J-Money: What Became of Abe’s Fourth Arrow?

J-Money, October 2014

When Prime Minister Shinzo Abe announced his plans to revitalize Japan’s economy shortly after coming to power in December 2012, he spoke of four arrows. The first was a $110 billion stimulus package, targeted at upgrading infrastructure. The second was a promise to end deflation, which was supplemented by the appointment of Haruhiko Kuroda as governor of the Bank of Japan. The third was a series of structural reforms to prompt long-term growth. But what about the fourth one?

Back then, the idea of the fourth arrow was to double the consumption tax to 10% in two stages, the first of which took place in April this year when it lifted from 5% to 8%. Over time, though, the definition seems to have changed, and to have become inexact. By late in 2013, instead, the 2020 Olympics in Tokyo were being described as a fourth arrow of stimulus: by then, the government had calculated a Y3 trillion economic impact from Olympics-related investment and spending, and 150,000 new jobs.

History is filled with Olympic Games that have become a burden to host cities rather than a boon. But in Japan, the appeal of the Olympics in economic terms is the idea that it could drive private sector capital. Public sector debt is a problem at every level in Japan, so if the private sector were to be attracted by the investment possibilities in infrastructure development ahead of the games, there could be long-term knock on effects well after the Olympics, if private investors have a positive experience and elect to continue to invest.

There is, after all, a lot to be built for the Olympics. Infrastructure will include a new airport terminal, the expansion of highways, more trains, and of course new stadia for the games to be held in. Additionally, the build-up to the games lasts six years, which is ample time for momentum to build.

Also in the mix – and whether this is part of a fourth arrow or simply another element of economic stimulus is open to debate – is the possibility of Japan allowing casinos to operate for the first time. A bill to allow the development of casinos will be debated in Japan’s parliament later this year, and if it passes, it may be that the first casino resorts open in time for the Olympics, in order to capture the considerable tourism business that should come with it. Some projections put potential income from legalized casinos at $10 billion a year. CLSA, the brokerage, has said that “Japan could become one of the largest gaming jurisdictions in the world, surpassed perhaps only by Macau.”

Certainly, something needs to happen, because the third arrow didn’t really hit its target, or at last not yet. Shinzo Abe wrote in the Wall Street Journal to international investors in September to address these concerns. “Some have said that Japan’s structural reforms – what I call the ‘third arrow’ of Abenomics, alongside the first two arrows of monetary and fiscal policy – are at a standstill and that wage increases aren’t keeping up with price increases,” he wrote. “But there is no reason for alarm. We remain on the path toward a revitalized Japan we began in December 2012.”

The Prime Minister’s article in the Journal made no mention of a fourth arrow, but it did go into considerable length about what the administration is doing to try to boost growth. Among other things, he mentioned reducing Japan’s effective corporate tax rate by 2.4 percentage points this fiscal year, with further cuts to come; strengthened corporate governance; bills to allow more new entrants in the electricity, health and medical services industries; a relaxation of visa requirements, leading to more than 10 million foreigners visiting Japan last year; the passing of bills to promote growth in agriculture, with the establishment of farmland banks to promote farmland consolidation and large-scale farming; various elements of regulatory reform; the allocation of revenue increases from the consumption tax hike towards social security; boosting women in the Japanese workforce, with more child-care facilities; and reviewing the use of pension assets. It’s quite a list, and the Olympics didn’t appear in it anywhere.

For foreign investors and issuers, the effect of the fourth arrow depends on what one thinks that arrow is, tax or Olympics (or general stimulus). “Any policy that impacts the behaviour of the investor base will also have an impact on the funding we can raise in that market,” says Andrea Dore, lead financial officer at the World Bank. “Japanese retail investors have a huge amount of savings and are getting very low interest rates in yen on those deposits. Over the last few years as rates have gone lower, even in other currencies too, those investors have started to diversify into other products and credits.” Dore notes that she was last in Japan at the start of the year, well before the consumption tax increase. She recalls “the upbeat expectations people had going into the beginning of the year. It will be interesting, as I go back and meet investors, to see if there has been a change in sentiment between January and now.”

One impact foreigners note is that Japanese capital is flowing out to them. “Abenomics has had a big impact on the flows of Japanese investment into our local currency market,” says Bogdan Klimaszewski, deputy director of the public fund department in Poland’s Ministry of Finance.

Foreign analysts have begun to doubt Japanese recovery. The UK-based investment house Standard Life is among them.  Govinda Finn, in Standard Life’s global strategy team, notes that since the Bank of Japan said it was “half-way there” in December 2013, “Governor Kuroda has seen relatively little progress towards achieving the bank’s 2% target.” Core CPI for July, excluding the consumption tax hike, was flat on the previous month and the same level as December 2013: 1.3%. “If anything, the ‘core-core’ inflation rate excluding the tax hike appears to have moderated.” At the same time the Bank of Japan has had to lower its real GDP growth outlook, “and, given the greater than expected contraction in growth during Q2, may have to do so again when it releases the October Outlook Report. However, if 2014 has been a bit of a damp squib, the Bank is reluctant to admit it.”

Still, foreign investors in the stock markets have shown more faith. Barings Asset Management, for example, has an overweight position on Japanese equities – Hayes Miller, head of multiasset investments, said in early September that his equity portfolios had four to seven percentage points more weighting to Japan than their benchmarks – and Pioneer Investments has also been buying Japanese stocks. Fund managers with overweight positions tend to cite the weak yen, which helps exporters, and a belief that even if Abenomics has paused, modest inflation is better than none.

Japanese growth has to be seen in the context of a difficult global environment, with tensions over Russia and ISIS, negative interest rates in Europe, and pending US mid-term elections. While none of these things directly impacts Japan, they do have an impact on global investor sentiment generally, and on the economic health of some of Japan’s key trading partners.