Investor optimism runs high for Abenomics Like the bright lights in Tokyo's Ginza shopping district, Japan has dazzled global investors this year. The Nikkei index is up almost 40 per cent and "Abenomics" - the economic policies of Shinzo Abe, prime minister - shows signs of working: economic growth has accelerated and, after two deflation-hit "lost decades," consumer prices are rising, albeit on the back of higher imported energy costs. In Tokyo it is easy to find optimists who believe Japan has found a way out of its economic paralysis. But visitors are also impressed by the scale of its monetary policy experiment, which has seen the Bank of Japan's balance sheet expanding more relative to the size of the country's economy than that of either the US Federal Reserve or European Central Bank. It is hard to escape concluding that the scope for market mishaps is large. Currently, the big worry in Tokyo is that the US's fiscal woes derail the global economic recovery. With its large-scale quantitative easing, which will double the monetary base within two years, the Bank of Japan has driven the yen sharply lower, helping exporters and raising import prices. More recently, however, the Japanese currency has become a haven for investors, strengthening against the dollar on worries about a Washington foul-up. Not helping sentiment were last week's downward revisions to the International Monetary Fund's world growth forecasts. Were the global recovery to splutter, optimism could evaporate and cracks appear in Abenomics. What has impressed markets most so far has been the success of Abenomics in boosting economic optimism domestically - as well as among international investors. The latest BoJ "Tankan" survey shows confidence among large and medium-sized enterprises at the highest since late 2007. This is a fillip for Haruhiko Kuroda, BoJ governor, who has leveraged the credibility of the world's central banks to new levels. By asserting with sufficient conviction that inflation will reach 2 per cent within two years, the BoJ hopes businesses, consumers and investors will plan accordingly and its target will become self-fulfilling. If not? Hey, it will just ramp up QE still further. Dragging Japan out of its deflationary slump would be a significant achievement. But to create sustainable economic growth, Abenomics has to go further in changing corporate mindsets. Two decades of deflation, warns Hajime Takata, chief economist at the Mizuho Research Institute, have left Japanese companies as "herbivores" focused on deleveraging and cost cutting, rather than the expansionary, world-beating "carnivores" of the period before the 1990s. New-found flesh-eating proclivities are hard to spot. One gauge - the number of stock market debuts - is barely flickering. This year has seen 39 initial public offerings so far, up slightly from 2012 but well below the 100-plus seen annually before 2007, according to Dealogic. A week spent talking to corporate executives, as well as politicians and analysts, leaves the impression that any turnround will take a long time. In the Ota City industrial development region, close to central Tokyo, the elderly chairman of a specialist hydraulic cylinder manufacturer proudly showed off his well-maintained factory. Asked if he planned to update his most expensive machinery, however, he replied with a smile: "We have to be patient." Japan's parliament on Tuesday started debating the Abe government's growth agenda - the "third arrow" of its economic plan (the first is the monetary stimulus, the second a targeted fiscal policy). Already slippage is occurring, for instance on labour market reforms. Without growth the BoJ's balancing act will become ever more precarious. Beyond Washington politics, an immediate danger (ignoring longer-term consequences of such aggressive monetary policy easing) is of a rise in yields on Japanese government bonds, which move inversely with prices. Central bank action has suppressed borrowing costs even as public sector debt has soared above 200 per cent of national income - the yield on ten-year Japanese bonds is still below 0.7 per cent, compared with 2.7 on US equivalents - and investors" confidence in the government's tax raising powers has acted as a stabilising factor. But a rise would quickly escalate Tokyo's borrowing costs and strain Japanese banks" balance sheets. A foretaste of possible vulnerabilities came shortly after Mr Kuroda took over at the BoJ in April, when bond yields leapt sharply, presaging the global volatility in May when the Fed hinted at a scaling back of US QE. That episode is now ascribed in Tokyo to central bank communication problems since resolved. Bond market investors may also have become better at judging equilibrium prices under Abenomics. But it is unlikely to have been the last upset.