In light of this week's elections in Japan, we take a look into the challenges for its economy.

This week we decided to take a necessary detour to East Asia, and more specifically – Japan. The country of the rising Sun doesn’t pop up often in our analyses, but it is in fact quite important in the financial world: Japan boasts the third largest economy in the world, and is home to the Japanese Yen (JPY), a popular reserve currency whose pairs are a popular trading choice. Japanese Prime Minister Shinzo Abe caused a tremor in the yen’s rates a few weeks ago when he called preliminary parliamentary elections. So in light of the elections which will take place this Sunday, let’s take a look at the Japanese economy.

Despite being largely known for their huge technological sector with famous manufacturers like Sony, Toshiba, Toyota, and Mitsubishi, among others, as well as a vibrant financial center (the Tokyo Stock Exchange), Japan’s economy has actually been marked by stagnation and a nearly absent growth for decades.

The current prime minister, Shinzo Abe, came into office five years ago with the bold promise of changes and economic revival. As head of the government, he began implementing a new set of policies which are now largely known as “Abenomics” and were aimed specifically at reviving Japan’s economy. In short, Abenomics consists of three things: reaching a healthy inflation rate of 2% (as Japan has struggled with deflation), a set of economic stimulus measures in terms of fiscal policy, and lastly focusing on reform to stabilize the private sector and encourage growth. Under Abenomics, the Bank of Japan got a new governor – Kuroda, who is currently leading it in a dovish manner, similar to the European Central Bank. Abe’s government also increased consumption taxes and provided stimulus packages for spending, but this backfired and caused a new recession to settle in. However, while his policies have improved some things such as growth and business confidence, there are still a number of problems in Japan.

Calling preliminary elections was a kind of power move for Abe – he was simultaneously showing a willingness to step down if the majority of people voted for another party, and the confidence that his party will actually win the election. Post polls so far show that he will earn another mandate as Prime Minister and will be able to continue with his reforms into the 2020s.

So, what are the economic challenges Japan faces?

For one thing, Japan has an enormous debt: according to data by the IMF, Japan’s debt is 239% of its GDP, which is the most for any developed country (more than the United States or China, even). In order to address this debt, Abe is trying to promote growth to ensure more money is coming in through taxes, gradually paying off the debt. Still, this problem is contained within the country, as the debt is mostly owned by the BoJ and the government.

Another major issue is the labor market. While Japan doesn’t struggle with unemployment, the wages there aren’t growing, which leads people to save rather than to spend, preventing inflation from rising. Prices are dropping to a lower equilibrium, bringing business revenues down, not to mention the fact that Japan’s famous industry sector has been riddled with failures recently, hurting business further. In addition, the economy is also hindered due to the fact that a huge portion of Japan’s population is elderly people, and the fact that the current systems makes it very difficult for women to remain in the labor force if they have children due to a widespread lack of childcare facilities.

International analysts seem to believe that Shinzo Abe has the right ideas, if not the best concrete measures. While his win is somewhat welcome and would calm the markets, further volatility in the yen is expected as we wait to see what steps Abe’s new cabinet will undertake to address all of these issues. If Japan is to stabilize and foster higher inflation, major reforms will be needed. If we do see those, then expect the yen to loosen against major currencies.