Diminishing returns from weak yen triggers Abenomics fears

Simon Watkins
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Sunday’s win in Tokyo’s gubernatorial election for Abe supporter Yoichi Masuzoe was a fillip to the PM’s economic programme, but faltering exports, weak sequential economic data and a peak in output/inflation suggest the yen needs to be much weaker for Abenomics to play out.

The victory by Masuzoe, the LDP candidate backed by prime minister Shinzo Abe, should bolster the chances of one of Abe’s cornerstone economic strategies – engineering sustained nominal annual economic growth of 3; there has been no average annual nominal GDP growth for 15 years – being implemented, says Sean Yokota, head of Asia strategy for SEB, in Singapore.

“His victory will place Tokyo as the model for economic reforms, where Tokyo will become one of the special economic zones, and additionally Masuzoe is calling for reforms in taxes, Japan joining the Trans-Pacific Partnership free-trade agreement, and loosening the labour market where he is open to more foreign workers,” he adds.

However, this growth, together with another cornerstone of Abenomics – achieving at least a 2% rate of inflation every year from 2015 – which largely entails the Bank of Japan (BoJ) buying ¥7 trillion ($69 billion) per month in domestic assets (plus a separate ¥25 trillion per year credit-loan programme), carries substantial risks for the country, according to the IMF.

That these concerns are beginning to gain traction in investors’ minds might be evidenced by the recent jump in Japan’s default risk – as implied by credit default swaps prices – to the most among developed markets this year.

In broad terms, as first spelt out by the IMF in its Global Financial Stability Report (Update) October 2012, and reiterated in subsequent releases, although Japan was trapped in chronic deflation, it was “a stable equilibrium”, with the real value of savings rising due to almost zero inflation, despite the concomitant perennially low interest rates.


However, with inflation now at substantially higher levels – the consumer price index in December was 100.9 (2010=100), up 0.1% from the previous month, and up 1.6% over the year, according to figures from the Ministry of Internal Affairs and Communications – and Japanese government bonds (JGBs) yields picking up, the IMF warns of a spike in debt costs and a domestic flight from JGBs.

This, in turn, says the IMF, could trigger a problem in Japan’s banking system, as the holdings of JGBs by Japanese banks account for 900% of their tier 1 capital. 


This high level of debt-holding by Japan’s banks is as characteristic of Japan as it is of euro area sovereigns under market pressure, and is expected to increase over the medium term, particularly for smaller, regional banks, the IMF concludes.

Such risks could reach a tipping point, according to a statement from Moody’s on January 14, with a sustained worsening of Japan’s current account into a structural deficit that could well trigger a sharp increase in government debt cost.

In this context, even with a yen that has depreciated from around 75 to the US dollar to more than 100 presently, since Abe became PM in 2012, Japan’s trade deficit widened to ¥11.47 trillion last year, from ¥6.94 trillion in the previous year – the third straight year of deficit, and the longest since records began in 1979.

And on Monday morning, data were released showing the current-account deficit widened to a record in December, to ¥638.6 billion, against November’s gap of ¥592.8 billion.


“Part of our strong conviction that the yen will fall over time is that, put simply, Japan needs a much weaker currency, but unfortunately for Japan, it is becoming very clear that the yen move to-date is nowhere near enough for this dynamic to play out,” says Ric Deverell, global head of commodities, GFX and Asia strategy for Credit Suisse, in London.

“Having traded sideways for five months, the boost to inflation and output growth looks to have already peaked, and while year-on-year rates of growth are still moving in the right direction, the sequential data are already showing the impact is fading, and the surge in exports seen earlier last year having also peaked.”


Worse still, given this backdrop, is the further potentially negative economic effect of the April increase in the sales tax – to 8% from 5% – which makes this year a “crunch year for Abenomics”, says Michael Taylor, chief credit officer for Asia Pacific for Moody’s, in Hong Kong.

Credit Suisse’s Deverell adds that his concerns about the economy – which has a more than JPY1 quadrillion debt burden, the world’s largest as a proportion of GDP – will be exacerbated if the government goes ahead with the tax increase, as is almost certain, given how difficult a task it is to end 15 years of deflation.

“While theoretically it should be possible, at a minimum the government needs all macro policies pointing aggressively in the same direction until it is achieved,” he says. “While tightening fiscal policy is necessary in the medium term, in our view a short-term tightening would all but guarantee a policy failure and a return to deflation.”