Not a milestone to rejoice in. Japan’s debt has tipped into the “quadrillion” zone for the first time. That is, as of the end of June, central government debt, looked like this: Y1,008,628,100,000,000, or $10.4tn.
It surely could not be a clearer message to Japanese Prime Minister Shinzo Abe that shilly-shallying over fiscal consolidation is no longer an option? Second-quarter economic output figures due on Monday are key to Abe’s decision about whether to raise consumption tax from 5 per cent to 10 per cent by 2015. Back in June in a speech in London, he pinned any decision to raise the tax – one he must make by October – on the strength of the economy in the second quarter.
Here are four reasons why we should care about Monday’s figures.
1. It’s likely to be good news for the global economy
Concerns about Chinese growth (albeit having posted some upbeat data this week), the eurozone’s shaky signs of exiting its longest recession on record, and steady but unspectacular growth in the US have left the global economy bereft of a strong source of demand. Market economists surveyed by Bloomberg expect Japan’s annualised real gross domestic product to rise 3.6 per cent, seasonally adjusted, a pace that is likely to be among the strongest of the Group of Seven developed nations, though slower than the 4.1 per cent pace of growth recorded in the first quarter. Net exports – helped by the weaker yen – probably continued to help drive that growth, as did the government’s fiscal stimulus. Credit Suisse estimates public spending rose 17.1 per cent.
2. VAT: To hike or not to hike?
But it is exactly that growth that opponents of a rise in the sales tax are worried about harming. Japan’s VAT may be low by international standards – the UK stands at 20 per cent. But some are haunted by the last time it was raised – from 3 to 5 per cent back in 1997, which was swiftly followed by a recession that some blame on the increase.
Strong second-quarter growth (Abe did not quantify the rate of growth that would give him confidence to raise the tax) will give proponents of a hike a boost. Earlier this month, the cabinet office forecast that the economy would grow just 1 per cent in the fiscal year starting in April if Tokyo moves ahead with the first phase of its plan to raise the tax – that would be to 8 per cent. As Tokyo bureau chief Jonathan Soble wrote:
“While the estimates highlighted concerns about the controversial tax, they implied that Japan would avoid a severe sales tax-related recession, suggesting their value as ammunition for opponents of the rise may be limited.”
Nomura analysts argue that delaying an increase would be harmful to Japanese equities, despite the general understanding that tax damages economic activity.
“Investors could lose confidence in the Japanese economy if the consumption tax were not raised as planned, as the tax increase is key to Japan’s fiscal consolidation. The rally in Japanese equities since the end of last year is based on expectations, primarily among nonresidential investors, that Japan will change.”
But reminiscing back to the fateful year of 1997, when consumption plunged following the tax increase, Peter Tasker, an analyst and long-time Japan economy watcher, recently wrote in the FT:
“The tax rise failed even in its own terms. Central government tax revenues fells more than 20 per cent over the subsequent 15 years and Japan’s debt-to-GDP ratio – a mere 40 per cent at the time – snowballed to more than 150 per cent.”
3. Inflating or deflating?
Part of the “Abenomics’” three-pronged approach to reviving the economy includes a pledge to finally push Japan out of its years of price declines. The country’s core consumer price index, which excludes fresh food, rose at its strongest pace since 2008 in June. And while that may have given some officials reason to rejoice, the reality was that it was mostly due to the yen’s sharp decline pushing up the price of imports, and not the “demand pull” inflation that is needed. Japanese wages would need to show healthy increases for that.
Many economists will be looking at the direction of the GDP deflator, a broader measure of price movements than CPI as it shows the level of prices of all new, domestically produced, goods and services in an economy, rather than just a basket of them. Credit Suisse estimates that the deflator moved closer to positive territory in the second quarter, estimating -0.5 per cent year-on-year, compared with -1.0 per cent in the first three months of 2013. This led the investment bank’s Japan economists to forecast that nominal GDP rose 0.8 per cent year-on-year last quarter, which would be the first expansion in four quarters.
4. Is capital spending finally waking from its slumber?
Capital spending is a key component to help drive a more sustainable revival in economic growth for Japan, an area that has so far been missing. It has been negative for the past five quarters, and anecdotal evidence suggested that Japanese companies had been sceptical about “Abenomics”. Credit Suisse estimates that in the second quarter, capital spending rose an annualised 2.5 per cent pace seasonally adjusted, breaking out of negative territory and forecasts it to continue to expand for the following seven quarters.