The FINANCIAL — With Japan’s economy returning to recession in 2014, causing the Prime Minister to delay the planned VAT increase, we have reduced our growth forecasts and now expect the Bank of Japan to announce further stimulus measures as early as the second quarter of 2015.
The country’s GDP contracted 1.6 per cent between the second and third quarters, according to preliminary figures. As the economy struggles to rebound from the April 2014 VAT increase, Prime Minister Shinzo Abe postponed until April 2017 the 2 percentage point further hike scheduled for October 2015.
The government also announced fresh stimulus spending totalling 2 to 3 trillion yen – roughly 0.4 per cent to 0.6 per cent of GDP – in the 2014 supplementary budget. Though this is slightly less than the stimulus we had assumed the government would deliver in 2015 to shore up growth before the second tax hike, it should be much more effective in boosting growth that year.
Instead of relying on public infrastructure spending – delayed by chronic construction worker shortages – the proposed stimulus will focus on reviving household consumption, which accounts for 60 per cent of GDP and has been hurt most by higher taxes and a weaker yen.
Specifically, local governments could be given subsidies to distribute as they see fit, provided they meet the general goal of spurring consumption. Private consumption should pick up more strongly in the second quarter of 2015 when the subsidies are disbursed.
However, we have cut our 2014 GDP growth forecast from 0.9 per cent to 0.3 per cent with the following year reduced from 1.0 per cent to 0.6 per cent. We still think core inflation will fall short of the central bank’s 2 per cent target in the second half of 2015. Even the yen sliding to a seven-year low is unlikely to be enough to offset the downward pressure stemming from lower oil prices.
We expect Japan-style core annual inflation to average just 0.8 per cent in the first half of 2015. Although consumer-price inflation should start to accelerate again towards the year end, we continue to see full-year inflation running at a low 1.0 per cent in 2015 and 1.1 per cent the following year.
That could put the Bank of Japan under pressure to deliver further easing sooner than the markets have expected. It aggressively expanded its asset-purchase targets in October 2014 to defend its credibility in achieving its 2 per cent inflation target by the end of the following year. We think the Bank of Japan may announce further stimulus measures as early as the second quarter of 2015 if inflation remains subdued.
A rapid yen depreciation or pick up in commodity prices would ultimately lead to stagflation for the Japanese economy if real incomes continue shrinking, hurting household spending. To avoid that, Mr Abe has called on businesses to support the economic recovery by using improved profits to fund wage rises and to invest domestically. However, companies are sceptical of the sustainability of the stimulus-fuelled recovery and see little improvement in domestic growth potential.
But, having pledged that the April 2017 tax hike will not be postponed again, Mr Abe has just two years to demonstrate – via structural reforms – that Japan can continue to grow when stimulus runs out.
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