'Abenomics' Gamble: How to Tell If It's Paying Off

Japanese Prime Minister Shinzo Abe.
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Debating the merits of "Abenomics" is much like talking about a new miracle diet or a life-saving drug: there are many skeptics, but very few who wouldn't want to see it work.

A stronger Japanese economy would help global growth and make domestic problems such as ageing and runaway debt more manageable, so it is no wonder many people give Prime Minister Shinzo Abe and his economic plans the benefit of the doubt.

So far, Abe's heady cocktail of massive money printing, public spending and promised pro-growth reforms has sent Tokyo stocks to five-year highs and kept his support at 70 percent - unheard of for a leader already more than three months in power.

But ultimately even well-wishing observers will want to be assured Abenomics is delivering the desired rise in economic activity: better jobs, wages and sustained growth Japan has not seen for two decades.

The first major test comes in June when the government will present its plans for reforms needed to sustain the impact of the initial stimulus brought about by money printing, a weakened yen and a feel-good effect of surging share prices.

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Business executives and investors are likely to look how far the government will stray from a well-trodden path of lavishing subsidies on "growth sectors" picked by bureaucrats and seek to remove general barriers to investment and growth.

They will also gauge Abe's appetite for controversial steps, such as liberalizing healthcare services or making it easier for companies to fire workers.

"The real uphill battle for the Abe administration starts now," Yasuchika Hasegawa, CEO of Takeda Pharma drugmaker and chairman of Japan Association of Corporative Executives, recently told foreign journalists.

There are some promising signs.

Last month Abe declared Japan's willingness to join the U.S.-led Trans Pacific Partnership trade talks, seen not only as a way of boosting exports but also as a catalyst for market liberalization at home.

Earlier this month, the cabinet also approved a plan to separate electricity generation from distribution, a first step to break up regional power monopolies and boost competition.

A medium-term fiscal plan also due in June will allow bond investors to judge how convincing will be Abe's plans to rein in ballooning debt and whether he will proceed with a plan to double sales tax to 10 percent, starting from April 2014.

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Equally important to a verdict on the quality of proposed reforms will be gauging how the economy is responding to the already deployed monetary and budget stimulus.

Abenomics is in principle a huge bet that a change in the expectations of investors, businesses and consumers - now already reflected in sentiment surveys and financial markets - will feed into the real economy.

Capital spending is one data to watch, given that cash-rich Japanese companies still have spare capacity so do not have a compelling reason yet to invest or borrow more.

In fact, while the latest BOJ tankan survey published this month showed an improvement in corporate mood, major firms said they planned to cut capital expenditure this business year.

Price-Income Quandary

Another worry for the government is that a weaker yen and a shift in inflation expectations will start pushing up prices before incomes start rising, squeezing household budgets and choking off rather than spurring growth.

"We need to pay attention to the possibility that this will become a big social problem as wage hikes may lag behind price increases caused by a weaker yen," a senior government official told Reuters.

There are some signs that the feel-good effect of a rising stock market has led to a pickup in sales of luxury goods.

But the last available retail sales data for February showed a 2.3 percent drop from a year earlier.

Fast Retailing, Asia's biggest apparel company, reported on Thursday a jump in March sales at its flagship Uniqlo stores in Japan but left its profit forecast unchanged, as doubts lingered over whether Abenomics would thaw a decades-long freeze in consumer sentiment.

That may not happen until average Japanese "salarymen" become convinced that their incomes, after two decades of declines, will start rising again.

A BOJ household survey offers quarterly updates on such psychology. In March it showed a distinct shift upwards in price expectations as well as growing expectations that incomes would rise. But only 9.5 percent saw their wages keeping pace with prices.

Corporate results for the March quarter, which are mostly due next month, will also offer a first taste of how much Japanese exporters and their suppliers have already gained from the weaker yen.

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Only a sustained improvement in earnings can persuade Japan Inc. to respond to Abe's plea to share the gains with workers. Summer bonuses may offer some early clues, though Tomo Kinoshita, chief economist at Nomura Securities, says it may take two years before regular salaries start rising.

"This year, only few companies will raise base salaries. Next year maybe we'll have the same, so we will have to wait until 2015 for them to change their minds," he said.

As the BOJ's goal is to defeat deflation, consumer prices are also on the Abenomics checklist.

Most economists and even some BOJ board members doubt the BOJ's target of 2 percent inflation is within reach in the next two years as the bank's new boss, Haruhiko Kuroda, says.

But Kinoshita says sustaining even 1 percent price increases would help Japan break out of its deflationary trap, where expectations of falling prices and incomes act as a self-fulfilling prophecy.

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Laurence Wormald, head of research at SunGard APT, which provides research and risk solutions for institutional investors such as pension and hedge funds, says many seem ready to be patient and allow Japan to go through with what they see as an "experiment that needs to be done".

But he said they would watch Japan's export performance for signs that Japanese might not be reaping the full benefits of the weaker yen because of rising costs at home.

"The question is whether Abenomics will lead to increased competitiveness of the Japanese economy instead of just feeding consumption and helping certain sectors such as construction. Erosion of competitiveness, that's a worry."