Cash & Investment Management

Japan in Focus – Q1 2017

Wednesday 29th March 2017

Four years have now passed since the Japanese initiated ‘Abenomics’ – Prime Minister Shinzo Abe’s three-pronged economic programme of fiscal expansion, monetary easing and structural reform designed to shake the country out of its torpor. Whilst the measures have not been an out-and-out success, one could argue that Japan’s economy is the strongest it’s been during this period. According to Bloomberg, real gross domestic product expanded for a fourth consecutive quarter at the end of 2016, the best run in more than three years. Exports rose in December for the first time in more than a year and fourth quarter industrial production gained the most in nearly three years.

Government data also showed that core consumer prices rose 0.1% in January from a year ago. This very small gain was the first increase since December 2015 and was primarily due to a pickup in energy costs. Despite this, inflation remains well below the central bank’s target of 2%. A traditional springtime wage increase offered by the top Japanese corporations such as Toyota disappointed however, with the lowest increase offered in four years. This is in spite of the robust health of corporate balance sheets and indicates that companies are still concerned about the global economic outlook.

The first ‘leg’ of Abe’s plan consisted of a massive monetary easing operation by the central bank designed to inject money into the economy via asset purchases. This helped to push down the value of the Yen, enabling Japanese exporters to regain their competitiveness and boost earnings. An intended knock-on effect was that stronger corporate earnings would facilitate some meaningful wage growth, resulting in more consumption and a modest pick-up in inflation, however, this has failed to materialise so far.

In fact, consumer spending has remained muted since 2014, when a controversial sales tax increase had to be shelved for fear of damaging already weak domestic demand. This highlights the fragility of the recovery taking place in Japan and the fine line that the government and central bank must tread. A potentially negative aspect of this easy monetary policy is that other countries may see Japan’s approach as one of ‘beggar thy neighbour’. Given Japan’s strong current account surplus over the past few years, it is likely that further criticism will come their way, especially from a vociferous Trump administration.

One overhaul the central bank made to their asset purchase scheme was the introduction of a policy termed ‘yield curve control’ introduced in September 2016. This involved the central bank intervening in the market to keep the 10-year government bond yield near to zero. At the time, 10-year yields were negative, the yield curve had been flattening (due falling longer-term yields) and this was hurting sentiment (a flatter yield curve often indicates growth concerns and/or a weaker inflation outlook). This tactic does have a chance of introducing inflation, however, with global bond yields on the rise, it is becoming more difficult to control and volatility in other (longer) maturities has increased.

On the fiscal side, the government has tried to adopt reflationary policies using ‘flexible’ fiscal spending. Given the very high level of indebtedness, the government tends to present a conservative initial budget but then implement supplementary budgets throughout the year. However, Abe appears to be emboldened by the reaction to Donald Trump’s plans for fiscal stimulus in the US and is likely to push for a more prominent role for fiscal policy in 2017.

A pick-up in lending in the first quarter is another tentative indication that Abenomics might be feeding through into the broader economy. A continuation of this trend will be welcome news for Japanese banks which have struggled in an era of extremely easy monetary policy. Negative interest rates have depressed lending margins, therefore, growth in the loan book will go some way to offsetting this.

Much has been said of Japan’s unfavourable demographics and this shows no sign of changing. A recent headline-maker was the annual birth-rate falling below 1m for the first time since records began in 1899. Japan is also expected to post a tenth year of population decline as deaths once again exceed births. According to the Economist, in the mid-1990s, Japan had a smaller proportion of over-65s than the likes of Britain or France. Due to the falling birth rate previously mentioned, increased longevity and a public that remains hostile to immigration, Japan’s potential growth rate will be lower than that of other developed countries if this trend persists.

One aspect that has improved under Abe is corporate governance (part of the structural reform measures).  The implementation of a corporate governance code in 2015 has helped to re-prioritise shareholder interests. One of the main principles within the code requires the appointment of two or more board members that are independent. Another is there to stop to the clustering of AGMs, making it difficult to attend them all.

A likely consequence of this re-focussing on shareholder returns is the pick-up in share buybacks and dividend increases seen over the last few years. Japanese companies tend to hoard cash on their balance sheets even if there are no productive use for it. A buyback culture (if implemented prudently) will help to boost earnings-per-share, instil some capital discipline and make Japanese stocks more attractive.