Feb 28, 2014, 17:00 JST

Feeling melancholic for Abenomics

Going through the barrage of Japanese data published on February 28, we cannot help feeling somewhat melancholic. All the data point to an economy enjoying a boom. If left alone to run its course for another 12-18 months, Japan could finally exit from the 15 years-long deflation. But the sad likelihood is that the good days of Abenomics is numbered. Thus the melancholy.

Let’s look at where Japan stands now. Japan's unemployment rate, at 3.7%, is virtually at the lowest point since 1998. Job offers to applicant ratio also recovered from the damage it suffered after the Lehman shock. The latest level, at 1.04, shows employers now need to compete to entice workers to fill their vacancies. 

Consumption is also booming in Japan. The level of retail sales in January 2014 is now at its highest in 15 years since 1998. Consumers are now willing to invest in consumer durables such as cars and TVs, fueled by the rush to purchase these large ticket items before the sales tax goes up in coming April. 

Consumers' robust willingness to buy also explains the reflation we are witnessing. Even after excluding food and energy inflation, core CPI has a positive inflation now. The 0.7% year on year inflation may seem low from an international perspective, but it is still the highest core inflation rate in Japan since 1998. The prices of the many of traditionally deflation-prone items, such as furniture, household utensils, apparel and TVs, are now starting to rise. There is a clear sign that deflation is on its way out in Japan. 

But can Japan really exit from its deflationary era? Unfortunately, here we need to turn pessimistic. We think the Japanese economy is likely to start stalling from April onward. The Abenomics has succeeded to prop up Japan’s growth through increased fiscal spending and monetary stimulus. What is likely to happen now is that the fiscal policy is about to be reversed. Through the course of 2014-2015, Japanese government plan to cut its deficit by an equivalent to 3% of GDP, half of it as the rise in sales tax, and the rest through spending cuts and a rise in social security contribution. 

Monetary stimulus could remain in place. Even better, there is a chance that BoJ could step up the stimulus. However, the governor Kuroda does not seem to be forthcoming in offering it. He seems to want to wait till he hears clearer evidences of the Japanese economy going south. In our view, by the time he decides, it may be too late. Once consumers and investment sentiments start to cool off, it will be formidably difficult for policy makers to reverse the sentiment.

We did not mention the famous third arrow. Well, that is because it is non-existent. In the 14 months since Mr Abe took the PM seat, he pratically accomplished zero structural reform. TPP was the most hopeful among the list of important items, but the chance of it happening seems to be diminishing. On deregulation, there has been very little to speak off. If anything there were reregulation through the form of subsidies. He made no progress in labor market reforms.  

Where does it leave Japan? In our view, Japan is likely to enter a period of low growth after April 2014, and the economy will probably experience a recession through the course of 2014-15. Policy makers will probably realize their mistakes and  attempt to regain the momentum through implementing fiscal stimulus in early 2015, but it will probably not alter the general direction of the economy.