• Bloomberg


Japan’s slowing recovery from its worst postwar recession is signaling the economy may be too weak to sustain the higher consumption taxes under consideration by Prime Minister Naoto Kan.

Reports this week showed the jobless rate reached a five-month high in May, and wages, factory output and household spending fell, showing little sign of revival in domestic demand more than a year after the economy stopped shrinking. A gain in the “tankan” business-sentiment index Thursday reflects a postrecession rebound in manufacturers’ earnings led by exports.

The risk is that without an end to deflation and rebound in spending, the economy won’t be able to withstand the higher levy Kan plans in as soon as two years. Kan, whose Democratic Party of Japan is facing the July 11 Upper House poll, is in danger of repeating the error of his late predecessor, Ryutaro Hashimoto, whose 1997 tax rise helped trigger a recession, Morgan Stanley MUFG Securities Co. said.

“Hashimoto raised taxes as soon as he thought the economy had gained back just a bit of its health, and that ended up sinking the Japanese economy into a bottomless abyss,” said Akio Makabe, an economics professor at Shinshu University in Matsumoto, Nagano Prefecture, who has written books on behavioral finance. “If the government doesn’t get its priorities straight, we’ll see another 1997.”

Evidence of a weakening rebound has contributed to a selloff in equities, with the Nikkei 225 stock average losing 6.8 percent in the past two weeks, to 9,382.64 at Wednesday’s close in Tokyo.

Kan is also feeling the impact, with eroding public support before the vote for the Upper House. His approval rating fell to 50 percent last week, 18 percentage points lower than when he took office last month, a Nikkei newspaper poll showed June 26.

The poll was taken on June 24-25, days after the prime minister said he would consider an increase in the sales tax in a few years to possibly 10 percent from the current 5 percent. Tax changes will be unveiled “soon,” the government said in a medium-term fiscal strategy June 22. The administration also pledged to balance the budget by fiscal 2020 and cap public spending for the next three years.

Policymakers need to implement a progrowth overhaul of business regulations and prod the Bank of Japan to stimulate credit expansion before considering a tax increase, according to Morgan Stanley and Barclays Capital.

“More aggressive monetary and regulatory policies are needed in Japan if 1997-style economic consequences of fiscal retrenchment are to be avoided,” Morgan Stanley economists led by Robert Feldman, who previously worked at the U.S. Federal Reserve, wrote in a report Wednesday.

“Strengthening the economy is the goal here — fiscal rehabilitation is only a result of that,” said Kyohei Morita, chief economist at Barclays Capital in Tokyo. He also advocates cutting corporate taxes, a move Kan is also considering.

Koji Miyahara, president of the Japanese Shipowners’ Association and chairman of Nippon Yusen K.K., said last month that the country’s companies need a corporate tax cut to continue competing in the global economy. The government should “offset the loss” of revenue from the corporate tax cut by increasing the sales tax, he said.

Sales taxes can be an effective way of raising revenue in developed economies, according to the International Monetary Fund. More than half of gross domestic product typically comes from consumer spending in the developed world.

Higher sales taxes, introduced gradually, could help the economy by spurring inflation expectations, according to Masamichi Adachi, an economist at JPMorgan Chase & Co. in Tokyo. An annual 1 point hike from next year, eventually reaching a 20 percent level, would minimize the impact on consumer spending, he said, adding, “When people get used to the fact that the consumption tax rises a percentage point every year, they’ll begin to assume that prices will keep rising.”

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