Shinzo Abe is on the warpath.
The second-time prime minister has embarked on forceful, proactive measures to reinvigorate the country’s economy – defying national pundits who had likened the country’s December general election to “choosing the least-bad option”, as one columnist put it.
Most notably, on December 23 Abe bullied the deeply conservative Bank of Japan (BoJ) to pledge its strongest resolution to overcoming stagnation in well over a decade, threatening to curtail its independence unless it did so.
Against its initial objections, Abe got the central bank to adopt a 2% inflation target, imposed an open-ended asset purchase programme (APP) and instituted a ¥10.3 trillion (US$115 billion) stimulus package.
Abe, who was previously premier for a truncated stint in 2006-2007, made few friends in the hallways of the BoJ with his behaviour. But observers and investors have lauded his newly assertive attitude.
“Leaders are welcoming Abe, and businesses in Japan are already seeing a change of mood and atmosphere,” says Jiro Yamaguchi, a professor at Hokkaido University’s Graduate School of Public Policy. “He’s been vocal about his policies. The message this time is that Mr Abe is trying to present himself as a new hero, or saviour, of Japan’s economy, and he has staffed his office with monetary liberals.”
The campaign that led to the Liberal Democratic Party (LDP) winning most seats in the lower house of the Diet, Japan’s parliament, on December 16 sent the benchmark Nikkei equity index on its longest rally since 1959, at 12 weeks. Five-year Japanese government bond (JGB) yields meanwhile dropped to their lowest on record on January 31 to 0.15%.
But Abe hasn’t convinced everybody that his bravado is for the best. Some sceptics claim the new prime minister has merely played upon the market’s psyche to affect change, without making concrete moves.
Since his election, the premier has taken a strong stance on raising inflation, yet hasn’t specified how the country will achieve that goal. He further disappointed market participants when the BoJ announced negligible changes to its asset purchasing programme (APP) to support a weakening yen, sending mixed signals about the extent of Abe’s true influence over the central bank.
Likewise, Abe has been strongly criticised for his stimulus programme, which will achieve short-term gains through public works projects yet offer few long-term solutions for the economy.
After little more than a month, the markets are beginning to question whether Abe offers more than bluster and failed policies to help Japan overcome its pressing problems. The danger is that once the “sugar rush” of Abe’s election win wears off, as Morgan Stanley MUFG put it in a November 8 report, the country is in a worse situation than ever.
Confounding stagnation
Abe has inherited the leadership of a country beset by difficulties and stifled by inertia.
Japan’s public debt burden, now 230% of gross domestic product (GDP), threatens to leave the country’s future generations footing the bill for years of misappropriated spending. Its population is aging fast, leading to rising pension costs. It has had to recalibrate its energy priorities following the damage done by a devastating tsunami in March 2011. And its relations with China have gradually eroded.
The country’s leaders have successively proved themselves unequal to the challenge of meeting these difficulties. Nobody, including Abe himself (see box), has been able to hold down the job for more than a year ever since Junichiro Koizumi concluded his five-year stint in 2006. With his second try, Abe has become Japan’s seventh prime minister in just over six years.
The biggest immediate economic issue is Japan’s worryingly strong yen. The currency steadily rose against the US dollar for much of 2012, narrowing from ¥83.02 in the week of March 19, 2012, to ¥77.84 in the week of September 10 as successive amounts of central bank quantitative easing led investors to throw their cash into defensive instruments such as the yen.
The rise hurt the competitiveness of Japan’s prized export-reliant companies, which now find it difficult to sell goods worldwide.
Abe wants to weaken the yen to help them out. To do so, in November he announced that he would impose a 2% medium-term inflation target – far surpassing the current consumer price index of -0.5%, excluding food and energy.
That led to his pressurising the BoJ to embrace the target as its own, and his tough stance persuading BoJ governor Masaaki Shirakawa to meet his view energised the markets [see box below]. And it worked; the yen weakened from ¥80.53 against the dollar on November 2, to ¥82.24 on December 3 and ¥89.76 by January 21.
Yet while the yen’s value has dropped, the BoJ’s statements since the showdown have managed to deflate much of the initial excitement.
At the central bank’s policy meeting on January 21, Shirakawa announced the bank would make its existing asset purchasing programme open-ended, vowing to continue buying JGBs until 2% inflation is in sight. But the bank said the open-ended portion of the plan would only begin in 2014; until then it would continue with its existing ¥101 trillion purchasing scheme through 2013. It did not elaborate on what that strategy would look like.
And while the BoJ said it would purchase approximately ¥12 trillion of assets each month from 2014, most of this is merely reinvesting debt due to mature. The bank only intends to spend ¥10 trillion more next year.
“Ten trillion yen more for 2014 isn’t very much,” says one Tokyo-based economist. “The BoJ will need to take additional action for the market to have confidence in its ability to [further] weaken the yen and meet its inflation target.”
In weakness, strength
Up until now the yen has continued to weaken, but without genuine action this looks likely to reverse. If Abe is to retain the market momentum he initially enjoyed, he needs to act fast.
“Until now talk has been sufficient to weaken the yen significantly. We’ve seen those periods before but unless the government implements real policies to contain the yen’s rise then disappointment will set in and the markets will show it,” says Klaus Baader, chief Asia Pacific economist at Société Générale, noting that if the yen weakens to ¥100 to the US dollar it will be sufficient to give exporters a more competitive advantage.
What bankers and economists hoped to see from the BoJ were policies closer to those of the US Federal Reserve (Fed), with a pledge to flush the markets with capital without any time or spending constraints until targets have been met. Abe’s inability to implement such aggressive measures spurs questions on whether there will be a solid and workable plan to achieve inflation.
“There’s always going to be a little bit of a honeymoon period, so the market has been reacting to Abe’s fairly aggressive comments,” says Mitul Kotecha, head of global FX strategy at Crédit Agricole. “But once underlying stimulus measures fade we will see that structural issues need to be resolved, and unfortunately there hasn’t been much on that front. There’s a need for the market to see real concrete plans.”
If the yen is to weaken against a US dollar that is constantly inflating due to the Fed’s quantitative easing, the BoJ will have to out-ease the US.
It’s a tall task. According to the World Bank, the US increased the dollar’s M2 level by 7.6% in 2011 – its most recent annual calculation – compared with Japan raising its M2 by 2.9%. If Japan increased its money supply by just tenths of a percentage point it would help the yen compete against the dollar.
Economists from Société Générale and Crédit Agricole suggest that a rate of ¥100-¥115 per US dollar would be most helpful to Japan’s companies that are struggling to sell goods. But according to Citi Japan’s chief currency strategist Osamu Takashima, the BoJ would have to expand its asset purchasing programme by ¥73 trillion this year just to maintain a ¥90 ratio against the US dollar. Weakening the currency even further to ¥95 per dollar would require it further expanding the programme to ¥95 trillion, while dropping it even more would require the purchase of trillions upon trillions of yens’ worth of extra assets.
That would be a major departure from the central bank’s current policy, and would probably require five to 10 years of commitment – longer than most of the country’s politicians hold their seats.
If the yen is to devalue at all, Abe will have to summon all of his assertiveness and press the BoJ to drastically expand its APP, by numbers and percentages. This will be more obtainable when Shirakawa steps down as BoJ governor in March, although the level that thepurchasing programme would have to be expanded by is so great that it’s unlikely the new BoJ head can sufficiently meet it.
Building bridges to nowhere
One area where Abe has announced concrete measures is his ¥10.3 trillion stimulus plan.
On January 11 the premier pledged to spend a sum equal to 2% of Japan’s GDP, largely on public works projects, including construction and disaster-prevention initiatives in the areas left damaged after the March 2011 tsunami, as well as defence spending. The purpose of the spending, most of which will come from yet more public borrowing, is to create 600,000 much-needed jobs to lift Japan out of recession.
The spending plans sound bold. They are also old, and politically motivated.
The LDP has often spent vast sums to fund public works across Japan, as part of a political sop to satisfy the party’s key electorate, rural and semi-rural voters who are central to the LDP’s conservative manifesto to preserve Japanese tradition and culture. Unfortunately such spending has done little to secure the nation’s longer-term economic prospects.
“An active stimulative package is necessary for Japan, but we need more investment in the long term. We need the government to use the money wisely to implement policies that will be very meaningful to help industries expand,” says Hokkaido University’s Yamaguchi. “Using the money for out-of-date pork-barrel initiatives is nonsense; they will increase public debt and decrease the value of people’s assets.”
Likewise, Citi estimates that Abe’s spending plans will result in only 100,000 jobs, just one-sixth of his job target, while BNP Paribas thinks 150,000 jobs will be created. Meanwhile Société Générale analysts doubt the stimulus will elevate Japan’s GDP by 2%, to 2.5%, for the 2013/2014 fiscal year as Abe expects. Rather, the bank revised its forecast up by 0.8% to 1.5% of GDP for 2013.
With the financial fortunes of blue chip companies such as Olympus, Panasonic and Sharp looking bleak, Abe’s administration should instead focus on encouraging a new range of high-end technological development to underpin the economy.
That entails investing into areas that offer the greatest long-term value and prospects, not those that secure votes in the next election. A good start would be to spend more on education and scientific development, offer grants to small-to-medium-sized companies, invest in high-tech industries such as clean energy and biomedicine, and encourage scholarships at top universities focused on the sciences.
Fanning a culture of invention would also lay the groundwork for development in the future, helping the nation’s youth and offering the potential for real long-term dividends.
These areas have not been utterly neglected by Tokyo. For example, the government reportedly intends to spend a few billion yen to give universities access to the ultra-speedy K Supercomputer, billions to revamp a disaster-tracking satellite, and approximately ¥21.4 billion for stem-cell research.
But Abe’s investments into science and technology are set to be a fraction of the amount spent on non-essential public works.
Drowning in debt
Worst of all is that Abe’s stimulus plans will just add to Japan’s mounting debt. Already standing at an estimated 230% of GDP, this burden is by far the highest of any advanced economy, outpacing second-placed Greece at approximately 170%. This debt level undermines Japan’s credibility as a global economic power, and needs serious remedying.
Tokyo has thus far managed the debt by continuously reissuing JGBs to domestic buyers at dirt-cheap yield prices due to virtually zero interest rates. As long as demand for JGBs exists, the government can keep raising cash for its fiscal obligations.
But it’s an unhealthy problem, and Abe’s government only looks set to add to it.
In fairness, the administration hasn’t entirely disregarded the country’s dependency on debt. On January 27, finance minister Taro Aso released the draft 2013 fiscal year budget, which includes a plan to raise more money through taxes – ¥43.1 trillion – than bond issuance – ¥42.9 trillion – for the first time in four years. He estimates total spending will reach ¥92.6 trillion for the fiscal year beginning April 1.
This will do little to alleviate Japan’s debt burden, but it would make small gains to contain it, giving the government a stronger alternative to generate revenue.
But Abe should consider more aggressive tactics to minimise debt – namely through more taxes.
Doing so would take gumption, given that hiking taxes in Japan can be a political career-killer. So far, the biggest success politicians have achieved in the past decade with regard to tax hikes is a doubling of the country’s consumer tax from its current 5% to 10% by October 2015, with a step up to 8% in April 2014.
But this tax alone won’t be enough to free Japan of its debt burden. According to RBS, a 1% hike in consumption tax equates to ¥2.5 trillion of gains. This means Japan will earn ¥12.5 trillion by raising consumption tax to 10%. Yet, just to maintain Japan’s current balance, the country needs to raise more than ¥20 trillion in total revenues annually.
Abe needs to combine tax hikes with some JGB issuance to help drive down debt. Economists believe there’s room for this. According to the World Bank, Japanese tax revenue has averaged approximately 9% of its GDP between 2008-2010 (more recent data isn’t immediately available). By comparison, fellow-G8 countries the UK, Germany, Canada and the US’s tax-revenue-to-GDP through those years equate to 27%, 11.6%, 12.3% and 9.4% respectively.
Deeds not words
Abe has approached economic reform with a gusto that residents of the Japanese prime minister’s office have lacked ever since Koizumi left, and the markets have rewarded him for it.
But big talk must come with a workable strategy, and economists and market participants aren’t convinced that the new prime minister has one.
Abe needs to prove them wrong. He should start by announcing an ideal rate for the yen and then work to achieve it by convincing the BoJ to far more aggressively print cash and buy assets, both domestically and overseas. Plus he must invest public money into technology and ingenuity, to generate a lasting effect on the economy. And he must do these things while being mindful of the debt level.
On the monetary front at least, Abe may soon be able to make some progress. The tenure of current BoJ governor Shirakawa expires on April 8 and Abe is sure to appoint an ally as his replacement. After that he may be able to get his way on the central bank adopting stronger measures for its APP.
There is also a view that Abe won’t try to rock the boat with strong fiscal policy until the LDP secures a majority in the Upper House, which undergoes an election in July. But waiting for these elements to fall into place sends the wrong message from a leader who wants to be seen as a maverick – Japan’s economy is comatose, and it’s waited long enough for a premier with the zest to revive it.
“People are intrigued because they believe he can be so much more than past leaders. But so much of what Abe has said really reflects his desire for short-term economic gains,” says Jeffrey Hornung, an associate professor at the Asia Pacific Center for Security Studies, who focuses on Japanese policy. “What he is discussing hasn’t concretely pointed to increased worker productivity, nor doing anything to build the economy for the long term. Abe’s given the economy a shot and that shot will wear off.”
Japan needs bold, concrete policies to begin righting years of misrule. Unless Abe can offer them, his second stab at leading the country could prove just as ineffective as his first.
