Japan in a post-Abe world

It is undeniable that Shinzo Abe has played a significant role in the direction of the Japanese economy during his long tenure stretching back to 2012, making him Japan’s longest serving Prime Minister. The surprise announcement of his resignation as Prime Minister due to health reasons came last Friday, whereby he intends on remaining in a support function and a member of Japan’s Diet.

The country has benefited from his aptly named 'Abenomics', which is economic policy largely based upon "three arrows", being monetary easing from the Bank of Japan, fiscal stimulus through government spending, and structural reforms. The Economist characterised the program as a "mix of reflation, government spending and a growth strategy designed to jolt the economy out of suspended animation that has gripped it for more than two decades".

During Abe's tenure, the rate of Japan's nominal GDP growth has been higher, and the ratio of government debt relative to national income has stabilized for the first time in decades. However, the "third arrow" of structural reforms has not been as effective as observers had hoped, and is considered a potential cornerstone for his successor.

Local news media reports that the ruling Liberal Democratic Party (LDP) will likely hold a general meeting of LDP members in both houses of the Diet sometime around 13-15 September. The leading candidates to succeed Abe include Chief Cabinet Secretary Yoshihide Suga, Policy Affairs Council Chair Fumio Kishida, and LDP’s former Secretary General Shigeru Ishiba. In this regard, Ishiba has consistently been most popular in recent opinion polls, albeit the race is considered wide-open.

The tone in a post-Abe Japan should be one of continuity. The first task of the newly elected party president will be to call a general election, which must be held by October 2021. This is expected to be called sooner, on the back of the momentum of the newly elected leader, despite the pandemic.

Consensus expectations are for the new administration to place an emphasis on continuity in virtually all aspects of policy. The current mainstay factions will remain the dominant force, while the balance of power in the Prime Minister's office may shift somewhat, the government will likely continue to run largely as it has, managed mostly by the same senior officials, as well as the same politicians.

Abe's successor may take a slightly more conservative approach to macro stabilization policies. That said, the government would have to continue spending to maintain social cohesion until Covid-19 has been suppressed, regardless of who is in charge. The Bank of Japan will have to contain the upward pressure on bond yields created by the government’s extra spending. That means the policy mix of fiscal expansion and accommodative monetary policy is not going to change. The government may begin to gradually scale back its additional spending once the pandemic is over. However, it is not anticipated that any major changes will be made in monetary policy for the near future, given the massive expansion of public debt and the difficulty of escaping a low-growth, low-inflation environment.

The implications for financial markets are mixed. While Prime Minister Abe has been a high-profile promoter of Japanese stocks, foreign investor appetite has waned in recent years. Aggregate foreign net buying of Japanese equities peaked in 2015, followed by a five-year period of structural net selling. As investors take on board the abrupt end to the Abe administration, there could be a moderate reversion of the typical Abenomics trade, implying a stronger Yen and lower equities due to a higher risk premium. An outside factor to Japanese securities is the likelihood of the Tokyo Olympics going ahead in 2021.