Coutts Cutting Japan Stocks on Concern About Abe"s Third Arrow

Coutts Co., the wealth management

unit of Royal Bank of Scotland Group Plc, is cutting holdings of

Japanese shares on concern Prime Minister Shinzo Abe won’t pass

the structural reforms needed to boost the economy.

Coutts shifted from overweight to neutral on the best-performing developed-market equities on signs Abe will squander

the early decisiveness of Bank of Japan Governor Haruhiko

Kuroda, said Gary Dugan, chief investment officer for Asia and

the Middle East. With a sales-tax increase approaching in April,

Abe is failing to deliver on reform measures that would ease the

burden of the levy, Dugan said.

“The ‘third arrow’ of Prime Minister Abe’s recovery plan

appears to be veering off target,” Dugan said by phone from
Singapore on Oct. 18. Coutts, the U.K. company founded in 1692,

managed 33.1 billion pounds ($53.4 billion) of assets as of June

30. “On the government side, things are just slipping. The

worry is that Japan is controlled by pressure groups.”

Inflation accelerated and growth quickened after Kuroda’s

unprecedented decision in April (TPX) to double the monetary base of

the world’s third-largest economy. While the signs of progress

drove the Topix index to an almost five-year high in May,

equities have since slumped about 5 percent as investors wait

for Abe’s so-called “third arrow” of structural reform to make

the economic recovery self-sustaining.

Sales Tax

Abe, grappling with a public debt more than twice gross

domestic product, is implementing the previous government’s plan

to raise the sales tax to 8 percent from 5 percent, the first

increase since 1997. He announced a 5 trillion yen ($51 billion)

stimulus package on Oct. 1 to cushion the blow, which a Cabinet

Office statement showed includes public-works spending and tax

breaks for companies. Specific measures will be explained in

early December, Abe said.

“A lot of people were expecting more detail,” Dugan said.

“And now we’re hearing stories about political infighting and

pressure groups are saying ‘please don’t touch this, please

don’t touch that’.”

Abe may have to put off plans for significant deregulation

of the labor market in special economic zones, including lifting

restrictions on working hours for white-collar workers, the

Nikkei newspaper reported on Oct. 18.

Japanese farmers, which benefit from tariffs to protect

local agriculture, oppose trade-liberalization talks with the

U.S.-led Trans Pacific Partnership group of nations. Rice has a

tariff of 778 percent.

Equity Investments

Coutts turned positive on Japanese shares a year ago as

signs emerged that Abe may win power, Dugan said. The bank added

to holdings around April as the BOJ said it will seek to drive
inflation (JNCPIYOY) to 2 percent. Coutts remained “maximum overweight”

until this month, when it started selling out of some Japanese

equity funds on concern Abenomics was stalling, Dugan said.

The private bank is watching for Abe to restart nuclear

reactors shut down after the March 2011 Fukushima nuclear

meltdown, and cut corporate taxes, he said.

Japanese businesses pay taxes of 35.6 percent, according to

the finance ministry. The levies are the highest after the U.S.

among Organization for Economic Cooperation and Development

nations. Abe on Oct. 1 asked the ruling party to look into

lowering the rate as soon as possible.

Such a step is the most crucial reform for the Japanese

economy, according to Dugan. If Abe fails to do that by about

December, Coutts will reduce Japanese investments even further

until it holds less of the nation’s equities than the benchmarks

it tracks.

Wage Growth

“The only way companies are going to give a big leap of

faith and increase wages is if the government delivers on

improving their cash flows by bringing down their energy bills

and reducing their corporation tax,” Dugan said. “Unless you

get wage growth, you cannot get sustained improvement in the

Japanese economy and you cannot reach the inflation targets.”

Regular wages for the nation’s workers excluding overtime

and bonuses fell 0.4 percent in August from a year earlier. The

decline underscores that companies have yet to grow confident

enough to start boosting salaries, even as they sit on what the

BOJ calculated was 220 trillion yen in cash at the end of June.

Abe took office in December vowing to revive growth.

Japan’s economy expanded for three straight quarters through

June, with output for the three months through September due to

be reported next month.

“Buy my Abenomics,” the Prime Minister said in a speech

at the New York Stock Exchange on September 25. “The Japanese

economy that now surrounds us is exceptionally good,” he said.

Confidence among Japan’s large manufacturers rose to the

highest since the early stages of the global credit crisis in

2007, the quarterly Tankan index showed on Oct. 1.

“The market will hold up as long as economic data remains

clear and it’s got a bit of momentum at the moment,” Dugan

said. “But if we get more headlines that Abe fails to deliver

on something else again, then in my mind I would say thank you

very much, I’ll just take more money out.”

To contact the reporter on this story:

Anna Kitanaka in Tokyo at

akitanaka@bloomberg.net

To contact the editor responsible for this story:

Sarah McDonald at

smcdonald23@bloomberg.net

Coutts Cutting Japan Stocks on Concern About Abe"s Third Arrow