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Marcuard’s Market update by GaveKal Dragonomics
After a tough summer with little to cheer about, investors finally got some good news on Monday. After five years of negotiations, culminating in six days of round-the-clock talks in Atlanta, the US, Japan and ten other Pacific Rim economies finally struck a deal on the Trans-Pacific Partnership.
If ratified by the signatories’ parliaments, the TPP will be the biggest liberalisation of global trade since China’s entry into the WTO, and the largest multilateral trade agreement since 1994 when Nafta took effect and the Uruguay Round brought agriculture, textiles, services and intellectual property rights into the global trade regime. That makes the TPP a very big deal.
But even if the pact passes the US Congress — which is by no means certain — it is unlikely to have the momentous impact of those earlier deals for one simple reason: it leaves out the world’s largest trading economy, China. Whether because the US designed the TPP as a counterweight to growing Chinese influence (which US officials deny), or because including China would have delayed the agreement by years, the omission means Monday’s agreement rates two cheers rather than three.
Nevertheless, there will still be clear winners among the 12 member countries. Small economies and those with high initial trade barriers should gain the most in relative terms (think Vietnam). However, the greatest absolute gains are likely to accrue to Japan. The TPP is by far the most significant trade liberalisation deal Japan has ever struck, and promises to advance key domestic structural reforms just as the economic agenda of Prime Minister Shinzo Abe appears to have got bogged down.
Recently, investors have started to lose faith in Japan’s reform programme. As the China-led slowdown has damped global activity and threatened to push Japan into a technical recession, foreigners have turned net sellers of Japanese stocks for six consecutive weeks, the longest such streak since the summer of 2012. At the same time, the passage of Abe’s controversial defense acts has eroded much of the prime minister’s political capital, which means the lack of progress this year towards drawing up and implementing the next round of domestic market reforms has raised serious doubts about whether Japan can successfully reflate its way out of what could end up to be the country’s fifth technical recession in ten years.
In the face of these concerns, the Bank of Japan is taking flack for sitting on its hands as the economy has deteriorated. To be fair, however, the central bank is reluctant to ease further while food inflation, which directly affects consumers, continues to run high, while it also wants to retain ammunition should global demand get even worse. The truth, even if the BoJ does not admit it openly, is that quantitative easing (QE) has proved to have little reflationary effect, except by weakening the yen, and at this point additional currency weakness would only damage global trade and industrial production further.
Against this gloomy backdrop, the TPP offers real hope. With the government’s credibility hinging on its ability to “do something” to get Japan back onto a growth track, and the BoJ constrained by the risk that further monetary easing may do more harm than good, the market opening measures required by TPP membership promise to be just the catalyst required to kick-start the structural reforms Tokyo needs to deliver renewed growth. By dismantling antiquated, high cost barriers within Japan’s economy, and especially in its huge service sector, TPP membership will encourage productivity-enhancing investment—from foreign as well as domestic players.
According to the latest comparable data, the stock of foreign direct investment in Japan amounts to just 6% of GDP, compared with 17% in the US, 22% in China, and 72% in Europe.
Of course, the economic benefits of the TPP will take a long while to materialise. However, the timing of the agreement could hardly be more fortuitous.
With Upper House elections nine months away, the agreement comes at the right time to resuscitate sentiment in the equity market, which has been the engine of Prime Minister Abe’s approval ratings. Such a positive impact on asset markets will take some of the pressure to act off the BoJ, leaving it free to hold more balanced internal discussions about the merits and demerits of further monetary easing, which will hopefully lead to a more rational policy decision, allowing the central bank to set realistic economic forecasts later this month without jeopardising either inflation expectations or corporate sentiment.
