Japan economy struggles to cope with sales tax hike

Japan’s latest growth figures show that the economy is struggling to manage with a sales tax increase instituted in April.

Japan’s economy had been struggling with stagnant growth and nearly two decades of deflation when Shinzo Abe became president. Last year, Bank of Japan governor Haruhiko Kuroda – Mr Abe’s preferred candidate for the role – unleashed a huge round of quantitative easing measures in a bid to kickstart the economy and get the country back on the path to growth.

However, as the latest data from the Cabinet Office shows, Japan is far from out of the woods.

Japan’s gross domestic product (GDP) fell by 6.8 per cent in the second quarter of the year compared to Q2 2013, marking a sharp contraction in the economy and cancelling out the 6.1 per cent rise seen in the previous quarter.

That was not as bad as had been expected – the median market forecast was for a 7.1 per cent drop, according to Reuters – but it was nonetheless the worst slump since the March 2011 earthquake took its toll.

It’s worth remembering that the decline hasn’t actually been quite as steep as these figures might suggest. On a quarterly basis, the economy shrank by 1.7 per cent between April and June compared to January-March.

Much of the damage came from the impact of the sales tax that came into force on April 1st. Analysts say that a consumer rush to make purchases before the tax came in led to a spike in the few months beforehand. That explains why Q1 performed so strongly, while Q2 saw the corresponding fall.

The decline was largely expected, but it still doesn’t bode well for one of the world’s biggest economies.

The Bank of Japan says it is still confident that Japan is set for a return to growth, and that it has no plans for further stimulus in the near future, though it is likely it will revise its economic projections downwards when it reviews them in the autumn. But if the next quarter’s figures show no signs of improvement, the government might start calling for even looser policy.

As Forbes contributor Tim Worstall points out, Japan is in a difficult position. It has to try and cut its huge debt and raise tax revenues at the same time, all without reducing growth in the economy – after all, without growth the debt burden will worsen. It’s a difficult balancing act and Tokyo has its work cut out.