It’s different this time. The four most dangerous words in markets, according to former U.S. Treasury Secretary Larry Summers.
With the consumption tax set to be raised for the first time since 1997, Prime Minister Shinzo Abe’s political future rides on a different outcome than last time — when the economy slid into a recession and the prime minister lost his job. To avoid a spending slump, Abe is poised to unveil a stimulus plan to counter the 3 percentage point bump in the sales levy to 8 percent.
“Abe must know that breaking the economy would mean the end of ‘Abenomics,’ ” said Masayuki Kichikawa, chief Japan economist at Bank of America Corp. in Tokyo, referring to the initiative to end deflation after two decades of stagnation. “The miserable failure of the 1997 sales tax rise is stuck in the mind of Japanese politicians.”
Abe, who is scheduled to speak Tuesday on his plans for taxes and an economic-support package, was left with little room to abandon the planned increase in the consumption tax that he inherited from the previous administration. Cabinet members, an independent panel of experts and Bank of Japan Gov. Haruhiko Kuroda have all advised proceeding with the rise to 8 percent in April, an unpopular move designed to shore up revenue for a government with the world’s largest public debt burden.
“From an economic point of view, Mr. Abe doesn’t want to increase the tax — I think he is being forced to do so for political reasons,” said Yoichi Takahashi, an economics professor at Kaetsu University who has advised Abe. “On paper, it means tax revenues will rise — and there will be a lot of lawmakers eager to spend that budget.”
Having run his election campaign in late 2012 on a platform of economic rebirth, Abe has the incentive to deploy yet further stimulus to avert a repeat of 1997, or put further pressure on the BOJ — which is already undertaking unprecedented quantitative easing — to expand liquidity injections. What may be just as important is that he has momentum in his favor — gross domestic product rose 3.8 percent at an annualized pace last quarter, after a 4.1 percent gain in January-March.
When Prime Minister Ryutaro Hashimoto oversaw a 2 point rise in the consumption levy in 1997, it coincided with a tightening grip of deflation. After the stock and land price bubbles collapsed in the early 1990s, banks began constricting credit. The nation also was hit by diminishing demand abroad as Asian countries from South Korea to Indonesia fell into financial crises that required International Monetary Fund bailouts.
GDP shrank after the April 1997 sales-tax bump, recouped some of the loss in July-September, then slid back into three straight quarters of decline. The Tokyo Stock Exchange’s Topix index slid almost 10 percent in the 12 months following the tax hike, a period when the MSCI World Index climbed about 32 percent. Hashimoto resigned in 1998.
“Abe understands the danger: If he fails, no one will be able to touch the tax for the next 15 years,” economic and fiscal policy minister Akira Amari said Sunday on Fuji TV.
Amari said if the elevation of the levy to 8 percent doesn’t go well, the further step up to 10 percent scheduled in 2015 would be called off.
“If the 8 percent hasn’t been a success, there will be no 10 percent,” he said. The current rate is 5 percent.
The administration will assemble a ¥5 trillion package to help counter the impact of the higher consumption duties, according to the median estimate of economists surveyed by Bloomberg. Among the items likely to be included are expanded tax rebates for companies boosting wages, incentives for capital spending, cash payments to homebuyers and infrastructure investment for the Tokyo 2020 Olympics, according to Deutsche Securities Inc. analysts in Tokyo.
Corporate income tax cuts are also on the table, the administration has said. A temporary bump in the rate that was implemented to help pay for reconstruction after the 2011 earthquake and tsunami may be ended one year early, in 2014, Deutsche Securities analysts wrote earlier this month. The Finance Ministry has opposed a permanent reduction in the effective rate.
Compared with 1997, this time round bank loans are rising, the real-estate market is seeing gains in prices and sales and companies are sitting on a near record cash pile of ¥220 trillion, according to BOJ data. Corporate profits are benefiting from a 21 percent slide in the yen against the dollar in the past year, prompted by radical BOJ efforts to expand the supply of money and verbal telegraphing of the move beforehand.
Toyota Motor Corp. in August raised its profit forecast for the year ending next March to ¥1.48 trillion, as the weaker yen bolstered the value of Japanese cars sold overseas. Panasonic Corp. said this month that full-year earnings could beat its forecast thanks to help from the exchange rate. Japan’s second-largest television maker, Panasonic is headed for its first annual profit in three years.
“A slump in private consumption after a hike in the consumption tax” is inevitable in April 2014, Deutsche Securities economists led by Mikihiro Matsuoka, wrote in a research note this month. “But we expect economic activity to turn around to month-on-month rises from May 2014 onward.”
Beyond Tuesday’s supplementary budget, Abe is planning a slew of growth-inducing structural reforms later this year, seeking to expand incentives for companies to invest in the domestic economy and boost wages.
The impact of the fiscal package, along with the structural measures, means the tax increase “should be almost entirely offset,” according to Credit Suisse AG economists led by Neal Soss in New York. Credit Suisse this month raised its 2014 GDP forecast for Japan by about 1 percentage point, to 2.3 percent.
Such a result would leave Japan with its strongest three years of economic expansion since the late 1980s through 1991, according to data compiled by the IMF. For now, Abe must manage the fallout of Tuesday’s decision on the consumption tax, which has been opposed by a majority of the public.
Only 17 percent of respondents to a Nikkei newspaper poll supported raising the tax as planned, while 55 percent favored a more flexible timetable and 24 percent didn’t want it lifted at all. The Nikkei surveyed 895 people from Aug. 23 to 25. A new poll published by the Nikkei on Monday found 48 percent against the tax rise and 47 percent in favor. For the more recent poll, the paper surveyed 902 people last Friday and over the weekend. It did not give a margin of error for either poll.
Sliding popular ratings could make lawmakers from the Liberal Democratic Party less enthusiastic about taking on vested interests with Abe’s structural reforms.
“Public support could go down,” said Koichi Nakano, a professor of political science at Sophia University in Tokyo. “The only reason why he has been popular is the early success of his economic strategy. If he loses support on that front, that could spark questions about whether he was any good in the first place.”
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