Towards Phase II of Abenomics What Will Happen when the US Devises an Exit Strategy?(No.187)

◆Japan’s economy may have entered a recession: In light of the 1^st preliminary Jul-Sep 2015 GDP release (Cabinet Office), we have revised our economic growth outlook. We now forecast real GDP growth of +0.8% in comparison with the previous year for FY15 (+1.0% in the previous forecast) and +1.5% in comparison with the previous year for FY16 (+1.7% in the previous forecast). Japan’s economy may have entered a recession, but we expect it to move toward a gradual recovery during the year 2016 due to the following factors: (1) Continuation of the virtuous circle brought on by Abenomics, and (2) A gradual comeback in exports centering on the US.

◆Towards Phase II of Abenomics: In this report we examine what has been referred to as the new third arrow of Abenomics, or the “Redistribution Policy.” Considering Japan’s difficult fiscal situation, shifting government expenditure from the elderly to the younger generation would help to realize improvement in Japan’s total fertility rate and increase labor productivity, while at the same time attaining sustained economic growth. A viewpoint encompassing all of these factors is considered essential. However, the overall scale of the country’s social security system must be downsized and a recovery attained in the balance of benefits and burdens. At the same time, carrying out clear and detailed system design and relieving the anxieties of citizens regarding the future is key. Meanwhile, regarding the supplementary budget, which is expected to be argued up until the end of 2015, it is crucial that a highly effective redistribution policy be devised. From this viewpoint, an income redistribution policy directed toward low income people with a strong propensity to consume and households with a large number of children regardless of income bracket would be effective.

◆What will happen when the US devises an exit strategy?: With the current slowdown in the economies of emerging nations, especially that of China, possibilities are that the global economy could enter a period of serious stock price lows and worldwide production declines. In producing this forecast, based on the assumption that the US will sooner or later come out with an exit strategy, we provide a detailed analysis of the merkmal (judgment criteria) determining whether or not the world economy will plunge into a period of falling stock prices and production declines, as well as the major leading indicators which suggest future trends. At the same time we examine the characteristics of periods in the past when the global economy has experienced major declines in stock prices and production. Our basic scenario sees the Fed raising interest rates at a pace matching the current economic and business environment. We assume that the financial markets and the real economy will not be shaken overly much. However, we also believe that trends in the Fed’s monetary policy should also be watched very carefully on into the future.

◆Japan’s main economic scenario – Moving towards a moderate recovery: Judging from the performance of major demand components in the GDP statistics, there is a possibility that Japan’s economy has officially fallen into a recession. However, examination of three major judgment criteria (“merkmal”) suggests that Japan’s economy is still in a temporary lull. In either case, the adjustment phase in Japan’s economy is expected to be both short-term and fairly minor. We see Japan moving toward a moderate recovery during the year 2016.

◆Risk factors facing Japan’s economy: Risk factors for the Japanese economy are: (1) The downward swing of China’s economy, (2) Tumult in the economies of emerging nations in response to the US exit strategy, (3) A worldwide decline in stock values due to geopolitical risk, (4) The worsening of the Eurozone economy, and (5) The Triple Weaknesses – a weak bond market, weak yen, and weak stock market due to loss of fiscal discipline. Our outlook for China’s economy is optimistic in the short-term and pessimistic in the mid to long-term. Looking at China’s economic situation in a somewhat reductive way, the fact is that China’s government holds treasury funds totaling between 600 to 800 tril yen with which it is standing up to over 1 quadrillion yen in excessive lending and over 400 tril yen in excess capital stock. China is expected to be able to avoid the bottom falling out of its economy for a little while, but in the mid to long-term, there is risk of a massive capital stock adjustment.

◆BOJ’s monetary policy: We expect additional monetary easing measures by the BOJ to be shelved until spring 2016 or later. The BOJ is expected to choose the timing for additional monetary easing measures carefully, keeping a close watch on world economic trends and Japan’s political calendar.

【Our assumptions】
◆Public works spending is expected to decline by -0.7% in FY15, and -3.5% in FY16. An additional consumption tax hike is planned for April 2017.
◆Average exchange rate of Y122.6/$ in FY15 and Y125.0/$ in FY16.
◆US real GDP growth of +2.4% in CY15 and +2.6% in CY16.