At an Institute of International Finance debate on Japans economic prospects in October, the government of president Shinzo Abe came in for heavy pounding from analysts, who derided the hard-fought consumption tax due in April.
Paul Sheard, chief global economist at Standard & Poors, and a seasoned Japan observer, charged that the tax would dampen economic activity, undermining the avowed aim of Abenomics, which includes a public infrastructure surge, aggressive quantitative easing, a devaluation of the yen and structural reform.
The Bank of Japan (BoJ) has set a 2% inflation target in two years and intends to double the monetary base by the end of 2014, which Barclays predicts will equate to close to 60% of GDP, compared with the Feds balance sheet at 30% of US GDP at its peak.
Sheard says: The BoJ looks aggressive but is it aggressive enough? Its plain vanilla quantitative easing. At the zero-bound, you might need to do something more aggressive.
The BoJ is swapping one form of expansion for consolidation through the consumption tax. I am concerned that Abenomics is a Trojan horse for consumption tax hikes to be pushed through.
Sheard, along with Richard Koo, chief economist of Nomura Research Institute, argues that raising the VAT would endanger the fledgling recovery and undermine fiscal consolidation, citing, in part, the fact real interest rate in Japan remains negative thanks to deflation, which exacts a toll on debt servicing.
According to a Bloomberg survey in October, economists reckon the consumption tax will trigger a 4.5% contraction in GDP in the first three months after the April tax is introduced, before the economy stages a recovery.
Says Koo: The consumption tax hike is an absolute disaster economically, but there is rare political consensus as all previous attempts have failed.
Its economic suicide if the private sector is saving 8% of GDP then the government better spend 8% of GDP, he says, adding the government should focus on structural reforms to boost nominal demand and the number of investment opportunities, in part through tax credits.
However, in comments to Euromoney on the sidelines of the conference, assistant BoJ governor Kazuo Momma, rejected these fears: We are fairly optimistic about consumption-tax hike. By the time it is introduced in April next year, the economy will be in a better state. It is fairly reasonable tax hike.
According to Lombard Street Research, the recent spate of bullish data in Japan in recent weeks, in part, underscores the fact consumers are looking ahead to Aprils consumption-tax hike from 5% to 8%. New car registrations in September were up 11.6%, after 5.8% in August, while retail sales were up 1.8% that month, compared with +0.9% in August.
However, with a rising cost of living and flat or negative wage growth, Abenomics faces its biggest test in the second quarter of next year.
The chief hope for Abenomics must be that wage gains respond upward to rising job gains, states Lombard. The September jobs number, up 0.8% from the year before, was good news, taking growth back to levels seen in buoyant 2004-07. But wages are still flat to down from the year before, and significantly down after inflation.
While the officials are all hoping for 2% inflation to result from the new policies, the optimal result would be for zero inflation once the import price hump has passed through the economy, with 1.5% gains in wages at full employment, and continuation of former productivity gains of this order.
But the economy first has to deal with the coming 2014 Q2 relapse after the consumption-tax increase.
With real GDP growing at an annualized 4% in the first half of the year, sell-side analysts maintain cautious optimism that Abenomics will succeed in reflating the Japanese economy, with Barclays advising clients to stay long Japanese equities and USD/JPY.
The early economic successes are reassuring, states Barclays. And still high approval ratings and a three-year, election-free window for PM Abe probably argues for giving Japan some benefit of the doubt for the time being.