In historic step, Japan PM hikes tax; will cushion blow to economy

Reuters

* Japan PM Abe announces sales-tax hike, stimulus package

* Hike is biggest fiscal-reform move since 1997

* Stimulus to offset some 5 trln yen of 8 trln yen hike

* Japan under pressure from credit rating agencies

By Tetsushi Kajimoto and Stanley White

TOKYO, Oct 1 (Reuters) - Japan's Prime Minister Shinzo Abetook a step on Tuesday that none of his predecessors had managedin more than 15 years - making a dent in the government'srunaway debt.

Abe, riding a wave of popularity with economic policies thathave begun to stir the world's third-biggest economy out ofyears of lethargy, said the government will raise the nationalsales tax to 8 percent in April from 5 percent.

But at the same time he softened the blow to the nascentrecovery. As the tax increase is set to raise an additional 8trillion yen ($81.42 billion) a year, Abe also announced aneconomic stimulus package worth 5 trillion yen.

"It is my government's responsibility to have Japan'seconomy regain hope, vigour and confidence for growth, while atthe same time maintaining trust in the country, as well assecurely passing on the social security system to the nextgeneration," Abe told a nationally televised news conference.

The tax increase marks the first serious effort since 1997to rein in Japan's public debt, which recently blew past 1,000trillion yen ($10.18 trillion). At more than twice the size ofthe economy, this is the heaviest debt load in the industrialworld. The country also runs a huge annual budget deficit of 10percent of GDP.

Yet, successive governments have done little to rein inspending. As Abe is watering down the impact of the tax hike andhas yet to address an explosion of social-welfare spending,critics doubt Tuesday's move will be enough to get Japan ontrack to achieve its goal of halving the budget deficit -excluding debt service and income from debt sales - by thefiscal year to March 2016 and balance it five years later.

"Even if Abe's policies go well, we still will not eliminatethe primary budget deficit," said senior Standard & Poor'sofficial Takahira Ogawa.

ABE'S BALANCING ACT

Still, pressing ahead with the tax hike bolsters the imageAbe has sought to foster of a decisive leader, withstandingopposition from his advisers and some of his own party.

"This plan was already in the works, but we have to give Abesome credit for following through with it," said Hiroaki Muto,senior economist at Sumitomo Mitsui Asset Management Co.

Abe is seeking a difficult balance with massive fiscal andmonetary stimulus to end 15 years of deflation and tepid growth,while setting the groundwork to get the government's finances inorder over time.

He sought to portray his decision within the long historicalarc of his country's development, harkening back 250 years tofiscal reforms by the Choshu Clan in his own home region inwestern Japan, which he said laid the groundwork foragricultural expansion and development of new industries, suchas salt and paper.

"The package we have compiled is not a transient step thatjust boosts the economy in the short term," Abe said. "It is aninvestment for the future that mitigates the burden we areasking you to shoulder, in order to strengthen and stabilisesocial security while driving investment, boosting wages andexpanding employment."

Financial markets have given Tokyo the benefit of the doubt:the government can borrow 10-year money for less than 0.7percent. But government officials and private economists havelong feared a crisis in confidence in Japan's creditworthinessthat could cause a crippling spike in interest rates.

Seven economists canvassed by Reuters forecast the tax hikewill shave 0.8 to 1.2 percentage point off growth in the fiscalyear from next April, while the stimulus package will restore0.4 to 0.8 point.

Although the public is split on the sales-tax hike,according to a survey this week, many business leaders expressedunderstanding for Abe's two-pronged approach.

"In the long term, for us to be able to do business with therest of the world, it's vital for the world to have a sense ofsecurity and confidence in Japan," Fujitsu Ltd President MasamiYamamoto told reporters. "The short-term concern is whether theeconomy suffers a relapse just as it's in a rising trend."

The tax hike is part of a package agreed last year by theprevious government and the two current ruling parties. It isthe first step in a doubling of the consumption tax - similar toa goods-and-services tax in other countries - over two years.

By law Abe had to confirm that the economy was strong enoughto weather the tax hike before proceeding.

Japan posted the strongest growth among the Group of Sevenpowers in the first half. On Tuesday, the quarterly "tankan"survey of corporate sentiment from the Bank of Japan gave Abethe final economic justification to push ahead with the taxincrease.

The closely watched survey found optimism surging amongJapan's big manufacturers, with the key sentiment index jumpingto 12 from 4 in June, the highest since December 2007 and wellabove the forecast of 7.

Still, the tax increase is an economic and political risk.

ENDURING TRAUMA

Japan spiralled into deep recession after the sales tax wasincreased in 1997 to 5 percent from 3 percent. Economists aredivided on how much the hike was to blame, as the Asianfinancial crisis and then Japan's own banking crisis followedshortly afterwards.

Regardless of the economic impact, the tax increase becamean enduring trauma for Japan's political leaders after it helpedend the career of then-premier Ryutaro Hashimoto. Even thepopular Junichiro Koizumi was unable to make significant headwayon fiscal reform during his 2001-2006 term.

Cushioning the tax-hike pain, Tuesday's package featurespublic-works spending for the 2020 Tokyo Olympics and tax breaksto promote corporate capital spending. Officials will alsoconsider an early end to a corporate tax add-on that has fundedreconstruction following the 2011 earthquake and tsunami, whichwould save companies 900 billion yen.

Abe also instructed the ruling coalition parties to start considering a permanent cut in the corporate tax rate, which henoted was high by international standards.

The package offers some goodies to individuals, such as aidto home buyers, but with the tax breaks mostly targetingcompanies and the tax hike directly hitting consumers, Tuesday'ssteps bolster the view of critics that "Abenomics" favourscorporate Japan at the expense of the little guy.

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