Abenomics’ is likely to lead to durable growth. Stoking up inflation is necessary but not sufficient to overcome the main economic challenges facing Japan. The government itself recognises that raising productivity is another important part of the job.
When Abe was elected, Japan’s nominal GDP had been stuck at about the same level since 1991. China had taken over as the world’s second-largest economy and the global crisis of 2008-09 had taken a particularly heavy toll. The massive earthquake and tsunami that hit northeast Japan in 2011, followed by the Fukushima Daiichi nuclear disaster, were another tragic blow.
Abe’s Liberal Democratic Party (LDP), which has dominated Japanese politics since 1955, won a landslide victory over the Democratic Party of Japan which had, at long last, been given a shot at ruling in 2009. After what was widely perceived as many years of ineffectual government, the time was ripe for decisive action – Abenomics.
Like the Japanese folk tale in which a father shows his sons that three arrows cannot be snapped when they are all held together, Abenomics was conceived as a tripartite policy: highly expansionary monetary policy; short-term fiscal stimulus; and structural reform. The implication is that Abe’s ‘arrows’ are part of an overall package, rather than separate elements.
There are several distinct problems that Abenomics is designed to address. The first is a liquidity trap; conventional central bank policy had become ineffectual as persistent deflation removed almost all incentive to spend or invest excess cash. The other pressing problem is low productivity. Although Japan has some world beating companies it also has areas of chronic inefficiency, such as agriculture and retailing.
Over the longer term, Japan also has a huge government debt burden to contend with. Gross debt reached about 246% of GDP at the start of 2014, according to the IMF. This compares with 179% for Greece, 111% for the US and 79% for Germany. That is why, although Abenomics involves a short-term fiscal boost, the longer-term perspective is for consolidation. With this problem in mind, the government is raising the sales tax in April, the first such increase since 1997, despite the ongoing monetary stimulus.
Although the main elements of Abenomics were known from the start, it took a while for the details to be fleshed out. It was only in March 2013 that Haruhiko Kuroda, a strong supporter of Abenomics, became the governor of the Bank of Japan. He has enthusiastically pursued the Bank’s 2% inflation target, introduced in January 2013, and the decision to substantially expand its monetary base.
It was not until June 2013 that Abe gave a keynote speech outlining the main elements of his third arrow, structural reform. These included liberalisation of the electric power system, creating new industries designed to help Japan cope with its ageing population and encouraging the private sector to help improve Japan’s infrastructure.
With over a year gone since Abenomics was introduced, it is possible to provide a preliminary assessment of the results. The monetary side has been the most successful so far. Inflation appears to be on an upward trend. As Willem Verhagen, a senior economist at ING Investment Management, points out: “If you want to end deflation, at least in theory, you can always do so.” It’s essentially a matter of being willing to print sufficiently large amounts of money.
Wage inflation is another important part of this story. Hideo Shiozumi, the president of Shiozumi Asset Management, is hopeful on this score. “For the first time in many years, government, labour unions and business leaders are working together to increase wages,” he observes.
Structural reform is in its early stages but many fund managers appear willing to give the government some leeway. “It’s unrealistic to expect everything to be dealt with in the first 12 months of office,” says John-Paul Temperley, a Japan fund manager at §. In his view it will take the government three years to push through the necessary measures.
The results on the fiscal side are also early to call. Simply injecting a fiscal stimulus is relatively easy but reversing course in the future could prove trickier. The reaction to the imminent sales tax rise could provide a tough first test.
Those fund managers who have braved a long-term presence in Japan seem upbeat about the prospects for equities, even after the price surge in Abe’s early months in office. Nicholas Weindling, a Tokyo-based fund manager at JP Morgan, says “fundamentals are good, profits are rising and the market is not stretched in terms of valuations”.
However, he points out that those companies that did well in the past are not necessarily the ones that will thrive from now on. For example, consumer electronics brands such as Panasonic, Sony and Toshiba have lost out to foreign competitors such as Apple and Samsung. In contrast, Japan is a world leader in robotics, while the ageing population also provides a theme that investors can play.
Shiozumi says that government schemes to promote retail investment should help bolster the market. The Nippon Individual Savings Account (NISA), a tax-free vehicle for investing in equities and mutual funds, has already attracted millions of investors since its launch in January 2014. The government is also expected to introduce an Individual Retirement Account (IRA), to provide tax advantages for retirement saving, by the end of the year.
Overall, it looks likely that Abenomics will provide the impetus for selective opportunities in the equity markets in the years to come. Whether it will succeed in pulling Japan out of its deep economic rut is another matter.