Japan volatile in wake of supply-side details

Prime Minister Shinzo Abe will reveal specifics on Friday this week, says Liam Ward-Proud

THE recent performance of Japan’s Nikkei 225 index can only be described as volatile. Yesterday, it saw its best day of trading in two years, surging 4.9 per cent to 13,514. Yet last week, the Nikkei lost almost 5 per cent in a few days, and is almost 14 per cent down from its 2013 heights.

To put these moves in context, as a result of Prime Minister Shinzo Abe’s radical economic programme, which aims to engineer 2 per cent inflation over the next two years, the yen has fallen 30 per cent against the dollar since November, and the Nikkei is up almost 33 per cent over the same period.

While Japanese markets remain volatile, the economy may be picking up. The cause of yesterday’s sharp climb has been attributed to an upward revision to the country’s first quarter GDP data. The economy grew by 1 per cent compared to initial estimates of 0.9 per cent. But the success of Abenomics itself is still far from secure.

However it may be changed qualitatively, the first arrow of Abe’s reforms – a huge programme of asset purchases by the Bank of Japan – has already had a dramatic impact, which may have translated into the fundamentals. In a recent note, HSBC investment strategist Dean Turner suggested that “abrupt changes have already delivered tangible results. The dramatic weakening of the yen has boosted the profits of exporters by increasing the value of their overseas revenues”. Consumer spending has also risen, jumping 5.2 per cent in March.

Monetary policy, however, cannot in itself build Japan’s recovery. While the OECD upgraded Japan’s growth forecast for the year from 0.7 per cent to 1.6 per cent, it warned that, unless the country maps out a credible fiscal rehabilitation plan soon, monetary policy could not prevent an erosion of credibility in Japan’s bonds or prevent a spike in long-term interest rates.

This points to the crucial second and third arrows of Abe’s three-pronged approach. Japan has already pushed through a ¥10.3 trillion (£75bn) fiscal stimulus package. But this trick cannot be repeated, and fiscal tightening looms. Japan’s national debt now stands at 240 per cent of GDP, and Abe plans to raise consumption taxes to 10 per cent by 2015. David Lipton, deputy managing director of the IMF, recently joined the OECD in warning that Japan desperately needs “concrete fiscal measures to bring down public debt”.

Given limited room for manoeuvre, the fortunes of Abenomics depend on supply-side reform, his third and final arrow. These will be detailed more specifically on Friday, but in a recent speech it was announced that women will be encouraged to enter the workforce in greater numbers, while the monopolistic electricity sector is to be liberalised. Selected cities will also be allowed to experiment with lower taxes and deregulation, and last weekend Abe signalled drastic reductions to corporate investment tax.

These measures could finally revive Japan’s moribund economy, but many are still worried by lack of detail. Ishaq Siddiqi of ETX Capital describes Abe’s recent announcements as “underwhelming on the whole”. And Japan has attempted large-scale reform before – with little success.

Much depends on the results of upper house elections in July. On current polling, Abe’s party will perform well, raising the chance that reform could succeed. But investors aren’t uniformly confident that he will. And if reality falls short of expectations, stocks may slide further.