Suga rush: Can Japan’s new PM deliver on reform promises?

Former Chief Cabinet Secretary Yoshihide Suga has replaced Shinzo Abe, Japan’s longest serving prime minister. As he faces the twin challenges of leading the country out of a pandemic and pushing through much-needed structural reforms, what can investors expect from the new administration?

Suga rush: Can Japan’s new PM deliver on reform promises?

In April 2019, Emperor Akihito abdicated the Chrysanthemum Throne in favour of his son, Naruhito, signalling the beginning of a new era of the Japanese calendar. Yoshihide Suga, Chief Cabinet Secretary and elder statesman of the ruling Liberal Democratic Party (LDP), appeared on television to announce the name of the new epoch: Reiwa, which translates as “beautiful harmony”.

At that point, few people will have predicted that Suga would go on to become Japan’s first new prime minister of the Reiwa era – he was widely regarded as a skilful backroom fixer, rather than a natural leader in his own right. But when a health issue caused Shinzo Abe to announce his resignation in August 2020, Suga quickly emerged as the favourite to succeed him. He duly won the party leadership vote the following month and was confirmed as prime minister on September 16.

Continuity candidate

Suga’s appeal stems chiefly from the sense of stability he offers at a time when Japan is grappling with the impact of the coronavirus pandemic. As Abe’s trusted right-hand man and a confirmed supporter of “Abenomics”, Suga is expected to continue with the key economic policies of fiscal stimulus and monetary easing.

Suga is ruthlessly committed to structural reform, the so-called “third arrow” of Abenomics

But there is more to Suga than meets the eye. Experts say he is ruthlessly committed to structural reform, the so-called “third arrow” of Abenomics that repeatedly failed to hit its targets under Abe.

Suga has already announced the creation of a new agency to oversee improvements in Japan’s creaky digital infrastructure. There are signs he also wants to tackle other deep-rooted issues, such as the impact of ageing demographics on the labour market and a lack of competition in certain sectors.

“Suga wants to push through structural reforms – that’s where his passion is,” says Jin Saito, founding partner and senior Japan analyst at Observatory Group, an economic and political consultancy. “Abe cared about the economy only in so far as a strong economy would allow him to pursue his real objectives, which lay in the areas of geopolitics and foreign policy. But Suga is different – he really cares about the nitty gritty of domestic policy.”

Factional politics

Unlike other candidates for the leadership, Suga does not belong to any one faction within the LDP. He has promised to unite the party and his cabinet picks distributed key posts among rival groups.

The new administration’s priority will be tackling the COVID-19 crisis. Japan had recorded 1.22 deaths per 100,000 people as of October 1, a record that compares favourably with other nations such as Spain (66.04), the UK (63.52) and the US (63.25), according to analysis from Johns Hopkins University.1

However, the economy has suffered badly despite the lack of a nationwide lockdown. Output fell 7.8 per cent in the second quarter of 2020 (largely due to a precipitous fall in consumption), the worst quarterly performance since modern records began in 1980.2

COVID-19 will set the policy agenda for at least the next year and possibly longer

“COVID-19 will set the policy agenda for at least the next year and possibly longer, depending on what the fallout is,” says Sunil Krishnan, head of multi-asset funds at Aviva Investors. “Whoever succeeded Abe would have struggled to implement any major policy changes in the short term, due to the immediate challenges presented by the pandemic. We can expect essentially unlimited monetary easing and substantial fiscal easing to continue for now, as the government seeks to lift the economy out of the pandemic-induced slump.”

While the Abenomics programme failed to meet many of the ambitious objectives Abe set when he took office in late 2012 – inflation lags the long-standing two per cent target – it had been successful in reversing Japan’s decades-long economic malaise. Before the pandemic hit, the nation was on course for its longest economic expansion in the post-war period. The policy approach has also pointed the way forward for other countries experimenting with extreme stimulus measures during the current crisis, Krishnan points out.

“Japan pioneered some of the policies we are seeing now around the world – in terms of unprecedented monetary easing and an attempt to seek greater coordination between fiscal and monetary policy. It proved they were possible without causing hyperinflation or a collapse in confidence in government as a borrower. That has been important in shaping global policy thinking and the pandemic response.”

Snap election?

As in most other democracies, Japan’s public was critical of the government’s handling of the pandemic in the early stages. Abe’s approval rating plunged to around 40 per cent at the height of the crisis over the summer, before recovering in the wake of his departure, suggesting a more favourable appraisal of his overall record. Around 70 per cent of the population has a positive view of his time in office,3 and Suga’s new cabinet enjoys some residual goodwill: it has an approval rating of 74 per cent, according to a recent poll from Nikkei/TV Tokyo.

There was speculation Suga would call a snap election this autumn to cement his position ahead of the scheduled general election in 2021. This now looks unlikely, even though senior politicians such as the finance minister and deputy prime minister, Taro Aso, have publicly called on Suga to hold a vote immediately.4

It would look as though Suga cared more about his personal political fortunes than COVID-19 if he called an election now

“Although the coronavirus ‘R’ rate has fallen below one in Japan, it would be hard to justify calling an election now – it would look as though Suga cared more about his personal political fortunes than COVID-19,” says Saito.

“Given his surprisingly high approval ratings, there is a virtual consensus in the LDP that Suga ‘should’ call snap elections immediately. But ironically, his strong approval ratings make it trickier for Suga to do so without something to show to voters who expect Suga to start tackling their everyday problems,” she adds. 

As well as continued fiscal stimulus and monetary easing, Suga may look at targeted policies to spur consumption in the autumn budget. As chief cabinet secretary, he was a vociferous advocate of the ambitious “Go to Travel” project, a ¥1.35 trillion (£10 billion) campaign to subsidise domestic travel expenses for Japanese families through the pandemic. The programme will be extended include the Tokyo region this autumn.5,6

“The biggest market impact of coronavirus has been caused by the sharp fall in tourist numbers, which has affected transport companies like the Shinkansen [bullet train] operators, as well as shopping malls and entertainment venues,” says Jean-Francois Chambon, Japanese equities fund manager at Aviva Investors. “We could see further subsidies to promote consumption in these areas.”

Structural reforms

Whether or not Suga gets the chance to govern for as long as his predecessor, he has quickly signalled his intentions to implement new reforms. Within 24 hours of becoming prime minister, Suga had announced the creation of a new post, minister for digital transformation, to oversee the development of a digital agency tasked with improving connectivity across the country. Improved digital solutions in state services such as healthcare and school education are key priorities (a recent study found wi-fi coverage in Japanese schools stood at only 26 per cent, compared with 88 per cent in the US).7

Few previous Japanese prime ministers wanted to spend precious political capital on fighting turf wars with entrenched bureaucratic interests

The digital transformation agenda could prove a test case for Suga’s structural reform ambitions. Few previous Japanese prime ministers wanted to spend precious political capital on fighting turf wars with entrenched bureaucratic interests, but Suga’s track record suggests he might be different. Saito points out that, as chief cabinet secretary, Suga successfully oversaw efforts to deregulate visa requirements to allow more tourists into the country.

“Suga encountered opposition from the Ministry of Justice and the National Police Agency, which argued that encouraging mass tourism from other parts of Asia would lead to more crime. Suga said that stance was ridiculous, and he got what he wanted.

“As well as making visa applications easier, he increased the numbers of low-cost domestic flights, boosted the number of English-language signs and eased restrictions on building more hotels. And it worked. Prior to Abenomics, tourism spending in Japan totalled about $1 trillion annually; it has now jumped to $5 trillion, around one per cent of GDP. That shows focusing on small details can lead to material change,” Saito adds.

Labour market

Suga is also likely to persist with the LDP’s long-running efforts to quietly loosen immigration rules in order to attract more foreign workers and offset the decline in the labour force caused by Japan’s ageing population. In 2018, the International Monetary Fund warned that without liberalising the labour market in this way, demographic shifts could cause Japan’s real GDP to decline by 25 per cent over the next 40 years, compared with its potential growth rate.8

“Suga overcame party resistance to implement a visa programme that opened the doors for unskilled foreign workers, a shift from the previous policy, which centred on internship programs that often confined foreign workers to low-paying jobs,” says Chambon. “The new programme calls for wages on a par with those of native Japanese and set the stage for bringing in needed foreign talent.”

Only 6.3 per cent of employees in senior positions at private companies are women

Another way of boosting the labour force would be to improve the numbers of women in full employment. Abe made this a key part of his policy agenda – the initiative was dubbed “Womenomics” – but progress has been slow. As of 2019, female participation in the labour market stood at 71 per cent, higher than in the US or the UK, and up from 63 per cent in the first full year of Abe’s premiership in 2013.9 But female representation at the senior executive level is woeful. Only 6.3 per cent of employees in senior positions at private companies are women, a figure that lags the Abe administration’s modest target of 15 per cent.10

A recent Goldman Sachs report on Womenomics highlights “gender pay gaps, inflexible labour contracts, tax disincentives, insufficient care-giving capacity, and unconscious biases” as the key bottlenecks.11 Suga may address these issues in time, but if he is truly intent on redressing the gender balance, his male-dominated cabinet does not send the right message, Chambon points out.

“Suga’s new cabinet contains only two women. And only 10 percent of Lower House seats are occupied by female lawmakers, so political leaders have not set the tone at the top. As a result, Womenomics has not garnered the desired momentum to fundamentally address gender inequality in Japan.”

Market competition

Another area in which Suga is known to have designs on reform is the telecoms industry. As communications minister in 2006-7, he called on mobile phone companies to cut rates to ease the burden on consumers, and repeated the argument as cabinet secretary in 2018, pushing carriers to slash fees by as much as 40 per cent.12

Japan’s Fair Trade Commission, the competition regulator, is likely to support any efforts to curb the power of the largest operators. In 2018, the commission raised concerns about the effective oligopoly operated by the three main mobile network companies, NTT Docomo, KDDI Group and Softbank, which together control 90 per cent of the market.13

It's Suga's ambition to tackle the kinds of “zombie” firms that have long been a drag on the economy

Suga is pushing for a different approach when it comes to Japan’s regional banking sector. Laws that restrict the market share a single bank can take in a given prefecture have enabled many small lenders to struggle on in recent years, despite a dwindling customer base in rural areas. Suga reportedly wants to change these rules to enable consolidation.14 This ties in with his wider ambition to tackle the kinds of “zombie” firms that have long been a drag on the economy, Saito argues.

“Suga’s view is that Japan’s low productivity derives from unproductive employees being employed at zombie companies,” she says. “After the financial crisis, many people had their wages cut rather than being laid off. That’s one reason the country fell into deflation. Suga’s argument is that continuously falling wages need to be addressed, and if a company can’t afford to pay its workers more then it deserves to go out of business. It’s all about encouraging higher productivity and greater efficiency.”

Geopolitical risk

While Suga’s domestic policy priorities seem clear enough, there are other areas in which his views are less well-known. Suga is known to want to continue with Abe’s policy of reshoring Japanese manufacturing operations from China. But when it comes to foreign policy and diplomacy, he is an unknown quantity.

Abe skilfully managed relations with other major powers during his tenure: for instance, he led the revival of the Trans-Pacific Partnership, a free trade agreement, after the departure of the US in 2017, while still maintaining a good relationship with the Trump administration.

Some fear Suga’s relative lack of experience in the role could be put to the test by China or the volatile North Korean regime

Much of Abe’s success was attributed to his personal charisma and rapport with other leaders. Though Suga has comfortably cleared his first diplomatic hurdles – a meeting with US Secretary of State Mike Pompeo and calls with regional leaders have gone smoothly – it is a time of delicate geopolitics in the Asia-Pacific. Some fear Suga’s relative lack of experience in the role could be put to the test by China or the volatile North Korean regime.

“In foreign policy, Abe will be a difficult act to follow,” says Krishnan. “He played a deft hand in diplomatic terms, managing to avoid major rifts with China and the US while also sealing multilateral trade deals in recent years. We may see other regional powers such as China, South Korea and North Korea seek to test Suga in the early stages of his premiership. It remains to be seen whether he will be able to handle these relationships as skilfully as Abe did.”

Investment implications

For the most part, however, Suga’s rise to the leadership should provide investors with the assurance of continuity, and this is reflected in the sanguine market response to Abe’s departure. Krishnan points out that there has been no major change in the value of the yen, which in any case tends to be influenced more by overall investor risk appetite than domestic politics.

“Earlier this year Japan’s Government Pension Investment Fund increased the allocation to international assets in its massive portfolio, and that was a headwind to the Japanese yen, but the currency looks a more attractive asset now that those hedging flows have receded.

During challenging times, we often see Japanese investors bring some international investment back home

“During challenging times, we often see Japanese investors bring some international investment back home, as they are not getting the same yield advantages on US Treasuries or European government bonds. That should provide structural support for the currency going forward,” Krishnan adds.

As for Japanese equities, Suga’s clear reform plans have already started to influence market performance in some sectors. Chambon observes that as soon as Suga emerged as the frontrunner in the LDP leadership race, shares in travel and transport companies rose, while major telecoms companies underperformed (the sector rose 1.74 per cent overall in August, compared with a rise of 8.16 per cent for the Topix index as a whole).15

COVID impact

But while the pandemic still rages, uncertainty will cloud the picture. COVID-19 could bring about deeper changes in the fabric of Japanese society than even Suga’s ambitious reform agenda.

Chambon believes equity and real estate investors should monitor the way the pandemic is reshaping working life in Japan. Multinational technology company Fujistu, which employs 80,000 staff in the country, has already announced it intends to halve the amount of office space it uses over the next three years, with more staff expected to work from home.16

If other companies follow suit, the trend could have major implications for weaker office markets within urban centres and may rejuvenate regions that have suffered from depopulation and economic decline in recent years. Nomura Real Estate Development has said it plans to expand its network of shared “satellite” offices six-fold to 150 locations by 2027, with a focus on suburban areas surrounding Tokyo.

If home working catches on in the long term, it could reverse the trend toward greater urbanisation we have seen in Japan over the past decade

“If home working catches on in the long term, analysts expect more employees will choose to live away from city centres and that companies will recruit more remote workers, which could reverse the trend toward greater urbanisation we have seen in Japan over the past decade. This could support the revival of local communities in Japan’s regions and lessen the concentration of economic activity in Tokyo, which would be good news for the economy as a whole,” Chambon says.

Along with real estate, regional transport and retail companies should benefit from these changes, following a period of reorganisation. But perhaps the biggest potential winner is the IT sector, given the growing demand for cloud services and networking capability amid the rise in remote working.

The changes being wrought by the pandemic may influence which parts of Suga’s reform efforts are viable in the medium term. The need for better connectivity may expedite Suga’s drive to transform Japan’s digital infrastructure; similarly, the supply-chain vulnerabilities exposed by the crisis could provide him with the impetus he needs to make good on his pledge to re-shore Japanese manufacturing.

Other parts of the agenda may need to wait until the pandemic subsides, although Suga has made a positive start, says Chambon. “Suga has hit the ground running. The digital transformation plan is progressing very swiftly – that proves he is serious about reform.”

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