Japan’s Prime Minister Shinzo Abe said: “Buy my Abenomics.” Did you buy it? Maybe yes. And you may not be alone. The Nikkei 225 average index almost doubled in a year, and the Japanese yen depreciated by 20%. Many record highs were reported, on a near daily basis.

The first two of his “three arrows” – bold monetary easing with an inflation target of 2% and flexible fiscal spending for reconstruction after the 2011 earthquake as well as reinforcing or rebuilding decrepit social infrastructures to strengthen “national resilience” – certainly uplifted market sentiment.

To be more specific, during the period from December 2012, when Abe took office, to May 2013, the Nikkei 225 jumped up stunningly by 40%. The world is now cautiously watching whether Japan can really exit longlasting deflation. The key to the success is the third arrow – revitalisation strategy.

Eight steps for revitalisation
Haruhiko Kuroda, governor of the Bank of Japan (BoJ), has also been well aware of the necessity that monetary easing and flexible fiscal spending should work together inseparably to get Japan out of the deflationary spiral. Prior to his inauguration as the governor, Kuroda stated at the Diet that the BoJ should push monetary easing forward and simultaneously seek the government’s support to create demand.

In this context, the following events – ideally in this order – have been suggested to end the deflationary state:
1 Bold monetary easing
2 Flexible fiscal spending
3 More investment in public infrastructures to strengthen national resilience
4 Improving corporate earnings
5 Creating more jobs
6 Increasing prices
7 Salary improvements
8 More consumer spending

At the beginning, more than a few economists were sceptical about the efficacy of such bold monetary easing. Many of them have since modified their outlook upwards, while others have maintained a cautious outlook and focus on the fact that wages have not increased.

The point is that Abenomics cannot be said to be working properly if it fails to increase wages, even if it pushes up prices. Although it may be a fact that average wages have not increased it is also a fact that employment has been increasing, which results in increasing GDP.

Catalysing growth
As for the expansion of public investment, opinion is divided among economists regarding the rights and wrongs of doing so when the debt-to-GDP ratio is over 200%. Given that Japan’s nominal GDP has been flat for the past 10 years – which explains why Japan’s debt ratio has expanded to this level – actions that help nominal GDP grow need to be taken.

In Japan, which is in a decade-long period of deflation, the private sector has become risk-averse and unwilling to spend money. Under such circumstances, the government is arguably the sole entity able to lead borrowers and encourage the money piled up in bank accounts to be recirculated back into the market, which is the first step to make nominal GDP grow.

Nikkei Shimbun, Japan’s leading financial daily, reported on February 6 this year that the trend in bank loans to small and mediumsized enterprises (SMEs) turned positive in December 2013. It is indeed a good sign for the Japanese economy, where SMEs account for 99.7% of the number of the companies and 69% of employment.

Japan’s current high debt-to-GDP ratio is certainly a challenge that must be overcome. As we learned during the euro crisis, the solution for debt reduction is growth rather than austerity measures.
 
Particularly, most of the public infrastructure built in the 1960s, the period of high economic growth in Japan, is getting old and needs to be replaced or rebuilt. In addition, reconstruction of the areas struck by the earthquake in 2011 should be carried out. Investment in public infrastructure should be well analysed and prioritised in terms of strengthening national resilience.

As mentioned above, revitalisation strategy, the third arrow, is now the name of the game. To ensure stable growth, the driving force of Japan’s economy needs to be switched from consumption to investment.

Since the 1990s bubble burst, investment in general has been stagnant, which has made it extremely difficult for Japan to exit deflation. To achieve these goals, the third arrow includes proposals such as the creation of national strategic special zones, where bold deregulation and reform can be realised, and the creation of an infrastructure fund for private finance initiatives (PFIs).

It may be too early to talk about whether the third arrow is working properly, but Japanese companies have accumulated know-how in the infrastructure industry as well as content industry such as manga, animation and computer games, which are expected to be the new driving forces of Japan’s economy.

How Abenomics affects financial markets
What will Abenomics do to financial markets? The core of the growth strategy in this area is deregulation. The politically challenging bedrocks of medicine, agriculture and labour law have been in the spotlight, though the reform of financial and capital markets to smooth out the flow of funds is equally important for enabling sustainable growth. The purpose of such deregulation is eventually to replace with private sector money the government spending that has been catapulting the Japanese economy.

Aiming to make Japan a better place for both issuers and investors, the Financial Advisory Council under the administration of the Financial Services Agency of Japan (JFSA) submitted an opinion paper to the Cabinet setting forth a refurbishment plan of the relevant laws.

Expand your horizon to startups
Startup incubation is one of the focal points of the council, and comes in four layers: crowd funding, Green Sheet issue system renovation, relaxation of initial public offering (IPO) rules, and a reduction in disclosure requirements. As a result, startups will have more diversified funding sources in their infancy and then carry less of a burden when going public. The JFSA is to reduce the financial disclosure initially required from the past five years to two years, and exempt the external audit on internal control report for three years from the IPO.

Listed companies are also covered by deregulation. The waiting period for public offering is to be abolished under certain circumstances. In an effort to eliminate ambiguity with preregistration offerings, premarketing will be explicitly enumerated in the safe harbour rule. Additionally, the 5% large shareholding report rule will no longer apply to treasury stocks, lightening the burden on the issuer.

The JFSA will take all the necessary steps to implement the plan of the council by amending the relevant laws for enforcement.

Time to break the piggy bank
Next, let us see what happens on the investor side. The challenge for the government to unleash household wealth to the equity market commenced this year.

This extremely risk-averse group seems to believe only in cash and bank deposits, collectively sitting on ¥1,500trn of unusually poor-performing portfolios, with only 10% in equities and trust funds and most of the rest in bank deposits.
 The weapon to break their precious piggy bank is a taxfree investment account system – Nippon individual savings accounts (NISAs).

Designed in the mould of the ISA in the UK, NISAs are supposed to give individual retail investors an incentive for taking a little first step towards the equity universe. The response so far is good. In spite of the rather choppy stock market, the number of NISA accounts quickly reached 5 million in the first month, and more investors are queuing up at brokers and banks to open accounts.
 
Although it has been only a month since the NISA came into effect, it has successfully attracted around ¥300bn to the markets already, according to the estimate of Nikkei Shimbun. The amendment to corporate law to enhance corporate governance under the growth strategy is certainly essential for the maintenance of momentum by supporting investors in having confidence in making longer term investments.

Genie out of the bottle
In the meantime, another conservative giant, the Government Pension Investment Fund (GPIF), the largest institutional investor in Japan managing over ¥120trn, is also making a move.

The council urged the GPIF to enhance its risk management capabilities and diversify its portfolio to achieve higher returns and, as a starting point, the GPIF started looking for investment opportunities in infrastructure funds abroad with support from the Development Bank of Japan.

This endeavour may eventually lead Japanese public pension funds to increase their presence in the domestic infrastructure market. Sizeable new projects in the pipeline for the 2020 Tokyo Olympic Games, together with ageing infrastructures that require renovation, mean opportunities are everywhere.

This is where the growth strategy creates synergies with the fiscal stimulus under the low-interest rate environment generated by monetary easing. We will see whether the third arrow hits the bull’s eye.