By some measures, the Japanese economy has gathered steam over the last year or so as aggressive monetary easing — a key leg of “Abenomics” — has boosted inflation and the proclivity to spend.
But now Japan is about to get punched in the gut, straight on.
On April 1, the consumption tax is set to rise, from 5% to 8%, and though this has been seen coming from a mile away, nobody has done anything about it. And now it’s here.
Most economists expect the world’s number-three economy to suffer its first contraction in more than a year in the April-to-June quarter, led by a sharp fall-off in consumption. What is less predictable is how deep and prolonged the decline will be. The answer will help determine the fate of the “Abenomics” revival fostered by Shinzo Abe, the prime minister, since he took office at the end of 2012.
The impact of the tax hike, according to Morgan Stanley’s Robert Alan Feldman, will be extended.
In its latest outlook on the state of the world’s biggest economies, Citi writes:
Meanwhile, despite the Abe Administration’s strong prompting, the hike in base salaries in the spring wage negotiations was modest even at large firms whose business conditions are relatively favourable, suggesting that companies remain cautious about increasing fixed compensation. We expect the consumption tax hike in April will erode badly the real purchasing power of household nominal income. Core inflation continued to surprise to the upside in 2013. In our view, the main reason for this surprise is the significantly higher sensitivity of the core CPI to the yen/dollar rate. Japan’s dependence on imports (“import penetration”) has risen substantially over time. But it also indicates that if the yen stabilises at a certain level, core inflation will start tailing off again in the future. In addition, the output gap is likely to widen after the consumption tax hike and this will probably reduce pricing power of the corporate sector. We currently expect core inflation to peak around April and to fall gradually in the second half of this year.
Meanwhile, back to Morgan Stanley, which takes a look at the impact by sector. Not surprisingly, consumer-oriented industries will likely get hit the worst:
We surveyed Morgan Stanley analysts to gauge the impact of this tax hike. We used our survey as the groundwork for a four-factor model to evaluate the attractiveness of each industry over the next 3-9 months when the impact of the tax hike is likely to be in full force. The model has four main factors with equal weights: 1) Demand pullback post C-tax hike based on analysts’ feedback 2) Foreign exposure 3) Valuations, profitability & performance. 4) Earnings momentum. Using this model, we find that Banks, Autos, Semis, Health Equipment and Real Estate are the most preferred industries in the post C-tax hike environment while Media, Retailing, Consumer Durables & Apparel, Consumer Services and Food & Staples Retailing would be least preferred.
The consumption tax hike fits into a longer story about Japan, basically its inclination to put obstacles in its own path, whether they be structural, fiscal, or monetary.
Bottom line: As the fiscal drag picks up, the burden on the Bank of Japan – and the monetary side of Abenomics – becomes more extreme.
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