At the start of this month, Moody’s took the controversial decision to downgrade Japan’s sovereign debt rating a notch, from Aa3 to A1. The credit rating agency cited several factors for the move, including “heightened uncertainty over the achievability of fiscal deficit reduction goals” as well as “uncertainty over the timing and effectiveness of growth enhancing policy measures”. A further driver was the implications of these factors for the “affordability and sustainability of Japan’s huge debt load”.
Yet despite the downgrade, Moody’s also noted the Japanese government’s “significant credit strengths, including a large, diverse economy with a strong external position, very high institutional strength and a very strong domestic funding base.”
Indeed the programme adopted in the past two years by prime minister Shinz? Abe, known as ‘Abenomics’, has focused squarely on addressing Japan’s economic woes. In the early 1990s, after decades of growth, the Japanese economy suffered a severe contraction as the asset bubble burst and both property values and share prices plummeted.
Efforts by the Bank of Japan (BoJ) and the government to effect changes did little to improve the situation, leading to Japan’s so-called ‘lost decade’. Gross domestic product (GDP) growth sank below zero for five years, unemployment grew and government revenues declined. The global financial crisis of 2008-09 only added to Japan’s woes, bringing a second lost decade. After a brief 12-month premiership in 2006-07, Abe began his second term in December 2012 by setting in motion his strategy to strengthen the country’s economy.
The Three Arrows of Abenomics
The aim of Abenomics is to target Japan’s continuing malaise with three “arrows”. The first of these is the printing of additional currency (between 60 and 70 trillion yen (JPY)), generating a degree of inflation to make the country’s exports more attractive. The second is new government spending in order to stimulate demand in the economy.
In 2013, Abe released these first two arrows with an ambitious programme of monetary and fiscal stimuli. The popularity of this policy was demonstrated by the reactions of both the stock market and by voters in general, with his Liberal Democratic Party (LDP) triumphing in the elections for the upper house of Japan’s parliament, the Diet, in July that year.
However it is the target of the third arrow – structural reform – that many believe holds the key to Japan’s ability to turn its economic fortunes around. It is widely agreed that reforms are needed in its industrial and agricultural sectors if the country is to regain a competitive edge in world markets. Proposed reforms include making it easier for companies to fire ineffective workers, something that historically has been difficult from a legal standpoint. Another goal is to restructure the utility and pharmaceutical industries and to modernise the agricultural sector.
More difficult to implement are the reforms that go to the heart of Japanese culture – including those relating to the country’s ‘sacred’ food items. The sale and distribution of rice, for example, is controlled by the government. Under the native religion of Japan, Shinto, many priestly functions revolved around rice, which has also been seen as a measure of wealth and even as a hard currency.
For decades, Japanese farmers have received generous subsidies for sowing less grain while a hefty tariff is imposed on imported rice. These practices have proved a source of friction in trade discussions between Japan and the US as they negotiate the terms an ambitious trade agreement dubbed the Trans-Pacific Partnership (TPP). In 2013 the government approved a plan to abolish a subsidy system which had compensated farmers for reducing rice acreage.
A further element of Abe’s growth strategy is promoting the role of women in the country’s economy. Research published by Credit Suisse in September found that only 1.6% of Japan’s corporate directors are women. In the US, by contrast, the figure is 13.7% and in Norway 39.7% of directorships are held by women. According to Goldman Sachs, closing Japan’s gender employment gap could pave the way for a 13% increase in GDP.
However, the proposed strategy requires a cultural shift. On having their first child, two in three Japanese women stop working for the next decade, compared with less than one third in the US. In addition the country’s demographics is also cause for concern, with the country’s population forecast to decline by a third in the next 50 years.
Abe has suggested that Japan’s tight immigration rules could be loosened to allow in foreign nannies. Together with a greater involvement by the private sector in childcare provision, increased childcare leave benefits and setting targets for greater female involvement, the government hopes to increase the proportion of women in management positions to 30% by 2020.
Impact on Treasury
Despite these measures, Japan’s economy contracted by an annualised 7.1% in the second quarter of 2014. The unexpected lurch back into recession followed an increase in the country’s consumption tax from 5% to 8% at the start of April. As a result, a proposed further rise, from 8% to 10%, next October has been postponed – which is one of the factors cited by Moody’s in downgrading the country’s sovereign debt rating.
However, while economic uncertainty remains, Kazuo Nagasaki, newly appointed country manager for software-as-a-service (SaaS) provider Reval in Japan, says that overall the Abenomics programme has been welcomed by the company’s corporate treasurers. He notes that it has dramatically changed the deflationary pressures that Japan has experienced over the last two decades.
The BoJ’s aggressive quantitative easing (QE) programme has made it much easier for corporate treasurers to raise funds. Meanwhile, the bank’s announcement that it will keep injecting money into the economy until Japan’s producer price index exceeds 2% makes it easy for treasurers in deciding when to fix the borrowing interest rate, says Nagasaki.
Where currency risk is concerned, Nagasaki points out that the QE programme has led to a dramatic shift in the exchange rate, bringing it to an appropriate level for most exporting manufacturers. He adds that it is, however, still difficult to manage overall currency risk in the country’s high volatility environment.
“From a market perspective, Japan’s manufacturers are experiencing the difficulties of hedging oil and other commodities when taking into account current FX volatility” says Nagasaki. “These treasurers are watching the Chinese economy closely, because when it picks up its impact on commodity prices will be felt globally.”
Meanwhile, Japanese corporations have a continuing appetite for overseas merger and acquisition (M&A) activity – although the way in which new treasuries are structured is shifting. Nagasaki says that in the past, governance of the treasury function was handed off to the acquired foreign entity. More recently though, Japanese corporations have begun to bring that governance back home by centralising the management of global treasury domestically. “This will help them better manage integration post-merger and better visualise their global cash position.”
With only days to go before the country’s general election, Abe’s party is predicted to enjoy a landslide victory, which will give the prime minister more time to achieve his goals. As Abe observed in a press conference last year, quoting 19th century intellectual Shoin Yoshida, “Once a man’s will is set, he can triumph through any obstacle.”
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