Bright spots for Japan despite worse than expected GDP report

“Yesterday’s Japan gross domestic product (GDP) report was exceptional for two reasons: first, because it was worse than expected, a 6.3% contraction against expectations of 3.8%; but second, because there is no question about what forced it. Yes, it was the tax hike (effective Oct 1 the VAT rose from 8% to 10%). This sort of clarity of cause and effect is rare in macro reports.

“The good news is that the report also confirms that underling positive trends continued. Specifically: while consumption crashed 11%, or Y7.4 trillion, workers compensation rose by 1.4%, up Y1.2 trillion, which is in-line with the steadfast 1-1.5% quarterly uptrend in place for the past three years or so. There are powerful reasons to assume compensation and income growth will continue its uptrend - Japan’s demographic cliff fueling an ever-intensifying war-for-talent. Watch for this year’s wage negotiations delivering 2.5-3% base-pay growth. If so, the snap-back in consumer spending should be strong, possibly very strong.

“When will this be? Obviously the current fear-factors forced by the coronavirus will cause an additional delay and, right now, it is prudent to forecast another drop in consumer demand in the current quarter. A technical recession two consecutive negative quarters is quite likely in Japan. The forces of fear are poised to keep Watanabe’s wallets closed and tight until the peak of the coronavirus spreading has been confirmed.

“More certainty comes from government fiscal spending. “Team Abe” already recognised the deeper-than-hoped-for cut in demand brought on by the tax hike; and they already compiled and ratified a record supplementary spending package of Y24 trillion (almost 5% of GDP). The first impact of an added fiscal thrust should start to boost domestic demand from late-February/early March and, by the April-June quarter, should add as much as 0.6-0.8% to domestic demand.

“All said, Japan’s October 2019 tax hike will go down in history as a policy mistake, with the misfortunes forced by the coronavirus adding pro-cyclical downward negativity. However, the mistake has already been recognised and forced a strong counter measure that will cumulatively gather positive momentum in coming months. If, and when, the coronavirus retreats a sharper-than-currently-expected positive snap-back in Japan’s economy will come into sight, with a surge in pent-up consumer demand compounding fiscal stimulus. All said, a 4-6% growth rebound by this summer is poised to become possible.”