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Abenomics approaches a moment of reckoning

Toru Yamanka | AFP | Getty Images

Japanese Prime Minister Shinzo Abe's grand plan to revive the economy, which has run into several stumbling blocks in the past year, is reaching a "moment of reckoning", Goldman Sachs has warned.

There are several key turning points before the year-end that will be key in determining whether Abenomics will succeed or stumble, according to the bank, pointing to this week's cabinet reshuffle, a potential expansion of the Bank of Japan's (BOJ) aggressive easing program, and a decision on whether to move forward with a second tax hike in 2015.

"Abenomics is approaching a moment of reckoning, with the decision on whether to further raise taxes next year perhaps the most crucial one," Naohiko Baba, Chief Japan economist at the bank said in a report. The government is due to make a call on a second hike in the consumption tax – to 10 percent from 8 percent - in December.

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Inability to raise the tax could be interpreted not only as a failure of Abenomics, but also as an abandonment of fiscal consolidation, Baba said, the biggest tail risk for foreign investors exposed to an economy with by far the highest debt-to-gross domestic product (GDP) ratio in the world.

Wages and exports must rise and Cabinet approval ratings must remain high in the coming months for Abenomics to succeed – all daunting challenge, he added.

Abe carried out a Cabinet reshuffle on Wednesday, an effort to re-energize his economic and security agenda amid declining approval ratings. A Cabinet reshuffle is a means of replacing incompetent - or scandal-ridden - ministers to ensure the government can make progress on different policies.

He kept key ministers including the finance, foreign and economy ministers, while appointing five women, matching the record high in Junichiro Koizumi's first cabinet in 2001, according to AFP.

Stumbling blocks

Abenomics, the name given to the massive economic program launched last year, is made up of monetary easing, fiscal stimulus, and structural reforms. The economy has not responded to the program as many had anticipated, however.

A sales tax hike- to 8 percent from 5 percent – implemented in April drove the economy into its worst contraction since 2011. Meantime, the economy continues to grapple with sluggish wage growth and subdued inflation.

Japan's nationwide core consumer price index rose 3.3 percent in July but remained well below the central bank's 2 percent inflation target when taking into account the effect of the tax hike.

These factors point to an "unraveling" of Abenomics, according to Charles Dumas, chief economist and chairman of Lombard Street Research, who says the inflation target will be unattainable without a major devaluation of the currency and/or an expansion of the Bank of Japan's quantitative easing (QE) program.

"Mr Kuroda has to choose between another big devaluation, risking an effective commitment to perma-QE and eventual financial crisis, or abandoning Abenomics," he said, referring to the BoJ governor.

Three indicators to watch

With Abenomics at a critical juncture the evolution of three indicators – wages, exports and cabinet approval ratings – holding the key to its continued success, according Baba of Goldman Sachs.

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"These elements will be critical to muting the negative effects of the recent consumption tax hike, pursuing another much-needed tax hike in 2015, and pushing through structural reforms to cement a sustainable path for economic growth," said Baba.

Nominal wages rose 2.6 percent on year in July, pushed up by temporary summer bonuses. The bank expects underlying wage growth to stabilize around 1 percent in the coming months.

Exports have been feeble, falling short of an expected improvement necessary to offset tax-related domestic demand weakness. In the year to June, exports declined 1.9 percent compared with the same period last year, according to Reuters.

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Cabinet approval ratings, meanwhile, slid below 50 percent in many opinion polls conducted in the summer, as items on the political agenda – such as reforms to allow the collective right to self-defense – failed to gain public favor.

Despite the decline, approval ratings remain high by historical standards meaning the political situation is unlikely to destabilize, the bank said.

Contact Asia Economy

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