J-Money: What tapering means for Japan

J-Money, November 2013

The progress of monetary easing and Abenomics in Japan is still unfolding. But one challenge for Japan is that its fortunes will be decided not only by what it does at home, but what is happening elsewhere in the world.

The clearest example of this is US quantitative easing, and the precise process and timetable for tapering of US intervention. This has to happen at some stage, and the reaction of world markets to Ben Bernanke’s first suggestion of tapering in May suggests that the process is going to be volatile and difficult – so much so that in September, the Federal Reserve seemed to step away from tapering, saying the US (and perhaps the world economy) were not ready for it.

What does this mean for Japan?

When tapering was first announced in May, the immediate impact was an outflow from emerging market currencies and securities. In that sense, Japan is among the least-affected of Asian economies. But there is a knock-on effect: those outflows increase upward pressure on safe-haven currencies, including the yen. That is at odds with what the Bank of Japan has sought to achieve in pushing the value of the yen down to support Japanese exporters and revive the economy.

“I would say the combination of Abenomics and tapering have had an impact on the markets where we fund,” says Ben Powell, senior financial officer at IFC, the private finance arm of the World Bank. “Abenomics brought a sudden weakening of the yen and there was, from some of the large investors, some profit-taking, some retraction from non-core currencies, as a result. And then combined with tapering, there was capital flight away from emerging market currencies. Obviously Japanese investor activity was caught up in that as well.”

Generally, when all major economies are acting together with quantitative easing strategies, the effect is consistent: a reflation of assets, plenty of liquidity globally, and increased risk appetite. A challenge arises when one key market steps back from QE, as the US must soon do, but others retain their own expansive policy, as is the case in Japan.

So when the Fed appeared to step away from tapering in September, was that good for Japan? In some senses, yes: stocks on the Tokyo Stock Exchange rose sharply on the news, as they did in the US, in the belief that it would help the performance of the world economy for a while longer. But from Japan’s perspective, it’s not quite that simple. Some argued that it made it harder for Bank of Japan Governor Haruhiko Kuroda to meet his target of ending deflation, and to bring inflation of 2% by 2015. It’s not that the Fed decision has a directly negative impact in Japan. It’s more that it shows how difficult it is to drive growth in an economy through quantitative easing, because the Fed clearly does not believe the US economy is strong enough to cope with tapering yet.

That said, an end to QE must eventually come. “The non-taper is just a momentary reprieve,” says Frederic Neumann, co-head of Asian economic research at HSBC. “It’ll happen. And our expectations remain that QE may end entirely by the middle of next year.” Specifically for Asia, he notes: “Tapering will not be terminal. But it will hurt growth and could lead to another spike in volatility.” Again, this will impact other Asian markets more than it will Japan, but could once again lead to upward pressure on the yen, which Japan wants to avoid.

European borrowers in yen are still trying to work out just what an end to US quantitative easing, coupled with the changes in Japan’s monetary policy, mean for them. “Probably it could result in an acceleration of the inflows of Japanese investors towards our local currency debt,” says Bogdan Klimaszewski, deputy director in the public debt department of Poland’s Ministry of Finance.

Alejandro Diaz de Leon Carillo, deputy undersecretary for public credit at the Ministry of Finance, adds: “I think that, overall, we have probably received more attention in the sense that some investors are looking into different types of instruments now. We have seen a lot of interest.”

And issuers of products to Japanese retail, in the uridashi format, are also watching closely. “Movements in the currency have an impact on highly structured dual currency products, which are on the rise,” says Alexander Liebethal, in the funding department at KfW, the German government-owned development bank. “We see that plain vanilla transactions in the more exotic emerging market currencies are temporarily very much on the decline, which is self-explanatory given recent moves in those currencies.”

Aside from US monetary policy, there are other domestic considerations in Japan, some good and some bad. “In recent days we have had the announcement on the Olympics as well, which in our view is another quite significant boost to the domestic scenario,” says Vince Purton, managing director and head of debt capital markets at Daiwa Capital Markets Europe. The precise effects of Olympics on national economies are varied: some countries have struggled with the debt burden, while others have been strengthened by the economic activity. In Japan, already construction stocks have gained, and one would expect tourism and travel to improve as well closer to 2020. The projected spending on Olympic buildings and facilities is expected to be Y455 billion.

In comments after the announcement, Simon Somerville, manager of the Jupiter Japan Income Fund, told The Independent in the UK that it would improve confidence among the Japanese and increase the strength of Prime Minister Abe. “This increased sense of confidence and purpose among Japanese people should also mean that Abe’s and Bank of Japan Governor Kuroda’s pro-growth policies will become much more effective.” He said the bid decision will also support Abe’s reform policy and drive his initiatives for PFI (private finance initiative) and PPP (public private partnership) funding.

In the short term, though, there is greater attention upon the consumption tax, which the government has proposed to increase from 5 to 8 per cent in April. Fund managers like Fidelity remember that the last time there appeared to be a sustained recovery in Japan, in the late 1990s, a tax hike ended it; but the other view is that if Japan does not show that it can reduce its deficit, the bond market could turn negative, pushing yields up and making it harder still for the government to service its debts.

Another tax issue, while not so closely watched, concerns a decrease in corporate tax. At the time of writing, the market was expecting an announcement of tax breaks for capital expenditure, potentially as much as Y500 billion in total, at some point in October, and up to Y1.4 trillion in overall corporate tax cuts. This is partly to offset the impact of the consumption tax increase, and partly to encourage Japanese companies to keep their investment within Japan.

One final issue is progress in the Trans-Pacific Partnership agreement, a proposed trade pact between Japan and Australia, Brunei, Canada, Chile, Malaysia, Mexico, New Zealand, Peru, Singapore, Vietnam and the USA. These are fundamentally trade tariff talks, which tend to be a mixed blessing to signatories: helping Japanese exporters to the US, for example, but also potentially increasing the ability of other exporters to sell into the Japanese market.

The challenge for Japan will be to combine these domestic and international forces and maintain the positive momentum in Japan that has been achieved since April.