Will policies solve long-standing weaknesses?

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Japan - December 2014

With so much focus on emerging markets and, in particular, China, investors can be forgiven for sometimes forgetting that Japan is still a major economic power.

Estimated figures from the International Monetary Fund (IMF) calculated on GDP based on purchasing power parity show that Japan is the fourth largest economy in the world behind China, the US and India.

But this is often overlooked, as Japan struggles to reverse its deflationary environment and boost growth.

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However, the Japanese economy has recently been given a new lease of life, following the arrival of Shinzo Abe in December 2012, after years of ineffective political and corporate governance.

Real GDP figures from the Organisation for Economic Co-operation and Development show growth since 2012 has remained pretty steady at 1.5 per cent in 2013 and 1.2 per cent for this year and next.

But Japan’s latest GDP figures released in November reveals the country has fallen into a technical recession with a contraction of 0.4 per cent in the third quarter, resulting in an annualised contraction of 1.6 per cent.

Meanwhile, consumer prices index figures show a year-on-year increase in inflation of 0.4 per cent in 2013, which may seem a long way off from the country’s 2 per cent target, but it is a vast improvement from the negative figures posted in 2009, 2010 and 2011.

Mr Abe’s ‘three arrows’ strategy has become less sharply defined in recent months as inflation remains stagnant and details on the third step of structural reform remains sketchy, but the decision by the Bank of Japan to further extend its monetary easing policy at the end of October has provided an unexpected boost to the markets, and, as a result, hopefully the economy.

Neil Walker, portfolio manager, multi-asset strategy group at Insight Investment, notes: “Prime minister Abe’s economic reforms are a massive experiment, and in the long term Japan’s huge government debt and poor demographic profile make it uncertain as to whether reflationary policies will succeed.

“However, we do believe that bouts of stimulus… will lead to significant market opportunities. To succeed in the long term, [Mr] Abe’s policies will probably require a tailwind from the global economy. If global growth slows or there is a major risk-off event, it could derail the Japanese story.”

The question of course is whether this policy announcement will give a long-term or a short-term boost to markets and the economy. The rise in the consumption tax in April has already been cited as a partial reason for Japan’s lack of inflation in the past few months, and with another one scheduled for next year the outlook remains uncertain.

Mike Woolley, client portfolio manager for Asia equity at Eastspring Investments, also cautions that “while this latest news is supportive for equities, one cannot rule out bouts of market volatility. This year has been a case in point: market performance and volatility has coincided with short-term-focused participants responding to thematic macroeconomic news flows, irrespective of company fundamentals.”