Japan: A farewell to Abe

Prime Minister Shinzo Abe unexpectedly announced his resignation on august 28th, due to health reasons. Abe suffers from a chronic intestinal disease, which already forced him to resign during his first stint as Prime Minister (PM) in 2007.

Japan now faces a period of uncertainty, as Abe’s ruling party (the Liberal Democratic Party, LDP) must hold elections among its members to choose a new leader, which almost certainly will also be the new PM. The LDP has decided to hold these elections (in which only parliament members and heads of local chapters can vote) on September 14th. Abe will remain in office until then.

Four of the five large factions of the LDP have endorsed cabinet secretary Yoshihide Suga as the candidate for succeeding Abe. This makes Suga the main contender for the spot. As cabinet secretary since 2012, Suga has effectively been Abe’s right hand man, so a choice for Suga signal’s policy continuity. And indeed, judging from Suga’s latest statements, he will likely continue with Abe’s policies.

Other contenders are Shigeru Ishiba (former defense minister) and Fumio Kishida (LDP policy chief and former foreign minister). Ishiba is a long-term rival of Abe. He is seen as a little more populist in terms of economic policies, although his stance regarding China is roughly the same as Abe’s (maintaining ties). Abe has said he prefers Kishida to Ishiba. However, Ishiba is more popular among the public (according to a recent news poll), which possibly makes him more popular for general elections in autumn 2021.

Whoever succeeds Abe, financial markets will experience increased volatility in the short term. For example, after Abe’s announcement, the Nikkei Stock Average Volatility index (a gauge of expected volatility in the next 30 days) jumped from 22 to 26, the highest number for August. Going forward, the Japanese stock market and currency will likely stay sensitive to any news on Abe’s successor.

In the medium to long term, the successor, whoever he may be, is not likely to change Abe’s policies very much, as most candidates that are poised to replace Abe do not have widely different views than him on trade, foreign policy or the economy. Moreover, major policy changes would only add to the already increased uncertainty about Japan’s prospects. Thus, Abenomics (Abe’s three-pillar strategy to revive Japan’s economy) will likely survive in more or less its current form in the medium term. In fact, frontrunner Suga has already said that he will continue with Abenomics.

For the longer term however, Abe’s drive for reforms (such as corporate governance reforms) will face resistance. Abe’s success in delivering such reforms was for an important part based on his ability to stay in office long enough to push the reforms through. It remains to be seen whether Japan’s new PM will also have that ability. Before Abe, Japanese PMs have averaged only about 17 months in office since the 1990s.

Meanwhile, the macroeconomic picture remains dim as ever. The release of official Q2 GDP figures confirms that the Japanese economy took a historically big hit in the second quarter, it contracted by 10% y/y. To put this in context, it is the largest decline in quarterly GDP in the past 40 years, and the decline was much worse than its regional peer South Korea, where the economy contracted by a relatively modest 2.9% y/y.

The deep dive in Japan’s GDP was driven mostly by consumption and exports. Private consumption declined by 11% y/y as consumers were restrained from buying goods and services due to containment measures in May and June. Exports declined by 23% y/y due to a slump in demand from Japan’s major trading partners. Investments declined more modestly (3% y/y). However, we caution that the real pain for investments is yet to come, especially given the increased policy uncertainty arising from Abe’s resignation.

Meanwhile, Japan’s second wave of coronavirus infections does not seem to be slowing down (Figure 1), which does not bode well for Q3 and Q4. Retail sales, for example, declined again in July (-2.9% y/y), after rebounding in June (Figure 2). In addition, industrial production for July came in at -15.3% y/y. Overall, we maintain our view of a deep recession in Japan for 2020 with a rather modest pick-up in 2021 (Table 1).

We continue to believe the BoJ will not alter its monetary policy much. The BoJ simply cannot afford to, given the weak state of the economy and resulting weak inflation (0.4% y/y in July). Moreover, given that the BoJ is a politically independent central bank, we also do not expect BoJ governor Kuroda to step down or change its course much without Abe. Rather, we think the BoJ will remain in wait and see mode to assess the effectiveness of its previous policy measures to fight the economic effects of COVID-19.