Second sales tax hike postponed from Oct 2015 to Apr 2017

Following release of a disappointing GDP.

PM Abe announced yesterday evening to postpone the second sales tax hike from Oct 2015 to Apr 2017, as well as dissolving the parliament and hold a snap election.

This followed the BOJ’s decision of expanding QE on 31 Oct, and the release of a disappointing GDP report this Monday showing that the economy has slipped into a technical recession after the first sales tax hike.

Whilst DBS has flagged the possibility of a technical recession and some form of policy fine-tuning, the actual policy changes are more substantial than expected. 

The short-term growth outlook has turned positive due to the delay of fiscal tightening and the further easing of monetary policy. The removal of the 2ppt sales tax hike from the 2015 baseline assumptions could lift consumption growth by 0.5ppt, equivalent to 0.3ppt in GDP growth. The rise of stock market prices asa result of QE expansion should also boost consumption growth, through liftingsentiment and creating wealth effects. 

On the flip side, the long-term fiscal prospects have become more challenging due to the postponement of sales tax hike. The further 2ppt rise in sales tax is designed to create a new source of tax revenues worth JPY 4trn per year. These revenues will kick in only in 2017, instead of 2015 under the original assumptions. Also note that the government has promised to compile additional stimulus measures next year under a supplementary budget, as well as cutting the corporate tax rate starting from FY2015. The goal of balancing primary budget deficit by FY2020 now appears increasingly distant and elusive. This carries negative implications for sovereign credit ratings and financial stability in the longer term.