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Assessment of Abenomics: Examination of current situation and future issues(No.177)

Japan to see real GDP growth of +3.1% in FY13 and +0.7% in FY14, nominal GDP growth of +3.0% and +2.0%

Mitsumaru Kumagai

Masahiko Hashimoto

Tsutomu Saito

Shotaro Kugo


Economic outlook revised:  In light of the first preliminary Jan-Mar GDP release (Cabinet Office), we have revised our economic growth outlook. We now forecast real GDP growth of +3.1% y/y for FY13 (previous forecast: +2.7%) and +0.7% for FY14 (+0.4%). The upgrades were made taking into account such factors as the improvement in the export environment which is benefitting from ongoing depreciation of the yen accompanying the Bank of Japan (BOJ)’s monetary easing, and the increase in personal spending accompanying the ascent of share prices.

Assessment of Abenomics:  In this report, we provide an assessment of the economic policies of the Abe administration (so-called Abenomics). Abenomics consists of three thrusts (priority areas): (1) bold monetary policies, (2) flexible fiscal policies, and (3) growth strategies to stimulate private sector investment. We believe that Abenomics represents an appropriate set of economic policies with the potential of sparking the revival of Japan's economy. In particular, monetary policies are steadily yielding results. In this report, we examine the prospects for achieving the BOJ’s inflation target of 2%. This target will be hard to achieve merely by reducing the GDP gap, and a significant increase in the expected inflation rate will be essential. A quantitative analysis of the economic impact of Abenomics based on Daiwa’s short-term macroeconomic model indicates that the positive effects coming from a weaker yen and higher stock prices will not be impaired as long as the long-term interest rate does not rise substantially. Hence, current favorable economic conditions will be sustained for the time being. On the other hand, the Japanese government will need to address the medium- to long-term fiscal deficit problem with more resolve than before.

Three issues regarding Abenomics:  First, there is the risk that the government failing to maintain fiscal discipline will invite the triple blow of falling JGB prices, falling stock prices, and a falling yen. Second, criticism is being widely voiced that medium- to long-term improvements in the nation's economic foundation and structural reforms are currently insufficient. Third, there is concern that employee income will not grow as inflation progresses. Thus, going forward, the Abe administration will need to actively engage in: (1) the maintenance of fiscal discipline, such as by making fundamental reforms to the social insurance system, (2) the strengthening of comprehensive growth strategies, such as deregulation, participation in the Trans-Pacific Strategic Economic Partnership Agreement (TPP), and the reduction of the effective tax rate borne by corporations, and (3) the achievement of higher employee income where the pain is shared among the government, business, and labor.

Main scenario for Japan’s economy:  Japan’s economy slipped into recession after peaking in March 2012. It now appears to have hit bottom in November 2012 and to have bottomed out. It is expected to continue expanding, supported by (1) the recovery of the US and Chinese economies, (2) the continuation of reconstruction demand and a large-scale supplementary budget, and (3) the ongoing depreciation of the yen and the ascent of stock prices accompanying the BOJ’s bold monetary easing. With regard to the last, we anticipate that the yen will gradually weaken against the US dollar. Also, in comparison to the real economy, it still cannot be said that stock prices are overvalued at their current levels.

Risks facing Japan’s economy: Risks that will need to be borne in mind regarding Japan’s economy are: (1) a reigniting of the European sovereign debt crisis, (2) the worsening of Japan-China relations, (3) the US fiscal issue, and (4) a surge in crude oil prices stemming from geopolitical risk.

BOJ monetary policy:  The BOJ has made a smooth start with the relaunch of monetary policies under the leadership of Haruhiko Kuroda, the new governor. Concerns are likely to surface, however, with the release of Outlook for Economic Activity and Prices in October 2013 regarding prospects for achieving the inflation target, and the BOJ will likely be compelled to ease monetary policy further, such as by actively purchasing risk assets (ETFs and other such assets).

Our assumptions
◆Public works spending will grow +12.2% in FY13 and –15.8% in FY14; the consumption tax rate will be increased in April 2014 
◆Average exchange rate of Y100.0/$ in both FY13 and FY14 
◆US real GDP growth of +1.9% in CY13 and +2.3% in CY14

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