Jul. 18, 2013, 12:00 JST

Abenomics: Progress report

Summary

In this report, we review the progress made by so called 'Abenomics', a combination of policies advocated by Prime Minister Shinzo Abe as he took power in late 2012. After a brief overview, we discuss how each policy is being implemented and later assess how these policies are affecting the Japanese economy. 

Overview

What is 'Abenomics'?

For now, 'Abenomics' is a combination of three categories of policies, namely, fiscal stimulus, monetary easing, and growth strategy. Some also argue that there is (or should be) a fourth component - fiscal reconstruction. Among these three to four categories of policies, the first two are well-defined making it relatively easy to assess its implementation and effectiveness. On the other hand, the third, growth strategy, is not well-defined, either by the Abe government themselves or by economic commentators like us. The fourth one, fiscal reconstruction, is well-defined, but we don't think the Abe government has adopted it as one of the core components of the 'Abenomics' package. 

How much of 'Abenomics' policies are actually implemented?

The first two, fiscal stimulus and monetary easing, are already well implemented, although we see some flaws in their implementation, especially in monetary easing. As for the third - growth strategy, the Abe government has come up with a large number of issues it plans to address, ranging from female labor participation to university rankings to clean energy. However, the assortments of policies lack coherence and they suspiciously look like a random mash-up of pet projects put forward by bureaucrats and politicians. It is difficult to assess the level of implementation of these 'growth strategy' policies. Many of these policies now put under the 'growth strategy' banner were pre-existing even before the word 'Abenomics'. We will discuss more on the topic later.        

Assessment of 'Abenomics' policies

1. Fiscal Stimulus

How much fiscal stimulus?

Firstly, how much stimulus has been added to the economy under the direction of 'Abenomics'? Some commentators use the total size of the FY2012 supplementary budget passed by the Abe government in January 2013, 10.2 trillion yen or about 2.1% of GDP. In our view, using this figure leads to an over-estimation of the stimulus, as the supplementary budget included a number of items that do not count as stimuli. For example, the supplementary budget included 2.6 trillion yen transfer to national pension fund. The transfer does not lead to any added spending nor cuts in taxes. Another source of over-estimation is that some of the spending in the supplementary budget (2.1 trillion yen) was financed through cuts in the FY2012 main budget. Such reallocation does not lead to any increased spending either. Counting out these items, the fiscal stimulus enacted by the Abe government comes to 5.5 trillion yen, about 1.2% of the GDP. This figure also corresponds to the change in IMF’s estimates for cyclically adjusted primary balance for Japan between 2012 October (-7.5% to GDP) to 2013 April (8.7% of GDP). 

Abenomics eased the 2013 fiscal policy by 5.5 trillion yen (1.2% to GDP)

 

Source: IMF, JMA

Where the fiscal spending is going? 

Majority of the fiscal spending seems to be going towards public work. According to the estimate published by the Ministry of Land, Infrastructure, Transport and Tourism in June, public construction in Japan would grow from 18.9 trillion yen in FY2012 to 22 trillion yen in FY2013, a rise of 16% year on year.        

Public construction spending to exceed 20 trillion yen in 2013

 

Source: Ministry of Land, Infrastructure, Transport and Tourism, JMA

2. Monetary Easing

'Abenomics' started to influence monetary policy much before Mr. Abe became Prime Minister on December 26, 2012. On; December 20, 6 days before Mr. Abe's inauguration, the BoJ decided to increase the size of its asset purchase by 10 trillion yen. It also indicated plans to change its inflation targeting regime ('1% goal' at the time) by directing its executive to review the subject. In the following meeting in January 2013, the BoJ eventually declared that it is targeting 2% CPI inflation. In April 2013, under the direction of the newly appointed Governor Haruhiko Kuroda, the BoJ took another large step by introducing a new easing regime it named as Quantitative and Qualitative Monetary Easing (QQME). This regime included a number of measures, but in our view, the most significant measure was its announcement to purchase significantly larger and longer-dated Japanese Government Bonds. As a result of the policy, the BoJ will be more than doubling its JGB holding from 91 trillion yen as of March 2013 to close to 200 trillion yen at the end of 2014. In our estimate, the BoJ will own 25% of total JGBs at the end of 2014, up from 12% as of March 2013. Moreover, the BoJ announced that the average maturity of JGBs it purchases will be around 7 years, about the double the average maturity of its JGB holdings as you could see from the following two charts. 

BoJ’s JGB holdings likely to double between mid-2013 and end-2014

   

Source:BoJ, JMA

BoJ to extend the average duration of its JGB holdings to 4.6yr 

Source:BoJ, JMA

Note:Figures are our estimates based on public information

Is the BoJ’s action leading to an actual monetary easing?

While the BoJ’s policy actions have been spectacular, it is not self-evident that these policy actions are actually leading to an easier monetary condition. For example, despite the repeated comments by the BoJ officials that the policy actions are intended to lower interest rates across the yield curve, interest rates has in fact risen, rather than fallen (refer chart below). Higher interest rates are usually associated with 'tighter' monetary policy, rather than 'easier' monetary policy. So what is happening?

Following Kuroda’s policy announcement, interest rates are higher across the yield curve

 

Source:MoF, JMA

Against such criticism, the BoJ typically responds that the rising interest rates are the results of a higher inflation expectation, and the real interest rates after deducting the now higher expected inflation have fallen. While we agree that the expected inflation may have risen in the past few months, we are far from certain if the real interest rates have fallen. The BoJ’s policy actions may have merely stoked the possibility of higher future inflation and the risk of earlier than otherwise tightening by the BoJ. In our view, there are ample valid reasons that the BoJ is likely to keep its policy rate at near zero for some time even when it has succeeded in reflating Japan. In order to maintain the monetary condition in Japan as easy as possible, the BoJ needs to communicate such an outlook to the market.   

3. Growth strategy

So many growth strategies, so many ways to waste tax payers’ money

In the web pages of Prime Minister’s Office, we can find large pile of documents describing Abe government’s growth strategy and details of 100s of specific policies under the strategy. If you are somehow interested in the subject or in need of some very boring documents to put you to sleep, here they are. 

Japan Revitalization Strategy - JAPAN is BACK - (PPT)

http://www.kantei.go.jp/jp/singi/keizaisaisei/pdf/en_new_senryaku.pdf

Japan Revitalization Strategy: Examples of Major Policies 

http://www.kantei.go.jp/jp/singi/keizaisaisei/pdf/en_sesakurei.pdf

There are even vastly more documents available in Japanese describing the details of growth strategy, hundreds of individual policies put under the 'growth strategy' banner. Upon reading some of them, our impression is this- what a colossal effort to waste tax payers’ money! In many cases, the goals of each policy are noble. Examples include raising the rate of new business establishment, encouraging senior population to remain in work force, raising Japanese universities’ ranking in the world, encouraging easier flow of information in the real estate market. Although, knowing how Japanese bureaucracy works, we know most of these policy initiatives result in subsidies, government funded projects and more work for public financial institutions. 

Of course, there are some policies that seem innocent enough. For example, in order to encourage tourism, Abe government seems to be considering relaxing tourist visa conditions for ASEAN nationals. However, these policies do not need the extra push by the 'Abenomics' to be realized. In our view, there is really no strategy in the 'Growth strategy'. It is just a big banner where bureaucrats and politicians put their various pet projects as well as other normal routine policy changes under.

Will the situation change after the Upper House election?           

Some argue that the Abe government may unveil more ambitious reform plans after the Upper House election. It is possible. For example, the Abe government has been somewhat vague about what it intends to achieve in the Trans-Pacific Strategic Economic Partnership Agreement, fearing backlash from agricultural lobby. With the election over, the government may push through with some liberalization in the agricultural trade. The government will also likely give a final confirmation to raising the consumption tax rate from 5 to 8% in April 2014. The government may also decide to tackle other politically tough questions such as raising the retirement age. However, we think it is unrealistic to hope that Abe government would suddenly be energized to tackle the harder issues such as broadening the corporate tax base or labor law reforms. For what reforms we think are important for Japanese long term growth, we would like to address them in separate reports. 

How 'Abenomics' is affecting Japanese economy

Japan has outperformed its global peers in 2013

The policy combination of Abenomics seems to have had its largest effects on the financial market, in particular in the stock market. The chart below tracks the performance of major stock indices from Japan, US, and Germany since September last year when Shinzo Abe won the leadership of his party virtually assuring himself of becoming the Prime Minister of Japan. Not only has the Japanese stock market risen by over 60%, but it has outperformed the other two markets.    

The Japanese stock market has outperformed other global peers

 

Source:JMA

We can see a similar outperformance of Japan in the pure economic growth term as well. The chart below shows how IMF revised its economic outlook on the world and on Japan since October 2012. While IMF has kept revising down its growth projection for the world, it has kept revising up its growth projection for Japan. For 2013, Japan seems to have positively surprised the world.

The growth in Japan has outperformed the world in 2013

  

Source:IMF, JMA

Is Japan's outperformance due to 'Abenomics'?

Some could legitimately ask if 'Abenomics' really had anything to do with the outperformance of Japan. In our view, while there are factors, 'Abenomics' clearly contributed. As we saw earlier, fiscal stimulus in the form of increased public spending is directly impacting Japan’s economic growth in 2013. We also see a modest but clear improvement trend in the private consumption since late last year. The wealth effects from the stock market as well as improving labor market condition are among the factors boosting private consumption. 

A modest but consistent recovery in private consumption since early 2013

Source:METI, JMA

Deflation is not over yet

However, while the economic expansion in 2013 is real, there is yet little evidence that the two decade long deflation is over. Despite the ongoing recovery in the labor market, we are yet to see any notable upturn in the wage growth. In our view, it will take at least another year for an upward wage pressure to build in the labor market. Could the economic expansion be maintained for one more year? We think, the likely fiscal tightening starting in April 2014 could prematurely terminate the positive cycle of wage growth and consumption driven growth.  

Wage growth is yet to turn YoY positive

  

Wage level remains depressed

 

Source:Ministry of Health, Labor and Welfare

The core CPI is yet marginally deflationary

Indeed, the underlying inflation trend remains deflationary. Both the headline as well as core CPI excluding food and energy are declining year on year. The trimmed CPI measure, the indicate we consider as the best representation of the medium term 'core' trend, shows that the trend is still slightly deflationary at -0.3% YoY as of May 2013.

Core CPI remains in the deflationary territory 

Conclusion

In the 6 months since its official inauguration, 'Abenomics' seems to have done well. The fiscal stimulus is definitely working to stimulate growth. There are some critical flaws in the implementation of monetary easing, but it does seem to be helping the Japanese economy through weaker yen and higher stock market. The growth strategy is really not there, but the lack of it does not seem to negatively affect the immediate growth outlook. As a result of these policies combined, the Japanese economy and its stock market has succeeded in outperforming its global peer in 2013.

The question is its sustainability though. We have strong doubts that Japan's outperformance may not last long. We are particularly concerned for what would happen in the second half of 2014 when the fiscal stimulus is withdrawn. Currently, a major fiscal tightening amounting to 2.5% of GDP is scheduled for 2014. Even when we assume that the Abe government would come up with a modest package of economic stimulus to offset the negative impact of the consumption tax rate hike, there will likely to 1-1.5% fiscal tightening in 2014. Can Japanese economy withstand the tightening? Will the private demand such as capital expenditure, exports, be strong enough to offset the negative repercussion from the fiscal tightening? While we would give some outside chance to such outcome, we think it is more likely that Japan would either fall into a recession in the second half of 2014, or need to rely on another wave of fiscal stimulus to boost growth. How long can Japan rely on such continuous fiscal adrenaline injection? That would be a topic for another report.