Fickle-minded Japanese: Leadership changes in Japan underscore government weakness

Noda replaces Naoto Kan, and previously served as Finance Minister in Kan's Administration. The new Cabinet was announced, emphasizing party unity and consultation with opposition parties. Noda is known as a fiscal conservative, advocating increases in consumption and income taxes to fund the nation's social welfare costs and post-quake reconstruction spending.

Frequent changes in Japan's leadership have underscored a climate of political instability and government weakness, at a time when decisive actions are needed to spur lagging growth, address the high public debt (over 200% of GDP), and implement post-quake reconstruction activities. Moody's ratings agency, citing the frequent changes in administration, lowered Japan's sovereign credit rating on August 24 to Aa3, playing catch-up to previous moves by S&P and Fitch.

A political consensus for Noda's efforts to implement tax hikes has yet to be reached, ahead of a third supplementary budget to be submitted to Parliament later this month. Another challenge to the new cabinet is the strong Japanese yen, which has appreciated sharply given the currency’s safe haven characteristics, thereby undermining exports, which are a key driver of Japan’s growth.

To soften the impact of the rising yen, the government recently announced a one-year subsidized loan program (USD 100 billion) to help domestic companies, following recent efforts at currency intervention in early August. Meanwhile, on the positive side, the economy is continuing to recover from disruptions following the earthquake and tsunami, reaffirmed by the July’s industrial production data (-2.6% y/y) released in the past week.

We expect a further rebound during the remainder of the year, on the restoration of supply chains as well as the post-quake reconstruction spending, despite power shortages.