The era of new policies
In our previous edition, we observed the possibility of an upside surprise in Japan’s economy in 2013. Recent developments indicate that the economy is probably bottoming out. After more than two decades of economic stagnation, policy makers are working together to do “whatever it takes” to revive growth. The economic policies proposed by the new prime minister, Shinzo Abe, popularly termed as “Abenomics,”1 now have the official support of the central bank of Japan. The governor of the Bank of Japan, Haruhiko Kuroda, announced his optimistic stimulus plans to revive the economy in his first monetary policy meeting earlier this month. The massive bond-buying program, aimed at doubling the monetary base over the next two years to reflate the economy and depreciate the Japanese yen, is considered to be a significant departure from the monetary policy stance experienced so far.
In March, Abe announced his plan to participate in the negotiations of the Trans-Pacific Partnership (TPP), which is perceived to be a symbolic move toward deregulation and reforms. While many industrialists have welcomed the move, it will face resistance from the farming sector, which is still a protected sector. The TPP can boost GDP by 0.7 percent over a decade and can lead the way to deregulation in the health and labor markets.
Improving economic sentiments
The fiscal and monetary stimulus programs, along with the reform agenda, aim to spur prices, spending, and borrowing, and thus create demand. Recent surveys suggest that the policies have already started impacting the sentiments across households and businesses. The Senior Loan Officer survey on bank lending has reported improving demand for loans among households and in large firms. Demand for housing and consumer loans by the household sector improved in the last quarter. However, bank lending standards continued to remain tight.
The profit outlook for businesses and business sentiments too has improved since the announcements. The Bank of Japan’s Tankan business conditions survey improved in March, with the big manufacturers’ index rising to -8 from -12 in December. This was the first survey conducted after the prime minister’s initial announcement of economic policies. The biggest gains came from the construction and real estate sectors, which are expected to benefit from the announced fiscal stimulus. The recent monetary policy will likely improve sentiments further to -1 in the forthcoming quarter. However, businesses will remain cautious since perceived unfavorable business conditions may continue to outweigh favorable conditions, as indicated by the negative sign.
Risk assets are looking attractive as the Nikkei index has been steadily improving and, in January 2013, reached its highest level since the Lehman crisis. Corporate earnings are gradually restoring health and are expected to improve in 2013, which will further boost equity returns. On the other hand, yields on 20-year bonds touched their lowest level since 2003 in March, while 10-year bond yields are hovering at a very low level, making bond markets very unattractive for investment.
The fiscal and monetary stimulus programs, along with the reform agenda, aim to spur prices, spending, and borrowing, and thus create demand.
The plan to end over a decade of deflation and reflate Japan’s economy by 2 percent in the next two years, along with aggressive monetary easing, has raised short-run inflation expectation in the economy. A survey by the Bank of Japan showed that nearly three-quarters of households expect prices to rise in a year from now, the highest proportion since 2008. The rise in price expectations, together with quantitative easing, has weakened the yen by 18 percent against the US dollar, since its peak in December 2012. A further weakening of the yen, as expected, will likely raise consumer price inflation through higher import prices and increasing input costs for businesses. However, downside risks due to global economic uncertainties, especially in the United States and Eurozone, may reverse yen depreciation.
Still a long way to go
While the surveys indicate that Abe’s policies have helped lift the overall economic sentiments, recent economic data releases suggest that they are yet to boost the ongoing economic activity. Real GDP remained unchanged in Q4 2012 relative to the previous quarter, though the figure was revised up from its previous reading of a contraction. Industrial production showed a surprise month-on-month contraction of -0.1 percent in February, down from the 0.3 percent expansion in January, due to a decline in electronics production.
Japan’s trade balance worsened in January, resulting in the third consecutive month of current-account deficit. The trade deficit is being driven up primarily by rising demand for energy imports, especially liquefied natural gas, following the shutdown of nuclear power plants after the 2011 earthquake. A weaker yen is likely to help struggling manufacturers as exports become competitive. However, increasing energy imports will likely result in a continued trade deficit in the short term. The net positive repatriated income may continue to keep the current account in surplus.
The way forward
The success and sustenance of the comprehensive agenda to boost the economy will be eagerly watched by both domestic and international investors. The structural changes are likely to improve the outlook of the economy at least in the short run, but more evidence has to emerge. Strengthening growth and making it sustainable will be a challenging task for policy makers. New growth strategies must focus on increasing productivity to offset the diminishing labor force, reducing barriers to trade, encouraging innovation and investment, promoting small and medium-scale enterprises, and reducing the gap in the standard of living. Japan’s fiscal problem is also a concern, with public debt reaching an unsustainable level. Japan has to correct its fiscal balance to ensure fiscal sustainability by limiting spending pressures due to the aging population.
- Abenomics refers to the economic policies advocated by the new prime minister of Japan, Shinzo Abe, to revive economic growth through a combination of fiscal, structural, and monetary policies. The goal is to reverse deflation by setting an inflation target of 2 percent, ensure correction of the yen to make exports more competitive, introduce radical quantitative easing, and increase public spending to boost domestic demand.