Investors and economists in Tokyo say Prime Minister Shinzo Abe’s weak agenda to promote industrial restructuring threatens his recovery programme because it won’t be enough to get companies to invest their cash.
Criticism of Abe’s June 5 policy address, which is widely viewed to have disappointed expectations regarding deregulation and liberalisation — the so-called third arrow of Abe’s economic reforms — focuses on creating an environment in which Japanese companies believe they can grow profits by putting cash to work. (Abe is meant to announce further concrete steps this Thursday.)
The fall in the Japanese stock market that accompanied Abe’s lacklustre address is not of great concern. The Nikkei 225 stood above 18,000 in June 2007, so trading around the 12,600 to 13,600 range, as it did last week, does not suggest it is overvalued, says Mitsumaru Kumagai, chief economist at Daiwa Research Institute. He generally praises Abe’s first arrow, the dramatic monetary expansion begun by the Bank of Japan in April. Kumagai spoke on June 6 at a conference organised by FinanceAsia’s affiliate title, AsianInvestor.
He is concerned by the other two arrows: fiscal stimulus in the form of more government borrowing, when the national debt-to-GDP ratio is already at 250%; and industrial restructuring to make the economy more open and competitive.
One danger Kumagai notes is that Japan will be forced to raise interest rates at some point if it is to attract further lenders, which could wipe out the recent rally in equities and send the yen back on a painful course of appreciation.
Yuji Kage, senior advisor to Blackstone as well as to the Pension Fund Association, one of Japan’s most important investors, says investor behaviour could derail the fiscal situation.
For investors, the longstanding paradigm was to invest in Japanese government bonds because they were the only vehicle that could deliver a positive return, adjusted for inflation. The equity market disappointed for 20 years and the strong yen made foreign investments unattractive. But now that the authorities are keen to fight deflation, rather than accept it, changes the equation. The likely response by investors will be to realise they are too exposed to JGBs, Kage says.
He also notes that the markets in Japan will also be impacted by the ultimate tapering off of quantitative easing in the US. Already the JGB market has been roiled on fears that the US might raise interest rates in the near future.
Kage notes that across the developed world, quantitative easing is pushing money into financial assets, and not the real economy. Investors are counting on central banks to step in if markets threaten to crash — the so-called Bernanke put. But this state of affairs can’t last forever, he says, noting that at some point, the gap between financial markets and the real economy has to close. The upshot, he says, is that while investors can be generally positive about the outlook for Japanese stocks, companies are not similarly bullish about investing their own money. “Corporate and institutional investors are not simply switching to risk-on positions,” Kage says.
This is where Abe comes in for the heaviest criticism. His June 5 proposals “were general and piecemeal and very small,” says Kumagai. “The most important points were not mentioned ... I have to be critical of the content.”
In particular, Kumagai wanted to hear a call for corporate tax rates to be cut from their current 35% to something closer to 20%. He also wanted Abe to talk about reforming agricultural protectionism in order to stimulate domestic demand and support exports of rice. Nor was there any mention of liberalising labour markets.
The upshot to Abe’s calls to double household incomes seemed to come in the form of protectionism rather than stimulating economic growth, he says.
Ultimately these reforms must convince Japanese companies to invest, if private-sector growth is to be sustained. Japanese companies are collectively sitting on ¥200 trillion (around $2 trillion) or more of cash.
Kage notes that even in the US, five years of QE have not convinced its corporations to spend either. “This is the key to stimulating the economy,” he says. “Does Abe have it in him to go ahead with bold structural reforms that require attacking vested interests?”
Yasuyuki Konuma, director of new listings at Tokyo Stock Exchange, says most of the Nikkei’s gains since November are attributable to foreign investors. Domestic retail investors have been net sellers. There is a sense that Japanese companies do not reward investors. Konuma says investors need to engage corporations about how to grow, and companies need to be more attuned to shareholder desires. He notes that Abe’s June 5 address included a call for more start-up companies, which the TSE would welcome as a source of new business, but Konuma says institutional investors will not invest in them if corporate governance is not improved.
“Japanese companies are trying to survive, so they’re keeping their debt levels low,” Kumagai notes. What is good for an individual company is a disaster at an aggregate level, however, because that refusal to use leverage means companies are not trying to grow their businesses. And foreign investors won’t buy them unless corporate governance is enhanced. These are not topics that Abe has championed.
Kage believes the unspoken growth strategy is to support Japan’s involvement in the US-led Trans-Pacific Partnership (TPP) trade deal. That is one way to fight embedded interests.
But whether the TPP actually forces the kind of governance reforms that companies need to attract investment and build enough confidence to engage in capital expenditures is unknown.
