Can Abe give Japan what money can't buy?
Even before Japanese voters returned Shinzo Abe’s party to power, he had already won over financial markets with an economic revival plan as seductively simple as economists say it is risky: print money and spend it. Lots of it.
The Liberal Democratic Party’s landslide on Sunday is likely to sustain a market rally fueled by economic stimulus hopes, but Abe’s economic legacy will probably be defined by how he tackles chronic ills that easy money alone cannot fix and that were largely ignored during the campaign.
The conservative leader set to return to the prime minister’s post he abruptly left in 2007 campaigned on a promise to double spending on public works and to push the Bank of Japan for radical action to end deflation and help exporters such as Toyota and Sony by taming the yen.
“The fact that Abe points to changes in the BOJ law or forex levels, or aggressive easing as solutions to Japan’s problems is, if anything, worrying,” said Yuuki Sakurai, chief executive of Fukoku Capital Management which manages $19 billion in assets.
“They should be treated as tools to buy time to implement structural reforms, but we’re not hearing anything about deep reforms that the LDP wants to carry out.”
The so-called Abe trade - a 4% slide in the yen and more than a 10% rise in stock prices over the past month - shows that for now, most investors just want to see the new leader fulfill his pledges.
Analysts said they expected Sunday’s vote, which according to TV projections based on counted votes gave LDP and its ally a two-thirds lower house majority, to sustain that trend in the near-term.
“Abe’s economic policies will be implemented so the economy will improve next year. The problem is what happens after that,” said Koichi Haji, chief economist at NLI Research Institute in Tokyo. “The key is whether Abe can implement long-term structural reforms and growth strategies.”
The BOJ is poised to heed Abe’s calls for more aggressive easing and a more ambitious 2 percent inflation target, with markets expecting the central bank to ease policy for the fifth time this year on Thursday.
Investors also expect an extra budget of up to 10 trillion yen as a down payment on Abe’s plan to spend such amounts per year over the next decade - double the current level - on public works long synonymous with the LDP.
Economists say pumping cash into the economy will only give it a temporary jolt if not followed by efforts to lift its growth potential and contain runaway debt.
In just three decades Japan has become the world’s oldest society, with those 65 or above making up nearly a quarter of a population that is greying and is estimated to have shrunk by over 260,000 in the last fiscal year alone.
Recipes to cope with it are well known: social security overhaul, including cuts in health care and pensions; boosting access to overseas markets and opening Japan to foreign goods, workers and investment; power sector revamp and bringing more women into the workforce.
All, however, carry political and social risks that Japan’s recent revolving-door leaders were unable or unwilling to take.
Left to sink or swim with swings in overseas demand for its exports and its currency, the world’s third-largest economy has been in and out of recession and dogged by low-grade deflation for the past two decades.
Now, in firm control of the lower house, Abe has a chance to prove his mettle and erase the memories of his first troubled year in office.
So far he has played it safe.
His “Abenomics”—a mix of potent monetary stimulus and big public spending—carries little political cost and he has been coy on touchy issues such the U.S.-led Trans-Pacific Partnership (TPP) free trade pact, or implementing sales tax increases.
With some luck, the new government may be even be able to call an end to a brief recession it entered last quarter.
Economists polled by Reuters last week predict the economy will start growing again in the first quarter of next year, largely due to expected recovery in China, Japan’s top export market.
Abe’s first stern economic test will come after next August, when the government, armed with second-quarter data, will decide whether the economy is strong enough to go ahead with a first round of planned sales tax increases.
With 10-year bond yields near a decade low below 0.7%, bond investors are now confident that he can steer the central bank to buy more bonds from the world’s most indebted government without setting off a market meltdown.
To keep that trust, Abe must convince investors that in his push for big scale-stimulus, he has not abandoned budget discipline. Economists say with Japan’s public debt at more than twice its economic output and climbing, the new government can ill-afford delaying a tax hike that has become a symbol of Tokyo’s fiscal rectitude. Their message is clear: “Just do it!”
“I hope they will go through with it,” said Takatoshi Ito, a Tokyo University professor, former adviser to the first Abe administration who is now mooted as a possible successor to BOJ Governor Masaaki Shirakawa when his term ends in April.
“Tax revenue is less than half of expenditures. Bond issuance is bigger than tax revenues. It’s like using a credit card for more than half of your monthly expenditure. It’s crazy, abnormal, you can’t go on like that.”
(c) Copyright Thomson Reuters 2012.