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Under the Banyan Tree – Japan heads to the polls
617 Plays5 days ago
As Japan gears up for a general election, Fred and Herald discuss what the outcome could mean for Asia's second-largest economy, and why the world is taking notice.
Click here for appropriate Disclosures, including analyst certifications, and Disclaimers that must be viewed with this podcast: https://www.research.hsbc.com/R/101/t9TcRsm
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Transcript
Introduction to Podcast Series
00:00:01
Speaker
Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
00:00:13
Speaker
Make sure you're subscribed to stay up to date with new episodes. Thanks for listening, and now onto to today's show.
Impact of Upcoming Japanese Elections
00:00:33
Speaker
Hello and welcome to Under the Banyan Tree, where we put Asian markets and economics in context. I'm Harold van der Linde, Head of Asian Equity Strategy here at HSBC's Global Investment Research. And I'm Fred Newman, Chief Asia Economist, and Japan is holding elections at the end of this week. We're going to talk about what that could mean for Asia's second largest economy, which is often seen as a barometer of how things could play out elsewhere in the world. Why are these elections happening now and what's at stake? Let's get the conversation started, dig into these questions, under the banyan tree.
00:01:14
Speaker
A little bit of background for you before we begin. Japan heads to the polls in a general election on February the 8th. So far, the ruling Liberal Democratic Party, the LDP, led by Prime Minister Sane Takeichi, is favored to win.
00:01:27
Speaker
So, Fred, we had elections in Japan not too long ago. So why why having elections again? Can you remind me of that? That's right. um We had actually actually elections last year. um And the Japanese are heading back to the polls now this Sunday. And that's because we have a new prime minister. and The party that is leading the government has essentially changed its leader. And now we have Sanne Takechi-san, who is the new prime minister. And it's her right um to call a new election, a snap election. And that's sometimes done in Japan just to go to the electorate and get a new mandate.
00:02:05
Speaker
She's doing it very early on in her tenureship. um It's in part also because she doesn't have a large majority in parliament. In fact, it's in the minority. It's just ruling in a coalition government and – And so, you know, there is a lot of eyes on this election to see how big a mandate the new prime minister will receive. So she's trying to get some freedom to implement reforms and policies that she
New Leadership and Economic Challenges
00:02:32
Speaker
stands for. So on the economic side... What are these policies that she really would like to implement if she gets a larger majority or has some more political freedom to to put these in place? Well, she she's seen a little bit as an inheritor of the policies that Prime Minister Abe had applied about a decade ago. um Famously, he was her mentor and she's very much in that same line thinking. Just a reminder, he had the three arrows, right?
00:02:58
Speaker
Monetary stimulus, fiscal stimulus, and structural reform. Structural reforms. And that was really quite aggressive fiscal monetary policy to get the juices flowing again and again in the economy. growth has been very weak and so they really want to invigorate the economy. And so, um you know, at at some point, Abe left office. Sadly, he he got assassinated. He's no longer with us.
00:03:20
Speaker
um But she kind of inherited that kind of broad thought, political thought, if you will. And so her view probably is to institute a more aggressive fiscal policy, a monetary policy, and get Japan working again. And and so that's in part what this election is about. Now, economically, though, there are a more constraints on her to implement these policies compared to Prime Minister ah Abe. And that's because at the moment, Japan has higher inflation. partly as a successful result of the Abe policy. The reinvigoration of the economy led to higher inflation. so you cannot be too aggressive on monetary policy because you already have inflation. um The other thing is on fiscal policy, you know we saw very large budget deficits under Abe. But at the moment, the bond market in Japan, a little bit jittery. So there's a question how big a fiscal stimulus can come without really upsetting you know the bond markets because otherwise yields will go up, the interest rate will
Fiscal Prudency and Global Market Impact
00:04:17
Speaker
go up. We've seen this already, right? Japanese bond yields have gone up. I mean, 10 and 30 year bond yields are significantly higher. They're still not very high on international standards, but significantly higher than they were, say, 12 months ago. so So there were some wobbles a couple of weeks ago in the Japanese bond markets, partly because during the election campaign and the run up to Sunday's election, There are some proposals to cut interest rates – to cut tax rates and to add more fiscal stimulus. And the bond market, you know, didn't have a good day um for many reasons because of lot of uncertainty. But, you know, the bond market you can see is kind of looking at, well, how aggressive are these policies? And if they become too aggressive – then the bond market is to say that means too much debt will be issued and so interest rates will have to rise. And so that that we already had a little bit of a preview of that. But in certain cases, this is important, right? Because Japan is seen as a sort of test case, if you want to use that word, of fiscal prudency and limits to fiscal spending because that's a question that has been raised in the U.S. bond market as well.
00:05:24
Speaker
maybe in Europe because there's a lot of fiscal stimulus going on there as well. So what happens in Japan is therefore actually something the the whole world is looking at in a sense, right? That's right. so So what you have in many developed markets, US, UK, some of the European markets, Japan, is very high public debt. And so if there is any signs of the the public debt markets starting to wobble, starting with interest rates start to rise,
00:05:50
Speaker
ah If that were to happen in Japan, it might send a signal that perhaps in other markets investors also might get nervous. And and so that's why this election is important because we have to see how the bond market in Japan will digest a result. How far can politicians, any politicians, by the way, it doesn't matter who wins, how far they can move the fiscal needle really without upsetting the bond market? and Because in in a sense what happens then, you as a government, you you want to spend more money. You say we're going to borrow some more money. But if the cost of borrowing is much higher, then actually the benefits you get from from actually spending that money is is not as high, right? Right. Well, it means it means you have higher interest rates. and as The government needs to spend more on servicing the debt. But it also means that interest rates in the economy go up because the government is borrowing so much and therefore it's more costly for private companies to borrow. and And so that's then also not good for growth. So having government bond yields rise too much is a drain or a drag on the economy overall. And that's why This election is so important that it's not just for's important for Japan, but it's really important for most developed markets that have relatively high debt levels.
00:07:02
Speaker
And where do they want to spend
Shift in Government Focus to Cost of Living
00:07:04
Speaker
their money on? what Is there anything in particular they'd like to look at? Or is it just tax cuts or these sort of things? Because I think there's some food taxes and these sort of things were discussed. Yeah, so so it's interesting it's changing, right? So in the past, we know that in Japan... A lot of fiscal stimulus was always on infrastructure. There are fantastic trains across the country. Bridges, roads everywhere. everywhere everywhere and That has changed actually. So increasingly, the government is focusing more on cost of living issues. And that's again reminiscent of you know the discussion in the US and UK and Europe. um is that the average person on the street is suffering from higher inflation, of higher food costs, right?
00:07:43
Speaker
Cost of living costs are going up. And so the government has redirected some of this fiscal spending towards easing the tax burden on ah purchasing food, for example, or or other household items, or supporting childcare, for example, healthcare costs, et cetera, and and energy and in particular in Japan. So um you're seeing the government shifting its spending. now That's a fair response to cost of living pressures with other countries as well. But how far governments can go, that's really being tested right now in Japan and in the government bond markets because there's a specific proposal to reduce the tax on food, on food purchases actually to zero for two years. And that would cost –
00:08:28
Speaker
about up to 0.9% of GDP, and that's already starting to sound quite expensive. And so the the question for the election is, will this actually be implemented? How large will her majority be? Or will there be another government? What exactly happens on fiscal policy? And I think that's why it's of wider significance than just with Japan.
00:08:50
Speaker
Very insightful, Fred. I think we're taking a very quick break here and then maybe look at what happens with interest rates in in Japan and the currency and what the implications are for the equity market.
Limits on Fiscal and Monetary Policies
00:09:11
Speaker
Fred, you talked about how they want to do more spending, fiscal spending, but this may be a little bit more constrained than what they had, say, 10 years ago. Is that the case as well, if you think about monetary policy, so interest rates set by the central bank?
00:09:27
Speaker
That's right. So fiscal court policy is a bit more constrained to what we're used to in Japan and on the monetary policy side as well because we have now inflation in Japan. And then, you know, core inflation is running around 2%. Headline inflation is above 2%. So you have essentially now that inflation is back. You don't have that much room to keep interest rates low. You need to actually raise interest rates.
00:09:51
Speaker
And so that too, that will be interesting to observe over the course of this year, how much the Bank of Japan can actually withhold interest rates hikes despite the inflation. And why this matters is because that directly links with the currency. You've seen the Japanese yen being very, very weak yeah as inflation increased in Japan, but interest rates did not as much. yeah Now, pressure is on for the Bank of Japan to raise interest rates in line with the increase in inflation. And if they don't do so, then there's a risk that the currency remain weak. And of course, the weaker currency in itself can be a double-edged sword for an economy like Japan's because it means households pay higher prices. higher spending costs. It means that energy will Anything you buy outside a country is more expensive, right? Everything you import will be more expensive. And and so, and and the Japanese electorate has become quite sensitive to the movements of the yen. So, even when the yen...
00:10:50
Speaker
falls in value, you see household confidence declining. And so, you know, there is also a need to stabilize the currency. And so that means there's really not much room to run very accommodative monetary policy. Monetary policy is much more constrained than it was 10 years ago.
00:11:08
Speaker
So there's not that much room on the fiscal side. There's not that much room. There is room, but not that much room on the monetary side. So then you have structural reforms, right? And that's been a... That's right. And that's maybe sort of the the bullish story here, if you will. You could say, well, you know, fiscal policy, we've kind of exhausted that avenue, monetary policy a little bit, or at least there's some more constraints in the past.
00:11:31
Speaker
and And what do you do then if you're a politician? You want to get growth back up. You want to, you know, get confidence back up. Well, you have to then look at structural reforms. And Japan has done quite a bit in recent years, um but there's a lot more you can do with this. liberalization of the services sector, this liberalization of employment law.
Corporate Governance Reforms in Japan
00:11:51
Speaker
There are certainly increases in productivity that could come through. But also, and Harold, and this is where I want to ask you, it's corporate governance reform because that matters directly for the equity market, right? And you saw enormous rallies in equities in recent years, partly I think because there's this reform on corporate governance that they've done. yeah what What we've seen, so about 10, 12 years ago, they started to talk about corporate reform and the market was probably initially quite skeptical and things were very slow.
00:12:23
Speaker
They raised dividend payments, which is good for investors. They did more share buybacks, but it was quite minimal. But I would say after 2016 17 or It started to accelerate for a variety of reasons. The stock exchange made it a big issue. They issued some, what is called a stewardship, or a sort of a code of conduct. A new index was put in the market whereby only high profitable companies were included in these sort of things. Pension funds said, we're going to pay more attention to this. And this is good. So we've seen a continuation of higher dividends and share buybacks. What we also need to see is that the Japanese corporate structures are very much still, I would say, um something that emerged after the Second World War. You have these larger conglomerates ah that are working together. So you have a bank and a steel company and maybe a consumer company, an insurance company. They all work together in a group. They have cross holdings and they need to dismantle that. That would really mean that you investments that you make in other companies, you can now then say, we're going to pay that back to your shareholders and they can do something else with it. We have seen some of that. And this is a slow process. It's got all kinds of implications. You need to go through legal reassessments of these these holdings sometimes. time So that will take time. But further pressure on corporate reform could be very positive. I don't think it's a necessary driver of the market, but it's a sort of additional source, and a cherry on the top, if you want to put it like that.
Regional Influence of Japanese Reforms
00:13:53
Speaker
And we talked about Japan, you know, in some ways the challenges that Japan is facing is also important for the rest of the world, right? The fiscal challenges that Japan is facing, even the constraints of monetary policy is something that we could see elsewhere. But also actually the – But the corporate governance reform, yeah. I Korea is – Because we see this absolutely. So Korea is very explicit about this. They have the value-up program. It's very similar. They also want to raise dividend payments and share buybacks.
00:14:18
Speaker
Maybe restructuring groups there is a sort of different dynamic in Korea. You also see it actually in China, but also, for example, in Singapore. More dividends, more share by banks. So it's something that is changing across Asia. and And Japan was arguably the first one to really explicitly talk about these sort of corporate structure reforms. And that's exciting.
Conclusion and Global Implications of Elections
00:14:39
Speaker
So all eyes on Sunday's elections. I know, Harold, you're going to you know take out your popcorn. You're going to sit in front of the TV and you're going to be tallying up those votes, I imagine, on Sunday night. Absolutely.
00:14:51
Speaker
Well, actually, I'm not going to take out the popcorn, but I'm going to take out some sushi maybe. Oh, yeah, election sushi. That's a good way to end it week, Harold.
00:15:02
Speaker
And on that note, it's thank you and goodbye from all of us here in Hong Kong. Thank you for joining us. And remember to like and subscribe to Under the Banyard Tree in our sister podcast, The Macro Brief, if you, of course, haven't done so already. Have a great rest of the week, and we'll talk to you again very soon.
00:15:43
Speaker
Thank you for joining us at HSBC Global Viewpoint. We hope you enjoyed the discussion. Make sure you're subscribed to stay up to date with new episodes.