Is Japan’s Prime Minister Shinzo Abe making any tax reforms come April 2014? Will it be enough to push forward his ‘Three Arrows’ policy?

On October 01, 2013, Japan’s Prime Minister Shinzo Abe is expected to weigh in on comprehensive tax reforms come April 2014, where it is expected that the Japanese government will raise the consumption tax, and reduce the corporate tax in order to push forward the ‘Three Arrows’ policy (Fiscal, Monetary, and Structural reforms). One of the major economic readings due out on October 01, 2013 is the quarterly ‘Tankan’ Survey released by the Bank of Japan. The ‘Tankan’ Survey is a quarterly measure of business sentiment. As the publication is about to be posted online during the early Asian morning trading hours on October 01, 2013, one of the survey’s critical measures on large manufacturers for the quarter ending September 30, 2013 showed a huge increase of 12.0 versus expectations of 7.0. The last quarter ending June 30, 2013 was a negative 4.0. A positive read on this key metric from the survey is expected to provide a temporary boost to the Japanese stock markets, with the Japanese Yen currency weakening to approximately 98.0 and change to the US Dollar, and Japanese stock futures trading on both the Singapore and Chicago bourses were shown rising, as this publication is being put out.

For an brief analysis on why a consumption tax increase in Japan is needed, we need to revisit some of the root causes for the prolonged slump in Japan in the past where public spending rose to hundreds of trillions of Japanese Yen, and debt-to-GDP rose over to 200.0 percent, which by far, is an unsustainable mode of leveraging up the country’s debt, and might be damaging to the country’s credit ratings. Although Japan’s credit ratings have been cut by some credit ratings agencies such as S&P and Moody’s, the country has not really taken seriously on its debt ratings, and continue to step up its fiscal expenditures to the extent which is financed by an increasingly shrinking population as a result of fewer births, and stringent immigration policies. Most of the debt was also covered by the sale of Japanese Government Bonds (JGBs) to foreign and local investors, where for the former; it is one of the major savings instruments used by the Japanese government to finance elderly care, welfare cheques, and other medical expenses.

With the accumulation of the budget deficits, Prime Minister Abe hopes to increase the consumption tax to approximately 8.0 percent, from the current 5.0 percent in order to reduce its National Debt. Prime Minister Abe is also thinking of reducing the corporate tax to 25.0 percent, from the current 30.0 over percent in order to encourage private spending, and consumption. A team of economists from Deutsche Securities, have estimated that in order to ‘cushion’ the expected increase in the consumption taxes, the Japanese government is expected to assemble a comprehensive package consisting of 5.0 trillion Japanese Yen (USD 51.0 million). Some of the items cited in their report include expected tax rebates to corporations, incentives for capital expenditures (CapEx), and infrastructure spending, such as the development projects that are expected to come on line as part of the preparations for the upcoming 2020 Olympics. These new tax code changes are efforts by the Japanese government to follow through its ‘Three Arrows’ policies

Some of the questions continue to remain with the upcoming proposed tax reforms in April 2014. Based on a news article published on September 30, 2013, entitled ‘Abe Bets It’s Different This Time with Sales Tax Rise’, there were mixed reactions to the looming tax hike in April 2014. According to the Bloomberg news article on Sept 30, it reported that only 17.0 percent respondents to a Nikkei newspaper poll supported raising the consumption tax, while 55.0 percent favoured to a more flexible timetable, and 24.0 percent do not want any government intervention on the current consumption tax rate of 5.0%. Some of the reasons pointed out were the historical experiences during the late 1990s, where in 1997; the then former Prime Minister Ryutaro Hashimoto in 1997 oversaw 2.0 percent points increase in the consumption levy, along with a tightening grip on deflation. This resulted in banks trying to restrict the flow of credit to businesses, and consumers. The impact to Japan was felt much harder as the Asian Financial Crisis was at the most critical stage at that time, and diminishing demand coming from foreign investors abroad including South Korea, Thailand, Indonesia due to their sovereign credit issues that requires much attention at home, and the slump in their currencies versus the Japanese Yen, which greatly impacted the regional trade flows at that time.

There are also other opinions expressed by several prominent Japanese leaders including the current Bank of Japan (BOJ) Governor Haruhiko Kuroda who expresses in favour of following through much of what is expected of a consumption tax hike in April 2014, explaining earlier that raising the consumption tax is not to be seen as damaging to the overall investment climate in Japan, but should be seen as efforts by the Japanese Government to reduce the overall debt burden, and carry out the ‘Three Arrows’ policy with a significant impact.

In conclusion, it remains to be seen whether history will repeat itself, and whether such reforms, including the expected consumption tax hike and reduction of the corporate tax will make any meaningful impact to Japan’s ongoing recovery. I believe that with last month’s announcement that Tokyo will be hosting the 2020 Olympics, there should be significant reforms taking place in Japan as it rises up from its decades-old economic downturn. Although there are many questions over the certainty of success through such reforms, I also do believe that despite the negative opinions by many observers, market analysts, etc., Japan, as a country itself, is serious on making the necessary economic reforms in order to boost the overall economic growth, and is focused on making the country more competitive in view of economic, social and political rivalry coming from neighbouring countries, including China.

About Hock Meng Tay - Chief Editor, Asia-Pacific Region

Hock Meng Tay, CAIA has written 181 post in this blog.

Chief Editor, Asia-Pacific Region Hock Meng Tay is a CAIA holder and is currently taking CFA qualification. He has over 10 years of experience working as research associate in several investment companies.He is an expert in financial analysis and has published research reports in his current role. He obtained his Masters of Business Administration in Integrated Management and Masters of Arts in Economics while serving his internship in Starsource Inc