Mar.31, 2014, 21:00 JST

Abenomics Progress report 2

For the pdf version of this report click here 


In this report, we review the progress made by so called 'Abenomics', a combination of policies implemented by Prime Minister Mr. Shinzo Abe to promote growth in Japan. After a brief overview on the performance of the Japanese economy, we discuss how the main three policy components of Abenomics, namely, fiscal stimulus, monetary stimulus and structural reforms, are implemented and are affecting the economy. Lastly, we discuss the outlook of the Japanese economy.

1.Overview of Japan’s economic performance

The Japanese economy has done relatively well since PM Abe took power in December 2012. In October 2012, before Mr. Abe took power, IMF projected Japan to grow by 1.2% in 2013. Instead, Japan grew by 1.5%. It is not a spectacular outperformance, but the achievement is remarkable since the positive surprise was delivered amid a generally disappointing global background. The world economy in 2013 grew by 3.0%, lower than the 3.6% growth that the IMF projected as of October 2012. 

A positive surprise in Japan’s economic performance in 2013  

Source: IMF, JMA

How did Japan manage the positive surprise? A breakdown of Japan’s growth by categories reveals that in most parts, private consumption and public demand led to the growth in 2013.  

Private consumption and public demand led Japan’s growth in 2013

One could argue as to how much of Japan’s upturn could be attributed to Mr. Abe’s policies (Abenomics). In our view, while there are other factors, 'Abenomics' certainly played an important role. As we discuss in more detail in a later section, fiscal stimulus in the form of increased public spending directly contributed to Japan’s economic growth in 2013. Bank of Japan’s easier monetary policy weakened the yen, boosted corporate profits and fueled the rise in Japanese equity prices. The rising equity prices, coupled with improved job security invigorated private consumption. If these fiscal and monetary stimuli were absent, Japan’s GDP growth in 2013 would have been considerably weaker.  

2. Implementation of 'Abenomics' policies

In this section, we discuss the three main components of Abenomics policies, widely known as the “three arrows”. They are, namely, fiscal stimulus, monetary easing, and growth strategy. The first two, fiscal stimulus and monetary easing, are well into their implementation phase. In fact, the fiscal stimulus has already reached its proposed result and it is about to be gradually withdrawn from April 2014. As for the third component, growth strategy, the Abe government has come up with a large number of issues which it plans to address, ranging from female labor participation, international tourism promotions to corporate tax cuts. However, the assortment of policies lack coherence and most of the policies have been incorporated from previous administrations. In our view, except for the corporate tax cuts, PM Abe does not seem to have his personal political stake in most of the policies. We do not think the third arrow is having noticeable effects on Japan’s growth performance, either short term, or long term. 

2-1. Fiscal Stimulus

Firstly, how much stimulus has been added to the economy under the direction of 'Abenomics'? Commentators often equate the size of supplementary budgets to the size of fiscal stimulus. PM Abe has passed two supplementary budgets. The first one was 10.2 trillion yen (2.1% to GDP) in February 2013, and the second was 5.5 trillion yen (1.1% to GDP) in February 2014. However, these figures could be misleading, as supplementary budgets are often funded through cuts in the main budgets. Our preferred measurement is to use the change in IMF’s estimates for cyclically adjusted primary balance for Japan, before and after the advent of Abenomics, as the difference should be the result of policy changes. In this method, we calculate the fiscal stimulus as 1% to GDP in 2013.

Abenomics eased the 2013 fiscal policy by 5.0 trillion yen (1.0% to GDP)


Source: IMF, JMA

Significant portion of the fiscal spending seems to have gone to public work. Cabinet office estimates that public fixed investment grew by 12.7% year on year in 2013, an increase of 2.6 trillion yen (0.5% of GDP). In our projection, public work spending is likely to continue to rise in 2014.

Increased public projects account for about half of the fiscal stimulus

Source: Cabinet office, JMA

2-2. Monetary Easing

'Abenomics' started to influence monetary policy even 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 as well as hinted its intention to change its inflation targeting regime. In the following meeting in January 2013, the BoJ announced that it is changing its CPI inflation target to 2%. In April 2013, under the direction of the new Governor Haruhiko Kuroda, the BoJ introduced a new asset purchase program called Quantitative and Qualitative Monetary Easing (QQME). QQME includes a number of novel measures such as purchase of equity ETFs and explicit targeting of money supply. However, the most significant measure in our view is its announcement to purchase vastly larger amount of Japanese Government Bonds. In our estimates, the BoJ increased its ownership of the Japanese government securities (JGB and TBills) from 13% to 19% between March and December 2013. If the BoJ is to continue its policy, it will own close to 30% of the market by the end of 2015. 

BoJ is set to own close to 30% of the JGB market by end-2015


Source:BoJ, JMA

The BoJ also made a conscious effort to buy longer dated government bonds to flatten the yield curve. In the QQME, the BoJ announced that it is extending the average maturity of JGBs that it purchases to 7 years. 

BoJ is purchasing longer maturity JGBs

Source: METI, JMA

BoJ's monetary easing is affecting the Japanese economy in a multiple ways. The BoJ’s policy is directly helping to lower interest rates across the curve. For the past 12 months, interest rates across the curve are stable despite the rise in CPI inflation rate. 

Moreover, BoJ’s monetary easing are working to weaken the yen. Interest rate spreads between Japan and US are widening as the federal reserve of U.S. and the Bank of Japan head in opposite directions to a direct result of their monetary policy. The wider spreads are leading to weaker the yen. 

Wider US-Japan interest rate speads are causing yen to weaken

Source:BoJ, U.S. Federal Reserve, JMA

3. Growth strategy

As we briefly touched on earlier, we do not think the growth policy package, the so called third arrow of Abenomics, is having material impacts to the Japanese economy, either short term or long term. From the web pages of the Prime Minister’s Office, we can find large pile of documents describing Abe government’s growth strategy. For example,

Japan Revitalization Strategy - JAPAN is BACK - (PPT)

Japan Revitalization Strategy: Examples of Major Policies 

There are vastly more documents available on the Japanese economy, describing the details of growth strategy. In many cases, the goals of most policies proposed 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. However, the problem is that PM Abe’s heart is not in them. Most of the policies are not “his”, but have been handed down from previous administrations, many of them from more than a decade ago. 

For example, PM Abe’s policy target to raise the percentage of female in leading positions to 30% by 2020 has received international attention. The target has in fact been Japan’s officially pronounced target since 2003. In the past 10 years, the ratio merely improved by 1.5% points from 9.7% (2003) to 11.2% (2013). So far, we do not see any serious policy initiatives that could contribute towards raising the ratio by another 18.8% in the next 7 years.  

3. How 'Abenomics' affected Japanese economy

'Abenomics' effects were apparent in the financial market even before PM Abe took power in December 2012. The chart below tracks the performance of major stock indices from Japan, US, and Germany since September 26, 2012 when Shinzo Abe won the leadership of his party, virtually assuring himself of becoming the Prime Minister of Japan. Nikkei 225, along with the other global indices rose almost without interruption till mid-May, by over 60% accumulatively.  

The Japanese stock market rose over 60% since the advent of Abenomics 



Consumers responded quickly to the rising equity price. Private consumption consistently recovered through 2013. In February 2014, the level of retail sales in Japan was the highest since May 1998. 

The retail sales level in February 2014 the highest since 1998 


A return to the same level, which existed more than 15 years ago may not seem much for a normal economy elsewhere in the planet. However, for Japan where retailers have been suffering from deflation as well as from shrinking population, it is a significant accomplishment.

The stronger consumer sentiments is allowing Japanese retailers to transfer the rise in import costs onto their clients. In February 2014, the Consumer Price Index (CPI) rose by 1.3% year on year. Core CPI excluding food and energy rose by 0.7% YoY. It may seem low from an international perspective, but for deflation-prone Japan, it is in fact the highest inflation rate since 1998.  

Core CPI inflation rate highest since 1998


The sustainability of the current reflation is still suspect though. In order for a reflation to be sustained, it has to be supported by a wage inflation enabling consumers to maintain their purchasing power. While there are signs that wages are starting to rise, the pace of wage inflation seems moderate at best and it is almost certain to lag behind that of CPI inflation. Unless the wage inflation catches up with CPI inflation, the reflation trend in Japan is not sustainable.

Wage inflation is unlikely to catch up with the CPI inflation for some time


4.The outlook for the Japanese economy

In our view, the Japanese economy will face a strong headwind from April onward. The consumption tax rate hike from 5% to 8% will weigh heavily on private consumption. As a result of the consumption tax rate hike, we forecast that the CPI inflation will reach 3.6% in Q2 2014. The growth in household income will be nowhere near it, leaving Japanese consumers with a severely negative real income growth. Private consumption, the driving force behind the Abenomics boom in 2013, will stagnate from Q2 onward.

Export growth seems stagnant despite yen depreciation 


Capital expenditure is recovering, but seems not robust enough to be a driving force

Towards the end of 2014, Prime Minister Abe will face a difficult choice of whether to cancel the scheduled consumption tax rate hike to 10% in October 2015. In our view, his choices are to 1) immediately cancel the tax hike and add fiscal stimulus, 2) immediately cancel the tax hike, 3) not cancelling the tax hike but adding fiscal stimulus through increased spending, 4) not cancelling the tax rate hike, and refrain from additional fiscal stimulus. We think he will choose 3).While PM Abe would be choosing to implement a fiscal stimulus through increased spending, we do not think the size of the increased spending would be large enough to fully compensate for the negative shock of the consumption tax rate hike. Consumer sentiments will continue to stagnate in anticipation of the consumption tax rate hike in October 2015. In our view, as long as the Japanese government does not abandon the consumption tax rate hike in 2015, there is a high chance that Japan will suffer marginal negative growth in 2015. 

A fiscal tightening probably results in a marginal negative growth in 2015