"Abenomics" is comprised of three major policies

Akiko Terada-Hagiwara, Economist at Asian Development Bank, on Japan’s economy after sales tax hike

There are concerns about Japan’s economy especially given the recent sales tax hike, which might have an adverse effect on the nation’s economic performance? To your mind, has Abenomics, a suite of measures introduced by Japanese Prime Minister Shinzo Abe to revive the sluggish economy, run out of steam?

“Abenomics” is comprised of three major policies, monetary, fiscal, and structural. So far, the first two policies have been the focus while specific steps are still to be taken on the structural policy. I believe that the monetary policy with the target inflation of 2% has yielded an intended impact so far with the CPI inflation having turned positive mid-last year. The fiscal policy has been used to lead the reconstruction efforts in the Tsunami affected area as well as to mitigate the impact of the VAT hikes.

Nonetheless, the third arrow of Abenomics, structural reform, is lagging behind the other two—monetary and fiscal policies so far. Overview and roadmaps of the third arrow were announced in June last year covering various areas including setting up of an economic special zone, increasing female and senior labor participation, and deregulating agricultural sector as well as health care sector. The announced strategy aims at achieving around 3% nominal gross domestic product (GDP) growth and around 2% real GDP growth, on average, over the next ten years, which is much higher than the currently estimated 0.7% potential growth rate by the Cabinet Office. Nonetheless, the targeted medium term sustainable growth is important to support the fiscal consolidation efforts.

Many economists argue that the sales tax hike in Japan may derail the nation’s economy. Nevertheless, officials are still willing to raise the tax, promising some extra stimulus in case the economy deteriorates. Do you think that the tax hike is a justified risk?

Yes. 5.5 trillion yen fiscal package (about 1% of GDP) was proposed last year and approved this year to mitigate the likely impact of the VAT hike. With this package expected to pick up the shortfall in demand after the VAT hike, further monetary easing by the Bank of Japan is not currently anticipated unless clean signs of deceleration in inflation and real sector emerge.

What reaction do you expect to see from the Japanese economy after the sales tax is increased? Do you believe that Japan will be able to weather the sales tax hike? Or have the Japanese officials and policymakers overestimated economy’s ability to withstand?

A slump in private consumption is expected after the VAT introduction during the second quarter of this year as people bought in advance of the tax hikes. Nonetheless, as stated earlier, Japan is expected to post modest recovery for the second half of this year partly supported by the fiscal stimulus as well as the gradual recovery in the global economy. Weaker than expected growth particularly in developing Asia will remain as a risk, however.

What are the major headwinds Japan’s economy might face in the long-term and what issues officials should deal with as the first priority?

In the medium- to long-term, the fiscal consolidation remains as the first priority, which at the same time might act as headwinds until reforms are implemented to put the fiscal balance on track. The fiscal consolidation is critical but will put strain on the policy levers the authorities can have. Drivers of Japan’s growth, therefore, will have to come from private demand, and not public, though continued efforts in pushing structural reforms of the areas with low productivities, such as agriculture and services.