November 18, 2014, 1:00 JST

Our views on Japan has changed

Our outlook for the Japanese economy has substantially changed in the last three weeks. The change is most pronounced for 2016 where we are revising up our forecast from 0% growth to 1.2% growth. We now see Japanese economy accelerating toward 2016.

The most obvious reason for the change is the PM Abe’s decision to delay the consumption tax rate hike from October 2015 to April 2017. In our view, the decision should substantially boost the confidence of Japanese corporates and households. For them, the planned tax hike in late 2015 has been a big dark cloud shadowing Japan’s economic horizon, discouraging them from spending and investment. Now that the cloud is gone, at least in the immediate future, they will be encouraged to spend and invest. On top of the postponement of the consumption tax hike, PM Abe is also likely to formulate 3 trillion yen (0.6% to GDP) worth fiscal stimulus in early 2015

The Bank of Japan’s QQE2 (Quantiative and Qualitative Easing 2) announced on October 31 was equally important. It was a bold step, as powerful as the first QQE1 announced in April 2013. In the QQE1, the BoJ was absorbing roughly 90% of the duration risk issued by the Japanese government on net. In the new QQE2 policy, the ratio will rise to 150%.  Yields on JGBs will be unjustifiably low for private investors to hold onto, forcing them to reallocate their assets toward Japanese equity and overseas assets. The combination of low interest rates, rising stock prices and weaker yen should results in substantial boosts to the Japanese economy.     

What about Japan’s fiscal sustainability?

Pundits may claim that the continuation of loose fiscal policy and aggressive monetary easing could cause a loss of confidence in Japan’s ability to maintain debt sustainability. While that is true, we would argue that it is a gamble Japan needs to take. In our view, defeating deflation is a pre-requisite to achieving fiscal sustainability. The JGB market is already in a bubble, but the BoJ should be able to maintain the bubble for a few more years while the Japanese economy is given a chance to rid itself of the deflation and return to growth path.   

Upside and downside risk to our outlook:

There are a number of potential sources of upside/downside risks to our main forecast. On the upside, we would point to 1) stronger than expected overseas demand as a major risks. On the downside, 2) overseas economic disruption leading to a global recession and yen appreciation, 3) a rapid rise in inflation forcing the BoJ to abandon its QQE prematurely, are major risks. In the medium term, 4) the BoJ mismanaging the tapering process, 5) Japan’s fiscal policy failing to tighten even after the defeat of deflation, are the two major downside risk for Japan.