In its latest World Economic Outlook the IMF notes: “In Japan, implementation of the remaining two arrows of Abenomics – structural reform and plans for fiscal consolidation beyond 2015 – is essential to achieve the inflation target and higher sustained growth.”
Under the IMF’s current economic forecast the GDP growth for Japan in 2014 is likely to remain steady at roughly 1.4 per cent, before falling to close to 1 per cent in 2015 and 0.7 per cent in 2016.
Meanwhile the gross government debt burden, as a percentage of GDP, is set to continue to grow, reaching roughly 247 per cent in 2016, and with the Bank of Japan (BoJ) currently in a wait-and-see approach to the effect the recent consumption tax increase will have on the economy, the situation is looking more precarious.
Jeremy Lawson, chief economist at Standard Life Investments, notes: “I think we’re going to get a lot of volatility in the data this year. The consumption tax brought forward activity, so we’ll most likely get a very weak quarter of GDP growth in Q2 so reading those signs will be difficult.
“Once we get into the second half of the year, the consensus expectation is of a solid rebound in growth in Q3 and Q4. That will be quite an important time. If growth matches that, then there will be a lot more confidence. If it does not occur, and the economy takes a broader wobble, then you may see more uncertainties creep in.”
Alex Lee, manager of Canada Life Investments’ Japan fund, suggests that any further monetary policy from the Bank of Japan will not occur until at least July.
He explains: “The BoJ is being more patient, but that being said, if real interest rates turn back from negative to positive, or if inflation starts to fall then I believe the Bank will step back in and do more easing to boost inflation expectations again. Lots of people are now looking at the July meeting to see what they’re going to do next.”
He adds that with such a high debt to GDP level, anything the bank does that could destabilise that debt market could be extremely negative.
“I don’t think it will be a problem as 95 per cent of the debt is owned internally, so unless you have a run on debt from within Japan, then the debt market should be stable as long as Japan has a current account surplus.”
But he acknowledges the current account has started to deteriorate recently so concerns are being raised about what it means for the debt market.
“I think the current account deterioration is temporary, I think exports will start to pick up with a time lag, I think the weaker yen will increase competitiveness – it just takes time. But it is one of the key things we have to watch,” warns Mr Lee. “If it does stay in deficit then interest rates could be forced higher and it could be bad for the domestic economy.”
Chris Taylor, manager of the Neptune Japan Opportunities fund, points out that investing in Japan is about investing in the country’s global multinational companies while in contrast the country is in fiscal difficulties.
He explains: “Japan’s consecutively increasing annual budget deficit is driven by a growing elderly population, with their associated health and pension costs, that cannot be supported by an ever shrinking workforce and tax revenues. Unlike many other OECD countries, the worsening debt levels have had little to do with the credit crunch. Therefore the major risk associated with Japan is the already extreme, and deteriorating, fiscal situation.
“If the government is not able to deal with the country’s fiscal deficit, Japan will go bankrupt. Therefore, a slowing global economy or a significantly appreciating yen would pose major risks to Japan’s health over the long term.”
Mr Lawson concludes that the near term is less of a worry as Abenomics has bought some time, but the long term problems of weak underlying growth and high public debt on an unsustainable trajectory will come more into focus as the fiscal and monetary stimulus tails off.
“It will be an interesting few years. If Abenomics is successful it will be quite a big deal, but if it’s unsuccessful then it could play out in quite an ugly fashion. Good or bad, the focus on Japan will remain for some time.”
Nyree Stewart is features editor at Investment Adviser
