Is this Abenomics' moment of capitulation?

IFR 2056 25 October to 31 October 2014
6 min read
Jonathan Rogers

THE HUBRIS THAT seems to be a key feature of Japanese Prime Minister Shinzo Abe’s plans to revive the country’s economy after decades of stagnation was laid bare last week when a disastrous September trade deficit was unveiled. This came after a second-quarter contraction of Japan’s GDP thanks to a sales tax increase introduced in April.

Do we now write off “Abenomics” as an unmitigated, embarrassing failure? It begins to look that way. I have been warning of such an outcome in this column ever since Mr Haruhiko Kuroda was installed as governor of the Bank of Japan in April last year and embarked, at Mr Abe’s behest, on the most aggressive quantitative easing programme the world has ever seen.

Some of the outcomes that the Abenomics plan was designed to achieve have occurred, including a substantial weakening of the yen and a push up in Japan’s inflation rate. But the sales tax increase – implemented on April 1 of all days – has had the contractionary effect that many old-time Japan watchers warned about. The country hadn’t experienced a rise in the consumption tax for about 17 years, and the last time it happened, it derailed what looked like a definitive economic rebound.

This time around it really looked like hubristic dicing with danger in the thought that, as was the case last time around, the economic momentum was just too strong to be knocked off course by a little bit of demand-side fiscal tinkering. Bad call. The IMF predicts that Japan will grow a paltry 0.9% this year, or half of what it predicted at the start of 2014 when Abenomics looked to be working.

It’s difficult to see how they can begin unwinding what they already started without inflicting untold damage

MIND YOU, THE IMF has not trashed the Japanese authorities’ decision to go ahead with the consumption tax rise and even urged the country to push forward with another rise in the tax next year, to a planned 10%. That would mean that since the April incremental rise from 5% to 8%, Japan has experienced a doubling of sales tax, something that it seems would push most economies – developed or undeveloped – into recession.

“It’s really about having a fiscal framework that is credible so that down the road if you have shocks, you can use fiscal policy instruments in a credible fashion to cushion a blow from any adverse shock,” said Roberto Guimaraes-Filho of the IMF’s Asia Pacific department at a regional seminar last week. He also stressed that the Bank of Japan must continue with its easy monetary policy in order to avoid any “communication issues”.

It might just be that communication issues are the least of the Japanese authorities’ woes and that darker underlying structural realities are emerging that policy – traditional or ultra-unorthodox – cannot address. The J-curve effect is supposed to boost exports and restore health to the trade balance once a nation has seen its currency devalued after an initial worsening. This has yet to emerge in Japan.

Indeed, the worse-than-expected ¥958.3bn (US$8.96bn) September deficit was far bleaker an outcome than the median forecast of a ¥768bn shortfall from Japan pundits.

I have no idea when the towel will be thrown in and the whole Abenomics project admitted as a failure by those running it. There might be much bowing in true Japanese apology mode. But the scary thing is that it’s difficult to see how they can begin unwinding what they already started without inflicting untold damage.

The IMF honcho might have a point when he talks about “communication” because Japan has rather a large amount of government debt – the highest, as a percentage of GDP, in the developed world – which the whole sales tax gig is designed to address. Indeed, a Japan government debt crisis is unfathomable. We must instead hope for the time being that this potentially devastating turn of events is kept as far away as possible.

MEANWHILE, JAPAN’S ARCH rivals, the South Koreans, are lapping it all up. They reckon they’re set to outpace Japan in terms of economic growth by the end of the decade. Something called the Korea Center for International Finance last week suggested that Abenomics had been a failure. In a report it warned of the “danger signals … [including] a decrease in real purchasing power caused by inflation, slow private investment in spite of expansionary fiscal policy and quantitative easing, national income drain from the weak yen, and the collapse of small firms and the service industry”.

Wow, scary. But I suppose they have a point. Apparently there has been a wave of SME bankruptcies in Japan this year in the face of rising import costs, an unintended outcome of Abenomics. Mr Abe has talked about structural reform, or the firing of the “third arrow” of his economic revival programme, but little has been done in this regard since the programme was introduced at full tilt in the spring of 2013.

He might need to subsidise SMEs in order to mitigate the effects of the weaker yen and a wider round of bankruptcies in the small to medium business enterprise sector. Somehow though, I have a feeling that will all be a little too late. Economists who were sanguine about the sales tax were that way because they believed external demand would meet the shortfall in the weak local economy.

With Europe showing signs of tipping back into recession and the robustness of US growth being called into question, that part of the equation is missing. Let’s just hope that the markets don’t take the next logical step of Japan falling into recession and hindering its ability to service its mountain of public debt. That really would be a scenario with terrifying ramifications.

Jonathan Rogers