By Stephen Cohen
The dramatic changes to monetary policy announced by the new governor of the Bank of Japan (BoJ), Mr Kuroda, in early April exceeded even the well-flagged expectations as the BoJ proposes now to double the monetary base in short order. The Prime Minister came to power promising this change to end the years of deflation and enjoys very high popularity because of this, the sense of optimism he conveys and his firm stance on the Senkaku islands with China.
He is also promising further large fiscal expenditure to restore the transport infrastructure, much of which dates back to the 1960s. Currency, bond and equity markets all anticipated these developments and the liquidity increase. The TOPIX index began to rally in mid-November and has risen by c. 67 % through 22 May this year.
There is a real chance this time that this is not just another attempt to reflate an indebted mature country with a shrinking population. If the proposed structural reforms prove significant and are actually delivered, many of the old assumptions about Japan will change. There could be material tax reform, both corporate and personal. The latter would help limit the decline in the savings ratio and shift the balance towards expenditure taxes away from income taxes, while a Japanese-style ISA may well be introduced as well. Corporate tax reform, in the form of reduced depreciation rates and lower headline rates of tax could help with misallocation of capital and promote higher dividend pay-out ratios.
A Trans Pacific trade agreement, even if it contains some special exception clauses, could begin to erode agricultural protectionism and shake up Japan’s inefficient farming as well as act as a trigger to reform restrictive wholesaling practices. Labour market reform could make it easier to hire and fire and together with other changes could increase the rate of female participation in the workforce, currently the lowest in the OECD, thereby easing any labour shortage arising from the ageing population. Constitutional change is also mooted. If Abe’s victory in the July Upper House elections this summer is as big as predicted then he will have a real mandate for change and three clear years to enact. So notwithstanding objections from China et al, defence spending could also rise after a long period of decline.
There is also a recognition that many major Japanese corporates have disappointed, as their decision-making has been lacklustre at best. For instance Korean electronics companies have often trounced their Japanese counterparts and proven better at getting into and out of business segments. Corporate governance is therefore also recognised as a national economic priority to encourage better strategic thinking at board level.
All this and possibly more could increase return on equity and profit margins at Japanese corporates towards European/ US levels and this could thus sustain the market rally. To date we have had much talk and straws in the wind and markets are travelling in hope. But Prime Minister Abe has established in his office the Headquarters for Japan’s Economic Revitalisation. We should not doubt his serious intent, nor easily dismiss the idea that this may just be a real paradigm shift. However, there is a shared sense of crisis in Japan, which should assist him and his revolution could well prove more dramatic than that wrought by Mrs Thatcher in the UK 1979-86 or Gerhard Schroder in Germany 1998-2005. That said, these measures do need to reignite growth, rather than simply end deflation, because Japan is reaching the limits of fiscal expansion and the bears are ready to pounce if “Abenomics” doesn’t deliver.
Stephen Cohen is chief executive at Governance for Owners
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