Tuesday, 22 January 2019

Great expectations

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  • Great Expectations

Japan’s hope of hitting an inflation target of 2% in two years, largely through increasing the purchase of government bonds, could kick start its economy, but the plan has its detractors.

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In an economy built on caution, the radicalism of Bank of Japan governor Haruhiko Kuroda and his boss, Prime Minister Shinzo Abe, has taken everyone by surprise.

Simply by committing himself to hitting a 2% inflation target – a rate last seen in 1997 – within two years, Kuroda has shown a remarkable willingness to break with, and learn from, the passivity and conformity of the past. 

Christine Lagarde, the IMF’s managing director, said such “unconventional measures” were helping to boost global growth. Reaching into a military handbook for inspiration, HSBC chief economist Stephen King said the announcement was the monetary equivalent of “shock and awe”.

The Kuroda-Abe double-act has even generated its own economic oeuvre. Unlike most economic portmanteaus (Reaganomics, Clintonomics), Abenomics was coined almost in advance of its coming, defining the bald ambition of boosting economic growth and private investment through higher prices, radical quantitative easing, and an aggressive round of often riskier asset purchases.

The central bank has not been coy about how it will achieve its lofty aims. Far from it. The BoJ aims to double the size of its monetary base over the next two years, increasing the purchase of government bonds by ¥50trn (US$520bn) a year.

Its first government bond-buying operations saw the BoJ buy ¥1trn of bonds with maturities of between five and 10 years, and ¥200bn worth of bonds bearing maturities of more than 10 years. The central bank also plans to boost purchases of riskier assets – notably exchange-trade funds and real estate investment trusts – and to increase to seven years, from three, the average maturity of Japanese Government Bonds.

Assertive face

Another aspect of the new, more assertive face of Japanese economic policy is the return of an aggressive programme of public works spending. In January, Abe’s cabinet approved a ¥10.3trn emergency stimulus package, half of which is being fast-tracked into much-needed public infrastructure projects. 

By committing itself to a new era of super-loose monetary policy, the central bank also hopes to force everyone in Japanese society – from private investors to corporates to domestic lenders – to put their money to work more actively and imaginatively, in an effort to boost the economy.

If Abenomics succeeds, the thinking goes, companies will invest more, banks will lend more, and Japanese citizens will spend more, creating a sustainable virtuous cycle of growth in the world’s third-largest economy for the first time in nearly quarter of a century. This would boost the national tax take, helping Japan eat into its vast public debt.

Economists, at least at first, were generous in their applause. Mark Williams, chief Asia economist at Capital Economics, said Kuroda’s “bold steps” had “set the central bank on a new and exciting path”. Citigroup chief Japan economist Kiichi Murashima said the BoJ’s “significant” announcement “exceeded anyone’s expectations”.

At first glance, it was hard to find anyone willing to doubt the seemingly alchemic properties of Abenomics. The markets appear to have given Abenomics the benefit of the doubt. The main Nikkei 225 stock index is on its first tear since 2008, surging 36% in the current year to April 5. The yen, steadily depreciating since November, weakened further, inching towards a new benchmark of 100 to the US dollar.

Some though are already starting to wonder how long this honeymoon period will last. Neither of the twin tenets of Abenomics – boosting prices and breathing new life into a wheezing economy – are guaranteed to succeed.

Bold vision

Perhaps the greatest uncertainty surrounds the core issue of inflation. Kuroda’s 2% target is magnificently bold. Yet it’s hard to find anyone outside the central bank willing to state publicly that it is even remotely achievable.

Certainly, most experts believe it will take more than a weaker currency to rid the country of the spectre of deflation. “We are sceptical that yen depreciation alone will boost inflation [to the stated 2% target],” said Citi’s Murashima. “In fact we find it hard to see inflation rising even to half that level.”

Murashima tips headline inflation to rise to 0.4% by end-March 2014, slipping to 0.3% the following Japanese fiscal year. Many experts tip inflation to rise through the second quarter before decelerating through the autumn.

Then there’s the quandary of whether to raise taxes in the coming months: an issue which, if badly handled, could eat into Abe’s runaway popularity (his approval ratings regularly top 70%).

Japan’s premier wants to raise value-added tax from 5% to 8% by end-March 2014 and 10% the next year, while raising household taxes by between 1% and 3%. This would effectively kill two birds with one stone: increasing Japan’s tax take by around ¥8trn a year (pushing more of the burden of paying for an ageing population on to older, and wealthier, citizens) while simultaneously boosting inflation. “Plans to raise consumption taxes would add around two percentage points to inflation in both years,” said Capital Economics’ Williams.

Yet rather inevitably, this seemingly wonderfully able solution to Japan’s deflationary disease would likely be neither wonderful nor, in the long term, particularly effective.

Planned tax hikes, economists fear, would also halt the country’s economic recovery in its tracks. Tax rises, said Murashima, would cause a “sharp slowdown in economic activity”, causing Japan’s economy to grow by just 0.2% in the fiscal year to end-March 2014. “On the one hand, the BoJ is trying to raise inflation by imposing monetary easing measures. On the other hand, the government is trying to raise taxes, which will slow the economy to a crawl,” Murashima said. “This is a big inconsistency.”

This returns us to an even bigger issue: the seemingly intractable question of what to do about the country’s yawning national debt. Japan faces challenges that cannot be solved through monetary easing or stimulus sprees, notably the sheer cost of paying for an increasingly elderly population. This, said Izumi Devalier, chief Japan economist at HSBC, is the “biggest culprit and the biggest cause when it comes to rising national indebtedness”.

Taxing quandary

Here, Abe and Co face another Escherian tax-related quandary. Japan desperately needs to push through structural reforms, notably in the forms of tax rises, to pay for rising welfare costs and trim the national debt.

But, again, any such move would likely act as a brake on Japan’s economy, reducing the tax take and, in time, further increasing public indebtedness. Many economists, indeed, believe Japan’s debt is destined to continue rising, whatever happens. “Japan’s debt-to-GDP ratio will likely deteriorate further this year, exceeding 240% of GDP,” said HSBC’s Devalier.

No one can accuse Abe or Kuroda of doing things by halves. Yet by attempting to alter an entire economy’s mindset by creating inflationary expectations in a market dogged by decades of deflation and falling prices, both are taking a remarkable gamble. And more is at stake here than the political credentials of two men determined to impose economic growth on a once-vibrant economy grown accustomed to pottering along in the slow lane.

From here on in, everything needs to go exactly to plan. If reflationary policies work to the letter, there’s every chance that Japan can pull itself out of its economic malaise. Yet if everything doesn’t magically intersect, Abe and Kuroda will merely have heaped more public debt on to to the country’s books. Worse, everyone, from investors and traders to Japanese banks, corporates and citizens, will quickly lose faith in Abenomics.

That may happen, and sooner rather than later. So far, the markets have extended Japan’s new radical political and economic chiefs the benefit of the doubt. But if inflation doesn’t continue rising throughout the year, said Capital Economics’ Williams, “the new-found trust in the capacities of the Bank of Japan will rapidly fade”. And if that happens, the entire radical philosophy of Abenomics will be called into question.

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