Japan Report June 2016 | By the Hon. Andrew Thomson Yet all is not lost. The larger companies are pushing ahead with overseas M&A, and are doing so in a more sensible fashion. The cyclical lows in commodity and energy prices have boosted corporate profits, easing the impact of the slowdown in China. Foreign tourist numbers are still strong and are likely to continue growing as we move towards the 2020 Tokyo Olympic Games. This is helping Japan’s retailers, airlines, and hospitality firms who benefit from tourist spending. On the international front, Prime Minister Abe’s vigorous diplomacy in every part of the world has restored confidence in the ability of government to protect the nation’s interests. The tension with China over the islands in the East China Sea has eased as the focus of conflict moves to the South China Sea. In May, Abe hosted a G7 Summit in Japan which came and went without controversy. And the summit was followed by President Obama’s historic visit to Hiroshima, an event that did much to assuage the feelings of the survivors of the atomic bomb. Further, to everyone’s relief, North Korea suffered yet another failed test of a medium-range missile on the last day of May. The threat from Pyongyang has not gone away, but at least it isn’t quite what Kim Jong-Eun claims it to be. Introduction As another summer approaches Japan continues to confront an unpleasant reality: there seems little prospect of achieving the reforms necessary to sustain its industrial prowess and maintain the standard of living its people have come to accept as normal. The population continues to age, though the birthrate is finally stabilising, Political reform, fiscal reform, and an end to the constant use of public spending as a stimulus seems far off. 1 Lander & Rogers | Japan Report - June 2016 Japan Report - June 2016 | Lander & Rogers 2 The Japanese economy continues to putter along as best it can, the annual real GDP growth rate running at a barely tolerable 1% or so. A labour shortage has pushed the employment ratio (a measure of available jobs to available workers) to 1.34% nationally, almost as high as it was in 1990 just before the Bubble Economy crash. This good news for employment, however, is not translating into stronger consumer spending or better GDP growth, and the outlook for domestic growth remains dim. There are two big issues in finance and the economy these days. The first is the negative interest rate policy of the Bank of Japan, which has failed to do anything for GDP growth except perhaps push up real estate prices in Tokyo. The BOJ has got itself into a difficult position where it will be very wary of raising rates into positive territory in future for fear of choking off what little growth there is in the economy. The second big issue is fiscal reform and the need to raise the consumption tax from 8% to 10% in order to change course towards a sustainable budget. This was due to happen this year, but Prime Minister Abe announced this week that the increase will be postponed for two years. Why the sudden turnaround? Abe said the G7 leaders frowned upon Japan urging other countries to stimulate their own economies while Japan itself is planning a tax rise. So in the face of sustained criticism from his fellow leaders (chiefly Merkel and Cameron), Abe buckled, leaving Finance Minister Aso Taro in a terrible public position. Aso has been warning for a long time that the budget needs repair in order to support the massive health and welfare burden of an aged society. Efforts to reign in Japan’s budget deficits and chronic borrowing are not being helped by pressure from the Cabinet and the incumbent Liberal Democratic Party to keep on spending. But strange moves are afoot. Japan’s public debt burden appears to be falling, at least on paper. Has the Abe Government stopped borrowing? Far from it. If you look at the statistics, the amount of government debt in private hands (banks, insurers, individuals) is now falling, and may reach 100% of GDP in two years, down from 177% in late 2012. What sort of magic is this? The Bank of Japan is now buying 90% of bonds issued by the Japanese Government at a rate of around $80 billion a month. These bonds, being owned by the central bank, are not in “private hands” for statistical purposes, so the ratio keeps falling. Quantitative easing is the polite, fictitious word for monetisation of government debt – pure money printing. The danger with this is that a sea change in global sentiment about the yen might see it fall drastically in value, igniting inflation within Japan and making imports of energy and metals suddenly very expensive. This would be a disaster. Just how long this monetisation policy can be sustained is a scary thing to ponder. Worse news came in the first week of June when Mitsubishi UFJ Bank suddenly announced it was handing in its primary dealer licence and would no longer participate in government bond auctions. The bank cited the negative yields on Japanese Government bonds – now at a yield of -0.092% - as the reason for walking away from the auctions. Buying negative yielding bonds is a one-way street to making large losses, and, not surprisingly, the bank’s shareholders were complaining about the bank doing this. Whether other banks will follow suit and withdraw from the auctions is yet to be seen, but it demonstrates the futility of the BOJ’s negative interest rate policy. Finance and the economy “The BOJ will be very wary of raising rates into positive territory in future for fear of choking off what little growth there is in the economy. ” Politics and government 3 Lander & Rogers | Japan Report - June 2016 “Within the LDP there is the usual pressure from the factions for a change when Abe’s current term under party rules ends in September 2017 ” The Abe Government remains reasonably popular among voters, the approval rating for the cabinet rising to 56% after the G7 Summit and Obama’s visit to Hiroshima. An election for the Upper House of the Diet is scheduled for July. While the various opposition parties have finally agreed to pool resources in certain battleground seats to fight the LDP more effectively, the outlook is for Abe to gain a few seats on the back of his vigorous campaigning and his deft footwork as Prime Minister. Employment is strong, the yen is more or less stable, and overseas troubles have faded in their intensity. The real question is whether the LDP and its ally the Komeito Party (a Buddhist-based group dedicated to clean government ) can achieve a two-thirds majority in the Upper House necessary to push through constitutional reform legislation. It’s unlikely that the Komeito would support the entire reform program of the LDP conservative faction, such as removing entirely the pacifist clause, but the LDP under Abe remain determined to get rid of the American-written constitution and introduce their own version. Another question is Abe’s longevity as prime minister. Within the LDP there is the usual pressure from the factions for a change when Abe’s current term under party rules ends in September 2017. But if he can avoid an economic disaster before then (most likely a run on the yen and a spike in inflation), or if there is a serious clash between China and the US over the South China Sea, Abe may yet wrangle another term based on the need for stability. International issues Japan Report - June 2016 | Lander & Rogers 4 “The Japan-China relationship remains tense, but not dangerously so at the moment. ” It’s fair to say that Japan has been shocked by the rise of Donald Trump in the Republican primaries and by what Trump has said about Japan and the security alliance between the two countries. Trump has insisted that Japan pay all the costs of the US military presence here. At present Japan claims to be paying around 75% of these costs, and Abe’s ministers have politely pointed out that the US is in North Asia to protect its own security and trade interests as well as provide security for Japan and South Korea. How would Abe get on with a President Trump? This is very difficult to predict. Behind the scenes, Japan is doing everything it can to strengthen relations with the socalled Republican Establishment in the hope of countering Trump’s hostile tendencies if he makes it to the Oval Office next January. The Japan-China relationship remains tense, but not dangerously so at the moment. China has eased off its pressure on Japan over the Senkaku Islands (which it claims as sovereign territory and call the Diaoyu Islands). Japan has stepped up efforts to aid Vietnam and The Philippines as a counter to China’s advances in the South China Sea. Indeed, a Japanese Maritime Self-Defense Force (i.e. Navy) made only the second ever call to the Vietnamese port of Cam Ranh Bay in May. But it’s the election of Tsai Ing-Wen as President of Taiwan that is the newest tricky diplomatic issue in Asia. Tsai was sworn in on 20 May. As President she has promised to maintain the status quo with Beijing while studiously avoiding any mention of the One China Policy, which is the bedrock of the peaceful relationship with Beijing. Yet Tsai in her heart is a pro-independence Taiwanese. Japan has been making moves to improve relations with Taiwan, which suffered under her conservative, pro-China predecessor, Ma Ying-Jou of the KMT party. An overt statement of support for Taiwan from Japan would be too provocative a measure at present, but if a new US president were to do so to face down Beijing then Abe would probably do his utmost to join in. Such a turn of events would be very dangerous. China’s Xi Jinping was once governor of Fujian Province and keeps a close eye on Taiwan. He could not tolerate foreign powers such as America and Japan stepping in to allow democratic Taiwan to break free. It would very likely force Xi to take military measures in response, and there must be some doubt about America’s willingness to risk all its security and trade interests in Asia over the island. A continuation of the tension between Taiwan and Beijing is the status quo that everyone needs. The international situation worsened in the first week of June. In a shocking move, at 9.50pm on 8 May a Russian naval vessel appeared in the contiguous zone around the Senkaku Islands, the first time this had ever happened. Then at half past midnight on 9 June a Chinese naval frigate likewise entered the contiguous zone. The Japanese Government expressed shock that (a) China had for the first time sent a naval vessel into the Senkaku waters (until now it has been limited to unarmed coast guard vessels), and (b) Russia was now coordinating with China to penetrate Japanese sovereign waters with armed naval vessels. 5 Lander & Rogers | Japan Report - June 2016 Japan’s national project to develop a hydrogen fuel industry for fuel cell vehicles (FCVs) continues to make steady progress. Earlier this year, Kawasaki Heavy Industries (KHI) announced a tie-up with Royal Dutch Shell to build and operate tankers designed to transport liquid hydrogen across oceans. The source of this mass-produced hydrogen is said to be Victoria’s brown coal reserves, but little headway has been achieved in realising this project. Meanwhile, R&D efforts are proceeding to find other ways of mass producing hydrogen. In May, Toyota and JX Energy—Japan’s major oil refiner— and several other companies announced a cooperative project to build a national network of hydrogen fuel stations for FCVs. Until now the effort to build these fuel stations has lagged the government’s target due to various companies pursuing their own rollout. By bringing the car makers into the joint effort it is hoped that the spread of FCVs will be boosted. The companies include Toyota, Honda, Nissan, Iwatani, JX, and Tokyo Gas. The new JV company will be capitalized at around Y10 billion (around US$90 million) and will receive subsidies from the government to build the hydrogen stations, which will be operated by the energy companies. METI has set a target of 40,000 FCVs by 2020, though as of now only 600 FCVs have been sold. The problem has been a lack of fuel stations. METI set a target of 100 stations by 2015, but so far JX and Iwatani have only 80 stations in the pipeline. Each such station costs Y400 million (US$3.6 million) to build and around Y40-50 million (US$360,000- 400,000) a year to operate. The current network of FCV fuel stations is concentrated in Aichi Prefecture (near Toyota), Tokyo, Kanagawa, Osaka, and Fukuoka. Artificial intelligence (AI) technology is another area where the Japanese Government is going all out to support industry in commercialising it in order to stay ahead of competitors, such as China, Korea, and the US. Dozens, if not hundreds, of Japan’s larger companies and banks have made AI a high priority. In particular, driverless cars are much touted as an AI product. Honda has set up a dedicated R&D centre for AI, concentrating on image and speech recognition, robotics, and software control. Electronics giant Hitachi is deploying AI technology into its smart-grid market systems, using AI to accurately estimate electricity demand by drawing on weather data, power consumption in office buildings and factories, and other consumer data. Hitachi is trialing a micro-grid in New York State with AI technology and claims the increase in efficiency can lower electricity costs by 10%. AI is also one of the key planks in the government’s labour policy. The government announced a growth strategy centred on what is now called the fourth industrial revolution of robotics and AI. Japan has a strong cultural aversion to immigration as a way of sustaining its population, and productivity growth is hampered by a labour and skill shortage in many areas. Can AI solve the population problem? Time will tell. Every week there are stories in the media about robots being used in aged care homes to help look after the residents. Bringing in and training sufficient numbers of Thai and Philippine workers to work as carers would solve the labour shortage in this sector, but when you consider industrial policy as a collateral benefit it seems Japan’s elderly will be getting a lot of their meals and even medical care from robots in the future. NEC, Fujitsu, and Hitachi are the companies most often associated with AI, but others, such as Softbank, are teaming up with IBM to use the latter’s Watson AI system in Japan. One of the cultural challenges for AI in Japan is known as jimae shugi – the habit of companies to develop in-house, non-collaborative technology to safeguard intellectual property. In the AI field such an approach is counter-productive because of the breadth of the technical aspects involved. Thus some companies such as Toyota, Fanuc, and Panasonic have begun collaborating through the company called Preferred Networks to jointly use AI for robotics and driverless car systems. Japan’s industrial priorities – hydrogen fuel and AI “The government announced a growth strategy centred on what is now called the fourth industrial revolution of robotics and AI. ” T: +81 92 328 3002 M: +81 80 4405 5025 email@example.com Andrew is Japan-based counsel and a member of Lander & Rogers’ Japan Client Group. He is involved in developing relationships with clients and targets in Japan and assists them with their commercial strategies for entering the Australian market. Andrew also provides “on the ground” support to our Australian-based clients wanting to do business in Japan. Andrew is a former Federal Minister in the Howard Government. He served as Parliamentary Secretary for Foreign Affairs, Minister for Sport and Tourism, Minister assisting the Prime Minister for the 2000 Sydney Olympic Games, and Chairman of the Joint Standing Committee on Treaties. Andrew speaks fluent business level Japanese, having studied at university in Japan in the 1980s and practised there since 2011. Hon. Andrew Thomson Further information Hon. 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