Country risk: Spike in Japanese risk puts investors in a funk
The sovereign improved last year, but experts have doubts over its economic prospects, and there are political risks from possible snap elections in the summer.
Japan’s investor prospects are weakening again, according to provisional first-quarter readings from Euromoney’s country risk survey.
If the falling score is confirmed when the final results are released next month, Japan will have failed to improve its ranking since the Liberal Democratic Party, led by prime minister Shinzo Abe, was returned to office in 2012.
Lying 25th out of 186 countries surveyed, within the second of ECR’s five risk categories, Japan’s fading appeal could see it drop below improving eurozone members Slovakia and Malta – and possibly even Ireland.
What went wrong?
The LDP, supported by junior partner Komeito, promised a new start when it took office. It had a three-pronged ‘Abenomics’ strategy: to reflate and reform the moribund economy; finally tackle the borrower’s rising debt load using monetary and fiscal stimulus; and introduce structural reforms.
Early portents were good. The economy grew in 2013, and inflation returned a year later on the back of fiscal and monetary policy stimulus. Sovereign debt was also lower, and largely covered by assets and domestic borrowing from the central bank.
Yet sustaining the economic rebound has proved difficult; reforms are still lagging.
Japan’s risk score might have risen last year, but on closer inspection that was largely caused by technicalities, leading to an improved budget outlook.
Takeshi Kasuga, an economist at JBIC, believes the improvement was attributable to the 2016 budget showing a smaller primary deficit because of a rise in tax income.
Nominal GDP increased in 2015 mainly due to currency depreciation raising the deflator. This provided a boost to tax revenue and probably narrowed the fiscal deficit from 7% of GDP in 2014 to around 5% in 2015.
It also meant the gross debt-to-GDP ratio fell for the first time in eight years, to just below 246% of GDP.
However, Kasuga warns against taking this at face value, “as recently the economic trend has altered and the yen appreciation gives the sense of a gloomy outlook”.
Economic growth fizzled out in the latter part of 2015. GDP declined by 1.1% on an annualized basis during the fourth quarter, and other indicators, including the latest purchasing managers’ index, make for difficult reading.
The stronger yen is hardly helping matters; China’s economic slowdown is crimping exports. The Bank of Japan’s new negative interest-rate policy was supposed to weaken the currency. There is now talk of yet more fiscal stimulus to rescue Japan from its torpor.
Anticipating the yen’s rise, ECR experts downgraded their scores for currency stability last year. The slight improvement in confidence regarding the economic outlook is now waning. Japan’s risk score is falling again.
Structural reforms are lagging, but are clearly critical to tackle Japan’s huge population-ageing problem, as the lower score for demographics in Euromoney’s survey highlights.
Dealing with the deficit and the debt will become harder without a growing economy, and much tougher if the recovery stalls again next year.
“The government has a plan to raise the consumption tax rate further from 8% to 10% in April 2017 to balance the primary fiscal budget by 2020,” says Kazuhiko Ogata, Japan chief economist at Crédit Agricole.
Yet Shinzo Abe and the LDP are now struggling in the opinion polls. Voters have lost confidence in Abenomics and are wary of politicians after a series of scandals has caused some MPs to resign.
The consumption tax will also be difficult to enact if the opposition stalls it as it is signalling it will. That might also help might convince the 30% or so of voters who are undecided which party to vote for.
Investor uncertainty is also being heightened by mounting speculation that the government will call a snap election, perhaps concurrently with the partial upper house elections scheduled for the summer.
“The risk is rising at the moment that this tax hike may be postponed again by one year or so, given the softening economic conditions in recent months,” says Ogata.
How the government would plan to fill the gap in public finances is unknown.
For investors, the question now is whether or not Japan is still a risk worth taking.
This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.