Abenomics Ends Darkness In The Land of The Rising Sun
20th February 2014
Abenomics has revived economic growth in Japan but long term structural reforms – the Third Arrow – holds the key to its ultimate success, argues Jagannadham Thunuguntla
Ever since the election of Shinzo Abe as Japan’s Prime Minister in December, 2012, the word “Abenomics”, a portmanteau of the words Abe and economics, has been creating a buzz in global investor circles. The economic policies of the Japanese Prime Minister, collectively represented by the word, have been credited with lifting the darkness that had been engulfing the Japanese economy, since the bursting of the asset price bubble in the Land of the Rising Sun in the early 1990s.
Undoubtedly, the bold risk implicit in the economic policies of Shinzo Abe has profound significance not only for Japan but also for economic policy-making across the world. One year down the line since its implementation, Abenomics seems to have electrified market participants and has pulled the country out of its economic malaise. Now the big question is: How long will Abe be successful?
So far, so good. At this time when most of the emerging economies from India to Indonesia are sailing the choppy seas of Current Account Deficit (CAD) and ballooning inflation, Japan seems to be riding an entirely different beast altogether with a surplus in the current account and chronic deflation/low inflation. This contrarion story is further underscrored by the fact while almost all policy makers across the globe are struggling to lure foreign institutional investors (FIIs), those in Japan are busy tackling the challenge of how to encourage capital outflows.
Why Credit To Abenomics?
At present the Western countries’ central banks (US, UK, Eurozone) are busy struggling with their own financial hangover, and here in Japan, Abe’s “three arrows” of economic reform offer a potential road map for revival. The “three arrows” are – a violent shift in monetary policy, vigorous fiscal stimulus and longer-term structural changes. With these “three arrows”, the Abe administration is leaving no stones unturned to conquer years of growth-undermining deflation during which companies and households have reduced their spending expecting that prices would not rise soon.
For now, the central bank of Japan has a target of 2 percent inflation. In reality, the goal of 2 percent is set aiming at lifting the nominal growth of the country, eroding debts and establishing a virtuous circle in which wages, consumption and investment would follow each other towards a “normal” economic cycle. Recently, the Bank of Japan (BoJ) Governor, Haruhiko Kuroda, has maintained its projection that the core consumer prices will rise 1.9 percent in the year starting April 2015 but has also clarified that the projection is excluding the effect of sales-tax increases.
Recently, with a view to support the fragile economic growth and to stamp out two decades long deflation, the BOJ has boosted lending programs, despite the fact that it is sticking to its plan for unprecedented assets purchase. It has doubled a funding tool to 7 trillion yen, which is around $68 billion and has also announced that individual banks could borrow twice as much low-interest money as previously under a second facility. But in reality, this may not affect the country’s businesses much as they are already sitting on a hefty cash position, but may give a good boost to investor sentiments in the financial markets and will definitely weaken the Yen.
Though the initial evidence on “Abenomics” is certainly positive and is attracting worldwide attention for its anti-deflationary and economic revitalization package, there is still a long way to go. At the moment, it is far too early to predict if Abe’s administration will be successful in ending deflation and bringing price stability and employment stability amid a stable recovery. Even though interest rates in Japan were at 0 percent for years, it failed to boost final consumption demand because of chronic deflation. Since last two decades, Japan has been spending trillions of dollars in an effort to lift its economy from the recession brought on by the bursting of a real estate bubble in the early 1990s.
The first two arrows in Abe’s quiver, namely, higher fiscal spending and radical quantitative easing have resulted in a sharp spike in equity prices and a weaker yen as against the dollar. The success of the two arrows has provided a lifeline to the export-oriented economy. Now, psychologically, the improving economic outlook have greatly raised expectations about vigorous implementation of Abe’s third arrow – growth-oriented structural reforms.
The Bank of Japan’s (BoJ) recent move to increase its special loan programmes to help sustain economic growth, indicates its determination to keep the positive mood generated by Prime Minister Shinzo Abe’s reflationary policies from withering. Perhaps, this also reflects the fact that Abenomics has cleared the darkness and made Japanese policy makers see a rising sun.
Success Of Abenomics Depends On “Third Arrow” – The Structural Reform
But Abe’s third arrow, which is structural reforms to boost Japan’s competitiveness, has not met with the same intensity of success that the implementation of the first two arrows led to. The most high-profile element of Abe’s structural reform plan is to conduct trade through Trans-Pacific Partnership (TPP), and for this Japan has conducted a series of trade negotiations with such countries as the European Union, Canada, Australia and neighboring Asian countries. But the same was opposed within the party and it has put brakes on the Trans-Pacific Partnership Participation, which includes 11 countries along the Pacific Rim.
At present the recovery in the economy is starting to cool off and consumer sentiment is declining, so more strong structural reforms are needed for stable economic growth. If Abenomics is to succeed some solid measures are required to be introduced. At this moment, the government should seriously look into labor market reforms along with agriculture and health care sectors, if it is serious about lifting the growth of the economy. No doubt, there will be ample of challenges to Abe’s policies because many times he has been opposed by his own party members. Also the results of any structural reforms will take more than five or six years to become visible.
Is Japan’s Economy Strong Enough To Weather Tax Hike Storm?
Since last year Japan has been rejoicing as it has finally re-found some backbone, with strong growth, better company earnings, falling unemployment and bullish stock markets, arigatou gozaimasu (thanks) to Prime Minister Shinzo Abe’s economic measures. However, the announcement of the hike in consumption tax has adversely impacted the Japanese peoples’ sentiments. In the month of October 2013, the Prime Minister confirmed that the tax hike will be introduced in two stages from 1st of April 2014. From April 1, the consumption tax rate will be hike to 8 percent from the current 5 percent, and then again on Oct 1, 2015, the rate will be increased to 10 percent, if the economy moves well.
Now the question is how will the tax hike impact the economy? Actually, this decision has been taken to restrict Japan’s huge public debt even at the risk of a slowdown in the economy in the short term. The Japanese government debt has now exceeded 1 quadrillion yen. The fear of the consumption tax hike has pushed up domestic demand and this is likely to continue until March 2014. No doubt, the hike in consumption tax from current 5 to 8 percent, will lead to an improvement in the government’s financial health in the long run and will raise Japan’s credibility across the world. If everything goes well, the economic measures so far taken by the government will have a big impact, and this will help to overshadow any negative impact of the consumption tax hike.
However, one cannot deny that the Japanese economy will see a contraction in growth during the second quarter of the calendar year 2014 due to the tax hike, but the economy is sure to recover swiftly in the second part of the year on the back of Abenomics’ growth strategies and other measures.
To conclude, the path of growth will depend largely on whether or not the Japanese government is successful in implementing the impactful structural reforms. The recent BOJ announcement of doubling the lending facility is, of course, a dovish signal. It indicates that the central bank will keep its promise that it will do whatever it takes to pull the nation out of deflation. If everything goes well, Japan will see wage hikes, bullish equity markets, stable and comfortable exchange rate, and an increase in capital spending and individual consumption in the days to come.