THE LAND OF THE RISING SUN

News emanating from the US, UK and Europe, whether it is Italy, Trump with his trade agenda or Brexit, is keeping journalists very busy. However, commentary on Japan has been scant. This being the case, we thought taking a closer look at what is happening in the land of the rising sun would be interesting. We looked at monetary policy, trade, currency, business reform, demographics and debt. We share our thoughts below.

Monetary Policy

Last Friday (15th June), the Bank of Japan (BoJ) Governor, Haruhiko Kuroda, announced that monetary policy is to remain unchanged. The BoJ are sticking with regular bond purchases and leaving interest target rates at -0.1%. While leaving policy unchanged came as no surprise to analysts, the continuation of accommodative monetary policy is supporting economic growth.

Japan’s private capital expenditure (CAPEX) formation is also impressive. It is on track to increase for the 8th consecutive year, this year. Bloomberg Economics state that capital expenditure is “being driven by investment in new facilities and technologies, not short-term spending to adjust to temporary shocks or inventory cycles”. This is good news for the long-term growth of the economy as structural CAPEX is less susceptible to monetary policy changes which can turn on a whim.

Imports/Exports

Ministry of Finance figures, released on Monday, show a significant increase in the value of Japanese exports and imports. Japan is a manufacturing and export-led economy. It is often said that Japan’s manufacturing is a warrant on global growth i.e. when the global economy is doing well, Japan’s manufacturing sector is doing even better.

Exports increased by 8.1% over the year to the end of May with their main exports, machinery, electrical machinery and transport equipment, growing at 9.9%, 11.3% and 1.7% respectively. Imports have also grown, at a faster rate than exports, increasing by 14.0% over the year. One of the main contributors to their higher import bill is the need to import vast quantities of petroleum. Japan relies heavily on imported oil, hence the jump in the oil price contributed to the 28.6% increase in the economy’s fuel bill.

Currency

The Japanese Yen is a significant factor affecting imports and exports. Generally, a stronger Yen pushes the cost of imports down. For example, the price of oil has risen by 37.9% and by contrast the cost of importing oil increased by a lower amount, helped by a stronger Yen. Exporting goods with a stronger currency makes them more expensive to overseas buyers, Japan’s evident ability to increase exports in the face of a stronger currency is deserving of respect.

The Yen has been strengthening as it is often regarded as a ‘safety’ currency. Investors tend to increase exposure to Yen when there is turbulence in the markets, such as increased trade tensions which kicked off between the US and China at the beginning of the year, see chart below. As mentioned, a stronger currency represents a headwind for Japan’s export-led economy. Japan still manages to increase exports showing they are highly competitive when it comes to trade.

Japanese Yen Value Against the US Dollar (Dollars per 1 Yen)

Source: Bloomberg. Data as of 20 May 2018

Business reform

Capitalists have for a very long time been critical of Japan’s business policies toward shareholders. The general sense is that shareholders are not treated fairly, with management and employees being overly protected.

In the Financial Times this week, it was pointed out that the Japanese and US stock markets have the same number of companies – 3,600. This statistic is relevant when you consider that the US economy is four times the size of Japan’s, and its stock market, in value terms, is 5 times bigger.

To counteract the lack of corporate zeal, business reform has been underway since Prime Minister Shinzo Abe was elected in 2012. This brought forth changes such as challenging large conglomerates to unwind complex cross-shareholding where large companies shield unprofitable subsidiaries. This is reinforced by targets set to ensure minimum levels of profitability are being met and by forcing through votes to increase the number of independent directors on company boards.

For some the pace of change is too slow but change is happening

Debt and Demographics

Levels of debt in Japan have burgeoned, with debt increases aligned with the ageing population. Debt levels also reflect the legacy of Japan’s banking crisis in the 1980’s when a large asset bubble in their economy burst, forcing the government to bail out the banking sector (sound familiar?).

It is estimated (in 2017) that there were 2.1 more deaths than births per 1000 people in Japan and the population is projected to fall by over 38 million by 2065. While this is happening, the Japanese authorities have been issuing debt to fund public services at a time when tax revenues have been falling. Debt, as a proportion of GDP, is now 224%.

Debt as a Percentage of GDP

Source: Bloomberg, Data as of 22 June 2018

While this is worrying, many economists say Japan has little option but to pursue reflationary policies (backed by high domestic savings) as deflation is an even worse problem to have.