.... there’s also enough scepticism among domestic institutions, economists and the media to suggest the Japan story is not overdone.

Many investors remain on the side lines given the widely held belief that economic recovery will be thrown off track by April’s sales tax rise.

With a wide range of one-off stimulus measures in force to counter a shock that may not come, growth could surprise significantly to the upside.

Prime Minister Shinzo Abe’s Abenomics is about boosting nominal growth in the economy in order to work off an excessive government debt burden built up during two decades of stagnation. Investors should not underestimate the sheer determination of policy makers to ensure Japan breaks out of its deflation trap.

History matters. Japan was just starting to recover when the trade effects of the Lehman failure of 2008 sent industrial production back to 1980s levels. Soon after, the Tohoku earthquake rattled consumer confidence and knocked out the nuclear industry. There is a sense that Japan has been unlucky and has decided it is time to make its own luck.

The Bank of Japan is central to the strategy. Quantitative easing is boosting asset prices and weakening the yen. If inflation rises as planned, Japan can hold interest rates negative in real terms while revenues grow and government debt shrinks as a share of GDP. So far, so good, but things may be about to get trickier. There will be difficult international issues for investors to navigate over the coming year, including rising tensions with China and the impact of Federal Reserve’s tapering on stocks.

However, Japan’s biggest risk is self-imposed. The government will implement a 3 per cent hike in sales tax from 5 per cent to 8 per cent in April as a first step towards bringing the budget deficit under control.

The ill-timed 1997 sales tax hike triggered a deep recession in Japan. Prime Minister Shinzo Abe knows this well and his aggressively pro-growth administration have put in place a wide range of measures designed to offset any negative impact.

There is a supplementary budget to counteract most of the fiscal drag. There are tax incentives to reward people who buy apartments and cars after the April tax increase. Acting as guarantor of all, the Bank of Japan is expected to ease monetary policy further in April on the basis that its own forecasts will predict failure to achieve an ambitious 2 per cent core inflation target on time.

The signs are promising that the BOJ will follow the Fed and move to a more open-ended and state-dependent framework with a promise to keep policy loose for as long as it takes to reach a new positive inflation equilibrium.

Japan should err on the side of caution. But things have moved on since the 1990s. The financial system is in good shape and property price declines are no longer sapping the strength from balance sheets. A recent industry survey by PwC showed Japan as the most popular market in Asia for investment and development in 2014.

Japanese equities should also benefit from a supportive global backdrop. The US economy is likely to pick up steam as fiscal drag eases. Fed tapering could create market volatility but the US dollar strength likely to accompany it is good news for Japanese exporters.

Relations with China will remain strained but the two nations have a great deal to gain from economic co-operation whatever the political posture their leaders adopt.

It is easy to criticise the pace of structural change in Japan but the reform agenda is impressive when compared to the rest of the world. Even sensitive matters like the inflexible lifetime employment system are under review.

Japan is no longer a backwater for investors.

07/01/2014
Trevor Greetham
Source:  Professional Planner    www.professionalplanner.com.au