The Tax Hike the Bank of Japan Can’t Afford to Ignore

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Japan’s economy risks being derailed for a third time by a sales tax hike this week if shoppers like 63-year-old Kuriko Iwaki suddenly close their wallets.

Iwaki bought a rice-milling machine for around $55 ahead of the tax increase and stocked up on other household items. “Shampoo and all these other things will go up in price, so it may sound a bit strange, but I ended up buying enough garbage bags and other daily items to last me around three months,” she said in central Tokyo.

The Tax Hike the Bank of Japan Can’t Afford to Ignore

After postponing the tax hike twice already, Prime Minister Shinzo Abe is going ahead with it to show Japan is serious about chipping away at the developed world’s largest public debt load, and to keep up with spiraling social security costs as the population ages.
Aware of the risks, Abe’s administration has bent over backwards to avoid the same economic whiplash Japan experienced in 2014 -- the last time the levy was pushed higher. A raft of counter measures has been designed to smooth out the boom and bust in consumption -- by some calculations they add up to more than the extra proceeds from the tax increase in its first year.

In Bank of Japan Governor Haruhiko Kuroda, a former finance ministry official, Abe has an ally who may also be poised to do his bit to ensure the hit to growth is temporary. In the fourth quarter, economists see the largest contraction since the levy was last raised in 2014, with a rebound to follow in 2020.

But in the near term, the push to tighten fiscal policy with the increase to 10% from 8% on Oct. 1 adds more pressure on Kuroda to deliver even more monetary stimulus.

The Tax Hike the Bank of Japan Can’t Afford to Ignore

Past Stumbles

The world’s third-largest economy has had a torrid time trying to lift its sales tax before. In 1997, a hike to 5% from 3% contributed to three quarterly contractions in less than a year and a half, and an election defeat that cost the job of then Prime Minister Ryutaro Hashimoto. In 2014, just as Kuroda’s massive stimulus program was gaining traction on inflation, an increase in the tax to 8% pulled the rug underneath consumption and prices, shrank the economy by more than 7% and forced the BOJ to expand its stimulus.

This time, the hike comes as U.S.-China trade tensions amplify a global slowdown that has prompted the BOJ to assess whether it needs to do more to support the economy and prices at its next meeting on Oct. 30-31.

“The BOJ is well aware of the danger of the sales tax hike taking place just as they fret about the risks from the global economy,” said Yoshimasa Maruyama, chief market economist at SMBC Nikko Securities. “That’s why they’re putting out signals hinting at additional stimulus next month and the chances are high that they will act, even if they really wish they didn’t have to.”

The central bank has signaled loud and clear its concern over the increase. Since July last year it has flagged the need to monitor the potential economic hit from the hike in its promise to keep interest rates extremely low for an extended period.

Analysts surveyed by Bloomberg currently predict the economy to shrink by an annualized 2.7% in the last three months of 2019. But the spread of forecasts is wide. While Japan’s service sector has helped the economy show surprising strength so far this year, outweighing the impact of slumping global demand for the country’s manufactured goods, a slide in consumption after the tax hike could transform that equation.

This time, the signs are better that the economy may show resilience after the sales levy goes up. Even still, some economists suspect the BOJ will prefer to be seen doing something -- possibly in tandem with Abe’s government -- to ensure the economy and the goal of goosing inflation stay on track.

The Tax Hike the Bank of Japan Can’t Afford to Ignore

Success in finding a formula to smoothly raise the unpopular tax would end up among Abe’s biggest economic achievements, after reflating the economy and restoring moderate growth.

The BOJ said in its July Outlook report that it expected front-loaded demand to be “marginal” this time round compared with 2014, though it still expects housing investment and private consumption to fall for some time after the tax hike.

Tax breaks on buying cars and property have limited front-loaded demand for big-ticket items. The prospect of tax-back points on cashless purchases after the hike are also giving consumers pause for thought. Looser restrictions on cut-price sales after Oct. 1 also present the possibility of bargain-buying after the hike as retailers try to keep demand steady.

Preliminary data for September show signs of a spike in home appliance and furniture buying, but not a mad rush to splurge. Spending on household appliances and goods rocketed 83% in March 2014, the month before the last hike, but early sales figures at some major retailers are generally not as strong as five years ago.

Sales at department stores are up between 4-5% so far in September from a year earlier compared with a 25% jump in March 2014, according to the Japan Department Store Association.

The Tax Hike the Bank of Japan Can’t Afford to Ignore

Televisions, fridges, air conditioners and washing machines are selling at around twice the pace of a year ago so far in September, according to early figures from Bic Camera Inc., an operator of about 40 electrical appliance stores nationwide.

At this pace, the increase in overall sales could match the 53% jump of March 2014, said Bic Camera PR official Tetsuya Yamazaki. He cautions that September, unlike March, isn’t usually a big month for selling appliances, so he doubts total sales in the month before the hike will reach the level seen last time.

Orders at major furniture retailer Nitori Holdings Co., which has more than 500 outlets in Japan, are up 22% in September compared with a 32% gain in March 2014. The rise in orders at rival furniture seller Otsuka Kagu Ltd. are also softer than last time around, according to spokeswoman Maki Iwaki.

What Bloomberg’s Economists Say

“If it’s simply a question of dealing with the sales tax impact on the economy, the BOJ lowering the negative short-term rate is likely to be counter-productive since it would drag on consumer sentiment, as it did in 2016, slowing the recovery in consumer spending rather than speeding it up. Buying more ETFs, while not entirely effective, would be a better option..”

--Yuki Masujima, economist

Click here to read more.

The Tax Hike the Bank of Japan Can’t Afford to Ignore

Beyond consumer durables, the last-minute buying pulse has been weaker.

Naoto Nagase, researcher at the National Supermarket Association of Japan, said there has been little sign of rush demand. Early data for September suggests overall sales may only just eke out a gain over the previous year, he said.

Daily necessities such as food have been exempted from the tax increase, helping explain the lack of a sales spurt at supermarkets. The exemptions should limit the relatively large impact of a sales tax on low-income earners. Still, higher prices will result in lower spending power, crimping consumption even if shoppers didn’t splurge ahead of the hike.

“We’ll have to wait until we see figures for November and December before we can finally judge if the sales-tax impact has been light or severe,” said Shinichiro Kobayashi, senior economist at Mitsubishi UFJ Research and Consulting Co.

He warns that while the rush-demand looks weaker this time around thanks to the government measures, it isn’t a guarantee the impact will be lighter. Negative sentiment and confusion over the cashless points system could also be keeping a lid on demand, he says.

Bargain sales could also become so aggressive that some prices are forced down instead of up by the tax hike, adding to pressure on the BOJ to act. “Prices are going to show a lot of weakness and inflation could even turn negative in the October-December quarter,” Kobayashi said.

Abe and Kuroda will be hoping most shoppers react to the increase like Azusa Hayashi, a twenty-something intern at a Tokyo-based company.

“It’s just a 2 percentage point rise this time. That’s not going to put me off buying things later on,” she said in Tokyo’s upmarket Ginza district. “There’s really no reason to go overboard buying items ahead of the tax hike.”

©2019 Bloomberg L.P.

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