Can Abe recover his popularity?

Can Abe recover his popularity? July 14, 2017 Managing Director Chief Economist Takuji Okubo +81.3.6894.9462 takuji.okubo@japanmacroadvisors.com Executive Summary In July, Prime Minister Abe's approval rate fell to 34%, the lowest polling results since he became the PM at the end of 2012. Can he recover his popularity and sustain his Abenomics policies? The economy is on his side, as the Japan is likely to have enjoyed 6 quarters of consecutive positive growth by this April- June quarter. However, past relationship between the economy and the survival rate of prime ministers suggest that economy alone will not save a government. If Mr Abe is to lose power, it will have a profound and destabilizing impact to the Japanese economy. PM Abe's popularity plummeted in the last 3 months Prime Minister Abe s popularity has sharply fallen in the last two months. In May, his government was enjoying 51% approval rate while only 33.5% of Japan's population expressed their disapproval. However, in the polls conducted separately by four large media organizations in Japan, the approval rate fell to 34% on average, the lowest approval rate since Mr Abe became Japan s Prime Minister at the end of 2012. The sharp decline in his popularity was driven by a series of scandals involving PM Abe and his close political allies. In the scandal involving PM Abe himself, he and his government are alleged to have provided undue favor to his personal friends. 1

What are the political and economic consequences? The sharp decline in PM Abe s popularity begs following two groups of questions. 1) Can Mr Abe recover his popularity? What are the chances he may be forced to resign? If so, when? 2) How does the loss of his popularity and potential change of PM affect economic policies in Japan? PM Abe was able to recover from a temporary loss of popularity in 2015 This was not the first time PM Abe suffered a sizable damage to his popularity. In the summer of 2015, his approval rate fell to 38.5% when he passed the unpopular Security Law in the Diet that enabled Japan to send its Self-Defense Force to military missions abroad. However, His popularity recovered in the succeeding 18 months as he pivoted his focus on the economy and delivered consistent growth. The Japanese economy grew positively in all of the 4 quarters of 2016. The unemployment rate was already low in the summer of 2015 at 3.4%, but it subsequently fell even further to 3% by the end of 2016. Economy is still on his side... From an It s the economy, stupid point of view, PM Abe has been and continue to be enjoying a follow-wind. The streak of positive growth in 2016 is being extended into the first half of 2017 and there is no apparent dark clouds on Japan s economic horizon. While other central banks in the world are turning to tighten their monetary policies, the BoJ seems persistent in maintaining its easing stance. Such disparity in monetary policies is likely to weaken yen, bolster Japan's economy and enable PM Abe to score economic points. 2

...But economic performace is not the biggest vote winner in Japan On the other hand, a review of past empirical studies in Japan on the relationship between economic performance and the longevity of governments seem to suggest that the economic performance may not be the dominant factor for voters. One example is the Koizumi government whose approval rate never fell below 40%. Under his government, the unemployment initially rose from 4.8% when he took the helm in April 2001 to 5.5% in April 2003, and it did not fall back to 4.8% until late 2004. However, apart from the initial decline that happens to any government, his popularity remained mostly high and level through the period. The unemployment rate eventually started to fall in 2004-2006, but we do not see any noticeable positive outcome to his popularity from the decline in the unemployment rate. No apparent causality between unemployment rate and popularity Note: Cabinet Approval Rates in this chart are from polls conducted by Asahi Newspaper. Source: Asahi Newspaper, MIAC, JMA 3

Economy alone may not save PM Abe this time Thus, judging from the past relationship between the economy and support for ruling government, the robust economy alone is unlikely to guarantee the recovery of popularity for PM Abe. One clear conclusion from past empirical studies on the survival rate of governments in Japan the decay in popularity with the passing of time. In this regard, as PM Abe has already been in power for 4 years, recovering his popularity should be tougher now than 2 years ago. Also, the loss of his popularity in 2015 was due to his unpopular policies. This time in 2017, it is not his policies, but his behaviour that is causing growing public mistrust. PM Abe still has a chance to staging a come back In our view, 34% is not yet a crisis level and he could still come back from the trough if he finds the right buttons to push. He is fortunate in not facing an important parliamentary election for another year, except for one by-election in Shikoku area this October. The next important one is the general Lower House election in December 2018. Such respite gives PM Abe plenty of time to try to recover his popularity. He has already announced his intention to reshuffle his cabinet in early August. He is still maintaining his direction to his ruling party to submit its proposal for constitutional revisions, but there is a chance he may retract his marching orders. While the revision of Japan s constitution is important to him personally, probably much more than economic issues, PM Abe understands that pushing ahead with the revision may be self-defeating as it could cost him the job. Better recover his popularity, win the Lower House election in 2018 and try again. Just as he did in the second half of 2015, pivoting his attention back to economic issues and shelving the constitution revision off his agenda could be his road back to popularity. What are the chances that PM Abe would be forced to resign in the next 6 months? The chances are slim, but we should not rule out the possibility. Further fresh scandals, potential defeat for the ruling party in the by-election in October could embolden some wings of his party to revolt, potentially deciding to form a new party by the end of 2017. The possibility of such scenario will increase if PM Abe tries to hold onto his unpopular and controversial constitutional revision agenda. PM Abe could decide to retire as PM in 2018 Alternatively, PM Abe could decide not to run for the LDP leadership election in September 2018. This scenario will become a quite realistic scenario if PM Abe fails to regain his popularity before mid-2018. As his party members demand an election-winning face to his party before the Lower House election in 2018, PM Abe may decide to retain his influence by agreeing to step down but recommend a successor. In our view, there is more than 50% chance that PM Abe will not be able to survive the two political hurdles in the second half of 2018, namely, the LDP leadership election in September and the general Lower House election in December. 4

How does the loss of Abe s popularity affect economic policies in the near term? One could argue that he may return his focus back to economic reforms. In our view, that is an illusion most of Japan policy watchers should have seen through by now. He was never an economic reformer. Of all the regulatory reform agenda he hoisted in his JAPAN is BACK strategy, most have failed to come through. Having said that, we could see some revival of his attentions to economic policies. The new-found willingness of the Japanese government to bring TPP11 to a conclusion is an evidence of such pivot back to economic issues. A renewed focus on economic reform could be an upside surprise we could see. A formation of fiscal stimulus could be another. It is also important to note that the terms of five out of nine BoJ policy board members will expire in the next 12 months. The most important seat will be that of the BoJ Governor Kuroda. HIs reappointment seems to us the likely scenario. He will be 73 years old by March next year, but he seems to in good health. Professor Takatoshi Ito, currently at Columbia University is a viable candidate, but his fiscal hawkishness may be an unwelcome attribute for PM Abe. When Abe is gone What could be the policy consequences if Abe loses power? His departure will have a profound and potentially destabilizing consequence to Japan s monetary policy and the yen. A strong resentment has been brewing within Japan s financial industry against the policy the BoJ has taken in the last 4 years. Even within the BoJ, many policy makers are wishing to dial back the aggressive balancesheet expansion and the strong-handed commitment to peg the long term interest rates. While the BoJ has started to taper its JGB purchase in the last 6 5

months, their holding is still growing. Regardless of the tapering, BoJ is quite likely to own over 50% of the whole government bond market at some point in 2018. How and if the BoJ could withdraw or even slow down its easing is another issue, but without the strong support from the government, BoJ is likely to be much less bold in pursuing its inflation target. The fiscal policy will also be impacted. The policy conducted by PM Abe was probably the dovish end of policy specrum and a change of leadership would probably mean a rebalancing toward fiscal conservatism. The next PM could argue that the economy is overheating, as evidenced by the labor shortage problems, and the economy warrants a mild tightening, starting with a raise in consumption tax rate to 10% in October 2019. In our view, these potential changes to the policy would be a grave mistake for Japan as it is close to reaching a point where the overheating in the economy would manifest itself as the long-awaited inflation. However, these points are probably not on the minds of the Japanese population when they consider whether to resume their faith in PM Abe or not in this autumn. About Japan Macro Advisors Our mission is to provide a concise and timely analysis on the Japanese economy for the benefit of global audiences. Communication, especially in foreign languages, has always been a weakness for the Japanese. For details on our service, please see www.japanmacroadvisors.com/products or send an inquiry to info@japanmacroadvisors.com Managing Director Chief Economist Takuji Okubo +81.3.6894.9462 takuji.okubo@japanmacroadvisors.com 6