Japan's New 'Growth Strategy' Elicits Little Enthusiasm

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Julian Jessop, chief international economist at Capital Economics in London, complains that the government's announcement showed a “worrying lack of urgency or ambition in their commitments to sort out Japan’s dire public finances.”

Jessop cited that the DPJ will wait more than a decade (2021) before even trying to slash the country's enormous debt/GDP ratio – currently at 225%, but which could balloon to 260% or more by then.

“The only chance of reducing the debt/GDP ratio before 2021 rests on the growth of the economy being significantly higher than the level of interest rates,” he explained.

Such astronomically high public debt, Jessop asserts, is “clearly dangerous,” because it would not allow for “fiscal policy to respond to future economic or financial shocks. It would also leave public finances vulnerable to just a small increase in interest rates.”

The new Prime Minster also suggested raising the sales tax (from 5% to 10%) – something the IMF had already recommended – as a way of starting to curb the country's massive public debt.

“The government’s growth strategy relies heavily on cuts in corporate taxes and increases in spending that, at least in the early years, will simply undermine the public finances further,” Jessop states.

“The plan also puts a lot of emphasis on the ability of the Bank of Japan to bring deflation finally to an end in 2011, which is at best wishful thinking and at worst another example of passing the buck.”

Jessop thinks the government's real GDP growth target of 2% is “achievable,” although this figure is well above consensus estimates. The IMF, for example, forecasts a 1.2% long-term, annual growth rate, reflecting, among other things, Japan's aging demographics and shrinking labor force.

Jessup indicated that the tougher rhetoric from the new Prime Minister over the past two weeks had encouraged him to expect something “more ambitious.”
“But in fact, the commitments are pretty weak,” he concluded.

None of these pressing issues can be seriously considered until Japan holds an election for its parliament's upper house on July 11; and implementation of any measure would take much longer, perhaps not until next year.

Masumi Yamamoto, equity market analyst at Daiwa Securities Capital Market, was quoted as saying "it may be difficult for market participants to take positions ahead of... elections. It is still too early to evaluate an impact of consumption tax on the Japanese economy,"

Japanese equity investors appeared to give a big yawn to the government's announcements – the benchmark Nikkei index barely budged in Friday trading, suggesting perhaps that the public in Japan has become so used to long-term massive debt and deflation that they too are skeptical of any real progress on these fronts.

On the bright side, however, another Capital Economics source, John Higgins expects the Nikkei-225 index to outperform the S&P 500 this year, citing among other things, an expected 4% growth in 2010 GDP, a reasonable valuation of Japanese shares; and a gradual near-term weakening of the yen.

“Over the past five years Japan’s stock market has tended to strengthen when its currency has weakened,” Higgins, the firm's senior market economist, said.