Chief economist update: Japan tightens fiscal policy

Just as the clamour among central banks for fiscal policy aid continue to grow - recently supported by prescriptions from international institutions such as the International Monetary Fund (IMF), the World Bank (WB), the World Trade Organisation (WTO) and the Organisation for Economic Development and Cooperation (OECD) - Japan does the opposite.

Japan effectively tightened fiscal policy on October 1 when the Abe government's twice-postponed consumption tax hike (from 8% to 10%) took effect, projected to raise around US$46 billion a year, and intended to cover the cost of supporting its ageing population and pay down its ballooning national debt (the world's highest at 238% of GDP as at 2018 end).

While the Japanese government's intention is honourable, the history of past consumption tax increases aren't auspicious.

The consumption tax (3%) was first introduced in 1989, when it was lifted to 5% in 1997 and raised again to 8% in 2014. All were followed by recessions and, as a result, produced the inverse of their desired outcomes - Japan's national debt increased even more instead of reduced.

While the initial introduction of the consumption tax in 1989 reduced the government debt to GDP ratio from 66.9% in 1989 to 64.3% the following year, the ensuing recession (which gave birth to the term Japan's lost decade) sent the ratio up to 107.7% in 1997 (when the tax was raised from 3% to 5%) and then to 236.1% (when the tax was again lifted from 5% to 8%).

Will history repeat or will it be third time lucky?

The uncertainty created by the on-going US-China stoush provides no help for Japan's external sector. More so given that this is prompting safe-haven buying in the yen compounding the challenges faced by Japanese manufacturers.

Recent data shows that the Jibun Bank Japan Manufacturing PMI fell to a reading of 48.9 in September - the fifth straight month of contraction in the sector.

Likewise, while it came in better than market expectations, the Bank of Japan's (BOJ) Tankan index - a measure of business confidence - for big manufacturers fall from a reading of +7 in the June quarter to +5 (the lowest reading in six years) in the third quarter provides little comfort for the Japanese central bank.

More so, given the deterioration in sentiment in all the other categories of the survey: "large manufacturing outlook" (down to +2 from +7); large non-manufacturing index (+21 from +23); large non-manufacturing outlook (+15 from +17); and all industry capex intentions (+6.6% from +7.4%).

Fortunately, household spending had been holding up well - retail spending rose by 1.9% in the year to August aided by a 1.9% lift in real wages over the same period or a result of forward purchases ahead of the consumption tax hike, or a bit of both.

However, forward indications are not so good. Japanese consumer confidence dropped to an eight-year low of 35.6 in September, marking the 22nd straight month of decline since peaking at 44.6 in November 2017.

Japan's biggest challenge is inflation.

Headline CPI inflation slowed to 0.3% in the year to August from 0.4% in the previous month. Core CPI inflation eased to 0.5% from 0.6% in July.

With virtually stagnant prices and potentially lower ones in the future, consumers have no reason to rush spending - especially if, as is likely, they've already bought what they could ahead of the October 1 tax hike.

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