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Tax hike, Crimea cloud economy

Kyodo

The timing of the Ukraine crisis and its impact on the global economy could be particularly bad for Japan, at a time of uncertainty ahead of the first consumption tax increase in 17 years from Tuesday.

The economy is expected to plunge in the April-June period following the 3 percentage point increase to 8 percent, but it is likely to rebound in the following quarter on the back of export growth, some experts say.

Others, however, predict that exports will not grow fast enough to offset the negative impact of the tax hike, given that the escalating turmoil in Ukraine sparked by Russia’s annexation of Crimea has darkened the entire global economic outlook.

If the situation in the Black Sea peninsula remains deadlocked for an extended period, inflows of foreign investment into Russia will fall, dealing a blow to its already creaking economy.

Japan-Russia trade ties have expanded in recent years alongside an increase in the number of Japanese companies operating there. A slump in Russia’s economy could thus weigh on Japan’s if bilateral trade stalls.

The intensifying geopolitical battle triggered by Moscow’s action in Crimea could also prompt financial market participants to divest risky assets and put their money in safe havens, such as the yen.

This would dampen hope that a likely economic downturn in Japan after the tax increase could quickly bottom out with the help of healthy external demand. A stronger yen cools exports by making Japanese products more expensive abroad and drives down the value of overseas revenues in yen terms.

Vowing to implement a ¥5.5 trillion stimulus package, Prime Minister Shinzo Abe’s government has been cautiously optimistic about the economy, forecasting it will grow 1.4 percent in real terms during fiscal 2014, which starts Tuesday.

The Bank of Japan projects the economy will recover moderately even if it is affected by a decline in post-tax hike demand, with Gov. Haruhiko Kuroda arguing a “virtuous economic cycle” of production, income and spending will not be interrupted and will continue to grow.

But the conflict between the West and Russia over Crimea has begun casting a shadow on the Japanese economy.

“It is unlikely that the current situation will drastically change,” said Toru Nishihama, an economist at Dai-ichi Life Research Institute.

If Moscow is isolated and faces difficulty in drawing investment funds from abroad, that will “put downward pressure on domestic demand, which has served as an engine of the country’s economic growth,” Nishihama said.

The Russian government already has become worried about an outflow of investment funds. Deputy Economy Minister Andrey Klepach said Monday that net capital outflows from Russia might reach $75 billion for the January-April period this year, exceeding the $63 billion logged for the whole of 2013.

Klepach added that capital outflow may accelerate and Russia’s economy could languish in the aftermath of sanctions imposed by the U.S. and European nations against Moscow, such as travel bans and asset freezes targeting Russian government officials.

The World Bank warned Wednesday that the Russian economy could contract 1.8 percent in real terms in 2014.

“As the Japan-Russia economic relationship has been deepening, the possibility cannot be ruled out that sluggishness in the Russian economy will hurt ours,” a government official in Tokyo cautioned.

According to the most recent data available from the Foreign Ministry, 427 Japanese firms were operating in Russia in 2010.

Further, a survey conducted late last year by the Japan External Trade Organization showed that 77.8 percent of companies entering the Russian market said they plan to expand their business there over the coming two years.

Russia is also a key supplier of resources to Japan, providing about 10 percent of liquefied natural gas imported annually by Japanese entities. The value of bilateral trade has hit new record highs for three years in a row, reaching $34.8 billion in 2013, the trade ministry said.

“The tighter the sanctions against Russia, the greater the economic impact on the two countries,” economic and fiscal policy minister Akira Amari said at a news conference Tuesday, adding he will carefully monitor how Western nations handle tensions with Russia.

To make matters worse, the confusion in Ukraine could make foreign exchange market investors reluctant to take risks, hampering Japan’s economic recovery.

“Speculation is growing that demand for the yen, regarded as a relatively safe haven investment, is likely to become even more robust with geopolitical risk growing,” said Yuzo Sakai, manager of foreign exchange business promotion at Tokyo Forex & Ueda Harlow.

“The yen has been weakening due in part to the BOJ’s aggressive monetary easing, but the trend may end,” Sakai added, indicating Japanese exporters could suffer from the currency’s appreciation.

After the consumption tax rate was raised to 5 percent from 3 percent in April 1997, the economy quickly fell into recession.

“Exports would also fail to help prop up the economy this time,” said Takeshi Minami, chief economist at Norinchukin Research Institute.