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The Japanese electorate will go to the polls on October 22, with Prime Minister Shinzo Abe seeking a stronger mandate for his policies. In this Q&A, Maulshree Saroliya explains what’s at stake for investors.
At a time when much of the world’s attention was focused on the increasingly belligerent rhetoric between the US and North Korea, Japanese Prime Minister Shinzo Abe on September 25 called a snap parliamentary election, setting a date for October 22. Abe positioned the election as a vote on new spending proposals and national security.
As far as security is concerned, Abe’s Liberal Democratic Party of Japan (LDP) may be seeking to capitalise on a recent boost in popularity after North Korean leader Kim Jong-un launched missile strikes over Japan, not to mention the disarray in the main opposition Democratic Party (DP).
If his election gamble is successful, Abe may also be able to push through a controversial increase in consumption tax. To make this more palatable to voters, Abe has promised to spend the proceeds on social programmes.
Although widely expected to retain its majority, the LDP could find itself up against some unexpected forces. Anti-establishment parties have been rattling the status-quo in national elections across the globe, and may yet prove a factor when Japan goes to the polls.
On the same day Abe called the election, Tokyo Mayor and former LDP Minister of Defense, Yuriko Koike, launched the reformist Party of Hope to challenge her former boss. The mayor has already handed the LDP a resounding, historic defeat in the Japanese capital and may make a dent in the LDP’s majority.
Furthermore, surveys suggest many disapprove of the early election, while up to 42 percent of voters are still undecided1.
In this Q&A, Macro Strategist Maulshree Saroliya looks at the economic implications of the upcoming election.
What are the key issues at stake in the upcoming election?
Two issues appear central to this election: constitutional reform and VAT.
The Japanese constitution has been a pacifist one for the entire post-World War II period, preventing Japan from being a military power. Abe wishes to amend the constitution’s war-renouncing Article 9 by 2020 to officially recognize Japan’s self-defence forces as its military.
With respect to VAT, Abe wants to allocate a part of those revenues to investment in human resources with the intention of raising productivity and trend growth. This would require revenues to be directed away from deficit reduction. Abe is proposing to delay achieving primary surpluses beyond 2020.
More generally, the key economic issue is the continuation of Abenomics. Over the summer months, there was a sharp decline in PM Abe’s and his cabinet’s popularity, which led to a rise in political risks associated with Abenomics. However, with the Japanese opposition in total disarray and the North Korea threat helping PM Abe re-gain his popularity, the threat of an election upset is small.
The LDP currently enjoys a two-thirds majority with Komeito, its coalition partner. What does Abe stand to gain by calling an early election?
The obvious gain for Abe would be a mandate to continue his economic policies until 2021, and to implement constitutional reform. He is betting on his resurgent popularity and the absence of a credible opposition. Regardless of his motives, calling an election now may be a practical strategy. It would cement his authority given the hugely divided opposition. The Party of Hope further complicates matters, but more so for the DP. Abe would have taken this into account in his calculations and would have been fairly certain of not facing sound opposition.
Another factor for Abe is that he cannot count on his popularity remaining high until late 2018, when the next general election has to be called. Hence, it’s an obvious tactical move for him to capitalise on his improved popularity.
Has Abe put recent scandals behind him?
The bottom line is that there is no credible alternative. The public is more focussed on the scandals currently besetting the opposition and appears to have moved on from the LDP’s own transgressions. Threats from North Korea have reignited the debate around the constitutional reform that Abe has been championing, and helped distance him further from involvement in recent scandals.
Presumably international investors will monitor Abe’s constitutional reform agenda closely given the implications for regional security?
Constitutional reform has been a key policy priority for Abe, and the threat from North Korea has helped him gain more support for it. This could be an important driver of sentiment towards the LDP, which electorally continues to look reasonably unassailable. Japan is unlikely to become a military superpower overnight. But, for historical reasons, the re-emergence of a Japanese military could potentially stoke tensions with China and South Korea. That will be a slow burn, but something investors will follow in the coming years.
Anti-establishment parties have been making gains around the globe in the past year. Are there parallels to be drawn in Japan?
The Japanese opposition is in too much disarray at the moment, and there is no single issue to unite them. More recently, Abe’s popularity has been soaring again in the wake of North Korea’s brinkmanship, so there is less evidence that anti-establishment parties could rise in Japan as they have done in other countries.
As for Koike’s Party of Hope, it is unlikely she can unseat the LDP. The best she can hope to gain is some defections from the main opposition party, but she has already indicated that she is not interested in the far-left faction of the DP. So the electoral arithmetic does not add up for Koike right now. In any event, she has indicated that she herself will not be a candidate in the forthcoming election.
Abe has unveiled new spending plans for education and childcare and proposed to pay for it with the upcoming increase in the consumption tax, which was originally earmarked to pay down the country’s debt. Consumption tax hikes have had adverse economic consequences in Japan previously: what is the likely impact this time around?
Japanese economic growth has been remarkably robust this year. Second quarter GDP surprised to the upside, driven mainly by domestic consumption and investment spending, which suggests a degree of fundamental resilience in the Japanese economic cycle that we have not seen in a long time. Manufacturing confidence has been strong and suggests continued expansion, especially since global manufacturing appears to be resurgent. This bodes well for trade-oriented economies such as Japan. In any event, the VAT hike is not scheduled to come into effect before 2019, so the impact over the next year should be muted.
What other economic reforms can we expect Abe to pursue should the LDP secure victory next month? Is further fiscal stimulus on the cards?
Abe’s immediate focus appears to be redirecting VAT funds to boost higher productivity. It is unclear whether there will be more outright fiscal stimulus, but the pace of fiscal tightening is likely to be eased as a consequence of Abe’s supply-side reform ambitions. In any event, given the strength of the Japanese economy, further fiscal stimulus may not be necessary if growth proves sustainable.
Does the election have any impact on the Bank of Japan’s monetary policy framework?
In recent months, there has been intense market speculation about the Bank of Japan having to consider its exit strategy from its yield-curve control (YCC) policy. During the period when Abe’s popularity was in decline, it emboldened the detractors of YCC to become more vocal, given that Abe’s support is the essential bedrock for BoJ’s policy. So a significant weakening of Abe’s political standing as a result of the snap election could potentially call in question both the durability and political viability of the existing Bank of Japan policy framework. If this risk were to materialise, it could send both JGB yields and the yen soaring and put large downward pressure on inflation expectations.
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