Abenomics is finally paying off for Japan

Over the next few weeks, one of the most important economic events in the world may happen. Japan might finally be moving away from its negative interest rate era. It will be one of the last major economies that will be moving away from negative interest rates.

How Japan got here is what is interesting. But why are we talking about Japan’s economy now? Well, last month Japan’s benchmark stock market index–NIkkei 225–touched its all-time high levels. One hitch though–this was after nearly 35 years. That is how long it took for the Nikkei to crawl back up to new highs.

Japan was stuck in a deflationary phase for many decades. After its economy entered a recession from 1995-1998, the country dabbled with many firsts in monetary policy measures to push its economy to grow.

One of these was the near zero benchmark interest rate set by the Bank of Japan (BOJ) since April 1999. Later in 2016, the BOJ reduced its benchmark and started paying banks and lenders to borrow money for onward lending. This essentially was the beginning of the negative interest rates in Japan.

Then Japan also started buying private sector bonds (apart from government bonds) and stocks & ETFs to inflate asset prices as the prolonged deflation was leading to uneven economic growth. Essentially, the Japanese government and central bank threw the kitchen sink at reviving Japan’s economic engine.

To be clear, Japan’s economy is still struggling. After contracting in Q3 of 2023, it managed to post modest growth in GDP in Q4 2023 only after a revision of GDP numbers in March 2024. The first estimate indicated a continuing recession. That begs the question–what is happening in Japan’s stock market?

Why did Nikkei touch a new high now?

It’s almost a cliche now to point the finger at companies wanting to diversify their supply chains that leads to other countries seeing some positive impact on their economy. But now that stock market investors across the world are looking at the China market as more of a short-term trade due to its deep economic problems, they are now looking at other regional options. The supply chains moving to other countries has also led to many companies that left Japan for China coming back to the country.

Japan is on their radar because the country has instituted a lot of reforms in its corporate sector over the past many years and many investors are beginning to notice. Japan is also heavily investing (through subsidies) in semiconductor manufacturing facilities and has lured Taiwan’s TSMC to set up a huge manufacturing facility, among many others. This is why the great quarterly numbers reported by Nvidia last month had an impact on Japan’s stocks markets as well as many of the country’s companies supply and manufacture semiconductor chips.

There are also many stalwarts like Toyota, Honda, Mazda, among others that have agreed with unions to raise salaries for workers by up to 4%. The wage hikes bode well for BOJ to shift its stance from negative interest rates. The hope is that a rise in income for Japanese workers can stimulate inflation.

Abenomics for the win

Rescuing Japan’s economy is no mean task and former Prime Minister Shinzo Abe painstakingly tried to bring some inflation into the country’s economy to kickstart its economy after the Great Recession in 2008.

Abe was instrumental in boosting money supply in Japan’s economy when he was elected to office for a second time in 2012. He also focused on boosting government spending, and other reforms and tried to make Japan’s economy very competitive. To bring back inflation, he also led and passed a law that raised its VAT rates in 2019.

But only when the pandemic kicked in did the country witness a spike in inflation that was sustainable. This rise in prices from 2022 onwards led many employee and workers unions to press for higher wage hikes. This is what is now keeping the BOJ hopeful that it can withdraw its monetary stimulus in terms of negative interest rates in 2024. Some expect this to happen as early as March 18-19.

What does no more negative rates in Japan mean now?

Firstly, the BOJ moving to non-negative benchmark rates will lead to strengthening of the Japanese yen. The yen is already strengthening against the dollar on hopes the BOJ will stop negative rates.

Secondly, the strengthening of the yen is not conducive for the export focused companies in Japan. Think of how Indian IT services companies make more money when the rupee depreciates against the dollar. The exact same logic applies here. If the domestic currency strengthens against a foreign currency, then the export-focused businesses suffer.

There is also a possibility of Japan stepping back on its copious overseas assistance that doles out to many countries, including India, through the Japan International Cooperation Agency. This may not happen instantly, but will slowly pan out.

If Japan’s economy grows faster over the next few years, the original rationale behind the expansive overseas assistance program might not hold water anymore. The loans that Japan gave out to various other countries were almost soft loans that helped bring business to many Japanese companies. These were essentially export orders. That helped Japanese companies post profits over the years. Many European countries sort of copied this model too like France and Germany.

In the meantime, Japan’s benchmark stock market index has receded from its new highs as news trickled in that the BOJ may raise rates to move its benchmark rates out of the negative. But all the work the Japanese authorities have put in to will their economy into growing almost feels like twilight. One hopes that the sun is rising.