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Japan: Far From Full Recovery Amid Political Uncertainties
July 22, 2009

On 13 July 2009, Japanese Prime Minister Taro Aso declared that the House of Representatives (lower house of parliament) will be dissolved within a month and a general election will be held on 30 August 2009. It was after the heaviest defeat in 40 years for Liberal Democratic Party (LDP) in the municipal assembly elections including Tokyo and Shizuoka which are regarded as a prelude to the upcoming lower house election. In this article, we examine several possible outcomes of the election results and its potential impacts on the nations economy.


Author : iFAST Research Team



Untitled Document
Chart 1: Tokyo Assembly Results
Chart 2: Government Parties Approval Rate

On 13 July 2009, Japanese Prime Minister Taro Aso declared that the House of Representatives (lower house of parliament) will be dissolved within a month and a general election will be held on 30 August 2009. It was after the heaviest defeat in 40 years for Liberal Democratic Party (LDP) in the municipal assembly elections including Tokyo and Shizuoka which are regarded as a prelude to the upcoming lower house election. The ruling party only won 38 seats while the opposition Democratic Party of Japan (DPJ) won 54 seats in Tokyo election as depicted in Chart 1. A landslide victory of the opposition DPJ exhibits there might be a new ruling party in the Japanese government after more than 50 years of almost unbroken domination of the LDP. The uncertainty on the political side has caused Japan’s stock market to slump 2.55% to its lowest level in two months on 13 July.

The lower house election must be held by October 2009 at the latest even if the lower house is not dissolved. Polls conducted by Japan’s top newspapers have shown the opposition party DPJ will prevail in the parliament election and would even win a majority. The House of Representatives is regarded as a more powerful and influential house as compared to the House of Councillors. The House of Representative is empowered to take precedence over the House of Councillors in making decisions on legislation and the budget. It can also override decisions of the upper house should the House of Representatives have the affirmation of two-thirds of its members for the vote. Since the opposition DPJ already controls the upper house of parliament, the election results in lower house will have great impacts on the government policies as well as the Japanese economy.

In this article, we examine several possible outcomes of the election results and its potential impacts on the nation’s economy.

The Most Possible Outcome: New Coalition to Rule the Government

In a telephone opinion poll conducted by Nikkei in June 2009, the ruling party LDP is following behind the DPJ which is favoured to win the lower house election (as shown in Chart 2). Even though the opposition party is expected to win a majority of becoming the biggest party in the lower house, it needs to form a coalition with other small allies (one conservative and one leftist) in order to maintain its dominance of the upper house, to resolve the political deadlock and to smoothen policy implementation.

This would be the best outcome for Japanese as they are frustrated with the ruling LDP’s weak leadership amidst the worst recession in the post-war period and looking forward to seeing a breakthrough in a political stalemate that has stalled government’s efforts to rescue the economy. In April last year, a three-week leadership vacuum at Bank of Japan (BOJ) after the predecessor Toshihiko Fukui stepped down was caused by a political impasse that the opposition party rejected and delayed the governor nominations from the ruling party. The dispute has eroded Japan’s international image and foreign investors’ confidence on the economy and stock market. A strong coalition could end the political deadlock and smoothen the legislation and policy execution process.

Table 1: The Estimates Impacts of the Stimulus Package on Japan's GDP (%)
  The Ruling Liberal Democratic Party (as at 10 April 2009) The Opposition Democratic Party of Japan
 (as at 8 April 2009)

Real GDP Growth

1.3 1.3

Domestic Consumption

0.7 1.7

Capital Investment

0.9 2.3

Residential Investment

0.5 1

Public Investments

13 -0.4

Exports

-0.1 -0.1

Imports

1.8 1.7
Source: Nomura and iFAST Compilation
Table 2: Descriptions of Stimulus Package
  The Ruling Liberal Democratic Party (as at 10 April 2009) The Opposition Democratic Party of Japan
 (as at 8 April 2009)

Amount

15.4 Trillion Yen 21 Trillion Yen

Main Proposals

1. Subsidies to buy energy efficient appliances

2. Car-makers will also be boosted as replacement of old cars will be given cash

1. To create a society where families can feel secure in childrearing. The state will issue a per capita child allowance of 26,000 yen per month.

2. To revive the regions through a dynamic agricultural industry.

Benefitting Industries

1. Infrastructure

2. Auto

3. Environment

4. Metal

 

1. Financials

2. Retail

3.Agriculture

 

Source: iFAST Compilation

Moreover, new coalition would focus its fiscal spending on boosting household income. The opposition DPL plans to freeze the supplementary budget for fiscal 2009 of 15.4 trillion yen initiated by Aso’s government and spend 21 trillion yen over two years on a new stimulus package once elected. The spending pledge focuses on the social welfare including child allowance and compensation for income losses in farmer households while the current Aso government’s package focuses mainly on infrastructure and public development including environmental measures and subsidy of fuel-efficient vehicles. In order to finance the expenditure without issuing additional debts, the DPL claims it is inevitable to reshuffle the planned government budget. It is believed that both packages will have similar effects on the economy. However, the impacts on GDP components as well as the benefitted industry will be different as shown in table 1 and table 2.

While the opposition DPJ is likely to oust Taro Aso’ Liberal Democratic Party to govern, we aware that there are some potential negative impacts on the economy from the possible political transition. Firstly, the new coalition is inexperienced. Besides, there are questions about how the DPJ’s government to fund the fiscal deficit as well as the fiscal stimulus. The DPJ’s spending spree plan may need taxpayers to pay more, thereby reducing the domestic consumption. Bondholders will also be suffered if the new coalition issues more debts to finance. In addition, the party has planned to eliminate on wasteful infrastructure projects. It would damage the existing vested industry interests and receive strong objections by those industries.

Another Possible Outcome: No Party to Dominate in the House of Representatives

It is not realistic to expect the ruling LDP to win either a majority or maintain its current two-thirds majority advantage in the lower house. However, there would be a chance that the ruling party loses marginally that no parties can dominate in the lower house. If neither party can get the two-third majority in the lower house of the parliament, they will try to form a ruling coalition through tempting defectors to join their camps. Should none of each side still can get the two-third majority afterwards, the policy deadlock would be deteriorated. Alternatively, the notion of grand coalition will be formed by both parties in order to break the impasse. However, it is unlikely to happen as the opposition DPJ rejected such notion initiated by former Prime Minister Yasuo Fukuda. Thus, in this case, there would be no clearer policy stance in the government and any policy implementation would be difficult.

Market Reaction to Political Changes

We believe the impact of potential political transition on Japan’s economy is limited. The most possible outcome is the DPJ to form a new coalition to govern. Based on the opposition DPJ’s election manifesto, we think the effects of fiscal polices on the country's economy would not have much difference as compared to those of the ruling LDP. On monetary policy, the new coalition is likely to support the current monetary stance of the BOJ to maintain the ultra low interest rate. The most important thing is Japan’s political leaders do not have enough ambition to make revolutionary changes and take aggressive approaches as Junichiro Koizumi did to resolve the structural economic problems like ageing population and uncompetitive corporate. As many Japanese interviewers have said, they understand the political transition will not bring much change on economy, but at least they would like to see a breakthrough in politics and express their resentment.

In the 4 recent terms of Japan’s Prime Minister, only Junichiro Koizumi can serve full-term while the other three served less than a year. During the period of Clinton’s administration in US, Japan has had 7 different Prime Ministers. While some argue that the short-lived administrations are attributed to Japan’s political system (the lower house can interrupt their terms by house dissolution and general election), it cannot be denied that the government’s inability to rescue the economy since the asset bubble burst in early 1990s is also a chief reason. This time has no exception. Despite Aso’ government insisted a series of stimulus packages had been passed under his 10-month administration, Japan’s economy has been getting worse during the period. For such reason, to determine whether the Japanese market has investment value, we should focus more on the economic factors rather than the short-term political issue.

Full Recovery Still Far Off

We believe that the worst recession since World War II may be ended. Both exports and industrial production have shown improvement while public investment also increased. The BOJ also said the economy has stopped deteriorating and will show more signs of recovery in the coming months. We believe the economy will start to experience a technical rebound in the current or next quarter reflecting a bounce back in inventory from nadir and the government’s huge fiscal spending. Afterwards, the GDP growth will likely to return negative or remain sluggish. Thus, it might be too early to tell that the Japanese economy has fully recovered.

Due to the huge drop in earnings and the low earnings base in 2008, we expect earnings growth in 2009 to rise drastically. The earnings growth in 2010 and 2011 are estimated to rise 94.4% and 28.8% respectively. Despite of the strong earnings rebound, the 3 year annualised expected returns is at 7.4% which is lower than the average of Asian countries. Estimated PE for Japanese equities is at 34.3X and 17.7X as at 17 July 2009 for FY2009 and FY2010, which is not attractive as compared to other Asian countries.



iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.


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