It is hard to cut spending and Japan with its ageing population will find it harder than most. So the only solution will be to raise taxes. One sales tax increase has already been passed and another was in the offing. Higher taxes are never good for spending levels, with the first tax increase inducing a gut-wrenching pause in the Japanese economy.
There is no reason to think the second would not have had a similar effect. And with fewer people spending and companies investing, it will get harder and harder for the Japanese government to hit the tax receipt targets it is hoping for. That is one difficult balancing act and arguably one that over time will fail to provide a stable and sustainable backdrop. That is why a few years down the track the default option still lingers.
So should investors ignore Japan? On the contrary, investors should redouble their interest in the country. All of the above issues could be applicable to many other countries – especially in Europe – in a few years’ time. And what about investments in the country? The one flipside of a lower yen and a volatile domestic economy is that Japanese companies with global sales and profits are going to have an easier time. Keep the focus on these names as the experiment unfolds.
Chris Bailey is European strategist at Raymond James Euro Equities
Expert view
James Dowey, chief economist at Neptune Investment Management, comments on the snap election called by prime minister Shinzo Abe:
“We believe that this will prove to be a very positive development for Japanese equities. This is because delaying the sales tax hike is good economics and calling a snap election for next month is good politics.
What we now know about the first part of the sales tax hike in April is that it had a substantial negative effect on the economy, both in terms of growth – as third-quarter GDP data underlines – but also, more importantly, in terms of working against one of the main goals of Abenomics: to raise the inflation rate to a sustained 2 per cent a year. It makes sense to get the inflation job done first and then hike VAT later, given that the effect of delaying the hike on fiscal sustainability is very small (adding probably less than 1 per cent to Japan’s government debt-to-GDP ratio).
Politically, this is a good moment for [Mr] Abe to consolidate power. His opponents are at present extremely weak – support for the opposition Democratic Party of Japan is currently around 6 per cent of the electorate, and minority parties are highly fragmented – and this election is likely to play domestically as a show of strength.”
