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Turning Japanese

By Yiannis G. Mostrous, on Jul. 6, 2013

Although Abe last month targeted private-sector capital investment to grow to private-sector capital investment to 70 trillion yen (US$693 billion) over the next three years, the much-touted structural reforms–such as the removal of tariff barriers, privatization of infrastructure and changes to the labor market–have yet to materialize. Up until now, the only legislation addressing these issues allowed for the private-sector to manage government-owned airports.

Promised changes to the labor market, which are of paramount importance, will also prove the most difficult to implement. For starters, the majority of the voters in Japan are above the age of sixty, and turnout among younger voters is relatively low. Expect the older generation, many of which have grown accustomed to a deflationary environment that has made Japanese households wealthier and, in turn, made stagflation politically acceptable.

However, the Bank of Japan has emphasized that it will do whatever it takes to inflate the economy, an effort though that’s unlikely to succeed without wage increases and other changes in the labor market.

Although growth in international trade remains an important upside catalyst for Japan’s economy, the exports account for only 16 percent of the nation’s gross domestic product (GDP)–compared to between 50 and 70 percent for South Korea and Taiwan. Given the importance of domestic demand to Japan’s economy, the Bank of Japan’s efforts may fall short without a real rise in aggregate wages.

Meanwhile, the Bank of Japan continues its accommodative monetary policy and quantitative easing, levers that traditionally have been bullish for equities. A weaker Japanese yen also benefits the country even more because the nation is one of the world’s largest net foreign creditors. Assets denominated in a foreign currency, account for 60 percent of Japan’s GDP, whereas liabilities are yen-denominated; a weaker domestic currency increases the value of these foreign assets in yen terms.

If individual investors see that the government’s efforts to stimulate inflation are working, this development might prompt an influx of liquidity to the stock market. At present, households in Japan have 56 percent of their financial assets in cash, while pension funds have allocated less than 10 percent of their portfolios to equities. There’s plenty of capital on the sidelines.

Source: Bank of Japan

Don’t expect Prime Minister Abe to push the envelope before the July 21 ballot for the Diet’s upper house. 

A big win by the Liberal Democratic Party-led coalition would give Abe the mandate to implement his ambitious reform program. Without the structural changes, Japan should grow its GDP by more than 1.5 percent this year, aided by positive sentiment toward the government’s effort to stimulate the economy. Private consumption accounts for 59 percent of the nation’s GDP; a relatively small shift in consumption can have an outsized effect on the economy.

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