The Japanese stock market greeted Sunday’s triumph for Shinzo Abe’s Liberal Democratic Party in the upper house of the Diet with indifference, as the Nikkei 225 futures index fell 2.6% in the first 12 minutes of trading yesterday.
Who knows what drives markets day to day? Expectations of an LDP victory were probably baked in. What matters is whether Abe can deliver on fiscal consolidation and industrial restructuring — the so-called second and third arrows of Abenomics.
If his party had been able to secure a supermajority in both houses of the Diet, the LDP would have been in a position to ram through all kinds of reform measures. The stock market would have skyrocketed.
But it’s a good thing Abe didn’t get everything he wanted.
The prime minister’s motivation for economic revitalisation is often perceived to derive from nationalist instincts, best represented by his open desire to amend the Japanese constitution to allow the government a freer hand with military activity.
Had the LDP secured the supermajority, Abe and his henchmen would have interpreted that as a mandate for far-reaching political change, and the PM would have been tempted to spend his time and capital on the Constitution.
As it happens, the LDP still relies on its coalition partner, the New Komeito party. That could mean some challenges in terms of pushing fiscal reforms, which may not please investors. But the New Kometio party is broadly in alignment with Abe’s economic goals, while being sceptical of constitutional changes and more inclined to a dovish approach to relations with Korea and China.
Abe has already signalled constitutional issues will require more time. These issues aren’t dead, but they have been safely kicked down the road.
So the question is whether securing majorities in both houses of the Diet will be enough to deliver fiscal reform and industrial restructuring.
The precedent of Junichiro Koizumi’s administration (2001 to 2006) is not heartening: the popular prime minister’s greatest reform, privatising the post office, proved a failure. The stock market enjoyed a few bullish years but ultimately lost ground after Koizumi left office.
The LDP remains divided internally between reformers and reactionaries in the pockets of those sectors most in need of restructuring, such as agriculture and construction. So while the LDP may look forward to three years of dominance (parliamentary elections don’t happen again till 2016), Abe’s hold on the prime ministry will depend on keeping the backbenchers happy. So aggressive cuts to subsidies aren’t on the cards.
There are signs, however, that Abenomics is already changing consumer and investor expectations, creating a cycle of positive reinforcement. Exporters have already received their boost from a weaker yen. That’s a one-off. What counts is what happens to the domestic economy.
Yoshinori Shigemi, strategist at J.P. Morgan Asset Management, says consumer confidence is on the rise, noting that department store sales in the first quarter of 2013 are up almost 3% year on year. That may not sound much, “but this represents a 17-year high,” he said (see chart).
The other benefit to a weaker yen is higher import costs, which is helping edge inflation into positive territory. Land and condominium prices are also rising, and overall GDP growth for the first quarter is estimated by J.P. Morgan to have clocked 4%.
“The election result should help drive consumption and thus build wealth,” said John Vail, strategist at Nikko Asset Management, who predicts reforms will advance “with alacrity.”
The hard parts will involve cuts to social spending, which coalition politics complicate; and industrial reforms. Regarding the former, Abe is expected to increase consumption taxes, if for no other reason than to support the finance ministry, which is struggling to pay the government’s bills.
Abe served as Koizumi’s chief cabinet officer and watched his boss’ signature reform melt away. He will have to retain public support, which means reforms will proceed slowly. A parliamentary supermajority would have enabled the LDP to push through bolder reforms — but that assumes the LDP itself would resolve its internal tensions right away, which is doubtful.
The small-beer aspects to Abe’s third arrow, the argument runs, must yield positive results that will lend support to more aggressive reforms. Abe has bought himself time with this election victory — but not much.
Japan faces long-term problems that could have used a more forceful approach by the Abe administration, which the election puts out of his grasp. A consumption tax hike won’t be enough to address vast welfare spending commitments; regaining industrial competitiveness still looks to hinge on the gamble of a trade pact with America and other Pacific countries.
But for investors, Sunday provided a shorter-term Goldilocks outcome: not too hot, not too cold. This sets the stage for domestically oriented corporate earnings to beat expectations. It’s now up to Abe’s political skills to see if the political porridge turns out just right.