Japan: Through Sales Tax and Elections Uncertainty
Japanese equity markets and USD/Yen soared this week as investors came to realize that Prime Minister Shinzo Abe, to their overwhelming surprise, was likely to delay implementation of the planned second installment of a consumption tax hike from 8% to 10% beyond October of next year, and call early elections in the process.
But many analysts responded to the news with less than complete enthusiasm. Some of the commentaries pointed to a loss of credibility for “Abenomics” – and revenue – in going back on a much needed fiscal consolidation plan. Others pointed to political risk in calling early elections, and the possibility that Abe’s Liberal Democratic Party may lose seats in the process.
We would safely look through both.
*** There appears to be no discussion whatsoever in the Abe Cabinet of scrapping the second installment of the sales tax hike altogether, only of a postponement until the economy is on more solid footing, perhaps by 18 months or so. That, we believe, once clarified, should quickly erase any fallout from or accusations of losing political or market “credibility.” The near-term potential loss of revenue from a sales tax delay may put some strains on the 2015-6 budget. But stronger growth will also in our opinion far outweigh that potential negative impact on the budget, and more than offset those concerns. ***
*** The temporarily foregone revenue may, however, make it more difficult for the Abe administration to fund some hoped for corporate tax cuts. But even here, the impact may be minimal, as expectations for more dramatic corporate tax cuts appear to have been dropping in Nagatacho already. What was originally a promise to broaden the tax base to capture the vast bulk of small and medium size business in Japan that pay no taxes, and then cut rates from 35% to “below 30%,” is, we believe, morphing into a more modest and politically palatable two-step plan to take rates down by a point or two next year, and perhaps another point in the second. And truth be told, even agreement on a modest tax cut, we believe, would be a welcome positive for the economy and markets. ***
*** On the political front, there is indeed a good chance that the LDP/Komeito coalition could lose some seats, but those losses should be modest, and will be from a level of almost unprecedented strength. Furthermore, any loss we believe will be far outweighed by the positives of the affirmation of another four year mandate for the LDP and for Abenomics (see SGH 10/14/14, “Japan: Sales Tax Delay and Early Elections”). And any concerns over the potential loss of the coalition’s two-thirds majority needed in the Lower House to override an Upper House veto of legislation is, for all practical purposes, now moot, given their control of the Upper House as well since the elections of July of 2013. ***
The Numbers that Matter
If early elections are called as expected, the LDP and Komeito are expected to easily win a majority. High expectations and complacency may lead to low turnout – in the previous Lower House election turnout was only 59.32%, the lowest on record since 1890. But both parties have strong organizations on the ground, and we believe should be able to turn out enough voters to stem any significant losses of seats.
And there is no question the coalition’s current two-thirds majority in the Lower House was too good to last forever. The ruling coalition currently holds 325 of the 480 Lower House seats (320 is the 2/3 threshold), consisting of 294 from the LDP and 31 from Komeito. But getting two-thirds of the Lower House in no longer as important as it was before.
When Abe first took office at the end of 2012, neither the LDP nor the opposition Democratic Party of Japan (DPJ) had the majority of the Upper House, which made the two-thirds Lower House control crucial. But the importance of that margin changed after the latest Upper House election in July 2013, and at present the LDP + Komeito have the majority in the Upper House as well as in the Lower House.
Some Context around GDP
On another note, almost lost in the political news, Monday will mark the release of the preliminary third quarter GDP data for Japan. Abe himself has pointed to that number on numerous occasions as a key data point in making the final determination for whether or not to proceed with the second sales tax hike as planned.
The significance of Monday’s release has been pre-empted by the talk of early elections as an effective plebiscite on the tax (which is clearly a no). But a number that is significantly far off expectations could nevertheless throw an unexpected wild card into the political debate.
The latest consensus on Bloomberg is for a 2.2% annualized GDP growth rate to be released on Monday. But those expectations are on the heels of a disastrous, negative 7.1%, GDP collapse in Q2, after the first sales tax hike, and it is a consensus that has already been drifting down.
According to a different, ESP survey, the most recent average forecast of 42 economists surveyed is for an annualized GDP of 2.47% for July – September (that survey was conducted between October 29 and November 5). That, however, is a downward revision from 3.66% in the previous month.
Any number close to consensus will generally be considered weak, and should help Abe further justify the decision to effectively delay the tax by taking the decision to the public with early elections.