Abenomics’ Structural Reform Problem


The effects of both the government’s inflationary policy and its consumption tax increase are becoming apparent this summer. As indicators come in and the government announces further economic policies for the rest of this year and into the next, Japan’s nascent economic recovery faces tough challenges that could cause it to stagnate yet again. Beyond the administration’s efforts to spur inflation and economic growth, Some of Japan’s largest asset managers are skeptical of long-term growth and are betting on declining returns.

While the government’s policy of quantitative easing has been underway since April 2013, and expectations around Abe’s new economic approach drove the yen down significantly beforehand in December 2012, this attempt at government-driven inflation has been a mixed bag of success and cost for the economy. The weakened yen made Japanese exports cheaper and was thus by and large a positive for Japanese companies, or at least its exporters, but the attendant increased costs for energy and inputs has tempered these gains. Signs are now emerging that Japanese companies may not be in favor of a weaker yen, especially one that rapidly depreciates. At a meeting of Bank of Japan branch managers on Monday, some voiced concerns that the yen was fueling increased prices of commodity imports. This view was expressed by the head of the BOJ’s Nagoya branch, where major machinery, auto, and other large manufacturers are based. Companies in these sectors were particularly concerned about sudden depreciations, for which they would be unprepared and which would leave them vulnerable to sharp increases in input prices.

To underscore this dilemma, the producer price index in June rose 4.6 percent year on year for the 15th consecutive month, which the BOJ attributed to rising oil prices. Even with the effect of April’s consumption tax increase taken out, the index still increased 1.7 percent and continued its 15 months of growth. Prices rose the most in the critical sectors of gas, electricity, and water supply, with an 11.8 percent climb.

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Addressing these key problems will be difficult for the government with its current approach, but it is taking steps over the next few months and into next year, as part of Prime Minister Shinzo Abe’s economic reform package, which it hopes will continue to drive growth. Part of that plan is the government’s recent announcement to allocate 4 trillion yen toward Abe’s policies as part of the 2015 fiscal budget. Approximately 1 trillion yen of that will be used for regional revitalization, and the other 3 trillion yen will be directed to the overall growth strategy. If passed this would be a doubling of the 1.9 trillion yen in special funding for Abenomics in fiscal 2014, with the government again asking agencies and ministries to find 10 percent in discretionary spending cuts to cover the costs.

Real progress in Japanese participation in the Trans-Pacific Partnership would also eventually provide a boost to the economy overall (even if it would spell short-term pain for sectors such as agriculture), and Japan appears to have made progress on this front at meetings in Ottawa this week. Japan reached agreement with its interlocutors on labor (such as sanctions for members exploiting child labor) and quarantine issues. The labor issue is seen as protecting developed countries from artificially low input costs. The meet also produced an agreement on how to settle disputes over quarantined products, which some fear would be used out of supposed safety concerns to effectively block the import of domestically protected goods. While this is indeed progress on two issues of concern for Japan’s highly protected industries, it does not address larger problems like the reform of state owned companies and the overall removal of agricultural tariffs, which is one of Japan’s biggest sticking points. Even if these larger issues are somehow resolved in remaining talks this year, a basic accord between the signing countries by year’s end would be unlikely to have a significant impact on the Japanese economy through much of the next year.

To underline the still fragile nature of the Japanese economy, and the underlying forces that dictate its long-term growth, one of Japan’s best performing domestic bond fund managers, who oversees part of Japan’s Government Pension Investment Fund, is betting against the long-term viability of Abe’s economic policies. Keisuke Tsumoto, who manages the strategic active bond fund at Manulife Financial Corp., has said that Abenomics will find it difficult “to change big trends… the economy’s growth potential is declining, so no matter how much stimulus is injected, a return to deflation is likely under my main scenario,” according to an interview with Bloomberg News. The larger structural problem of an aging and declining population still remain largely unaddressed by Abe’s current reform model. Although inflation has increased over the past year and corporate profits have appeared to level off after the consumption tax increase took effect, Tsumoto has summed up the situation succinctly: “Abe is saving time for the economy, but overall it isn’t changing… It’s hard to imagine there’s a bright future after this period of calm.”

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