Abenomics 2.0 starts with a delay in the VAT hike

Following the G7 meeting in Japan, Prime minister Shinzo Abe has decided to delay a VAT hike to October 2019. 

The Japanese economy is still facing some structural headwinds and “Abenomics” measures are being increasingly criticized: the inflation objective remains distant, business confidence has been hit since January and the recent Yen appreciation is a genuine source of worry to Japanese corporates, weighing on their earnings forecasts. In the first quarter, corporate profits fell at the fastest pace in four years and downward revisions have been accelerating. Japan’s competitiveness is also being called into question as export volumes are still contracting.

Until now, Shinzo Abe has been committed to raising VAT for a second time in April 2017, from 8% to 10%, as Japan targets a return to budget surplus in 2020. However, even if the deficit is still around 6% of GDP, domestic activity remains weak and a VAT hike could kick Japan into recession as it did two years ago. Along with the VAT delay, Shinzo Abe announced he was going to take “bold economic measures” this autumn. This fiscal package could reach 5 to 10 trillion Yen, the equivalent of, respectively, 1% and 2% of GDP. Proposals could include the construction of a magnetic-levitation train line from Nagoya to Osaka, the issuance of vouchers to boost consumer spending, an increase in pay for child-care workers and the setting-up of a scholarship fund. These reforms could tackle structural challenges such as productivity and workforce, but also boost consumer spending and provide a reminder of the concept of “helicopter money”, through a combination of fiscal and monetary policy. In this approach, the BoJ could also unveil additional purchases of, especially, some Japanese equity ETFs and bonds. The BoJ, it should not be forgotten, is already buying 80 trillion Yen per year, the equivalent of 16% of GDP.

As structural headwinds are mitigated by policy actions, we are keeping a strategic neutral view on Japanese risk assets. Any short-term fiscal boost and the addition of some additional monetary policy measures could represent tactical opportunities, especially regarding current investors’ positioning. The Yen could depreciate quickly and equities could also rebound as investors find themselves underweight for the first time in four years.