Abenomics to Hold Fort in the Short Term

After close to eight years in office, Japanese Prime Minister Shinzo Abe has announced his intention to resign from his premiership due to health issues. His tenure was characterized by political stability as well as the important reforms that he passed, which have had major economic and market implications. In the near term, any of Mr. Abe’s potential successors is expected to follow his policy mix of aggressive government spending and monetary easing. Although this should soften any adverse effects on markets for the time being, possible policy changes in or after 2021 are risks that need to be considered.

Mr. Abe’s Accomplishments Since Assuming Office

The incumbent prime minister’s economic reforms include the appointment of Haruhiko Kuroda as the governor of the Bank of Japan (BoJ), which resulted in the launch of aggressive monetary policies; corporate tax rate reduction to support Japanese businesses and equity market; consumption tax hikes; increase in labor force participation (especially of women); trade liberalization; and a move to increase inbound tourism and immigration, among others. We think that these changes have had a meaningful impact on Japan’s economy (Figure 1). The current pandemic crisis should ensure that this policy mix remains unchanged at least in the near term.

The Abe administration’s corporate governance reforms have delivered tangible results and significant long-term benefits for shareholders. The introduction of the Stewardship Code (2014) and the Corporate Governance Code (2015) has had a strong influence on corporate behavior through institutional investor engagement and internal reforms. The Corporate Governance Code, revised in 2018, has, among others, encouraged companies to nominate a minimum of two outside directors, increase return on equity targets, reduce cross-shareholdings, improve shareholder engagement and further transparency in allocating resources.

These transformations along with the promotion of Environmental, Social and Governance practices, diversity and financial disclosure have had a positive impact on the country’s corporate culture. Companies have gradually responded to these reforms, bringing tangible benefits for shareholders. During Mr. Abe’s tenure, we saw strong relative equity performance as well in light of the measures listed above (Figure 2). As bottom up investors, the improvements that we have seen in corporate governance, shareholder returns and corporate engagement have been a strong driver of our stock picking process and a solid factor in improving asset values.

On the day the Japanese prime minister announced his resignation, we saw the equity market moving lower, Japanese government bond yields moving higher and the yen becoming weaker. These market movements were reasonable considering they were mostly in the opposite direction of what Abenomics sought to achieve over the current prime minister’s reign.

Possible Successors and Likely Market Implications

We will continue to evaluate the market through the lens of improving corporate governance and stewardship parameters. Of course, we are also focused on how this political event would affect Japanese companies on a bottom up basis as well. A stronger JPY/USD would be a negative for companies with higher global sales mix and this warrants close monitoring. We will also be focusing on how the new prime minister would be adjusting Japan’s current trade policy vis-à-vis the evolving trading skirmishes between the United States (US) and China and whether this would have any impact on Japanese companies. Finally, we will be looking for new government stimulus measures that may come with the new leadership, which would be supportive of the economy/markets.

A new prime ministerial candidate would first need to be the president of the Liberal Democratic Party (LDP) before he can assume premiership. The presidential election, expected around mid-September, is not open to the public. Since the current LDP Diet members have a large weightage, the process tends to be more of a power game than any substantive discussions about policy. Against this background and considering the pandemic emergency, we expect policy continuity.

Although some candidates, such as Shigeru Ishiba, the former defense minister, have a markedly different policy stance, we think a candidate more aligned to Mr. Abe’s policy perspective has a greater chance at the election. These include Yoshihide Suga (Chief Cabinet Secretary during the current Abe era) and Fumio Kishida (LDP’s policy chair), both of whom have a long history of working with the incumbent.

Once selected by the Diet, the bicameral legislature of Japan, the new premier’s primary focus should be on ensuring continuity as well as enhancing the ongoing measures against the pandemic and restoring support for the LDP. The next focus could be on deciding the timing of the upcoming general election, which will happen by October 2021 at the latest.

Considering the low support rate for the opposition parties, we do not think that the LDP and its coalitions will lose power in the next election. But if the new prime minister were to lose seats meaningfully, another candidate with a different policy perspective may assume the leadership position. In such a scenario, global investors will likely focus on whether there is continuity in the BoJ’s current policy stance.

It is worth reiterating that Japanese politics was not on a firm footing before the Abe era. Absent a strong leadership and nationwide support for the new prime minister or the LDP, Japan might return to a period of political instability, which could have a significant bearing on how the Japanese market is perceived by global investors.

The Road Ahead

In the slightly longer-term horizon, we are keen to understand how Japan’s policy mix will develop especially in relation to central bank policies in the West. This is especially pertinent since Japan has long been considered a monetary policy forerunner, not least because of its pioneering quantitative easing measures and other unconventional measures that were instituted long before central banks in other developed countries.

The core of Abenomics has been about its efforts toward limiting the yen’s appreciation (Figure 3). This was easier in a world where other developed economies offered some yield differential as well as a more credible fiscal trajectory. However, with COVID-19, the “Japanification” of Europe and the US, characterized by extraordinary but mostly ineffective monetary stimulus, is arguably complete. In this context, the major policy challenge may pivot around containing the yen’s future appreciation. This pressure could manifest in terms of a renewal of policy innovations in capital markets, for instance in terms of promoting capital outflows from resident investors or lessening the attractiveness of Japanese bonds for foreign investors.

This is also the context that should inform Japan’s future trade relations. Although Mr. Abe was skillful in balancing Japan’s trade relations with the US and its Asian partners, this happened under the umbrage of an initially weakening but subsequently stable exchange rate. His successor may find himself confronting the opposite challenge, of a stronger currency, and this could turn out to be the trial that determines Japan’s trade relations with the world more strongly than any ideology or who ultimately occupies the White House.