Abenomics is failing to deliver feel-good factor
In December 2012, Prime Minister Shinzo Abe came to power with a new vision for Japan. After two decades of stagnation, he promised to bring to an end the corrosive effects of deflation and in so doing revitalise the country’s economic health. He not only promised bold action but introduced some concrete goals to judge progress by. Of course, these were ambitious by design; as much aimed at raising expectations as to be fully realised. Unfortunately, the credibility of a number of these has been seeping away.
The Bank of Japan’s Governor, Haruhiko Kuroda, pledge to achieve its 2% inflation target in two years looks no closer than when he announced it in April 2013. The government’s pledge to build a ¥600trn economy by 2021 also looks in jeopardy, with nominal growth required to exceed 3% in the interim. To put that in perspective, two of the last four quarters have seen the economy contract on a nominal basis. The question is has the failure to meet his aims delivered a fatal blow to the Abenomics project?
As anyone who has participated in a lottery can testify to, multiple failures are not necessarily a deterrent to buying a ticket. As long as some success stories exist they can impact expectations more widely. The most obvious candidate in Japan is the surge in jobs. With unemployment at a 19-year low of just 3.2% and the jobs-to-applicants ratio at a 24-year high, few labour markets can claim to be as healthy. This achievement has rightly been celebrated but there is a rather large caveat. With unemployment falling, one would typically expect wage growth to rise as employers bid up wages and consumption to grow. However, the falling unemployment has coincided with higher participation rates with the senior labour force having increased by 1.35 million since 2013, while female participation has also risen noticeably. Unfortunately, many of these new additions to the labour force have taken up non-regular employment, which has outstripped full-time employment in recent years. This has had the effect of subduing average total compensation. It has also served to dampen consumption, as the propensity to save among these cohorts is higher given the income is often deemed supplementary.
Another potentially winning story - frequently cited by Abe himself - is the decline in corporate bankruptcies, which have declined to the lowest level in 16 years. Again, this would typically be welcomed as a sign of robust corporate health. However, we are wary about exaggerating the importance of this figure as it may reflect Japan’s unusually slow economic metabolism. Even during the global financial crisis, bankruptcy rates barely rose, while start-up rates are less than half the US. Perhaps even more worryingly, corporate behaviour does not reflect a renewed confidence, with the yen-induced surge in profitability among Japan’s listed exporters failing to trickle down to the rest of the economy. Indeed, cash hording remains a persistent problem, with accumulation of cash and deposits in the last three years reaching 6% of GDP.
Given the inability of Abenomics to generate a feel-good factor, it is no surprise that the deleveraging instinct remains intact among Japanese corporates and households. For us to conclude that this was a temporary phenomenon, we would need to see a significant improvement in leading sentiment indices. Unfortunately, consumer confidence continues to tread water, while the large company and small company indices are both depressed. As a result, investors are looking to policymakers to resuscitate Abenomics. The government appears ready to respond, with increasing emphasis attached to the fiscal and structural reform elements. We are concerned that an excessive recalibration would confuse the vision that Abe set out and may not have the desired effect in terms of lifting expectations.
Instead, we would argue the Bank of Japan continues to have a pre-eminent role to play, both in terms of lifting price expectations and growth expectations. Lest we forget, the most unique experience of Japan’s recent economic history was the sustained decline in prices. At an annual inflation rate of minus 0.3%, Japan saw its price level fall by 5% over the 15 years prior to Abe’s arrival. By way of comparison, if the Bank had achieved its 2% target during that period, it would have resulted in a cumulative 35% increase in the price level! The lesson from the limp reaction to the Bank of Japan’s QQE experiment is simple that shocking an economy out of a deflationary equilibrium is extremely difficult. The onus is on policymakers to find the tools to succeed, and in so doing convince a sceptical public that the future will be brighter than the past. On the other hand, if the role of monetary policy is diminished the policy mix is unlikely to prove as favourable to risk assets as that which we have seen in recent years.
Govinda Finn, Senior Japan Analyst, Global Strategy, Standard Life Investments
First published in Investment Adviser 1st August 2016.