Japan's snap election this weekend has Prime Minister Shinzo Abe seeking a mandate to delay further hikes in consumption tax. Our Japan Managing Director gives an insight into the local situation.
Japanese Prime Minister Shinzo Abe last month dissolved the country's parliament and called a snap election for mid-December. He seeks an electoral mandate for his decision to postpone the next stage of a hike in consumption tax for another 18 months amidst opposition from his colleagues and economists.
The announcement came a day after Japan announced a 1.6% fall in its third-quarter GDP, following a 7.3% decline (the deepest decline in more than five years) in the previous quarter. Two back-to-back quarterly contractions put the country in the fourth recession since the 2008 Global Financial Crisis.
The world’s third-largest economy was dragged down by an increase in the national consumption tax (from 5% to 8%) in April. The tax increase was the first of a two-stage increase put in place in 2012 by then-Prime Minister Yoshihiko Noda.
Although Mr Abe delayed the second stage of the hike, the damage was already done. The hike brought negative impacts on the economy as it halted consumer spending and corporate investment.
The rise in Japan's consumption tax was implemented to curb the country’s current budget deficit (9% of GDP), rising social security cost (reaching US$1.24tn by 2025) and its US$8.5tn public debt (250% of GDP and the highest among developed nations). Policy makers wished to boost government income with the tax rise but never expected its impact would linger among Japanese households and corporations for more than one quarter.
The rise in consumption tax has driven up the living cost and reduced the buying power of Japanese households. This is because they are struggling to cope with the slight increase in the price of goods and services with the slow wages growth. As a result, household spending has decreased for the seventh month falling 4% year-on-year in October as consumers held back on their expenditure. The consumption tax increase also led to a 24% fall in the third quarter’s private residential investment.
Not only are consumers in thrifty mode, but private investment also slowed in the six consecutive months after the tax increase. In the second quarter, Japanese corporate capital expenditure fell to only 50% of the record level set in 2007. The holdings of cash and deposits were the second highest on record US$1.98tn (larger than the Canadian economy).
Abenomics and the Lost Decades
For the past two years, Mr Abe has been trying to pull Japan out of the two “Lost Decades” long of low growth and continuous deflation. He is advocating a series of economic policies coined as the “Abenomics” that comprises of “three arrows”: monetary stimulus, fiscal stimulus and structural reforms. The first arrow was carried out through Bank of Japan’s (BOJ) aggressive monetary policies. Last month itself, the BOJ surprised the market by widening its quantitative easing programme to increase the value of bond purchases to US$700bn per annum (double the value of new bonds actually issued by the government). It made BOJ’s bond buying programme the most extensive that the world has ever known – far greater the United States’ Federal Reserve.
BOJ’s bold monetary policies caused the value of the yen to depreciate 28% to a seven-year low. Japanese corporations have gained significantly from the weakening of yen as it increased market demand, improved product exports and lifted corporate profit. For example, Toyota Motor Corp - Japan’s biggest automaker - is expected to post another record profit consecutively due to the 11% depreciation in yen so far this year.
Since December 2012, the first arrow of Abenomics has also powered the Nikkei Stock Average to a seven-year peak of 17,649 points in December after climbing nearly 70% while the Tokyo Price Index (TOPIX) surged 65%. Another step by PM Abe to stimulate the local bourse is approving the Government Pension Investment Fund (the world’s largest pension fund with US$1.1tn in assets) to double the weightage of local equities in its investment portfolio from 12% to 25%.
Besides the upbeat corporate sector and stock market, the falling yen has also brought in a record number of visitors to Japan for the second year in a row. In the first 10 months of 2014, up to 11,009,000 (a 27.1% increase from 2013) tourists visited the country. Mr Abe’s government aims to double the number of foreign visitors from the current 11 million to 20 million by 2020, the year Japan is set to host its second Olympics after more than half a century.
In fact, the 2020 Tokyo Summer Olympic Games are projected to generate between US$25bn to US$1.26tn for the local economy from construction of sport facilities, hotel and infrastructure to tourist consumption. The rush in infrastructure construction prior to the Olympics works in tandem with the second arrow of Abenomics, namely to boost the economy through fiscal stimulus in public works. The Games are estimated to create a total of 1.21 million jobs or 170,000 new jobs per annum in the seven years leading up to 2020.
Real household income falling
While Abenomics has generated some positive impact on corporate Japan, those gains are outweighed by the negative side effects it has brought to the overall economy. The consumption tax hike has reduced the real income of Japanese households due to the domino effect of price increase in almost everything sold in supermarkets.
The delay of a further tax hike may prevent the Japanese economy from a downward slide, but the country still has to find ways (either through tax hikes or expenditure cuts) to reduce its massive budget deficit before it erodes the market’s confidence.
Japan will have to carry out the hardest but yet the most important part of Abenomics - the third arrow of structural reforms – in order to revive its economy and sustain growth for the long term. Reformations proposed by Mr Abe include the establishment of nine designated areas in Tokyo as Special Zones to attract foreign direct investment (FDI) by liberating regulations and trade barriers.
The Japanese government aims to double its FDI stocks to US$294bn by 2020; they are offering a series of incentives to attract foreign investors through the “Invest Japan” campaign. One of the incentives for companies establishing their Asian headquarters or R&D centres in Tokyo’s Special Zone is the exemption of the Metropolitan Corporate Enterprise Tax.
Besides that, Japanese policymakers also plan to reduce the corporate tax rate from 35% to late 20% gradually. This is a two-pronged approach to ensure the competitiveness of Japanese companies in the global market and attract foreign companies to come and stay in Japan. Other reformation measures in the pipeline include the liberation of the labour markets, reduction in trade tariffs, improvement in corporate governance and deregulation of the healthcare, agriculture and gambling industries.
However, Mr Abe has not been able to unleash his third arrow due to significant political resistance to reforms. He is hoping a victory at the polls will provide him with the political muscle he needs to transform Japan before it becomes addicted to its money-printing programme with no exit plan in sight.
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