Japan: Tough policy choices amid good performance

Japan: Tough policy choices amid good performance

Japan: Tough policy choices amid good performance

Asia Pacific Economic Outlook, November 2013

The prime minster is facing a tough balancing act: providing a stimulus to improve long-term deflation and poor growth, while undertaking bold actions to improve government finances.


Abenomics’ revolution of policies is steadily changing the landscape of Japan’s economy. Prime Minister Shinzo Abe’s policies are now having the desired effect on Japan’s growth, consumer price indices, household wealth, and business sentiments. Real GDP increased 1.3 percent year over year in Q2 2013, led by a boost in domestic demand. Consumer prices increased 0.5 percent in the second quarter over the previous quarter, the highest quarterly growth since 2008. A steady rise in house prices in 2013 and improvement in equity prices have improved net wealth of the household sector. Higher wealth and improved consumer confidence have strengthened consumer spending, which is reflected in higher sales of automobiles in September. The October release of the quarterly Tankan survey of corporate sentiments by the Bank of Japan indicates that optimism is surging among Japan’s big manufacturers. The business conditions sentiment index jumped to 12 this quarter from 4 in June 2013, the highest since 2007 and well above the forecast in June.

However, some challenges persist, as small businesses remain downbeat and the manufacturing sector’s capital expenditure continues to be weak. The labor market remains fragile as employment conditions continue to deteriorate.

A tough balancing act

The prime minister is managing a difficult balance between providing fiscal and monetary stimulus to end one-and-a-half decades of deflation and poor growth while undertaking bold actions to improve government finances. Abe’s policies on fiscal stimulus and deregulations have been appreciated, as well as his unconventional expansionary monetary policy; all of these provided a significant thrust to the world’s third-largest economy. However, his policies have also raised concerns about the rising fiscal deficit, which is currently nearing 10 percent of GDP, and the enormous outstanding debt that accounts for about 250 percent of GDP.

Aware of the deteriorating fiscal account, Abe has promised to remain committed to achieving both economic growth and fiscal reforms with his pro-growth agenda.1 In October, Abe announced plans to raise the national sales tax to 8 percent from the current 5 percent, effective from April 2014. Despite opposition from his advisors and some of his party members, he stuck to the plan of containing the country’s enormous debt, for which a law was passed prior to the election of the current government. The revenue generated will likely help improve tax revenue as a percentage of GDP, which is currently very low. However, the risk associated with raising consumption tax is high because it could disrupt the economy’s nascent growth. There are apprehensions that it could lead to a situation similar to that of 1997, when a decision to raise taxes from 3 percent to 5 percent was considered one of the primary reasons for a decade-and-a-half-long economic recession and high debt.

To prevent these fiscal consolidation measures from derailing the growth process, revenue from the increased taxes will be reinvested into the economy in the form of an economic stimulus package. The prime minister announced a package of 5 trillion Japanese yen, including cash handouts to low-income families. Other measures will likely include public spending for the 2020 Tokyo Olympics, tax breaks to encourage corporate capital spending, early repeal of temporary taxes that were implemented to finance earthquake reconstruction, and aid to home buyers.

The governor of the Bank of Japan is supporting Abe’s plans to achieve the objectives of high growth, inflation, and fiscal consolidation. In October’s monetary policy announcement, the governor strongly endorsed the tax-rise plan and announced that the policy settings will be put on hold, unless significant downside risks to inflation targets emerge.

The policy choices for the prime minister are tough, and the risks associated with implementing them are high.

Risks still looming

That said, the fiscal consolidation measures are not enough to overcome the rising expenditures. Pressure on public expenditures will likely increase due to demographic challenges. The outstanding debt is too high, and the current policy measures are not enough to alleviate investors’ concern about the risks associated with the ballooning debt.

The economic outlook has undoubtedly improved since Abe assumed leadership of the economy. However, Japan’s economic recovery remains uneven, as evident from the continued slowdown in exports and poor production data. Capital expenditure in the manufacturing sector continued to remain weak; new investment in manufacturing contracted by 5 percent quarter over quarter in Q2 2013. This indicates that corporates are still cautious about resuming their investment as the outlook for overseas demand remains uncertain. While the Tankan index shows a jump in the sentiments of large manufacturers, business sentiments for small-scale manufacturers remain negative. These uneven trends make the growth’s sustainability dubious in the long term. Any economic disruptions such as fiscal consolidation or external shocks could reverse the growth optimism.

The net wealth of the household sector improved by 4.7 percent year over year in Q2 2013 due to a 40 percent boost in the year-to-date performance of equity prices, as well as year-over-year growth of more than 3 percent in house prices in the first half of 2013. The rise in wealth is expected to help cushion the impact of growing sales taxes. However, the wages in the economy are on a steady decline, which limits the spending ability of average consumers. The labor market has structural problems that need to be addressed in order to increase labor participation and output. A lack of labor reforms further restricts growth in labor employment and income. Meanwhile, in its stimulus plan in October, the government has announced incentives to companies to boost wages; rising inflation also will likely motivate businesses to increase workers’ compensation. However, uncertainty regarding inflation and consumer spending due to the tax-rise plan may prevent businesses from increasing wages and salaries in the near term.

Japan still has a long way to go to ensure sustained economic growth and optimism. The policy choices for the prime minister are tough, and the risks associated with implementing them are high. However, credit goes to him for tackling the changes with clearly defined policies.


View all endnotes
  1. The cabinet, in a statement to the G20, the International Monetary Fund, and the Organization for Economic Co-operation and Development, has pledged to achieve surplus by 2020. (Source: Ben McLannahan, “Shinzo Abe faces dilemma on Japan’s consumption tax,” Financial Times, September 4, 2013, http://www.ft.com/intl/cms/s/0/134c01f6-1540-11e3-950a-00144feabdc0.html.)


Dr. Rumki Majumdar

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

Asia Pacific Economic Outlook, November 2013: Japan
Illustrations by Jessica McCourt (Cover), Stephanie Dalton Cowan (Japan)