Shinzo Abe’s policy programme has boosted growth and lifted Japan out of its deflationary slump. But a growing political scandal could prevent the prime minister from finishing the job.
6 minute read
When Shinzo Abe became Japanese prime minister for the second time in December 2012, he revealed three policies designed to revive the economy, naming them ‘arrows’ after an old folktale. The first arrow denoted extraordinary monetary easing, intended to banish the threat of deflation; the second, fiscal stimulus to offset the slack in private investment; and the third, structural reforms to spur greater efficiency and productivity.
While Abe’s project is falling short of his ambitious targets, there has been undoubted progress over the last five years. As of January 2018, Japan’s nominal GDP was the highest it has ever been, at $549 trillion; corporate earnings peaked at a record $21.1 trillion, up from $12.4 trillion in 2012; and the Nikkei reached a 26-year high.1 These figures indicate Japan is starting to emerge from its decades-long economic slump.
But just as Abenomics begins to bear fruit, a damaging political scandal has erupted. Allegations that Abe and his wife used their influence to force a land sale to an ultra-conservative education group have left his approval ratings in tatters – and may yet bring about the downfall of the Liberal Democratic Party (LDP) government. So how sustainable are the gains made under Abenomics? And can Abe’s policies survive, even if he falls?
The first arrow
To properly assess Abe’s record, you need to look at the predicament Japan faced before his second stint as prime minister began (he previously served a brief term in office from 2006-‘07). Following the asset-price bubble of the 1980s and the crash of 1991-‘92, the country had endured almost two ‘lost decades’ of low or negative GDP growth and price deflation.
“When Abe took office the country was grappling with political stagnation, sluggish growth and falling wages,” says Jean-François Chambon, fund manager, Japanese equities at Aviva Investors in Paris. “Abenomics may be falling behind the government’s own objectives but the country has come a long way since 2012.”
Abe is trying to shake Japan out of its economic funk as part of a wider project of national renewal (he also wants to modify Japan’s pacifist constitution). He has been able to call on support from a key ally, Bank of Japan (BoJ) governor Haruhiko Kuroda, whom Abe nominated for the post after he took office.
Kuroda fired the first arrow of Abenomics soon after his appointment in April 2013, when he announced the BoJ planned to double Japan’s monetary base to 270 trillion yen ($2.8 trillion) by December of the following year, mainly by expanding its purchases of long-dated government bonds.2 But Japan’s deflationary slump was more difficult to shake than expected, and the yen proved stubbornly strong. In 2015, volatility in China’s equity market prompted safe-haven flows and the Japanese currency rose in value.
Not to be dissuaded, the BoJ doubled down on its easing policies: the following year it introduced negative interest rates; reiterated its commitment to inflation of two per cent; and started a policy of ‘yield curve control’, a method of using QE to hold the 10-year government bond yield at zero per cent.
Unlike its peers in other developed economies, the Japanese central bank has also engaged in large-scale equity purchases. As of March 2018, the BoJ held about three trillion yen in domestic equity ETFs, an amount equivalent to three per cent of the entire capitalisation of the Tokyo Stock Price Index (Topix), according to estimates from the Nikkei Asian Review.
Figure 1. Japanese equity market performance
Fiscal stimulus and structural reform
After hiking the consumption tax from five to eight per cent early in his tenure – a move that was widely criticised – Abe also pressed ahead with more-aggressive fiscal stimulus in 2016 to match Kuroda’s renewed monetary expansion. He launched a new $45 billion round of investment, including support for small- and medium-sized enterprises and financing for reconstruction on the earthquake-wracked island of Kyushu.
Abe has made some progress on structural reforms, overhauling regulation of the farming, energy and health-care sectors. He has also taken steps to improve the efficiency of corporate Japan, encouraging the country’s giant pension fund, Government Pension Investment Fund, to start pushing the firms in which it invests to improve profitability.
A new corporate governance code, introduced in 2015, has compelled Japanese banks to significantly reduce so-called ‘cross-shareholdings’ that foster close connections between bankers and their clients. The practice had been identified as one of the reasons why Japanese companies are rarely held to account for failing to deliver higher returns.
So have these policies succeeded in reviving the Japanese economy, five years on? As of January 2018, the key inflation rate stood at 0.9 per cent, still far below the BoJ target. But the spectre of deflation appears to have been successfully exorcised: the year-on-year change in consumer prices (excluding more-volatile fresh food items), has now risen for 13 consecutive months.
Figure 2. Inflation picks up
Greater coordination in monetary and fiscal policy over recent years may also have started to pay dividends in the form of stronger economic activity and higher employment (although a strengthening macroeconomic environment will have played a role too). GDP grew for eight consecutive quarters to December 2017, the longest positive streak for 28 years. In January the jobs-to-applicants ratio stood at 1.59, its highest level since 1974; the unemployment rate stood at 2.4 per cent, the lowest since 1993.3
“There are clear positive signs of a broad-based recovery,” says Maulshree Saroliya, macro strategist at Aviva Investors. “The private sector appears to have stopped shrinking for the first time in 30 years. Corporate profitability is rising and the job market is booming. Capital investment, rather than exports, was the chief contributor to growth in 2017. And all this happened without any significant new stimulus last year. However, given the long history of deflation in Japan, we must await more evidence before declaring a domestic revival.”
More remains to be done. Improving consumer confidence has not yet convinced companies to invest in new products and services, partly because wage growth has yet to pick up. The latest round of shuntospring wage negotiations between management and unions resulted in wage growth below the three per cent level targeted by Abe, despite soaring corporate profits.
Ironically, low wage growth may be a consequence of Abe’s successes in another area: structural reform. The LDP has been pushing for a rise in the number of women and retirees in employment and this has imposed downward pressure on wages, according to Saroliya. Widening participation in the workforce should help Japan cope with the effects of its rapidly-ageing population over the longer term, however.
The latest corruption allegations have thrown the future of Abe’s economic programme into doubt. They relate to the cut-price sale of state-owned land to Moritomo Gakuen, a nationalist school with links to the prime minister’s wife, Akie. The news first broke last year but the scandal escalated in March, when the finance ministry admitted removing references to the Abes, along with finance minister Taro Aso, from the sale documents.
In a testimony to the upper house of the Japanese parliament on March 27, Nobuhisa Sagata, a former finance ministry official, said neither the Abes nor Aso instructed him to falsify the documents. But he refused to elaborate on why the files were altered, citing an ongoing investigation. The prime minister’s political opponents are pressing for Akie Abe to appear in parliament to answer questions.4
Abe denies any wrongdoing, but his standing among voters has already been affected. A poll conducted by the Asahi Shimbun newspaper in late March had his approval ratings down 13 percentage points, at 31 per cent, the lowest they have been during his tenure.5 Abe is due to stand for re-election as head of the LDP in September.
Despite the controversy surrounding him, the lack of an alternative might buy Abe some time. The opposition is in disarray after the LDP’s landslide win at a general election in October 2017 and there are no obvious successors within the ruling party itself. “Currently there is nobody in the main opposition party, the Constitutional Democratic Party of Japan (CDP) ready to lead the country,” says Chambon. “Even if the popularity of the LDP is going down, the popularity of the CDP is not going up.”
These developments will be watched with keen interest by investors in Japan, for whom Abenomics has brought significant advantages. Sunil Krishnan, head of multi-asset funds at Aviva Investors, points to the structural support provided by the BoJ’s ETF-buying programme, for example.
“The Bank of Japan’s willingness to purchase equities as part of its monetary stimulus toolkit places it apart from its major peers. The simple fact of a structural buyer is supportive for the market, but it’s also noticeable that the BoJ is a more active purchaser during periods of market weakness.
“March 2018 is set to be a record for purchases, having already passed the previous high of 830 billion yen during the market decline of September 2016. This, together with evidence that monetary stimulus is actually working to deliver a solid domestic recovery, leaves Japanese equities well positioned in a global context,” Krishnan adds.
The rising value of the yen could yet erode corporate profits, and continued QE is unlikely to offer as much of an advantage for fixed-income investors, given the policies the BoJ uses to hold yields low.
“The variation in JGB yields has been minimal since the advent of the yield control policy in 2016,” says Saroliya. “With the yield curve exceptionally flat, the total returns available to investors are very low. There is very little residual QE tailwind for fixed income returns in my view.”
Abenomics without Abe
For a long time, talk among investors focused on when QE was likely to be withdrawn; now the chief topic of discussion is the potential demise of Abe’s government. The prime minister appears to retain the support of his core constituency, and if no hard evidence emerges linking him to the land sale he may yet survive.
Even if he doesn’t, there are signs that Abenomics may live on. Kuroda was reappointed for another five-year term as BoJ governor in early March – backed by two new deputies who support his loose monetary policy – which means there is the institutional will across the broader policymaking framework to continue firing the first arrow.
Abenomics has also won the backing of some influential institutions, including the initially-sceptical International Monetary Fund (IMF), which last year proclaimed it a ‘success’ for banishing deflation.6 With a growing consensus at home and abroad that Abenomics is working, the programme could yet prove resilient – even as Abe looks ever more fragile.
“Abenomics could continue without Abe, as his successor would need to keep moving forward with the ‘three arrows’. Structural changes are not a luxury but a necessity,” says Chambon. “But there’s no doubt that effecting these changes will be far more difficult without Shinzo Abe at the head of the government.”
1 Observatory Group
2 ‘Bank of Japan unveils aggressive easing,’ Financial Times, April 2013
3 Observatory Group
5 ‘Poll: Abe Cabinet support rate plunges to 31 per cent after files faked’, Asahi Shimbun, March 19
6 See the concluding statement of the IMF mission in June 2017.
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