26May 2016

Hugh Young

Managing Director of Aberdeen Asset Management Asia

Japan: why faltering reforms shouldn’t hide corporate achievements

Japan looks set to go to the polls this year. The Japanese could be casting their votes as early as June in elections to fill around half the seats in parliament’s upper house. Prime Minister Shinzo Abe may also call a separate snap general election if he thinks this would enhance his chances of securing four more years in power.

Voters are being asked to choose their leaders at a time when the economy is struggling. It shrank in the fourth quarter of last year after narrowly avoiding a technical recession in the preceding three-month period.

Despite the best efforts of the Bank of Japan, a 2% inflation target remains elusive because consumers lack the confidence to spend freely. In fact, the country seems to be flirting with deflation once again, in a worrying sign that, despite some three years of Abenomics, nothing has really changed for the man in the street.

The central bank’s latest move – negative interest rates – is seen by some as evidence that policymakers have run out of options and are now resorting to ever more desperate measures to promote growth.

For the time being, the banks haven’t passed these negative rates to their depositors, but if they do, people might as well start stuffing cash under the mattress – taking money out of circulation and thwarting the Bank of Japan’s aim to inject liquidity into the financial system.    

Why is the economy losing steam again? There are many reasons but clearly Japan has made little headway in tackling the structural issues essential to boosting productivity and competitiveness. What’s more, Japan, like other exporting economies, is struggling with weak demand for its goods as other major economies grapple with their own problems.

Behind this is an increasing sense that Abenomics is less of a coherent economic programme than a series of single-issue agendas: raising the consumption tax; the central bank’s inflation targeting; the need to keep the yen competitive.

Part of that impression comes from Abe himself. The prime minister seems more interested in making Japan a regional power again, hence his desire for a more muscular mandate for the armed forces (which is at odds with the country’s pacifist constitution). He also wants to restart Japan’s nuclear plants with the memory of the Fukushima disaster still fresh in many people’s minds.

These pursuits have made him less popular, as have damaging ministerial scandals. But Abe remains the electorate’s only real choice because there are no serious challengers within his own Liberal Democratic Party, or among the opposition.

From afar foreign investors may be forgiven for thinking that reforms are a pre-condition for investment success. Clearly if Abenomics does come good then the outlook for Japan improves considerably.

But the country’s best companies – firms such as Japan Tobacco, the third largest cigarette company in the world, Fanuc, the world’s largest robot-maker and Calbee, Japan’s leading snacks manufacturer – haven’t been sitting around waiting for politicians to deliver on their promises.

That’s why we continue to be optimistic. The best companies have been expanding overseas revenues for years now. Today around a third of revenues generated by the 1,933 companies in the Topix index comes from outside Japan and the proportion of overseas earnings is only set to expand.

This allows firms to benefit from growth in other parts of the world, especially in fast-growing emerging markets where middle class affluence is driving demand. Many of the best companies have relocated their manufacturing to lower-cost countries. As the factory automation industry demonstrates, the best are industry leaders that have developed world class technologies and manufacturing processes.

We have also seen improvements in corporate governance. For example, senior executives are more accessible, while inclusion in the JPX-Nikkei 400 index, which was launched in 2014, rewards the most shareholder-friendly companies.

Japan’s economy faces daunting problems that have been well documented. When the country’s biggest nappy-maker sells more adult incontinence nappies than baby nappies, no amount of tinkering with monetary policy will help.

But we’ve been investing long enough to know that even the most challenging markets can play host to really good companies.

Japan is no different. The country’s best companies were forced to adapt to the conditions that defined the country’s ‘lost’ decades. Our sense is that, over time, their fortunes will become ever less tied to that of the country they call home.

Hugh Young, Managing Director of Aberdeen Asset Management Asia

Image credit: © PATRICK SEEGER/epa/Corbis

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