Japanese prime minister Shinzo Abe will deemphasise his popular monetary reform policy in favour of fiscal reforms following the Liberal Democratic Party’s (LDP) expected takeover of the upper house following elections on July 21.
As the win will give the LDP unprecedented power over government policy, Abe is expected to push through more aggressive tax and labour reforms in a bid to make Japan investible and business-friendly – regardless of backlash from Abe’s own constituents.
“If major opinion polls are right in expecting that the ruling coalition of the LDP and New Komeito will secure the majority in the upper house, that will create a very rare and very stable political situation in Japan because we would have no other major national-level election in three years with both houses controlled by the ruling parties,” Masayuki Kichikawa, chief Japan economist at Bank of America Merrill Lynch, told Asiamoney PLUS on July 19.
Kichikawa notes that this will be the first time for Japan to enjoy such a political stability since 1986, when prime minister Yasuhiro Nakasone, also a LDP member, held the elections for the upper house and lower house on the same day and won both. “This is a very unnaturally stable situation and this could give prime minister a chance to push through policies that will put Japan on a path for growth but won’t necessarily be the most popular with the Japanese people,” he added.
Prime minister Abe won his leadership position in December after campaigning for economic reform under a three-pronged strategy that tackles monetary, fiscal and growth, dubbed ‘Abenomics’.
Abe has focused on monetary policy in the first six months, which has proved popular as the weakening yen improved exporters’ prospects and led to inflation. But now that the government can proceed to the second phase of Abenomics, analysts expect upcoming policies to be more contentious.
“The current USD/JPY dollar exchange of about 100 is very comfortable for Japanese companies. So, in the short term, there’s no incentive to sharply weaken the yen anymore,” said Daiju Aoki, senior Japan economist at UBS. “In the long term there will be slower depreciation. By the end of next year [the USD/JPY exchange] may be at 110…Now prime minister Abe’s priority will be driving economic growth and improve Japan’s fiscal situation, though doing this will be tough for some people and industries.”
Tackling taxation
First among these reforms will be long-awaited clarity on Japan’s consumer tax, which is slated to rise from 5% to 8% in April 2014 and from 8% to 10% a year later if plans proceed. While this tax hike has been on the cards long before Abe took office, politicians continue to debate the tax on the grounds of causing popular and economic instability. However, delaying this tax rise means debt-to-growth domestic product (GDP) will continue to inflate above the current 230%.
However, while consumers’ tax will rise, corporates may see theirs drop from 38% to 35%. Regulators may introduce this tax break to offset the negative economic effects of the new consumption tax: corporate activity will buoy the economy even as consumers minimise their consumption to avoid paying higher taxes.
Despite consumers’ peevishness, economists say the LDP’s hard stance on taxes will give domestic and foreign investors faith in Japan’s ability to manage its house.
“The consumption tax may be negative for consumers, and a smaller corporate tax may disappoint them. But foreign investors will continue to be excited about the growth prospects of Japan and regulators’ ability to make changes,” said a Tokyo-based economist.
Raising consumption taxes from 5% to 8% is expected to generate an extra ¥7 trillion-¥8 trillion (US$70 billion-US$80 billion) of revenue, which will help alleviate Japan’s debt load. Raising it from 8% to 10% will bring in an additional ¥5 trillion, creating an additional ¥12 trillion-¥13 trillion by increasing taxes 5% to 10%, according to UBS. This compares to the ¥3 trillion gained from the tax break for corporates.
“Giving corporations a tax break still means Japan will see net gains because of the revenue generated from the consumption tax,” said Aoki. “Doing this should have a 0.6% impact on Japan’s GDP.”
Overriding disappointment
The LDP additionally looks to play hard ball with other long-time supporters, namely the agricultural sector.
The LDP has often spent vast sums to fund public works across Japan as part of the party’s bid to satisfy its key electorate, rural and semi-rural voters. Yet, analysts anticipate that Abe is prepared to give corporations freer access to acquire agricultural land to grow their own business.
Likewise, prime minister Abe took heat on January 11 for pledging to spend a sum equal to 2% of Japan’s GDP on largely public works projects, including construction and disaster-prevention initiatives in the areas left damaged after the March 2011 tsunami. This was meant to create jobs for these same rural voters.
Yet construction and infrastructure companies that engage in this business may see their taxes rise from 35% to 38%, say economists.
“Pandering to voters who back agriculture and public works was a mechanism to get votes, and now Abe will tax them,” said a Tokyo-based economist, adding that these higher taxes are meant to be short-term measures to take place over the next three years.
Abe’s administration would be also prepared to undertake other hard measures to straighten Japan’s own balance sheet. These include tackling social security reform, which could mean raising the eligibility age for elderly citizens to receive social security and enforcing privatisation solutions to shoulder the costs of Japan’s aging demographic.
The strategy could also mean labour reform, mandating that citizens aged 65-70 continue participating in the workforce.
“Privatisation and raising the age of public pension are options to keep a cap on government spending, but that’s a very contentious issue", said Kichikawa. “It will require a lot of time and political capital for the government to build a consensus.”