SINCE winning the lower house election in December, Japanese Prime Minister Shinzo Abe and his ruling LDP party have been pushing for economic stimulus policies, aimed at pulling Japan out from the two-decade long deflation and stagnation.

Dubbed "Abenomics", the stimulus policies contain three pillars - monetary easing, fiscal stimulus, and structural reform.

Aggressive monetary easing has been taken by the Bank of Japan. Under the new governor Haruhiko Kuroda, the BOJ announced "a new phase of quantitative and qualitative easing" on April 4. The BOJ will double the size of base money in two years, from 138 trillion Japanese yen (US$1.39 trillion) in end-2012 to 270 trillion Japanese yen in end-2014.

The scale and the pace of easing are unprecedented. Since the global financial crisis in 2008-2012, the BOJ increased base money by only 45 percent. During the 2001-2006 quantitative easing (QE) episode, the BOJ boosted base money by 70 percent over five years.

The BOJ is also aggressive compared to the United States Federal Reserve. The Fed tripled its monetary base between 2008 and 2012 (outstanding size: US$2.7 trillion as of end-2012). By end-2014, the BOJ will also triple its monetary base versus 2008, and the size of base money will also equal to US$2.7 trillion.

Considering that Japan's economic size is only one-third of that of the US, base money as a percentage of GDP in Japan will be three times of that in the US.

Meanwhile, under the quantitative and qualitative easing, the BOJ will lengthen the remaining maturity of its holdings of government bonds (JGBs) to an average of seven years in 2014, from slightly less than three years currently.

This will be different from 2008-2012 when the BOJ mainly focused on buying short-term JGBs. Compared with the Fed, the BOJ will also catch up in terms of the composition of bond purchases - the average duration of the Fed's bond holdings is about 10 years at present.

Moreover, the BOJ set a two-year timeframe for achieving the 2 percent inflation target at April's meeting. This sent a strong message to the markets and the public that the central bank is determined to end deflation. In the past, the BOJ failed to convince people that it would succeed in overcoming deflation.

Inflation target

When introducing the 2 percent "price stability goal" in February, the central bank emphasized that 2 percent is a medium-to-long term goal and the short term target is 1 percent.

In January when raising the inflation target to 2 percent, the BOJ only said it will achieve this target "at the earliest possible time". In fact, the former Governor Shirakawa often publicly expressed the view that deflation in Japan is related to structural economic weakness, indicating the effectiveness of monetary policy is limited.

Thanks to the BOJ's stronger commitment to ending deflation and the implementation of aggressive QE, expectations have been boosted in the financial markets this time.

Equity prices have risen and the yen has weakened. Compared to mid-November, the Nikkei is up by 50 percent and the yen is 20 percent weaker against the US dollar. Financial market movements should offer a short-term boost to the economy, as the stock market rally generates positive wealth effects for consumers and the weaker yen benefits exporters.

Monetary easing also creates favorable financing conditions for the public and the private sectors. The BOJ's increase of JGB holdings this year (51 trillion yen) can fully cover the new bond issuances required by the 2013 fiscal budget (45 trillion yen). In the private sector, there is also a hope for releveraging, should inflation expectations increase amongst consumers and businesses and real interest rates decline. Thanks to the deleveraging in the past two decades, the debt-to-asset ratio in Japan's corporate sector has fallen sharply to 63 percent from 80 percent in 1980s. The household debt-to-asset ratio of 23 percent and household debt-to-GDP ratio of 75 percent today are also lower than the comparables in the US (25 percent and 85 percent respectively).

By pursuing quantitative and qualitative easing, the BOJ has taken all the "necessary and possible" easing measures, as said by Governor Kuroda after April's policy statement. Creating new surprises to market expectations and generating a new round of market rally will become increasingly difficult. The stimulus effects on the real economy as a result of equity price increases and yen depreciation can't last for long.

Public debt

Fiscal expansion cannot be sustained either. While the private sector has deleveraged in the past two decades, public sector debt has risen to 227 percent of GDP, currently the largest such load in the world. The government has a self-imposed target of balancing the budget by the end of this decade.

As the first step toward fiscal consolidation, the former administration under Prime Minister Noda has legislated to hike consumption taxes in April 2014 and October 2015 (from 5 percent to 8 percent and then to 10 percent).

Despite Abe's ambiguous stance over the consumption tax plan, he has pledged to maintain the target of balancing budget deficit by 2020. This means even if the consumption tax hike is postponed or suspended, some other forms of tax increases or spending cuts would replace them.

The public sector's deleveraging will start in 2014 at the earliest and the impact will be negative - unless the private sector can releverage to offset.

Importantly, the market forces prompting public deleveraging may also surface in mid-2010s. Japan's public sector that heavily depends on domestic financing will need to borrow externally to a larger extent in the coming years. The country's gross saving ratio has fallen to a record low of 20 percent in 2010, from 25 percent in 2000s and 30 percent in 1980s-1990s. Based on the worsening demographic profile, the saving ratio is likely to drop further to 15 percent in mid-2010s.

Given the investment ratio of a steady 20 percent in recent years, the saving-investment gap may turn negative and the current account would fall into a structural deficit.

As the public (and also the private) sector's dependence on foreign financing increases, domestic market yields will be more susceptible to global liquidity conditions and foreign investors' risk-rating on JGBs (and other JPY assets). Due to a larger participation of foreign investors in the JGB market, the BOJ would also need to be prudent on monetary easing, due to concerns about creating the perception of debt monetization, weakening foreign investors' confidence, and triggering excessive capital outflows and disorderly currency depreciation.

Financing pressure

In short, higher dependence on external financing implies the risk of higher yields. This will increase government financing pressures and accelerate the process of public deleveraging. The prospects of private sector releveraging would also be weakened due to rising interest rates.

The room for monetary and fiscal policies is both limited in Japan. What the country really needs is a long term growth strategy that addresses the structural economic weakness and the lack of competitiveness. This points to the supply-side reform measures to boost population growth, labor participation, private investment and productivity.

Abe will present a long term economic plan in June. In the supplementary budget unveiled in January, Abe has proposed some measures to promote productivity via research and development, innovation and human capital development. The government has also made a step toward increasing trade openness and competitiveness, announcing in March that Japan will join the negotiations of Trans-Pacific Partnership (TPP, a regional free trade agreement).

Reforms still face hurdles. The government will continue to confront pressures from domestic lobby groups during the free trade negotiations, surrounding sensitive topics such as agricultural tariffs and foreign investors' access to domestic services industry.

One major drag to Japan's potential growth is actually the rapid aging of population. Tackling this requires measures to boost the birth rate, increase the labor participation of female and old people, or relax immigration policies, the latter two of which are socially controversial.

Strong leadership, political stability and policy continuity are crucial conditions for the long term growth strategy to be implemented successfully. Ironically, dealing with the controversial reform issues involves the risks of losing public support and provoking political conflicts. Comprehensive reforms will not be easy to push through.

Ma Tieying is a Singapore-based economist with DBS Bank. The article was based on a DBS research report issued on April 17. The opinions expressed are her own.