Markets wait and watch as Japan's PM rethinks tax hike

Written by Reuters | Tokyo | Updated: Jul 29 2013, 17:07pm hrs
Japan's most significant fiscal reform in years a planned increase in the country's sales tax could be delayed or watered down in a move that might rattle financial markets and amount to an own goal for the prime minister.

Despite holding the strongest political mandate of any prime minister in years, there are signs Shinzo Abe is seriously rethinking the plan out of concern it could derail a nascent economic recovery he has crafted with an aggressive policy mix, dubbed Abenomics.

Abe says he will decide in the autumn whether to proceed with the first part of the two-stage plan after gauging the state of the economic recovery, especially GDP data that is due on September 9. The tax, similar to general sales tax and value added tax in other countries, is due to rise to 8 percent in April 2014 and then 10% in 2015.

Abe does not want to raise the tax, given the likely economic and political repercussions, but he understands the risks of upsetting the markets by giving the appearance of backtracking on promised reform, said a person involved in crafting economic policies.

At 5%, Japan and Canada have the lowest equivalent consumption taxes in the Organisation for Economic Co-operation and Development, OECD data shows.

The stakes in Japan are high. The tax hike was passed into law last year with the support of Abe's current coalition parties and the previous government and is meant to be the first step toward repairing Japan's tattered finances. However, the law also requires the government to judge the economic conditions before giving the final go ahead.

Reneging on fiscal reform could hit investor confidence, which has allowed Tokyo to borrow money cheaply even though its $5 trillion public debt, well over twice the nation's annual economic output, is the heaviest burden in the industrial world. At the same time, Abe has stressed that his top priority is to rouse Japan from 15 years of deflation and tepid growth through his Abenomics programme of heavy government spending, massive monetary easing and promises of a longer-term growth strategy.

Abe himself admitted the thorny dilemma just hours after scoring a landslide win in upper house elections on July 21 that gave his ruling bloc a clear parliamentary majority.

"It will be a difficult decision," he said of the looming tax choice.

"The economy is just starting to recover and now is the best chance for Japan to emerge from deflation," Abe said. "I don't want to lose this chance. At the same time, markets are watching (our progress) on Japan's fiscal reform."

Despite his electoral triumph, Abe's team is split. A small number of vocal reflationists, such as cabinet office adviser Koichi Hamada, say Abe should prioritise recovery and go-slow on raising the tax. Pitted against them, the Finance Ministry says it is vital for Japan to show markets and trading partners that it is serious about putting its fiscal house in order.

Japanese media reported on Saturday that Abe had instructed his government to study the impact on the economy and prices of four tax-hike options, including sticking with the existing plan, raising the rate 1 percentage point a year for five years and delaying the hike entirely. Abe, speaking at a news conference on a visit to Manila, said: "I haven't yet issued any instructions to come up with several proposals."

Government officials also say they haven't received any formal orders to draw up fresh scenarios, although an advisory panel to the premier had already been mandated to study the impact of the current plan on the economy and prices.

Public opinion may play to the advantage of the reflationists.

A survey of 902 people in the Nikkei business daily, conducted just after the election, found only 11 percent supporting the existing plan, compared with 58 percent who favour "flexibility" in the timing or scale of the increase and 27 percent who oppose raising the tax at all.

History too provides a cautionary tale for Abe, who got a rare second chance at running the government in December.

Noboru Takeshita, the premier who forced the first sales tax through parliament in 1988, and Ryutaro Hashimoto, who raised it to 5 percent from 3% in 1997, were driven from office as their public support collapsed although other problems also plagued both men.

The decision to double the tax contributed to the defeat of Abe's predecessor, Yoshihiko Noda.

Adviser Hamada, a 77-year-old emeritus professor at Yale University and a key member of Abe's brain trust, told Reuters on July 23 that Japan needed much more evidence of a sturdy recovery before raising the tax. The economy, which grew at an annualised rate of 4.1 percent in the first quarter the fastest among Group of Seven industrial powers needs to maintain similar growth for two more quarters before enduring a tax hike, Hamada said.

He set the bar higher still, saying he is pushing Abe to wait not only until growth picks up but until employment improves, ensuring a firmer footing for the recovery. The government should wait until unemployment falls to 3% from around 4% now and job seekers outnumber job offers "in all regions" of the country, Hamada said. It is unclear how much influence Hamada has on fiscal policy, but the views of the reflationists might "have significant influence on Abe's thinking on this subject," said former Bank of Japan deputy governor Kazumasa Iwata, head of the prominent think tank, the Japan Centre for Economic Research.