Japanese Prime Minister Shinzo Abe announced this week that he will dissolve the lower house of parliament and conduct an early election on October 22. The House of Representatives election will be the last for Abe (he can be prime minister until September 2021 if he wins the LDP’s leadership election in September 2018).
The timing of the election is earlier than most people expected. But Abe seems to think October is the best time for three reasons:
• Abe’s approval rating has improved to 40-50 percent from around 30-35 percent two months ago thanks to his hard stance on North Korea and an improving economy (2Q GDP grew 2.5 percent q/q annualized).
• Since the recent leadership election, the largest opposing party, the DPJ, has been in disarray as several of its members resigned amid political scandals.
• Calling for an early election will give Tomin First (the new party led by popular Tokyo Governor Yuriko Koike) less time to form a national-wide opposition bloc to run against Abe’s LDP.
Likely policy agenda for election campaign
Abe is likely to focus on five policies during the election campaign: the acceleration of Abenomics; a VAT hike as scheduled, with the reallocation of tax revenue to education; enhancing the Work-Style Reform; changing Japan’s Constitution, including the revision of Article 9; and measures regarding the North Korea crisis.
Also, Abe is likely to implement an additional supplementary budget of around 2 trillion yen (0.4 percent of GDP) without the issuance of new JGBs; but we do not expect any new economic policies that will boost Japan’s growth or productivity.
Positive in the short term, but slightly negative in the end
We think the market will continue to react positively in the short term, similar to how it reacted following previous snap election announcements. Also, the market might expect the political situation to improve after the election, which could extend the lifespan of Abenomics, with Abe implementing new policies to revitalize the economy.
However, we think investors will soon realize that the implications of an early election may not necessarily be positive. Rather, things may turn sour after the election for the reasons below.
• Firstly, while Abe’s popularity has recovered to 40-50 percent, we think it will be difficult for the ruling alliance (LDP and Komei) to maintain its two-thirds majority in the Lower House. Currently, it holds 321 (LDP 286, Komei 35) out of the 475 seats. Due to some electoral changes (related to sectioning), the total number of seats will be reduced to 465 seats from 475 now (which means the alliance needs 310 seats to maintain its two-thirds majority). And in case the LDP’s seats are reduced to less than a simple majority (232 seats), Abe’s power to push policies through will be weakened.
• Secondly, Abe is likely to propose a VAT hike, which will take effect in October 2019. This may hurt equities because the market was expecting the VAT hike to be postponed. Even though most of the tax revenue may be re-allocated to new spending on education and childcare, we think the net impact on the economy would be still negative.
The last sales tax hike in 2014 (from 5 percent to 8 percent) hurt consumer spending seriously. Abe also plans to delay the primary balance target, which is to achieve a surplus by 2020. Even if the VAT hike is introduced as scheduled, a primary balance surplus by 2020 is unlikely. But as the delay in achieving a surplus is widely expected, it would likely have limited impact on the market.
• Thirdly, a new Abe government would likely prioritize changing Japan’s constitution (to clarify the country’s self-defense stance in Article 9, which defines Japan’s pacifism) over economic reforms that boost growth or productivity. Beyond the education pledge, we do not expect a dramatic fiscal expansion or painful (but necessary) economic reforms/ deregulation. We think a fresh election increases the chances of BoJ Governor Haruhiko Kuroda being reappointed, versus a more radical dove like Honda Etsuro.
Although the market has been reacting positively to news of the snap election, we do not expect any effective economic policies that could boost Japan’s growth or productivity. If the LDP and Komei maintain a two-thirds majority, the market may react more positively. Still, we believe prioritizing the revision of the constitution over painful (but necessary) reforms and a VAT hike as scheduled could weigh on market sentiment. Investors should focus on stocks that are likely to benefit from increased spending on education and workforce training, as well as on beneficiaries of a serious labor shortage and an improving inflation trend.
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