Must-know: What lies ahead for Japan?

Market Realist

Japan's decrease in GDP shows the importance of consumer spending (Part 6 of 6)

(Continued from Part 5)

What lies ahead for Japan?

April’s consumption tax hike did hurt consumer confidence because goods became expensive. However, the effects of the increased tax seem to be easing. Consumer confidence increased to 41.5 in July from 41.1 in June, according to government data released on Monday, August 11.

Most of the second quarter contraction in gross domestic product (or GDP) has been attributed to April’s 3% consumption tax hike. This caused consumers to stock up before the hike—increasing first quarter consumption—with less purchase demand left for the second quarter. As a result, the decrease in consumption demand in the second quarter led to a steep contraction in the gross domestic product (or GDP) for April–June.

The rising debt burden

In the light of the steep, sudden fall in Japan second quarter GDP, Prime Minister Shinzo Abe may decide on another supplementary budget—his third—to boost the economy, instead of abandoning the tax increase.

Another supplementary budget could risk piling more debt on the world’s most indebted, advanced economy. Japan’s government debt-to-GDP ratio is ~227.2%. This—compared to the other developed nations like 101.53% in the U.S. or 90.6% in the UK—speaks volumes about Japan’s economic debt situation. Note that we have compared public debt (excluding external debt) in the above chart, to facilitate comparison. For Japan specifically, the proportion of it’s internal (or public) debt (that is, debt owed to the people of the nation) has shown a gradual increase over its external debt (debt owed to foreign countries or nationals). This can be seen in the chart below, which provides a breakdown of how Japan’s external and internal debt have been over the last 10 years.

Third quarter expectations

Analysts are viewing the contraction as a one-off event. They’re expecting a sharp rebound in the third quarter. However, policymakers shouldn’t take a strong rebound in July–September for granted. The weakness in consumer spending comes amid a net decline in people’s disposable income. The decline was caused by the tax hike and rising prices that were induced by the weak yen.

Going forward, if the third quarter growth remains subdued, the Bank of Japan could come under pressure to add a stimulus. The pressure could come before Prime Minister Shinzo Abe decides whether to increase the sales tax further.

Investors in exchange-traded funds (or ETFs) like the iShares MSCI Japan ETF (EWJ) and the WisdomTree Japan Hedged Equity Fund (DXJ) invest in the Japanese equities like Toyota (TM) and Honda (HMC). The iShares MSCI EAFE ETF (EFA) invests in the performance of equity markets in Europe, Australia, and the far east. Investors in these ETFs should remain wary of their holdings.

To learn more about the earnings and stock market outlook for Japan, read our Market Realist series, Japan: Time to give the land of falling stocks another look?

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