By Andrew Nelson
Japan is entering a new era, the era of Abeconomics. This refers to the new economic policy platform being rolled out by the new Japanese Prime Minister, Shinzo Abe. According to Abe, he has three arrows to fire, arrows that hopefully find their target.
The three arrows have names: Loose monetary policy, loose fiscal policy and structural reform. The loose monetary policy arrow is aimed at bringing about 2%pa CPI inflation. The loose fiscal policy arrow is to provide near term support for growth. The structural reform arrow is aimed at lifting the overall growth rate of the economy.
Analysts from Commonwealth Bank note that the structural reform arrow is the most important, but also the most difficult to aim. In fact, CBA is not optimistic.
Arrow 1: The stated purpose of the looser monetary policy is to overcome deflation. To achieve this, the Bank of Japan's monetary policy needs to become even more accommodative under a new BoJ Governor. Asset purchases will need to be doubled. The BoJ will also need to look at buying some private sector instruments such credit, equities and real estate investment trusts.
Abe has gone so far as to suggest the possibility of establishing a private-public joint venture to purchase foreign bonds. One of the potential candidates for the new Governor job thinks the BoJ should create a JPY 50 trillion fund. The bank has already started moving in this direction in saying it will fund unlimited bank lending, which could spill over into buying foreign assets, an eventuality likely to raise no objections in Europe. At least if some of those yen find their way to European sovereign bonds.
The key to this plan is who actually ends up being the new BoJ Governor. And because the government does not control the upper house of parliament, it's not a certainty Abe will get his way. CBA notes Haruhiko Kuroda, currently head of the Asian Development Bank, is the most likely choice.
CBA cites the fact that Kuroda has not worked at the (previously criticised) Bank of Japan and has international and management experience, including solid including English language skills. CBA suggests Japan may nevertheless not want to lose its position as the head of the ADB.
Arrow 2: The pursuit of short-term fiscal stimulus. While such a move would be an about face from the fiscal consolidation that Abe pursued during his earlier term as prime minister, CBA believes he now thinks fiscal stimulus is necessary to make up for the fall in demand while broader structural reform is under way.
The lower house of Japan's parliament has already approved a budget stimulus package of 2%-2.5% of Japanese GDP. Were such a bill to make it through the senate, CBA still doubts the package would lift Japanese economic growth in a meaningful way in 2013. The bank explains that much of this stimulus is focused on infrastructure and Japan has a long history of infrastructure spending with little noticeable pay-off.
There is further risk in a stimulus push given the already high levels of government debt. All it would take to force up interest rates on government bonds is for the market to get a bit spooked about the sustainability of government debt. Interest payments on the new debt would quickly rise, thus making Japan's debt load quickly unbearable. Admittedly, this hasn't happened yet, with CBA noting interest expense is currently manageable at just over 2% of GDP and 6% of total government spending.
Arrow 3: While none of the aforementioned is easy, CBA thinks structural reform is a big problem given it is the most important arrow. Sure, structural reform has the potential to raise productivity growth via the deregulation of markets, but productivity growth already needs to be increased just to offset the effect of a rapidly ageing population.
Further, such reform is famously difficult to implement. There are costs, which are mostly up front and it's hard to get politicians to spend money on anything that doesn't deliver benefit tomorrow. And once the money has been spent, if it has been spent, and it can take years to see the real benefits. Thus even if the population is behind the idea of reform, it's hard to keep them onside when they can't immediately see the benefits they're buying. Just look at Italy.
Given a rapidly ageing population, the most obvious reforms are to the pension system. The number one pick would be to increase the pension eligibility age to bring it into line with rising life expectancy levels. CBA thinks this would have a positive impact long run economic growth and would be a fairly equitable way to spread the burden. But even if you add in the clawing back of some pension benefits from wealthy retirees, reducing preferential tax treatments and collecting contributions from dependent spouses, the benefit is only estimated to be 1.25% of GDP by 2020.
Thus while far from small change, a budget deficit improvement 1.25% of GDP falls well short of addressing the already massive budget deficits that Japan normally run with. Thus, much more radical reform is needed and this is far from likely, thinks CBA.