In an article I wrote in this paper last February, I had spoken about the start of a programme by the Japanese government to push the country towards a two per cent inflation target. Until then, Japan passed through a 20-year period during which nominal GDP had stagnated – the period after the bursting of the asset price bubble, better known as Japan’s two ‘lost decades’.
Monetary easing will effectively double the monetary base by 2014
As you may recall, Japanese Prime Minister Shinzo Abe was brought to power as a result of the country’s December 2012 general elections. However, in the run-up to that election, in which it was clear that Abe was heading towards a landslide victory, the effects of the aggressive monetary easing to follow started to be felt with a soaring Japanese equity market and a yen in free fall.
The plan Abe wants to put in place is based on a three-pronged attack, policies collectively known as ‘Abenomics’. These include fiscal stimulus, aggressive monetary easing and structural reforms.
With respect to fiscal policy, the headlines focused on news last January that Japan will spend 10.3 trillion yen (€78 billion) – equivalent to around two to three per cent of GDP – to drive a recovery and boost growth over two to three years. The extra spending is expected to create around 600,000 jobs and itself increase GDP by two per cent.
However, the government will also be looking to gradually double consumption tax, from the current level of five to 10 per cent by October 2015. This clearly amounts to a major fiscal tightening and could counter the effect of the extra spending mentioned above.
Another Abenomics element is the massive monetary easing, with a clear inflation target averaging two per cent within two years. New Bank of Japan Governor Haruhiko Kuroda announced last month that the Bank intends to unleash circa 130 trillion yen into the economy in less than two years, mainly by purchasing Japanese Government bonds (JGBs). The news sent the yen tumbling further and bond yields to record lows. The extra €980 billion will effectively double the monetary base by 2014.
Quantitative easing (QE) is not a new topic for Japan – nor for Kuroda himself. In fact, whilst acting as a vice-minister in 2002, Kuroda called for “aggressive monetary policy” from the central bank, including an inflation target to radically change price expectations. He urged a two per cent inflation target and a sustained QE, criticising the BoJ for not doing enough.
Japan started dabbling with QE in the early 2000s. In March 2001, the BoJ initiated a programme which ultimately increased the monetary base by 67 per cent by 2005; however the effects of this programme were at best defined as ‘mixed’.
The tricky bit of Abenomics is yet to come: the structural reforms Abe intends to propose will be a challenge to push through. These will include opening up to competition an economy which is vastly domestic, and to immigration to counter an ever-declining working-age population; deregulation and reforming the corporate tax regime. So what could be the downside to Abenomics?
Public debt as a percentage of GDP currently stands at 240 per cent. During the ‘lost decades’, the economic environment encouraged households and corporations to save, and in its efforts to maintain aggregate demand, government spent more, in turn adding to the burden on public debt. Furthermore, the government needs to raise further debt equivalent to 59 per cent of GDP in 2013.
Given the extremely low cost to service this debt, the level is currently still sustainable – as long as yields remain this low. Yields on 10-year Japan sovereign bonds have been below 1.5 per cent for most of the last five years, reaching a low of 0.45 per cent last month, only recently creeping up once again. An increase in yields of 0.4 per cent would cost Japan an extra 0.2 per cent of GDP. Should Japanese investors sell low-yielding assets fearing inflation; the debt pile will become expensive to service.
Inflation could push prices up before wages, depressing spending power. The increase in consumption tax has the effect of both countering real growth and increasing inflation, whilst the lower yen is a net negative for consumers purchasing imported goods.
On the bright side, in Q1 of 2013, Japan enjoyed 0.9 per cent qoq growth, and both consumption (tax not in effect yet) and exports rose strongly, whilst unemployment is falling.
This article is the objective and independent opinion of the author. The information contained in the article is based on public information. Some of the opinions expressed here above are of a forward looking nature. Curmi and Partners Ltd. is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business. Should you wish to discuss this article in further detail, feel free to contact the author on 2342 6116.
Vincent Micallef is an executive director at Curmi and Partners Ltd.