Reform and Restructuring Takes Hold in Japan

Amid excitement about possible reform and restructuring in Europe, some investors may have missed the fact that Japan is actually putting the theory into practice while fiscal and monetary policy-makers are lending continued cyclical support to reform efforts.

The October 2017 general election yielded ideal conditions for Prime Minister Shinzo Abe to accelerate economic reforms. Abenomics, the three-pronged economic strategy introduced in 2012, incorporates monetary easing, fiscal stimulus and structural reforms. Though its reputation is mixed, there are signs of success which suggest that the country is finally starting to respond to change.

The long-suffering Japanese economy, much like Europe, should perk up at last and deliver 1.7% growth in 2017 as the benefits of global growth, domestic reform and stimulus take hold.

Growth for this calendar year is expected to be close to 2%. This is partly down to monetary stimulus (quantitative easing) reducing the attractiveness of holding cash and thus encouraging households to spend rather than save. Policies encouraging women to enter the workforce have been very successful, injecting additional income into Japanese households. Moreover, the growth of Japan as a destination for the burgeoning Chinese tourist market is also acting as a new catalyst for domestic demand.

Japan is now also a primary beneficiary of wealth creation across the Asian continent with tourist arrivals from Asia alone reaching 23 million in 2017, up from a modest 6 million over the past decade.

It is against this backdrop that Prime Minister Abe emerges from the election with two opportunities. First, because the opposition has been severely weakened after an early strong showing, Abe has a two-thirds majority in both the lower and the upper houses of parliament. Abe can now pursue reform of Article 9 of Japan’pacifist constitution. Defence, industrials, technology and services would all be beneficiaries of a beefed-up military. The second opportunity is in structural reform. Corporates have reported record profitability and yet the labour share of income has been falling steadily since the 1990s. PM Abe’s opportunity is to arrest that decline.

The strong and increasingly diversified economic backdrop should allow Prime Minister Abe to refocus and bolster economic reform momentum. His government should be driven by a more effective opposition and a desire to reshape Japan’s constitution, to adopt bold policies, and to keep reforms focused on growing domestic demand and restructuring to support the transformation of the Japanese economy. It is here that reform of the Labour Standards Act is important. Abolishing the large difference in employment protection and benefits that exist between regular and non-regular employees is essential. More recently, Shinzo Abe called for a 3% increase in wages and salaries. With inflation currently at 0.7% a rise of 3% would significantly improve real wages and household spending power.

Monetary support for the economy remains in place as well, with the Bank of Japan now the only major central bank not to have begun to unwind its support for its local economy. Whereas US interest rates are rising and the European Central Bank is preparing to withdraw its quantitative easing, we expect the Japanese yen to emerge as an additional catalyst for earnings in 2018.

Though geopolitical concerns about North Korea will continue to overshadow Japan’s politics and economy, this is the case for the world economy as a whole. Should the tension escalate into conflict, global equities as a whole will be impacted. On the other hand, if the threats, as they have over the past two decades, once again turn out to be bluster, Japan will be ready to recapture investors’ attention in 2018.

As with all reform programs, the opportunities lie in the execution. Having made good progress through the first two arrows of Abenomics, with his October 2017 election victory Prime Minister Abe has the platform to pursue the final arrow to secure a more durable recovery in Japan.

Norman Villamin – CIO Private Banking – Union Bancaire Privée (UBP)