The third ‘arrow’ of Abenomics – How is the plan impacting the world financial markets?

The bold attempts taken to fix Japan’s ongoing economic woes have been seriously dealt with by the current Prime Minister, Shinzo Abe, but the essential question remains, are these economic reforms sustainable in bringing inflation up to at least 2.0%, promote economic competitiveness through the weakening of the Japanese Yen currency, bring about change in the form of structural reforms of the Japanese economy, etc.? So far, financial markets have reacted to the recent moves/announcements by the Prime Minister with less than expected enthusiasm, with several Asian Pacific markets seeing their stock indices moving downwards, and the continuing volatilities shown on Japan’s Nikkei 225 index, which has seen hitting new lows since the onslaught began on May 23, 2013. The Topix is also down by approximately 14.0 percent from its May 2013 high. These various reactions coming from investors and the Japanese people do deserve some serious analysis on the viability and sustainability of the ongoing reforms should they be introduced, and how it will impact the global financial system.

On June 05, 2013, Prime Minister Shinzo Abe announced a series of measures, dubbed ‘The Third Arrow’ calling for renewed legislation targeting at reforms spanning from health care deregulation to enhanced cooperation among private enterprises in replacing aging infrastructure from waterworks to highways (Remember the highway construction projects announced by President Barrack Obama during his first term in office to revive the US economy through massive infrastructure spending?), and along with the ongoing monetary and fiscal stimulus aimed at reviving the weakness of the Japanese economy. However, this announcement was met with more volatility shown in the Nikkei 225 and Topix indices with Nikkei 225 ending the market trading day down by 500 over points or approximately 3.0% decline on the day of the announcement of the plan. One of the causes for such massive volatilities shown in the Japanese and other regional bourses has to do with the lack of clarity in the Prime Minister’s economic reform plans, especially in the area of labour reforms such as the hiring and termination of employees. This lack of clarity has caused many investors to be sceptical about the enactment of the reforms which is expected to take place following the Upper House elections on July 21, 2013, and might take several years to get it implemented. During the period between now till July, there could be additional uncertainties, and this led to one of the causes of the massive selloffs on June 05 and it was a continuation of the paring off of risky assets since May 23, 2013.

According to a news article published on June 06, 2013, it was reported that economists from HSBC interviewed by the news agency were quoted as saying that any major additional stimulus is unlikely to be debated by the Bank of Japan (BOJ) before October 2013 at the earliest. One of the reasons cited by Masamichi Adachi, one of the senior economists at JP Morgan Chase & Co. in Tokyo, and a former central bank official, was that the central bank officials from the BOJ needs some time to evaluate to evaluate the effectiveness of the past stimulus measures before implementing new ones, which includes the ongoing massive purchases of Japanese REIT (J-REIT) stocks, Japanese Government Bonds (JGBs). Already, the JGBs has come under heavy selling pressure which resulted in higher than expected yields, and by the end of the market trading day on June 06, 2013, it is expected that the new set of auction for JGBs will likely face similar selling pressure, which will further increase the yields of the bonds. The disconnection among Prime Minister Abe’s economic plans, the BOJ’s monetary easing measures, and the relatively high JGB yields are some of the issues faced by many policy makers in the country on how to revive the Japanese economy using unorthodox economic measures, given that the moves shown in the financial markets are not working in tandem with the Japanese Government’s plans to kickstart the economy.

With the recent stock market moves shown this week, and since May 23, it remains to be seen how Prime Minister Abe’s so-called ‘The Third Arrow’ will go far enough to revive the economy. The total public debt to Gross Domestic Product (GDP) ratio is estimated to stand at 230.0 percent by the year’s end according to estimates from the International Monetary Fund (IMF), and quoted by Bloomberg. United States ratio of debt to total GDP is second in line with 104.0 percent. The huge amount of debts incurred by Japan is certainly mind-boggling, and it does deserve a serious look at the effectiveness of additional spending measures under this so-called ‘The Third Arrow’ economic plan announced by Prime Minister Abe on June 05.

In conclusion, I believe that the Japanese policy makers cannot rely solely on the continuation of the Yen currency weakness in order to revive its economy. There needs to be concrete actions to be taken on the structural reforms, namely the continued emphasis on the flexibility of the hiring laws, the emphasis on developing local entrepreneurship talent, constant innovation, less ‘red tape’ bureaucracy, greater emphasis on female workforce participation rates, foreign immigration reforms, etc. Relying solely on the Japanese Yen weakness and public infrastructure spending have failed miserably in the past. There should be a conscientious relook at economic reforms, the viability and sustainability of such reforms, and whether the Japanese public on the whole benefit in the long-run through these various economic reforms.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc