Japan: Fourth component of Abenomics stepped in - BBH

Research Team at BBH, notes that the Japan's Prime Minister Abe seemingly hurriedly confirmed some details of his fiscal plan.  

Key Quotes

“If he intended on cajoling the central bank into joining the fiscal stimulus with a large dose of monetary support, it was insufficient.  Abe is expected to provide more details of the fiscal package.  The cabinet will formally approve it, and it is not clear whether the cabinet will do so before or after it is reshuffled, and the sequence may not matter. 

Reports already indicate that the only about a quarter of the headline JPY28 trillion will be real fiscal spending.  The freshwater number may also include spending associated with a supplemental budget that Japan habitually announces.  Even a slimmed down estimate needs to be discounted because frequently all the earmarked spending goes unused.  At the end of the day, the large fiscal package is not so large really, and it may not provide as much stimulus as head figure of around 6% of GDP suggests. 

And even if there was greater real spending, it is not clear that it would change investors' views.  At its best, government spending would create a short-run demand shock, and even given a reasonable multiplier, one cannot be very optimistic.  The recent data shows domestic demand (overall household spending) and foreign demand (exports) are weak and falling. 

It is not as if this is priming the pump in the popular Keynesian image or that the Japanese economy has been starved of public investment as some European countries.  Japan has recorded an average budget deficit of 8.1% of GDP per annum in the last six years.  The deficit has been below 8%of GDP for the last two years when it has averaged 7.2%.  This year's deficit was to come in below 6% before this latest round of stimulus, and the details will help economists and investors update their forecasts. 

Expanding the monetary base by JPY80 trillion a year (more than 15% of GDP) is not stimulating inflation expectations or actual inflation.  Running a significant and sustained budget deficit has been unable to push the world's third largest economy onto a self-reinforcing growth path.  Observers may differ on precisely what Japan should do, but many appear to be growing increasingly convinced that it is not a question of a marginal tweak. 

Although Abenomics is usually associated with the three arrows of fiscal and monetary stimulus and structural reforms, there was a fourth component.  Pension funds, including the government's gigantic GPIF, diversified overseas and with apparently low hedge ratios...initially. Some suggest that it was these outflows that helped drive the yen's decline.  Reports now suggest that since that hedge ratios are being increased, this is one of the important drivers of the appreciating yen.  It may be a bit of a vicious cycle.  As the yen appreciates, pressure mounts on Japanese global investors to buy yen as a hedge, driving it higher, requiring more hedging.”