By Joseph Moss – International Banker
Last month, official data revealed that Japan’s consumer prices had fallen for the fifth consecutive month in July, dropping by 0.5 percent from the previous year, eclipsing the 0.4-percent contraction in June, and marking the biggest annual consumer price decline in more than three years. The disappointing inflation data also came hot on the heels of figures showing a tepid 0.2-percent gross domestic product (GDP) growth rate for the second quarter, while Japan posted its first trade deficit in three months in late September. With an 18.71 JPY billion shortfall, the deficit easily missed the consensus estimate of a surplus, adding more pressure on the Shinzo Abe government and, in particular, on its policy of “Abenomics”.
Abenomics is effectively an umbrella term for the economic measures adopted by Prime Minister Shinzo Abe since taking power in 2012, in order to counter 18 years of economic stagnation in Japan. The Abe government has primarily used a “three arrow” approach to break this cycle—fiscal expansion through higher government spending, monetary easing by increasing the money supply and structural reforms designed to improve competition among businesses. Despite the best efforts of Abenomics, however, the world’s third-largest economy has continued to underperform, with consistently falling consumer prices, negligible wage growth and weak levels of consumption and investment. Moreover, the yen has strengthened significantly during the year, which has incurred much damage on the earnings of Japanese companies, the exports of which have become significantly more expensive when priced in foreign currencies.
Should the US Federal Reserve raise interest rates in the coming months, the US dollar should strengthen against the Japanese yen, which in turn is likely to bolster the country’s exports and boost inflation as a result. However, given the slowdown in US economic growth this year, as well as the modest inflation rate of 1.1 percent, the likelihood of any meaningful monetary tightening by the Fed remains low.
It appears that Abe still has the confidence of the Japanese population, having swept to a resounding election victory in July. Nevertheless, Japan’s weak economic performance has remained the biggest headache his Liberal Democratic Party government has faced during its time in power. Thus far, it has failed to dislodge the deflationary sentiment from the Japanese economic mind-set, although this has not been through a lack of trying. The Bank of Japan (BoJ) has sent interest rates into deep negative territory to encourage spending and inflation; the government has pumped trillions of yen directly into the economy through bond purchases, corporate loans and substantial spending on new infrastructure projects; and more recently, Abe announced a 28 trillion yen (276 billion USD) stimulus package after this year’s election victory, and following the UK’s decision to leave the EU, which sent investors into the relative safe haven territory of the Japanese yen, triggering a rally in the currency.
After Abe was appointed prime minister in 2012, Abenomics was largely deemed to be successful during the ensuing couple of years, with a loosening of monetary policy resulting in a welcome weakening of the yen, as well as the stock market reaching multi-year highs. Indeed, last year saw the country’s benchmark index, the Nikkei 225 Stock Average, reach its highest level in 15 years. The JPX-400 stock index was also created to direct investor capital towards the country’s most profitable companies, and as such, encouraged companies to focus on boosting profitability and maximising returns for shareholders. However, after the Ministry of Finance came under pressure to balance the budget following the implementation of the second arrow—the fiscal stimulus—the sales tax was increased in 2014, which contributed significantly towards ending the recovery and plunged Japan back into recession.
There have been glimmers of success from Abenomics, however, most notably Japan’s real estate sector. During a time of considerable market volatility, investors have flocked to the housing market, which has been increasingly perceived as a safe haven option. Indeed, since Abe took power in 2012, property prices have shown consistent growth, attracting international investment at a faster rate than other growth markets, such as Mumbai and Shanghai. This influx has resulted in foreign purchases of real estate, as a proportion of total real estate investment in the country, rising from 4 percent in 2011 to 22 percent by 2015, while the value of property deals has surged from $19 billion to $34 billion during the same period.
Such successes, however, remain as minor victories for Abenomics amidst a general sentiment of gloom that exists across the nation. A working paper from the International Monetary Fund (IMF) in early September made several policy recommendations for Japan to adopt in order to finally rid its economy of low wage growth and persistent deflation. Among them was the introduction of a “new arrow” of “an incomes policy for Japan to put an end to low wage growth and induce inflation”, in which the government determines a wage-inflation threshold of which companies would be required to remain in compliance or be required to provide a public explanation if not met. The paper also suggested that the BoJ’s inflation forecast becomes a solid intermediate target for monetary policy, which would in turn help the bank to build credibility with financial markets, as well as solidify long-term inflation expectations to its 2-percent target.
Most recently, the BoJ has decided to introduce an interest-rate target for 10-year government bonds in a bid to combat deflation. The central bank stated that it will commit to keeping 10-year rates around zero, as well as continue quantitative easing, until inflation exceeds 2 percent. The measures, therefore, indicate a shift in thinking by monetary policymakers away from solely targeting asset purchases towards monitoring the shape of the yield curve, or as the bank calls it, “QQE with yield curve control”. This will effectively mean that it will purchase government bonds with a much wider range of maturities than was previously the case. This increase in flexibility has been welcomed by financial markets thus far; however, given Japan’s long history of stagnation and underperformance, it would be wise to wait before concluding that the country has managed to break out of the cycle once and for all.