Japan Watch
Group Economics
18 April 2016
VAT hike delay likely • Maritza Cabezas Senior Economist Tel: +31 20 343 5618
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maritza.cabezas@nl.abnamro.com
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Japan’s economy is desperately in need of policy action; GDP contracted in Q4 and core inflation is sliding Authorities remain committed to a further consumption tax hike, but more stimulus and structural reforms needed a priori to get economy back on track We expect authorities will announce further monetary stimulus and fiscal measures likely in April and July, while at the same time they will delay the consumption tax hike scheduled for 2017 A scenario of a delay in the VAT rate hike could lead to a possible negative rating outlook
There is growing speculation that the Abe government might announce a new fiscal stimulus package, which would include another postponement of the consumption tax/value added tax (VAT) hike scheduled for April 2017. This note looks at the economic setting in which the consumption tax hike would occur and the impact it would have for Japan’s economy. We think that delaying the VAT hike is unavoidable. Our base scenario, is that this decision will have to come with alternative measures to make the fiscal stance more resilient in time. If the process is not managed appropriately though, we see increasing risks of a possible downgrade of Japan’s sovereign rating outlook to negative from stable. Consumption growth falling… Economic activity in 2015 was less robust than expected and Japan’s economy even contracted in the fourth quarter. One of the main drivers of weak GDP growth in Japan is sluggish consumption growth. In the fourth quarter the drag of consumption growth on quarterly GDP growth was 2ppts in annualised terms. This was the second contraction of consumption in the year. On top of this, consumer confidence has fallen. This suggests that consumption weakness could be prolonged.
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2 Japan Wattch – VAT hike h delay lik kely- 18 Aprril 2016
Co onsumption g growth contracting
Japan’’s consumer and businesss confidence e falling
% contribution
index
46 44 42 40 38 36 34 32 30
1 10 5 0 -5 -1 10 -1 15 -2 20 Q1 2012
Inv vestment Go overnment consum mption Inv ventories Nett exports Priv vate consumption n GD DP growth
15 10 5 0 -5 -10 -15 -20 10
11
12
13
14
15
Consumeer confidence (lhs) Q4 2012
Q3 2013 3
Sou urce: Thomson Re euters Datastream m
Q2 2014
Q 2015 Q1
Q4 20 015
Tankan business b conditions manufacturing (rrhs) Source: Thomson T Reuters Datastream
…whille other driverrs of economiic activity also o weak Meanw while, drivers th hat could offset the impact of weaker consuumption, including export growth h and businesss investment grrowth, have bee en lacklustre. I t seems unlike ely that export growth will bo oost the econom my in the near term given the strong yen. Ne evertheless, Japan’s current acco ount surplus ha as been improving, as a resultt of the lower energy e imports. This is a possitive developm ment when assessing Japan’ss external finan ncing needs. Meanw while, Japan’s T Tankan survey y in March show wed that busineess sentiment across both manuffacturing and n on-manufacturring firms deterriorated. This ppartly explains why w despite high co orporate profitss, business inv vestment remains weak. As finnancial conditio ons tighten given the t weak equitty market and strong s yen, bus siness investmeent could deteriorate furtherr. At the same ttime, PMI surv veys are pointin ng to a shrinkinng manufacturin ng sector. Inflatio on expectatio ns deteriorating… The tre end of the core e CPI (ex food ex energy) has s improved. Foollowing the intrroduction of quantittative and quallitative easing, core inflation has h turned possitive and is now w around 1%. Ho owever, inflatio on expectations s are clearly weakening. Mannufacturers are e not expectting output pricces to increase e, despite some e pressure com ming from wage es. In fact, survey ys show that ou utput prices have been comin ng down steadi ly. Mainly, sma aller manuffacturers and n non-manufactu urers are expec cted to raise theeir output price es in the longer-term. Meanwh hile, household ds are becomin ng more scepticcal that prices will w rise. We think th hat falling inflattion expectatio ons is not solely y explained by declining oil prices, but is more related r to weakk domestic dem mand.
3 Japan Wattch – VAT hike h delay lik kely- 18 Aprril 2016
Co ore inflation m measures ex energy around 1%
Inflatio on expectatio ons falling
%
index
4
100
3
20 10
80
0
2 1
60
0
40
-10 -20 -30
-1 1
20
-2 2 11
12
13
14
1 15
16
-40 0 08
09
10
11
12
13
14
15 5
16
Houseehold inflation expeectations (lhs)
C Core inflation ex frresh food C Core core inflation n ex fresh food ex energy
Sou urce: Thomson Re euters Datastream m
Business output prices expectations e (rhs) Source: Thomson T Reuters Datastream
…but authorities re emain committted to anotherr consumption n tax rate hike e Despitte these consid derations, autho orities remain committed c to inncreasing the VAT V rate in April 2017. Japan’s ffinance ministry y, has support from the businness community y to raise the tax x given the incrreasing worries s about high pu ubic debt and fifiscal deficits, as a well as the rising spending in n healthcare an nd pensions. Businesses alsoo favour the fin nancing of lower corporate c taxess in the coming g time to reach similar rates aas in other large Asian countries. But the tra ade-off is large if the consump ption tax hike ccomes at the co ost of economic growth. Final decision crease consumption tax de d to inc epends on eco onomic activitty If the economy e contin nues to be so weak w then raising the VAT ratte would be se elf-defeating, since it will eventuallyy reduce dema and and put furrther downwardd pressure on inflation. i It would also give Japa an’s authorities s more arguments to delay thee rate hike, without major interna ational resistan nce. But even iff the economy will continue w weakening, the decision to finally delay the next consumption tax t hike, will ha ave to come wiith alternative measures m to make the t fiscal stancce more resilient in time, as well w as additionnal monetary sttimulus to fight th he falling inflatio ns, including further interest raate cuts and ad dditional QE. on expectation If this does d not occurr then Japan’s deteriorating fiscal position co could trigger un ncertainty. …and right timing tto avoid a dow wngrade in the e sovereign ou utlook Indeed d if fiscal policyy is loosened without w measure es to compenssate, we expectt rating agencies to take som me action. Therrefore, the announcement of a delay of the mption tax hike e is likely to be made after the e first quarter G GDP data is released on consum May 18 8. The BoJ willl want to wait to o see how the economy is peerforming after the recent round of monetary sttimulus. Indeed d, in late Janua ary 2016, the B BoJ introduced negative a the jury is sstill out. We thiink it will still take some time tto evaluate the e rates and effectiv veness of this p policy.
4 Japan Wattch – VAT hike h delay lik kely- 18 Aprril 2016
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