Has a Proper Environment Come Together for Raising the Consumption Tax?-Firm domestic demand vs. some uncertainty overseas(No.178)

◆Economic outlook revised: In light of the first preliminary Apr-Jun GDP release (Cabinet Office), we have revised our economic growth outlook. We now forecast real GDP growth of +3.0% y/y for FY13 (previous forecast: +3.1%) and +1.2% for FY14 (+0.7%). We have assumed the formation of the FY13 supplementary budget of around Y3 trillion (new spending basis) and have accordingly revised our FY14 outlook upward.

◆Main scenario—Japan’s economy to continue growing: After hitting bottom in November 2012, Japan’s economy has entered a recovery phase. We believe it will continue to expand steadily. Economic policies of the Abe administration (so-called “Abenomics”) represent an appropriate set of policies with the potential of jump-starting the revival of the Japanese economy and monetary policy measures in particular are yielding marked results. We anticipate that the economy will continue to expand, supported by (1) the expansion of the US economy, (2) the persistent reconstruction demand related to the 2011 Great East Japan Earthquake and the formation of a large-scale supplementary budget, and (3) the ongoing depreciation of the yen and the ascent in stock prices accompanying the BOJ’s bold monetary easing. When we compare the current recovery with past recoveries, it is distinguished by a robust household sector that is being supported by a recovery in consumer confidence from a rising stock market. While the improvement in the income environment, exports, and capex was somewhat slow in relative terms, these categories are not faring all that poorly compared to past recoveries in Japan and the US. With regard to criticisms against Abenomics such as 1) it will have an adverse impact on the economy if long-term interest rates rise and (2) employee income will fail to increase as inflation progresses, and living standards will fall, we believe these criticisms have little basis. Going forward, the Abe administration will need to actively engage in measures such as (1) the maintenance of fiscal discipline by making fundamental reforms to the social insurance system and (2) strengthening comprehensive growth strategies through deregulation and the reduction of the effective corporate tax rate.

◆Has a proper environment come together for raising the consumption tax?: In this report, we provide a multifaceted examination of the pros and cons of raising the consumption tax. At the present moment, we believe that a proper environment has come together for raising the consumption tax as scheduled. Compared to 1997 when the consumption tax was last raised, domestic demand is expected to trend firmly. There will be a need, however, to carefully assess the risk of a downswing in China and other foreign economies.

◆Four risk factors—examination of the world economic cycle: Risks that will need to be kept in mind regarding the Japanese economy are: (1) turbulence in emerging economies, (2) China’s shadow banking problem, (3) a reigniting of the European sovereign debt crisis, and (4) a surge in crude oil prices stemming from geopolitical risk. Of these four risks, it is worth underscoring that the first is closely related to the second and third. In this report, we examine the world economic cycle. In the past, advanced economies led by the US drove emerging economies. However, a decoupling has currently taken place—advanced economies are performing well but emerging economies are stagnating. We believe that this decoupling is occurring for three reasons: (1) the dwindling in the amount of loans from European financial institutions to emerging economies in light of the European debt crisis, (2) the sluggishness of the Chinese economy, and (3) concerns that money will be taken out of emerging economies based on worries that the Federal Reserve Board will implement exit measures from a third round of quantitative easing. In the final analysis, we anticipate that the collapse of emerging economies will be avoided as the US economy continues to expand. Nevertheless, the state and the future direction of the Chinese economy will continue to require close monitoring.

◆BOJ monetary policy: With the recovery of Japan’s economy, we believe that the timing for the BOJ to implement further accommodative measures will be FY14 or later. The BOJ is likely to purchase additional risk assets (ETFs and other assets) in Apr-Jun 2014 or later in part to mitigate the adverse impact of a higher consumption tax rate.

【Our assumptions】
◆Public works spending will grow +11.7% in FY13 and –0.9% in FY14; the consumption tax rate will be increased in April 2014
◆Average exchange rate of Y99.7/$ in FY13 and Y100.0/$ in FY14
◆US real GDP growth of +1.5% in CY13 and +2.6% in CY14