It is almost 50 years since the IMF and World Bank last held their annual meetings in Tokyo, and this year’s event is in a very different Japan. Then, Japan was just getting into its stride towards becoming a global economic power, while today it is the most advanced nation in Asia.
So the annual meeting should, in theory, present an opportunity for Japan to showcase its success to the rest of Asia and to the world. The meetings will no doubt display Japan’s legendary efficiency, but beneath the surface Japan’s transition into a western-style post-industrial society is not going so smoothly.
Politics are in turmoil as Japan tries to come to grips with the idea of two-party parliamentary democracy, launched in 2009, after half a century of what was in effect one-party rule. Since then there has been a change of prime minister every year, and now the brief rule of the Democratic Party of Japan (DPJ) appears set to end.
Prime minister Yoshihiko Noda can probably keep the DPJ show on the road long enough to preside over the annual meetings with his finance minister Jun Azumi. But after that there is likely to be an early election, which will probably end with the Liberal Democratic Party returning to power in coalition with a growing proliferation of other parties.
Not that much of this is likely to be visible to most attendees at the Tokyo meetings. “Politics do not matter in Japan; it is the bureaucracy that keeps things running,” Eisuke Sakakibara, a long-time financial career adviser to various political and economic leaders in Japan, tells Emerging Markets.
World financial leaders will be too focused on how to cope with a global slowdown and in particular with fallout from the eurozone crisis to worry about Japan’s problems, says Sakakibara. The nation’s external position is weakening while its government finances are looking increasingly shaky.
Japan’s economy is slowing too as the impact of the eurozone crisis hits exports, directly through slowing demand from Europe and indirectly via a knock-on effect into China and the rest of Asia. As reconstruction spending after the March 2011 earthquake falls off, Japan’s growth will slide from around 2% in 2012 to 1% or even 0.5% in 2013 and 2014, says Sakakibara.
“The situation as I see it is one of worldwide recession, and Japan will certainly be affected,” he says. “The European economy is in crisis, the US has balance sheet problems, and China and India have decelerated. All this will eventually affect the Japanese economy.” Meanwhile Japan’s trade account has slipped into deficit under the impact of a surge in natural gas and other fuel imports to compensate for the loss of most of the nation’s nuclear power generating capacity.
Despite the weakening in Japan’s trade account, however, money continues to flow into the country from overseas, keeping the current account in surplus, while the yen continues to hover around record high levels against the dollar and the euro. The yen is seen as a safe haven from the euro and the dollar, and also benefits from reserve diversification by central banks.
YEN STRENGTH
Chief foreign exchange strategist Tohru Sasaki at JPMorgan Chase Bank in Tokyo says: “Japan’s trade balance has turned to a deficit, and many people say, why does the yen continue to be strong while Japan’s trade balance turns to a deficit?” One important reason, he says, “is foreign buying of Japanese government bonds”.
In these circumstances, any attempt at intervention by Japanese authorities to weaken the yen would be “like fighting a tsunami”, he says. “Last year, the government intervened in March, August, October and November (spending more than ¥10 trillion yen in all). Eventually, the US Treasury issued a report criticizing Japan very severely, so I think it is getting difficult now to intervene through the markets,” says Sasaki.
This June, IMF first deputy managing director David Lipton in Tokyo described the yen as being “moderately overvalued”.
“But that does not mean we can intervene,” says Sasaki. Nor, despite repeated expressions of protest and dismay from Japanese manufacturing lobbies – vehicle and electronics firms especially – can the government afford to allow the yen to slide far downwards.
That would precipitate a rise in bond yields that could spell disaster for a government that is wrestling with an ever-expanding fiscal deficit, and with a level of gross outstanding government debt to GDP of over 200%.
“People complain about the yen being too strong, but we do not want to see the possibility of it becoming too weak,” says Takatoshi Ito, dean of the Graduate School of Public Policy at the University of Tokyo. “That would be a disaster,” he tells Emerging Markets.
“We need a stable currency,” he says, suggesting that the yen cannot be allowed to deviate more than plus or minus 20% of its current level around ¥78/$. This is no time to promote internationalization of the yen says Ito, however tempting that idea may be when the world’s eyes are on Japan as host of the annual meetings.
“Enhancement of the yen’s use in trading is fine,” says Ito, “but this is no time to talk up the idea of the yen as an international currency and putting it at the whim of volatile foreign exchange markets. Japan needs currency stability while it focuses on fiscal consolidation,” he says.
“Everyone talks about an eventual fiscal crisis in Japan, and if that happens it will be very difficult for the government to deal [with the situation] because of the sheer size of the debt. There is a looming possibility of a fiscal crisis in Japan – nobody denies that – and it is most important for future governments to gradually consolidate the fiscal position to avoid a crisis. It is most important to keep the yen stable.”
The need to walk a tightrope between keeping the yen strong enough to avoid a run on the currency and a consequent crisis in the government bond market, yet not allowing it to rise above a level where the pain becomes too great for exporters – many of which have already defected from Japan – explains why prime minister and former finance minister Yoshihiko Noda has staked his political career on raising Japan’s consumption tax.
After strenuous urging by the IMF, the OECD and others, Noda managed to get through Japan’s parliament in August a bill to raise the consumption tax from its current level of 5% to 8% in 2014 and then to 10% by 2015. Even that, however, will not be enough to make a significant dent in the need for extra government revenues to cover soaring social costs in the world’s fastest-ageing nation.
Noda has seen his public popularity slide to all-time lows since he pushed through the legislation, and Sakakibara for one says he is “not comfortable” with the move. “Eventually we’ll have to raise [the consumption tax], say within the next five or six years,” he says. “But right now we are in the process of recovery from the earthquake and the tsunami. Raising taxes at the start of the recovery is a wrong decision.”
DEALING WITH DEFLATION
The tax hike just might provoke Japanese consumers into stepping up spending in the run-up to the increase, and thus provide a boost to growth at a time when government spending (in the wake of the earthquake) and external demand for Japanese exports are weakening.
But the boost is unlikely to be a big one. “First there would be a boom to consume before the tax increase and a slump after, so you have to average them out,” says Ito. “The net impact will be not much.”
Nor does the adoption this February by the Bank of Japan (BoJ) of an inflation target or ‘goal’ of a 1% annual increase in consumer prices – a move that commentators dubbed a “Valentine’s Day gift” to the market – seem likely to have more than a fractional impact on private spending in Japan. The move sent Tokyo stock prices soaring for a while but, says Ito, there was no “follow-through”, and meanwhile deflation continues for a 20th consecutive year in Japan.
There are calls for a more aggressive monetary strategy, especially now that US Federal Reserve chairman Ben Bernanke has opted for a third round of quantitative easing, QE3. On September 19, the Bank of Japan increased the size of its financial asset purchase programme by 10 trillion yen to 80 trillion yen. The move signalled growing concern within the central bank over the slowing pace of Japan’s economic growth as external demand weakens.
“Raising the BoJ’s inflation target to 2% or even 3% annually could be futile,” argues Rei Masunaga, a former senior BoJ official and former deputy president of the Japan Centre for International Finance. “It is considered that when there is inflation targeting at a high level people will rush to consume, because in future they consider that prices will be higher, but the view of the Japanese consumer is very conservative,” Masunaga tells Emerging Markets. “There is a good chance they would reduce consumption more in order to face future inflation. That’s a very different attitude from the established economic policy.”
Ultimately, Japan’s only way out of its fiscal and other economic problems is to increase growth, most economists agree. But achieving the needed growth has long been an elusive goal, more elusive even than that of reversing chronic deflation trends in Japan.
“I’m for a growth strategy, but it cannot take the form of fiscal stimulus,” says Tokyo University’s Ito. “We need structural reforms and to open up the economy and deregulate and liberalize. That’s the only way to raise the growth potential without spending.”
He cites by way of example the need for deregulation of Japan’s agricultural, medical, welfare and education sectors. “We need to make them more efficient and more global – raise tuition levels and get more foreign students. We need to use Japan’s intellectual potential to its maximum, which will lessen the need for subsidies from the government.”
Ito also wants Japan to extend its membership of free trade agreements including the Trans-Pacific Partnership (TPP). “These are important steps, but progress has been very slow because there are significant vested interests opposed to reform,” he says.
Others say that Japan needs to extend its innovation in the manufacturing sector to restore growth at a time when China and other Asian economies such as Vietnam and India as well as South Korea are seizing the initiative. “Unless Japan can invent something that is [useful] to the rest of the world, in particular for emerging markets like China, it will not be easy to maintain the share of exports of Japan in the world market,” says Masunaga.