A Tricky Path Ahead
While Abe and his party now have the time and the mandate to implement their agenda, they will need to navigate the path ahead with care. I’m keeping my eye on two things. The first is the potential for “bad” inflation brought on by the plunging yen and rising import costs, which could curb spending. The second is Japan’s massive national debt, currently around two times GDP. Rates need to stay low, and the recovery to continue, in order for the country to service its debts. (See our interactive chart for more detail on the economy.)
That said, we think these risks are low, with more potential upside than downside. If you’re looking for a way to access the Japan market, consider iShares MSCI Japan ETF (EWJ) or its currency-hedged sibling, the iShares Currency Hedged MSCI Japan ETF (HEWJ).
Market Realist – Burgeoning debt in Japan could lead to an even weaker yen.
The graph above shows the breakdown for Japan’s external and domestic debt. The total debt is ~2.3 times Japan’s GDP, which is a concern for the economy. Japan is one of the most leveraged economies within developed markets (EFA)(VEA). In fact, emerging markets (EEM)(VWO) now have better fiscal health compared to developed markets.
One of the fallouts of higher government debt is a weaker currency, which could lead to higher import costs. The Japanese yen has already depreciated by more than 30% since December 2012. However, a weaker yen would make Japanese goods appear cheaper for foreigners. This would support exports and the export-heavy Nikkei 225, which hit a multi-year high recently.
Read our series Look to Japan to find a bargain amid today’s pricey markets for more information on the Japanese economy.