IMF a scrooge on Japan and Europe, but investors should watch out for complacency
Is the IMF a Cassandra on Japan and Europe?
Last week, the release of first quarter GDP data in Japan showed that the economy grew at an annualised pace of 2.4 per cent, beating analysts’ estimates of 1.4 per cent and a notable improvement on the 1.5 per cent rate in the final quarter of last year.
While growth was driven largely by a strong build-up in inventories, private consumption and investment - crucial components of any meaningful and sustainable economic recovery in Japan - both expanded at an annualised rate of 1.4 per cent, showing that the world’s third-largest economy is pulling out of a recession in the middle of last year.
Yet no sooner were the GDP figures released than the International Monetary Fund (IMF) struck a decidedly downbeat tone on Japan’s economic prospects in its publication of the findings of its latest staff visit to the country. The IMF’s concluding statement of its so-called Article IV mission to Japan, released on May 22, said that Abenomics - the reflationary programme pursued by Japanese premier Shinzo Abe and Bank of Japan (BoJ) governor Haruhiko Kuroda - was in grave danger of failing.
Stressing that “risks to the outlook are tilted to the downside”, the Fund called on Japan’s government to “embark on a sustained long-term effort to meet the unprecedented challenges Japan is facing - ending an entrenched deflationary mindset, raising growth, restoring fiscal sustainability and maintaining financial stability.”
The IMF takes an equally dim view of the eurozone’s economy despite growing signs that the bloc’s recovery is gaining traction, with France and Italy - the two weakest economies - posting growth in the first quarter of this year, allowing Europe’s single currency area to grow at a faster rate than the US.
In its latest World Economic Outlook, published last month, the IMF said “high real debt burdens, impaired balance sheets, high unemployment and investor pessimism about prospects for a robust recovery will continue to weigh on demand”, adding that “deep seated obstacles to productivity and competitiveness are likely to weigh on the [eurozone’s] growth potential.”
At the European Central Bank’s annual conference in Portugal last weekend, the Fund’s outgoing chief economist, Olivier Blanchard, said unemployment in the bloc will remain high because the eurozone suffers from “hysteresis”: a concept traditionally associated with physics which, when applied to economics, refers to a permanent increase in the non-accelerating inflation rate of unemployment (NAIRU) due to the enduring legacy of a severe economic downturn.
While this may well be the case, talk of “investor pessimism” about the eurozone economy is misplaced given the 18 per cent rise in eurozone equities this year (compared with just a 3 per cent increase for the benchmark US S&P 500 index) and investors’ more upbeat assessment of Europe’s single currency area since the ECB’s programme of full-blown quantitative easing (QE) got underway in March.
As for Japan, the Nikkei-225, Japan’s main equity index, currently stands at a 15-year high, buoyed by the persistent weakness of the yen and the continued appeal of the reflationary policies of the Abe government. Japanese equity funds just recorded that 13th consecutive week of inflows - the longest streak in two years.
That investor sentiment and the economic assessments of the IMF differ is by no means surprising. The same can be said for the disconnect between many countries’ credit ratings and market conditions.
The question is whether the IMF is too pessimistic - or, alternatively, whether investors are far too sanguine.
In the case of the eurozone, the IMF appears to belittle the significant improvement in business and consumer sentiment over the past several months, borne out by the recent batch of monthly purchasing managers’ index (PMI) surveys undertaken by Markit. Growth in the eurozone may be lacklustre, but the bloc is no longer at risk of falling into a protracted deflationary slump - a serious threat towards the end of last year.
As for Japan, the IMF, although somewhat alarmist, is more convincing when it warns of the dangers of not putting in place a credible medium-term plan of fiscal consolidation. Abe’s belief that faster growth will help reduce Japan’s towering public debt burden is far too rosy an assumption at this stage.
Investors, meanwhile, should not be lulled into a false sense of security by the distortive effects of QE.
The lack of liquidity in debt markets - which contributed to the recent sell-off in government bonds - is raising the stakes. The IMF may be too bearish but it is investors who have most to lose if they are overly complacent.
Nicholas Spiro is managing director of Spiro Sovereign Strategy