The Prime Minister, Shinzo Abe, and Bank of Japan (BoJ) governor, Haruhiko Kuroda have rolled the dice aggressively and eased monetary policy in 2013 in a big change to previous years’ policies. Monetary policy was the first of Abe-san’s three arrows, to be followed by a bold set of macroeconomic reforms designed to revive the country’s economy, which has lain dormant for two decades. While the monetary policy arrow has gained praise by its success in 2013, progress on the other two arrows — fiscal policy and growth policy — has been slower and is ongoing.
A weaker exchange rate
Yen weakness has kick-started that process, by pricing the country’s manufacturing base back into the global economy. From here, aided by policy initiatives Japan must attempt to become self-reliant as the weaker yen leads to improvements in domestic activity. While in the past, benefits from a weaker currency soon petered out, there are positive signs of sustainability this time around. Deflation is being gradually squeezed out of the system; in November 2013 the consumer price inflation rose above 1% for the first time in many years, making steady headway under the BoJ’s efforts to achieve a 2% inflation target via aggressive monetary stimulus.
In the latest BoJ quarterly Tankan survey of business sentiment released in December 2013, business confidence rose to the highest level in six years. Sentiment improved not just for big firms but also for smaller companies, which have been slower to reap the benefits of a recovering economy. Small manufacturers' sentiment hit a six-year high and the small non-manufacturers' index turned positive, which means optimists outnumbered pessimists, for the first time since 1992. The monthly Reuters Tankan survey in January 2014 also painted a similar picture as current conditions continued to improve with rising demand and a weaker yen having a favourable impact. Proactive policies are feeding through to a better domestic environment and this can also be seen via an increase in bank lending in the domestic economy and improvements in the housing market.
The story is only half-toldThere are good reasons to be positive on the future of Japan. With political stability (no elections due until 2016), the popularity of the government and a strong relationship with the central bank, the fundamental political forces in favour of Abenomics remain. Shoots of recovery in the economy are also very encouraging; in January 2014 the International Monetary Fund upgraded its October projections for Japanese growth by 0.4% to 1.7%. Whilst weakening the exchange rate has carved a path for economic recovery, it would appear that the currency is already at a level which provides enough impetus for higher levels of activity.
Potential catalysts that could derail this recovery process are likely to be policy errors and/or politicians stepping back from their promises. If global growth was to falter this too would be difficult as Japan would not be immune from such a development. However, as long as policies are kept on track, the benefits of a weaker yen should provide higher profits which in turn should lead to higher wages.
The big question is how will equities react in Japan? The stock market has risen by more than 75%* since the beginning of this move, which started over a year ago albeit from very low levels. There is conceivably room for a move higher provided policies remain on track and the benefits of increased profitability percolates through the economy. Perhaps more importantly there is scope for a change in inflationary expectations to take place so that consumers, who wisely kept saving throughout the deflationary period, begin to spend more avidly. A change in mind-set is difficult to transact but it must be a prerequisite if the authorities are to be successful in rejuvenating Japan.
*Source: Thomson Reuters Datastream, Nikkei 225 Average index, total returns, 31 July 2012 to 31 January 2014
Conclusion: The first arrow has successfully been deployed but this is just part of the plan. Attempting to move an economy out of deflation to one of inflation must surely be fraught with difficulty and setback but the reward can be substantial. It is this transformation which sets Japan apart from countries elsewhere. Japan has always been regarded as being rather unique from the excessive years of the 1980s to the deflationary wilderness of the decades which followed. Can Japan maintain this originality as it attempts to move towards sustainable expansion and win friends back from the investment world? Whilst we cannot be certain of the outcome we can be sure that the leaders of that once vibrant nation will do their utmost to reinstate premier status.
