Japan: Sales Tax Delay and Early Elections

Published on November 11, 2014
SGH Insight
"As recently as yesterday there was overwhelming consensus in the media, markets, and analyst community that Prime Minister Shinzo Abe would press ahead and announce as planned the second installment of sales tax hikes around December 8, after the release of the final reading of Japan’s third quarter GDP. We had been warning for some time, however, that despite those expectations the political landscape was shifting and that it was in fact probable Abe would delay the second tax hike, even with the major monetary stimulus assist provided to the economy by Bank of Japan Governor Haruhiko Kuroda at the October 31 Monetary Policy Committee meeting."
Market Validation
(CNBC 11/18/14) "Japanese Prime Minister Shinzo Abe called a snap election on Tuesday, and announced a delay in the second sales tax hike by 18 months after the country fell into recession."

As recently as yesterday there was overwhelming consensus in the media, markets, and analyst community that Prime Minister Shinzo Abe would press ahead and announce as planned the second installment of sales tax hikes around December 8, after the release of the final reading of Japan’s third quarter GDP.

We had been warning for some time, however, that despite those expectations the political landscape was shifting and that it was in fact probable Abe would delay the second tax hike, even with the major monetary stimulus assist provided to the economy by Bank of Japan Governor Haruhiko Kuroda at the October 31 Monetary Policy Committee meeting (see SGH 10/31/14, “Japan: QQE, Yen, and the Looming Sales Tax Hike Decision”).

*** That consensus for the planned second sales tax hike started to shift suddenly in the last 48 hours with leaks that Abe may call early elections as soon as next month to lock in another four year mandate for “Abenomics.” Early elections would presumably include the postponement of the highly unpopular second sales tax hike. ***

*** Abe has neither confirmed nor denied rumors he may call early elections, but we believe he will. These leaks have been interpreted as trial balloons and a potential warning to opposition parties to cooperate on legislation, and they will to some extent. But the opposition to the ruling Liberal Democratic Party remains weak, unable to capitalize on recent scandals or the sales tax issue, so the timing is right for Abe. ***

Another four years of Abenomics would be welcomed not just by markets, but by most global financial officials as well, as would be the postponement of the second sales tax hike.

Despite Japan’s G20 commitment to addressing its 240% debt to GDP ratio, aging demographics, and increasingly burdensome social programs, there is also an acute awareness among global officials of the importance of avoiding a premature application of fiscal headwinds to the long sought Japanese recovery.

A defined postponement of the second sales tax hike would avoid exactly that and, especially in light of the severe negative reaction to the first tax hike, we believe would cost the Abe government little if any credibility in financial markets either.

A Political and Economic Window

The bold decision by Bank of Japan Governor Haruhiko Kuroda to ease monetary policy further at the October 31 MPC meeting, overcoming internal resistance and pleasantly shocking financial markets, was a badly needed shot in the arm for an economy still struggling to recover from the first installment of a two-part sales tax hike, from 5% to 8%, in April of 2014.

It was also almost universally interpreted by analysts and in the media as monetary policy support from Kuroda for Prime Minister Abe to go ahead with the second installment of the sales tax hike, slated for October of next year, from 8% to 10%. Kuroda, a former senior Ministry of Finance official, is well known for his support of the sales tax hikes, and expectations mounted that Abe for his part would follow through.

We, however, did not believe that to be the case, and understood the Abe Cabinet to be far more cautious on another tax hike than widely assumed.

Many economists and Finance Ministry officials, and even some key members of Abe’s LDP party, have indeed been pushing to raise the tax rate as scheduled.

But Japanese households and corporate management have been increasingly fearful of the possible downward impact of a tax hike to 10% on an already sluggish economic recovery. And Abe has increasingly come to understand that if he were to propose to postpone the tax, there is a very good chance the LDP could win early elections by a wide margin.

Chatter over early elections suddenly started to pick up in the local Japanese press this weekend. The speculation was initially attributed to unnamed sources, but our understanding is that a trial balloon for early elections was in fact kicked off by Isao Iijima, a former aide of the popular ex-Prime Minister Junichiro Koizumi.

Iijima, who is now a Special Adviser to the Abe Cabinet, initially told a TV show that the Lower House could be resolved on December 2nd and a general election be held on the 14th. When further pressed, he later denied it.

The trial balloon had nevertheless been floated.

Good Timing for Abe

The idea behind the timing of elections in December is that in the (likely) case the July – September GDP figure to be released initially on November 17 comes in weak, rather than wait for the final release of the revised data on December 8, Abe would propose not to raise the consumption tax rate as planned (most probably postponing it) and assert that he would like to ask the Japanese electorate what it thinks on the issue through elections.

The timing is right for Abe and the LDP. In addition to the consumption tax issue, opposition parties have been attacking the Abe Cabinet on the “politics and money” issue, successfully forcing Minister of Economy, Trade, and Industry Yuko Obuchi and Minister of Justice Midori Matsushima to step down.

But political sources believe the Japanese voters are fed up with the finding of fault in Cabinet members, and the less than spectacular conflict of interest and corruption attacks on the LDP have not resonated with the electorate.

In fact, they may even have backfired on the opposition Democratic Party of Japan, increasingly seen as mired in political mudslinging and personality attacks, and on two female rising stars for that, rather than providing any support or new ideas for boosting the economy.

And Abe continues to score highly on economic policy, at least for now, even if that support is slowly eroding.

Abe has also sought to earn points on foreign policy issues, underscored in his persistence in seeking a one-on-one meeting with President Xi Jinping of China at the just concluded APEC meeting, as well as with Russia’s President Vladimir Putin.

And in that he was successful, albeit with what will now be remembered as a famously awkward handshake between the Chinese and Japanese leaders. Abe has also aspired from what we understand to show some progress on the abduction issue with North Korea, but that appears impossible, at least in the near future.

There is nevertheless more than enough momentum now to lay the groundwork for the dissolution of the Lower House this December.

Back to list