Recently, I have been asked the same question, in various guises, by international investors; that is, ‘Has Abenomics failed?’ It’s easy to understand the reasons for their concern. Economic growth has disappointed, as consumption still doesn’t seem to be picking up as much as expected.
Nikko Asset Management’s response to this understandable scepticism is that Abenomics has had major achievements in some areas, although it has much further to progress in other areas. In our view, stimulative measures rely to some degree on timing, requiring alignment with other supportive factors such as an improvement in global demand, while structural reform is a long-term process that takes time to come to fruition. The success of Abenomics relies on both and while it still faces many frustrations and challenges, I believe it is premature to sound its death knell. Positive changes are occurring and for investors that know where to look, there are some rewarding opportunities to be found.
In this article, the first in a series, we focus on the first and second ‘arrows’ of Abenomics: fiscal stimulus and monetary policy. We assess whether or not they are failing in their intention, what further measures we expect from the Bank of Japan (BoJ), including the possibility of ‘helicopter money’, and the likely impact on the Yen over the coming year.
Monetary policy faces global headwinds
Prime Minister Shinzo Abe was elected in 2012 with a mandate to end deflation and revitalise Japan’s economy. As part of his implementation of Abenomics and in a move widely considered to be compromising the BoJ’s neutrality, he selected Haruhiko Kuroda as Governor. Kuroda swiftly launched the first arrow of Abenomics with a huge quantitative easing (QE) programme and the introduction of a 2% inflation target.
Despite the initial success of these measures in boosting inflation, the past year has seen a fall in the CPI. However, while headline inflation remains near zero, as the chart below shows, Abenomics is having a positive impact on core inflation, which remains closer to 1% than the zero or sub-zero level it had been accustomed to for the better part of two decades. Although core inflation hasn’t returned to the BoJ’s 2% target, it is demonstrating the first genuine and sustained price increase of the past 15 years and suggests that there is little risk of a return to deflation.
It is also worth noting that Japan is not alone—inflation in many regions, including the US and Europe, has been struggling over the past year. Overall demand continues to be low and US consumption has not been recovering as fast as expected despite a recent pick up in wage growth. The May non-farm payrolls result and the US Federal Reserve’s (Fed’s) recent more dovish rhetoric suggest that the US recovery, which global markets were counting on to drag the rest of the world with it, is proving to be somewhat slower than had been hoped.
Recent economic recovery in Japan has tended to be driven by external demand so without a recovery in global demand, Japan’s economy will struggle to improve further. Weakness in the global economy, particularly the US and China, has led to a rise in the Yen (as a safe-haven currency) and, consequently, to weaker exports. This has forced the BoJ to adopt a negative interest rate policy (NIRP) in attempt to combat these global headwinds. Unfortunately for Japan, the Yen continued to strengthen due to a weakening US dollar as markets became less certain of the Fed’s rate rise trajectory. This has led to increasing scepticism over Abenomics and has led some to denounce it as a failure.
However, in our view, this is not the time to give up on Abenomics. In fact, the current market environment only reinforces the case for it. David Lipton, First Deputy Managing Director of the International Monetary Fund (IMF) concurs. In a recent interview with the Financial Times, Mr Lipton said that “the three arrows remain the right arrows” although he believes the BoJ needs to relaunch them with more force. He added that the “weakness and fragility of the global economy makes a strengthened Abenomics more necessary, not less necessary. They need to double down. If monetary policy is less effective than it used to be you have to do more of it”.
We expect further rate cuts from the BoJ, but not ‘helicopter money’
In our view, we are likely to see the BoJ cut interest rates further into negative territory. At the same time, we believe that it could assist market stability by being somewhat clearer in its communications. As with many other market participants, we were slightly surprised that the BoJ kept monetary policy steady at the June 15-16 meeting. Given the spike in the Yen and the Fed dovishness, the market was expecting action. When the BoJ didn’t move, it led to considerable volatility. Communications between markets and central banks are always important, but even more so in the current environment. Rate cuts alone cannot quickly improve the economy–however, communication and indication of intention is critical.
In our view, the BoJ should have cut rates in June, not because it would mean a swift improvement in investment but as an indication of the bank’s intention to continue its focus on inflation targeting. NIRP is a necessary measure to support Japan’s economy and prevent a slide back into deflation, effectively buying time until global demand returns to form. We believe the BoJ has more room to act if it wishes. If the US improves significantly, then it might alleviate the pressure on the BoJ to act but we still think that additional measures are likely over the coming months, particularly in light of ‘Brexit’.
However, we do not believe that ‘helicopter money’ will be one of those measures. As our Global Head of Multi-Asset recently wrote in article called ‘'Helicopter money' could prove effective, but it entails significant risks’, in theory, this concept could be effective in boosting consumption. Nevertheless, in our view, it is extremely unlikely that this will occur while Kuroda is Governor of the BoJ and would actually require a change to Japan’s legal system. As Governor Kuroda has said, ‘helicopter money’ would be illegal under the current system and it would blur the lines between the central bank, which sets monetary policy and parliament, which is responsible for fiscal policy.
Currently, we consider ‘helicopter money’ an interesting academic concept, but it shouldn’t be thought of as anything more concrete. Kuroda says he strongly rejects the idea and isn’t seriously considering it; we believe him. We are not ruling it out in the longer term – it could potentially be implemented in future if required, particularly if we were to see another global recession, but we don’t envisage its implementation over the short to medium term.
Expansionary fiscal policy is continuing with stimulative measures
Abenomics’ second arrow of fiscal policy was launched with the implementation of a Yen 10.3 trillion stimulus package in January 2013, mainly focused on infrastructure spending. This was followed by supplementary packages, including a Yen 5.5 million package in April 2014 and a Yen 3.5 trillion supplementary budget in December 2015. One of the beneficiaries of the stimulus has been nursery care services, since remedying the shortage of child-care options assists one of the third arrow goals of returning more women to the workforce.
Another aspect of fiscal policy is consumption tax or VAT. Tax hikes were planned by the previous government in an attempt to consolidate Japan’s public debt and achieve a primary surplus by 2020. The first increase in the tax from 5% to 8% in April 2014 had a significant negative effect on growth, leading to a brief recession. Given the current environment with global aggregate demand slowing, the Abe administration recently took the step of delaying the next tax hike (from 8% to 10%) for the second time, from April 2017 to October 2019. Prime Minister Abe noted that global risks meant that he had to reignite Abenomics with fiscal as well as monetary policy. He faces Upper House elections on 10 July and this could be a popular move with voters ahead of the election, where he intends to seek a mandate for the delay.
The risk of this policy move for investors is how it will affect the government’s budget position. Mr Abe has stated he is not abandoning the pledge to return the budget to surplus by 2020 although there is some scepticism in the market. In our view, this relatively short delay is not likely to have a long-term impact on government revenue, but it does help in removing downside risk from the economy. We expect that growing consumption in the US and a steady improvement in its economy should help Japanese exporters as demand increases, thereby increasing the tax take from corporate Japan. This is a short-term and, in our view, necessary solution for slower-than-expected global demand growth. We would be concerned if the sales tax hike were to be delayed further but currently have no reason to expect that this will be the case.
Mr Abe also plans a further fiscal policy expansion to be decided in the October-December post-election Diet session. The market is expecting further stimulus of Yen 5 trillion now that the sales tax hike has been delayed. However, it is possible that Mr Abe will provide a supplementary budget of up to Yen 10 trillion. In our view, anything over the Yen 5 trillion expected would be a positive surprise for the market.
What is our outlook for the Yen and for risk assets?
With the recent Brexit vote, Nikko AM’s Global Investment Committee (GIC) now estimates the Yen will remain at around its current level or a little lower. Thanks to Japan’s continued aggressive monetary stance vs. the Fed, coupled with Japan’s weaker economic growth relative to the US, the GIC expects the Yen to remain in a range of around 100-104 Yen to USD over the next 6-12 months. This is likely to put further pressure on Japanese exports and, as already mentioned, require the BoJ to initiate further rate cuts.
However, our view remains that a stronger US dollar and normalisation of the global economy post-GFC are key trends for the next few years, which will have positive implications for Japanese exporters, inflation and the outcomes of Abenomics. We expect market volatility to continue, but as we are seeing weak cycles amid strong trends, it will offer potential opportunities to buy risk assets, such as Japanese stocks, at attractive prices.