Japan: political deadlock and the economy

Jul 15, 2010

Minute Read

Election result threatens to postpone Japan’s efforts to tackle the world’s largest budget deficit and revive growth; Japan’s gross deficit is expected to reach 204% of GDP by 2011 however is unlikely to lead to a European-style crisis; Next general election is due by July 2013…

For professional investors and advisers only

Deadlock and the deficit

Only six weeks into his first-term, Japan’s Prime Minister Naoto Kan is facing the possibility of a power struggle after his party – the DJP – suffered an unexpectedly heavy defeat in the upper-house elections on Sunday, therefore shortening the odds of yet another leadership crisis. The disapproval rate for the DPJ-led ruling coalition cabinet has risen to 52.2% after failing to win an overall majority in the upper-house of the nation’s legislature, adding to speculation that Japan could soon see its seventh prime minister in just four years.

The DPJ’s failure to secure a majority in Sunday’s national elections will do little to ease the concerns of foreign investors. The government now finds itself facing a struggle to pursue its agenda as proposals to raise taxes and reduce the government deficit meets heavy opposition from coalition parties. According to the Ministry of Finance, Japan’s outstanding liabilities could reach 204% of GDP in 2011, the highest of any developed nation in the world. Although Japan’s very low interest rates help to make this deficit sustainable, investors remain sceptical as to whether the DPJled coalition will be able to gain any traction on key proposals needed to curb the country’s growing debt.

How will it affect the markets?

In our view, although expectations for a DPJ victory had diminished in recent weeks, the actual outcome was worse than expected and increases the chance of political deadlock for the next couple of years. Any policies aimed at more radical reforms are likely to be blocked in the Upper-House. For the region’s equity market, there are likely to be both positive and negative ramifications. Regarding specific tax changes, a reduction in corporation tax appears to have broad political support and could still be enacted reasonably quickly. But a rise in consumption tax now seems much less likely in the near term. This was one of the key themes associated with Prime Minister Kan going into the election, and the defeat has effectively weakened his mandate for pushing through unpopular policies.

Opposition parties have ruled out possible coalition deals but have, however, stated they are open to cooperating on a case-by-case basis. Whether or not the Prime Minister will be able to unite the opposition parties under his proposals is yet to be seen. While this political situation can be seen as a mild negative for the equity market – as it delays the prospect of progress on the domestic economy – on the positive side it also reduces the risk of fiscal policy being tightened too early in this recovery.

Important Information:

The views and opinions contained herein are those of Nathan Gibbs, Fund Manager, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. For professional investors and advisers only. This document is not suitable for retail clients.

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Author: Nathan Gibbs: Fund Manager Japan Equities – Schroders

Source: ETFWorld – Schroders

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Japan: political deadlock and the economy

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