Japan Sales Tax Increase Plan Triggers Some Concern in IMF

Japan’s plan to double a sales tax by 2015 to improve its finances has triggered some concern within the International Monetary Fund’s board.

While IMF directors “generally” supported the plan, “a few” expressed concern over a possible hit to growth, the fund said today in a statement summarizing the view of its executive board. The term “a few” is used by the IMF to mean between two and four. It urged the country to gradually increase the levy to “at least 15 percent” to bring down its public debt over the medium term, according the IMF’s staff report of its annual review of Japan.

Prime Minister Shinzo Abe will decide within the next two months whether to increase the tax to 8 percent in April from 5 percent now and risk damaging a recovery from Japan’s third recession since 2008. While Finance Minister Taro Aso has said he doesn’t understand opposition to the tax increase, adviser Koichi Hamada said he is cautious on an immediate increase, a delay that HSBC Holdings Plc warns would rattle bond markets.

Japan’s gross public debt could reach almost 248 percent of annual gross domestic product next year, the fund projected, an increase of 10 percent from 2012. Japan should adopt “a credible medium-term fiscal plan” as quickly as possible, and needs “growth-friendly revenue and expenditure measures” in the medium term to bring down its debt-to-GDP ratio, the fund wrote in the report.

Sales Tax

Under current legislation, the sales tax will rise to 10 percent in October 2015 after next year’s increase, subject to a final call by the government. Hamada said last month one option could be to raise it by 1 percentage point at a time, according to Kyodo News.

Increasing the sales tax would “knock back growth,” Frederic Neumann, HSBC’s co-head of Asian economics research, wrote in a research report today. “The temptation is thus to back off tax reform. That would be a mistake. Markets need reassurance that the government is set on long-term fixes,” he said.

Fiscal stimulus and the BOJ’s easing introduced in April -- two “arrows” of Abe’s economic policies aimed at ending 15 years of deflation and reviving growth -- have led to a pickup in domestic demand, the IMF said. Real GDP growth will rise to 2 percent this year from 1.9 percent in 2012 before slowing next year to 1.2 percent, the fund forecast.

Strong Growth

“An incomplete version of Abenomics would be unlikely to sustain the current strong growth,” Jerry Schiff, IMF mission chief for Japan, said during a conference call today. “In such a case, over-reliance on fiscal and monetary stimulus could also generate important costs for the rest of the world.”

Schiff said the IMF supports the plan to increase the consumption tax.

“We think this approach balances in an appropriate way the desire to have fiscal adjustment be gradual and the need for the government to establish credibility now in its efforts to bring the debt burden down,” the IMF official said.

A two-step increase in the sales tax won’t cause “major damage” to the economy, BOJ Governor Haruhiko Kuroda said in a speech last month in Tokyo, referring to the BOJ’s growth projections. The BOJ forecast 2.8 percent expansion in the fiscal year started in April, and 1.3 percent growth the following year, according to the median estimate of policy board members released last month.


The BOJ’s board forecast last month prices would rise 1.9 percent in the fiscal year starting April 2015, without the effect of the tax rise. The BOJ’s key price gauge excludes fresh food.

Excluding the effect of the two planned tax increases, Japan’s won’t see gains in overall prices of 2 percent until 2017, said the IMF.

The risk of Abe altering the timetable for the tax increase is “low” because a change would undermine the government’s credibility, Masamichi Adachi, senior economist at JPMorgan Chase & Co. in Tokyo and a former central bank official, said by e-mail today.

Japan’s GDP will contract for three months starting April next year if the tax is introduced as planned, and then return to expansion, according to a Bloomberg News survey of economists. Wages have not kept pace with the growing economy, only rising in two of the 12 months through June.

Moderately Undervalued

The IMF urged Japan to press ahead with reforms to its economy, the “third arrow” of Abe’s reflationary policies.

“To generate growth synergies, measures should include deregulation in agriculture and domestic services, lifting constraints to the provision of risk capital, reducing Japan’s excessive labor market duality, reforming the tax system to stimulate investment, and further relaxing immigration requirements to areas with labor shortages,” the IMF said.

The yen appears to be “moderately undervalued” following its recent slide, “although as long as a full package of reforms is implemented, this would not be seen as problematic,” the IMF said.