Japan After the Snap Election

December 18, 2014

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Japanese Prime Minister Shinzo Abe’s gamble to call a snap election was successful, as the voting over the weekend assured that Abe will have another four years to complete his efforts to revive the Japanese economy, the world’s third largest after those of the US and China. Abe’s Liberal Democratic Party (LDP), together with Komeito, its coalition partner, have maintained their two-thirds majority in the lower house of the Diet, which will permit them to legislate economic reform measures even if they are opposed by the upper house. His mandate to proceed with his wide-ranging economic program, “Abenomics,” has effectively been renewed. The election was a relatively easy step, as the opposition was in disarray. Moving forward with economic reforms that are likely to encounter stiff headwinds, including some opposition from elements within the LDP and the government bureaucracy, will be considerably more difficult.

It is the “third arrow” (structural economic reforms) of Abenomics that has been notably weak during the first two years of the Abe government. The “first arrow” (monetary stimulus) has been pursued aggressively by the Bank of Japan, with an unprecedented rate of monetary expansion relative to the size of the economy. The “second arrow” (increased government spending) was more than offset by the negative consumer reaction to the April sales tax increase.

The list of “third arrow” reform measures thus far enacted is limited. Abe has sought to force companies to adopt improved corporate governance, including more accountable management practices and increased transparency. He has also moved to improve the status of women in the workplace. A move to change rules on overtime pay was watered down after it encountered stiff resistance.

Abe has indicated in interviews that, with his renewed mandate, he intends to push forward with reforms to loosen the rigid labor market; to seek an early conclusion of the Trans-Pacific Partnership (TPP) free-trade negotiations, which could be a very positive development for the Japanese economy; to reform Japan Agriculture, a vast and politically powerful network of agricultural cooperatives that stands in the way of liberalizing the highly protected agricultural sector; and to break up the regional electricity monopolies.

Abe recognizes that, despite his electoral success, many Japanese have not yet benefited from Abenomics, as wages have not kept up with increases in the cost of living, largely as a result of the depreciation of the yen. He will need broad public support if he is to overcome the resistance by vested interests to his reform efforts. He is pressing companies to raise wages in the coming year. It is uncertain how successful such “guidance” will be.

Prime Minister Abe’s legacy will depend on the success or failure of his structural economic reform efforts. He has rightly targeted some key areas where reforms are greatly needed. Neither monetary nor fiscal stimulus, however aggressive, can assure a recovery in the Japanese economy that will be sustainable over the medium to long term. We remain bullish on the near-term prospects for Japanese equities hedged for expected additional depreciation of the yen versus the US dollar. The positives remain strong overseas earnings, improving domestic demand, attractive profits benefiting from yen depreciation and a likely reduction in corporate taxes. However, we will need to see significant follow-through by the Abe government on its reform promises if we are to maintain our Japan positions beyond the short term.

 

The ideas and opinions expressed in this blog are those of the author, and they should not be perceived as investment advice or as any other kind of advice.

The preceding is an abridged commentary by Cumberland Advisors and has been reposted with permission. Cumberland Advisors commentaries are available at http://www.cumber.com/commentary_archive.aspx.

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