Koizumi’s LDP won a landslide in elections to the lower house of the Japanese parliament. At first sight this outcome is everything the markets wanted: a decisive result which ends political uncertainty, the re-election of an administration with a superior track record on the economy, and a fresh mandate for reform under a strengthened Prime Minister whose position now appears to be unassailable.
There was also a substantial upward revision to second quarter GDP: the original increase of 0.3% q/q was raised to 0.8%, mainly due to a larger positive contribution from investment and a smaller negative contribution from inventories.
Growth is now on track for at least 2% this year and next, comfortably above the latest consensus forecasts of around 1.5%. This might be unremarkable by the standards of other developed economies, but the ageing population means that Japan’s trend growth rate is barely 1%. The upshot is that even quite modest growth above this rate will be sufficient to eliminate the negative ‘output gap’ (the broadest measure of spare capacity) that has built up in recent years, and so bring an early end to deflation.
Our own views have long been among the most bullish on Japan and (aside from any short-term profit-taking) we expect further gains in both the Nikkei and the yen. In particular, the consensus has yet to take on board the prospect of an early end to deflation.
Two lingering concerns
Given all this, it might seem odd to state our concerns over political developments. Nonetheless, a more balanced view might be a helpful contrast with some of the euphoria now seen in the markets.
Our first concern is that Koizumi has reiterated his intention to step down as Prime Minister in September next year once his term as LDP leader expires. (That is his choice, as it would be easy enough to change the LDP’s term limits.) This means that he may only be around for another twelve months and, as this deadline approaches, his influence over the party and policy will inevitably diminish. In turn, this begs the question of whether the LDP has changed sufficiently to continue economic reform without Koizumi: if so, that would be his greatest legacy to Japan.
Early indications from Sunday’s elections are positive. Many ‘non-traditional’ (often female) members have now been elected to parliament. These include most of the official candidates put up against the 37 members who had opposed postal privatisation in the lower house. Several dissidents who opposed postal privatisation in the upper house have seen which way the wind is blowing and now say that they will back reform. It is also encouraging that, despite the LDP’s absolute majority, Koizumi has said he intends to continue governing in coalition with the reform-minded New Komeito party.
However, the size of this weekend’s victory may yet prove to be a mixed blessing, because it will consolidate the LDP’s near-monopoly on power. The rise of the opposition DPJ had been a positive force in Japanese politics, creating the prospect of a genuine multi-party system. Although untested in government, the DPJ had the more radical agenda and little of the baggage of vested interests that the LDP has accumulated during its post-war dominance of Japanese politics. Now the DPJ is in crisis and looks set to break apart.
The risk is therefore that, despite a fresh electoral mandate, the reform process will gradually lose momentum. Indeed, here too the strength of the economic recovery may prove to be a mixed blessing. It should provide the opportunity for more radical reform. But it might simply encourage complacency in the LDP, especially among those vested interest groups who have, for example, blocked attempts to reduce wasteful infrastructure spending and cut civil service jobs.
Our second concern is that Koizumi himself seems willing to put off some difficult but necessary decisions for his successor. Fiscal consolidation is typical. Koizumi has said that a rise in the consumption tax (currently a relatively low 5%) is ‘inevitable’ at some point to make a dent in the huge government debt, which is expected to top 150% of GDP this year. But at the same time, he has ruled out any increases in consumption taxes while he is Prime Minister.
Admittedly, this stance has played well in the markets: the DPJ’s plans to raise taxes and cut government spending were seen as a threat to growth. Japan does have a deserved reputation for premature tightening of both fiscal and monetary policy. However, it would be a great shame if the collapse of the DPJ discouraged other politicians from tackling these issues seriously.
It’s not just about the Post …
Privatisation of the post office will now be back on track and this is undoubtedly a big positive. Nonetheless, there are still huge battles to be won over other issues such as health care and pension reform. Again the DPJ appeared to have the more decisive policies here, let down by poor presentation. Indeed, this is one important reason why domestic investors (who tend to be aware of these issues) remain much more cautious about Japanese equity markets than foreign investors. Thus, there is a valid concern that Koizumi might focus on postal privatisation at the cost of letting other policy priorities slip.
… but Koizumi beats Bush, and the rest
Of course, everything is relative. The economic recovery will continue largely independently of political developments. It is therefore right to end on a positive note: we have far more confidence in the Koizumi government’s ability to tackle the structural problems facing Japan than in the competence of the Bush administration, or the ability of the Chirac and Berlusconi governments to reform the economies of France and Italy. The outcome of the German elections is also unlikely to be as decisive. Thus, while the markets should expect further political hiccups along the way, we will continue to be fundamentally bullish on Japan.
By Julian Jessop, Chief International Economist at Capital Economics