What Sunday’s Japan election means for Abenomics

Japanese Prime Minister Shinzo Abe
Kazuhior Nogi | AFP | Getty Images
Japanese Prime Minister Shinzo Abe

If Shinzo Abe's ruling coalition wins Sunday's elections to the upper house of parliament, as predicted, Japan's prime minister will have a clear mandate to push ahead with his radical economic agenda. The only question now is will he run with it?

Opinion polls point to a clear majority for Abe's Liberal Democratic Party (LDP) and its coalition partner, the New Komeito party that would end years of parliamentary stalemate.

Even with a majority in both houses of parliament, there have been some doubts about how committed Abe is to delivering the painful reforms needed to revive long-term economic growth and take on powerful groups within the LDP. Critics say a strong election win could also make Abe complacent.

(Read More: How a big election win for Abe could defeat reforms)

One thing is clear: Once Sunday's vote is out of the way, the real test of Abe's economic policies, dubbed "Abenomics" by some, is likely to begin.

"The jury is still out on Abenomics, but what is different this time is that there are three arrows and not just one," Fuyuki Fujiwara, fund manager at Nezu Asia Capital Management, told CNBC. He referred to the "three arrows" of Abe's strategy – monetary stimulus, fiscal spending and structural reform.

Abe pledged to turnaround the economy after becoming prime minister following a solid win by the LDP in the lower house elections last December. While Japan is the world's third largest economy, it has been hampered by deflation and slipped in and out of recession in recent years.

Aggressive monetary stimulus, fiscal spending and promises for long-term reform have so far succeeded in generating a buzz in Japan and optimism about the future.

(Read More: Japan's quarterly commercial real estate sales soar 78%)

That has fueled Abe's popularity at home and put his ruling party on course to win Sunday's elections.

"People don't really believe in Japan, but what drives Abe in his second time as prime minister is that he recognizes how desperate the situation is," Ron Napier, head of Napier Investment Advisors told CNBC's "The Call" last week.

"Japan is like a swimmer in a river drowning and what Abe is saying is: 'I'm going to throw you a lifeline, please reach out for it.' And Japan has reached for it and there are risks here but the risks of not doing anything are much, much worse," he said.

Why Sunday matters

Wining the upper house elections is significant because Japan has suffered from deadlock in parliament ever since the LDP, led by Abe, suffered a big defeat in upper house elections in 2007. Abe's first stint as prime minister came to an end shortly afterwards.

Half of the upper house's 242 seats come up for election every three years.

Voter preference polls taken between Sunday and Tuesday published by the Japanese press show the LDP and the New Komeito were likely to win more than 70 of the 121 seats contested, Reuters reported this week.

(Read More: Japanese stocks may be getting interesting: Pro)

"In the medium-term the "twisted" diet [where the opposition controls the upper house] is likely to be resolved after the election and implementation of policy will be easier than it has been under previous administrations," said Kenji Abe, equity strategist at Citigroup Global Markets.

"Deregulation in sectors such as agriculture for instance is expected, so the elections should have a positive impact on equities," he added.

Investors reacted with disappointment to Abe's outline for long-term reforms in June, pushing stocks down.

Still, after a wobble in June, Japan's stock market appears to be back on the upward path it started on in November.

The Nikkei is up almost 41 percent this year, easily making it the world's best performing major stock market. The S&P 500 is up almost 18 percent and European stocks have gained about 14 percent.

The yen is trading around the 100.50 mark against the dollar and analysts say Sunday's election could be key to whether it continues to weaken.

(Read More: Fate of yen hinges on Japan's weekend elections)

A weak yen is a key part of Abe's strategy, since it provides a powerful boost to the Japan's exporters and gives Abe leverage to lobby them to raise wages, helping to end deflation.

"Abe's strategy is simple – it's about getting the yen down to 110, 120; doing it this year and locking in that move," said Napier. "That way Japanese corporates know that they can invest in Japan and create jobs."

— By CNBC's Dhara Ranasinghe; Follow her on Twitter: @DharaCNBC