Japan – Revitalizing Localities, Equities, and Abe

Published on July 16, 2014

Since the release of the “Japan Revitalization Strategy” in late June, the mood in Tokyo’s Kasumigaseki district has been relaxed, with ministry bureaucrats settling in for a bit of summer season wining and dining. Indeed, the busiest areas appear to be staffing and personnel, as departments scramble under pressure from Prime Minister Shinzo Abe’s Cabinet to ensure that at least 30% of new university graduate hires are female.

After securing a hard fought agreement revising Japan’s pacifist rules for military engagement, and with corporate tax cut details now being hashed out in the back rooms of the Ministry of Finance (see end of the report), Abe’s Cabinet is indeed not focused at this time on any broad new stimulus plans for the Japanese economy. But that does not necessarily mean an uneventful summer.

*** The Prime Minister’s political capital will now be deployed toward a reshuffle of his cabinet and personnel changes of LDP party officials, originally rumored for September but now looking to be moved sooner, into August. The reshuffle will be done with an eye to securing three new Gubernatorial elections in the fall, a nationwide local election in April of 2015, and perhaps even the possibility of an earlier resolution of the lower house of Diet for general elections before the currently scheduled 2016 date. ***

*** In order to bolster local and rural LDP support, in the upcoming fall Diet session Abe will stress greater support for local economies, and in the Cabinet reshuffle he will set up new Minister responsible for revitalizing local economies. At the same time, the LDP has already decided to postpone the more controversial discussions over defense related laws until the ordinary Diet session next January. ***

*** Although lacking any major new policy stimulus, the Japanese stock market may also nevertheless continue to receive some support from policies already set in motion. Ahead of the widely publicized increase in the GPIF’s (Government Pension Investment Fund) allocation to equities, three other public pension fund associations (the National Public Service Personnel, Local Government Officials, and Public School Teachers) seem to have already started to increase their allocations to Japanese equities starting in May (this has been reflected in net purchase of shares through trust banks). ***

*** Such public funds, along with the GPIF, will furthermore press Japanese companies to deploy a greater portion of their massive cash stockpiles into capital and R&D investments, Mergers and Acquisitions, and in increasing dividends. The introduction of a “Japanese stewardship code” is intended to introduce similar activist-type pressure on corporations. ***

GPIF and other public funds are shifting their benchmark of Japanese equity investments from TOPIX to the JPX400, which is a new stock index that is generally comprised of higher Return on Equity issues. And the Bank of Japan is also reported to be considering purchases not only of Nikkei and TOPIX ETFs (Exchange Traded Funds), which they have already started to buy, but also of JPX400 ETFs in the future.

These purchases of issues with higher ROEs by public funds are all intended to put further pressure on Japanese corporations to push up profits relative to capital.

Politics all the Time: Securing an LDP Victory

Last weekend the LDP was handed a defeat in the race for Governor of the western prefecture of Shiga that triggered widespread chatter of a growing backlash against Prime Minister Abe’s policies. In that race, the LDP supported candidate Takashi Koyari was defeated by Taizo Mikazuki, a lawmaker formerly belonging to the up to now hapless opposition Democratic Party of Japan.

While the result was a clear blow to Abe, it seems to have not been completely unexpected, and is being taken in stride by the politicians of Tokyo’s Nagatacho district.

The reasons behind the defeat were, as widely reported, clearly related to Abe’s controversial decision on collective defense rights, as well as a protest against the resumption of nuclear activities in neighboring Fukui province so soon after the 2011 Fukushima disaster. But the defeat was the result of lesser and more local factors as well, including an unseemly scandal over an LDP statesman caught in a local Tokyo assembly jeering at a female statesperson, and Shiga prefecture’s outgoing Governor Yukiko Kada’s support for Mikazuki, the DPJ supported candidate.

Abe has already started preparations for upcoming local elections, and is looking to re-gain momentum through an increase in support for local economies, and possibly through bringing home some positive results in negotiations over the Japanese citizen abduction problem with North Korea, following the playbook of popular former PM Junichiro Koizumi from back in September of 2002.

Tokyo is furiously negotiating the release of a certain Ms. Megumi Yokota, and the initial signals from North Korea have been that this could happen around the end of August to the beginning of September.

US Secretary of State John Kerry is, however, reported to have placed a call to Fumio Kishida, Japan’s Foreign Minister, on the 7th of July, to warn of the dangers to international resolve of an overly enthusiastic unilateral outreach by Japan to North Korea.

It is increasingly expected now that Abe will reshuffle his cabinet and officials in LDP earlier than September (as first expected), maybe in late August, without waiting for the public relations boost from the expected first report from North Korea on abduction.

The reshuffle will be politically significant as a sign of some fresh blood and of a revitalization of the cabinet, but the officials most important to economic policy and financial markets, Finance Minister Taro Aso, Chief Cabinet Secretary Yoshihide Suga, and LDP Secretary General Shigeru Ishiba, are expected to stay.

Beyond the local elections, a potential early resolution of the Diet in 2015 and new elections would appear to be quite a bit of gamble for Abe considering his recent lower approval ratings on the back of controversial changes to the interpretation of the Constitution on Japan’s right of collective self-defense.

After the initial drop, recent polls, however, show a more mixed result for the Abe Cabinet. For example, the Asahi Newspaper (which is most hostile to the LDP) has reported that the approval rate for Abe actually climbed from 43% in late June to 44% in early July. And in fact general opinion in Japan isn’t totally against collective defense right (our feeling is that under the surface the Japanese population is roughly half for and half against).

The result of the Shiga election from what we understand is thus probably far an omen of an LDP collapse – especially if Abe continues to ensure the economy and markets continue to perform.

Stimulating Localities, and Local Candidates

In parallel with the North Korea negotiations and cabinet reshuffle Abe will also be putting more effort in politics in the local arena. This of course is with an eye to critical elections for Governor of Fukushima in October, and Okinawa in November. Next April Japan will also hold nation-wide local government elections.

Beyond setting up a new Minister in charge of local economies, we are not however aware of any concrete proposals yet for stimulating the localities. There are of course plenty of suggestions for that in discussion papers and reports, from both private companies and government offices.

Many of these suggest that government should introduce special deregulation areas (e.g. labor, agricultural corporation, medical) into local economies. That appears to be likely. And ideas have been floated like the establishment of a kind of “local university – local ventures – local government” complex with some support of R&D tax shields. There are also proposals to encourage the shifting of resources (people, capital and others) from very rural and depopulated areas to local cities (like Sendai, Niigata, Fukuoka).

We doubt any of these efforts will however lead to major proposals for the expansion of local infrastructure projects. The Abe regime has espoused very tight budget discipline, and Japan will not go back to Kakuei Tanaka spending era.

The State of Corporate Tax Cuts

Japan’s “effective” corporate tax (national and local) was first cut from 37.00% in 2012 and 2013 (national 26.17% and local 10.83%) to 34.62% in 2014 (national 23.79% and local 10.83%). But that was only due to the abolishment of the special corporate tax for the reconstruction area of 2011 tsunami and Fukushima disaster.

This December, along with the formulation of the FY 2015 budget, the Abe Government will decide on the long awaited further cuts in the corporate tax rates.

Abe and Aso have said they will lower the effective rate to under 30%, but Aso has also hinted that he would expect only a 5% cut. That would mean we believe the new effective rate will probably be around 29.62% – just a hair under the advertised 30% threshold.

The Ministry of Finance is still stubbornly searching for other tax sources to offset a corporate tax cut, looking to make any cut revenue neutral. Those include suggestions such as “sin taxes,” like taxing Pachinko gambling parlors for example.

We suspect Abe does not support the MOF’s push for a static balance of tax income that ignores the dynamic economic stimulus effect of tax cuts. And we expect him to fight it.

It is still early days, but it has been suggested to us that Abe may even hold the second stage of the consumption tax rate hike, from 8% to 10%, in 2015 hostage if necessary in negotiating corporate tax cuts with MOF.

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