Asian reforms and growth

Cherry Blossom

The Asian economies are growing well, with their stock markets responding favourably to higher company earnings and dividends. Japan in particular has put in a strong performance in recent weeks in the wake of Mr Abe’s victory in an early election. Foreign investors have been keen to back the renewed government as it continues with its three arrows policy to promote growth.

Most assume the first arrow of monetary growth will continue as before. The question of the Bank Governorship will come up in April 2018. It is widely assumed Mr Kuroda will be reappointed or replaced with someone who thinks similarly. The Central Bank remains wedded to keeping the 10 year government borrowing rate at zero, with negative rates for shorter dated borrowings. This provides a good underpinning to Japanese financial markets, and an incentive to investors to take more risk by moving out of bonds into shares to get some income.

The second arrow of providing government stimulus through running a deficit also stays in place. It is true the government is pledged to increase the sales tax from 8% to 10% in October 2019 unless there is some big setback that would make that unwise. The aim is to spend more on education and childcare to offset any negative effects of the tax on activity and incomes.

It is the third arrow of reform which has taken longer. Armed with a large majority for the coalition he leads, Mr Abe has decided to spend his renewed political capital on reform of the constitution. His aim is to change Article 9. This article states that Japan renounces the use of force or the threat of force to settle international disputes. Mr Abe wants an amendment to allow the armed forces to operate beyond the task of providing home defence. There is also talk of authorising casino resorts, but it looks as if major economic supply side reforms will be sidelined by the constitutional issue.

This has been enough to stimulate substantial buying of Japanese shares, though the most recent buying has been driven by overseas investors. Corporate earnings have been growing well, and the weaker yen flatters the reported results.

Meanwhile in India a major supply side reform has been implemented and is currently bedding in. On 1 July India went over to a country wide General Sales Tax. This replaces various taxes including the central excise, additional excise, service tax, additional customs duties, State VAT and sales taxes, entertainment tax, purchase tax, luxury tax, lottery, betting and gaming taxes. It is a major simplification of the complex local and national structure of consumer taxes, but has also brought its own complications. The tax is levied on the goods or services at final destination, with tracking of the value chain that has produced them. The GST network computer system is there to help businesses do this.

The tax currently has 5 rates and an exempt category. Some want a single tax rate, but the government has explained this is not possible given the wish to tax luxuries at higher rates than other items, and given the fact that the tax is shared with local and state governments that also have some preference to preserve differential rates. The government is currently tweaking the system, taking some products down to lower rates of tax to reduce the impact of some parts of the package on prices and to build consumer support where the tax burden is lower. There is some discussion of merging two of the middle bands in due course.

Prime Minister Modi is now using his political strength to undertake serious economic reform, which should be to the long term benefit of India. Following hard on the heels of the monetary reform which sought to get many more Indians using bank accounts instead of hoarding larger denomination banknotes, the pace of change has been lively. It looks as if it will work, and will assist the Indian growth trajectory next year. The Asian growth story should continue to support share investment.


The above article was first published by Charles Stanley on 14th November 2017