As expected, Prime Minister Shinzo Abe's ruling bloc won a decisive victory in an upper house election on Sunday, setting the stage for Japan's first stable government since Koizumi left office in 2006. The Japanese people voted for moar of the same irresponsible monetary policy and this provides a three-year window without a national election and strengthens PM Abe’s hand to supposedly deliver on the promised reforms. As Reuters reports, "people wanted politics that can make decisions", and, "'Abenomics' is proceeding smoothly and people want us to ensure the benefits reach them too." So moar trickle-down wealth-creation for the Japanese, moar surging energy prices, moar currency wars, and moar leverage. There will now be a significant tradeoff among his 'three-arrows' strategy - between monetary and fiscal/reform policy - as the reform agenda may actually enable less monetary policy, increasing the chances of higher inflation in Japan without additional monetary stimulus. This may be just what Kuroda needs to save the JGB market from failure (at least in terms of jawboning if not actuality).
...ruling parties control both houses and have a rare three-year window without a national election to pursue policies involving short-term pain in exchange for long-term gain. Here is how we expect the three “arrows” of Abenomics – Prime Minister Abe’s program to tackle deflation and promote growth – to evolve in this context.
The first arrow – bold monetary policy – has thus far spurred consumption through wealth effects and improving sentiment linked to higher share prices and JPY depreciation, as well as housing investment. We expect the BoJ to ease further in April 2014, as its target of “2% CPI inflation in two years” (set in April 2013) starts to look more elusive and the government calls for action to offset the effects of the planned VAT hike in April 2014.
“Flexible” fiscal policy, the second arrow, has given a boost to public investment in the initial stages, but we expect a slowdown later this year and a pullback in Q2 14, as the LDP shifts toward a phase of fiscal consolidation. We expect this to be signaled by an official decision, around October, to go ahead with the April 2014 VAT hike. Although the government could still compile some one-off measures to offset the impact at the time of the hike, we have not factored such a scenario into our outlook and generally expect efforts to rebuild public finances given the LDP’s pledge to cut the national/regional primary deficit as a share of GDP to half of FY10 levels by FY15 and to aim for a surplus by FY20.
The next big focus will likely be the government’s “growth strategy” – the third arrow of Abenomics. In June, Mr Abe unveiled his first version, which disappointed the markets, but the strategy remains a work in progress and could contain bigger reforms after the upper house election. Mr Abe has already hinted that an extraordinary Diet session will be held in September and that tax and other legislation related to the growth strategy will start to be passed around October.
From a macro perspective, we believe the key points to monitor are measures to:
- boost labor flexibility;
- cut corporate taxes; and
- promote free trade.
Mr Abe has not mentioned a plan to ease Japan’s onerous restrictions against job termination, the key to boosting labor flexibility and, hence, productivity and wages, in our view. As shown in the chart below, the unemployment rate remains a much less “adjustable” variable in Japan than in the US or Europe.
It appears that corporate taxes will initially be lowered in special economic zones, but a general cut to more internationally competitive levels (toward 20% from current 25.5%, on a national corporate tax rate basis) would do more to boost domestic capex and induce inward FDI. Japan will join the TPP negotiations on 23 July (the current round, in Malaysia, is being held 15-25 July), and we expect resistance from special interests within the ruling camp to ease, perhaps partly through a post-election Cabinet reshuffle.
Japan currently has 13 FTAs, but none with a major economic power. Korea, by contrast, has already signed FTAs with the US and EU, and has begun negotiations with China a year ahead of Japan. This gap can be measured through a comparison of “FTA coverage ratios” – a country’s trade with FTA partners as a share of its total trade.
Japan could improve its ratio significantly by joining the TPP, which would effectively amount to an FTA with the US. We believe a higher FTA coverage ratio could expose Japanese corporations (and regulators) to competitive pressures that would encourage more thorough structural reform.