In the 25 years since Japan's bubble economy peaked in 1989, the Japanese economy has struggled, with only a few periods of brief respite, with deflation, the stagnation or decline of prices of assets and many goods. In 2013, Prime Minister Shinzo Abe launched Japan's most serious effort to end Japan's deflationary struggle, a series of stimulus and reform packages collectively known as Abenomics. In 2016, three critical factors will determine the health of Japan's economic recovery.
Wage Growth
Prime Minister Abe has pressured Japanese companies to raise wages for workers, which he believes will create a virtuous circle of increased consumer spending, resulting in higher corporate profits that will create room for further wage increases. As an enticement, the ruling coalition plans to lower the corporate tax rate from 32% to 30% in April 2016. If Prime Minister Abe is successful in convincing corporate executives to spend the tax savings on wage increases, it should goose consumer spending, which should in turn boost growth.
Value-Added Tax
Consumer spending has struggled, in part, due to the 2014 increase in Japan's value-added tax (VAT), from 5 to 8%. Japan's national debt is enormous as a percentage of gross domestic product (GDP), at nearly 250%, and the government needs to raise revenue where it can. The VAT is currently scheduled to increase further in 2017 to 10%. Consumers struggled mightily with the 2014 increase, and there is significant disagreement within the government as to whether the scheduled 2017 increase should be postponed. Consumer spending in 2016 will be closely watched as a determining factor of whether the economy can withstand another increase in the tax next year – a decision likely to be made before the end of 2016.
The Value of the Japanese Yen
The value of the yen has declined approximately 30% since 2012, which has been a boon for corporate profits. Japanese manufacturing competes primarily with Korean, Taiwanese and Chinese companies, and the value of the yen is a significant factor in the price competitiveness of those products. The weaker yen has made Japanese products more compelling overseas, and profits earned in U.S. dollars or euros convert back into greater amounts of yen, boosting locally denominated profits.
The weaker yen has come with a cost: reduced buying power for Japan's many imports, particularly food and energy. While higher prices for imported goods helps support inflation, higher prices can also have a chilling effect on demand. The Bank of Japan must do what it can to strike a careful balance between a yen level that is weak enough for Japanese manufacturers but not so weak that it inhibits consumer demand. The Federal Reserve's commencement of a rate-hiking cycle only complicates this task.
Abenomics Must Deliver
Abenomics has already delivered some meaningful reforms. Of note are liberalization of the electricity industry, participation in the Trans-Pacific Partnership and implementation of changes in corporate governance. Critics maintain there is much more to do, particularly in the areas of labor regulation and immigration. Because of Japan's graying demographic profile and enormous national debt, time is growing short. 2016 will be a critical year to determine if the economy in the Land of the Rising Sun can rise again.
Two popular exchange-traded funds (ETFs) for capturing the potential for Japan's escape from deflation are the iShares MSCI Japan ETF and the WisdomTree Japan Hedged Equity ETF. The iShares MSCI Japan ETF is not currency-hedged, while the WisdomTree Japan Hedged Equity ETF is hedged. If you expect the yen to weaken further, the WisdomTree Japan Hedged Equity ETF protects you from losses associated with the currency, while the iShares MSCI Japan ETF incorporates the yen's gains or losses into your return.
