Abe's Return May Prod Japan Forward

Japan's politics have entered 2013 with a mixed freshness. Former Prime Minister Shinzo Abe has clinched a rare second shot at the prime minister’s post. His first term, which began in late 2006, lasted only about a year and ended with his sudden resignation. But following its landslide victory last month, his Liberal Democratic Party (LDP) has secured a two-thirds majority in the 480-seat Lower House, giving it the constitutional power to override Upper House opposition, where no single party holds a majority, on almost all issues.

I was in Japan during the week leading up to the election, meeting with corporate executives across various sectors. Business executives in Japan generally expect very little from changes in political leadership. In fact, many view politics more as a sideshow—something that hopefully will not interfere with business. Such low expectations are understandable given the daunting challenges the government faces. Japan’s economic development has been slow amid weak global growth. Meanwhile deflation and a strong currency continue to undermine both consumption and investment appetite domestically.

Though my own expectations for Japanese politics have also been low, I now see some opportunity for positive changes to occur. The LDP campaigned on a platform to overcome deflation via an aggressive monetary policy by the Bank of Japan (BOJ). The current BOJ governor has been somewhat reluctant to expand quantitative easing compared to his counterparts in the U.S. Federal Reserve or the European Central Bank. This has led to the continuous strengthening of the yen, which has pressured Japan's export sector. But Prime Minister Abe has indicated he will seek to replace the current governor, whose term ends in April, with a candidate who supports aggressive easing. If renewed monetary expansion can stem deflation and weaken the yen, it would be a big boost for Japan's export sector. In fact, the yen has already weakened by roughly 9% against the U.S. dollar to a two-year low since Lower House elections were called for in mid-November.

In addition, the LDP coalition has already agreed on a US$120 billion supplementary budget to jump start the economy. For those who that think this sounds like “bridge to nowhere” spending (destined to be wasted on projects that will never come to be), such a budget may seem odd given the government debt situation. But infrastructure spending in Japan has actually been quite low over the past decade. In fact, some parts of the public infrastructure are in need of a major facelift, evidenced by a recent highway tunnel collapse. Additional public spending should provide at least some relief in the short term.

There is no shortage of critics who are quick to point out the various structural issues facing Japan, but in my view, deflation is the single-largest challenge that Japanese companies face. Turning the tide on deflation and the strong currency would be a major step toward putting Japan Inc. on better and stronger footing.

Kenichi Amaki

Portfolio Manager

Matthews International Capital Management, LLC

The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in small- and mid-size companies is more risky than investing in large companies as they may be more volatile and less liquid than large companies.

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