Political uncertainty is once again unsettling Japan’s markets as the country prepares for a snap general election on October 27.
Incoming Prime Minister Shigeru Ishiba, who recently took over the leadership of the ruling Liberal Democratic Party (LDP), called for an early election in a bid to secure public support.
However, this move has triggered significant market volatility, raising concerns about the future of Japan’s economic trajectory amid his support for higher corporate taxes and ongoing interest rate hikes.
The Nikkei 225 index dropped 4.8% just minutes after Ishiba’s election announcement, reflecting investor unease. His stance on fiscal policies—particularly support for higher taxes and the Bank of Japan’s (BoJ) monetary tightening—has fueled concerns as Japan grapples with both internal pressures and external challenges like a weakening global economy.
Investors are worried that the upcoming election will add another layer of uncertainty.
What does the market think of Ishiba’s leadership?
Shigeru Ishiba’s unexpected rise to power comes at a delicate time for Japan’s economy, which is struggling to gain momentum.
His call for an early election is widely seen as an effort to consolidate power within a divided LDP and secure a public mandate during a period of growing dissatisfaction over rising living costs and stagnant wages.
The market’s reaction was swift and negative.
Stocks fell sharply, with manufacturers and exporters suffering the most due to concerns over a stronger yen.
Property and retail sectors also experienced significant losses as fears of higher corporate taxes weighed on profit expectations.
Unlike his predecessor, Fumio Kishida, who pushed for a “new capitalism” focused on innovation and equitable growth, Ishiba has shown a willingness to pursue policies that may not sit well with Japan’s corporate sector.
His backing of the BoJ’s interest rate hikes, marking a departure from Japan’s ultra-loose monetary policy, has further rattled investors.
Japan’s economic recovery now faces new challenges
Japan’s post-pandemic economic recovery has been mixed, with deep-rooted structural issues hindering long-term growth.
The economy rebounded strongly in the second quarter of 2024 with a 3.1% annualized growth rate, largely driven by a rise in private consumption. However, this followed a contraction in the first quarter, highlighting ongoing volatility.
August saw a steep 3% drop in industrial production, exceeding market expectations and underlining the challenges faced by Japan’s manufacturing sector.
External demand remains weak, particularly due to slowdowns in key markets like China, which has dampened the appetite for Japanese goods.
While real wages rose for the first time in two years following strong wage negotiations, inflation continues to erode purchasing power.
This casts doubt on the sustainability of the recent recovery in private consumption, especially for lower-income households.
Is Japan’s monetary policy really on the right path?
The Bank of Japan’s shift in monetary policy has become central to the ongoing debate.
Under Governor Kazuo Ueda, the BoJ raised its benchmark interest rate in 2024 for the first time since 2007, aiming to curb inflation and unwind years of ultra-loose monetary stimulus.
While inflation has exceeded the BoJ’s 2% target, driven mainly by import costs due to a weaker yen, the broader impact of higher rates on Japan’s economy remains concerning.
A 12% rise in the yen against the dollar since July has already dented export competitiveness, further straining manufacturers struggling with higher input costs.
Ishiba’s backing of the BoJ’s rate hikes complicates the economic outlook further.
Higher interest rates may help control inflation, but they could stifle growth in sectors that have long benefitted from the BoJ’s low borrowing costs, particularly export-driven industries.
Can Japan overcome its long-term structural issues?
Japan’s long-term economic challenges extend beyond monetary policy.
The country’s aging population and shrinking labor force have put immense pressure on social welfare systems, while government policies to encourage immigration and increase workforce participation have had limited success.
Japan’s productivity also continues to lag behind other advanced economies.
Despite adopting new technologies in fields like robotics and AI, rigid labor markets and underinvestment in research and development have hindered broader productivity gains.
Traditional industries, many of which are facing declining global demand, further complicate the issue.
The International Monetary Fund (IMF) recently downgraded Japan’s 2024 growth forecast from 0.9% to 0.7%, citing weaknesses in the automotive sector and broader economic headwinds.
The IMF also emphasized the need for structural reforms, particularly to address labor market inefficiencies and boost investment in high-growth sectors.
Kishida’s unfinished economic legacy
The upcoming election also casts a spotlight on outgoing Prime Minister Fumio Kishida’s economic legacy.
His “new capitalism” agenda, which aimed to drive innovation and reduce inequality, led to wage increases and higher corporate investment in sectors like semiconductors and green energy.
However, much of Kishida’s policy framework continued the structural reforms and deficit spending established under Shinzo Abe’s Abenomics.
While he attempted to introduce tax incentives to boost household investment in the stock market, these initiatives were overshadowed by rising inflation and public dissatisfaction with stagnant wages.
His appointment of Kazuo Ueda as BoJ governor to raise interest rates could prove to be his most lasting decision, though its long-term impact remains uncertain.
What is next for Japan?
Japan’s economic recovery offers some optimism, particularly with strong private consumption and a resurgence in tourism.
Spending by foreign tourists is projected to reach 8 trillion yen ($54.74 billion) in 2024, providing a crucial boost to the retail and hospitality sectors.
However, the strength of the yen, coupled with slowing global demand, poses a risk to Japan’s export-driven economy.
Higher interest rates may cool domestic consumption in the coming quarters, especially if inflation continues to outpace wage growth.
The upcoming election only adds more uncertainty.
While Ishiba’s policies may align with the BoJ’s current tightening stance, his support for higher corporate taxes could dampen business investment and slow economic momentum.
Investors will be watching closely for any shifts in fiscal policy after the election, which could have far-reaching implications for Japan’s economic future.
In the short term, markets are expected to remain volatile as Japan navigates this period of political and economic transition.
Assessing the markets that stand to benefit or falter in this environment will be key for investors seeking opportunities.
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