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Monday, 23 October 2017

Beware the buzz of Abenomics

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All’s not good news for bond bankers, says IFR Asia’s Jonathan Rogers.

Jonathan Rogers

Jonathan Rogers
IFR Asia Columnist

I SPENT LAST week in Tokyo meeting bankers as part of the exhaustive due diligence that accompanies the annual IFR awards. Before making the long trek from Narita airport, I paused to consider whether I would experience the effects of Abenomics, Prime Minister Shinzo Abe’s drive to breathe new life into an economy that has been moribund for over two decades.

These things can be deceptive, or rather possibly self-deceiving, but I was sure that I could sense more of a buzz in Tokyo than I ever had on regular visits over the past decade. The main drag in Ginza was awash with stores peddling every international brand under the sun, there was no shortage of foot traffic and, while not on the scale of Singapore or Shanghai, construction was in evidence. That’s the anecdotal part, and it might well have been wishful thinking or rose-tinted spectacles on my part.

But the substantive part was less rose-tinted. When I asked about the achievability of Abe’s 2% inflation target, quite a few of the bankers scoffed at the notion. There are structural impediments, such as Japan’s ageing demographic. And it seems that the banks aren’t really lending. Much of the growth seen this year has been the result of the weaker yen boosting exports and the consolidated profits of the country’s exporters.

The price action in the JGB market last week underlined the scepticism towards Mr Abe’s inflation target: the yield on the 10-year fell to 0.6%, its lowest since the May rout that greeted the announcement of the Bank of Japan’s aggressive quantitative easing programme.

The business of domestic bond underwriting in Japan remains basically detached from the lending business

I ASKED ABOUT the use of balance sheet in cross-selling investment banking services, a modus operandi that is standard in ex-Japan Asia, where ancillary lending is often a prerequisite for bagging bond mandates, and was greeted with what could best be described as blank stares. It seems that nothing has changed on that front – the business of domestic bond underwriting in Japan remains basically detached from the lending business because there isn’t a whole lot of competitive lending going on. 

There have been pockets of brightness in the domestic yen bond market, with large deals having come through for corporates with strong name recognition such as Seven & I Holdings (owners of the eponymous 7/11 brand), Fujifilm and SoftBank.

That would give you the impression that, were there to be any cross-selling between lending and bond issuance, it would have been on deals such as these. But these deals stand out amid a landscape in which much of corporate Japan simply hoards cash, and where any money circulated from the Bank of Japan’s money-printing exercise will simply end up on corporate balance sheets.

It’s perhaps ironic that during the 20-odd years of deflation in Japan, the country’s households have done the opposite of what classical economic theory posits in such circumstances: they have been saving less. Meanwhile, the corporate savings rate has steadily increased. That is because Japanese corporates can’t identify projects which have a sufficiently high internal rate of return to justify borrowing from banks or using to cash to finance.

Deflationary expectations have underpinned this reluctance to invest and kept a tight lid on capital formation. Judging by the response I received to my question about the likelihood of Mr Abe’s inflation target being reached, that mentality hasn’t yet changed.

THERE WERE QUITE a few bankers and others I met on my trip, however, who talked about more radical solutions. Making it easier to fire workers and create a more dynamic workforce in the hope of increasing productivity – and thereby creating the basis for wage inflation – was mentioned by quite a few. Immigration was also talked about, although it’s widely considered to be something that goes against the grain of Japanese thinking. While Singapore has thrived on this model, large-scale immigration is a prospect which strikes fear into the average Japanese salaryman.

All in all, the take-away from Tokyo was that “it’s too early to say” with regard to the efficacy of Abenomics, and that deep-rooted cynicism skewed the banking and investment community towards the belief that it will not deliver on its promises.

But this is a community that might, perhaps, be hoping that Abenomics fails, at least if the individuals concerned are operating in the fixed income rather than the equity field. If the 2% inflation target is indeed achieved, it seems unlikely to be done without a sharp rise in bond yields, unless Bank of Japan bond purchases succeed in capping them. The projections for bond portfolio losses are of apocalyptic proportions should JGB investors all rush for the exits at the same time.

We had a glimpse of just what would be inflicted on the primary yen bond market in April and May when yields spiked and new issuance dried up. Yields subsequently stabilised, but Tokyo’s debt origination and syndicate bankers had a vision of what the successful execution of Abenomics might entail for their business – and it wasn’t pretty.

If there is a newly discovered spring in the step of Tokyoites going about their daily business, that might give the average fixed income investment banker pause for thought. Should everyone start to spend again and inflation push up to the target, the result is likely to be misery for debt portfolio managers and underwriters in the midst of all that newly discovered cheer. 

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