The below from our MiJ, Joe Kraft, is a powerful piece explaining why a Snap Election (if it happens) and the likely resulting LDP win is such HUGE news for Japan.
IMPORTANT: At the risk of sounding utterly pretentious, I hope you realize the magnitude of what is potentially about to happen. PM Abe is about to go “ALL-IN” in the reflation game. In other words, there could be a timeframe set to achieve clear and sustainable economic growth (which includes significantly higher asset prices). To meet that (short-term) deadline, the Abe Administration, MOF and BOJ is likely to throw everything it’s got to achieve it. It could make the Oct 31 BOJ easing look like a nursery rhyme…
It seems odd to analyze an election that hasn’t been announced, but if and when it happens it will be useful to have some basic understanding of the Lower House Diet power structure as well as outcome scenarios of the election. I apologize for the length and please understand that it’s difficult to predict scenarios and attach probabilities when the actual facts have not yet been unfolded.
Bottom-line: I believe a consumption tax delay and election is most likely to be announced and have positive implications for Japan asset prices. It could potentially be a huge event, signaling another 2013 like year. However the downside risks are also possibly large and should not be ignored as well. This could equally be a volatility play in addition to a directional bet and in this regard, mid to long-term vols at current levels seem cheap. In order to understand the potentially huge opportunity as well as the risks, I believe it is important to be familiar with the Diet structure as well as the election dynamics and mentally prepare a scenario analysis.
Quick Background on the Consumption Tax Delay and Why an Election is Significant…
There is no doubt the consumption tax picture changed in a very short period. Canvassing MOF/BOJ/PM Office contacts, inner circle consensus was that the sales tax was “a done deal” as of the beginning of October. However, the tide apparently started to shift around mid October and by the end of the month, senior policy insiders began to get concerned. Pure speculation, but perhaps Gov. Kuroda shared that concern and the BOJ surprise easing was partly motivated in hopes of changing that “tide.” Another piece of conjecture, but it’s possible that the US Treasury (Jack Lew) played a role in Abe’s reconsideration.
In my opinion a delay in the consumption tax MUST be accompanied by an election. The biggest concern in a decision to delay the tax is whether the (cooperative) relationship between the administration, MOF and BOJ will begin to crumble. Consumption tax (hike to 10%) was a core component of Abenomics and the #1 priority of the MOF and as well as an important policy framework for the BOJ/Kuroda. There is no doubt MOF & BOJ officials are not content with the potential developments. I believe it is important for Abe to achieve two things to ensure that the MOF/BOJ/Admin triangle remains intact: 1) Confirmation of public support/mandate (ie. election) and 2) Guarantee a specific time to reenact the consumption tax. The election or referendum achieves those two goals.1) Win Public Mandate - If the country fully supports a delay in the tax, in other words prioritizing reflation over fiscal reform, MOF & BOJ must respect that, but more importantly it means the Abe Administration will be in power for another four years. The Administration now has legal control of bureaucratic appointments (Civil Service Reform Bill). That means this administration has the power to determine the promotion of MOF officials for the next four years. That is powerful in ensuring MOF support. The BOJ promotion ladder is less affected, but the govt still has direct authority over appointments to its board. But most importantly, the MOF & BOJ need the government as much as the government needs them.
2) Reenactment of the Consumption Tax – I say “reenactment” and not “postponement” because legally you cannot delay. The current legislation can only be cancelled. In order to implement the tax at another date, the govt must submit a new bill. This point is what the MOF/BOJ is concerned about. If you could simply amend the current law, then you have a high level of guarantee that the tax will be effectuated at a later time. Although the MOF/BOJ may not like it, they can and will accept a delay in the tax. But the current situation is that a new bill has to be submitted and there is no guarantee that the government will do so in the future. It’s not about trust. Even if Abe & Company have full intention to reenact the tax, if they don’t have a significant majority or worse a two-thirds majority, a new bill could be defeated. In addition to popularity, the election is crucial indicating that Abe has the actual authority to bring the tax back.
If Abe can demonstrate the above two points, then the MOF & BOJ will fully support the reflation initiative and the all-important “support triangle” will remain intact. SO IT’S ALL ABOUT HOW ABE WINS THE ELECTION.
House of Representatives (Lower House) Structure…Understanding the configuration (# of seats) of the lower house and what those numbers imply in terms of authority or power is an important element in evaluating the election dynamics. The Lower House consists of 480 seats in total. It is similar in power structure to the US Senate (although the # of seats closely mimics the House). A two-thirds majority (320 seats) allows the Lower House to veto or override all decisions made by the Upper House (with the exception of appointments). Currently the LDP has 295 seats and its coalition partner (Komeito) has 31 making a total of 326. This is effectively complete control of parliament.
Below is a chart of the current make up of part seats in the Lower House. Below that is a description or category of majority and the authority for each level of power structure.
Election Outcome Probability and Market Impact Forecast…
As noted above, the Abe led coalition currently has a 2/3 majority with 326 seats. Maintaining that majority and extending your term for another four years is a HUGE win.
From a election tactic/strategy perspective, the LDP would like to turn this election into a yes/no referendum on consumption tax delay. This is similar to what Koizumi did in 2005 with Postal Privatization and achieved an historic landslide victory. The opposition DPJ will be forced to run on the platform of supporting immediate consumption tax. Currently polls indicate that 70% of voters are against the consumption tax. Additionally the opposition parties are in such disarray, most including the DPJ will unlikely be able to post candidates in all election districts (many will barely able to fight in half the districts). From a tactical standpoint, Abe/LDP has a strong advantage.
What is the election forecast? Although unconfirmed, the LDP election committee is currently building in a scenario of plus/minus 15 seats from the current 295. However in reality, I don’t think the LDP and political analysts expect them to lose some seats. The key focus for them is how many to lose? You may wonder why would the LDP lose seats if they have a tactical advantage. It’s simply because the last landslide victory was an overshot due to significant negative backlash on the former DPJ government. Now that has subsided, it’s more likely that voters will readjust back to more normal historic standards.
The bottom table outlines potential election scenarios coupled with purely my personal forecast as to those probabilities. It’s deemed difficult to maintain a 2/3 majority. In the unlikely event that LDP manages a standalone 2/3 majority, it will be a “Holy Cow!!” game changer as Abe will effectively have sole control for the next four years. I give this scenario a 10% probability. But enough dreaming and back to reality.
Although ideal, the coalition does not necessarily need a 2/3 majority to proactively and effectively control parliament. If the LDP alone can maintain an absolute majority (more than 269 votes) and the coalition above 300, they will still have sufficient power to pass most if not all desired legislation. The MOF/BOJ would be comfortable that the govt can make good on its promise of eventually reinstalling the tax. I think this is the most likely scenario and give it 50%.
LDP to Fall short of this line (ie. 268 and below) is going to be problematic. The LDP is prepared to lose some seats, but there is a limit in its tolerance. Triggering elections and losing nearly 30 seats will call into question the validity of Abe’s decision even if they secure another four years. However, it won’t be a disaster as long as the Komeito can maintain their seats and the coalition together can maintain an absolute majority. However in this territory, Abe will begin to risk alienating certain LDP factions as well as potentially MOF & BOJ. I’m guessing a 25% chance.
Anything less than this is bad news and asset prices should go into sell-off mode. Such a disastrous result for the LDP is highly unlikely so I won’t comment further, but answer questions if there are any.
For what it’s worth,
Joe
