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Abenomics on the line as Japan heads to the polls

Abenomics on the line as Japan heads to the polls

Tadamori Oshima, Japan’s speaker of the lower house, read aloud at the opening of parliament  on 27 September a resolution from prime minister Shinzo Abe to dissolve the lower house one year earlier than scheduled.

The ceremonial dissolution of parliament, despite having largely been expected, triggered snap elections that are seen as a bid to strengthen Abe’s position in the house and ensure his term is extended for another three years.

After earlier falling back from a near decade high the week before, investor sentiment – as measured by the MSCI Japan USD index – cheered the move, climbing back toward its recent peak.

Yasunori Iwanaga, Amundi Japan’s chief investment officer, said the expected easy win would boost Abe’s political capital and increased the likelihood that his economic reform agenda would be achieved.

‘The markets have already reacted positively and the consensus is expecting a comfortable vote for Abe and his ruling Liberal Democrat Party (LDP) party in coalition with the Komei Party,’ said Iwanaga. ‘The hope is he will be emboldened to carry through his reform agenda leading to a primary balance surplus by 2020.

‘He looks set to replenish his stock of political capital when the main opposition Democratic party is grappling with new leadership, defections and threats of splits. It is simply not ready to fight an election now.’

The prime minister’s return to popularity is, at least in part, due to a strong stance on North Korea, which has included measures such as participation in military exercises in the Pacific with the US.  

Abe said he was seeking a renewed mandate on his defence policies, following threats from North Korea, while taking advantage of an opposition in disarray over its response to government tax policy.

Unpopular tax hike inevitable

Jesper Koll, head of WisdomTree Japan, said: ‘The political decision on the next consumption tax hike will have to be made in November/December 2018.

This is by far the most significant macro policy decision Japan faces because every tax hike in the past has forced recessions, as well as equity bear markets.

‘For markets, the key implication will be an almost certain change in Japan’s macro policy mix; the probability of taxes going up in 2019 has now risen, which in turn raises the odds that the Bank of Japan will have to do more for longer to ensure against the inevitable recession that has always followed consumption tax hikes.’

Geoffrey Yu, head of the UK investment office at UBS, noted that Abe’s knowledge of the impact of previous tax raises could curb more radical proposals.

‘Abe will likely err on the side of caution when it comes to tax hikes over the next few years,’ he noted.  

‘He may not want to tackle unpopular tax increases that may affect his much needed labour reform when it begins to take effect. Especially since Japan already has a high savings ratio and its corporation tax is low.’

Tax reforms

The government had already earlier postponed the scheduled consumption tax hike but the revenue has been earmarked to pay for parts of its agenda, primarily education and childcare, and cannot be postponed indefinitely without compromises elsewhere.

‘Abe already used his powers once to delay the unpopular tax hike as a bargaining chip for voter popularity two years ago,’ said Koll.

‘It seems reasonable to assume he would do this again, particularly since the tax hike decision basically coincides with when he will have to call an election anyway, Japan’s lower house has a maximum term of four years, and these are up in December 2018.’

While the majority of overseas investments have been happy to price a near done-deal into the result, Gavekal analyst Neil Newman cautioned against excessive complacency. He warned that the electorate is not immune to the lure of populism, and there remains space and time for a challenger to emerge.

Dissident members of Abe’s own party are already deep in discussions with smaller groupings about creating a new parliamentary block capable of exerting leverage in the government.

‘His probable re-election promises four more years of the accommodative policy settings that are slowly delivering macro-economic results,’ Newman argued.

‘What is more, the emergence of a new right of centre party to challenge Abe’s Liberal Democratic Party is likely to spur the governing LDP to step up the pace of its structural reform program after the 22 October election, supporting Japan’s equity market beyond the usual “buy on rumour sell on fact pre-election run-up”.’

However, Iwanaga added: ‘As we have seen in Europe’ electorates have a habit of disregarding market consensus.’

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