Important Times for China and Japan
The attention of financial markets over the past few weeks has correctly been on assessing the implications of a shift in the Fed’s policy communication towards a less dovish stance. There has been little focus on economic developments in Asia, with the exception of the plight of China’s manufacturing sector. Asia’s two largest economies, China and Japan, are facing important near-term policy challenges. In the case of Japan, there is a crucial test that needs resolving: will the increase in consumption taxes on April 1 to 8% from 5% push the economy back into recession? If the answer is “yes,” then there will be enormous pressure on the Bank of Japan ...view middle of the document...
Any decision to increase monetary stimulus will be driven by the magnitude of Q2’s slowdown, as well as developments on the inflation front.
The central goal of Abenomics is to break deflationary psychology in the Japanese economy. Part of the objective is achieved through a deliberate weakening of the exchange rate. Under Governor Kuroda, the BoJ has flirted with claims that it has diluted its independence by embracing a 2% inflation target, which is to be reached by 2015. The effects of the higher sales tax are excluded in the BoJ’s calculations of core inflation. The latest reading for the BoJ’s chosen gauge is +1.3%, having been rising for the past nine months. The issue about whether the target can be reached, and sustained, by 2015 will hinge critically upon the economy’s response to the higher sales tax. There are also huge implications for fiscal sustainability and long-term interest rates.
Another Tax Increase Tentatively Planned
After seemingly countless public-funded measures to stimulate the economy, the issue of fiscal sustainability has come back to haunt the Abe government. The combination of aggressive fiscal and monetary stimulus that heralded the start of Abenomics is clearly unsustainable. The main reason for the higher sales tax is to broaden the tax base. This will assist in putting fiscal policy back onto a more sustainable path. Thereafter, a further sales tax increase from 8% to 10% is being touted for October 2015. The final decision to proceed will be driven by the outcome of the first hike and whether there has been a notable change in the psychology of Japanese consumers, who have become experts in the art of thrift. In terms of economic performance, both the BoJ and the government are braced for a much more mediocre year in 2014 compared to last year. The credibility of Abenomics is arguably facing its sternest test yet in the wake of this week’s tax increase. A repeat of 1997’s relapse into recession would significantly raise the ante on Japan’s financial markets, because there appears to be no Plan B in the wings.
China’s State-Owned Banks: Facing Much Tougher Times
China’s four largest state-owned banks are in the process of announcing their financial results for 2013. If expectations are correct, they will all share a common feature of marked deceleration in profits growth. This will reflect the slowing economy. More importantly, these results could be their last under the political patronage that they have enjoyed over the past twenty years. The pressures of competition will become more vibrant.
State-owned banks have been able enjoy large profits, partly due to ceilings on deposit interest rates. Thus, this meant very high net interest margins. Proposed liberalisation of deposit rates will remove this mechanism for making easy profits. Furthermore, deposit flows will come under increased pressure from the shadow banking system which is offering higher returns. Competitive pressures will also be compounded...