Japan: Elections, Monetary, and Fiscal Stimulus

Published on July 7, 2016
SGH Insight
Prime Minister Shinzo Abe’s LDP Party is entering the weekend with momentum for a strong victory, possibly even for a slim outright majority, in this Sunday’s Japanese Upper House elections. That would be a positive for markets.

We expect the Bank of Japan to then follow through at its July 28-29 Monetary Policy Meeting with additional monetary stimulus through asset purchases, while refraining from cutting the deposit rate deeper into negative territory.

And in August the Cabinet will start planning for a second supplementary budget that will provide a fiscal stimulus of 10 trillion yen, or possibly even a bit more, to the Japanese economy.
Market Validation
(Bloomberg 7/11/16) -- The yen tumbled the most since April as Japanese Prime Minister Shinzo Abe said he planned to add fiscal stimulus following the ruling party’s victory in Sunday’s upper-house elections.

(FT 7/11/16)
The broad Topix benchmark ended 3.8 per cent higher for its biggest one-day rise since February 15 and its third-largest advance so far this year. The Nikkei 225 closed 4 per cent higher for its biggest one-day gain since March 2 and its fourth-largest rise this year.

Key Takeaways:

Prime Minister Shinzo Abe’s LDP Party is entering the weekend with momentum for a strong victory, possibly even for a slim outright majority, in this Sunday’s Japanese Upper House elections. That would be a positive for markets.

We expect the Bank of Japan to then follow through at its July 28-29 Monetary Policy Meeting with additional monetary stimulus through asset purchases, while refraining from cutting the deposit rate deeper into negative territory.

And in August the Cabinet will start planning for a second supplementary budget that will provide a fiscal stimulus of 10 trillion yen, or possibly even a bit more, to the Japanese economy.

July 7, 2016

Japan’s electorate will be going to the polls this Sunday, July 10, to elect their representatives to the Upper House of parliament, or House of Councilors.

*** Prime Minister Shinzo Abe has been downplaying expectations for a big victory on Sunday, but his LDP Party is entering the weekend with clear momentum, and could win an outright majority in the Upper House, without his coalition Komei partners. That would cement the LDP’s dominant position in the Lower House and clear the path for constitutional reform. ***

*** That will be followed by the Bank of Japan meeting of July 28-29, when we expect the Monetary Policy Board to again lower its inflation outlook. But we believe they will also combine that forecast revision with further monetary stimulus in additional JGBs, J-REITS, Equity ETFS purchases, which could potentially include local government and corporate bonds. They will not cut the controversial deposit rate deeper into negative territory. ***

*** The Japanese Diet will then probably convene in early August for a few days to elect a new President of the House to reflect Sunday’s election results, before going on break. The Abe administration will take August and early September to compile a second supplementary budget stimulus plan of at least 10 trillion that will be presented to the full parliament at a special Diet session being eyed for September 26, where it is certain to easily pass. ***

A Strong LDP and Abe Victory

According to big data analysis by Yahoo Japan that is widely considered to have been the most accurate forecaster in recent years, Prime Minister Abe’s ruling Liberal Democratic Party is now expected to win 57 out of the 121 seats being contested in Sunday’s elections for Japan’s Upper House of parliament (half of the total number of seats in the Upper House).

That would give the LDP 122 out of the 242 Upper House seats in total (the LDP has 65 seats that are not up for election), just enough for a majority by the LDP itself even without its Komei coalition partners.

Whether the LDP secures an outright majority in the Upper House or not, it, Komei and other small parties that are expected to be for the reform of the Japanese constitution are forecast to win 162 seats in total (elected and non-elected) in these most recent polls. That would be just over the two-thirds of total seats threshold that is required for Abe to have the Diet initiate Amendments to the Constitution.

The LDP and its allies, of course, already hold more than the requisite two-thirds margin in the Lower House. In order to amend the Constitution, a national referendum would also need to be called.

Other surveys corroborate these polls, and many point to the LDP gaining momentum due to the bungling and low popularity of opposition parties.

The opposition has been running mainly on Constitutional issues and appears to lack any coherent or attractive alternative proposals to stimulate the Japanese economy, even as surveys show the primary interest of the majority of the Japanese electorate is in the recovery of the economy.

And so in light of recent global uncertainty, signs of ebbing momentum in the economy, and turmoil in the stock markets, the LDP is still seen as the safe hands and a reliable steward of the economy, and if anything appears to have been strengthened by the recent events.

If the LDP wins by the margins expected, we believe the Japanese equity market will welcome the results, and markets will turn their focus on to the upcoming series of economic stimulus measures.

Monetary Stimulus Despite Diminishing Returns

The Bank of Japan will be up first when it holds its Monetary Policy Meeting on July 28 and 29.

And despite a clear understanding in Japan, and indeed across the major central banks of the world, that monetary policy in a world of ultra-low and negative interest rates may be losing its effectiveness and should increasingly take a back seat to fiscal stimulus, we expect the BOJ to nevertheless provide additional stimulus at its meeting this month (SGH 5/31/16, “Japan: BOJ and Fiscal Stimulus Plans”).

On July 29 the BOJ will issue its Outlook Report for the Japanese economy. As widely expected, the BOJ will revise its inflation outlook downward, regardless of the recent recovery in energy prices.

But even if that means if may take longer to reach its 2% inflation target, the BOJ will not abandon that target, as some policy members have suggested. Rather, it will provide another dose of stimulus to supplement the fiscal stimulus that is sure to follow soon after. That is all the more likely given the recent, and rather painful, drop in equity market and appreciation of the yen.

We expect the BOJ to offer further monetary easing in the form of additional purchases of JGBs, J-REITs and equity ETFs, and the central bank may add local government bonds and corporates to the shopping list as well.

A further cut in the negative interest rate on the current account, however, is unlikely. There is still far too much uncertainty and criticism from the Japanese banking sector and general public dismay in an even lower interest income for that to happen any time soon, despite Bank of Japan Governor Haruhiko Kuroda’s numerous attempts to explain and keep that policy lever alive.

So we expect the BOJ will keep the deposit interest rate intact at negative 0.1% at its upcoming meeting in July.

A Growing Fiscal Package

Soon after the Upper House election, perhaps for a few days in early August, the Diet will convene to elect the President of the House. However, the Session will be for that purpose only, and will be thus kept short.

The Abe government and LDP party members, however, are already planning to start a Special Diet Session on September 26 to discuss a second supplementary budget and other related laws needed to implement economic stimulus measures.

But even before that, in August and early September, the Government will start to formulate a concrete stimulus package, which will be intended to support both the economy and stock market.

The size of the supplementary budget will now be inflated to 10 trillion yen or perhaps even a little more, considering the recent sluggish economic recovery, dull equity markets, and yen appreciation.

At that budget size, we detect almost no pushback from the traditionally austere bureaucrats of the powerful Ministry of Finance against the politicians and Cabinet, and with a solid majority in both houses, it would pass through parliament with ease.

That open door is in no small part also due to very clear and public requests by the US and international community (G20, G7, etc.) for Japan to shift its emphasis from monetary policy to fiscal stimulus.

Presumably, some of these countries will soon also practice what they preach.

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