Overconfident Kuroda urges sales tax increase

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Bank of Japan governor Kuroda has entered the debate about the controversial increase in sales tax (or ‘consumption tax’ as it is also known) that the government is mulling over at the moment. He seemed to be attempting to drive home the rather obvious point that unless public finances are repaired, bond yields are bound to move higher, which will topple the proverbial house of cards, since this will cause government debt repayments to explode beyond what can possible be financed by the government through tax revenues.

He is quoted as saying that:

“Ending deflation and raising the sales tax are achievable at the same time.”

He added:

“Generally speaking, as a result of the continuance of large budget deficits, the government’s debt levels are already at extremely high levels. Considering that issue, it is extremely important for the government to clarify the path of fiscal rehabilitation and to move ahead with fiscal and structural reforms. The Bank of Japan is strongly hoping it will steadily implement them.”

As NipponMarketBlog has mentioned several times, Japanese public finances are in such dire straits that urgent action is needed, which is why both fiscal and monetary stimulus in the shape of Abenomics has been launched.

The idea behind Abenomics (see our piece here) is to kick-start the economy and propel it onto a self-sustained growth track that can then carry the tax increases necessary to mend public finances and eventually reduce government debt (at least as a percentage of GDP). However, the key word here is ‘self-sustained’. Simply raising nominal growth by using fiscal stimulus (to create the accounting effect of higher GDP numbers), and monetary stimulus to weaken the Yen and thereby boosting corporate profits in the short-term (whilst wage inflation lags behind), is not a sustainable strategy. It does not increase the long-term capacity of the economy to create wealth, and consequently it does not provide the tax foundation required to decisively mend public finances.

We make three observations about governor Kuroda’s statements:

1. Kuroda is in charge of monetary policy, not fiscal policy. But of course the distinction between the two is becoming ever more blurred. As we mentioned in this piece, the Bank of japan has effectively ceased to exits and has been replaced by what is just an extension of the Ministry of Finance.

2. The comments quoted above appear to NipponMarketBlog as a display of overconfidence in the extent to which Abenomics is working, specifically the permanent effects that the policy is expected to have. This is especially the case since past increases in the consumption tax has been widely blamed for derailing nascent economic recoveries in Japan at least once in recent history.

3. Kuroda’s meddling in law makers’ decisions about the tax code also seems to demonstrate a level of perceived urgency on the part of the BoJ, which is not necessarily conducive to creating the impression that the BoJ is in control of the situation. At the same time however, one can not help suspect that perhaps Prime Minister Shinzo Abe and Finance Minister Taro Aso have asked Kuroda to issue these statements, in order to put pressure of law makers to ensure that the sales tax hike goes through parliament.

Bank of Japan Governor Haruhiko Kuroda speaks during the lower house budget committee session at the parliament in Tokyo

At any rate, in NipponMarketBlog’s opinion there are certainly signs of higher growth and higher levels of economic activity in general at the moment, but it is still very tenuous and far from sufficient to start increasing taxes. We believe the hike in sales tax is very much premature. A surging equity market (partly due to the BoJ’s QE and higher inflation expectations) and rising corporate profits (largely due to the weakening Yen), along with positive CPI numbers (almost exclusively due to the weakening Yen and resultant higher energy prices) does not constitute a sustainable recovery. At least not to the point where tax increases should be considered.

The focus in Kuroda’s comments on deflation as a problem rather than a symptom is also quite worrying. Kuroda’s statements underline the idea that deflation is perceived as a problem in itself, rather than a symptom of a dysfunctional economy. This brings with it the risk that officialdom in Japan are treating the symptom and not the illness. This approach historically never ends well.

NipponMarketBlog is reminded of a quote from a well known investor, who once (perhaps slightly harshly) remarked that:

“Japan has never missed an opportunity to miss an opportunity”.

We are concerned that history might be repeating itself. It is too early to tell, but the impatience with which the consumption tax hike is being treated is certainly worrying.

The whole situation is of course very much characterized by a sort of ‘Catch 22”, where taxes have to be raised for public finances to be repaired, but in order for that to happen growth has to be encouraged, and the only way for a government to do this quickly is to increase fiscal and possibly also monetary stimulus, which worsens the fiscal balance and creates doubt about the long term solvency of the government respectively (the latter due to the risk of rising bond yields).

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It is tempting to think that Abenomics is actually just a short-term measure to create a nominal growth spurt that can buy the country some time, but as we have made the case for before, Japan is effectively already insolvent (see our piece here), and eventually some sort of default and/or debt restructuring has to be implemented.

However, we also believe that if and when this default or debt restructuring occurs, Japan as a whole (and corporate Japan in particular) has a golden opportunity to re-invent itself and again emerge as a dynamic center of growth in the global economy (see our piece here).

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