June 29, 2016, 17:00 JST

In search for Post-Abenomics

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Prime Minister Abe will probably remain in office for some time. However, Abenomics has already ended its shelf life as a credible economic policy package. The policy package, when unveiled in early 2013, had a simple set of goals and tools to achieve them. It aimed for 2% growth, 2% inflation in 2 years through a combination of monetary easing, fiscal expansion and structural reforms. After more than three years, the growth remains subdued and the inflation remains close to zero. Moreover, the tools themselves are found to be flawed and no longer effective in bringing Japan closer to aimed goals. We also suspect that some of key policy makers, most importantly the Bank of Japan, have started to lose faith in the viability of their policy objectives. In our view, it is time to think about what would follow Abenomics.

A number of factors affects our verdict on Abenomics, but the following three factors stand out. 1) policy tools that have been employed to pursue Abenomics goals are becoming unsustainable or already withdrawn 2) these policy tools are found to be not having their expected economic effects, 3) Policy makers seem to be losing their resolve.

1)  Abenomics policies are becoming unsustainable 

BoJ has nearly exhausted its means to stimulate the economy

Out of so-called three arrows of Abenomics, the first arrow, the monetary easing, have been implemented in earnest in the last three years. The Bank of Japan’s massive purchase of JGB successfully flattened its yield curve and yen depreciated to its 40 years-low in real terms by mid-2015. 

However, the cost of executing the massive quantitative easing is becoming visible as a dramatic rise in the central bank’s market share in the JGB market. At the beginning of 2013, the BoJ held slightly over 10% of the whole JGB market. By May 2016, its market share has risen to 37%. At the current pace, it will reach 40% by the end of 2016 and 50% by early 2018. Many economists, including those from IMF, argue that the scarcity of JGBs in private sector will soon start to impair the normal function of the financial system in Japan. As the 50% mark approaches, we expect that voices against further dominance of the BoJ in the JGB market will grow and the BoJ itself will come to judge that the further purchase would on net harm, rather than benefit the Japanese economy.

While the bank of Japan has other policy tools, such as bringing its policy rate further into negative territory and expanding its risk asset purchases, we think the additional scope to which these tools can be employed is already limited. There are some silver bullets left such as a coordinated fiscal and monetary easing, but these measures require different level of political determination and we do not think the BoJ is ready to cross the bridge under the current circumstances. For more details on our view of Japan’s monetary policy, please see here.

Fiscal expansion has already been withdrawn

The second arrow, the fiscal stimulus, was implemented in 2013, the first year of Abenomics, but it was not pursued in an effective scale and duration. Japan’s fiscal policy turned contractionary in 2014 when the consumption tax rate was raised from 5% to 8%.  

All talk and no actions on structural reforms  

As for the third arrow, structural reforms, it is difficult to make a conclusive argument either way as any reforms take time to make a progress and bear fruit. However, when we see all the poster children of so called reforms pursued under Abenomics, we see that most issues are those whose progress are inevitably slow or hard to measure. Promoting a wider female labor participation is certainly an important issue, but the female labor participation in Japan is already relatively high. At 66.0% in 2014, it was already higher than OECD average of 62.8% and is comparable to 67.1% in US. It is not as if there are millions of housewives idle at home. In order to increase the supply of labor, raising retirement age will be far more effective. Immigration could provide another big potential break. However, these issues are currently shut out from the policy debate. One could argue that the Womanomics under Abenomics is about the quality of the female labor, pointing to its target to fill 30% of socially leading positions by female by 2020. One unknown fact is that the target was nothing new. It has been Japan’s official policy since 2003 when Prime Minister Koizumi adopted it. It progress has been slow, rising from 9.7% in 2003 to 11.3% in 2014. Raising it to 30% by 2020 was simply an unrealistic target and we do not see any novel policy that could significantly speed up the process. TPP is another poster child, but its immediate economic effects are not big. In 2013, the Japanese government estimated it to be 0.66% of the GDP even assuming all tariffs are immediately removed. While we do believe trade liberalization is highly important, TPP is definitely not a game changer. The current Japanese government is also using TPP as an excuse to increase agricultural subsidies. 

Rather than arguing over each policy, we could use the strength of private capital investment as an indirect measure for the effectiveness of the third arrow. If the structural reforms are actually working, it should have raised the expectation of future growth in Japan, encouraging Japanese companies to increase their investment. However, despite the record profits, their capital investment only saw a moderate increase, unlike the period 2003-2006 when investment grew with profits.

To summarize, the monetary policy has been effectively deployed as Abenomics promised but its sustainability is increasingly in question. The second arrow, the fiscal stimulus, was only deployed in limited scale in 2013 and it is already withdrawn. As for structural reforms, our perception is that so far, there has been no reform worthy to be called structural.

2) Policies did not have its intended effects

When Abenomics got rolling, the theory was that the monetary easing and the resulting weak yen would spur exports, private investments and private consumption. The high growth should diminish the negative output gap and eventually raise inflation both in consumer prices as well as in wages. Almost three years since the advent of Abenomics, the results are rather dismal. Exports never took off. Private investments are growing, but the magnitude of its growth has been disappointing. Private consumption initially lived up to the expectation, but the shock of the sales tax rate hike in 2014 seemed to have deprived its life out of it.

On the inflation front, the consumer price inflation initially rose till early 2014, probably mostly as a result of imported inflation through weak yen. However the recent decline in commodity prices seems to have killed off the inflationary momentum. Meanwhile, despite the tightening in the labor market, there seems to be no sign of any meaningful wage inflation. The expectation for low inflation among the Japanese population seems quite entrenched and neither corporate managers nor workers seem to feel that any marked rise in wages is in order. 

3) Policy makers seem to be losing their resolve.

The following sentence was in one of the first speeches Mr Kuroda made after becoming the BoJ governor.

First, the Bank decided -- as I mentioned earlier -- to convey a strong and clear commitment.  The Bank clearly announced in a statement that "[it] will achieve the price stability target of 2 percent in terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible time, with a time horizon of about two years."  This is the decision of the Bank's Policy Board -- namely, it expresses the will of the Bank as an institution.

(Haruhiko Kuroda, Governor of the Bank of Japan, April 12, 2013)

The end of the time horizon of “about two years” is now long in the past. He currently maintains on surface that his expectation is that the BoJ will meet its inflation target by the end of the fiscal year 2017. However, judging by recent press conference given by Governor Kuroda, we sense that the governor himself is no longer in a hurry to achieve the inflation target. While the BoJ seemed to have been pursuing the inflation target at “any cost” until mid-2015, their policy stance has changed through the course of 2015 so that the inflation target has now become “a medium term” target that the BoJ should pursue “while taking into account of other policy objectives”. While we understand the logic behind the change in their policy stance, we think the BoJ has damaged its credibility by not clearly communicating the change to the market.  

The BoJ is neither the only nor the most important institution whose credibility is deteriorating. As we commented earlier, the Japanese government failed in delivering meaningful structural reforms. Moreover, since early 2015, Prime Minister Abe seems to have all but lost his interest in the economic agenda, and seem to be spending most of his attention to changing Japan’s geopolitical security policy framework, chiefly changing Japan’s constitution, de jure or de facto, to enable Japan to engage in collective use of force.

What will follow Abenomics?  

In our view, Abenomics may have some shelf life left, but it is likely to be months, rather than years. As our forecast show, the Japanese economy is likely to do moderately well in 2016. The BoJ could even inject another monetary stimulus, although their arsenal will be quite depleted once they do. However, it is difficult to see how Abenomics policy mix could go on beyond 2017. The economy, and the inflation will likely cool down again with the rise in the sales tax rate currently scheduled for April 2017. At that point, it will be clear to any economy watchers’ that the Japan’s policies are not sustainable.

Is there any way out of this conundrum? One possibility is a cancellation of the scheduled sales tax hike in 2017. If the Japanese government decides to postpone the tax rate hike again, it may prolong the shelf life of Abenomics, and it could even help reach the original goal of reflating Japan, although it may be temporary. The labor market is already tight, and two or three more years of robust growth should be enough to ply upward the entrenched low inflation expectation in Japan. Whether the BoJ could solve the problem of exiting from its QE policy, with over 50% of the JGB market in its balance sheet and in a reflationary environment, is a big if though.

In our view, the time is not yet ripe to declare Abenomics a failure, but we must say that we are getting there.