Japan’s Revival Could Be Its Neighbors’ Worry

For more than two decades, Japan has been caught up in a slow-burning crisis. Rapid aging population and low productivity have added to the declining financial health of the country. Japan’s public debt is twice the size of its annual GDP.

For more than two decades, Japan has been caught up in a slow-burning crisis. Rapid aging population and low productivity have added to the declining financial health of the country. Japan’s public debt is twice the size of its annual GDP.

With interest rates close to zero, the central bank of Japan had to come up with a conventional monetary policy so as to lower funding costs and spur banks to make loans. Therefore, on October 2014 Bank of Japan (BoJ) expanded its Quantitative Easing Program by buying $721 billion worth of Japanese bonds each year. The shock treatment so far has proved not as impactful in jumpstarting the economy as estimated. In February 2015, inflation was closing to zero, with household spending slowing to an 11^th straight monthly decline. While all this happened, credit rating agency decided to downgrade Japan to ‘A’ from ‘A+’. The reason given by Fitch was more to do with fiscal concerns citing lack of government’s efforts to address fiscal consolidation in the budget.

It is believed that Bank of Japan’s Governor Haruhiko Kuroda is unlikely to make changes or expand the QE Program. A top regional economist of Organization of Economic Cooperation and Development (OECD) has advised Japan to keep a watchful eye on its massive bond buying.

According to the OECD’s head of Japan and Korea Desk, Randall Jones, “QQE (qualitative and quantitative easing) has been very successful at raising inflation expectations to around two percent…and we have to trade off the risk of qualitative and quantitative easing with allowing deflation to continue.”

BoJ’s asset purchases are structured to allow more money supply in the market so that people start spending and push the prices up to jumpstart the economy. So far the QE program might look optimistic for Japan but critics argue that the size of the QE program could disrupt the bond market.

Impact on Japan’s trading partners due to its currency

In addition, Japanese Prime Minister Shinzo Abe’s revival policy ‘Abenomics’ has also raised concerns across its neighboring countries. This comes at a time when he is visiting US for closer trade-ties. While the revival policy made some massive quantitative easing followed by weakening of Yen. It seems this could have had a serious impact on some of its neighboring nations like S. Korea. The reason being that S. Korea exports about 6.9% of its total trade to Japan (which is next to China-23% and US-11%) and the price competitiveness of South Korean goods is getting affected in Japan.

South Korea’s trade with Japan has already been on a decline for the past three years since it peaked at $108 billion in 2011. With the devaluation, Japan is curbing its imports while trying to increase its exports. However, with continued devaluations, trade disputes might emerge against Japan’s exports. According to a senior research fellow at the Hyundai Research Institute, Lee Bu-hyoung, ”Countries like Korea and Germany, where exports take a huge part and the domestic market is relatively small, are damaged most. Korea is especially so, as its export items overlap with those of Japan.”

So the won/yen rate fluctuation can be damaging for S. Korea even though it might be working for Japan. In addition the tourism industry in S. Korea seems to be shrinking since the number of Japanese tourists visiting S. Korea are getting fewer.

The Third crucial arrow of Abenomics: Trans-Pacific Partnership

The Trans-Pacific Partnership (TPP) is a free trade deal of 12 Pacific Rim namely US, Japan, Brunei, Malaysia, Vietnam, Singapore, Australia, New Zealand, Canada, Mexico, Chile and Peru. It covers one-third to 40% of world trade missing out on China. With Prime Minister Shinzo Abe’s visit to the US, the finalizing agreements could be coming to a close. As many critics in the US see this as a shift of employment oversees, many support it saying that it will increase US exports and improve the overall economy.

As for Japan, the trade-deal fulfills the target of third arrow of Abenomics: Increased economic growth through reform plans.  China remains one of the largest economies in the Asia-Pacific region and with many countries supporting China in most of its ventures latest being Asian Infrastructure Investment Bank (AIIB), TPP becomes more important to both US and Japan, the world’s two leading economies.

In an interview with Wall Street Journal, President Barack Obama said, “If we don’t write the rules, China will write the rules out in that region.” Japan could gain from TPP the most since it could help in bringing back confidence among its investors and consumers. Also there will be more foreign direct investment in the Japanese markets. Signed in 2005 by Chile, Brunei, New Zealand and Singapore, the TPP has eight other countries whose membership remains pending.

The third arrow of Abenomics had fallen flat The economic deal could help Prime Minister Shinzo Abe achieve something out of the third arrow in Abenomics which is to boost Japan’s long-term growth potential. However, the farm lobby in Japan has opposed any trade concessions to the US. With Japanese agriculture in decline and the average age of its farmers at 66, Prime Minister Abe emphasized on stressing on some change in order to survive.

The OECD Economic Survey 2015 looked at Japan’s economic development based on its recent policies and reforms. It stresses on the adoption of some bold structural reforms to raise output growth. The report also highlighted the priority of reducing government debt. Japan currently holds more US government debt ($1.2244 trillion) than any other country.

For the countries that are Japan’s trading partners but not partners to TPP, this visit could raise some concerns across trading nations of Japan. The trading countries already continue to suffer from Japan’s currency fluctuations. In this visit, TPP remains one of Prime Minister Shinzo Abe’s top priorities or may be Japan’s only revival hope.