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Japan Fires 'Third Arrow,' but Will It Work?

Wednesday, 5 Jun 2013 | 2:03 AM ET
Hiroshi Higuchi | Photolibrary | Getty Images

Japan's Prime Minister Shinzo Abe on Wednesday unveiled a long-term plan to revive a weak economy, with economists saying more detail and implementation are now essential to prevent the strategy from failing as so many efforts to rejuvenate growth have done in the past.

Abe pledged to raise incomes by 3 percent annually over the next decade and set up special economic zones to attract foreign investment. He said the retail electricity market would be fully liberalized and he would aim to boost power related investment to 30 trillion yen ($300 billion) over the next 10 years.

Most of the measures had been flagged by the local media and there was some disappointment in markets that Abe did not announce bolder reforms in areas such as the labor market. The Nikkei stock index closed down 3.8 percent and the yen, which has weakened sharply this year on aggressive monetary easing in Japan, firmed.

(Read More: UBS Warns of 'Abegeddon' Risk in Japan)

"Every prime minister in the last 20 years has had an economic growth plan, the key is implementation," Bank of Singapore's chief economist, Richard Jerram, told CNBC Asia's "Cash Flow".

"There is a lot of focus on the [upper house] elections in July and if he [Abe] has a majority in both houses, it will be the first time in years they can be in a position to implement change, and then there can be no excuses," Jerram said. "Either you make some progress in the next 6-12 months, or people realize it is just another bunch of hollow promises."

Japan is the world's third largest economy after China and the United States. Yet, it has been plagued by deflation for two decades, slipped in and out of recession in recent years and past efforts to implement long-term reform have fizzled out.

(Read More: Consumers Not Sold on Abe's Promise of Change)

Analyzing the Benefits of Abe's 'Third Arrow'
Richard Jerram, Chief Economist at Bank of Singapore and Nick Maroutsous of Kapstream Capital react to Prime Minister Shinzo Abe's long-term structural reforms.

Abe became prime minister in elections last December and his pledge to turn around an ailing economy has created a certain buzz in Japan. His economic strategy, dubbed "Abenomics" rests on "three arrows:" monetary and fiscal stimulus to get growth going and long-term structural change to ensure sustainable growth.

It's this final "arrow" of structural change that is the most important and without which "Abenomics" will fail, economists say.

"These figures [on national income] play a significant symbolic role," said Yuji Kage, a senior advisor at Blackstone in Tokyo. "Just think about last year, everything was so pessimistic."

The Nikkei is off about 15 percent from a 5-1/2 year high hit last month, while the yen has recovered about 3.5 percent from a 4-1/2 year low hit in May. The moves in the markets suggest that a degree of caution has set in about the success of Japan's economic policies.

The country's government bond market in particular has been marked by heightened volatility over the past two months amid uncertainty about what the central bank's massive bond-buying plan means for the market.

(Read More: Why Japan Equities Sold Off on Abe's Plans)

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"These reforms that they [Japan policymakers] want are going to take a long time to implement," said Nick Maroutsos, founder and managing director, Kapstream Capital. "It's not like we're going to wake up next week and all of a sudden Japan is growing. We're talking about lowering tax rates, increasing productivity from an investment perspective, getting consumers to spend."

And while Wednesday's speech was a little thin on detail, analysts expected the government to announce further parts to the reform plan in the weeks ahead and especially after the July elections to the upper house of parliament are out of the way.

"There's not a huge amount on labor laws, maybe we will get more next week and then we can see what the plans means for growth over the next few quarters," said John Woods, chief investment strategist at Citi Private Bank told CNBC.

Kapstream Capital's Maroutsos added: "Only time will time whether the plan will work. The words have to be put into a plan and that will happen in the next few weeks and provide a clearer direction for markets."

- By CNBC.Com's Dhara Ranasinghe, Follow her on Twitter: @DharaCNBC

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