Abenomics turns Japan upside down

The new prime minister is pulling all the levers to boost the stagnant economy, writes Brian Robins.

It was not quite what Japan's policymakers had in mind when they decided to change tack and pump massive volumes of funds into the economy in a bid to end a 20-year deflationary slide.

The first round of price rises came from the glitzy end of town, the wall-to-wall purveyors of luxury goods in Ginza - where the likes of Tiffany, Chanel, Bulgari, De Beers and Cartier stand cheek by jowl - as the first winds of the lower yen in foreign exchange trading made their presence felt.

Japan's consumers were quick out of the box, figuring they would get in fast before prices rose too far. Similarly, property developers recorded a quick rise in inquiries and sales on new developments as buyers, long accustomed to falling property prices, decided that if the government succeeded in stemming deflation, prices would pull out of their long-term funk.

But perhaps more fundamental of the first waft of price rises seeping through the economy was McDonald's, which raised the price of its cheapest burger to 120 yen ($1.21) from 100 yen last month, and its cheeseburger to 150 yen from 120, the first price rises in five years. Japan is McDonald's largest market outside North America and the price rises were quickly felt.

After more than two decades of sluggish growth and seemingly never-ending deflation, the central bank, the Bank of Japan, has set a target of achieving 2 per cent inflation within two years.

Its change of policy follows the election of a new Prime Minister, Shinzo Abe, who has made it clear that he wants the central bank to become more aggressive in pulling the economy out of its despondency.

He has said he has "three arrows" in his quiver - monetary, fiscal and reform programs - and he is pushing on all three levers to force change.

Optimal Fund Management founder Warwick Johnson said the difference this time around for Japan is that the government is not leaning just on monetary policy to break the deflationary spiral.

"The government is not just saying monetary policy will have to do it all," he said, pointing to the fact that the Prime Minister has established three advisory councils on macro policy, micro policy and deregulation, along with surrounding himself with a cabal of advisers.

Much of the recent bout of deflation has come from a super strong yen. The same is true with the Australian dollar. The woes of the global financial crisis that have laid both the US and more recently Europe low have seen global investor funds flow into countries such as Japan and Australia.

This has stalled growth and especially government income, which has exacerbated an already stretched national balance sheet.

Now, Japan's currency is beginning to "normalise", sliding back below 100 yen to the US dollar.

And the country's manufacturers were quick to breathe a sigh of relief. A lower dollar gives them breathing space in export markets. They have uniformly upgraded profit forecasts and, perhaps more importantly for the domestic economy, flagged higher bonuses for their staff.

This will help to give consumer spending a solid lift when the midyear bonuses are paid in August. But deep-seated concerns remain.

Just this week the former head of the World Bank and a former US trade representative, Robert Zoellick, warned that the liquidity hit from "Abeconomics" - the slew of new policies being pursued by the new government - was just a "sugar high" that would soon fade.

And Thursday's 7 per cent slump on the Tokyo sharemarket reinforced those concerns.

That selloff came on the back of comments by US Federal Reserve chairman Ben Bernanke, who rattled financial markets around the world when he indicated he would move to wean the US off its super-cheap monetary policy, along with doubts about the Chinese economy.

As well as putting the skids under the Japanese sharemarket, his comments prompted a selloff in the Japanese government bond market, with yields pushed to 1 per cent, and raised questions whether the Bank of Japan would be able to hold yields in check.

"The Bank of Japan will not allow a disorderly government bond market," said Jack Lowenstein, joint managing director of Morphic Asset Management. "It will ensure yields do not rise above 1 per cent."

Notable Japan bears such as US hedge fund manager J. Kyle Bass claimed this week's market turmoil would eventually overwhelm the Bank of Japan's ability to cope.

Lowenstein, a regular visitor to Japan for almost 30 years, said he was concerned that many of the analyst forecasts for corporate earnings have become too bullish. "There are growth companies with good prospects but too much optimism was priced into the market," he said.

Some of that optimism was washed out of the market in this week's abrupt selloff, he said.

"We could see more froth come off, as analysts adjust earnings," he said. Often, analysts were pricing in the benefits of the yen's decline on exporters, for example, often without taking the cost factor into account, since it also pushes up the cost of a range of inputs.

Pessimists on Japan's prospects have more than two decades of missed opportunities to support their view. But perhaps they underestimate the shift in sentiment.

In 1854, a fleet of "black ships" from the US forced Japan to open its doors to the outside world. This year, it was the "red ships" - the fleet of Chinese naval vessels encircling contested islands in the north Pacific - that have helped to shake Japan from its torpor.

Now, after years of fractious debate, there is an unusual sense of unanimity of the need for broad-based reform. Suddenly, after toying with the proposal for the Trans-Pacific Partnership free trade bloc with little enthusiasm, Japan is embracing it with open arms and is willing, for example, to wind back some farm protection.

The subtext is the need for a stronger Japan to be able to stand up to a resurgent China. This puts the focus on more than just efforts by the central bank to hold down interest rates but also on a broader slew of policies to kick-start growth.

The government is to outline its new growth policy next month but it may be cautious since, with upper house elections to be held in July, it wants to win control of both houses of parliament to help ease implementation of its legislative program.

Easing fears of unemployment is giving consumer sentiment a lift, although the economy still has enormous hurdles to overcome, and the high level of public debt, which exceeds the size of gross domestic product, may limit its policy options since in many respects Japan has "spent its future".

To rein in the spiralling public debt the previous government locked the country into raising taxes, by raising the consumption tax to 8 per cent from 5 per cent early next year, before rising to 10 per cent the year following. This may be one reason why households are moving to spend now rather than later, especially on expensive items.

While it will take time for the government's policy response to emerge, there is plenty of opportunity for foreign investors to profit.

For Optimal's Johnson, the financial sector will be a clear winner, along with domestic demand-linked sectors such as home builders, broadcasting and telcos as the economy changes gears.

Lowenstein also reckons it is hard to go past the finance sector.

"There is tremendous opportunity, chiefly in financials, where investors are so used to low growth," he said. Loan growth will begin to emerge, and there is a steepening yield curve that will also help.

Leasing companies such as Century Tokyo will also benefit from the government's push to encourage leasing in a bid to revive capital spending, he said.

Already, a range of economic indicators are turning upwards, from machinery orders experiencing their sharpest rise in seven years to stronger than expected manufacturing output, up 0.9 per cent in March for the fourth straight month of gains.

But few expect a straight line recovery. "For any non-yen investor, I should look at some hedging," Johnson said.