The end of Japanese economic reform is nigh

The end of Japanese economic reform is nigh

The upcoming snap election looks like a walk in the park for Prime Minister Abe and the ruling coalition of Liberal Democrats and Komei. Opinion polls certainly point to a commanding lead. Better yet, opposition parties are in serious disarray following the chaotic disintegration of the Democratic Party into two separate groups and Tokyo Governor Yuriko Koike’s decision to forgo her candidacy for premiership. With North Korean provocations rekindling public interest in national security and solid economic growth adorning news headlines, the unexpected fragmentation of the political landscape seems almost tailor-made for Prime Minister Abe – offsetting increasing voter fatigue toward him.

A fresh four-year Abe mandate would have four implications. First, implementation of the second consumption tax hike (from 8% to 10%) has been staked on the result of the election. That said, in an attempt to manage the economic impact of the hike, the Abe cabinet will not only exempt food items from the tax but also plan offsetting fiscal disbursements to the tune of JPY 2 trillion, with a focus on investment in “human resources”. While undoubtedly smart politics, we are skeptical about their true economic impact. The promised supplementary budget is smaller than the estimated revenue windfall (roughly JPY 5 trillion) from the tax hike – meaning that fiscal policy will actually tighten somewhat. Also, Abe’s (indeed the entire political establishment’s) pledge for free early childhood education – as a cure-all for Japan’s female labour participation problem – faces supply-side constraints.

Second, the Abe cabinet will be in a strong position to maintain a dovish leadership at the Bank of Japan (BoJ). The terms of the three top BoJ officials, including Governor Kuroda, end in March/April 2018 and a solid victory in the snap election will give the Prime Minister a freer hand as regards their reappointment or replacement. With some important caveats, however. Should Kuroda serve a full second term, he will become the longest serving BoJ governor since Masamichi Yamagiwa in the 1950s. This fact alone makes it likely that he serves only part of a new term. All the more so since the BoJ has been facing increasing public criticism on some of its stark policy choices. That said, a dovish Kuroda-led BoJ will be a near-term support for the economy.

Third, the Abe cabinet will try to restart more nuclear reactors in coming years. Having set the target of generating at least 20-22% of electricity from nuclear sources by 2030, it has been working diligently to place various key reactor facilities across the country on the path back to reactivation. An victory in the election could boost the chances of an immediate reactivation of some of these reactors, notably those that have passed the new safety standards. Unfortunately for Abe, public opposition is unlikely to go away any time soon even if the economic case for restarting these reactors is strong. The potency of the nuclear power issue is such that opposition parties continue to make it an explicit campaign issue, with the Party of Hope’s “zero nuclear power by 2030” being a good example.

Fourth, we suspect that constitutional amendment will become a dominant issue in Japanese political discourse after the election because of the geopolitical calculus in East Asia, Abe’s focus on his personal legacy, and the legislative window provided by the advent of the right-wing Party of Hope. Revising the country’s unique pacifist constitution has been the long-term objective of nationalist forces that underpin the LDP, and growing threats from North Korea have added urgency to the project. With Abe unlikely to extend his Prime Minister term beyond the end of his LDP presidency in 2021 (assuming he is re-elected as the party leader in September 2018), LDP factions and political forces wanting to enshrine the country’s self-defence forces in the constitution might see the next two or three years as an opportune period to bring their vision to fruition. Note that the last-minute resurgence of the new pacifist coalition led by the Constitutional Democratic Party could actually reinforce nationalists’ view that a renewed Abe mandate is their last chance for constitutional amendment. Also, the Party of Hope’s potential 50-plus seat presence in the parliament helps provide a realistic legislative path to this effect. Instead of facing the indefinite quiet veto of its coalition partner, Komeito, the LDP could choose to partner with the Party of Hope to amend the constitution. At that point, all other political issues will likely take a backseat.

All told, the upcoming election should prove rather irrelevant as regards Abe’s agenda for economic reform. If the LDP’s majority is unexpectedly reduced, Japanese politics will start to gravitate toward Koike and LDP factional leaders, who will see any unpopular reform item as an opportunity to weaken Abe’s standing – the consumption tax hike and nuclear power being obvious candidates. And even if the LDP wins a commanding majority, efforts to revise the country’s constitution will take precedence over economic reform. Fiscal giveaways or a dovish central bank cannot be considered “reforms”, even though they might contribute modestly to 2018 economic growth.

That Japanese economic reform efforts are compromised is a great pity, particularly since “third arrow” policies have finally started to deploy some positive impact. The public debt burden has stabilized due to tax reform and monetary policy support. Cyclical indicators are at their strongest levels in over a decade. Labour market participation has risen. The number of foreign workers has increased. Still, it appears that even these modest achievements might feel punitive to some voters. Their verdict will be known on October 22.

 

 

 

Information Importante

Le présent document de marketing a été préparé par Lombard Odier (Europe) S.A., un établissement de crédit agréé et réglementé par la Commission de Surveillance du Secteur Financier (CSSF) au Luxembourg. La publication de document de marketing a été approuvée par chacune de ses succursales opérant dans les territoires mentionnés au bas de cette page (ci-après « Lombard Odier »).

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