Abe’s Third Arrow

Japan’s Abe’s gamble to call snap elections shortly after the stunning
defeat in the Tokyo elections appears likely to pay-off.
  He called
the bluff of his former defense minister
and now Governor of Tokyo Koike who is leading the main opposition party now,
the Party of Hope.  The Party of Hope may have over-reached and now
appears to be stumbling.   The polls suggest that the LDP may secure
more seats in the lower chamber than it a current
hold.  

Even though the LDP may not need to be in a coalition, it still seems
likely that the junior coalition partner, the Komieto Party, will remain in
government, even if it loses a few seats.
  In other countries, this
may not be the case, but in Japan, a coalition is helpful in demonstrating the
consensus nature of policy and soften the image of the LDP, which has largely
governed Japan with only a few exceptions
for more more than 60 years.  

Recall that when Abe was first elected, Abenomics was presented as three arrows.  Fiscal stimulus, monetary
stimulus, and structural reform.  The first two are tangible.  The third is more elusive.   It is
more elusive not because it is less real or developed, but because the
structural reforms are more numerous and may deny an easy soundbite to capture
imaginations, the way that greater public investment or quantitative and
qualitative easing and targeting yields are
easily grasped
.  

Among the unsung efforts is are corporate governance reform. 
Recent news of Kobe Steel falsification of the strength of several of its
products, used in auto and airplanes, and
Nissan’s decision to shut all of its domestic output for the next two weeks as
it rebuilds its inspection operations illustrate to many the ongoing needs for
greater efforts.  Still, these
issues seem to involved fraud, which is illegal even before
Abenomics.  

The key institution to watch for corporate reforms is the Financial
Services Agency (FSA).
  It met earlier today.  It continued to
develop the stewardship, and corporate
governance codes and the changes announced a few months ago, regarding asset
managers, including disclosure of shareholder specific voting records, and
strengthening stewardship of asset owners (including GPIF).  What caught
our attention were new issues that the FSA identified.  

Two of its concerns seem related.  The FSA appears to be getting
more interested in the “hoarding of cash in internal reserves” and
the low management awareness of the cost of capital.  It also expressed
concern about the slow pace of unwinding cross-shareholdings.   

Reports suggest the FSA will develop guidelines to encourage the
deployment of the some JPY406 trillion (~$3.6 trillion) on corporate balance
sheets
. The large cash piles, in the face of weak investment and wage
growth, has become politicized in Japan.  The Party of Hope, which may be
the largest opposition party in Japan, has suggested taxing retained earnings. 
The FSA does not appear to want to go
down this route, recognizing that businesses ought to decide how to use their
earnings.  Nevertheless,  the FSA cited its own surveys that show a clear divide between how companies and
shareholders view the cash, and this is of a concern given the emphasis on shareholder value.  

The FSA found that 60% of the businesses consider their cash holdings
appropriately sized, while more than 80% of the shareholders think the cash is
excessive. 
Retained earnings in Japan have risen by more than 40%
over the past five years, according to the FSA.  When asked, how the cash
should be used, more than 60% of
investors favored growth investments.  Nearly 1 in 16 agreed with the
corporate priority of keeping such large liquidity on hand.  Nearly 2/3 of
investors did not think businesses satisfactorily
explained the size of their cash holdings
.  

The FSA recognized that the return on equity for Japanese companies has
been rising, but it is still low by international comparison.
  It
cited that nearly one in three companies trade less than book value.  It
also noted that while the large banks have made consistent progress towards
unwinding cross-shareholding, non-financial firms have been considerably
slower,  They detect declining interest and many firms still admit to
cross-shareholding accounted for nearly half of their shares.   

Foreign investors were net sellers of Japanese shares this year until the
last few weeks.
   MOF weekly data that covered through October
13 showed foreign investors been on a three-week buying spree that was the
greatest since at least 2001 when the
current time series began.  The buying seems to be driven by the decline in the yen, the rise in US yields, and
expectations of continuity in Japanese politics.  Even though incumbents
have been turned out of office, or severely punished, as May and Merkel were in the UK and Germany, Abe
and LDP appear to be exceptions.  Perhaps the trouncing in Tokyo in July
was a catharsis of sorts.  The Nikkei is up nearly 5.4% this month. 
It follows a 3.6% gain in September.  The Topix and Nikkei are trading at
their best levels in two decades.  The domestic buying appears to have
primed the pump and also may have encouraged the renewed foreign
interest.  

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