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Can the land of rising sun rise again?

Issue Date - 28/02/2013
The newly-elected government in Japan has come up with a blueprint for growth that might just be enough to put an end to decades of economic stagnation and falling prices and usher a new era of growth. And there are reasons to be hopeful

The Japanese economy has begun 2013 with a great deal of uncertainty. The economy is fragile and perhaps in recession, and a new prime minister, Shinzo Abe, is at the helm. Yet for the first time in 20 years critics across the globe are somewhat optimistic about the economyís future. The reason is simple. Abe has some fresh ideas that might just be enough to lift the economy after two decades of underperformance.

Since his partyís (Liberal Democratic Party) comprehensive win in December 2012 election, Abe has been vocal on national security and on a radical economic plan (his election agenda too) that will form the focal point of his administration. And there are reasons to be hopeful. The incoming government has already provided a blueprint for growth that if successful could bring the Japanese economy back to life.

Abeís new plan stands on three pillars. The first is redefining the Bank of Japanís (BoJ) ďprice stability targetĒ to consumer price index growth of 2% y-o-y over the medium to long term, from the previous 1%. The second measure is that the current quantitative easing (QE) programme, which is set to expire on December 31, 2013, would be extended indefinitely, mirroring the US Federal Reserveís current programme, called QE infinity among other things. The third and the final component is a commitment by the BoJ to increase monthly asset purchases from the current rate of about 3 trillion yen per month to 13 trillion yen per month starting January 1, 2014. No doubt a sharp shift in policymaking under Abe was keenly anticipated, but these moves are not as dramatic as they appear from the top, particularly the third constituent.

The total value of BoJís assets under current QE programme stands at 40 trillion yen (as on December 31, 2012) and is perhaps the best single gauge of the extent of the BoJís QE programme. For uninitiated, three things determine the size of a central bankís balance sheet Ė new asset purchases (or sales), depreciation or appreciation in the value of existing assets, and the rolling over of government bonds as they mature. The BoJís 3 trillion yen in monthly purchases between now and the end of 2013, alongside some short-dated government debt paper reaching maturity, gets the BoJ to its target of 76 trillion yen, the proposed final target of the current asset repurchase programme.

However, while the current 3 trillion yen in monthly asset purchases consists of 1.8 trillion yen in long-dated Japanese Government Bond (JGB) purchases, as well as around 1 trillion yen in short-dated Japanese Treasury bills, with the remainder in other assets (corporate bonds, commercial paper, exchange-traded funds, etc), the new 13 trillion yen in monthly purchases from January 2014 will consist of 2 trillion in JGBs, 10 trillion in Treasury bills, and 1 trillion yen in other assets. This means the bulk of the increase is in short-term government Treasury bills, which roll over quickly, implying that the BoJís balance sheet will not increase at a substantial rate, although its assets will still rise faster than under the current programme.

Nevertheless, these three essential moves Ė a doubling of the inflation target, a lift in the asset purchase programme from January 2014, and an open-ended QE commitment Ė all signal a significant loosening in monetary conditions, a key pillar of Abeís new economic policy and an agenda being seriously pursued by the newly elected members of The National Diet.

The motive is clear. Abe wants to break the deflation cycle and a strong yen, both of which have been choking off Japanís economic growth over the last 15 years. In fact, the two problems are interconnected. Typically when central banks pump liquidity into markets following recessions, businesses and consumers borrow, growth picks up and eventually inflation rises. This is not the case in Japan, where deeply entrenched deflationary expectations and other factors weigh on loan demand. The combination of deflation in Japan and inflation elsewhere pushes up the purchasing power of the yen relative to other currencies. A strong yen in turn weighs on exports, the main driver of growth in the Japanese economy. And thatís exactly what is happening in the Land of the Rising Sun, which has been in recession for most of 2012 (its fifth recession in the last 15 years).

Even the revised estimate of Japanís third quarter GDP was unchanged at -0.9% q-o-q, against expectations for a modest improvement. The annualised figure too remains unchanged at -3.5%, confirming the economyís dire state through the second half of 2012. Consequently Tankan Survey (an economic survey of Japanese business issued by the BoJ) shows a sharp deterioration in sentiment through the fourth quarter of 2012. The headline diffusion index for large manufacturers has fallen from -3 in the September quarter to -12 in the December quarter. Confidence among small and medium-sized manufacturers and among non-manufacturers has also fallen. All this clearly reflects an economy that is contracting through 2013


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