Magazine issues » Autumn 2013

INSIDE VIEW: What next for Japan?

ArrowsWith the first arrows of prime minister Shinzo Abe’s three-arrow policy fired, Osamu Kikuchi at Tokio Marine Asset Management discusses whether this will really lead to a revival in the Japanese economy.

With prime minister Shinzo Abe and his administration taking the majority in both the Upper and Lower Houses, investors ask whether this will lead to a revival in the Japanese economy.

In July, his Liberal Democratic Party (LDP) won a landslide victory in the Upper House, following the win in the Lower House election in December last year.

The first of his three-arrow policy targeting a revival of Japan have been fired: monetary policy and fiscal policy. The third arrow, growth strategy, has yet to be fully released.

Even though it is still too early to foresee all aspects so shortly after passing the Upper House election, there are two possible future scenarios.

One is a positive scenario of a stable economic recovery supported by strong leadership by the Abe Administration via political reform in the Diet. I stand by the positive scenario.

The other is a pessimistic scenario. Because of the majority obtained by the LDP in both the Upper and Lower Houses, the government may become complacent and lose focus on the economy. Abe has a strong interest in constitutional reform and may focus too much on such an agenda – which is less pressing than economic recovery. In such a scenario, investors’ expectations from Abenomics, as his policy has been dubbed, recede and the stock market and economy continue to decline.

CONSUMPTION TAX HIKE
Another concern is the consumption tax hike. Previously, the proposed hike was viewed as a done deal. However, pessimists say Abe’s announcement of a further provisional study on the hike until early October is a sign of political indecision.

Furthermore, an increase might lead to a further slow-down of the economy and a weakening stock market – a repeat of what happened in 1997. Such an increase is necessary and may lead to a strong response from the stockmarket, but Abe seems likely to concentrate on economic recovery prior to embarking on any constitutional reform.

What we may actually end up with is a combination of both scenarios: a gradual hike in consumption tax of 1% per year for three years, avoiding the initially predicted one time jump from 5% to 8% in April 2014.

Even if there is a one-time 3% consumption tax rate jump, we could expect some economic assistance to offset any declines in economic activity. For example, public investment initiatives for the Great East Japan Earthquake reconstruction effort, replacement of obsolete infrastructure across the country, tax cut measures to encourage cash rich corporations to increase capital expenditure or increase shareholder return.

The subject of corporation tax rates is just as important for Japan’s economy as other core topics such as free trade agreements and deregulation.

Some argue that a simultaneous reduction in corporation tax and a rise in consumption tax will send a controversial signal that the government is supporting large corporations at the expense of normal members of the public.

Despite such risks, the fact that the government has decided to open the door for a cut in corporation tax is indicative of how serious it is when it comes to economic recovery.

The Abe administration will probably seek constitutional reform eventually, ending the post-war regime of the current constitution. But in order for this to happen, it is crucial to first maintain political power over a long period.

Perhaps the next move would be in 2016, after the next election. For this purpose, Abe needs to be re-elected in 2015 and revitalisation of the Japanese economy must take place by then.

To overcome deflation by spring 2015, Abenomics must not just utilise monetary and fiscal policy but also conduct deregulation and structural reform. This, in turn, may help Abe to achieve his goal of constitutional reform in 2016. I believe that the Abe administration will be entirely devoted to the economy, leading the way to possible constitutional reform.

There is a tailwind for the Abe administration that is the US economy, which has overcome the balance sheet recession in the household sector after the Lehman crisis and fiscal cliff problems, and is now entering a phase of economic recovery. This is supportive of the Japanese economy as well as others.

Looking back to successful Japanese administrations since 1980, only two have survived more than 1,000 days: the Nakasone administration and the Koizumi administration. A common feature for these administrations is that the US economy was strong.

The Nakasone administration under former prime minister Yasuhiro Nakasone achieved privatisation of Japan National Railways and the Nippon Telegraph and Telephone Public Corporation. The Koizumi administration under former prime minister Junichiro Koizumi won a controversial postal privatisation bill. Perhaps the Abe administration may survive over the long term and conduct its own reforms?

TRANSITION
There are always a number of concerns surrounding Japan: the Chinese shadow banking system and its potential impact on the economy, the confrontation of the Republicans and the Democrats in the US Congress, the end of quantitative easing in the US, uncertainty over European economic integration without financial integration, an ageing population in Japan and Japanese fiscal concerns and so on.

With this in mind, we are carefully monitoring the progress around core issues such as consumption tax hikes, growth strategies and possible constitutional reform. We will watch these during an interesting transition phase for Japan while being cautiously optimistic.

Osamu Kikuchi is chief economist at Tokio Marine Asset Management and based in Tokyo

©2013 funds global asia

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