The Liberal Democratic Party's (LDP) return to power has lifted
optimism of many, as seen in the impressive climb of the country's
equity indices. We expect the aggressive policy action undertaken
by both the government and the central bank to lift economic activity,
as businesses and households move their spending forward to
take advantage of subsidies. On these trends, we have upgraded
our growth forecast for 2013 to 1.4%. That said, we believe the
pickup in growth this year will be at the expense of growth further
down the line, and continue to highlight increasing downside risks
that accompany increased bond buying by the Bank of Japan (BoJ).
The latest slew of measures from the BoJ under the new governor
Haruhiko Kuroda, while aggressive, in our opinion, pushes Japan on
the road towards debt restructuring and monetisation. We expect that
BoJ will succeed in raising price growth, as it has set out (although
not meet its 2% target), and see this as dangerous given the pressure
it places on government bond yields. We further highlight that
with the government needing to refinance approximately 12% of its
outstanding bonds for FY2013, its growing exposure to interest rate
risks and waning demand could lead to a loss in confidence and a
rush for the exits.
The massive changes in Japan's current account dynamics continue
to push the country's current account balance towards zero and into
the red beyond 2016. We have downgraded our expectations for the
trade balance, as we revised down our expectations for nuclear plant
restarts. Furthermore, the pace of export recovery was slow in Q113,
which suggests that the trade deficit is likely to widen. We believe
that recent sell-off in the Japanese yen has been overdone, as we
see other factors that will instead encourage Japanese investors to
increase investment at home.
Long-term household savings rates will continue to decline as a
progressively ageing society and a shift towards lower-paying contract
(non-regular) employment forces more Japanese households
to consume a greater proportion of their income. Consequently,
this should place significant downward pressure on Japan's net
international investment position, although a shift from positive to
negative territory should take more than 30 years.
While post-earthquake reconstruction should result in higher loan
demand in the short term, we believe the longer-term impact will be
muted. Moreover, we believe earthquake assistance should result
in further increases in lenders' bond holdings, leading to greater
industry exposure to mounting public debt risks.
Major Forecast Changes
We have raised our forecasts for economic growth to come in at
1.4% in 2013, as Prime Minister Shinzo Abe's policies are expected
to encourage households to front-load their expenditures. This
change in forecasts does not change our long-held view that Japan
continues to edge closer to a fiscal crisis – even more so now that
the BoJ's actions suggest that more debt monetisation is in the
pipeline, shaking the confidence of the market.
The outlook for exports has improved as improving global sentiment
has lifted demand. The weakness in the Japanese yen, on the back
of expectations of more monetary easing by the Bank of Japan,
provides further upside pressure on export growth. Furthermore, with
our expectation for the Chinese economy to remain on the upswing
for the next two quarters, we believe that Japanese outbound goods
are likely to record a modest recovery in 2013.
Key Risks To Outlook
A fiscal crisis could result from the increase in debt issuance as welfare
expenditure increases. The recent volatility in the debt markets and
the growing debt burden of the central government further highlight
the growing possibility of a failed bond auction – which could lead
to a severe loss in confidence.
Another major risk is another collapse in external demand, like that
seen at the height of the global financial crisis. This would come at
the worst possible time for the economy, which is currently suffering
from subdued domestic demand growth.
Unconventional quantitative easing, including the purchase of risk
assets, may help stem deflation over the next few quarters. However,
the risk of a sudden onset of hyperinflation over the longer term has
increased considerably, as the government is determined to push
the Bank of Japan into indefinite easing and a 2.0% inflation target.