A landslide victory in last december’s federal election gave Japan’s Prime Minister Shinzo Abe a mandate for structural reforms aimed at putting the economy on a self-sustaining growth path after 20 years of stagnant growth and deflation.

The growth of about 0.5% last year in Japan’s real gross domestic product (GDP) was disappointing, says Stephen Lingard, senior vice president of Franklin Templeton Solutions, a division of Franklin Templeton Investments Corp. in Toronto, and portfolio manager of Franklin Quotential Diversified Equity Portfolio.

The Bank of Japan’s quantitative easing program has succeeded in weakening the yen, which, in turn, boosted exports and economic growth in early 2014. But a sales tax increase to 8% from 5% in April resulted in drops in real GDP in the second and third fiscal quarters. That led Abe to delay a second sales tax increase to 10%, initially scheduled for October this year; that increase now is planned for 2017.

This was a wise move, as Japan’s monumental government debt – more than 200% of GDP – limits Abe’s ability to repair the economy by using fiscal spending alone, says Mark Grammer, senior vice president, investment management, at Toronto-based Mackenzie Financial Corp. and portfolio manager of Mackenzie Global Growth Class Fund.

“The amount of money [Abe and the government] can spend is limited because they have to borrow to do that,” he says. “[This] is why they need to encourage consumption – because if the economy is going to grow, it’s going to be the consumer doing it.”

Abe’s government has had difficult choices to make, says Grammer. They needed to generate extra revenue from taxes, but the economic environment has not been motivating consumers to spend.

More favourable conditions would be created if workers could count on better wages to offset higher taxes. This is why Abe has been pressuring the corporate sector to increase employees’ pay. So far, companies, conscious of Japan’s deflationary history, haven’t stepped up to the plate. However, portfolio managers hope to see that happen this year.

The end of 2014 saw some improvement in the income situation, says Tomonori Kaneko, investment analyst in Hong Kong with Toronto-based RBC Global Asset Management Inc. and a specialist for RBC Japanese Equity Fund. He notes that some large Japanese firms gave their employees bonuses and he hopes that mid-sized businesses will raise employee wages this year.

A weaker yen also may motivate companies to keep their production on Japanese soil. Outsourcing is a big issue, especially with some Japanese auto manufacturers, which have been importing their own cars back to Japan, thanks to the country’s historically strong yen, says Lingard.

Grammer says there is evidence the now weaker currency could be changing this: “Toyota [Motor Corp.] is expected to build a new plant in Japan that originally looked like it was going to be built in Mexico.”

Major structural reforms, such as new free-trade agreements and changes to Japan’s labour culture of “jobs for life,” will take longer to have an impact. Lingard anticipates three years for these to roll out.

To help keep the economy growing, the Japanese cabinet has approved a stimulus package of ¥3.5 trillion (US$30 billion). The hope is that this move also will reassure domestic corporations that the economic environment is improving, so they will be more comfortable in raising wages and increasing capital spending, Lingard says.

Lingard is anticipating that this and other changes will produce GDP growth of 1.2% this year. Grammer is even more optimistic, assuming 2% growth.

The recent slide in oil prices will help. Japan is a large importer of energy, and the decreasing cost of oil has been a nice reprieve for corporations and consumers.

But the country is vulnerable to slowdowns in other economies, given Japan’s large export sector. China’s growth slowed last year; if that worsens, Japan’s recovery will be affected, says Eileen Dibb, portfolio manager with Pyramis Global Advisors in Smithfield, R.I., a division of Boston-based FMR LLC (a.k.a. Fidelity Investments) and portfolio manager of Fidelity Japan Fund.

China’s reliance on Japanese machinery is why Dibb has Mitsubishi Electric Corp. in her fund’s top 10 holdings as of Sept. 30, 2014. Mitsubishi produces various industrial and electrical products, including factory-automation systems. “As wages rise in China,” she says, “the factories there are [implementing] more automation to take the place of certain labourers.”

Kaneko and Grammer both favour Japan’s auto industry, holding Toyota in their portfolios. Kaneko also likes Fuji Heavy Industries Ltd., which makes Subaru cars: “Generally, I like well-managed companies with a good set of businesses and potential growth overseas.”

© 2015 Investment Executive. All rights reserved.