Japan: Weak GDP will Trigger Fiscal Stimulus

Published on November 13, 2015
SGH Insight
"Another negative reading, we are told, will galvanize the government of Prime Minister Shinzo Abe to formally propose an approximately 3 trillion yen supplementary budget, which will be discussed in the Diet session in early January 2016, as well as an acceleration of the previously proposed corporate tax cuts (see SGH 10/26/15, “Japan: Scraping for More Stimulus”). These should be rolled out next week."
Market Validation
(Bloomberg 11/17/15) "Yen drops for second day against dollar; Japanese PM Abe may order extra budget to support economy: Economy Minister Amari; says biggest help would be for companies to use their cash reserves to boost wages and investment; Cabinet Secretary Suga says scale of extra budget not decided"

Japan will release its Q3 2015 GDP figures this coming Monday, November 16. According to the ESP Forecast Survey, an annualized 0.55% real GDP growth was initially expected compared to the previous quarter. But among other data points, industrial production has been soft, decreasing by 1.3% over the same period.

 

And so expectations for real GDP have since been lowered to where it could be negative, making for two consecutive quarters of declines (the second quarter declined by 1.2%); even if recovering, it still amounts to a politically damaging “technical recession.”

 

*** Another negative reading, we are told, will galvanize the government  of Prime Minister Shinzo Abe to formally propose an approximately 3 trillion yen supplementary budget, which will be discussed in the Diet session in early January 2016, as well as an acceleration of the previously proposed corporate tax cuts (see SGH 10/26/15, “Japan: Scraping for More Stimulus”). These should be rolled out next week ***

 

*** The initial tax cut plan was to lower the effective corporate tax rate (national tax plus local) from its current 32.11% to below 30% over several years. But since October there has been speculation the Government was planning to lower it to under 30% in 2017. Under a new economic stimulus package that cut below 30% from what we understand will be brought forward another year, to 2016, making it immediate for all effective purposes. ***

 

*** The corporate tax cut will likely be accompanied by a broadening of the corporate tax base through the imposition of higher rates on the basis of “size-based” taxation. While that offset may dampen some of the direct fiscal stimulus to the broader economy, the tax adjustments will nevertheless favor larger and listed companies, and thus should be a positive for Japanese equity markets. ***

 

Minimum Wage Tweaks, and a BOJ (Still) on Hold

 

Along with the corporate tax cut, Abe will also propose a hike in the minimum wage in the package. That hike, while welcome, will not come as a surprise and will have limited immediate impact on consumption as it will not take effect until the next fiscal year.

 

For FY 2015, the national average of the minimum wage (minimum wages are differentiated across prefectures) has already been increased from 780 yen per hour to 798 yen, or by 18 yen (2.3%). That marks the 4th consecutive hike of over 10 yen.

 

As for the BOJ and monetary policy, no action will be taken at the upcoming November 18 and 19 Monetary Policy Committee meeting, even if there is as now increasingly expected a slightly negative GDP number release on Monday.

 

The BOJ for its part already lowered its economic forecasts in October and furthermore, reflecting complaints by small to medium sized companies on rising import prices with a weaker yen, the LDP has remained very quiet, if not downright reluctant, to push the BOJ into offering more yen liquidity to foreign exchange markets (see again SGH 10/26/15, “Japan: Scraping for More Stimulus”).

 

Indeed, according to the October Economy Watchers Survey conducted by Japan’s Cabinet Office and just released on November 10, some “watchers” continue to point to the negative impact of higher imported prices of food and other materials on corporate profits, as well as on private consumption.

 

And besides, the US Federal Reserve is for now doing plenty to keep the dollar buoyant and the yen soft, without the need for any additional help from the BOJ.

 

The Politics of Stimulus

 

Despite all that, after taking a hit over national security legislation, public support for Abe and his cabinet has been drifting higher.

 

A survey by the Yomiuri Newspaper conducted between November 6 and 8 shows the supporting rate for the Cabinet to have risen to 51% in November from 41% in September and 46% in October.

 

That re-gained popularity is in part owing to the Trans-Pacific Partnership  negotiations and a summit meeting among Japan, China and South Korea. Furthermore, Japanese equity markets have shown some resilience these days, despite the sea of turmoil in global markets.

 

The release of yet another weak GDP figure, however, could quickly shift that public and market sentiment toward the negative side, and Abe and Finance Minister Taro Aso will simply not allow that happen.

 

We are told they are thus already well prepared to swiftly roll out their additional fiscal stimulus programs as soon as next week.

 

Tax Breaks – for Profitable Corporations

 

But even as the politicians of Nagatacho, facing continued and stubborn growth headwinds, are keen to front-load stimulus, the bureaucrats of Kasumigaseki, namely the still powerful Ministry of Finance, remain insistent any corporate tax cut be accompanied with alternative tax revenues.

 

So it is very likely the corporate tax cuts will be accompanied with the broadening of the base of tax collections through an expansion of “size-based,” as opposed to the more traditional “income based,” corporate taxes.

 

That size-based tax is levied roughly according to the amount of capital, number of employees, and so on, and adds in profits that are distributed before they are reported on a tax basis.

 

This mixture of lowering corporate taxes while hiking size-based business taxes will result in the shift of the overall tax burden from corporations with profits to those without (officially declared) profits.

 

In Japan, according to statistics provided by the national tax office, only 31.8% of corporations are profitable (i.e. their profit before tax is more than zero). So with the hike in the tax rate of the size-based business tax MOF will be able to generate more revenue from 68.2% of total corporations.

 

The overall impact of the tax change on Japan’s macro economy may therefore be neutral to perhaps slightly positive, with more corporations motivated to earn more money. But it should be an unmitigated positive for the more profitable listed firms and the Japanese equity markets.

 

And accompanied with such a hike in size-based business tax and, very probably, the final hike in the consumption tax scheduled for April 2017, MOF will not block the corporate tax cut.

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