Why Japan's "Massive" ¥28 Trillion Fiscal Stimulus Plan Was A Disappointment

Last week, when details of Japan's "massive" JPY28 trillion stimulus plan emerged, we pointed out the "minor" snag that assured the plan would be a disappointment: only about JPY7 trillion of this amount would be in the form of new spending. Overnight, Japan finally revealed the full plan, and as expected it was met with significant disappointment by the market, which sent the Yen soaring to new multi-week highs, with the USDJPY tumbling under 102 which, together with a very poorly received 10Y auction, sent Japanese bond yields surging.

So what was in the plan? 

First the good news: as the FT writes, "Shinzo Abe has put Japan at the forefront of a global shift away from austerity and back towards looser fiscal policy as he launched a new ¥4.6tn ($45bn) stimulus to boost a struggling Japanese economy." 

However, as previewed here last week, while Abe proclaimed a total package of ¥28.1tn, the actual new government spending is ¥6.2tn, of which ¥4.6tn — 0.9 per cent of gross domestic product — will fall in the current fiscal year. The package includes ¥2.5tn in welfare spending, ¥1.7tn for infrastructure, ¥0.6tn for small and medium-sized businesses hit by “uncertainty due to Brexit”, and ¥2.7tn for reconstruction after an earthquake on the southern island of Kyushu earlier this year.

 

The Japan Ministry of Finance released the following breakdown of key stimulus component:

As the FT reports, the package marks a return to the basics of the prime minister’s Abenomics program, which was supposed to combine monetary and fiscal stimulus, as Japan wrestles with weak consumption and the drag on exports from a stronger yen. “The key word is investment in the future,” said Mr Abe as he announced the decision in cabinet. He exhorted ministries to put the package into effect as fast as possible.

At the heart of the package are measures to help low-income pensioners and bringing forward the completion of a maglev train line from Tokyo to Osaka by eight years using soft government loans.

 

“There was no surprise at all,” said Daiju Aoki, an economist at UBS in Tokyo. “Last year we had ¥3.3tn and this year it will be ¥4.6tn,” he said, arguing that the additional impetus to growth might be as little as 0.1 or 0.2 per cent of GDP.

Bloomberg adds that a key part of the spending on infrastructure will be to help double the number of tourists visiting the country, speed up the construction of a magnetic levitation line and aid building projects overseas. Japan is aiming to double the number of overseas visitors to 40 million by the time of the Tokyo Summer Olympics in 2020. The government will also provide loans to help bring forward the completion of a Nagoya-Osaka maglev link, originally scheduled to open in 2045, by eight years, it said.

Even so, there was few precise details: the package contains a laundry list of measures for ministries to spell out later,  but the welfare spending is expected to include childcare subsidies and a payment of ¥15,000 ($147) each for 22m low-income individuals.

Direct spending on families and low-income households should find its way into consumption quickly. Some of the infrastructure spending may not take effect for years.

The underwhelming stimulus announcement comes just days after the Bank of Japan itself disappointed markets with a modest addition to its monetary stimulus last week, in which it only upping the pace of stock market purchases to ¥6tn a year (which however is equivalent to the Fed purchasing over half a trillion dollars worth of ETFs over 2 years).

Taro Aso, finance minister, sought to portray the stimulus as a joint effort with the BoJ, holding an unusual meeting with central bank governor Haruhiko Kuroda on Tuesday evening to discuss the details.

“We want to accelerate Abenomics in co-operation with the BoJ,” Aso told reporters. Kuroda sought to keep fiscal and monetary policy separate, saying only that there is “synergy between the stimulus measures and the accommodative financial environment”.

Regardless of how it was spun, the market's reaction was less than favorable, with the Yen surging, while government bond yields rose sharply in Tokyo, with the 10-year yield close to positive territory for the first time since March.

 

 

Masamichi Adachi, senior economist at JPMorgan in Tokyo, said investors went into last Friday’s BoJ meeting expecting a large easing. They were disappointed when the BoJ did nothing but boost stock market purchases.

There is still hope: Kuroda also announced a “comprehensive review” of monetary policy to take place at the central bank’s next meeting in September. “There are basically two views in the market about what that means,” said Mr Adachi. Adachi thinks the review could lead to more stimulus. He takes Mr Kuroda at his word: the BoJ governor insists that the review is about how to reach 2 per cent inflation as fast as possible. However, as we reported last week, others think the review means the BoJ will admit defeat and accept it will take longer for inflation to get to target.

“Many Japanese bond investors think the comprehensive review means the BoJ is now facing a serious limit and it will step back and normalise to some degree,” Mr Adachi said.

A report overnight in the Nikkei confirmed this skepticism when it announced that "Tokyo grows skeptical of BOJ's inflation target", saying that the Japanese government is increasingly diverging from the Bank of Japan's stance that 2% inflation can be achieved soon. "The central bank has targeted 2% price growth within a roughly two-year time frame since 2013, when Haruhiko Kuroda became governor. Yet the government sees inflation falling steadily instead."

It concluded that the Finance Ministry and the Financial Services Agency meet regularly with the BOJ to ensure they are on the same page regarding the economic situation. Even at these meetings, some people are apparently arguing against the insistence of reaching 2% inflation in two years.

"The view is gaining ground in Tokyo that trying to force a sharp rise in stubbornly weak prices is unnecessary. A surge in prices amid stagnant wage growth could dampen consumer spending, as seen with the slump that followed the 2014 consumption tax hike."

Several analysts joined the chorus of concerns over what may be a dramatic shift in Japanese strategy:

Hideo Suzuki (chief manager for forex & financial products trading at Mitsubishi UFJ Trust and Banking)

  • Uncertainty surrounding BOJ’s assessment will continue to weigh on JGBs
  • Investors doubt BOJ’s stance toward additional easing as the assessment will consider the negative-rate policy and the 2-year timeframe for reaching inflation target
  • May not want to take the risk of buying JGBs ahead of U.S. non-farm payroll data on Friday
  • Suggests buying on the dip if 10-year yield rises to 0% and 20-year yield to 0.3%

Satoshi Shimamura (head of rates & markets at investment strategy department at MassMutual Life Insurance)

  • Looks as if the market is pricing in an end to BOJ’s QQE
  • Increase in 10-yr yield may be capped at zero

Makoto Suzuki (senior bond strategist at Okasan Securities)

  • 10-yr JGB may trade around -0.1% until Sept. meeting, and could rise above zero percent should the market start to see risks over the central bank’s commitment toward easing
  • Sees it as unlikely BOJ will make a drastic change on monetary policy

* * *

Needless to say, if Abe has indeed thrown in the towel on monetary policy this would mark a stark transformation to Abenomics, which has over the past 3 years relied almost exclusively on monetary policy. If Japan is U-turning toward a fiscal stimulus driven response, it will result in an accelerating surge in the Yen, a plunge in risk assets and a spike in Yields, rekindling fears of Japan's numerous VaR shocks over the years.

It remains to be seen if Abe is willing to take such a large gamble.