Japan's Debt Solution: Go for Growth

Investors have been more focused Japan's aggressive monetary policy and the structural reforms promised under Abenomics than fiscal policy. However, the Abe government is taking a new fiscal initiative.

 It has taken on a new more ambitious goal, which was unveiled yesterday, and will be voted on by the cabinet next week.   After reiterating its goal of eliminating the primary budget deficit by 2020, it provided an interim target. It will strive to achieve a 1% primary deficit in FY2018. 

The primary budget deficit for the current fiscal year is projected to be 3.3% of GDP.   Previously the target for FY2018 was 2.1% under its optimistic (revitalization) scenario.  The baseline was 3.0%, which would be little changed from this year. 

How will the more ambitious target be reached?  There are three factors:  growth, revenues, and spending.  The government is assuming 2% growth per annum for the next three years.   Implicitly, the government does not expected the sales tax increase projected for 2017 will hurt the economy as last April's did.  

New fiscal projections are due in July, but the local press suggests that the government is anticipating a greater multiplier effect from growth in terms of revenues.  Previously it assumed that 1% growth would lift tax revenues by 1%.  Now it assumes that 1% growth will generate an 1.2%-1.3% increase in tax revenues.   It is not clear the reasoning behind this shift.  It could be that the weak yen is expected to boost the profits earned overseas.  

The government plans on restraining expenditures.  Previously the government assumed revenues would rise JPY3-JPY4 trillion a year (under the revitalization and baseline scenarios respectively).  Under the new plan, it intends to cap increase in government expenditures to JPY1.6 trillion a year.  The main initiative here is limiting the growth of social security spending, which seems to present political risks given Japanese demographics and aging population.    

The details are not complete, but it appears that the plans call for greater reliance on generic prescriptions.  There is also an attempt to reduce the gap between the prefectures with the highest health spending and lowest by half.  These spending plans are "rough indications" rather than hard and fast targets, which allows for greater flexibility.

Within the fiscal plans, there are some structural reforms.  The national university system will be reorganized to make them more competitive from an international perspective.  Abe is also proposing where higher immigration should be allowed.  The Prime Minister is proposing allowing foreign-born IT workers from India, students, ski instructors and hotel front desk staff with appropriate language skills.   Japan had eased its visa rules and there has been a surge of Chinese tourists according to reports.  Japan's tourist sector has also been bolstered by the weakness of the yen. 

Meanwhile, over the past two weeks the dollar has built a shelf near JPY122.40.  The rise in US Treasury yields and equity market gains (the Nikkei closed at near 15-year highs today).  appears to be helping underpin the dollar.   The technical indicators are supportive.  Still, the dollar is likely will likely encounter offers in the JPY124.40-60 area.  We often find that the dollar-yen is a range bound pair and when it looks like it is trending it is moving from one range to another.  The dollar trended higher from mid-May through early June.  It was moving out of the previous range of roughly JPY118-JPY122.  The new range looks to be JPY122-JPY126. 

Official commentary ahead of the US congress debate on whether to include stiffer currency manipulation measures in the trade promotion authority, and ahead of the G7 meeting, helped deter the market from pushing the dollar above JPY126.  Now that the lower end of the range appears to have been established, the market looks poised to re-explore the upper end. 

Speculators in the futures market had dramatically reduced their short yen exposure when the dollar was chopping around the JPY118-JPY122 range.  The gross short position fell from 153k contracts in early December 2014 to about 54k contracts at the end of April.  Speculators rebuilt the short yen position in May and early June.  It peaked two weeks ago near 160k contracts.  

In the reporting week that ended on June 16, speculators cut the gross short yen position by over 13k contracts and increased the gross long position by 50% to 65.7k contacts.   We suspect that the new long yen positions are in weak hands.  in the spot market, the dollar averaged about JPY123.35 during the latest reporting period.  Some of these new longs likely have been trimmed, and more will likely follow suit if the dollar rises above last week's high near JPY124.45. 

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