Research and analysis

Japan: Abenomics, future challenges - September 2014

Published 3 September 2014

0.1 Detail

Abenomics has had several successes to date:

• Economic growth has increased (2.3% in FY2013 vs. 0.7% in FY2012);
• Nominal wages are rising at their highest rate in over 17 years (2.6% including bonuses in July);
• Inflation is now at 1.3% (excluding the impact of April’s VAT increase);
• Employment is up, and the unemployment rate down to 3.7%;
• Exports are up (albeit less than many predicted from the fall in the yen);
• Japan has started to address its public finances by raising VAT;
• Some structural reforms to make domestic markets more open and flexible have begun; and
• Business sentiment has improved with corporate investment reaching Y69tn (£398bn) in Q1 2014, the highest in 6 years.

The Government asserts that this recovery remains on course. But commentators note that the economic contraction in Q2 following April’s VAT increase was sharper than initially expected and that the recovery has been driven by monetary easing and fiscal stimulus measures to date. They believe that structural reform of Japan’s economic and social systems will be crucial to sustaining growth. The labour market and other reforms announced in June are seen as a start, but most judge that much more is needed. The financial markets have focussed on potential reform of Japan’s Government Pension Investment Fund (GPIF), among the largest pension funds in the world, to allow a wider range of investments.

Debt is also seen as a major concern. Japan has the world’s highest national debt as a percentage of GDP and a large primary deficit, largely driven by increasing social security costs. In 2015 the Finance Ministry projects Japan will need to pay Y24.8tn (£143bn) on debt servicing – approximately a quarter of all spending, spend Y32.4tn (£187bn) on social security but receive just Y55.5tn (£320bn) in tax revenue. For now, the Bank of Japan (BOJ) is suppressing Japanese Government Bond yields by buying US$68bn every month. But this risks storing up problems for the future.

Other challenges have been highlighted. Japan’s shrinking population reduces its growth potential by about 0.5% each year. Many services jobs are unproductive, but retained for cultural reasons. All act as a disincentive for investment. The Government wants to boost efficiency, including through labour market reforms bringing more women back into the workforce.

The key political decision this autumn will be whether to proceed with the planned additional 2% VAT increase in October 2015. Following the Q2 contraction some have questioned the prudence of a second tax rise. Others believe that Q3 figures in November should show more than 2% (annualised) growth and the economy strong enough to withstand another tax increase. For now, most expect the increase to go ahead.

The BOJ stands ready to expand monetary easing if needed, but this is not inevitable. Despite doubts among commentators, it remains confident of achieving its 2% inflation target in 2015. Critics suggest that tighter labour markets will not be strong enough to compensate for the weakening impact of the yens’ devaluation on inflation. However, the BOJ believes that Japan’s output gap has now closed which should boost inflationary expectations.

Japan’s trade balance will largely be driven by its ability to restart its nuclear reactors and becoming more globally competitive. TPP talks show signs of accelerating, which bodes well for the EU-Japan FTA and Japan’s commitment to free trade – and should also boost deregulation and growth in Japan. Meanwhile, there will be further talks on the EU-Japan FTA focusing on procurement and non-tariff barriers with a view to concluding talks next year.

0.2 Comment

Structural reform is seen by many as essential to drive growth in the medium-term. Such growth is in turn crucial if Japan is to meet its international pledges on fiscal consolidation. Abe has committed to reform.

0.3 Disclaimer

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