Is Japan headed for another recession?

Is Japan headed for another recession?

Japan has struggled in recent months, posting economic losses for the second straight quarter, eliciting fears that the country is headed for another recession. Prime Minister Shinzo Abe’s experiment may prove to be exceedingly important in the country’s immediate future.

Japan unexpectedly fell into recession as preliminary data from last week showed the country had shrunk by an annualized 1.6 percent in the third quarter. This follows a 7.3 percent contraction in the second quarter and means that Japan is faced with a harsh reality: after two consecutive quarters of contraction, it has met one definition of a recession.

Prime Minister Shinzo Abe immediately reacted by announcing on Tuesday last week an 18 months delay of the second sales tax hike, originally intended to take place on October 2015, and called for a snap election.

Japan’s first sales tax hike, designed to increase government revenue, took place in April of this year, at an aggressive increase from 5 to 8 percent. The December 2013 5.5 trillion yen ($47 billion) stimulus package aimed to help the economy cope with the 3 percentage-point hike proved to be insufficient, and GDP change plummeted to an annualized 7.3 percent contraction in the second quarter. The second sales tax hike was intended to be milder to 10 percent.

Kozo Yamamoto, a veteran lawmaker in the Liberal Democratic Party, says the second tax increase needs to be put off “until wages catch up” to prices. But this may have dangerous repercussions. “If you delay the tax increase a year and a half, you risk raising the tax when the Bank of Japan is starting to end its easing. So you have tapering and fiscal tightening at the same time,” said J.P. Morgan Securities’s top Japan economist, Masaaki Kanno, “that is very dangerous.”

Prime Minister Abe’s grand economic experiment, a combination of fiscal discipline and monetary stimulus, and often referred to as Abenomics, is failing.

Shinzo Abe, leader of the Liberal Democratic Party, was first elected two years ago vowing to pull Japan out of two decades of deflation. Japanese stocks soared and the economy seemed to be improving during the first few months of his administration. The Bank of Japan aggressively bought government bonds – more in fact than when the US Federal Reserve was at its peak when comparing the size of the US economy with the Japanese – and billions of dollars were feverishly injected into the economy.

What was the direct result of this? The value of the yen dropped, making Japanese exports cheaper. Investors quickly moved their sights from bonds to stocks. The Tokyo stock market sky rocketed, and by mid-2013, it seemed as though Japan’s economy was back on track.

However, the stock market’s sudden resuscitation only benefited a handful of people. 80% of Japanese people do not own any shares. Critics argue that Abe has focused too much on a pump-priming stimulus and not enough on deregulation and trade. After years of lethargic wage growth, rising sales taxes have served only to discourage consumers from spending.

Abe recognizes the need for an immediate structural reform and thus decided to dissolve the lower house of parliament on November 21 to hold an early election, in a desperate attempt to extend his term and save his set of economic policies.

The yen fell to a seven year low against the dollar this week on speculation Abe would delay the tax increase. Japan faces a tough road ahead. It has the highest government debt-to-GDP ratio in the OECD, an ageing and declining population, making its economic future a challenging.

Categories: Asia Pacific, Economics

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Itziar Aguirre

Itziar currently works as a Research Consultant at JLL, a commercial real estate capital intermediary. She holds an MBA in Accounting and Finance from the University of St. Thomas and an MSc in Comparative Politics from the London School of Economics.