Will the Strong Tankan Send Abenomics Off Course?
Japanese Prime Minister Shinzo Abe could interpret the robust Tankan survey as a cue to relax, but if he fails to persevere with structural reform, the so-called "Abenomics" - or Abe's radical measures to boost the economy - could veer off track, analysts warned.
Sentiment among Japanese manufacturers moved into positive territory for the first time in nearly two years on Monday, according to the Bank of Japan's main economic indicator, the Tankan survey.
The headline index for big manufacturers' sentiment came in at 4, exceeding analyst forecasts of a 3 reading, according to a Reuters poll. Monday's result was a dramatic 12 point rise from the previous quarter's result which came in at -8.
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Big firms also plan to increase capital expenditure by 5.5 percent in the current business year that ends in March 2014, the survey showed, more than a Reuters forecast for a 2.9 percent increase.
While most analysts celebrated the results as a clear sign "Abenomics" is working, others are looking past the data and pointing to the upcoming Upper House elections on July 21 as the real game changer. Even if Abe gains a majority, a thriving economy could make it more difficult for him to push through the final arrow of his policy agenda.
"I'm not sure they [the data] are hugely relevant," said Alistair Newton, senior political analyst investment bank Nomura.
"The key focal point for markets today has got to be what is going to happen after the Upper House election. That is the key to the success of 'Abenomics' from now on, in terms of his third arrow. The risk is that the economy is doing well enough that it actually dis-incentivizes the drive on structural reforms and that would certainly lead to a dampening of sentiment," he added.
Abe's policy agenda, which involves a three-pronged approach of aggressive monetary stimulus, fiscal spending and structural reforms, has so far powered the country's main stock exchange around 55 percent higher since he first started talking up his agenda in mid-November.
(Read More: Japan Fires 'Third Arrow,' but Will It Work?)
But confidence in Abe has waned in recent months after he disappointed investors with his 'third arrow.' His plans which involved raising incomes by 3 percent per year over the next decade, liberalization of the retail electricity market and steps to boost foreign investment, have been panned by market watchers for lacking in detail and implementation steps.
According to Nomura's Newton, a lack of clarity on the third arrow of Abenomics is holding back the progress of the policy regime overall.
"Market expectations will be dependent, after the election, on what Abe lays out on structural reform and let's be honest so far we have not seen anything on what the shape of the third arrow is going to be," added Newton.
Alvin Liew, senior economist at United Overseas Bank, agreed that even if Abe's party wins the elections in July, he could struggle to push through his planned structural reforms.
"That has always one of the key risks, because people think if they [the Liberal Democratic Party of Japan] win the Upper House elections come July, there might be a push for more [reforms]. But if they win and things are going well in terms of the economy, the push back for some of the harder challenges could be more difficult," he said.
(Read More: How a Big Election Win for Abe Could Defeat Reforms)
However, Paul Gruenwald, chief economist for Asia-Pacific at Standard & Poor's credit ratings agency, said implementing the third arrow of Abe's policies would not be vital for the success of Abenomics.
"I think it's important to separate the structural reform, which is the third arrow, from the second arrow which is monetary policy," said Gruenwald.
"Structural reform will help the growth picture ... but defeating deflation and getting to 2 percent inflation is monetary policy alone. If he starts mixing the two up he's shooting himself in the foot," he added.