nomura on japan

8/13/2019 Nomura on Japan

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Nomura

See Appendix A-1 for analyst certification, importan

disclosures and the status of non-US analysts.

Any authors named on this report are research

analysts unless otherwise indicated.

The investment implication of Abenomics

June 2013

Buy Japan

Nomura Securities Co., Ltd.


2/83

Contributing authors and contacts

Source: Nomura

Managing Director

Head of FX Strategy, Japan

[email protected]

+81 3 6703 3885

Managing Director

Chief Economist Japan

[email protected]

+81 3 6703 1280

Managing Director

Chief Japan Rates Strategist

[email protected]

+81 3 6703 3864

Managing Director

Chief Equity Strategy Japan

[email protected]

+81 3 6703 1680

Managing Director

Global Head of Asset Allocation Strategy

[email protected]

+44 207 102 7800

1

Yunosuke Ikeda

Naka Matsuzawa

Kevin Gaynor

Tomo Kinoshita

Hiromichi Tamura


3/83

Introduction


4/83

Japan has embarked on aprocess from the lost

decades to a very different future.

Abenomics is merely the toolkit to deliver that future.

Investors need to understand both the problem being

addressed and what would constitute success.

The application of the 3 Arrow toolkit has identifiable

investment implications too. However, it is unlikely that

these implication will be linear from the old Japan to

the new Japan.

In any event, whether successful or not Japan and its

markets are likely to be an important factor for the

global economy and markets for several years andtherefore cannot be ignored.

This presentation tries, as best as can be done today,

to define what success looks like and the path from

here to there.

Japan has embarked on a multi-year process

Source: Nomura3

A multi year process

Gracefuldecline, but

turning intofuture crisis?

Abenomics

Trading thetoolkit

Arrow 1

Arrow 2

Arrow 3

Objectiveachieved?

What does itlook like?

Asset classwinners andlosers

New

Opportunities

1992-2012

The problem

2013-2015

Newdirection

2015->

Success


5/83

The old Japan


6/83

Decline in potential growth rate

Decline in population

Decline in international competitiveness

Deflation entrenched as the government and the corporate

sector failed to act when needed

Lag in restructuring balance sheets after demand shocks (1990 bubble

collapse, 2008 Lehman bankruptcy shock)

Fiscal stimulus lacked consistency and monetary easing fell behind the

curve

Current account surplus and deflation exacerbated strong JPY, pressuring

corporate earnings further

Ballooning government debt and risk of JGB sell-off?

Despite increases in government debt, private sectors surplus cash flows

back into capital markets, thus preventing a fiscal crisis.

Loss of corporate competitiveness led to a decline in foreign currency

reserves, gradually depleting domestic surplus cash.

Reliance on currency policies

With fiscal and monetary policy failing to bring about intended results, the

government would have little choice but to depend on a weak currency.

Domestic political instability and waning international

influence

Asset allocation

Very long cash and deposits, bonds and underweight equities

Large offshore holdings

Domestic credit market very small

No inflation hedging required and thus small linker market

Banks balance sheets swap from loans to government

bond holdings

Fixed income investment behaviour becomes focused on

particular modes of analysis such as carry and roll

Decline in growth potential and deepening deflation

Source: Nomura5

The problems The market implications


7/83

Potential growth declined after the 1990 bubble burst

Source: Cabinet Office

Real potential growth rate

Japans potential growth rate declined from above 4.0% to around 0.5% after the two

demand shocks (i.e., collapse of financial bubble in 1990, Lehman shock in 2008).

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1995 2000 2005 2010

(%)

6


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Nominal GDP growth

With lower inflation rates, nominal GDP growth fell to zero

Source: Cabinet Office, Government of Japan

Japans GDP growth rate has been kept extremely low over the past two decades

7

-5

0

5

10

15

20

25

1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011

(FY)

Nomura

Forecast

(12-15)


9/83

Long-term population trend

And the population peaked in 2010

Note: 1)Some data missing for periods of conflict. 2) Projections are median estimates from National Institute of Population and Social Security Research data.

Source: Nomura, based on Ministry of Internal Affairs and Communications, and National Institute of Population and Social Securities Research Data

Population decline and an aging society are hindering growth

8

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

0

20

40

60

80

100

120

140

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Estimates

(mn) (%)

(CY)

Total Population(lhs)

% of population 65 years and

over (rhs)


10/83

Perhaps little surprise then that there has been instability in

Japan politics?

9

Source: Nomura, based on Nikkei

The big difference is, Prime Minister Abe has won great popularity unlike several previous Prime Ministers.

We finally see signs of political stabilization, which would be positive for the economy.

Liberal Democratic Party (majority) Democratic Party (the leading party) ?

LDP (the leading party ) LDP (majority) LDP (majority) The House of

Representatives

House of Councillors

Democratic Party

(majority)

0

10

20

30

40

50

60

70

80

90

01 03 05 07 09 11 13 15 17 CY

Koizumi

AbeFukuda

AsoHatoyama

Kan

Abe

cabinet support rating, %

Noda

29Jul 09 11 Jul 04

11 Jul 05

29 Jul 07

30 Aug 09

11 Jul 10

16 Dec 12

28 Jul 13

Dec16?

Jul 16

Cabinet support rating


11/83

120

130

140

150

160

170

180

190

200

210

220

2000 2002 2004 2006 2008 2010 2012 2014 (FY)

(as % o f no minal GDP)

And given this macro and political backdrop, debt levels have

continued to grow

Primary central and local government fiscal balance Japans government debt(vs. nominal GDP)

Source: Nomura and Japans MOF

10


-8

-6

-4

-2

0

2

4

1990 1993 1996 1999 2002 2005 2008 2011 2014

If add itional s timulus is implemented in FY14/15

If no addi tional stimulus in FY14/15

Reduction target (half FY10 level)

(as % of no minal GDP)

(FY)


12/83

With large domestic holdings

11

Note: Figures are as of CY2002.

Source: Nomura, BOJ

JGBs are mainly held by domestic financial institutions

12.0

37.5

22.2

9.7

2.58.7

7.3

Bank of Japan

Depositary institution

Insurance & Pension

funds

General government

Households

Overseas

Breakdown of JGB holder (%)


13/83

Lack of growth and weak domestic capex has led to continued

corporate surplus and a tiny credit market

Source: Nomura, based on Bank of Japan data

Abenomics is trying to move frozen cash in corporate sector

Targeting 70trn capex from current 60+ trn level

12

Cash of Japanese companies Private capital expenditure

160

170

180

190

200

210

220

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

(trn)

Note: Total cash and deposits for nonfinancial business

50

55

60

65

70

75

80

2000 2004 2008 2012

(trn)

(FY)

70trn


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And so while Japanese banks are some of the healthiest, they

have very high loan-to-deposit ratios

Source: Nomura, Company data 13

Ranking of Banking Systems Based on Banks Balance Sheet

Indicators, 2012:Q3 CET1 ratio (FY12)

Sources: Bloomberg L.P.; SNL Financial; and IMF staff estimates.Note: AT = Austria; CH = Switzerland; DE = Germany; ES = Spain; FR = France; GR = Greece; IE = Ireland; IT = Italy;

JP = Japan; NL = Netherlands; PT =

Portugal; SE = Sweden; UK = United Kingdom; US = United States. The closer a banking system is to the center of the

figure, the more balance sheet

adjustment it needs to undertake. Rankings are based on the aggregate position for a large sample of banks

headquartered in each country (more than 90

percent of the banking system in most cases) as of 2012:Q3 or as of the latest available data before then. Bank buffers

are the ratio of core Tier 1 capital and

loan loss reserves to impaired loans as reported in banks financial statements. The loan-to-deposit ratio is gross loans as

a percentage of deposits (for Italy

and Spain, adjusted for retail debt). Change in the impaired loan ratio is the annual change in impaired loans as a

percentage of gross loans. Return on assets

is average annualized retained earnings over the past year as a percentage of tangible assets minus derivatives. See

footnotes 17 and 18 in the main text.

Japanese banks

0%

2%

4%

6%

8%

10%

12%

MUFG

SMFG

Mizu

ho

JPM

Citi

BOA

HSBC

Barc

lays

BNP

SG

Deu

tsc

he

CET1 ratio

Totally different from early 2000s when Japans banks faced a major NPL concern


15/83

Composition of household financial assets in Japan

Household asset allocations different from other G7 countries for

good reason

Cash has been king for the long deflation period in Japan

14

Cash & deposits,35.8%

Cash &deposits,

14.3%

Cash & deposits,55.2%

Bond s, 7.0%

Bonds, 9.5%

Bonds, 2.1%

Investment trusts,7.2%



Equities, investments,14.3%

Equiti es, investments,32.8%

Equities, investments,6.8%

Insurance andpension reserves,31.7%

Insurance andpension reserves,

28.1%

Insurance andpension reserves,

27.7%

Other total, 3.9%

Other total, 3.2%

Other total, 4.2%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Euroarea

US

Japan

Source : Nomura, based on Bank of Japan data

TOTAL

USD15.9trn

USD54.4trn

USD25.4trn


16/83

Long-term household asset composition of equity and real interest rate

Japanese households portfolios badly protected against inflation risk

A rise in CPI may push households to shift deposits that have been steadily rising from late 1980s into risk

assets

15Source : Nomura, based on Ministry of Internal Affairs & Communications and Bank of Japan data

-5

-4

-3

-2

-1

0

1

25

10

15

20

25

30

79 82 85 88 91 94 97 00 03 06 09 12

Equities, investments & investment trusts (lhs) Real interest rate (deposit rate - CPI (ex food & energy))(rhs)% inv, %

CY

J i f d h d d J it


17/83

Weight of Japanese Equities in Corporate Pension Funds and GPIF

Japanese pension funds have decreased Japanese equity

allocation for more than a decade

Pension funds are possible net buyers of Japanese equities other than nonresident and individual investors

16

5

10

15

20

25

30

35

FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11

Corporate Pension Funds GPIF(%)

Source : Nomura, based Government Pension Investment Fund and Pension Fund Association data


18/83

TOPIX 12 month forward P/E

No surprise that equities are cheap versus historical levels

Current P/E of 16.2x still lower than post-2000 average of 19.6x

17

0

10

20

30

40

50

60

70

80

90

82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12

(times)

Source: Nomura, based on Tokyo Stock Exchange and Toyo Keizai data


19/83

Source: MOF, Nomura

The earthquake changed current account dynamics

18

-16.8

-24.8

-35

-30

-25

-20

-15

-10

-5

0

5

10

15

20

2007 2008 2009 2010 2011 2012

Export volume Import volume

Price Actual change

(JPYtrillion, annualized)

Cumulative change since April 20070

20

40

60

80

100

120

14070

80

90

100

110

120

130

140

150

160

170

180

1995 1997 1999 2001 2003 2005 2007 2009 2011

Terms of trade (lhs)

Oil price (rhs, inverted)

Terms of trade deteriorates Oil price rises

Cumulative changes in trade balance Terms of trade and oil price


20/83

Source: MOF, Nomura

Loss of nuclear generators had an impact too

19

Changes in nominal mineral fuels imports

(from Jan-Nov 2010 to Jan-Nov 2012)

Estimated capacity utilization ratio

of nuclear generators in Japan

32.3%27.9%

57.1% 50.1%

15.8%11.2%

6.6%

2.9%

-3.6%

22.5%

14.1%

1.1%

38.9%

30.8%

53.5%

72.6%

29.8%

12.3%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Mine ra l fue ls Crude o il Pe troleumproducts

LNG LPG Coal

Volume contribution

Price contribution

Percentage changes

5%

10%15%

64%

32%

21%

16%

5%0%

5% 5%

0%

5%

0%

10%

20%

30%

40%

50%

60%

70%

Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Before

quake

2011 2012 2013

Upside scenario (Ikata 3, Tomari 1&2, Shiga 2, andSendai 1&2 restart)

Current schedule (Ohi 3&4 restart)


21/83

FDI flows in Japan

Source: Nomura and the Bank of Japan20

-16,000

-14,000

-12,000

-10,000

-8,000

-6,000

-4,000

-2,000

0

2,000

4,000

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Overseas FDI by residents

Inward FDI by non-residents

JPYbn

FDI outflows have recovered since 2010


22/83

Defining Successthe new Japan


23/83

Return to positive trend growth in region of 1-1.25%

End psychology of deflation with return to stablepositiveinflation

Fiscal accounts on stable footing

Higher return on capital

Retain culture but modernise attitudes

Higher labour and social mobility

Political stability at home and more influence abroad

Asset allocation

Increased equity holdings

Reduced cash holdings

Higher credit exposure

Inflation protection to play a role

Real estate included

Ambiguous impact on net foreign holdings

Manage process of higher bond yields

Re-emergence of domestic credit market and linker market

Leveraged loan market and securitised asset market growth

Higher domestic and cross-border M&A volumes (inward

FDI higher too)

What is the objective?

Source: Nomura22

Success The market implications


24/83

Economic outlook: yearly

23

Forecast assumptionsNomuras outlook on Japans economy

Source: Nomura

Source: Nomura

, y-y, except where noted FY12 FY13 FY14 FY15

USD/JPY rate

(average)83.0 101.0 105.0 108.0

Consumption

tax rate (end-

fiscal year)

5.0 5.0 8.0 10.0

WTI spot

price110.0 100.0 97.0 96.0

FY10 FY11 FY12 FY13 FY14 FY15 CY10 CY11 CY12 CY13 CY14 CY15

(F) (F) (F) (F) (F) (F) (F)

Real GDP 3.4 0.2 1.2 2.5 1.8 1.9 4.7 -0.6 2.0 1.6 2.5 1.7 2.6 1.3 2.0 2.3 1.2 1.2 2.9 0.3 2.9 1.6 2.0 1.0

2.5 1.0 0.8 1.6 0.9 1.4 2.5 0.3 1.8 0.8 1.5 1.1

0.1 0.2 1.2 0.7 0.3 -0.2 0.4 -0.1 1.1 0.8 0.4 -0.1

0.8 -1.0 -0.8 0.2 0.7 0.7 1.7 -0.9 -0.9 0.0 0.5 0.7

Private consumption 1.7 1.5 1.6 2.1 0.1 0.8 2.8 0.4 2.3 1.6 1.2 0.3

Private housing investment 2.2 3.7 5.3 6.8 0.1 -2.1 -4.5 5.5 3.0 7.9 1.4 -1.1

Private capital expenditure 3.6 4.1 -1.5 0.4 6.3 6.8 0.3 3.3 2.0 -2.5 5.9 6.5

Changes in inventory investment 1.0 -0.5 -0.1 0.1 0.0 0.1 0.9 -0.5 0.0 0.0 0.0 0.1

Public consumption 2.0 1.4 2.6 1.7 1.2 1.4 1.9 1.4 2.6 1.9 1.2 1.4

Fixed public capital formation -6.4 -2.2 15.2 8.3 1.0 -8.9 0.7 -7.5 12.5 9.9 4.6 -7.1

Exports 17.2 -1.6 -1.3 4.0 8.5 9.4 24.4 -0.4 -0.1 1.4 8.0 9.2

Imports 12.0 5.3 3.8 3.0 5.0 5.9 11.1 5.9 5.4 1.5 5.3 5.8

Nominal net exports (as % of GDP) 0.9 -1.3 -2.2 -2.5 -2.0 -1.5 1.2 -0.9 -2.0 -2.5 -2.2 -1.7

Nominal GDP 1.3 -1.4 0.3 2.4 4.1 3.2 2.4 -2.5 1.1 1.0 4.3 3.2

GDP deflator -2.0 -1.7 -0.9 -0.1 2.2 1.2 -2.2 -1.9 -0.9 -0.6 1.8 1.5

Industrial production 9.3 -1.0 -3.4 3.7 3.5 3.4 16.4 -2.3 -0.3 -0.2 4.9 3.1

Corporate goods price index 0.4 1.3 -1.1 1.5 3.9 2.1 -0.1 1.5 -0.9 1.0 3.4 2.3

Consumer price index -0.6 -0.1 -0.3 0.3 2.9 1.8 -0.7 -0.3 0.0 -0.1 2.4 1.9

Excl. fresh food -0.9 0.0 -0.2 0.4 3.0 1.9 -1.0 -0.3 -0.1 0.1 2.4 1.9

Excl. fresh food and the impact of

consumption tax rate hike-0.9 0.0 -0.2 0.4 0 .7 1.1 -1.0 -0.3 -0.1 0.1 0.7 1.0

GDP deflator -2.0 -1.7 -0.9 -0.1 2.2 1.2 -2.2 -1.9 -0.9 -0.6 1.8 1.5

Unemployment rate 5.0 4.6 4.3 3.9 3.8 3.5 5.0 4.6 4.3 4.0 3.8 3.6

Customs cleared trade balance ( trn) 5.3 -4.4 -8.2 -10.3 -9.0 -7.6 6.6 -2.6 -6.9 -10.6 -9.3 -8.2

Balance of goods ( trn) 6.5 -3.5 -6.9 -8.7 -7.5 -6.0 8.0 -1.6 -5.8 -9.1 -7.8 -6.7

Balance of goods and services ( trn) 5.2 -5.3 -9.5 -9.7 -8.1 -6.5 6.6 -3.4 -8.3 -10.4 -8.4 -7.2

Current account balance ( trn) 16.7 7.6 4.3 6.0 8.9 11.2 17.9 9.6 4.8 5.0 8.2 10.4

Current account balance ($ bn) 194.8 96.5 51.4 59.5 84.5 103.6 203.9 119.0 60.9 51.4 79.1 96.4

As a % of nominal GDP 3.5 1.6 0.9 1.2 1.8 2.1 3.7 2.0 1.0 1.0 1.6 2.0


25/83

The 3 Arrows toolkit for achieving the policy objective


26/83

This is a multi-year process.

There are several failure

modes and dates to get

through.

Ultimate success is not

guaranteed, which implies

market returns will not move in

a straight line.

Reforms like this almost

always generate unintended

consequences and unknown

unknowns we have to keep

monitoring.

However, falling at the first

hurdle seems unlikely plus

sensible policymakers always

make the cost of reversal higher

than the cost of moving on (c.f.

the euro area).

Investors may believe or be

sceptical but the process is

likely to be live and important

globally for several years.

What is the package of tools?

Source: Nomura25

Observations Three Arrows to re-engineer Japans economic engine

represents three arrows under

Abenomics

standsfor the effects that have

already materialised whileshows effects that have partiallymaterialised

Aggressive

monetary

policy

Flexible

fiscal

policy

Growth

strategy

(including taxreform)

Higher

importprices

Break away from deflation

Shrinkage of

deflation gap

Rise incorporate

profit

Weakeryen

Higher

stockprices

Creation of effectivedemand = higher

growth

Increase in

privateconsumption

Increase inpublic

investmentHigherwages

Increase in

corporate capex

Increase in

exports

Wealtheffects

Financial

markets

Expectationeffects


27/83


28/83

132.0

200.0

270.0

0

50

100

150

200

250

300

1980 1985 1990 1995 2000 2005 2010 2014

Current account

Currency in circulation

Banknote

Monetary base

JPY, trn target

Aiming to control monetary base rather than interest rate

Monetary base: actual value and target by the BOJ

Note: December's average figures are used for actual figures. For target figures, year-end figures are used.

Source: The Bank of Japan and Nomura Securities Co. 27

Th BOJ di it b l h t i l


29/83

The BOJ expanding its balance sheet aggressively

The Bank of Japans balance sheet

28Source: The Bank of Japan and Nomura Securities Co.

Others

11 1Q 59.1 0.3 0.2 0.2 0.02 82.6 18.2 53.9 - 0.6 1.5 0.2 126.2 40.8 80.9 4.5 142.42Q 60.9 1.6 0.6 0.3 0.02 66.1 19.3 35.3 0.2 0.0 1.5 0.1 117.0 33.2 79.3 4.5 129.63Q 62.0 1.5 1.1 0.6 0.05 72.5 22.4 39.4 0.4 0.0 1.4 0.1 118.0 34.6 78.9 4.5 137.74Q 66.1 2.0 1.5 0.8 0.06 72.5 24.1 36.0 0.5 0.0 1.5 0.1 125.1 36.5 84.0 4.5 143.0

12 1Q 70.7 1.6 2.0 0.8 0.07 64.3 16.6 35.4 0.5 0.0 1.4 0.1 119.8 34.4 80.8 4.5 139.52Q 77.5 1.9 2.2 1.3 0.09 60.6 16.7 32.4 0.4 0.0 1.4 0.0 128.9 43.1 81.2 4.5 143.6

3Q 81.7 1.4 2.7 1.4 0.10 62.7 21.2 30.7 0.4 0.0 1.3 0.0 129.4 44.0 80.9 4.5 149.94Q 89.2 3.3 2.1 2.9 1.5 0.11 59.3 24.5 26.9 0.4 0.0 1.4 0.0 138.5 47.2 86.7 4.6 158.4

13 1Q 91.3 3.4 1.2 2.9 1.5 0.12 63.8 34.0 21.7 0.4 0.0 1.4 0.0 146.0 58.1 83.4 4.5 164.3

12 1 67.9 1.7 1.7 0.8 0.07 64.7 14.6 37.2 0.5 0.0 1.5 0.1 114.6 29.9 80.2 4.5 136.9

2 70.1 1.6 1.8 0.8 0.07 69.8 14.5 42.6 0.5 0.0 1.5 0.1 113.0 28.0 80.5 4.5 144.2

3 70.7 1.6 2.0 0.8 0.07 64.3 16.6 35.4 0.5 0.0 1.4 0.1 119.8 34.4 80.8 4.5 139.5

4 73.2 1.6 2.0 0.9 0.08 63.4 17.2 34.7 0.5 0.0 1.4 0.1 123.1 36.4 82.2 4.5 141.2

5 76.3 1.7 2.2 1.1 0.09 61.5 16.8 33.3 0.5 0.0 1.4 0.1 115.7 30.9 80.3 4.5 142.8

6 77.5 1.9 2.2 1.3 0.09 60.6 16.7 32.4 0.4 0.0 1.4 0.0 128.9 43.1 81.2 4.5 143.6

7 79.9 1.7 2.4 1.3 0.09 60.1 17.8 31.0 0.4 0.0 1.4 0.0 122.5 36.8 81.1 4.5 145.5

8 82.9 1.5 2.6 1.3 0.09 61.5 19.7 30.6 0.4 0.0 1.4 0.0 122.6 37.0 81.1 4.5 150.0

9 81.7 1.4 2.7 1.4 0.10 62.7 21.2 30.7 0.4 0.0 1.3 0.0 129.4 44.0 80.9 4.5 149.9

10 86.1 1.5 2.9 1.4 0.11 61.7 21.5 29.0 0.4 0.0 1.4 0.0 128.5 42.8 81.3 4.5 153.7

11 88.9 1.9 3.0 1.5 0.11 60.9 22.7 27.0 0.4 0.0 1.4 0.0 125.9 39.7 81.7 4.5 156.4

12 89.2 3.3 2.1 2.9 1.5 0.11 59.3 24.5 26.9 0.4 0.0 1.4 0.0 138.5 47.2 86.7 4.6 158.4

13 1 91.3 3.3 2.0 3.0 1.5 0.11 58.5 27.3 23.3 0.4 0.0 1.4 0.0 130.9 43.7 82.6 4.6 159.8

2 92.9 3.3 2.0 3.0 1.5 0.12 60.6 29.0 23.6 0.4 0.0 1.4 0.0 131.3 43.9 82.9 4.5 163.53 91.3 3.4 1.2 2.9 1.5 0.12 63.8 34.0 21.7 0.4 0.0 1.4 0.0 146.0 58.1 83.4 4.5 164.3

4 98.1 3.4 1.4 2.9 1.7 0.13 67.1 36.0 23.1 0.4 0.0 1.4 0.0 155.3 66.2 84.5 4.6 174.7

Outlook

140 13.0 2.2 3.2 2.5 0.14 59.0 - - - - - - 200.0 107.0 88.0 5.0 220.0

190 18.0 2.2 3.2 3.5 0.17 72.9 - - - - - - 270.0 175.0 90.0 5.0 290.0

End-2013

End-2014

CP

(repos)

Short-

term

JGBs

(net)

Fund

supply

operation

s

against

pooled

collateral

Funds-Supplying

Operation

to Support

Financial

Institution

s in

Disaster

Areas

PecuniaryTrusts

Japan Real

Estate

Investment

Trusts [J-

REITs] Held

as Trust

Property

Stock

(amount

outstanding)

Pecuniary

Trusts

Index-

Linked

Exchange-

Traded

Funds[ETFs

] Held as

Trust

Property

JGBs

(Outright

Purchases)

Breakdown of the BOJ's Balance Sheet and their Outlook Monetary base

Money

in

trust

(stock)

Commercial

paper

Corporate

bond

Loan

Support

Program

CoinsLoans

Current

acct

deposits

BoJ

Accounts/Total

Assets

Bank

notes

Th BOJ t t b b t 75% f l i d JGB


30/83

The BOJ set to buy about 75% of newly-issued JGBs

Comparison of monthly JGB issuance with BOJ purchases of JGBs

Note: Bond issuance data are monthly amounts for FY13 while the bond purchase figures are monthly averages for May 2013 through end-2014.

Source: Japan Ministry of Finance, the Bank of Japan and Nomura Securities Co. 29

(trn) (trn)

Remaining maturity

Up to 1 year 0.22

2-year bonds 2.90

5-year bonds 2.70

10-year bonds 2.40

20-year bonds 1.20

30-year bonds 0.57 More than 10 years 0.801.20

40-year bonds 0.13

0.05 0.01

Floating-rate bonds 0.07

9.95 7.50

Amount of JGBs to be purchased by the BOJ per

month

Gross JGB issuance per month

Type of JGBs Type of JGBs

Bonds w ith couponsBonds with coupons

Inf lation-linked bonds Inflation-linked bonds

TotalTotal

5.60More than 1 year

and up to 5 years3.003.50

1.90

More than 5 years

and up to 10 years

3.003.50

>

>


31/83

The maturity of JGBs held by the BOJ set to rise

JGBs held by the Bank of Japan as of end-February 2013

30

Source: Nomura Global Economics from the BOJ and the MOF of Japan

JPY trn

Remainingmaturity

(years)

JGB held by the BOJ

APP Other Total holdings


32/83

3

4

5

6

7

8

9

0

20

40

60

80

100

120

140

160

1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

Issued JGBs outstanding (lhs)

Average years to maturity (rhs)

trn

FY

ears

Longer maturity for BOJ purchases to help JGB market

Amount of issued JGBs outstanding and average years to maturity

Note: Actual figures through FY11; budget draft for FY12

Source: Nomura, based on MOF data 31

J t it f d fl ti i t


33/83

Japan to exit from deflation environment

Source: Nomura, based on BOJ and Cabinet Office data

Forecasts of the majority of Policy Board Members

32

-0.2

0.7

1.4

1.9

0.90.8

1.6

2.2

0.4

0.7

1.1

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

2012 2013 2014 2015

Forecasts of the majority of Policy Board Members Upper bound

Forecasts of the majority of Policy Board Members Mediun

Forecasts of the majority of Policy Board Members Lower bound

Nomura's forecast

%

Fiscal year average


34/83

-10

-8

-6

-4

-2

0

2

4

6

-3

-2

-1

0

1

2

3

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

10

11

12

13

14

15

16

Core CPI (lhs)Supply/demand gap (lagged by 2 quarters, rhs)

(% y-y) (%)

(CY)

2% inflation is a challenging target

33

Core CPI (all items less fresh food) and output gap simulation

Note: (1) Actual output gap figures are Cabinet Office assumptions, forecasts by Nomura.

(2) We assume potential growth rate of 0.5%, the same as the figure used by the BOJ. For estimates, we use the median forecast of the majority of policy board

members, as shown in the BOJ's Outlook Report (April). (3) Core CPI is extrapolated from the future supply/demand gap.

Source: Nomura, based on BOJ, Cabinet Office, and MIAC data

2% i fl ti t t i h ll


35/83

2% inflation target is a challenge

Historical CPI inflation

34Note: Core CPI is CPI excluding fresh food.

Source: Nomura, based on Ministry of Internal Affairs and Communications data

-4

-2

0

2

4

6

8

10

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12

Headline CPI

Core CPI ( = CPI excluding fresh food)

Core core CPI ( = CPI excluding energy and food)

2% level

% y-y


36/83

L i d ll


37/83

-15

-10

-5

0

5

10

02 03 04 05 06 07 08 09 10 11 12 13

Total loans Large enterprises

Individuals Small enterprises

% y-y

Loans increase gradually

36

Source: Nomura, based on CEIC and BOJ data

Domestic bank loan growth


38/83

SECOND ARROW: large economic impact through Q1 2014


39/83

0

500

1,000

1,500

2,000

2,500

2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q

(annualized, bn)

2011 2012 2013 2014

FY11 2nd

budget

FY11 1st supplementary budget

FY11 3rd budget

FY12 budgetforreconstruction

FY12 1st economic stimuluspackage

FY12supplementary

budget

FY11 4th

budget

FY12 2nd economic stimuluspackage

FY13 reconstruction package

2015

FY14 economicstimulus package

FY14 reconstruction package

FY15 economicstimulus package

Forecasts for public works spending as part of reconstruction efforts and economic stimulus

Source: Nomura Global Economics and MOF38

g p g Q

Economic packages


40/83

Economic packages

Emergency economic stimulus package to revive the Japanese economy

Note: Figures for public works spending are Nomura estimates based on Cabinet Office estimates of project sizes.

Source: Nomura, based on MOF and Cabinet Office data39

JPY trn

MeasuresFiscal

Spendingoutlay

Reconstruction and disaster management 3.8 5.5

Acceleration of post-quake reconstruction 1.6 1.7

Disaster prevention and mitigation 2.2 3.8

Wealth creation through growth 3.1 12.3

Enhancing growth potential by attracting private investment 1.8 3.2

Support for SMEs, small businesses, and

agriculture/forestry/fisheries0.9 8.5

Support for Japanese companies overseas 0.1 0.3Training and employment 0.3 0.3

Ensuring the livelihood of the public and the revitalization of regional

areas3.1 2.1

Public livelihood (healthcare, childcare, etc) 0.8 0.9

Regional revitalization (help for farmers, etc) 0.9 1.2

Help with regional funding, rapid implementation of these

measures1.4

State's share of multiyear public works projects 0.3 0.3

Total for economic stimulus measures 10.3 20.2

Of which, public works spending 4.7 6.8

Implementation of 50% government contribution to state pensions, etc 2.8

Total for supplementary budget 13.1 20.2

Consumption tax is set to be the biggest source of tax revenue


41/83

40

Tax revenue by major taxes

Source: Nomura, based on MOF data

Consumption tax is set to be the biggest source of tax revenue

4

6

8

10

12

14

16

18

20

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

Income tax

Corporate tax

Consumption tax

(trn)

FY

Nomura est

Fiscal challenges facing Japan


42/83

120

130

140

150

160

170

180

190

200

210

220

2000 2002 2004 2006 2008 2010 2012 2014 (FY)

(as % o f no minal GDP)

g g p

Primary central and local government fiscal balance Japans government debt(vs. nominal GDP)


41


-8

-6

-4

-2

0

2

4

1990 1993 1996 1999 2002 2005 2008 2011 2014

If add itional s timulus is implemented in FY14/15

If no addi tional stimulus in FY14/15

Reduction target (half FY10 level)

(as % of no minal GDP)

(FY)

THIRD ARROW: growth strategy under a new framework


43/83

Framework for planning and implementing Abenomics

Source: Nomura Global Economics and CEIC data 42

Consists of private-sector

participants

Will submit a proposal in June 2013

Consists of ministers and private-sector participants, headed by PMAbe

Submitted a proposal in June 2013

collaboration

Microeconomicpolicy Macroeconomicpolicy

Consists of ministers, h eaded by PM Abe Consists of ministers, BOJ

Governor and private-sectorparticipants, headed by PM Abe

Will announce in June the

Basic Policies for Economic and

Fiscal Management andStructural Reform

IndustrialCompetitiveness

Council

Headquarters forJapans Economic

Revitalization

Council onEconomic and Fiscal

Policy

Regulatory reformpanel

collaboration

Growth strategy will be announced in mid-June


44/83

Growth strategy-related schedule

Source: Nomura, based on various news reports43

From mid-MayIndustrial CompetitivenessCounc il to formulate growthstrategies

21 July (tentative)Upper House elections

Post-Upper House electionsSubmission to th e Diet of the Act to Strengthen IndustrialCompetitiveness (provisional title)Further d ebate in the Regulatory Reform Council and other forums onemployment system reform

28 JuneEnd o f current Diet session

4 July (tentative)Official announcement of Upper Houseelections

By mid-MayCouncil for Science and Technology Policy and RegulatoryReform Council to rep ort their discussions

By 1718 JuneGovernment to officially announce growth strategies (and the BasicPoli cies for Economic and F iscal Management and Structural Reform)

By end-MayEducation Rebuilding

Implementation Council to report itsdiscussions

Mid-MayEstablis hment of agriculture

ind ustry-related council within th ePrime Minis ters Office

Mid-MayAhead-of- schedule announcement

of g rowth strategies? (second time)

Mr. Abes first announcement


45/83

Source: Nomura, based on Prime Ministers Office data44

Category Target

Foreign policy Advance economic partnership talks with Asia-Pacific and Europe

Launch economic diplomacy drive, including overseas visits by top officials

Promote concept of leading-edge healthcare centers on PM's visit to Russia

Promote concept of leading-edge healthcare centers on PM's visit to UAE, aim to reach agreement

Medical servicesLaunch public-private initiative Medical Excellence Japan with view to promoting Japanese healthcare

internationally

and healthcare Provide around 110bn of assistance for iPS cell research over 10 years

Amend Pharmaceutical Affairs Act in order to significantly reduce screening times

for regenerative medicine products

Allow outsourcing of cell culturing to private sector

Shorten certification review periods for medical equipment and support market entry by smaller companies

Move from an approval system to a registration system for medical equipment manufacturers

Establish a Japanese version of the National Institutes of Health (NIH)

Promote measures to tackle intractable diseases

Labor and employmentFacilitate shift of human resources from mature industries to growth industries (by increasing support

subsidies for labor movement, etc)

Expand trial employment system that supports three-month trial employment

Establish a voluntary career advancement system that helps individuals gain qualifications

Extend period in which third-year university students are prohibited

from job hunting to March, from December

Introduce mandatory practical English tests for public sector workers

Women in the workplace Call on Japanese industry to ensure at least one female is appointed to the board of every listed company

Target women accounting for at least 30% of leadership positions by 2020

Aim to eliminate childcare waiting lists by FY17

Extend eligibility for financial support to extended-hours childcare at kindergartens

Ease subsidy requirements for childcare facilities inside business premises

Call on Japanese industry to allow childcare leave to be taken until a child reaches three years old

Provide support to individuals returning to the workplace following childcare leave (retraining subsidies, etc)

Growth strategies announced by Prime Minister Abe at 19 April press conference

Mr. Abes second announcement


46/83

45

Note: Of the growth strategies mentioned in Prime Minister Shinzo Abe's speech on 17 May, we have li sted those that are not among the growth

strategies proposed by the Industrial Competitiveness Council and theme-based committees.

Source: Nomura, based on Prime Minister Shinzo Abe's speech

Growth strategies included for the first time

Measures to promote capex using leases

Break from practice of requiring startups to provide personal guarantees

Easing of visa requirements for people from Southeast Asia, including Thailand, Malaysia, and Vietnam

Creation of plan to double agricultural income

Establishment of agricultural development fund

Direct payment system for farming households

Establishment of public-private Cool Japan Promotion fund

Creation of single point of contact for processing rights related to content exports

Some numerical targets for growth strategies unveiled at news conference

Current Target Period

Private-sector capex 63trn 70trn 3 years

Overseas infrastructure order receipts 10trn 30trn 2020

Agricultural income - Double 10 years

Agriculture, forestry, and fisheries exports 450.0bn 1trn 2020

Market size of senary industry 1trn 10trn 10 years

Number of visitors to Japan 8mn people a year 1020mn -

Exports of broadcasting content - 3x or more 5 years

Non-Japanese university professors - Double 3 years

Number of universities ranked among the world's top 100

universities 2 universities 10 universities 10 years

Growth strategies announced by Prime Minister Abe on 17 May


47/83

Key components of growth strategy (1)


48/83

Growth strategy proposals by the Industrial Competitiveness Council and theme-based committees(1)

Note: The above lists various items presented by theme-based committees prior to the Industrial Competitiveness Council meeting of 23 April.

Source: Nomura, based on Industrial Competitive Council materials

47

Agenda items for theme-based committees and growth strategy candidates

Promoting industrial metabolism

Encourage industry consolidation, business restructuring Create new industries (businesses), further expand existing industries

Maintain the industrial baseMake the next five years a period of focused structural reforms to industry. Initiatives to include the introduction of a Japanese limited liability company (LLC) system (whereby profit/loss can be

offset between parent and subsidiary); greater clarification of rules and regulations for termination of employment; simplification/expansion of angel investor tax procedures; a tax regime to

promote intra-company ventures, carve outs and spinoffs; incentives for replacement of aging facilities and equipment; and corporate tax breaks to stimulate investment within Japan and f rom

overseas.

Strengthening of the human resource pool, and employment reforms

Promote measures to tackle the dwindling birth rate Reform education

Reform employment Promote employment of youth, women and the elderly

Examine ways to stem the population decline and maintain the population at a certain size. Examples include: tax breaks for c ompanies that offer childcare support; use of TOEFL in university

entrance exams and other areas; establishment of international universities either by invitation to leading overseas universit ies or jointly by Japanese universities; large-scale expansion of

student capacity at technical colleges; c reation of mid-to-long-term internships as part of formal education programs; greater diversification of work contracts (fixed contracts of over three years,

region-, job- and project-specific contracts, etc); rationalization/clarification of rules of employment; wider scope of eligibility for government subsidies, inc luding for trial employment; regional

ransfer and opening-up to the private sector of the Hello W ork scheme; establishment of social systems to support September university entrance and Gap Year programs.

Enhancing Japan's competitiveness as a place to do businessImprove the regulatory environment Rectify high-cost structures

Enhance traffic and urban infrastructures Improve urban environments

Internationalize the business environment Promote Abenomics strategy zones (tentative name) that feed directly through to

economic growthAugment measures to stimulate regional economies

Make effective use of government assets and household financial assets

Take steps to rectify areas that make it diffi cult to do business globally. Examples include: reduction in corporate tax; international leading-edge tests and their trial introduction in special zones;

separation of power transmission & distribution operations at an early stage (introduction of "negawatt" trading by this summer); implementation of the internet/ICT AutoBAHN concept; extensive

improvements to airports in the greater Tokyo area; easing of regulations on plot ratios and property uses in metropolitan areas; measures to make active use of big data and open data;

promotion of Abenomics strategy zones (tentative name); promotion of Doshusei system; sale of low-priority government assets; study into best practices for investing public and quasi-public

funds and managing associated risk.

Achieving balanced supply-demand for clean, economic energy

Supply-side (procurement) initiatives Demand-side (consumption) initiatives

Distribution initiativesAdopt policies to support the areas of supply, demand and distribution/logistics in order to secure an affordable and stable supply of the energy Japan needs. Supply-side initiatives inc lude the

early restart of nuclear power plants verified as safe, greater efficiencies in coal-fired thermal power generation via use of gas turbine combined cycle and other systems, sourcing of LNG more

widely and affordably, deregulation to promote wind power generation. Demand-side initiatives include the introduction of a purchasing scheme for cogeneration power, the introduction of

energy-saving homes equipped with energy management systems, the development and promotion of next-generation automobiles, installation of smart meters and other infrastructure (demand-

response infrastructure), promotion of the Energy Bank concept (battery development), study into possible introduction of summer time. Initiatives in the area of distribution include electricity

system reform (the establishment of wide-area regional transmission organizations, full liberalization of retail electricity sales) and the strengthening of electricity cooperation (expansion of

capacity of systems to convert frequency).

Key components of growth strategy (2)


49/83

Growth strategy proposals by the Industrial Competitiveness Council and theme-based committees(2)

Note: The above lists various items presented by theme-based committees prior to the Industrial Competitiveness Council meeting of 23 April.

Source: Nomura, based on Industrial Competitive Council materials

48

Agenda items for theme-based committees and growth strategy candidates

Creating a long-living society

Build a society in which people can live a healthy, long life Provide impetus to the healthcare industry, build a society in which everyone can receivethe world's highest levels of healthcare

Enable people to return to normal life quickly via access to high-quality healthcare

Build a society in which the health of the populace supports economic growth

Consider taking the following steps to create a society in which people live long and healthy lives: lay foundations for affordable, simple medical consultations ("one-coin consultations"); lower

medical fee deductions for the elderly; promote iPS cell research; ease regulations for approval of medical equipment; introduce a Japan-style NIH system and manage budgets of relevant

ministries/agencies on an integrated basis; introduce a "my number" system and basic income program; eliminate elderly waitlists for special homes for the aged; create a healthcare REIT market;

conduct a national debate on broader acceptance of migrant workers.

Expand agriculture exports and boost competitiveness of agriculture industry

Consolidate farmland Provide direct income compensation

Encourage corporate entry into agriculture industry (revise requirements for gaining status of

agricultural production corporation)

Promote greater industrialization of agriculture and use of ICT

Human resource development and R&D

Set up growth industry fund for agriculture, forestry and fisheries (sixth-order industry fund)Establish an export structure

Public-private initiatives with overseas partners (such as mutually beneficial partnerships in

food, energy)Agricultural special zones

Agricultural export special zones Initiatives in forestry/fishery industries

Maintain functions of farming communities

Reorient agriculture industry to one focused on the consumer rather than the producer, and aim to turn agriculture into a growth industry and an export industry. Specific initiatives include:

deregulation to support large-scale business enterprise in agriculture; use of trusts to match farmland to producers; incentives to increase use of vegetable factories; establishment of agricultural

schools and business schools; creation of an accreditation system to boost value added via introduction of Japan-style agricultural occupancy condition (AOC) scheme; establishment of agricultural

export special zones; creation of agricultural export business model with the aim of achieving Japan-style "food valleys"; construction of healthcare and long-term care facilities in farming

communities.

Enhancement of science & technology innovation and IT

Appreciably strengthen frameworks for promoting innovation in science & technology Step up public-private R&D investmentStrengthen activities to support innovation by the private sector

Enhance functions of universities and public research institutes

Enhance IP strategies, standardization strategies

Consider the following measures to promote innovation as a key source of industrial competitiveness: Reorganize the existing Council for Science and Technology Policy and strengthen its

command functions; set up the FIRST-II program as a successor to the FIRST project for leading-edge R&D; ensure an equal footing in terms of plant, property and equipment tax, etc; provide IP

support for small and midsize enterprises.

The TPP should benefit Japans economy


50/83

Impact of TPP on GDP growth

Source: Nomura, based on the Government of Japan

49

ItemImpact on GDP

(JPYtrn)% GDP

Consumption 3.0 0.61

Investment 0.5 0.09

Exports 2.6 0.55

Imports -2.9 -0.60

Net impact on GDP growth 3.2 0.66

The government looks likely to

underestimate the real economic impact of

the TPP as it merely takes into account the

impact from reducing tariffs to zero.

The TPPs actual benefits stem not only

from reduced tariffs but also from (1)

harmonized trade rules, (2) liberalized

service trade, and (3) fewer restrictions oncross-border investment activity.

The TPP is also likely to generate further

benefits by spurring negotiations for a

Japan-China-Korea FTA and RCEP

(ASEAN+6).


51/83

Other areas of growth strategy


52/83

New growth strategies featured in newspaper reports (including items under consideration)

Note: Collated from articles between 23 April and 9 May in the Nikkei, Yomiuri Shimbun, Asahi Shimbun, Mainichi Shimbun, and Sankei Shimbun. Includes items

still under consideration, so all may not be included in the final growth strategies.

Source: Nomura, based on various news reports

51

Introduction of special zones, including Abenomics strategic zones

Revival of domestic infrastructure using PFIs

Export of high-efficiency coal-fired power generation technology

Easing of regulations on industrial robot installation (to reduce factory construction costs)

Initiatives to promote wider use of affordable long-term care robots

Establishment of "human resource bank" (tentative name) as a means of providing support to SMEs when female workers take maternityand childcare leave

Initiatives to raise minimum wage

Easing of visa restrictions for Southeast Asians (Thailand, Malaysia, Vietnam, etc)

Placement of Japan tourism advertisements in overseas magazines and on television

Study into legalizing casinos

Establishment of farmland middle management organization (tentative name) to support consolidation of farmland, elimination of uncultivated farmland

Study into export of agricultural production data system in which produce cultivation technology is collated in digital form

Introduction of private-sector English language tests such as TOEFL as part of career bureaucrat examinations for new ministry and agency workers from FY16


53/83

Investment themes: Equities


54/83

Japan again: Recent TOPIX has exceeded 20-year movingaverage


55/83

Historical trend of TOPIX

Japanese stock market has seen a sudden surge after the long slump

54

0

500

1,000

1,500

2,000

2,500

3,000

3,500

1968 72 76 80 84 88 93 98 2003 08 13

TOPIX 20-yr moving average

(FY)

Source: Nomura, based on TSE data

Market outlook: Corporate earnings and stock prices


56/83

Russell/Nomura Large Cap Recurring Profits and TOPIX

Estimated recurring profit levels returning to pre-Lehman-crisis levels, while the index is still at half the pre-

Lehman level

55

Note: Latest data as of 21 May. Recurring profits for FY12 and thereafter are based on Nomura estimates

Source: Nomura, based on Tokyo Stock Exchange

600

800

1,000

1,200

1,400

1,600

1,800

2,000

0

5

10

15

20

25

30

35

40

95 97 99 01 03 05 07 09 11 13 15

Russell/Nomura Large Cap Recurring Profits (lhs) TOPIX (rhs)(trn) TOPIX

FY

Market outlook: historically low P/E supporting bullishoutlook


57/83

TOPIX 12 month forward P/E

Current P/E of 16.2x still lower than the post-2000 average of 19.6x

56

0

10

20

30

40

50

60

70

80

90

82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12

(times)

Source: Nomura, based on Tokyo Stock Exchange and Toyo Keizai data


58/83

Market outlook : What does the success of Abenomicsimply?


59/83

Nikkei 225 and corporate profits

Source: Nomura from Bloomberg data

We estimate 2018 N225 at the 25,000 level, based on 1,650 EPS & 15x P/E

58

-500

0

500

1,000

1,500

2,000

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

85 90 95 00 05 10 15

Nikkei Average (lhs) N225-EPS (rhs)

\

yy

N225-EPS \

Japanese Banks are healthy compared with US and EUBanks


60/83

Source: Nomura, Company data 59

Ranking of Banking Systems Based on Banks Balance Sheet

Indicators, 2012:Q3 CET1 ratio (FY12)

Sources: Bloomberg L.P.; SNL Financial; and IMF staff estimates.

Note: AT = Austria; CH = Switzerland; DE = Germany; ES = Spain; FR = France; GR = Greece; IE = Ireland; IT = Italy;

JP = Japan; NL = Netherlands; PT =Portugal; SE = Sweden; UK = United Kingdom; US = United States. The closer a banking system is to the center of the

figure, the more balance sheet

adjustment it needs to undertake. Rankings are based on the aggregate position for a large sample of banks

headquartered in each country (more than 90

percent of the banking system in most cases) as of 2012:Q3 or as of the latest available data before then. Bank buffers

are the ratio of core Tier 1 capital and

loan loss reserves to impaired loans as reported in banks financial statements. The loan-to-deposit ratio is gross loans as

a percentage of deposits (for Italy

and Spain, adjusted for retail debt). Change in the impaired loan ratio is the annual change in impaired loans as a

percentage of gross loans. Return on assets

is average annualized retained earnings over the past year as a percentage of tangible assets minus derivatives. See

footnotes 17 and 18 in the main text.

Japanese banks

0%

2%

4%

6%

8%

10%

12%

MUFG

SMFG

Mizu

ho

JPM

Citi

BOA

HSBC

Barc

lays

BNP

SG

Deu

tsc

he

CET1 ratio

Totally different from early 2000s when Japans banks faced major NPL concerns

Signs of leveraging increasing by Japanese companies;bank lending steadily increasing


61/83

Loan growth of Japanese banks y-o-y

60

-6

-5

-4

-3

-2

-1

01

2

3

4

5

01 02 03 04 05 06 07 08 09 10 11 12 13

(%)

Source: Nomura, based on BOJ

Individual investors starting to come back into theJapanese equity market


62/83

61

Share of brokered trading turnover on Japans three main

markets

Net subscription of publicly offered Japanese equities

investment trusts

-400

-200

0

200

400

600

800

1,000

Mar-

10

May-1

0

Ju

l-10

Sep-1

0

Nov-1

0

Jan-1

1

Mar-

11

May-1

1

Ju

l-11

Sep-1

1

Nov-1

1

Jan-1

2

Mar-

12

May-1

2

Ju

l-12

Sep-1

2

Nov-1

2

Jan-1

3

Mar-

13

May-1

3

(bln yen)

0

10

20

30

40

50

60

70

80

00 01 02 03 04 05 06 07 08 09 10 11 12 13

(%)

(CY)

Nonresident investors

Retail investors

Japanese institutional investors

Source: Nomura, based on Tokyo Stock Exchange Source: Nomura, based on Japan Investment Trusts Association

Implementation of individual savings account from Jan 2014 hasbig potential to move retail investors cash in to riskier assets


63/83

62

Value of stock ISA's in UK

Composition of household financial assets in Japan, the US,

and Europe

16

26.330.3

34.5

46.8

55.1

70.4

80.1 78.6

116.1

173.5

192.7

0

20

40

60

80

100

120

140

160

180

200

00 01 02 03 04 05 06 07 08 09 10 11

(bln pounds)

Cash &deposits,

35.8%

Cash &deposits,

14.3%

Cash &deposits,

55.2%

Bonds, 7.0%

Bonds, 9.5%

Bonds, 2.1%

Investmenttrusts, 7.2%



Equities,investments,

14.3%


32.8%


6.8%

Insurance andpension

reserves,31.7%


reserves,28.1%


reserves,27.7%

Other total,3.9%

Other total,3.2%

Other total,4.2%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Euroarea(USD25.1trn)

US(USD54.4trn)

Japan(USD15.5trn)

Note: Data after 2009 includes Personal Equity Plan.

Source: Nomura, based on Financial Services Agency

Note: Data for Japan and the US as of end-Dec 2012; data for Europe as of

end-Sep 2012.

Source: Nomura, based on BOJ

When the current growth strategy is a success,government debt outlook should stabilize


64/83

Government Outlook for Outstanding Debt

63

Assumption of Growth Strategy

Scenario: The average annual growth rate

for the FY2011FY2020 period is projected

to reach approximately 3% in nominal and

2% in real terms. The rate for change in

the Consumer Price Index is projected to

turn positive in FY2012, and to stay as

high as around 2%over the medium to

long term.

Assumption of Prudent Scenario: The

average annual growth rate for the

FY2011FY2020 period is projected to

reach mid-1% in nominal and over 1% in

real terms. The rate of change in the

Consumer Price Index is projected to turn

positive in FY2012, and to stay as high as

around 1% over the medium to long term.

Source: Nomura, based on Cabinet Office

100

125

150

175

200

225

250

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23

Actual

Prudent Scenario

Growth Strategy Scenario

(FY)

(% of nominal GDP)


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Investment Themes: Rates

Market forecast

(%)


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67

Source: Nomura

- We expect 10yr yields to trade at around 0.80% at end-June and 0.70% at end-December. We expect the next major

market downturn to take place sometime in January-March 2014.

- We expect 10yr UST yields to trade in a 1.8-2.2% range at end-June and trade in a 1.8-2.2% at end-December.

- As the amount of JGB purchases by the BOJ is set to exceed the national budget deficit, JGB supply and demand

should tighten if investors simply replace redeemed bonds.

- The BOJ is unlikely to increase JGB purchases further. It could increase equity purchases if conditions warrant. We

think the Japanese government will devise a supplementary budget after the July upper house election.

- Fed officials will likely tone down their language on an early QE3 exit toward summer.

- As US rates rise, major domestic investors and retail investors (via toshin) could shift funds out of JGBs.

-Weaker JPY could cause investor selling of super-long JGBs that exceeds BOJ purchases.

(%)

Latest

7-Jun

Japan

Basic loan rate 0.30 0.30 0.30 0.30 0.30 0.30 0.30

Unsecured O/N call 0.08 0.08 0.00 ~ 0.10 0.08 0 .00 ~ 0.10 0.08 0.00 ~ 0.10 0.08 0 .00 ~ 0.10 0.08 0.00 ~ 0.10 0.08 0 .00 ~ 0.10 3M Tibor 0.23 0.22 0.20 ~ 0.23 0.20 0.18 ~ 0.23 0.20 0.18 ~ 0.23 0.20 0.18 ~ 0.23 0.20 0.18 ~ 0.23 0.20 0.18 ~ 0.23

2yr JGB 0.13 0.13 0.10 ~ 0.16 0.11 0.10 ~ 0.16 0.11 0.10 ~ 0.16 0.13 0.10 ~ 0.18 0.15 0.11 ~ 0.20 0.15 0.11 ~ 0.20

5yr JGB 0.28 0.33 0 .23 ~ 0.50 0.25 0 .20 ~ 0.45 0.25 0 .20 ~ 0.45 0.33 0 .20 ~ 0.55 0.43 0 .25 ~ 0.60 0.43 0 .25 ~ 0.60

10yr JGB 0.84 0.80 0.60 ~ 1.00 0.70 0.60 ~ 0.95 0.70 0.60 ~ 0.95 0.80 0.60 ~ 1.10 0.95 0.65 ~ 1.20 0.95 0.65 ~ 1.20

20yr JGB 1.66 1.60 1.45 ~ 1.80 1.55 1.45 ~ 1.80 1.55 1.45 ~ 1.80 1.70 1.45 ~ 1.95 1.80 1.50 ~ 2.05 1.80 1.50 ~ 2.05

30yr JGB 1.80 1.75 1.60 ~ 1.95 1.70 1.60 ~ 1.95 1.70 1.60 ~ 1.95 1.90 1.50 ~ 2.15 2.00 1.70 ~ 2.25 2.00 1.70 ~ 2.25

USD/JPY 97.56 98 94 ~ 105 98 94 ~ 105 100 94 ~ 105 103 96 ~ 106 105 98 ~ 110 105 98 ~ 110

EUR/JPY 128.96 127 123 ~ 135 127 123 ~ 135 128 123 ~ 135 130 125 ~ 135 132 125 ~ 138 132 125 ~ 138

Nikkei 225 (K) 12.88 13.5 12.0 ~ 15.0 13.5 12.0 ~ 15.0 14.0 13.0 ~ 16.0 14.5 13.0 ~ 16.0 15.5 14.0 ~ 16.5 15.5 14.0 ~ 16.5

2013 2014

June September June September December March

Key issues


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BOJ: Market stabilization measures, policy duration, further easing

options

Government: Stimulus measures, fiscal reform, consumption tax hike

Investors: Domestic accounts reducing yen bond exposure, their

alternative investment options, foreign investor trends

Money flow: A decline in current account surplus and capital flight,bank deposit-loan balance, retail investors toshin flow

US and eurozone economies: Monetary easing (exit), Japanization of

euro area and US markets

68


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Summary of long-term views


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Long-term views (from end-2013; accelerated growth, end to monetary easing)

- Weak yen should encourage investor and corporate funds to shift into foreign markets; yen

rates to trade in higher ranges as deflationary pressures decrease.

- Retirement of baby-boomers helps companies reduce payrolls (2012~); wage deflation eases.

However, we expect CPI inflation to remain in a 0.5-1.0% range, with the BOJ missing its 2.0%

inflation target.

- A consumption tax hike from April 2014; decrease in bank deposits and increase in public

pension funds to create flattening pressure; ahead of a consumption tax hike, last-minutepurchases should boost spending in H2 2013.

- UST rates back up as the Fed exits QE3. Major banks incur valuation losses on foreign bonds

and reduce exposure to yen bonds.

- BOJ should begin to decrease JGB purchases in January-March 2016.

- Rates downside risks: Downshift in growth expectations; slowing corporate capital spending.- Rates upside risks: Japanese governments greater reliance on a weak-yen policy; decrease in

the current account surplus; increase in capital flight.

70

Recommended investments


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Short term (to September 2013)

- Long 5s (at 0.40%, target of 0.25-0.30%)

- Long 10s (at 0.90%, target of 0.65%)

- Long 20s (at 1.75%, target of 1.50%)

- Long 20yr Asset Swaps (at 0bp, target of -10bp)

Long term (from end-2013; assuming accelerated growth and end to monetary easing)

Short 20s (at 1.50%, target of 1.80%); caution needed in timing the entry due to negative

carry.

5s20s steepener (at 125-130bp, target of 145bp); caution needed in timing the entry due

to negative carry.

71

Is inflation target a downside or upside factor for JGB rates?


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0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

0.00 1.00 2.00 3.00 4.00 5.00

10yr JGB yields (%)

5yr1m swaps rate

10yr forward rates vs. 10yr JGB yields

If the market factors in a 2% inflation rate, 1% real growth, and 2.5% short-term rates in five

years, 10yr JGB yields should be trading slightly below 2.0%.

Assuming that the BOJ fails to achieve its inflation target within two years and continues

with JGB purchases for a sustained period, interest rates should be kept down.

Source: Bloomberg, Nomura Securities Co., Ltd.

72

5yr and 10yr forward rates

0

1

2

3

4

5

6

1996 1998 2000 2002 2004 2006 2008 2010 2012

10yrf 1m 5yrf 1m

(%)

Source: Bloomberg, Nomura Securities Co., Ltd.

10yr JGB yields and 10yr OIS rates 10yr UST yields and 10yr OIS rates

Rates continue to sell off despite improved supply and demanddue BOJ purchases


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0

0.1

0.2

0.3

0.4

0.5

1

1.5

2

2.5

3

3.5

4

4.5 [a] less [b] 10yr UST yields (RHS) [a] 10yr USD OIS [b]

(%) (%)

-0.1

0

0.1

0.2

0.3

0.4

0.5

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6 [a] less [b] 10yr JGB yields (RHS) [a] 10yr JPY OIS [b]

(%) (%)

Source: Bloomberg

10yr JGB yields and 10yr OIS rates 10yr UST yields and 10yr OIS rates

As BOJ purchases brought the JGB-OIS spreads close to zero, JGB rates would be unlikely

to decline further on improved supply and demand conditions. The rates backup since theQQE adoption was not caused by the widening of JGB-OIS spreads, but rather by a rise in

OIS rates.

When 10yr OIS rates were above 1.0% in Japan, those in the US were at 3.5%. A QE3 exit

alone should not be enough to cause 10yr JGB yields to trade consistently above 1.0%. 73


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Summary

The BOJs impact on the JGB market: The BOJ is going to purchase about 70% of monthly JGB issuance.


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76

e OJ s pact o t e JG a et e OJ s go g to pu c ase about 0% o o t y JG ssua ce

The share of the BOJ in total JGB outstanding is expected to rise to 20% from 12% currently.

The direct impact throu gh po rt fo l io rebalancing: Households own less than 3% of JGBs, so institutional

investors (Banks: 38%, Insurance: 19%, and Pensions: 10%) must move. Insurance companies are buyers of

the super long zone, while banks trade at the shorter end. Pensions are investing more broadly.

The FX impact f rom port fo l io rebalancing: The FX impact may be smaller than expected.

Banks: Fund in local currencies when investing in foreign bonds.

Pensions: Contrarianscan be forced to change reference portfolios, but can still be dip buyers.

Lifers: Most natural alternative investment is hedged basis foreign bonds.

Indirect impact thro ugh r isk appet i te channel: More important for FX.

Retai l in vestors: Sentiment is clearly improving.

Confidence indicators are at their highest levels in 10 years.

The BOJs most recent policy announcements should improve risk appetite further

30%:BRL, TRY:20%, MXN:10%, ZAR:10%, RUB:10%?

Lifers: A lower hedge ratio is more likely for high yield currencies: AUD in G10

Major government bond index: MXN, PLN, ZAR

The imp act on f ixed incom e: Lifers may still prefer core, semi-core eurozone bonds (France and the

Netherlands). UST investment will likely shift to the longer end to increase carry. US mortgage and EM bonds

(MXN, PLN, AUD) are also likely targets, in our view.


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FX: Money flow is structurally supporting JPY decline

Trade balance has shifted from surplus to deficit since 2011


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78

Trade Balance & Current Account Balance Trade Balance

Note: Nomura estimates CY13 toCY15

Source : Nomura, based on Trade Statics of Japan Source : Nomura, based on Trade Statics of Japan

-40

-30

-20

-10

0

10

20

30

40

88 90 92 94 96 98 00 02 04 06 08 10 12

Trade balance

Trade balance (ex. fossil fuels)

Fossil fuels

(as % of nominal GDP)

(CY)

-15

-10

-5

0

5

10

15

20

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13E

14E

15E

trillion yen

CY

Trade Balance

Current Account Balance

Trade balance has shifted from surplus to deficit since 2011

FX: Relatively more monetary easing has meant depreciationof JPY

BOJ is getting more dovish than the Fed


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Monetary base ratio of US/Japan, and the USD/JPY rate

BOJ is getting more dovish than the Fed

79

0

10

20

30

40

50

60

70

80

90

100

110

60

70

80

90

100

110

120

130

140

150

160

90 92 94 96 98 00 02 04 06 08 10 12 14

USD/JPY(lhs)

US/Japan monetary base ratio(rhs)

US/Japan monetary base ratio forecast(rhs)

(end 1989 = 100)

Source: Nomura, based on Bloomberg and Bank of Japan

Disclosure Appendix A1


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80

ANALYST CERTIFICATIONSWe, Yunosuke Ikeda, Tomo Kinoshita, Naka Matsuzawa, Hiromichi Tamura and Kevin Gaynor, hereby certify (1) that the views expressed in this report accurately reflect my personal views about any or all

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may be associated with any investment decision Nomura Group produces a number of different types of research product includi ng among others fundamental analysis quantitative analysis and short term


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