Japan Unveils Stimulus—Don’t Get Too Excited Yet

Japan's Prime Minister Shinzo Abe
Yoshikazu Tsuno | AFP | Getty Images
Japan's Prime Minister Shinzo Abe

Japan's $117 billion economic stimulus package is a positive start to revive a frail economy. But the government needs to follow this up with long term structural changes and the central bank has to chip in with some bold moves — otherwise disappointment is sure to follow, analysts said Friday.

Faced with an economy in recession, Japan's new government unveiled the country's biggest spending boost since the financial crisis and one it hopes will boost economic growth by 2 percentage points and create 600,000 jobs.

Japan's economy, the world's third largest, has contracted for two quarters running, pushed into a recession by weak global demand for its exports.

"Japan's economy has been very weak over the past couple of quarters and some stimulus is necessary to get the growth rate up at least over the near term," Thomas Byrne, senior vice president at Sovereign Risk Group, Moody's Investors Service, told CNBC Asia's "The Call." "Other things are necessary to keep the growth rate up over the longer-term though."

Shinzo Abe, who became Japan's new prime minister last month after his Liberal Democratic Party was returned to power with a comfortable election win, has promised to revive the economy and urged the central bank to introduce aggressive monetary easing and double its inflation target to 2 percent.

(Read More: Bank of Japan to Consider Easing Again in January)

But analysts said that Friday's stimulus measures are likely to have only a short-term boost and should be just the start of steps needed to really kick start the Japanese economy.

"The latest package is big and I expect there would be a bigger bump to growth, but I would also expect that it would have the same short-lived impact as past stimulus and growth would fall back," said Tim Condon, head of research, Asia ING Financial Markets in Singapore. "I would be much more positive if the Bank of Japan (BOJ) says it agrees with Mr Abe and that it is going to change the way it does do monetary policy and become much more accommodative."

The expectation of aggressive monetary easing and a much bolder BOJ since Abe, who was prime minister in 2006-2007, returned to power has sparked a bull run in Japanese markets.

Tokyo's benchmark stock index, the Nikkei 225, has soared more than 20 percent since mid-November, while the yen has fallen roughly 11 percent in anticipation of aggressive monetary easing. The Nikkei hit a fresh 23-month high on Friday following the release of the stimulus package.

(Read More: Nikkei's Stunning Rally – Why It's Time to Be Cautious)

The BOJ is expected to discuss the government's proposal to lift its inflation target to 2 percent from 1 percent and easing monetary policy when it meets later this month.

"We think there is going to be a significant easing by the BOJ and what we're seeing in the yen is a re-pricing ahead of that announcement," said Condon.

"If we are wrong and they don't deliver and there is nothing dramatic announced either at the next meeting or when the new governor takes over, we will see a retracement of the yen and Nikkei," he added referring to a change in the Bank of Japan governor that is expected to take place in April.

(Read More: Glimmer of Japan Reform Hope Among Clouds of Skepticism)

Don't Forget Long-Term Reforms

Along-side a bold monetary policy and a short-term fiscal boost, Abe also needs to implement long-term reforms to maintain the upbeat mood in markets towards Japan, analysts said.

"We need to see what kind of structural change they (the government) will agree on. At the end of the day the main hopes hinge on coordinated action yielding results rather than the fiscal stimulus in itself," said Vishnu Varathan, market economist at Mizuho Corporate Bank.

Long-term changes to lift the growth potential of Japan's economy should include deregulating labor and financial markets, analysts said.

"Overall we see Japan recovering on a cyclical basis, but they still have a lot of structural issues," said Barclays' investment strategist Wellian Wiranto. "We see the stimulus being helpful on a cyclical basis and the economy should pick-up this year, with growth of 0.8 percent and 1 percent next year, which by Japanese standards is actually quite good."

Byrne at Moody's Investors Services added that he would also want to see further reforms before becoming more upbeat about Japan's long-term growth prospects.

"The significant reforms we're really looking for is a growth policy. We know that Japan has a huge government debt but yet, you can take a view that Japan has more of a growth problem than a debt problem," he said. "If Japan can get its growth rate up through a package of structural reforms, and probably a weaker yen is an element of this, Japan could grow out of its debt problem."

Japan has one of the highest debt-to-GDP ratios in the world, standing at about 233 percent in 2012.