Japan: Elections, BOJ and the Economy

Published on January 23, 2014

The highly publicized race for Governor of Tokyo Prefecture officially kicks off today, with all eyes on February 9 to see whether the front-runner, former Health Minister Yoichi Masuzoe, supported by the ruling LDP party, their coalition Komeito partners, and Prime Minister Shinzo Abe himself, survives the high profile challenge from, among others, former Prime Minister Morihiro Hosokawa.

The election is being framed mainly as a referendum on the future of nuclear energy, highly unpopular among the Japanese electorate after the Fukushima disaster. Hosokawa, as the anti-nuke candidate, is steering clear of any substantive discussion on other major issues, and the still popular former Prime Minister, Junichiro Koizumi, has very publicly broken ranks with his own LDP party to support Hosokawa’s candidacy.

After local defeats in Kawasaki, typhoon ravaged Fukushima, and in the small Okinawan town of Nago, the latter fueled by anger over Abe’s concession to US pressure to relocate the unpopular US Futenma military base to Nago, the Tokyo election, beyond the all-important public referendum on nuclear energy policy, is also now being seen as somewhat of a mid-term test of Abe’s political clout.

*** Early polls, however, show Masuzoe, the “establishment” candidate reluctantly supported by Abe after the resignation of the popular Naoki Inose over a corruption scandal, holding a comfortable lead over Hosokawa, scoring in the 40% range, with the opposition candidates all splitting votes somewhere in the teens. ***

*** And a victory by Masuzoe would matter to Abe (and markets). It has been argued that even a Hosokawa victory largely on an anti-nuclear vote may not be a political disaster for the Prime Minister that the mini-chain of defeats may imply, but informed political observers in Tokyo are not so sanguine, and express concern that despite the success of the all-important Abe/Aso/Kuroda economic platform, yet another loss in the series of local elections could open up rifts within the LDP party, including on the more militaristic defense and  foreign policy as well as on energy policies. ***

*** On the positive side, a Masuzoe victory, which we expect, would at a minimum help clear the air and solidify Abe’s position, laying some of these concerns to rest. And Masuzoe would specifically not only also ease some of the pressure off of Japan’s nuclear industry, but also throw greater political momentum behind the more aggressive expansion of infrastructure for the upcoming Olympic Games. ***

*** The elections will then be followed by the long anticipated hike in the sales tax from 5% to 8% on April 1, and while the vast majority of economists are relatively sanguine at this point on its long term impact on a Japanese recovery that is believed to be fairly resilient, there may nevertheless be a big drop in private consumption after that date, perhaps from April to June. That could lead to some erosion in Abe’s popular support with the electorate, which, after all is based first and foremost on his economic, and not his more controversial nationalistic, policies. ***

*** There also is a strong expectation in markets that the Bank of Japan will provide more liquidity either before or immediately after the consumption tax hike, but we have been cautioned by informed observers that such a rapid response may be unlikely and difficult to pull off. ***

Even as recently as at this week’s BOJ monetary policy meeting, the Bank of Japan stuck with an outlook for economic recovery and improving prices (escaping from deflationary situation) that is totally consistent with their earlier expectations, thanks almost entirely to the massive quantitative easing announced in April 2013. That includes some expectation of a slowdown around the April tax hikes.

So while Governor Haruhiko Kuroda has proven himself an extremely aggressive and flexible leader, and will not hesitate to change tactics, he will not be able to simply jettison the BOJ forecasts – including of the slowdown around the tax hikes – and resume another round of emergency measures before a reasonable amount of sustained evidence of economic data after the tax hike that would imply weakness above and beyond their expectations.

The BOJ we believe would therefore only likely offer more easing if necessary only after there has been enough time to assess and confirm a larger negative impact from the sales tax hikes on the economy than expected.

The Economy and Sales Tax Hike

Many economists are anticipating, to various degrees, a big drop in private consumption in the April to June period after the consumption tax hike, but expect the Japanese economy to recover after it. The respected “ESP” Forecast shows expectations for quarter on quarter GDP to rise from 3.4% in calendar Q4 2013 to 4.4% in Q1 2014, but to then plunge down to -4.6% in Q2 2014 after the tax hikes, only to recover gradually from there in subsequent quarters to a more modest 1.9%, 1.7% and 1.5% respectively.

Underlying the growth forecasts, Cabinet Office data also shows a modest drop off in consumer sentiment and momentum from the peaks of May and September of 2013. There is, on the other hand, evidence of a true recovery in the labor markets underway.

The improvement in the unemployment rate since the Lehman shock and downturn has been clear and steady, if anything, but until recently, the main engine of the labor market improvement had been growth in the number of part-time workers. Recently, however, the number of full-time workers has started to increase.

Officials and economist are hopeful that, under enormous moral suasion from the Abe administration, private sector wages will also start to grow now along with inflation (some of that inflation fueled by a weaker yen and thus not entirely stimulative for consumers). The main concern now is that wages may not grow along with (or in best case not much more than) the rate of inflation. So as consumer sentiment loses some steam, even if temporarily, the main policy “third arrow” for the Abe administration may not be those elusive structural reforms after all, but rather doing everything possible to ensure wage growth.

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