Morgan Stanley discusses "high market early rice trading": The policy stance has shifted to a moderately conservative approach, fiscal policy will not adopt MMT, and interest rate hike expectations may cool down

Kishida Sanae won the Liberal Democratic Party presidential election and is expected to become Japan's first female prime minister. Morgan Stanley's analysis believes that investors' concerns about the new government potentially implementing extreme fiscal expansion or pressuring the Bank of Japan have been overstated, and Kishida Sanae's policy stance has shifted to a more moderate conservative route.

According to news from the Wind Trading Desk, Morgan Stanley's Chief Japan Economist Takeshi Yamaguchi analyzed in a research report on the 5th that Kishida Sanae avoided reiterating past statements about cutting the consumption tax or opposing interest rate hikes by the Bank of Japan during her campaign, indicating a more cautious attitude in her policies. This shift may help her gain more support from LDP members in the final election.

Kishida Sanae advocated for "responsible expansionary fiscal policy" in her campaign promises, but Morgan Stanley emphasized that some overseas investors mistakenly believe she supports extreme fiscal expansion similar to Modern Monetary Theory (MMT), although she has never made such statements. Analysts question whether a politician who enjoys reading Margaret Thatcher's memoirs would genuinely support MMT.

Regarding monetary policy, Kishida Sanae stated at a press conference after her election that the government and the Bank of Japan must closely coordinate, which is fundamentally consistent with the cautious stance of Bank of Japan Governor Ueda Kazuhiro. Morgan Stanley believes that market expectations for recent interest rate hikes may cool down.

Policy Stance Has Shifted to Moderate Conservatism

Kishida Sanae defeated Koizumi Shinjiro in the final election on October 4, a result that surprised the market. However, Morgan Stanley pointed out that to expand support within the party during her campaign, she has shifted from her previous hardline stance to a more "moderate conservative" position.

For instance, she no longer reiterates past statements about cutting the consumption tax or opposing interest rate hikes by the Bank of Japan; this pragmatic shift has helped her win more votes. The report also specifically mentions that Kishida Sanae claims to admire former British Prime Minister Margaret Thatcher, and her favorite book is "The Downing Street Years." This also suggests that her policy background leans more towards conservatism rather than radical populism.

One of the biggest concerns in the market regarding Kishida Sanae is her fiscal proposals. Some overseas investors mistakenly believe she supports extreme fiscal expansion similar to Modern Monetary Theory (MMT). Morgan Stanley explicitly refuted this, emphasizing that these concerns "have been overstated."

The report provides a detailed interpretation of Kishida Sanae's definition of "Responsible Expansionary Fiscal Policy" in her campaign platform. The core of this policy is to strategically mobilize fiscal resources to invest in areas that address social issues, thereby driving employment and income growth, ultimately leading to a natural increase in tax revenue. More importantly, this policy explicitly states " efforts to gradually reduce the government's net debt-to-GDP ratio," which is contrary to the principles of MMT.

The report also points out that Kishida Sanae's economic policies are heavily influenced by one of the architects of "Abenomics," former Cabinet Special Advisor Honda Yoshihiro, and her policy platform includes orthodox measures such as refundable tax credits and the abolition of temporary gasoline tax rates. As for the market's concerns about cutting the consumption tax and increasing financial income tax:

• Reduce Consumption Tax: She has stated that this is not a priority, and the likelihood of implementation is low.
• Increase Financial Income Tax: The report believes that in the short term, the " likelihood is extremely low." She proposed in September 2021 to raise the financial income tax rate from 20% to 30% for annual incomes exceeding 500,000 yen, but this was contingent on achieving a 2% inflation target and not for immediate implementation.

For investors, this may mean that the fiscal sustainability risk in Japan is not as significant as imagined, and there is no need for excessive panic.

Monetary Policy in Line with Kazuo Ueda, Rate Hike Expectations May Cool

In terms of monetary policy, Sanae Takaichi has shown respect for the independence of the Bank of Japan. She clearly stated that the government is responsible for setting fiscal and monetary policy goals, while the Bank of Japan is "the institution that decides the best means of monetary policy."

More critically, her economic judgment aligns with the cautious stance of Bank of Japan Governor Kazuo Ueda. For example, both are cautious about the impact of U.S. tariffs and believe that Japan's current inflation is primarily driven by supply-side factors such as food prices. Morgan Stanley believes that this consistency in stance may lead to a cooling of market expectations for a recent rate hike by the Bank of Japan.

Of course, the report also adds that if future economic recovery is clear and wage growth stabilizes inflation at 2%, the Takaichi government would not oppose a rate hike by the Bank of Japan. This flexible and synchronized attitude with the central bank helps stabilize market expectations regarding monetary policy.

Core Policies: National Security, Domestic Investment, and Structural Reform

Sanae Takaichi's policy agenda focuses on national security, domestic investment, and structural reform. Among these, "economic security" is of utmost importance. The report outlines key policies that are significant for investors:

• Strengthen Defense Capabilities: Plans to review three defense documents, aiming to increase defense-related spending to 2% of GDP by the fiscal year 2027. Notably, the report suggests that "defense-related spending" may include investments in broader security areas such as infrastructure, energy, healthcare, and agriculture.
• Promote Investment in Key Areas: Plans to encourage investment in growth areas critical to economic security through bold tax incentives, specifically naming artificial intelligence (AI), semiconductors, perovskite and solid-state batteries, digital technology, quantum, nuclear fusion, biotechnology, aerospace, shipbuilding, and innovative drugs.
• Establish a "Foreign Investment Review Committee": This move aims to review inbound investments from an economic security perspective, which may attract market attention.
• Other Reforms: The policy list also includes measures to address rising prices (abolishing temporary gasoline taxes), enhancing energy security (promoting next-generation innovative nuclear reactors), and ensuring food safety (agricultural structural reform), among others.

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