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Has Abenomics run out of steam?

Japan's foreign investors sense a chill in the air and may pull out in 2020

Changes to Japan's foreign exchange law impose tougher controls on foreign investment in companies operating in strategically sensitive industries.    © Reuters

TOKYO -- Japan's Prime Minister Shinzo Abe, whose government is in its eighth year, has thus far handled himself well on the international stage.

On the diplomatic front, Abe has managed to reach a trade deal with U.S. President Donald Trump without a major hitch. He has also gradually improved prickly Sino-Japanese ties. Last year, Abe successfully chaired the Group of 20 summit amid intense U.S.-China trade friction. His performance has made him popular at home, particularly among business people, contributing to his record-long premiership.

Similarly, Abe has had success with the domestic economy, engineering Japan's longest growth streak since the end of World War II. Abenomics, as his reflationary program in known, has relied on unprecedented monetary loosening by the Bank of Japan and heavy government spending to keep the economy ticking over.

These measures have produced a steady rise in stock prices, giving the economy a further boost. Foreign investors have responded positively, helping Japanese capital markets -- where individual domestic investors play a limited role -- to stay buoyant. Japan's ability to draw foreign capital in recent years is the biggest factor behind the success of Abenomics.

Immediately after Abe returned to power in late 2012, he appealed to the City of London, as the financial district is known, to invest in Japan. Although partly show business, the pitch was effective. The government touted U.S.-style reforms to Japan's corporate governance, particularly giving greater weight to outside directors on company boards. He made frequent references to directors' fiduciary duty, a Western notion unfamiliar to many Japanese: that is, their obligation to look after the interests of shareholders.

This year, however, keeping the favorable trend going looks tricky due to another big policy change. In the spring, Japan's revised foreign investment law takes effect.

The law requires foreign investors seeking to buy an equity stake of 1% or more in Japanese companies deemed important to national security to give advance notice and submit to screening by regulators. The government says the move is in line with measures taken by other Group of Seven members in response to concerns about Chinese investment, particularly in high-tech companies.

Data from the Bank for International Settlements in 2019 shows that Japan accounted for 4.5% of global foreign exchange trading, putting it in fifth place worldwide.   © Reuters

The new restrictions have drawn complaints from foreign investors, which the Ministry of Finance has tried to address by narrowing the range of industries requiring advance notice for big stock purchases. But investors have lingering doubts about how the rules will work in practice, fearing that the regulatory climate in Japan is becoming less friendly.

Not only are market participants worried about how the revised law will affect specific transactions, many were surprised to find that the government, which paid such close attention to investors previously, pressed ahead with the changes and left until after the fact the question of how the new rules would affect those looking to buy a piece of corporate Japan.

Japan still has a long way to go if it wants to draw big capital flows from abroad. Data compiled last year by the Bank for International Settlements reveals that Japan accounted for just 4.5% of global foreign exchange trading, putting it in fifth place. The survey, conducted once every three years, shows that Japan's share of global forex trading has fallen since 2004, when it accounted for 8% of the total behind only the U.K. and the U.S. Even among Asian economies, Japan has been overtaken by Singapore and Hong Kong in recent years.

It is cause for concern that Japan's share of global forex transactions has fallen below where it was when Abenomics was launched in 2013. This underscores the relative decline of Tokyo as a global market and may reflect growing investor disillusionment with Abenomics, particularly delays in dealing with the structural problems in the Japanese economy and the government's complete reliance on fiscal and monetary expansion to gin up growth. Even discounting for the vagaries of the foreign exchange markets, it seems clear that drawing foreign money to Japan is becoming harder.

Later this month, the Abe government will present to parliament a supplementary budget for fiscal 2019 worth more than 10 trillion yen ($92.2 billion). It looks like a repeat of 2013, when the spending taps were last opened wide. The real challenge for the government is developing long-term plans.

What matters is whether it can come up with policies that convince overseas investors that Japan has a bright future. Without their help, Abenomics will become a spent force.

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