Japan’s Abenomics programme lies in tatters
A sharp spike in the value of the yen against the US dollar has undermined efforts to reflate
For an indication of the extent to which the limits of ultra-loose monetary policy have been reached, look no further than Japan.
On Monday, the publication of GDP data for the final quarter of last year showed that Japan’s economy shrank at an annualised rate of 1.4 per cent, an even sharper contraction than the one anticipated by analysts. That this was mostly due to a steep fall in private consumption - a crucial gauge of the success of premier Shinzo Abe’s reflationary economic programme, dubbed “Abenomics” - is a double whammy.
More than three years of aggressive monetary easing - the so-called “first arrow” of Abenomics and the boldest element in a three-pronged strategy which also includes fiscal stimulus and supply-side reforms - has left the Bank of Japan (BoJ) and Abe’s government with little to show for.
In January 2013, just months before the BoJ launched its first round of large-scale asset purchases, the central bank and Abe’s cabinet signed a joint statement pledging to haul the world’s third-largest economy out of a protracted period of entrenched deflation.
Three years on, Japan’s inflation rate stands at just 0.3 per cent (0.8 per cent in the case of core inflation, which excludes volatile food and energy prices), still way below the BoJ’s seemingly elusive 2 per cent target.
While corporate profits have surged as a result of the 40 per cent decline in the value of the yen against the dollar since the end of 2012, and domestic demand has at least been growing of late, the economy only managed to expand 0.4 per cent last year, following no growth at all in 2014.
While Japan’s “modest recovery”, in the charitable words of the International Monetary Fund (IMF), has been impeded by a number of factors - the struggle to ignite inflation has made it extremely difficult for the government to convince companies to award meaningful wage increases, ensuring that domestic demand has remained weak - the chief culprit was the ill-fated decision in April 2014 to raise the consumption tax from 5 per cent to 8 per cent.
This self-inflicted wound helped tip Japan’s economy into recession and undermined confidence in the government’s reflationary agenda.
What is worse, the rug has been pulled out from under the first arrow of Abenomics - the most successful of the programme’s three policy goals and the one that was responsible for the dramatic 108 per cent increase in the Nikkei 225, Japan’s main equity index, between the end of 2012 and July 2015.
A toxic combination of concerns about China’s economy, the fallout from the plunge in oil prices and a “flight to safety” stemming from the recent sell-off in European banks has caused a sharp spike in the yen, whose sharp depreciation was supposed to grease the wheels of Abenomics by boosting corporate profits which, in turn, would lead to higher wages.
Since June 2015, the yen has strengthened nearly 10 per cent against the greenback, with the bulk of the decline occurring since the end of January. This has contributed to a 23 per cent drop in Japanese equities since early August, with most of the fall occurring this year.
Over the past several months, the “Abenomics premium” - the stock market gains stemming from the stimulus-driven depreciation of the yen - has disappeared.
Indeed the BoJ’s policies themselves are now viewed much more critically by investors following the recent backlash against the negative interest rates policy (NIRP) pursued by many leading central banks, including the BoJ.
On January 29 the central bank unveiled a minus 0.1 per cent rate that applies to one tranche of reserves held at the BOJ by financial institutions, or in the BOJ’s own words:
“Specifically, the Bank will adopt a three-tier system in which the outstanding balance of each financial institution’s current account at the Bank will be divided into three tiers, to each of which a positive interest rate, a zero interest rate, or a negative interest rate will be applied, respectively.”
Japanese banking stocks have come under severe strain while numerous money market funds have had to suspend (and even close) some of their funds because of the BoJ’s decision to cut rates into negative territory.
Yet growing doubts about the first arrow of Abenomics pale in comparison with concerns about the second and third ones.
Plans for a second increase in the consumption tax next year - deemed essential in order to avoid a loss of credibility in fiscal policy in a country whose public debt stands at a staggering 250 per cent of GDP - risks further crimping private consumption.
As for the third arrow of supply-side reforms, there has been little in the way of meaningful structural reforms to raise Japan’s long-term growth rate.
The IMF claims that “Abenomics needs to be reloaded” to ensure that the programme does not end in failure.
But the inescapable feeling is that this has already happened.
Nicholas Spiro is a partner at Lauressa Advisory