Abenomics show early signs of breaking deflationary cycle

Abenomics show early signs of breaking deflationary cycle
Business & Markets 2013
Written by Report by RAM Ratings
Monday, 03 June 2013 11:26


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Japan — one of the G7 economies — is a large, wealthy and advanced economy with strong external liquidity and is a net external creditor nation. A holder of reserve currency, its institutional framework is superior in most aspects.

Nevertheless, the nation is mired in deflation while its financial system remains in a classic liquidity trap, where no interest rate is low enough to encourage lending and borrowing activities. It is hoped that the introduction of a comprehensive programme entailing fiscal, monetary and structural policies (popularly known as the Three Arrows of Abenomics) will jumpstart the Japanese economy.

RAM Ratings opines that this unprecedented policy is not aimed at triggering a competitive devaluation of the yen, but is rather an attempt to induce inflation.

In this respect, we recognise the stronger commitment and better coordination between the Bank of Japan (BoJ) and the ministry of finance, as well as the government’s pro-growth stance. Japan’s first quarter seasonally adjusted real GDP grew 0.9% quarter-on-quarter, mainly reflecting the psychological effects of improved expectations as private consumption picked up while trade deficit narrowed owing to bigger than expected increase in exports.

While the early signs of an economic recovery are noted, sustainable growth can only be achieved over the long term and is highly dependent on pro-growth and structural reforms which Prime Minister Shinzo Abe has yet to announce. There are also risks within the Japanese bond market where spikes in the yield curves may be a concern if they persist.

As a highly advanced and industrialised nation, Japan is the third largest economy in the world after the US and China. Well known for its efficiency and competitiveness in the services and export-oriented manufacturing sectors, Japan’s strength lies in its external position, underpinned by a hefty US$1.3 trillion (RM3.99 trillion) of foreign reserves — second only to China.

This exceptional external liquidity covers 15 times its current account payments and 25 times its short term external debt obligations. Japan is also a net creditor whose net international investment position is equivalent to 56% of its GDP, generating substantial income inflows. Despite eight consecutive quarters of trade deficit to date, Japan’s current account remains a surplus.

On the other hand, the weakest link in Japan’s credit fundamentals is the government’s feeble balance sheet — persistent and widening fiscal deficits as well as an increasing debt load. The strength of the yen as a reserve currency bolsters its financial flexibility while the country’s high savings rate provides ample funding to support the government’s lofty debt level, which came up to 201.7% of Japan’s GDP as at end-2012.

Given that the government’s current interest servicing burden stands at an onerous 21.0% of its revenue, any rise in interest rates that is faster than the increase in inflation could undermine the BoJ’s policies, further straining the government’s finances.

Meanwhile, frequent changes in leadership have hampered proper policy execution to address Japan’s anaemic growth and other structural weaknesses such as its ageing and dwindling population. This demographic challenge is shrinking the Japanese labour force and draining the government’s coffers as expenditure on social security amounts to a hefty 62% of the nation’s revenue.

Along with its heavy interest servicing burden, the current government may face challenges against containing its spiralling debt while it initiates a fiscal stimulus to revive the sputtering economy.


RAM Rating Services Bhd provides credit rating services for the Malaysian capital market.