A nation’s gross domestic product (GDP) is usually evaluated at quarterly intervals with the quarter-on-quarter figure showing growth or contraction relative to the preceding quarter. The quarterly figure is sometimes propagated to indicate what the full-year GDP growth (or otherwise) would be if the performance for the quarter was maintained for the full year.
Japan’s latest quarterly performance (Q2) came in at a contraction of 1.8%, compared to Q1 growth of 1.5%. On a full-year basis, the Q2 figure suggests that the Japanese economy would shrink by an alarming 7.1%. However, the obvious elephant is the increase in Japanese sales tax from 5 to 8% which came into force in April – right at the start of Q2. The tax increase was known about for months and the Q1 figure was flattered by consumers spending more heavily to beat the tax increase towards the end of Q1. Consumer spending accounts for 60% of Japanese demand, so it has a significant impact on the quarterly GDP figure.
The contraction was the worst seen since the March 2011 earthquake and tsunami fed through to the figures. Japan needs to raise sales tax to partially offset increases in social security spending as the population ages – not to mention the funding of the nation’s enormous public debt. It is also needed to lift Japan out of a cycle of price deflation which has bedevilled the economy for much of the past 20 years and acts to damp down domestic demand. A second hike is planned for October 2015 which will raise the tax to 10% - quite modest by many standards, but a doubling of the tax in Japan over 18 months should it go ahead.
Inevitably, the latest quarterly figures have generated calls for the Bank of Japan (BOJ) to take further stimulus actions and for the prime minister to delay, or shelve, the next tax increase. However, Japan is expected to return to growth in Q3 so any such decisions will probably be taken after the initial tax hike has worked its way through the system. The BOJ is targeting inflation of 2% as a healthy level for the economy; getting there is bound to involve some pain and discomfort.