‘Abenomics’ – his three-pronged policies of monetary easing, fiscal changes and domestic reforms – underpinned his election campaign and he will be hoping to cement that goodwill during what is becoming a challenging period.
With the yen having fallen 7 per cent against a resurgent dollar since the end of October and poor third-quarter growth figures that pushed Japan into a technical recession, what is the outlook for the Japanese economy and is it poised for yet another deflationary cycle?
Ian Heslop, who runs the £1.2bn Old Mutual Global Equity Absolute Return fund, says: “While the top-line numbers have generally been good… the promised programme of structural reform has made little progress.”
Meanwhile, Jeremy Lawson, Standard Life Investments’ (SLI) chief economist, says the Bank of Japan (BoJ) intends to combat deflation by closing the output gap and changing the relationship between the latter and prices, to help eradicate a deflationary mindset.
With Japan’s potential growth rate at roughly 0.5 per cent, he says an increase in activity above this rate should close the output gap. Until the consumption tax hike in April 2014, the signs had been encouraging, but since then, annualised growth rates have fallen 7.3 per cent and 1.6 per cent in the second and third quarter, respectively.
So is Japan experiencing a temporary downturn or a more sustainable opening up of the output gap?
“The best guide to changes in the output gap is the level of excess labour capacity in the economy,” Mr Lawson explains.
“The unemployment rate is currently 3.6 per cent, while September’s openings-to-applicants ratio stood at 1.09x, marginally below the August reading of 1.10x, which was the highest level since 1992.
“These indicators suggest labour conditions remain tight and the recent weakness in activity has yet to result in a widening of the output gap.”
In the area of deflation, both survey and market data indicate a stalling in the rise in inflation expectations since April’s sales tax hike, but whether this leads to a plunge back to previous levels will depend on the response by the government.
The BoJ has increased its easing programme and Mr Abe has postponed a second consumption tax hike, but it is unclear whether these measures will be sufficient.
Mr Lawson says that, primarily for political reasons, the challenge had become far greater than Mr Abe was willing to admit, so he was not aggressive enough in his initial round of Abenomics announcements.
However, Mr Abe has now mobilised all the fiscal, monetary and structural tools at his disposal and set an explicit target of exiting deflation.
Assuming his political power base remains solid, SLI’s view is that a fall back into a deflationary cycle is unlikely.
Near term, Mr Lawson believes the impact of the April consumption tax hike will be temporary, given that the third-quarter consumption data were not that bad, rising 1.6 per cent on an annualised basis.
“Public investment was a big contributor to Q3 activity, up 8.8 per cent, and given rumours of a ¥3trn (£16.2bn) fiscal package for financial year 2015, further support looks likely,” Mr Lawson claims.
Elsewhere in the economy there is concern that debt or Japan’s ageing demographic will be a drag on future recovery.
With borrowing costs low, Mr Lawson sees the risk of a sovereign solvency crisis as unlikely.
The bigger issue, he believes, is Japan’s “awful demographics”.
To keep the economy growing, Japan needs to see unprecedented levels of productivity growth or deep labour market reforms, to prevent a future collapse in the country’s workforce, while mass immigration is unlikely.
Some have speculated that a weak yen could save the country by making exports cheaper.
And the weaker yen has indeed increased corporate profits, but exports have responded sluggishly. In any event, Mr Lawson thinks Japan’s reputation as an export-oriented economy is somewhat “disingenuous”. From 1980-2013, the average share of exports in GDP was about 12 per cent, not far off the US economy’s.
“The impact of net exports to growth in recent quarters has disappointed, indicating a problem that yen weakness is unlikely to solve,” he says.
Instead, he says Japan has seen the real value of its currency fall against a basket of currencies for nearly two decades and that structural reforms offer the best way of unlocking Japan’s export potential.
“Japan suffers from poor capital allocation (a low return on assets, insufficient company creation and destruction), insufficient returns from research and development investment, poor energy infrastructure and inefficient labour utilisation,” he explains.
However, Tony Lanning, multi-manager at JPMorgan Asset Management, says he is more optimistic.
“The introduction of the new JPX-Nikkei 400 index has put further pressure on chief executives to improve corporate governance,” he says.
“Companies exercising cost-cutting measures, as well as share buybacks, have resulted in rising return on equity and return on asset [metrics] and a subsequent re-rating.”
