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Will It Be Hit or Miss for Shinzo Abe's Final Arrow?

Japanese Prime Minister Shinzo Abe.
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Japanese Prime Minister Shinzo Abe.

There has been a certain buzz around Japan since Prime Minister Shinzo Abe promised radical change to breathe life back into a run-down economy six months ago. Whether that will last or fizzle out will depend on what long-term strategy Abe outlines as early as this week.

Analysts expect Abe to fire his third salvo to improve the competitiveness of the world's third largest economy. From introducing more flexible labor policies to steps that encourage more women into the workforce, Abe could also tackle deep-seated issues such as opening up the farm sector or loosening the country's tight immigration laws - widely seen as a necessary step given a rapidly-aging population.

(Read More: 'Abenomics' Success Hinges on Reforms: World Bank)

"Japan has now agreed and announced globally that it is willing to embrace change, something that it has not been willing to do for two decades and that's a shift that's still not priced into equity markets," said Glen Wood, head of sales at Japanese bank Mitsubishi UFJ. "People globally are skeptical about 'Abenomics' given what's gone on historically. A long-term plan would be helpful."

Abe, who became prime minister in December, has delivered on two fronts: fiscal stimulus announced earlier this year to give the economy a boost and pushing the Bank of Japan to adopt aggressive monetary stimulus to end two decades of deflation.

(Read More: BOJ Throws In Kitchen Sink in War With Deflation)

These are short-term steps and it's the long-term structural changes implied by the last arrow of the three arrow strategy on which the success of Abe's economic policies, dubbed "Abenomics," hinges, Japan watchers say.

The International Monetary Fund said on Friday that it supported "Abenomics," urging Japan to implement structural reforms and fix its public finances.

Japan has slipped in and out of recession in recent years, been hurt by two decades of falling prices, while previous efforts to implement long-term change have fallen short of expectations.

The Nikkei stock index hit a 5-1/2 year high in May, propelled higher by a weak yen and optimism over Japan's outlook. But recent sessions have seen a sharp pull-back, casting a shadow over Abenomics.

"Investors are starting to believe that if there's no follow through in structural reforms then this program [Abenomics] is not going to get traction," Stephen Roach, a former executive at Morgan Stanley told CNBC.

(Read More: Japan Expert Warns of Risk Factors)

Different This Time?

Some Japan watchers say they are hopeful that Japan under Abe has entered a new era of change. In addition to the short-term monetary and fiscal stimulus measures, there have been some signs that the government is willing to take on strong opposition to make changes.

Japan, for instance, will be part of the next round of U.S. led Trans-Pacific Partnership talks to be held in July, and that could lead to negotiations to open up its agricultural sector.

Abe's Liberal Democratic Party is also expected to win elections to Japan's upper house of parliament in July and that could put the government in a stronger position to push through change.

(Read More: Trade Pacts: Not Too Exciting, but This One May Be)

"The farm sector is clearly a big issue, so is immigration, but right now the emphasis has to be on investment, productivity, the core of the Japanese economy and getting it back on track," said Uwe Parpart, managing director at Reorient Financial Markets.

"The Sonys, the Panasonics, they really need to become competitive against the likes of [South Korea's] Samsung again," he said referring to the well-known big Japanese brands. "That's a big task and I think they will take that on and handle it properly."

Hedge fund manager Daniel Loeb has caused a stir by calling for a break-up of the electronics giant Sony which analysts say could mark the start of much-need change and restructuring at Japan Inc.

(Read More: Sony Board Will Review Loeb Spinoff Proposal: CEO)

Abe's use of the term "three arrows" comes from a Japanese folk story, in which a father shows his three sons how one arrow can be bent, but when together the arrows are unbreakable.

The point here is that Abe needs to deliver on that third arrow for the other two arrows of "Abenomics" to succeed.

"Nobody has said that Abenomics can work without structural reform, that is stating the obvious," said Parpart. "After the upper house election, there is going to be three years of Abe, so unless he really messes up, he has the leeway to make the change."

— By CNBC.Com's Dhara Ranasinghe; follow her on Twitter @DharaCNBC

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