Japan's economic challenges

Less than two years into his term, Abe recently dissolved the country's parliament and called a fresh election for December 14. The prime minister's announcement came a day after the Japanese economy slid into recession for the third time in four years, calling into question the effectiveness of "Abenomics" - a combination of monetary, fiscal and structural policies.

As Asia's second largest economy struggles with stagnation and deflation along with the largest debt-to-GDP ratio in the developed world, Abe also announced his decision to delay the second sales tax hike to 10 percent - planned from October 2015 - until 2017.

The latest contraction followed an initial sales tax increase in April to eight percent from five percent. Rajiv Biswas, Asia-Pacific Chief Economist at the analytics firm IHS, says in a DW interview that even if Abe wins the next election, he is likely to struggle to win political support for many of his reforms.

DW: Japan recently slipped into its third recession in four years. Has Abenomics failed?

Rajiv Biswas: Abenomics is on the ropes as the Japanese economy has plunged into yet another recession. PM Abe has called a snap election to seek an electoral mandate for his economic policies, particularly his plan to defer the next stage of the sales tax rise, which was due to be implemented in October 2015.

The reality is that PM Abe faces a monumental task to try to engineer a sustainable upturn in Japanese economic growth. The Japanese economic outlook remains bleak, faced with the highest government debt to GDP ratio in the OECD, ageing demographics and a declining population.

How has Japan benefitted so far from Abe's economic policies?

PM Abe's main economic policy platform has been Abenomics, comprising the "three arrows" of fiscal stimulus, monetary stimulus and structural reforms. The impact of fiscal and monetary stimulus was relatively easier to implement, and boosted growth soon after PM Abe took office. However, it has proven difficult to implement the third arrow of structural reforms due to political resistance to reforms.

As fiscal stimulus has faded and the sales tax hike has pushed Japan back into recession, the country still faces an uphill challenge to try to stabilize government debt levels as a share of GDP. Nevertheless, Japanese multinationals have benefited from Abenomics since the BOJ's monetary stimulus have resulted in significant yen depreciation, improving exports and boosting profitability for Japanese exporters.

How do Japanese assess the government's handling of the economy thus far?

Although the Japanese public was initially very enthusiastic about Abenomics, there is now much greater skepticism about the probability of success of PM Abe's economic policy measures.

However, the opposition Democratic Party of Japan (DPJ) is still scoring very poorly in electoral polls, which continue to indicate that PM Abe and the LDP will likely win the next election on a platform of continuing to pursue Abenomics. A key issue will be Abe's intention to delay implementation of the next sales tax hike from October 2015 to April 2017.

Why did Abe postpone the second sales tax hike initially planned for next year?

With the first sales tax hike in April 2014 having pushed Japan into recession, PM Abe decided the second hike planned for 2015 had to be postponed given the weak state of the Japanese economy.

PM Abe has not been able to unleash the third arrow of Abenomics - the structural reforms that are needed to boost growth - due to significant political hurdles. While deferring the next sales tax hike will help to stabilize the economy, Japan still faces a difficult fiscal outlook and unless further tax hikes or expenditure cuts are made, the government debt to GDP ratio is unlikely to be stabilized, let alone reduced.

In terms of fiscal policy, was it a mistake to implement the first sales tax hike in April this year?

The process of getting political agreement in the Japanese Diet for the sales tax hike was very contentious and heavily debated. Consequently, the Abe government may have been reluctant to reopen the issue about the size of the sales tax hike even though there were concerns about its negative impact on household consumption and GDP growth.

While it may have been better to implement the sales tax hike in smaller incremental steps over a number of years, the Japanese government was also under pressure to take some action to stabilize government debt levels.

In your view, what must Japan do to revive growth and fight deflation?

The Japanese economy is facing many key challenges to its economic outlook, including ageing demographics, high government debt levels and the continuing threat of deflation. Japan's manufacturing competitiveness has also been eroded by competition from other Asian manufacturing hubs.

For decades, Japanese manufacturing has faced hollowing out as the country's multinationals have located production facilities in low wage, fast growing emerging markets, notably in China and ASEAN countries.

Japan therefore confronts a difficult long-term outlook unless it can make significant structural reforms that lift average annual economic growth by between 0.5 percent and 1 percent per year.

While the BOJ had some success in moving Japan out of deflation into modest positive inflation, the latest global downturn in world oil prices could again act to reduce Japanese inflation rates in 2015. Japan's manufacturing sector has received some boost from yen depreciation, but Japan will also need to diversify its exports and increase the competitiveness in exports of services such as tourism and financial services.

If Abe gets reelected, what steps do you see him take in terms of fiscal and monetary policies?

The impact of BOJ's quantitative easing (QE) policies since PM Abe took office in late 2012 has resulted in the sharp depreciation of the yen, which has helped export competitiveness and corporate profitability. Initial fiscal stimulus measures implemented by the Abe government also helped to boost growth in 2013.

However, with fiscal stimulus fading and the sales tax hike hitting consumption, the Japanese economy faces a very weak medium term growth outlook. This will force the Japanese government to be increasingly reliant on monetary stimulus by the BOJ.

Eventually, unless significant structural reforms can be implemented following the elections, Japan will face a policy dilemma whereby the country will become highly dependent on continued BOJ QE policies with no exit strategy.

The third arrow of Abenomics is yet to be fully implemented. What development do you expect in terms of structural reform and do you expect Japanese society to go along with these changes?

Although PM Abe has been quite outspoken about the need for his third arrow structural reforms, and his government has proposed a number of significant reforms, there has been limited progress to date, due to political opposition from within his own party - the LDP.

Even if Abe wins the next election, he is likely to struggle to win political support for many of his reforms. Japanese society still remains very conservative and issues such as increasing foreign worker immigration to improve Japan's demographics are politically unpopular.

Even though other advanced countries such as the US, Germany, Canada and Singapore have used such immigration policies to manage their workforce demographics, any attempt at such reforms in Japan would face a political backlash from the Japanese electorate.

Rajiv Biswas is Asia-Pacific Chief Economist at IHS, a global information and analytics firm. He is responsible for coordination of economic analyses and forecasts for the Asia-Pacific region.