Published on September 1, 2015, 17:00 JST

Abenomics nearing its expiry date
On the surface, our views are little changed since we last revised our forecast in February 2015. We
currently forecast Japan to grow by 0.9% in 2015 and by 2.0% in 2016. These figures are moderately
weaker than our previous forecast, but hardly a big change.

However, on the broader issue of Abenomics, the policy mix pursued by Prime Minister Shinzo Abe,
we think its chance of success has become much slimmer. In our view, it will not be long before the
credibility of Abenomics as a sustainable policy package expires.
A number of factors affected our assessment on Abenomics, but the following three factors stand
out. 1) Abenomics policies are becoming unsustainable or already withdrawn to some extent 2)
Policies are not having their expected economic effects, 3) Policy makers seem to be losing their
1) Abenomics policies are becoming unsustainable
Out of so-called three arrows of Abenomics, only the first arrow, the monetary easing, was effectively
deployed and remains in effect. The Bank of Japan’s massive purchase of JGB successfully flattened
its yield curve and yen depreciated to its 40 years low when measured in real terms.

However, the cost of executing the massive quantitative easing is becoming visible as a dramatic rise
in the central bank’s market share in the JGB market. At the beginning of 2013, the BoJ held slightly
over 10% of the whole JGB market. By August 2015, it market share has risen to 30%. At the current
pace, it will reach 40% by the end of 2016 and 50% by early 2018. While we think there is no
alternative as long as deflation plagues Japan, the higher the market share, the more fragile the JGB
market will become against possible future shocks, including the eventual tapering by the BoJ itself.
As the 50% mark approaches, we expect that the voice against QE will grow to such extent that the
BoJ itself probably cannot ignore it. A sense that the QE has to stop to stem the rise in its market
share in itself will harm the effectiveness and the credibility of its monetary policy.

The second arrow, the fiscal stimulus, was implemented in 2013, the first year of Abenomics, but it
was not pursued in an effective scale and duration. The fiscal easing policy is also already withdrawn
in 2014 when the sales tax was raised.

As for the third arrow, structural reforms, it is difficult to make a conclusive argument either way as
any reforms take time to make a progress and bear fruit. However, when we see all the poster children
of so called reforms pursued under Abenomics, we see that most issues are those whose progress
are inevitably slow or hard to measure. Promoting a wider female labor participation is certainly an
important issue, but the female labor participation in Japan is already relatively high. At 66% in 2014,
it is higher than OECD average of 62.8% and is comparable to 67.1% in US. It is not as if there are
millions of housewives idle at home. In order to increase the supply of labor, raising retirement age
will be far more effective. Immigration could provide another big potential break. However, these
issues are currently shut out from the policy debate. One could argue that the Womanomics under
Abenomics is about the quality of the female labor, pointing to its target to fill 30% of socially leading
positions by female by 2020. One unknown fact is that the target has been Japan’s official policy since
2003 when Prime Minister Koizumi adopted it. It progress has been slow, rising from 9.7% in 2003 to
11.2% in 2013. In 2014, it rose to 11.3%. Raising it to 30% by 2020 is simply an unrealistic target and
we do not see any novel policy that could significantly speed up the process. TPP is another poster
child, but its immediate economic effects are not big. In 2013, the Japanese government estimated
it to be 0.66% of the GDP even assuming all tariffs are immediately removed. While we do believe
trade liberalization is highly important, TPP is definitely not a game changer. The current Japanese

government are also using TPP as an excuse to increase agricultural subsidies.
Rather than arguing over each policy, we could use the strength of private capital investment as an
indirect measure for the effectiveness the third arrow. If the structural reforms are actually working,
it should have raised the expectation of future growth in Japan, encouraging Japanese companies to
increase their investment. However, despite the record profits, their capital investment only saw a
moderate increase, unlike the period 2003-2006 when investment grew with profits.
To summarize, the monetary policy has been effectively deployed as Abenomics promised but its
sustainability is increasingly in question. The second arrow, the fiscal stimulus, was only deployed in
limited scale in 2013 and it is already withdrawn. As for structural reforms, our perception is that so
far, there has been no reform worthy to be called structural.

2) Policies are not having its expected effects
When Abenomics got rolling, the theory was that the monetary easing and the resulting weak yen
would spur exports, private investments and private consumption. The high growth should diminish
the negative output gap and eventually raise inflation both in consumer prices as well as in wages.
Almost three years since the advent of Abenomics, the results are rather dismal. Exports never took
off. Private investments are growing, but the magnitude of its growth has been disappointing. Private
consumption initially lived up to the expectation, but the shock of the sales tax rate hike in 2014
seemed to have deprived its life out of it.

On the inflation front, the consumer price inflation initially rose till early 2014, probably mostly as a
result of imported inflation through weak yen. However the recent decline in commodity prices
seems to have killed off the inflationary momentum. Meanwhile, despite the tightening in the labor
market, there seems to be no sign of any meaningful wage inflation. The expectation for low inflation
among the Japanese population seems quite entrenched and neither corporate managers nor
workers seem to feel that any marked rise in wages is in order.

3) Policy makers seem to be losing their resolves.

The following sentence was in one of the first speeches Mr. Kuroda made after becoming the BoJ
First, the Bank decided — as I mentioned earlier — to convey a strong and clear commitment. The
Bank clearly announced in a statement that “[it] will achieve the price stability target of 2 percent in
terms of the year-on-year rate of change in the consumer price index (CPI) at the earliest possible
time, with a time horizon of about two years.” This is the decision of the Bank’s Policy Board —
namely, it expresses the will of the Bank as an institution.

(Haruhiko Kuroda, Governor of the Bank of Japan, April 12, 2013)

The end of the time horizon of “about two years” was 4 months ago. Since October 2014, he has
maintained that his expectation is that the BoJ will meet its inflation target in the first half of fiscal
year 2016. Of course, the juries are still out to see if this delayed commitment would be met, but we
must say that it is starting to look unlikely. There is a saying that goes “fool me once, shame on you,
fool me twice, shame on me”. At this point, the longer the governor Kuroda maintains that the

inflation target will be met in 2016, the lower the market will regard the credibility and the “will of
the Bank as an institution”.
Of course, the BoJ is neither the only nor the most important institution whose credibility is
deteriorating. As we commented earlier, the third arrow misfired or it was not in the quiver in the
first place. And since early 2015, Prime Minister Abe seems to have all but lost his interest in the
economic agenda, and seem to be spending most of his attention to formulating and passing the
security bill, the bill that would enable Japan to engage in collective use of force. The unpopular bill
seems to be costing a significant portion of his political capital. In August 2015, his approval rating
has dipped below his disapproval rating for the first time since he became PM this time, according to
the survey of NHK, Japan’s public national broadcaster.

While his approval rating is yet recoverable, it will take a careful political maneuvering to recover his
popularity. With the Upper House election approaching in the summer of 2016, he will probably
dislike the idea of risking further decline in his popularity by embarking on structural reforms such as
labor market deregulation or pension reforms.

What will follow Abenomics?
In our view, Abenomics still has some shelf life left, a year, may be a bit longer. As our forecast show,
the Japanese economy is likely to do reasonably well till 2016. The BoJ could even inject another
monetary stimulus, although their arsenal will be quite depleted once they do. However, it is difficult
to see how Abenomics policy mix could go on beyond 2017. The economy, and the inflation will likely
cool down again with the rise in the sales tax rate currently scheduled for April 2017. At that point, it
will be clear to any economy watchers’ that the Japan’s policies are not sustainable.
Is there any way out of this conundrum? One possibility is a cancellation of the scheduled sales tax
hike in 2017. If the Japanese government decides to postpone the tax rate hike again, it may prolong
the shelf life of Abenomics, and it could even help reach the original goal of reflating Japan, although
it may be temporary. The labor market is already tight, and two or three more years of robust growth
should be enough to ply upward the entrenched low inflation expectation in Japan. Whether the BoJ
could solve the problem of exiting from its QE policy, with over 50% of the JGB market in its balance
sheet and in a reflationary environment, is a big if though.
In our view, the time is not yet ripe to declare Abenomics a failure, but we must say that we are
getting there.

Takuji Okubo
Managing Director and Chief Economist
Japan Macro Advisors

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