Abenomics A Short-Term Fix Only For Construction Sector
BMI View: We continue to expect Japanese construction activity to improve in 2013, with a stimulus package in early-2013 and a large project pipeline generating real growth of 3.2% in 2013, higher than the growth rates seen in 2011 and 2012. However this short-term boost in construction activity will come at the expense of long-term growth in the construction sector, with fiscal and borrowing cost concerns adversely affecting long-term capital expenditure plans. Although there have been attempts by the government to carry out reforms to spur long-term construction growth, the successful implementation of these reforms is still in doubt and, more importantly, they fail to address the structural problems affecting long-term construction demand.
Japan's construction activity has continued to improve since 2011. Latest data from the Ministry of Land, Infrastructure, Transport and Tourism (MLIT) show that monthly construction works executed in Japan grew at an average rate of 5.5% year-on-year (y-o-y) in 2012, significantly higher than the -1.0% y-o-y seen for the same period in 2011. This improved performance in construction activity has continued in the first three months of 2013, with monthly construction works executed in Japan averaging 4.3% y-o-y between January and March 2013. We believe this indicates that the economic stimulus package approved by the recently-elected Liberal Democratic Party (LDP) on January 11 2013 is providing some impetus in spurring reconstruction and infrastructure activity in the country.
|Orders Slowly Translating To Activity|
|Japan - Monthly Value of Construction Orders Received And Work Executed, Big 50 Construction Companies, % chg y-o-y|
Despite this pick-up, we believe that a large portion of the project pipeline in the construction sector has yet to be completed. Since April 2011, monthly construction orders in Japan have grown at an average rate of 7.3% y-o-y, but monthly construction works have only grown at an average clip of 3.6% y-o-y over the same period. We attribute this sluggish progress in clearing the project backlog to insufficient building materials and manpower to carry out reconstruction, the inefficient allocation of the government reconstruction budget, as well as the slow progress by the government in removing debris created from the March 2011 natural disaster. The designation of safe zones for reconstruction in the areas impacted by the nuclear reactor in Fukushima prefecture also contributed to delays.
We maintain our view that construction real growth will improve in 2013 due to the January 2013 stimulus package and the sector's robust project backlog. Construction real growth is forecast to reach 3.2% in 2013, higher than the 2.9% and 1.0% growth rates seen in 2011 and 2012 respectively. Under the supplementary budget, around JPY1.6trn has been allocated to accelerate the reconstruction process in the disaster-hit Tohoku region, while around JPY1.4trn will be channelled into public works projects - namely infrastructure repairs and the construction of quake-resistant schools, hospitals, roads, bridges and tunnels across Japan.
However we doubt that the stimulus package will have as much of an impact on economic (and construction) activity as the government expects. This is because the sluggish construction activity in the past two years is not due to the lack of financing, but due to factors such as the shortage of labour and buildings materials and slow planning by the central and local governments. The LDP government, led by Prime Minister Shinzo Abe, is currently attempting to address these bottlenecks, but we believe they could take sever al years to be fully resolved.
As such, we remain convinced that the stimulus package will only have a transitory impact on construction activity. This is reflected in our forecasts, with real growth for Japan's construction sector forecast to peak at 3.4% in 2014 and slowdown to 1.9% in 2015.
|Growth Not To Last|
|Japan - Construction Industry (and its Components) Forecasts|
Short-Term Boost Comes At Long-Term Expense
It is our opinion that this short-term boost in construction activity will come at the expense of long-term growth in the construction sector. The supplementary budget is part of Prime Minister Abe's strategy to revitalise the Japanese economy, where the first two phases (the so-called 'arrows' of the growth strategy) involved liberal fiscal spending and aggressive monetary easing.
These two arrows have boosted economic activity in Japan over the first half of 2013, but they have also placed further pressure on Japan's precarious debt balance and increased domestic borrowing costs ( see 'Corporates Insulated But Not Immune From Sovereign Bond Malaise', May 28 2013). The additional public spending requires the issuance of new government bonds and the government domestic debt already exceeds 220% of GDP. Meanwhile, the rise in Japanese government bond yields is likely to lead to higher financing costs for the public and private sectors, which could eventually pose a risk to their capital expenditure plans.
This could negatively impact construction activity as early as 2016 and this view is reflected in our forecasts, with Japan's construction sector expected to contract by 1.5% in 2016.
|Capping Public Spending|
|Japan - Total Government Domestic Debt, % Of GDP (LHS); % chg, y-o-y (RHS)|
Economic Reforms Not Certain Or Uniform
The LDP government is planning to ensure that growth from the first two arrows is sustainable beyond the short term. Under the third arrow of Prime Minister Abe's revitalisation strategy (announced in June 2013), the government has stated that it will carry our several initiatives to deregulate key sectors and provide support for Japanese producers. Some of the initiatives include the launch of strategic special zones to attract foreign investment, the full liberalisation of the electricity market and the increased use of public-private partnerships and private finance mechanisms to impl ement infrastructure projects.
These initiatives could increase construction activity over the long term, but it remains to be seen if they are to be successfully implemented by the LDP government. The lack of strong executive leadership within the Japanese political system means that the implementation of these economic reforms could be hampered by political upheavals - Shinzo Abe is Japan's 15th prime minister in 20 years - and factional rifts within political parties. Although the LDP and its New Komeito coalition partner have a 'super-majority' in the lower house following elections in December 2012, they would need to repeat this favourable outcome in the upcoming upper house elections in July 2013. Without control of the upper house, the LDP's ability to push through its economic reforms could be severely weakened. At present, we highlight that strong support for the LDP remains, as the liberal fiscal and monetary policies carried out by Prime Minister Abe have boosted economic activity in Q113.
|LDP Win A Game Changer|
|Japan - Distribution Of Seats In The Upper House, %|
The third arrow also does not liberalise all aspects of the Japanese economy (such as the agriculture sector and the labour market) or tackle key structural problems that are dampening construction demand such as the country's declining population and worsening demographics picture. Such structural dynamics will continue to adversely affect construction growth over the long term. A decline in population growth is likely to eventually lead to a decline in demand for housing, electricity and intra-city transport services (such as urban rails), while a worsening demographic picture could impose greater fiscal constraints on the government (i.e. a decline in tax revenues due to shrinking working population and an increase in public welfare expenditure), making it difficult to finance new construction projects.
|Japan - Key Population Ratios|
Therefore, we remain bearish towards the Japanese construction sector over the long term, with the sector forecast to contract at an average rate of 0.7% per annum between 2017 and 2022.
|Roads And Utilities Lead Growth|
|Japan - Infrastructure Industry Value Forecasts, By Industry, JPYbn (LHS); & Real Growth, % chg y-o-y (RHS)|
Overall, these macroeconomic developments would have varying ramifications in the sub-sectors that make up the Japanese construction sector, particularly in the infrastructure sector, which is reliant on public spending. We expect roads and the utilities sectors to be the primary drivers for infrastructure activity between 2013 and 2015, with infrastructure real growth averaging 3.5% per annum between 2013 and 2015. However, the potential decline in construction investment from the public and private sectors as well as the structural weakness in Japan's macroeconomic environment could reverse this bullish growth performance, with infrastructure real growth forecast to reach a negative 2.1% in 2016 and average a negative 0.3% per annum between 2017 and 2022.