Japan has gone ahead with the scheduled consumption tax increase that many analysts feared would jeopardize its long awaited recovery, but Prime Minster Shinzo Abe also announced a ¥5 trillion surplus to counteract the effects of the tax hike. Although they generally think the tax increase should have been postponed, Societe Generale analysts Takuji Aida and Kiyoko Katahira estimate that the stimulus will be enough to stop Japan from falling back into a recession.

Shinzo Abe

Japan’s consumption tax increase

Even though the consumption tax increase has been in the works for a long time, it goes against the ‘Abenomics’ anti-deflationary policies that have been working so far. “The timing of the consumption tax hike at the current stage of economic recovery seems too early, as corporates are still deleveraging and Japan is still not completely out of deflation,” write Aida and Katahira. They think that ¥5 trillion is enough to prevent a downturn, but would prefer to see a stimulus of around ¥10 trillion to keep GDP growth around 1 percent.

Abe’s stimulus details

The exact details of the stimulus haven’t been worked out yet, or at least haven’t been made public, but Abe’s announcement set out the policy’s framework. It is intended to support capital investments for small and medium companies; cut corporate taxes and encourage wage increases; reconsider some corporate regulations and possibly abolish corporate income taxes used for reconstruction a year earlier than planned; subsidize people with low incomes and provide support for job seekers; and provide money to spend on the 2020 Olympic Games. There will also be a ¥1 trillion tax cut alongside the direct stimulus.

But all this assumes a USD/yen rate of about 100. If the exchange rate changes significantly in either direction, this would affect the country’s growth (with a weaker yen driving more growth). According to Aida and Katahira’s model, the yen would have to strengthen significantly, reaching a USD/yen rate of just 85, in order for Japan to lose ground. Of course, there are more tax increases coming down the pipeline, and if Abe decides to implement them he may need another round of stimulus to keep the economy above water.

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