Bloomberg News

Japan Sales Tax Risks Growth Grinding to Halt in 2014: Economy

June 27, 2012

Japanese Prime Minister Yoshihiko Noda

Yoshihiko Noda, Japan's prime minister, center, speaks with Koichiro Gemba, Japan's foreign minister, during a plenary session at the lower house of the Diet in Tokyo. Photographer: Haruyoshi Yamaguchi/Bloomberg

Japan’s Prime Minister Yoshihiko Noda risks stalling the economy by pushing through a higher sales tax that may damp consumption even as it aids efforts to tame the world’s largest debt burden.

The nation’s recovery after last year’s earthquake and tsunami could grind to a halt in 2014 when the first increase will take effect, according to UBS AG and Itochu Corp. (8001)

Parliament’s lower house yesterday approved the bill to raise the tax to 8 percent and then 10 percent in 2015 from 5 percent now. A slump would be a repeat of 1997, when an increase in the levy contributed to pushing the economy into a 20-month recession, costing then Prime Minister Ryutaro Hashimoto his job.

“If there are no economic stimulus measures along with a consumption tax hike we can see around zero percent growth in fiscal 2014,” said Takuji Aida, a Tokyo-based economist at UBS, who raised his growth forecast for the year ending March 2014 to 2.9 percent from 2.2 percent because he sees a 4 trillion yen ($50.4 billion) rise in consumption and investment ahead of the tax increase.

A 1 percentage point increase in the tax would cut growth in real gross domestic product by 0.32 percentage point in the year after implementation, according to the Cabinet Office’s Economic and Social Research Institute.

Growing Debt Burden

Even with the sales tax increase, the government said in January that it will probably miss its goal of achieving a primary balance surplus, which excludes debt servicing costs, by fiscal 2020. It forecast a primary deficit of between 1.9 percent and 3.1 percent of GDP in that year, compared with the fiscal 2011 deficit of 7.4 percent.

“Achieving a primary balance would do nothing more than stem the bleeding,” Shigeki Morinobu, formerly director of the Ministry of Finance tax bureau who helped supervise the 1997 tax hike, said in an interview yesterday. “It’s just a step to stop further expansion of debt, not to start paying back accumulated debt.”

Gross public debt will be 223 percent of GDP next year, up from the projected 214 percent in 2012, “pushing Japan’s public finances further into uncharted territory,” the Paris-based Organization for Economic Co-operation and Development said in a report last month.

Low Bond Yields

Japan’s benchmark 10-year yield was 0.805 percent at 3:15 p.m today in Tokyo. It reached 0.79 percent on June 4, the lowest since June 2003 and the least globally after Switzerland’s. Five-year credit-default swaps for Japan’s bonds were 94 basis points yesterday, having slid 12 basis points since Noda took office in September, data compiled by Bloomberg showed.

The yen was trading at 79.47 to the dollar, strengthening more than 5 percent since mid-March. The Nikkei 225 Stock Average closed at 8,730.49, down about 14 percent over the same period.

“Higher taxes will automatically shore up tax revenues even though an accompanying economic slowdown will somewhat reduce the amount collected,” said Hiroshi Watanabe, a senior economist in Tokyo at SMBC Nikko Securities. “Even so, Japan must raise the consumption tax to 16-17 percent if it wants to eliminate the budget deficit with taxes alone,” he said, adding “the government simply has to slash spending.”

Korean Confidence Falls

Elsewhere in Asia, an index measuring South Korean manufacturers’ confidence for July fell to the lowest level in four months, and a gauge at non-manufacturing companies also declined. New Zealand reported a narrowing of its trade surplus in May as the biggest jump in imports since November, led by crude oil and gasoline, outpaced a gain in shipments abroad.

In Europe, Germany may say consumer-price inflation slowed in June, according to a Bloomberg News survey. Romania’s central bank is forecast to keep its benchmark interest rate unchanged, a separate survey showed.

The U.S. Commerce Department may say durable goods orders rose for the first time in three months in May, while the National Association of Realtors is forecast to report the number of Americans signing contracts to buy previously owned homes grew in May from April, economists predicted.

Inflation Rises

The Japanese government report in January also indicated that the planned tax increase would lead to inflation accelerating to between 3.1 percent and 3.8 percent in fiscal 2014, compared with between 0.7 percent and 1.4 percent if the levy wasn’t raised. The report forecasts the tax rise would affect prices until the end of fiscal 2016.

These prices rises could bring temporary relief to the Bank of Japan (8301), which has added 20 trillion yen to its asset-purchase program this year as it looks to meet its 1 percent inflation target and pull the nation out of more than a decade of deflation.

Moody’s Investors Service on June 20 said the government won’t eliminate Japan’s primary deficit without further reforms. It added that Japan may reach “tipping point” where the market demands a risk premium for Japanese government bonds if the current political “gridlock” is not eliminated. Thomas Byrne, a senior vice president of the New York-based rating company said yesterday that the passage of the legislation was “credit positive,” although Japan still needed to increase revenue further.

Snowballing Debt

“The upcoming sales tax increase would be a very tiny step forward for Japan’s fiscal reform,” said Azusa Kato, an economist at BNP Paribas in Tokyo. “Japan would need to increase sales tax up to 25 percent just to avoid any further expansion of snowballed debt and avert a jump in bond yields.”

The bill passed despite opposition from some ruling-party members who argued it may discourage spending. The legislation now goes to the opposition-dominated upper chamber, where it is expected to pass during the current session of parliament ending Sept. 8. Yet even Diet approval doesn’t necessarily mean the increase will be implemented.

The bill has a non-binding stipulation that the higher tax rate will only go into effect if economic circumstances have improved. This could make the increase politically difficult to implement if growth decelerates next year from this year’s pace, in line with the median forecast of economists surveyed by Bloomberg News.

“I really doubt they would dare raise taxes if we had growth at zero,” said Naomi Fink, head of Japan strategy at Jefferies Japan Ltd.

To contact the reporters on this story: Andy Sharp in Tokyo at asharp5@bloomberg.net; Mayumi Otsuma in Tokyo at motsuma@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net


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