Is Abenomics Slipping? Stocks in Focus

Japanese Prime Minister Shinzo Abe’s much vaunted program to boost the country’s economy seems to be treading troubled waters. The country’s latest GDP figures reveal that the world’s third largest economy contracted during the last quarter of 2015, a development which threatens to derail Abe’s program of economic stimulus. A soaring yuan and the impact of recent monetary stimulus measures, namely negative interest rates, on the economy are other factors which have investors worried.

Q4 GDP Contracts

The last three months of 2015 were not particularly encouraging for Japan. Latest figures show that GDP contracted by 1.4% during the fourth quarter of last year on an annualized basis. This decline is far worse than all forecasts for the metric. It also comes immediately after a 1.3% increase in the third quarter of last year.

A fall in private consumption was the major reason for the contraction. Private consumption declined 0.8% during the quarter. However, a section of economists attributed the weakness in household consumption to the reluctance of consumers to purchase winter related products due to unexpectedly warm weather.

Soaring Yuan to Hurt Automakers

But there were other worrying details in the report. Exports declined by 0.9% during the fourth quarter. However, demand from abroad continues to make up nearly 0.1% of total GDP. This figure is arrived at if one takes into account the trade balance. Imports declined by 1.4% over the quarter.

Following the release of GDP data, the yen declined. However, Japan’s currency has moved upward recently and is expected to hurt the profits of exporters as a whole and automakers in particular. Last week, the yen surged to the highest level experienced since October 2014. This prompted analysts at Mitsubishi UFJ Morgan Stanley Securities Co. and TIW Inc. to forecast a decline in earnings for Japan’s automakers over the next fiscal year.

According to estimates compiled by Bloomberg, Toyota Motor Corporation (TM - Analyst Report) and six other automobile companies from Japan are expected to garner combined earnings of 4.55 trillion yen or $40 billion during the fiscal year which ends in March 2017. This would be the most dismal rate of growth experienced by the industry over five years.

Even this may be an exceedingly optimistic picture. The likes of Nissan Motor Co. Ltd. (NSANY - Snapshot Report) and Honda Motor Co., Ltd. (HMC - Analyst Report) have suffered major declines in operating income during the last quarter of 2015 due to unfavorable foreign exchange rates.

Impact of Negative Interest Rates on Banks

Given the dismal economic background, the impact of the Japanese government’s recent policy measures is also worth considering. On Jan 29, the Bank of Japan (BOJ) adopted a negative interest rate policy on Friday to ensure 2% inflation "at the earliest possible time." BOJ announced that it has cut its key rate to -0.1% on excess reserves.

A negative interest rate is expected to discourage banks and financial institutions from parking excess reserves with the BOJ. Instead, they may be lent to businesses and individuals, which in turn will ease flow of money into the economy. This in turn will help achieve the 2% inflation mark and improve the overall economy of Japan.

However, it is likely that the country’s large banks will suffer as a result of this decision. A section of analysts have predicted that this move will eat into the profits of major banks like Sumitomo Mitsui Financial Group, Inc. (SMFG - Snapshot Report) and Mitsubishi UFJ Financial Group, Inc. (MTU - Analyst Report).

Shares of these companies were downgraded by Citigroup Inc. (C - Analyst Report) earlier this month, predicting that earnings would come under pressure. Further, the move to push interest rates into the negative zone would reduce yields on bonds and domestic loans which constitute a major share of the balance sheets of these banks.

Can Abenomics Survive?

Several economists expect growth to rebound over the next few quarters. According to a survey conducted by the Japan Center for Economic Research, GDP is expected to expand by 1.44% during the first quarter of 2016. This would be the highest rate of growth recorded over five quarters.

However, the two major problems plaguing the economy are the soaring yuan and the reluctance of Japan’s companies to share profits. The move to fix negative interest rates was aimed at combating the first of these. The second issue can only be addressed by Abe’s promise to enact structural reforms such as those related to labor markets. Market watchers and investors have pinned their hopes on these measures which are likely to determine the success of Abe’s policies in the days ahead.