Negative inflation, stagnant wage growth and an ageing population are forcing Japanese policy-makers to take innovative and, some would say, counterproductive measures to revive the economy. Stefania Palma reports.

Japan economy

By the end of March 2017, Japan’s economy had grown for the fifth consecutive quarter, its longest streak of economic expansion in more than a decade. But wages remain stagnant, corporates are hoarding cash and consumer confidence remains low.

The Japanese central bank, the Bank of Japan (BoJ), is opting for aggressive and innovative forms of monetary easing in an attempt to revive the economy. But some market participants believe the BoJ’s measures are either insufficient (in that they should be accompanied by sound structural reforms) or even counterproductive.

Japan has been battling deflationary pressures for more than two decades. To counter this trend, the BoJ set a 2% inflation target in April 2013, which it has so far failed to meet. Although in January 2017 Japan’s consumer prices rose for the first time in a year, core consumer prices grew year on year by only 0.2% as of March 2017.

Radical policies

The BoJ has resorted to extreme measures to prop up inflation. Japanese rates have been in negative territory since January 2016, with a short-term interest rate target of -0.1%. The BoJ also stands out for its quantitative and qualitative easing (QQE) policies, with a pledge to push the 10-year government bond yield to about 0% via aggressive asset purchasing. This new yield curve control (YCC) initiative is atypical, in that central banks typically focus on short-term rates. With the YCC, the BoJ hopes to steepen the broader yield curve, one of the intended consequences being to prop up local banks’ profitability. But as spreads between Japan and the US widen, the BoJ’s ability to sustain the YCC at current levels is questionable, according to an HSBC report.

As part of QQE, the BoJ has been buying Japanese government bonds (JGBs) at an impressive rate of Y80,000bn per year. The central bank held 39% of outstanding JGBs at the end of 2016, up from 32% 12 months earlier. This leaves only Y650,000bn outside the BoJ, which is making market participants, such as Nobuyuki Hirano, president of Mitsubishi UFJ Financial Group (MUFG), question the sustainability of the central bank’s asset purchasing (see article on Japan’s mega-banks).

Despite the BoJ’s impressive policy efforts, some market participants, such as Naoyuki Yoshino, dean of the Asian Development Bank Institute (ADBI), believe its 2% inflation target is unattainable, partly because it does not take into account recent drops in oil prices. “The BoJ is keeping the 2% target to stay in line with the US and European central banks,” he says. “In their analysis, as long as capital flows are stable, the inflation target remains unchanged. But oil imports differ from country to country, and a drop in oil prices means inflation drops too. They cannot just look at capital flows.” 

Is 2% possible?

Mr Yoshino also argues the BoJ has kept the inflation target unchanged partly to avoid losing credibility and to maintain market stability. “The best-case scenario for Japan is if the US Federal Reserve continues hiking rates, which means Europe will follow and Japan will then finally start hiking rates again,” he says.

BoJ governor Haruhiko Kuroda disagrees, and believes the 2% target will be reached by fiscal year 2018. “Almost all major central banks have opted for a 2% inflation target in the past four years. In the central banking community there is even a strong argument to raise the target to 3% to 4% or more,” he told The Banker at the Asian Development Bank meetings in Yokohama, Japan.

Output gaps and inflation expectations are what determine inflation, according to Mr Kuroda. “After oil prices dropped quite sharply, inflation rates dropped too, and with a time lag, inflation expectations in Japan decreased as well. In Japan, inflation expectations are not as well-anchored around the 2% target as they are in the US,” he says.

But Mr Kuroda thinks the recent uptick in Japan’s gross domestic product (GDP) growth will help raise inflation expectations. “Since Japan’s economy has been growing at a level well above growth potential, the output gap will improve and the pressure to increase wages will strengthen,” he says. “Since inflation expectations are determined by inflation in the recent past, once the inflation rate starts growing, inflation expectations will increase too. So improving the output gap and increasing inflation expectations will both help inflation move closer to 2%.”

Domestic dynamics

Some market participants argue that reinvigorating the economy is not so straightforward and that the BoJ’s negative interest rate policy may even be backfiring. “Even with negative interest rates, we don’t see significant growth of capital expenditure,” says Yasuhiro Sato, president and group CEO of Mizuho Financial Group. “Company CEOs don’t have confidence in the future. They see negative interest rates as an uncertainty. They think: we need negative interest rates because the economy has not sufficiently recovered.”

Japan’s current wage system, combined with an ageing population – almost one-third of Japanese people are over 65 – is part of the problem. “The impact of monetary policy when the population is ageing is something that is not understood by Western economists,” says the ADBI’s Mr Yoshino.  

Japan operates a seniority-based wage system, meaning salaries rise with employees’ age. This means corporates avoid keeping older staff to cut costs, which in turn increases the burden on public welfare. Some experts, including Mr Yoshino, argue structural reforms leading to a productivity-based wage system could push corporates to retain older employees, whose salaries could boost domestic consumption and decrease the tax burden on younger people. Indeed, social welfare accounts for one-third of Japan’s budget, one of the highest ratios in the world. With a smaller tax burden, the young’s disposable income would rise, boosting consumption further, argues Mr Yoshino in his studies.

Japan’s welfare programme is particularly onerous also because it is not offset with tax revenue from value-added tax (VAT), for example, which sits at a low 8%. In countries with a high social welfare budget, such as Germany or Sweden, VAT is at 19% and 25%, respectively.

Boosting GDP

So in this context, how can Japan revive its economy? Exports, consumption and investment are all drivers of Japanese GDP growth. In Japan, consumption is already significant, accounting for about 60% of GDP. “Growing consumption when it is already so high is difficult,” says Graeme Knowd, managing director of banking at Moody’s.

Given that exports only account for about 18% of GDP, the key driver of Japanese growth should be investment. But Japanese corporates are hoarding cash in savings. “They don’t believe there is growth. Getting corporates to start investing may be the hardest way [to put these savings to work] unless the government, through structural reforms, creates an environment where corporates believe they can make sufficient returns on investment,” says Mr Knowd.

Dividend payments and wage increases might be simpler ways to stop corporates from hoarding cash. “Dividends are generally rising and high dividend stocks have done very well,” says Mr Knowd. Moreover, demand for equity that provides cash is growing among pension funds, including the state’s Government Pension Investment Fund, as a growing number of Japanese citizens are opting to cash in their pensions.

Will wages grow?

In terms of wage growth in Japan, some market participants remain pessimistic. As of March 2017, wages in real terms dropped for the second consecutive quarter, by 0.1%. This squeezed year-on-year growth in real wages from 2.2% in the fourth quarter of 2016 to 0.5% by March 2017.

However, Mr Knowd thinks Japan is on the cusp of a rise in wages. Major delivery service Yamato Transport announcing a price hike in 2017, and its competitors looking set to follow suit, is widely seen as a positive sign. “This raise will go either to hiring or raising wages. The question will then be whether employees will start consuming more,” says Mr Knowd.

Yamato’s announcement to increase prices makes Kunihiro Asai, global head of the corporate office at Nikko Asset Management, equally hopeful. “I am the most optimistic about achieving the 2% inflation target than I’ve been in the past 10 years,” he says. “There is a huge shortage of workforce in the delivery and construction industries, which could push wages up. And the government is now advising corporates to increase wages too.”

Japan is facing significant challenges from a demographic, macroeconomic and social perspective, forcing policy-makers into uncharted territory. But the complexity of tackling deflationary pressures in a developed market demands more than aggressive monetary policy. “Printing money is not going to produce more children or [pay the costs] of the elderly,” says Mr Yoshino. Structural reforms just might, however.


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