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Can clockwork Japan embrace Abenomics?

Can clockwork Japan embrace Abenomics?

In Japan, it is paramount that things run like clockwork.

So against a backdrop where acts of randomness raise stress levels and extreme change can spark panic, Abenomics really is an extraordinary experiment.

‘The mindset [of the Japanese people] has to change,’ said Threadneedle head of global equities William Davies. ‘Change is slowly happening but it doesn’t happen overnight.’

It is not surprising this juggernaut of conservative sentiment will be a challenge to transform. After all, this is a country which has grappled with deflation for more than two decades following the bursting of the Japanese bubble in 1989.

A prime example of this was last night's data showing the Japanese economy shrunk by 6.8% in the second quarter following the 6.1% rise in the previous three months.

The sharp decline was attributed to the sales rush before the country introduced a sales tax in April. It is yet another example of the lengths the government has to go through to get the Japanese people spending on a consistent basis.  

Richard Koo, chief economist at the Nomura Research Institute, highlights the predicament. ‘During the bubble, the corporate side borrowed massively and when interest rates fell to zero, everyone paid off debt, rather than borrowed. This resulted in shrinkage in the financial system.’

He adds: ‘The biggest problem in Japan is the need to get companies to borrow and [prime minister Shinzo] Abe is the first one to recognise this problem. If people start to see the Japanese economy recovering and companies starting to borrow, then I’m sure Japanese investors will start to return.’

Shortly after taking office in December 2012, Abe unveiled his plan to medicate the recession-riddled country. The policies have come in three tranches – the three arrows – focused on monetary easing, fiscal stimulus and reform and growth.

The first two arrows sparked a huge stock market rally. Now the tough work to get the third arrow to hit the target begins. 

Mixed signals

So far the signs are mixed. After an initial spike in inflation, the core consumer price index eased for the second consecutive month in June, falling from 1.4% to 1.3% as the sales tax introduced earlier in the year took effect.

The figure is some way off the Bank of Japan’s 2% target and it would be rash to declare Japan’s deflationary days over.   

It is crucial for Abenomics to get people to start spending.

This makes labour reform and the introduction of a more meritocratic system important and no small challenge in a culture where people tend to graduate into a job for life. Under this set-up, seniority is indiscriminately rewarded and it is rare for workers to be made redundant for poor performance.

As a consequence, there is little in the way of wage inflation in Japan. ‘Every year, real wages and the value of property go down in Japan,’ said Threadneedle Japan fund manager Sarah Williams.

‘Reforms are needed, the labour market is too tight and we need to see wages rise. If we start seeing that, we will really know Abenomics is working.’

If inflation fails to hit 2% by the end of the year, there is every chance the Bank of Japan (BoJ) will pump more money into the system. However, Koo hopes the BoJ resists the temptation.

‘Quantitative easing (QE) could be a huge problem and I really don’t know how we’re going to get out of this mess. QE is the unwanted child of a balance sheet recession. If the central bank stopped QE, everyone could relax and let the economy recovery naturally.’ 

With the 2020 Olympics on the horizon, Williams sees a big opportunity in infrastructure.

‘The last time Japan spent serious money on infrastructure was in the 1960s when it last had the Olympics. It is getting to the point where bridges are falling down and money needs to be spent, especially with 2020 in mind.’  

While companies such as technology bellwether Sony find it almost impossible to get emotional about Abenomics, others are excited by what is happening in their country.

These include Japan’s largest advertising agency, Dentsu, which saw 9% growth in domestic revenue in 2013, its biggest increase for a number of years. This was largely thanks to the depreciation of the yen, which Abenomics manufactured to help increase the competitiveness of Japanese companies.

‘The correction in foreign exchange benefited larger companies, many of which were Dentsu customers,’ said Dentsu investor relations manager Shinya Mori. ‘This allowed corporates to allocate more spend to advertising. While it is hard to quantify, we are definitely seeing signs of a significant improvement in appetite from domestic clients.’

Online retailer Rakuten, dubbed the Amazon of Japan, has also seen a pick-up in business. 

‘In the first and second quarters of 2014 we saw a rise in every product category, with luxury items doing especially well,’ said Jeremy Tonkin, the company’s investor relationship manager. ‘While some of this was due to the last minute rush due to the consumption tax rise, we are keeping growth momentum.’   

Japan has experienced so many false dawns, what is so different this time? ‘If Abenomics gets Japan into growth, it will create a whole new range of opportunities,’ said Williams, who has more than 20 years’ experience of investing in the country.

‘I can remember the bubble, and Japan is really interesting again. What seems different to me this time is that the Bank of Japan and the government are working together.’  

Meanwhile, Davies sees a marked change in the attitudes of companies. ‘Changes are taking place and companies are now being run for the benefit of shareholders. They are now engaging and addressing shareholders’ needs.’

The author was a guest on a Threadneedle trip to Tokyo.

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