investment insights
VAT hike – Fourth time is the charm?
In a nutshell:
- The consumption tax hike will dominate Japan’s outlook, but its negative impact should not be over-estimated as the government seems better prepared this time round.
- The Japanese cyclical context remains positive, with Q4 growth set to rebound solidly and employment growth continuing at strong pace.
- Unless external conditions deteriorate substantially, the Bank of Japan (BoJ) will maintain its current strategy of silently tapering asset purchases.
A year from now, Japan will likely be coping with the initial negative shock of Abe’s second consumption tax hike (from 8% to 10%). Given the rough patch that followed the first hike in 2014, most view this event as a hard constraint on policymakers. We beg to disagree. The scale of the hike is smaller this time, and it represents the final leg of Abe’s tax reform. More importantly, the government has learnt the lessons from the painful last three tax hikes (1989, 1997, and 2014). In addition to granting exemptions for food (excluding dining) and non-alcoholic beverages, it is drawing up offsetting fiscal support measures. The extreme granularity of some of these preparations suggests that a large decline in consumption will be avoided.
We also note that the Japanese cyclical context remains positive, even though unexpected weather-related shocks muddied third quarter data.
We also note that the Japanese cyclical context remains positive, even though unexpected weather-related shocks muddied third quarter data. October saw industrial output surge, merchandise trade volume growth swing back into positive territory, and year-on-year total employment growth accelerate to over 2% (see chart 7). With the government having begun disaster relief disbursements, public spending will increase materially through Q1 2019. The combination of a potentially “back-loaded” second supplementary budget for FY 2018, VAT mitigation measures, and project completions and foreign visitor flows ahead of the 2020 Olympics will then preserve positive labour market and economic momentum.
As we wrote last quarter, the remainder of Abe’s probably final term should see focus shift to the revision of Japan’s pacifist constitution. This is no done deal, as the ruling Liberal Democrats don’t have a clear two-third majority in the Upper House and face new elections in the summer. The resulting distraction from supply side policies might, however, be manageable with the cabinet having already carried out or formalised many important reform measures.
As we wrote last quarter, the remainder of Abe’s probably final term should see focus shift to the revision of Japan’s pacifist constitution.
This encouraging cyclical and structural backdrop means that the likely tax hike induced softness should not be significant enough for the BoJ to change its current policy of silent bond purchase tapering (see chart 8). It might similarly move away from a crude quantity target to a purchasing budget approach in the exchange-traded funds (ETF) space – effectively not changing guidance much but giving a more concrete signal on future action if/when economic upside risk materialises.
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