Kuroda’s Stimulus Turns Focus Back to Abe’s Third Arrow

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The Bank of Japan’s unexpected expansion of stimulus puts the spotlight back on Prime Minister Shinzo Abe’s economic policies and the decision he faces on raising the sales tax.

While corporate profits are higher, the yen is lower and stocks have surged 57 percent since Abe came to office 22 months ago, sustained economic expansion remains elusive. Consumer price gains are only halfway to the central bank’s target and gross domestic product contracted the most in five years in the second quarter after a first-installment increase of the sales levy.

Abe is under pressure to accelerate efforts to strengthen corporate governance, deregulate agriculture, increase female participation in the workforce and secure trade agreements to fuel long-term growth. He must also decide in the coming months if Japan can weather another sales-tax hike to help rein in the world’s heaviest debt burden, even as he considers how much to lower company taxes.

“While the BOJ is buying time, the government should be doing two things: promoting the growth strategy and fiscal consolidation,” said Masaaki Kanno, chief Japan economist at JPMorgan Chase & Co. in Tokyo and a former central bank official. “If the government remains lazy and complacent and just enjoys the benefits of a weak yen and the rise of equity prices, then we will waste time and the result will be terrible.”

Breathing space for Abe came in the form of a statement on Oct. 31 that the BOJ would raise the annual target for expanding the monetary base to 80 trillion yen ($712 billion), up from 60 trillion to 70 trillion yen. Governor Haruhiko Kuroda also led the board to decide to triple the pace of purchases of exchange-traded funds and Japanese real estate trusts.

Market Impact

The bank’s move was followed just hours later by an announcement from Japan’s Government Pension Investment Fund that it would put half its holdings in local and foreign stocks and start investing in alternative assets.

Global stocks rose, Japan’s Topix index surged the most in 16 months and the yen fell to the lowest level since December 2007. The currency has depreciated about 24 percent since Abe became prime minister, helping make some Japanese exporters more competitive.

“It’s very likely that the BOJ moved with the GPIF to boost stocks, the key gauge Abe cares about.” said Takahiro Sekido, a Japan strategist at Bank of Tokyo-Mitsubishi UFJ. “There had been growing doubt over Abenomics but it will come back to life again. Abenomics started with the BOJ and it will restart with the BOJ.”

Sales Tax

The central bank’s additional stimulus also increases the chances of another bump in the sales tax, said Sekido. The levy was raised to 8 percent from 5 percent in April this year and a hike to 10 percent is planned for October 2015.

Abe has likened his program to three arrows, which on their own can be snapped, but taken together are unbreakable.

The first two arrows, monetary easing from the BOJ and fiscal spending from the government, are in place, and bolstered by Kuroda’s actions last week.

The third arrow, the growth strategy centered on structural reform and deregulation, faces opposition ranging from bureaucratic inertia to farmers seeking to maintain trade barriers.

“Policy loosening by the Bank of Japan confirms the scale of the challenge confronting the Abe government in seeking to deliver sustainably stronger real growth and inflation, while also reducing the fiscal deficit,” Andrew Colquhoun, head of Asia-Pacific sovereigns at Fitch Ratings, wrote in a note.