QUARTERLY INVESTMENT STRATEGY: JAPAN OUTLOOK
The latest news in Japan is that the country avoided a “technical recession”. Initially estimated at -0.8%, 3rd quarter real GDP growth was revised up to +1.0% thanks to the release of unexpectedly solid business investment data.
IN A NUTSHELL
- Policymakers’ main focus will be Prime Minister Shinzo Abe’s new medium-term nominal JPY 600 trillion GDP target.
- The policy mix will improve during the next 12 months with short-term fiscal stimulus likely to complement continued Bank of Japan (BoJ) easing efforts.
- Summer elections and Chinese growth are the key risks for 2016.
The concept of “technical recession”, two consecutive quarters of negative real GDP growth, is of course largely irrelevant for the Japanese economy whose long-term average real growth is close to nil and thus structurally vulnerable to periodic dips into negative territory. Still, the positive revision confirms that Japan remains in an uptrend, however modest by international standards.
With unemployment also grinding down, the BoJ will likely refrain from further aggressive action in the near-term. It should, however, maintain its current pace of asset purchases throughout 2016 since domestic economic conditions are far from overheating. In particular, there are no fundamental (wage-driven) inflationary pressures. Recent renewed weakness in commodities actually creates material downside risk to the BoJ’s inflation guidance.
Will this be sufficient for the Abe cabinet? Probably not. The “Abenomics 2.0” program announced in the autumn targets nominal GDP of JPY 600 trillion in 2020, 20% above the current level. This implies 3.5% annual nominal growth for the next five years, an unrealistic path even under optimistic assumptions for inflation (2%) and potential growth (0.5%). Yet, despite consensus doubts, the cabinet seems determined to invest significant political capital into this objective. Perhaps it feels that it is a politically marketable way to sell the reflation initiative that could silently tackle Japan’s extreme public debt burden at the expense of voters’ purchasing power. After all, the GDP target is nominal, not real.
The Abe cabinet is thus likely to try yet again to boost its policy mix. Relying overly on the BoJ would trigger another bout of yen depreciation, undesirable in the wake of the trade deal with the US. Fiscal spending, on the other hand, could be a solution – at least in 2016. Japan’s fiscal balance has improved somewhat since 2013, creating a little leeway for stimulus. There is also the additional political benefit of doling out spending programs and tax cuts ahead of the important upper house elections in the summer of 2016.
Maintenance of a pro-growth policy mix should help Japan eke out slightly higher annual growth in 2016 than in 2015. Consumer front-loading ahead of the early 2017 consumption tax hike could also add a few basis points to growth. Still, the fundamental picture has not changed: Japan faces a long, arduous and uncertain journey toward lower debt and a more robust economy.
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