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Japan: Abenomics: the risk of having too much success

May 29, 2013

Half a year has passed since the Japanese government led by Prime Minister Shinzo Abe pledged to implement a program to revive the ailing Japanese economy and put an end to two decades of deflation. The "Abenomics" program is based on the so-called "three arrows" strategy, which involves bold fiscal stimulus, an aggressive monetary policy and structural reforms to boost competitiveness.

The fiscal stimulus program, unveiled on 11 January, is the country's most ambitious fiscal plan since the financial crisis and aims mostly at boosting spending on public works and the reconstruction of the Tohoku region. On the monetary side, the newly appointed Bank of Japan governor Haruhiko Kuroda announced his plan to achieve an inflation target of 2% in about two years. In order to attain this goal, Kuroda presented an unprecedented plan of "quantitative and qualitative monetary easing" on 4 April, which, at a projected JPY 128 trillion by the end of the fiscal year 2014, is poised to become the world's largest monetary easing in terms of percentage of GDP. Finally, although no specific details have yet been presented on the structural reforms side, Abe has vowed to unveil his strategy before the next G-7 summit scheduled for 17-18 June.

While the jury is still out on the effectiveness of "Abenomics", the battery of measures appear to already have succeeded in jolting the Japanese economy out of its long-lasting slump. In the first quarter, GDP expanded the most in one year and more recent indicators suggest that the Japanese economy maintains a renewed momentum. Going forward, economic activity should experience a further boost, as the effect of the weaker yen buttresses the Japanese export industry. Since elections were announced on 14 November, the Japanese yen steadily weakened and is now hovering at levels not seen since October 2008. On 31 May, the yen traded at 100.5 per USD, which was 28.2% weaker than last year. FocusEconomics panellists expect the yen to weaken even further and end this year at 106.1 JPY per USD. For 2014, the panel projects the Japanese currency to close the year at 108.5 JPY per USD.

However, Abenomics also has significant downside risks. Many economists are concerned that if the plan succeeds, the subsequent pick-up in inflation expectations will push interest rates higher, thereby adding even more pressure on Japan's already massive debt burden. According to Finance Minister Taro Aso, debt-servicing costs will rise JPY 100 billion for each 10 basis-point increase in yields. With a debt burden of JPY 997 trillion, the risks are substantial and could be already materializing, as yields on 10-year Japanese government bonds spiked to a one-year high of 0.94% by 29 May. According to FocusEconomics panellists, the yield on the 10-year bond is expected to reach 0.85% by the end of this year, before rising to 1.07% by the end of 2014. The effect on public debt, however, is seen to be largely compensated by faster GDP growth, with public debt expected to rise to 221% of GDP by the end of 2013 and to 224% of GDP in 2014.


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