Japan Election Result to Bolster Policy Implementation, Says Fitch

The ruling LDP's victory in Japan's general election on 22 October has bolstered the standing of Prime Minister Shinzo Abe and should strengthen his hand in implementing his political and economic agenda, says Fitch Ratings.

A twice-delayed consumption tax hike now looks more likely to be implemented in October 2019, owing to Abe renewing his commitment to the increase in the run-up to the election and evidence of stronger momentum in the economy. A consumption tax hike could have a positive effect on public debt dynamics to the extent that increased revenue is earmarked for debt consolidation.

The LDP has retained its "super-majority" of two-thirds of the seats in the lower house of parliament. This gives Abe a mandate to continue the "Abenomics" economic strategy launched in early 2013 that aims to revive growth and end deflation through the three "arrows" of loose monetary policy, fiscal flexibility and structural reforms.

Importantly, Abe will now be able to re-appoint Haruhiko Kuroda as Bank of Japan governor when Kuroda's term ends in April 2018, or choose a successor supportive of accommodative policies.

Revisions to Japan's historical GDP data in late 2016 suggest the economy has performed better under Abenomics than previously thought, even if the strategy has been less successful in pushing inflation up toward the 2% target.

The revisions bring the national accounts data in line with 2008 United Nations Standards; and by expanding inclusion of R&D spending, capture how far Japan has shifted towards R&D-intensive sectors.

More recently, the economy has continued to benefit from loose financial conditions and supportive fiscal policy, as well as robust external demand and a tight labour market. Real GDP grew by 0.6% qoq in 2Q17, as public investment and private consumption rose at their strongest pace in over five years. Fitch expects GDP to grow by 1.5% in 2017 - up from 1.0% in 2016.

Improved economic outlook has lowered risks

The improved economic outlook has lowered risks associated with the public debt trajectory, and was a key factor in Fitch's decision to revise our Outlook on Japan to Stable from Negative in April 2017, when the rating was affirmed at 'A'. Nevertheless, high public debt remains a key fiscal policy constraint and rating weakness.

The gross general government debt/GDP ratio is by far the highest among Fitch-rated sovereigns, at 230% of GDP in 2016, and our baseline projections show it rising to 238% by 2024.

Abe's indication during the election campaign that his government will proceed with a consumption tax hike from 8% to 10% in October 2019 may have a positive impact on these baseline debt projections, which do not currently factor in a rise during the next decade.

Fitch has previously calculated that the consumption tax hike could reduce the fiscal deficit by around 0.8pp per year in the medium term - and stabilise the public debt/GDP ratio - if the proceeds were used predominantly for debt consolidation.

However, Abe has said that JPY2 trillion of the projected JPY5 trillion raised will be spent on social spending, such as education and childcare provision. This will dampen - but not eliminate - the positive effect of the tax hike on debt dynamics.

The government was due to review its fiscal strategy during the fiscal year ending 2019, and we expect more clarity once the review is complete.

Prospects for structural reform remain limited, despite the convincing election win. There have been pockets of success in supply-side reform since 2013, such as a rise in labour force participation. However, there is still little sign of the transformative breakthrough needed to boost long-term growth significantly and achieve the government's "economic revitalisation" scenario. 

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