Why Japan’s tax increase impacted GDP and consumer spending

Market Realist

Japan's decrease in GDP shows the importance of consumer spending (Part 1 of 6)

Japan’s tax increase impacts GDP

On Wednesday, August 13, Japan’s government announced a 6.8% contraction in its second quarter real gross domestic product (or GDP). On a quarterly basis, the economy contracted 1.7% in the second quarter after a 1.5% increase in the first three months.

Steepest fall since 2011

Japan has the world’s third largest economy. This year Japan has seen its steepest fall in GDP figures since early 2011. In 2011, the economy contracted at an annual rate of 6.9%.  This was the year of the Tohoku earthquake. The earthquake  triggered a tsunami that hit Japan’s north-eastern shores in 1Q11. The tsunami caused extensive and severe structural damage. There were also nuclear accidents at the Fukushima Daiichi Nuclear Power Plant in north-eastern Japan.

What caused the fall?

Japanese economy minister, Akira Amari, blamed the contraction on the decision to raise the consumption tax from 5% to 8% in April. Akira Amari expects that the economy will rebound in the next quarter.

The April 1 decision to raise the consumption tax was based on the government’s rising concerns over ballooning public debt in Japan. According to Japan’s Minister of Finance, the current debt-to-GDP ratio is 227.2%. Japan is the world’s most indebted advanced economy. The government didn’t expect that the increase in consumption tax would lead to one of the steepest contractions in the economy’s GDP.

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

Continue reading the next part of this series to understand what caused the sudden contraction in Japan’s GDP and to see why companies like Sony (or SNE), Honda (HMC), Toyota (TM), and Canon (or CAJ) may be impacted.

Continue to Part 2

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