“Welcome to Tokyo, the only city in Asia with clean air, no traffic jams, and a banker who will lend you 95 percent loan to value,” JP Morgan’s Jesper Koll tells visitors to the Japanese capital.
The Diplomat’s Anthony Fensom recently asked the Tokyo-based economist about the future of Abenomics and why he remains bullish about the world’s number three economy.
What’s your view of the latest Japan GDP data, which showed an annualized 0.7 percent expansion compared to economists’ median forecast of a 0.9 percent rise?
It was very encouraging as it showed domestic demand growth is becoming more balanced. For the first six to nine months of Abenomics, it was only the consumer, it was Mr. and Mrs. Watanabe via consumption and housing which was a consistent engine of growth. Now business investment is beginning to contribute, particularly by small and medium-sized enterprises (SMEs), and this is confirmed by some of the leading indicators, such as machinery orders.
Loan growth to SMEs over the last four months has started to go from negative to positive for the first time in about six years. At the end of the day, it’s the SMEs which are the belly of the economy and their strengthening is the reason why you should be optimistic on the outlook for the Japanese economy.
There’s been debate over the impact of the consumption tax hike. Is it going to kill the recovery?
There’s obviously going to be some volatility with the VAT [value-added tax] hike coming in, but it’s unlikely to derail the recovery. The reason is twofold: number one, the banking system is very healthy, credit growth is accelerating, borrowing by both the household sector and SMEs is rising, and the banking system is well capitalized. The money economy is actually working and that’s one reason why one should be optimistic.
The second reason is that the labor market in Japan is actually very tight; you’ve seen the unemployment rate come down substantially. This isn’t because of some gimmickry or arithmetic on participation rates, which is what you’ve seen in the U.S., but instead there’s genuine tightness in the labor market.
There is now in most sectors of the economy more demand for jobs than there is supply. Non-farm payrolls, the people who receive average pay, are growing at around 3.5 percent right now. Japan is actually the biggest job creation machine in the OECD. So it’s the labor market plus the money economy that make me very optimistic that for the VAT hike, outside some short-term volatility, the economy’s fundamental strength is going to stay intact.
The shunto (spring wage offensive] labor-management talks are only expected to generate modest wage hikes. Is this going to be enough to offset the hit to consumption from the increased tax?
The shunto only covers the large industrial companies, or about 15 percent of the workforce, and they’re getting a moderate pay increase of about 1 percent. But in the belly of the economy you’ve got a very different picture. For example in wholesaling and retailing, pay is increasing by around 3 percent. For civil servants, from bureaucrats down to firemen and schoolteachers, their pay is actually going up by 8 percent starting in April, which provides a wonderful cushion.
Japan’s latest current account deficit was its worst since 1985. Is this cause for concern, given the weakening yen doesn’t seem to be boosting exports?
The trade and current account falling from surplus to deficit had long been expected by economists. It’s very interesting if you look at it since four years ago, where the deterioration came from. About one-quarter came from increased fossil fuel imports because Japan has gone ex-nuke. But the other three-quarters are because of the surge in imports, and this is across the board.
When you go to a convenience store in Japan now, about 15 percent of what’s on the shelf is actually imported products, whereas five years ago it was less than 3 percent, so the country really has opened up. On top of that you’ve got consumer electronics and telecommunications and IT equipment, these imports have surged and it shows you the structure of the Japanese economy has changed.
More than half of the productive capacity owned by Japan is now outside of Japan, and utilizing those higher margin, high profit factories to pull products back into Japan is a win-win. The companies win because their profit margins on offshore factories are twice as high as domestic factories, and the consumer wins because the products are cheaper and of very high quality.
Looking at Prime Minister Shinzo Abe’s “Abenomics,” there’s been a lot of talk about the third arrow of structural reform having gone missing. What’s your view on Abenomics’ progress?
You have the analogy of the three arrows—one arrow, you can break, two arrows you can break, but three arrows together you can’t break. So it’s money, fiscal and regulatory policy all coordinated, that’s what Abe brings to the table. So what people refer to as the third arrow, the regulatory and growth policy aspect, I think it should be called 10,000 needles like acupuncture—which all add up to something that feels good. There I think that progress is very good.
If you look at agricultural policy, energy policy, healthcare policy, even labor policy—they will soon pass a bill in parliament which effectively opens the door to immigration in the form of a new visa category for temporary workers for trainers in the construction, healthcare and retail industry.
In November, they passed a bill that breaks up the generation monopoly of the utility companies, so now any entrepreneur can apply and receive licenses to generate power for profit. So you’ve got the big guys like Marubeni, Toyota, which have applied and received licenses to generate power for profit and from 2015 they will be able to feed power into the grid.
That’s a big deal…we estimate that the equivalent of about 2.5 nuclear power plants worth of independent power providers have applied for licenses to generate power.
[On agriculture] the problem with Japanese agriculture is it’s inefficient due to the large number of small lots—the average farm size is less than two hectares. Now that’s been deregulated, so the agricultural co-ops will lease plots of land so you can get scale into the system. So the yield and productivity of agricultural land in Japan is going to be increasing.
When the yen falls, Tokyo stocks rise. How long will this correlation continue?
Right now listed companies on the stockmarket are net exporters, so they benefit from a weaker currency. For a 10 percent depreciation of the yen, you basically add back about 10 percentage points to corporate profits. But as more and more companies shift production overseas, that sensitivity is going to go down because there will be dollar costs and dollar revenues, rather than yen costs and dollar revenues.
If you look at [the] Topix [index], the consensus is for earnings going to about 100 eps [average earnings per share] from 95 right now. We think that’s too conservative and it can actually get to 115, which would be a historic high. The previous high was 103.
That’s obviously a numerical reflection that something really has changed in Japan. For investors, it’s always important to have a knight in shining armor like Mr. Abe, but much more important than any one politician is that corporate Japan has restructured, they have taken out costs and invested in new businesses and consolidated their businesses. Just recently, Mitsubishi Heavy and IHI decided to pool and set up a new company for aircraft production, so the creation of national champions is now very much on the agenda.
What’s your forecast for the dollar-yen exchange rate?
I’m bullish on the dollar and the moment it becomes clear that [US Federal Reserve Governor] Yellen is not making a mistake and America can grow by 2.5 to 3 percent, the dollar should be a very strong currency. By Christmas the dollar-yen trading at 115 to 118 is a perfectly reasonable forecast to have.
Are you expecting more easing from the Bank of Japan?
In April-May there are chances of additional bond purchases. The Japanese economy should expand by around 2 percent over the next year.
It’s been a year or so since Abenomics was launched. How do you rate its success?
On a scale of one to 10, I think they probably deserve an eight out of 10. They can always be more aggressive, policies can always be implemented faster with a greater sense of urgency, but overall [Japan is] the one country where the government is very focused on promoting economic growth, not just by printing money but by also having a growth policy. They are not afraid to discuss and change agricultural policy, energy policy, healthcare policy. Concrete changes are happening—unlike what’s happening in Europe.