Japan: It’s wait and watch for policymakers

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Japan: It’s wait and watch for policymakers

Japan: It’s wait and watch for policymakers

Asia Pacific Economic Outlook, June 2014

Economic activity picked up in Japan in the last month of Q1 2014, supported by a last-minute rise in consumer spending in anticipation of the rise in consumption tax in April.

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Economic activity picked up in the last month of Q1 2014, supported by a last-minute rise in consumer spending in anticipation of the rise in consumption tax in April. Japanese household spending in March jumped 10.7 percent month over month, the highest growth since 1975, even though real disposable income of working households dropped 3.2 percent year over year. Consequently, retail sales increased at their fastest pace in 17 years. Growth in retail sales jumped to 11 percent month over month in March from 3.6 percent in February, while total commercial sales saw an increase of 8.6 percent. Industrial production in March grew 0.3 percent from the previous month—an increase after a sharp decrease of 2.3 percent in February. The pickup in activity in March points to a possibility of stronger GDP growth in Q1 2014.

However, March’s increased activity is very similar to what Japan experienced 17 years back, right before the sales tax was increased. What followed was a plunge in consumer spending that drove the economy into a recession. Is history about to repeat itself? There is no doubt that the pickup is unsustainable and spending is expected to fall in the coming months following the tax increase. Some forward-looking indicators are already indicating deterioration; latest sales data on automobiles have given the first indication of this decline. What is to be seen is whether the economy has the capability to pull itself together and rebound in the coming quarters.

A decline as expected

Consumers rushed to buy goods before the sales tax rise, setting the stage for a decline in consumer spending in the following months. This is evident from the consumer confidence index, which has slumped in recent months and is at its lowest since December 2011. Confidence fell 1 percent month over month to 37.5 in March 2014, primarily due to a sharp decline in consumers’ willingness to buy durable goods. According to the Bank of Japan’s (BOJ’s) Tankan survey in March 2014, domestic demand is expected to fall post the sales tax hike that came into effect in April.1

In March car sales reached their highest monthly level in eight years. Latest data suggest that automotive sales fell 5.5 percent from March to April. However, the fall in sales was softened as many cars ordered in March were actually delivered in April. The industry expects a much bigger decline in May and subsequent months.

It is probably too early to draw a firm conclusion on the possible impact of the sales tax on domestic demand. As of the date of writing this article, more data were yet to be released for April. The downside risks are high, and data for April may not even reflect the complete impact. Not all consumers might have felt the impact of tax increases yet, and some may take time to adjust their consumption patterns. Therefore, it is highly probable that the data for the subsequent months may worsen. But, at the same time, labor market improvements and a widespread rise in wages since 2008 may partially cushion the impact of the tax rise in the coming months. Additionally, a price rise will likely result in more business investment, already evident from the recent strengthening of core machinery orders. In other words, market speculations will be high now, and data in the coming months will give a clearer picture about the downside risks resulting from the impact of taxes on demand.

It is not just domestic demand that is a concern for Japan. The other cause of worry is the steady fall in exports, on which many Japanese companies rely and which are the key driver of Japan’s economic growth. Sluggish economies overseas have limited Japan’s export growth. In addition, the banking crisis in China has resulted in greater uncertainty in the demand for exports from Japan’s second-largest export destination.

The good news is that inflationary pressures have re-emerged in Japan; the seasonally adjusted consumer price indices increased 1.6 percent year over year in March. Factors such as easy monetary policies, the tax rise, and a depreciated currency will likely continue to put an upward pressure on prices. According to a consumer confidence survey by the Cabinet Office, around 77 percent of respondents expect prices to rise more than 2 percent in the next year.2 A year back, only 43.5 percent of survey respondents expected prices to go beyond 2 percent.

BOJ’s balanced outlook

In its latest semiannual report, the BOJ has cut its target for real GDP growth to 1.1 percent for FY 2015 (ending March 2015), down from its January projection of 1.4 percent. The BOJ cited structural weaknesses such as fiscal and external balances as factors that will likely weigh on growth. In addition, it expects the impact of the consumption tax rise on demand to be significant in the immediate quarters. The bank, however, has kept its real GDP forecast for FY 2016 unchanged at 1.5 percent.3

According to the governor of the BOJ, the overall outlook of the economy is balanced. He expects the negative impact of the tax hike to be temporary.4 Private consumption will likely remain resilient, underpinned by an improvement in employment and incomes in the second half of 2014. Exports are likely to increase, albeit moderately, supported by a depreciated Japanese yen and stronger growth in the United States. Therefore, the economy is likely to grow at a pace above its potential growth.

The BOJ is also confident that Japan will achieve its 2 percent inflation target within two years. The bank will continue with quantitative easing for as long as necessary to achieve the inflation target and growth stability. However, there might not be any immediate action by the bank in response to the tax hike. The bank will examine both upside and downside risks to economic activity and prices before taking appropriate policy measures.

Endnotes

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  1. Bank of Japan, Tankan: The comprehensive data set of the March 2013 survey, March 2014, http://www.boj.or.jp/en/statistics/tk/zenyo/2011/all1303.htm/.
  2. Cabinet Office, “Price expectations a year ahead,” Consumer confidence survey, April 2014, http://www.esri.cao.go.jp/en/stat/shouhi/shouhi-e.html#price.
  3. Bank of Japan, Outlook for economic activity and prices, April 2014, http://www.boj.or.jp/en/mopo/outlook/gor1404b.pdf.
  4. Ibid.

About The Author

Dr. Rumki Majumdar

Dr. Rumki Majumdar is a macroeconomist and a manager at Deloitte Research, Deloitte Services LP.

Asia Pacific Economic Outlook, June 2014: Japan
Cover Image by Jessica McCourt (Cover), Stephanie Dalton Cowan (Japan)