Japan sees fall in second quarter GDP of 1.7% as increased sales tax bites

13th August 2014


Japanese GDP contracted by 1.7% in Q2 2014, the largest economic contraction in Japan since the 2011 earthquake.

The contraction is seen by experts as primarily a result of an increase in Japan’s sales tax, from 5% to 8%, in April of this year. This rise served to bring consumption forward from Q2 into Q1 2014.

The first quarter of this year saw a 1.6% rise in GDP, mirroring the Q2 decline. In short, Japan’s economy is now back to where it was at the beginning of the year, though another rise in the sales tax to 10% is pencilled in for 2015.

The contraction is raising questions over the capacity for Abenomics to revive Japan’s economic fortunes. However as Hargreaves Lansdown points out, the IMF is still predicting growth for Japan this year, of 1.6% over 2014. This is only marginally behind the 1.7% growth forecast for the US economy this year.

Indeed, the market was expecting this fall in GDP, and the Nikkei is actually up on the day. Japan does undoubtedly face challenges, in particular an ageing population and a shrinking workforce. The working age population is falling by around 1 million every year, and unemployment stands at just 3.7%. One of the paradoxes of Japan is this has not translated into higher wages for workers, which Abe wants to encourage to stimulate consumption.

This is why Abe’s ‘third arrow’ for reform included measures to reform the labour market to make it more flexible and encourage more participants, particularly women, giving rise to the idea of  ‘womanomics’.

The Japanese market has returned 23% for UK investors since Abe came to power in December 2012. This includes an 18% devaluation of the Yen against Sterling, in local currency terms the stock market has actually risen 51%

Hargreaves says its long term valuation analysis suggests Japan is the world’s cheapest developed market, suggesting that investors buying Japan today are doing so at a reasonable valuation relative to other markets.

Laith Khalaf, senior analyst, Hargreaves Lansdown says: “The drop in GDP was fully anticipated, in fact consensus was for a slightly worse contraction, and so the Japanese market has shrugged the data off. Japan’s economic fortunes still hinge on the success of Abenomics, and in particular the third arrow of structural reforms which aim to change Japan’s labour market.

“The stock market doesn’t currently look particularly expensive compared to its own history and compared to other developed markets, which suggests investors buying Japan today are doing so at a reasonable valuation.”

Andrew Rose, Japanese Equities Fund Manager at Schroders says: “Japan’s second quarter real GDP fell a bracing 6.8% compared to the previous quarter on an annualised basis. At the same time the previous quarter’s growth rate was revised down from 6.7% to 6.1% yielding the obvious conclusion that the economy shrunk during the first half of 2014.

“Whilst undeniably weak (and significantly worse than the quarter immediately following the last consumption tax increase in 1997 – although the degree of front-loaded demand was also lower at that time) the rate of decline was slightly ahead of consensus expectations. Central to the decline was the “payback” from the front-loaded demand that occurred during the first quarter of this year to beat the 3% increase in the consumption tax on April 1st. Not surprisingly, therefore, the weakest areas were private demand components of GDP such as private consumption and housing investment,( i.e. where sensitivity to the tax increase was highest).

“The GDP release came out just before the Japanese stockmarket opened this morning. Given that expectations were for a weak number, the release had little impact on the market, which rose slightly, although the yen weakened modestly. The market’s attention is already on the shape of the rebound in GDP this quarter. Whilst the dislocations caused by the tax increase render it difficult to gauge the underlying strength of the economy, it seems reasonable to expect growth to resume in the third quarter. Some of the data surrounding consumption post the end June cut-off for second quarter GDP is more encouraging, survey data surrounding private capital spending is indicative of a rebound and exports are finally showing some signs of responding to the currency’s weakness over the last 18 months.”

HL suggests funds such as the GLG Japan Core Alpha, or Schroder Tokyo, or the BlackRock Japan Equity Tracker.

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