Splits emerge between BOJ and Japan’s policy makers

This article is published by the FT as part of a collaboration with Nikkei that started in 2013 to provide added insight to our readerships.

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Since he returned to power more than two years ago, Prime Minister Shinzo Abe has been tackling the challenge of re-energising Japan’s deflationary economy more vigorously and effectively than during his first, one-year tenure as prime minister, which ended in September 2007.

Judging by the sharp rise in the Nikkei Stock Average since the start of his second government, many corporate executives and market participants in Japan share that opinion. The benchmark index is now close to 20,000, surpassing its peak during his first stint in office.

But while the economy has become healthier, there is still much to be done. Mr Abe’s quest to pull the economy out of its deflationary hole can be divided into three stages.

The first began when his expansionary economic policy — known as “Abenomics” — got off to a flying start immediately after his government was inaugurated in December 2012.

Abenomics is composed of “three arrows”: bold monetary easing; aggressive fiscal expansion; and a new strategy for economic growth. Implementation of the first two elements has radically changed the economic mood in Japan. The “unprecedented” monetary easing delivered by Haruhiko Kuroda, governor of the Bank of Japan, handpicked by Mr Abe, has corrected the yen’s excessive strength, improving export profits and pushing up stocks.

The second stage began in April 2014, when the local sales, or consumption, tax rate was raised from 5 to 8 per cent to address the country’s disordered public finances.

Consumer spending plunged after the rise, partly because of a spending surge beforehand and partly because of a fall in real incomes. As a result, the economy lurched downward in 2014.

Abenomics entered its third stage in November 2014 when Mr Abe switched his focus to rekindling economic growth. With the risk of sliding into de facto recession, Mr Abe postponed the next scheduled increase in the consumption tax by a year and a half.

The challenge for the prime minister is to set into motion a cycle of stable expansion by April 2017, when the consumption tax will rise to 10 per cent, regardless of economic conditions.

Abenomics faces a tough test this year, but there are three factors supporting efforts to pump up the economy: a weaker yen; low interest rates; and cheaper oil.

With Japanese companies reporting record profits, wage rises are expected to be bigger this year than last. A growing number of companies is also tapping swollen cash reserves to ramp up capital investment, hire more people and pay out bigger dividends.

The government is working hard to ensure investment and employment growth will lead to an economic upswing. At a press conference in November, after he dissolved the lower house for a snap election, Mr Abe pointed out that leading Japanese companies were bringing their investment back home, citing the examples of Nissan Motor and Canon.

As part of his growth strategy, Mr Abe also aims to improve the environment for business spending and job creation by eliminating disincentives such as high corporate tax rates, big electricity bills and excessive economic rules.

To unravel the country’s thick knot of red tape, he has pledged to submit more than 20 bills to the current Diet session to ease the “bedrock regulations” in such areas as agriculture, health, energy supply and employment.

He has scored a success in the agriculture sector by stripping the powerful Central Union of Agricultural Co-operatives, or JA-Zenchu, of its legal authority to oversee management of local groups.

In attempting to accelerate negotiations for the Trans-Pacific Partnership trade pact, Mr Abe is seeking to tear down the wall of regulatory protection built to maintain the status quo.

It will, of course, take time for his growth strategy to start producing tangible economic benefits. The question is whether businesses and households will start spending actively before the economic momentum created by Abenomics peters out.

Mr Kuroda has said the economy needs powerful thrust to escape the downward pull of deflationary pressure. So it is vital to persuade the public that the government and the central bank are committed to tackling this through concerted and co-ordinated efforts.

There are, however, some signs of discord between the government and the BOJ over fiscal policy and the inflation target. Some observers say Mr Abe is feeling uncomfortable about Mr Kuroda’s persistent emphasis on the importance of fiscal rehabilitation and the prime minister is not as enthusiastic as before about achieving the 2 per cent inflation target.

Observers say the government and the central bank need to speak with one voice about key matters, even if they disagree on minor points. This is all the more important as the government attempts to capitalise on market forces to push through its policy agenda.

As it struggles to steer the economy toward stable growth and steadily improving fiscal health, the government is clearly keen to keep long-term interest rates low and prevent the yen from rising sharply, at least for the time being.

The government’s attempts to kick-start the economy are constantly being evaluated by global financial markets. The Nikkei index’s rise above the high logged during Mr Abe’s first term indicates that investors approve of those efforts.

But, with his tough mission incomplete, he has no room for complacency.