Japan’s Economy Contracts Sharply

Article Summary:

• The GDP for Japan contracted 6.8 percent on an annual basis in the second quarter.
• Policy makers feel this is a natural reaction to April’s new consumption sales tax level at eight percent.
• Other economic data, like machinery orders and wage bonus, point to an economic rebound, albeit moderate, for the rest of the year.

As expected, the world’s third largest economy contracted sharply in the second quarter. This comes as a cause and effect from the new consumption sales tax Japan enacted in April which weighed heavy on economic growth.

The gross domestic product (GPD) shrank, on an annum basis, 6.8 percent for the quarter ending in June of 2014. We had expected it to contract 7.1 percent after expanding 6.7 percent in the first quarter of this year. On a quarterly basis (QoQ) the GDP shrank 1.7 percent following a 1.6 percent expansion in Q1. This is the largest contraction since the impact of the earthquake and tsunami of 2011.

Financial markets, while lower at first, shrugged this off as we all knew a decline was coming. Since the data was in line with expectations if not a bit better, this turned into a nonevent. On the flip side, volatile releases like this, tend to have volatile revisions, so we might not have heard the last of this. The question for investors and Japan’s policy makers, is how fast the GDP can recover. The question is now whether consumption and investment will return to normal levels before the end of this year.

This data highlights problems facing Prime Minister Shinzo Abe, who has made it his ambition to revitalize his nation’s stagnating economy. He wants to accomplish by keeping his government’s debt, which is the highest in the developed world, under control. In order to reign in debt to GDP ratio, which is well above 240 percent, Abe raised the consumption sales tax to eight percent. The first time in 17 years this was done. When Japan last did this, the country fell into a recession.

Following today’s GDP release, the economy minister, Akira Amari, said any further hikes to the consumption sales tax, as planned in 2015, to 10 percent will be based on forward economic data. This means it is not written in stone and might not happen. He was very upbeat about the surge in the economy before the tax rate and remains confident this growth will continue. He feels this contraction is a normal response to the new tax level. Amari is confident of a more moderate recovery going forward this year.

Since the tax hike, we have noted some return to normalcy. Consumption spending has begun to improve and thanks to strong bonuses, we are expecting wages to increase. If wages improve, consumers will have more money to spend and this will increase consumer consumption. The increase in bonuses also hints businesses are ready to spend as well. The recent 15 percent increase in machinery orders was a good indication of this. We have also seen, in the recent confidence survey of mid-sized and large business, confidence growing. Take all of this recent data, and this should put the economic recovery back on track for a more moderate recovery.