Abe’s Measures Push Japan Closer To The Edge

For some time now, there has been a tendency to ignore or down play Japan’s importance on the world stage, mainly because of its chronic economic weakness and low-profile foreign policy. In short, with the exception of 2011’s triple disaster, little new happened in Japan. For better or for worse, that might be about to change.

The Bank of Japan (BoJ) on January 22 decided to introduce a consumer price inflation target of 2.0% year-on-year (y-o-y) into its monetary policy framework, something that new Prime Minister Shinzo Abe has been pushing for. The BoJ’s previous inflation target was 1.0% y-o-y. The central bank has also decided to embark on US-style monetary easing from 2014, setting monthly purchases of financial assets at JPY13trn (without setting any termination date). While the Japanese government seems convinced that the return of inflation is essential for economic growth, we remain cautious towards its implementation given the possibility that these efforts could instead weaken investor confidence in the government bond market.

As regards fiscal policy, the Japanese cabinet recently approved a supplementary budget worth JPY13.1trn, consisting of public works and other social security-related spending. The government’s increasing need for ever more bond sales, at a time when demand from the private sector is likely to decline with the ageing of the population, will likely put upward pressure on Japanese Government Bond (JGB) yields. With few effective tax and pension reforms in the works, investor confidence could be eroded and further stimulus from here on is likely to hasten the arrival of a fiscal crisis in Japan.

Island Dispute Another Big Risk

Meanwhile, Japan faces another major risk in the form of its dispute with China over the Senkaku/Diaoyu islands. Lately, even mainstream news publications and commentators have been raising the spectre of war. Although the idea of a full-scale Sino-Japanese war still seems far-fetched, a limited air and naval confrontation at sea is hardly unthinkable. Even if such a clash is avoided, China-Japan relations are likely to remain tense. In a recent article, we identified several triggers for further deterioration.

The greatest risk is that China and Japan will deploy more aircraft and ships to the East China Sea, resulting in stand-offs, collisions, or ‘incidents’ that cause fatalities. Civilian vessels could also get drawn into the fray. Any deaths could lead to a surge of emotionalism in the country of the victim(s), leading to angry protests, or public demands for retaliation. This would not necessarily trigger outright conflict, but could send relations into deep freeze. In a worst-case scenario, China could use force to seize the islands. If Tokyo failed to respond, it would risk becoming geopolitically subordinate to Beijing.

Other triggers for a worsening of relations are as follows:

  • Japan builds new facilities on the disputed islands
  • Abe officially moves to further downplay Japan’s wartime legacy
  • Japan amends its constitution to bolster its military status and operational remit
  • Japan boosts cooperation with Taiwan

Full analysis of Japan’s economy and geopolitical challenges is available to subscribers at Business Monitor Online.

This blog is tagged to:
Sector: Country Risk, Defence & Security, Financial Markets
Geography: Asia, China, Japan

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