Abenomics – the latest Japanese export

loading Central business district of Shibuya Ward.

Japan’s economy is undergoing reform, and this has immediate repercussions for the rest of the world. What should little Malaysia do?

Abenomics has taken Japan and the world by storm. Its effects have been impressive.

1) Japan grew by an annualised 4.1% in the first quarter of 2013;

2) The Nikkei rose by over 70% between November 2012 and May 2013, the Nikkei has risen over 70%, but has since fallen from the year’s peak; and

3) The Yen has dropped over 20% against the USD$ and RMB since August 2012.

The three-pronged Abenomics comprises aggressive monetary easing, a more credible fiscal stimulus and a growth strategy based on structural reforms. Of the three, monetary easing is the easiest as the Bank of Japan is engaging in quantitative easing (QE) on the same scale as the Federal Reserve, but on an economy a third of the size of the US. While this headline number is rather startling, Japan has a long way to go to catch up in the QE game compared to the UK and US.

Currency manipulation is no doubt against the rules of the WTO and G8. However, Abenomics has been presented as a domestic policy attempting to reverse years of deflation and to kick-start the economy; the fall in Yen is an unintended consequence. The Yen’s slide has raised concerns that Japan is exporting its deflation through currency devaluation. Such a “beggarthy- neighbour” policy has been rejected outright by Tokyo, but its ramifications have already been felt especially in Japan’s trading partners and nations that sell complementary goods.

So, will Abenomics be successful?

Nihon Keizai Shimbun, the main Japanese business newspaper, reported that every Yen1 fall in the Yen/Dollar rate will translate into a US$2.7bil increase in profits for the 30 largest Japanese exporters. As the “wealth shock” filters through and electrifies the economy, Japanese personal consumption has been soaring.

While inflation can always be generated via currency depreciation, its impact on those on fixed income (retirees) will be harsh, especially in Japan which imports a significant amount of food and all of its energy (post-Fukushima). Besides, it remains to be seen how much export sales can offset the rising energy costs. With Japan ageing fast, the consequences of this policy might be felt in the future when inflation really hits. This is significant because, to date, Japan has been able to issue mountains of debt to its dutiful citizens. But with domestic demand for debt dwindling, Japan might have to rely on offshore bond traders/ investors who might demand higher yield.

Even assuming the impossible scenario of no response from other nations, growth in Japan is difficult to sustain as the conditions are not conducive. Growth can come from growth in productivity or growth in factors of production of which labour is a significant element. Japan’s population is shrinking fast and the working population is falling even faster (reducing by one per cent per year over the next 10-20 years). Besides, real productivity cannot be conjured up by dialling up the monetary base; this requires structural reforms. While the government is going to deregulate (with a focus on the labour market, energy sector and healthcare) to reform the corporate tax regime and to liberalise trade (e.g. by joining the Trans-Pacific Partnership), it remains to be seen how successful and timely its reforms will be.

In any case, other countries will certainly respond to the erosion of domestic exports due to the Yen’s fall. The Bank of Korea cut its benchmark interest rate for the first time in seven months in May 2013, joining other central banks in easing to counter currency appreciation. The loss of export competitiveness will be first felt by Korea, Taiwan, Singapore and Germany. Nevertheless, the cascading effect will eventually hit countries like Thailand, China and Malaysia which are lower down the value chain.

This global simultaneous “race to the bottom” and currency debasement will translate to higher prices for real assets. This will inevitably increase the rich-poor divide and the risks of social instability. Some governments rely on price controls, social welfare and cash handouts to maintain stability. However, this can only be a temporary measure, as long-term implementation of this policy will cultivate a class in society that is highly dependent on government handouts – a policy that not only does not generate economic wealth but can also be exploited for political reasons.

Malaysia can respond in different ways. A Ringgit devaluation may be the easiest and most likely since:

1) Bank Negara can lower interest rates given that the official inflation rate remains subdued (although there are signs of increasing food inflation lately);

2) Fitch Ratings has warned Malaysia in August 2012 of possible downgrade in light of the continued deterioration in public debt ratios, so unless a credible plan is laid out, a credit rating cut (in a region where other countries such as the Philippines have been upgraded) will cause an outflow of portfolio funds;

3) Oil and food subsidies will stretch the federal budget deficit as agriculture commodities and crude oil prices rise in the global market (as they act as an inflation hedge); and

4) Economic growth decelerated from 6.5% year-on-year in the fourth quarter of2012 to 4.1% year-on-year in the first quarter of 2013 (significantly below median forecasts of 5.5%) due to sluggish exports. Lower growth might prompt foreign investors, who have been net buyers of Malaysian equities and bonds in past few months, to allocate their funds away from Malaysia.

As with Japan, currency devaluation in Malaysia can only provide temporary respite. Although Malaysia’s demographics remain favourable and the country is rich in natural resources, structural reforms need to be undertaken to move the economy on a sustainable growth trajectory, and at the same time cope with the social pressures caused by higher inflation and greater wealth gap.

As a region, Asia has gone down this path before. In mid-1990s, the devaluation of the Renminbi and Yen, rising US interest rates and strong US$ culminated in the Asian Financial Crisis in 1997/98. While domestic economic conditions in Asia are different now and not all financial crises emanate from the same factors, one should be cognisant to the risks involved.

Lim Kim-Hwa is a fellow at the Penang Institute, a fellow in Finance and Financial Reporting at the University of Cambridge and a chartered accountant (ICAEW). He was a portfolio manager and an assistant professor at the University of Cambridge.



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