February 12, 2016, 23:00 JST

Abenomics is all but over

In September 2015, we wrote a report titled “Abenomics nearing its expiry date”, arguing that its chance of success had become slim and the credibility of the policy package would expire soon. It seems that the expiry date has now come to pass. Since the beginning of 2016, Japanese stocks have lost 23% of its value, while the Japanese yen has appreciated from 120 per USD to 112 per USD. The BoJ has tried to pre-empt the appreciation by introducing a negative policy rate on January 29, but to no avail. While these financial market developments have more to do with the global economic outlook, rather than with some Japan specific issues, we think that the chances are that the current adverse global current is strong enough to put an end to the so called Abenomics boom in Japan.

As for why we think Abenomics has failed, we have detailed it in the aforementioned report. In short, we think the idea behind Abenomics was sound, but it was badly executed. In theory, the policy package aimed to implement painful structural reforms while expansionary fiscal and monetary policies played the role of painkillers. In reality, no significant structural reforms were executed. An attempt to deregulate the labor market was quickly abandoned. The rigid and uncompetitive service sectors remained untouched. No attempt was made to reform the public pension system, but it was instead used as a way to prop up the stock market. TPP, the trade agreement with Asia Pacific countries, is probably the most visible achievement, but its economic importance is heavily over-rated.

In the meantime, painkiller policies were used in abundance, especially the monetary easing. Under the newly installed governor Haruhiko Kuroda, the BoJ went on an asset purchasing spree in bonds and equity. The government bond purchase program is so massive that the bank of Japan’s ownership of the JGB market, in terms of aggregate duration risks, rose from 6.6% in March 2013 to 28.9% by the end of 2015. It is expected to reach 50% by mid-2018 even under the assumption that the BoJ will make no additional expansion in its asset purchase program.

 

As a result of the massive monetary easing, the Japanese yen has weakened to a historic level in real terms. This led to a surge in the profit margin of Japanese corporations.

 

 

However, it seems that Japanese corporate managers did not mistake the short term benefits from the weak yen as an improvement in the long term competitiveness of exporting from Japan. Export volume from Japan hardly grew, as companies refrained from shifting production capacity back to Japan.

 

The persistence of pessimism in Japan’s long term economic future is likely to be one of the important reasons why wage inflation did not rise. Hiring needs for temporary workers did increase, leading to a healthy wage inflation for temp workers, but not for regular workers. Granted, the wage growth for regular workers has been slowly accelerating, and if it were allowed to continue, it could have eventually reached the level required to bring about healthy inflation in Japan. However, a downturn in an economic cycle could easily reverse the acceleration and that seems to be the likely scenario now.

 

Is Abenomics salvageable? 

We do not think so, but public policy makers will try. In the near term, as the market continues to go south, Japanese policy makers are likely to add stimulative monetary and fiscal policy. As the monetary policy seems to have lost credibility, perhaps it is a turn for a fiscal policy again. In our view, it would be wise for Prime Minister Abe to announce that he intends to cancel the sales tax hike currently scheduled in 2017. In our view, the hike could trigger an economic downturn, while doing little to restore long term fiscal sustainability for Japan.     

On the monetary policy side, our view is that the BoJ still has a formidable arsenal to help Japan cope with a potential recession. The BoJ could drive its policy rate lower to restrain yen from rising. The BoJ could expand its risk asset purchase program to bolster market confidence. However, the BoJ needs to seriously reformulate its market communication strategy. The governor Kuroda seems to think that surprising the market is an effective policy, even if it involves deliberately misleading market participants. He should know that such strategy is undermining the credibility and the effectiveness of the BoJ’s policy tool.

When will Abenomics literally ends?

In our view, Prime Minister Abe could lose heavily in the Upper House election this summer. While the public poll results are still favorable for him, his personality was never particularly popular among the Japanese public. His approval rate primarily comes from the fact that the Japanese economy was seemingly doing OK under his reign. 

 

However, recent turmoil in the financial market must be shaking the public’s confidence in his economic policy making ability. There is one particular news that is likely to make him very unpopular. In October 2014, Abe cabinet made an important change in the asset allocation of the public pension funds. The allocation of equity assets were raised from 24% to 50% and the allocation to foreign bonds were raised from 11% to 15%. While the public pension had not yet raised its actual allocation to the new target levels by September 2015, the allocation to equity and to foreign bonds were raised to 43% and to 14% respectively. Assuming that the allocation ratio had not changed, the public pension fund would have incurred the loss of over 10% of the total fund by now. While it is an inevitable consequence of taking risks, what the Japanese government effectively did was to increase the allocation to the equity asset as the market was nearing its peak. People would probably question the wisdom of such decision. Unless financial market recovers between now and the end of March, the news of a severe loss in the public pension fund will hit the newswire toward the end of May, in time to be used against PM Abe in the upper house election. A while ago, some pundits were talking about PM Abe potentially staying till Tokyo Olympic in 2020. Instead, we are likely to see the back of PM Abe as early as this year.