Japan has shrugged off 20 years of economic stagnation and deflation through Abeconomics – the ambitious reform programme to stimulate the economy launched by Japan’s Prime Minister Shinzo Abe. But the positive results and the feel-good factor, after only a year since Mr Abe’s election, come at a price.
RISING city house prices, a 57 per cent gain in the Nikkei-225 stock market index, and the feel-good factor of the Tokyo Olympics in 2020, have given Japan a good start to 2014.
‘Abenomics’ - Japanese Prime Minister Shinzo Abe’s economic reform programme launched after his election in December 2012 - has delivered benefits to Tokyo and the financial institutions, industrial companies and wealthy individuals.
The ambitious reform programme aimed to put Japan back on a growth path after more than two demoralising decades of stagnation and deflation.
The ambitious reform programme aimed to put Japan back on a growth path after more than two demoralising decades of stagnation and deflation
After only one year in office, Mr Abe has delivered currency devaluation, fiscal spending and monetary easing, the first two ‘arrows’ of his growth strategy. None of these measures was innovative. They represented the old economic policy of the Liberal-Democratic Party (LDP) - kick-start the economy by borrowing or freshly creating money to spend on public-works projects.
All governments have tried variations of this approach since the economic bubble burst in the early 1990s, and this has kept the Japanese economy above the waterline.
Japan survived the Asian crisis of 1997-1998 and the internet crisis of 2001-2002 relatively unscathed because it was focussed on cleaning up the mess left by the asset bubble of the 1980s. The global recession of 2008-2009 hit Japan’s real economy hard - especially its export-oriented manufacturing sectors. But Japan’s financial sector took advantage of its domestic orientation and proved its resilience. Japan did not face a banking crisis like Europe or the United States.
Keeping the economy from sinking into negative territory with fiscal and monetary policies has come at a steep price: Japan’s gross government debt is now approaching 240 per cent of annual gross domestic product (GDP) - more than double levels in the US and eurozone, each at around 100 per cent.
Nobody knows how and when this still rapidly increasing amount will ever be paid back because of Japan’s ageing and shrinking population and the decreasing savings of households.
However, interest rates of Japanese public debt remain low, currently at around 0.7 per cent for the 10-year government bond. One of the reasons is that about 90 per cent of the debt is held by domestic creditors - particularly the Bank of Japan, the national pension fund, and private-sector investors such as banks, pension funds and life insurance companies. Most of these must invest their clients’ money in domestic government debt as it is rated a ‘safe’ investment.
Most Japanese households are unaware that the lion’s share of their financial assets - savings, pensions and life insurance capital - is actually invested in an asset category that, by all objective standards, can only be rated as ‘high risk’.
The second reason for the ongoing extremely low interest rate is the Bank of Japan’s (BoJ) massive bond-buying programme, modelled on the ‘Quantitative Easing’ (QE) approach of the US Federal Reserve, but on a much larger scale relative to GDP. The BoJ bought 50 trilllion Japanese yen, about US$500 billion, in government debt between April and December 2013. The BoJ’s total assets have climbed to JPY229 trillion (US$ 2.3 trillion), or 48 per cent of Japan’s nominal GDP.
The bank aims to increase its balance sheet to JPY290 trillion by the end of 2014. In contrast, the US Federal Reserve’s assets were equivalent to 24 per cent of America’s GDP.
What was different about ‘Abenomics’ compared with the growth programmes of previous governments was the scale and speed of implementation. This gained rapid traction within a few months, supported by a recovering global economy and increasing demand from China. Within weeks, the Yen fell about 20 per cent to the dollar and has been hovering around an exchange rate of 100 yen to the dollar for almost a year.
This has improved earnings for industrial exporters, especially in the automotive, electronics, machinery and chemicals sectors. But it has not helped their strategic position in global markets as they have been unable, generally, to turn the currency advantage into an increase in units sold. For them, the weaker yen has largely remained an accounting issue.
What was different about ‘Abenomics’ compared with the growth programmes of previous governments was the scale and speed of implementation
By contrast, importers suffer from higher prices for foreign goods. The weaker yen and high imports of fossil fuels have resulted in monthly trade deficits since July 2012.
Japan’s annual GDP growth rate in 2013 is estimated to be in the range of 1.7 to 2 per cent. Consumption tax, currently five per cent, will increase to eight per cent in April 2014 and, most likely, to 10 per cent in 2015. There are few indicators that increasing consumption tax will have a major negative impact on the economy.
Mr Abe’s government has done a good job in communicating the reasons for the tax hike. His approval rating is still well above 50 per cent, an extraordinary success for a Japanese prime minister. This reflects a change in the mood of households and corporations.
Mr Abe’s massive deployment of monetary and fiscal stimuli has created a ‘feel-good economy’.
His reform programme originally included a third arrow - structural reform - which is much needed especially in highly regulated, internationally uncompetitive sectors such as healthcare, energy, food, retail, agriculture and telecommunication.
So far, despite continuous announcements, including at the World Economic Forum in Davos, Switzerland, on January 22 - Mr Abe has done nothing which might hurt vested interests of protected sectors.
A notable exception is Mr Abe’s support for the Trans-Pacific Partnership (TPP) trade agreement negotiations, on condition that Japan can keep protecting its ‘core’ agricultural products such as rice, butter and wheat with three-digit custom rates.
Mr Abe has also invested time and energy supporting export industry by travelling to South East Asia, the Middle East and Africa, actively promoting Japan as an alternative to China. The US$20 billion sale of a nuclear power plant to Turkey has been his biggest success so far.
These activities do not hurt anyone domestically, but they do not help Japan build a foundation to perform on the global stage of the 21st century, wedged in the middle of the United States and China.
The key reason for keeping the third structural reform arrow is the LDP’s instinct for political survival. The LDP is determined to do whatever is necessary to stay in power until the next general election in 2016 and beyond. It pursues a three-pronged strategy to achieve this goal:
· First, create and maintain a feel-good economy by Quantitative Easing and public spending
· Second, announce sweeping structural reforms to those who want to hear, especially the business community
· Third, avoid decisions which could lose votes.
Mr Abe has learned much from his political mentor former Prime Minister Junichiro Koizumi, whose failed privatisation programme of Japan Post triggered the LDP’s steep decline in the mid-2000s, and lost the 2009 general election. The LDP is united that this must never happen again.
Political and financial stability are the key factors behind Japan’s ‘Abenomics’ and its economic performance outlook for 2014 and beyond.
There are no major elections in 2014 except for that of Tokyo governor on February 9. It is most likely that Mr Abe will remain in office, probably until the end of the current Lower House’s term in 2016, regardless of the election outcome. Consequently, a stable political environment can be assumed for the next two to three years.
Financial stability is a different issue. Japan faces the same challenge as other major economies: how to reduce or abandon the QE programme? The question, how Japan will handle its rapidly increasing public debt and dramatic annual budget deficit, will eventually arise.
The BoJ is approaching the upper limits of its target for buying bonds. But the honey is too sweet to be spurned and the BoJ has made clear that it will maintain its stimulus programme. It plans to increase the monetary base at an annual pace of JPY60 trillion (US$600 billion).
There is no relevant political voice in Japan warning of the risks of amassing public debt, so a drastic reduction of QE is unlikely. This is welcomed by the stock market and Tokyo property investors.
There is no relevant political voice in Japan warning of the risks of amassing public debt, so a drastic reduction of QE is unlikely
Japan will keep muddling through in 2014, supported by continued fiscal and monetary measures, and a recovery of the global economy. GDP growth will remain broadly unchanged in the range of 1.5 per cent. The consumption tax increase in April will dampen the second quarter, but will not have a major impact on the year. Consumer prices will rise by 1.3 per cent or less.
Mr Abe will keep open his options for structural reform. His chances of winning the next general election are high if he is able to maintain this situation for the next two to three years.
In contrast, importers are suffering higher prices for foreign goods. The weaker yen and high imports of fossil fuels have resulted in monthly trade deficits since July 2012. Japan logged a record trade deficit of JPY11.5 trillion (USD115 billion) in 2013, the third consecutive year in the red.