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Economic Outlook 2016: Japan

Ai Uchida

This week, Newsline will air a five-part series on the world's biggest markets. We'll ask experts to talk about how each market is likely to fare in the year ahead.

We begin with Japan. Many firms here had a bumper year, but 2015 wasn't so good for the economy as a whole.

We asked Robert Feldman, Chief Economist at Morgan Stanley MUFG securities, how 2016 is shaping up. He's spent decades analyzing the Japanese economy.

Uchida: What kind of year are you expecting?

Feldman: In 2016, we're expecting a moderate growth. For the calendar year, we have 1.2 percent, for the fiscal year, a little bit higher. That will include a little bit of demand brought forward before the consumption-tax hike in 2017. So it'll be a good year, not a huge year for growth.

The export sector's doing a little bit better. Net exports are doing a little bit better. We've got some recovery of consumption coming along, and a little bit of acceleration of capex. So those are the key three things that are behind it. None of them is, you know, wildly positive, but they're all contributing some.

Uchida: What would you say is the number-one risk to the economy?

Feldman: I think the number one risk to the Japanese economy is complacency. When things get better, people sort of slow down and say, 'Well, maybe I don't have to do as much reform as I thought I did, because things are okay. And maybe we can go a bit slower.' That's exactly kind of the thinking that pushes you back into a crisis. So to me, the key risk in the Japanese economy is that people get complacent and fail to do the investments they need, make the changes in industrial structure they need, make the changes in regulation that they need, make the changes in corporate behavior that they need in order to raise productivity growth. That's, to me, the key risk.

Bank of Japan policymakers have spent nearly three years pumping money into the markets. Feldman anticipates their monetary easing program will continue, but in a different form.

Feldman: Now the problem they've run into now is buying ¥80 trillion of bonds per year means you run out of bonds to buy. And they're getting pretty close to that. So there has to be some kind of regime change. The trick is how do you maintain the current amount of easing without buying the 80 trillion? And the answer is you target real yields. So we think somewhere during the year, they're going to shift to a different kind of regime where they can hold the real yields down by buying any bond that anybody wants to sell up to a certain yield level and keep the real yields down in that fashion rather than saying, '80 trillion, 80 trillion, 80 trillion,' as they have for the last few years.

Over the past two years, we've seen the yen fall by 20 percent against the dollar. Feldman says this year the Japanese currency will come back.

Feldman: We actually are expecting the yen to strengthen a bit by the end of 2016. The real effective exchange rate of the yen already is extremely weak. Second, some of the private pension funds in Japan are beginning to repatriate foreign assets in order to pay out pensions, because they're in the pay-out phase now. And third, our view is that the markets are overestimating the pace of federal-reserve rate hikes, also overestimating the likelihood of Japan further monetary easing. And if markets are wrong on both sides of that, as we think they are, then the current exchange rate for the yen is probably a little too weak, and so it should strengthen.

Uchida: Are you optimistic for Japan in 2016?

Feldman: Yes, we are, because we see enough going on in the reform side, enough going on in the exiting of deflation, that we think that the economy will do okay. It's not going to be brilliant. We're not at 2% growth yet, probably not going to be. We need more progress on inflation, we need more progress on capital investment by businesses so that inflation can help them invest more, or the inflationary environment can help them invest more, so that they can raise productivity growth.

For Tuesday's instalment of our "World Economic Outlook 2016" series, we'll take a look at China.

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