GDP Collapse More Than Just A Sales Tax Hangover

BMI View: The large contraction in Japan's real GDP in Q214 supports our bearish growth outlook for 2014, and we continue to see full-year growth coming in at 0.9%, compared with consensus expectations of 1.4%. While the poor GDP print is largely the result of the aftermath of the sales tax hike, Japan's economic weakness runs deeper than this, and we continue to see wealth being destroyed by the current policy mix.

Japan's Q214 real GDP collapsed by 6.8% quarter-on-quarter (q-o-q) in seasonally-adjusted annualised (SAAR) terms, supporting our view that full-year growth is set to come in at just 0.9%, far below the 1.4% consensus expectations. The contraction in the economy was largely due to the inevitable hangover effects of the government's sales tax hike, which led to a surge in growth in Q114. However, the fall in real GDP wiped out all the growth since Q113, and we believe that something much more negative is occurring as the government's ongoing efforts to stimulate growth increasingly backfire.

The inflationary policies implemented by the Japanese government and the Bank of Japan (BoJ) are aimed at generating nominal GDP growth, and the surge in inflation allowed nominal GDP to stay roughly constant. However, wealth is increasingly being sacrificed in a bid to generate growth. In US dollar terms, the economy continues to contract, and is now no larger than it was in 1994.

Record Collapse In Final Domestic Sales
Japan - Real GDP Growth, % chg q-o-q Annualised

BMI View: The large contraction in Japan's real GDP in Q214 supports our bearish growth outlook for 2014, and we continue to see full-year growth coming in at 0.9%, compared with consensus expectations of 1.4%. While the poor GDP print is largely the result of the aftermath of the sales tax hike, Japan's economic weakness runs deeper than this, and we continue to see wealth being destroyed by the current policy mix.

Japan's Q214 real GDP collapsed by 6.8% quarter-on-quarter (q-o-q) in seasonally-adjusted annualised (SAAR) terms, supporting our view that full-year growth is set to come in at just 0.9%, far below the 1.4% consensus expectations. The contraction in the economy was largely due to the inevitable hangover effects of the government's sales tax hike, which led to a surge in growth in Q114. However, the fall in real GDP wiped out all the growth since Q113, and we believe that something much more negative is occurring as the government's ongoing efforts to stimulate growth increasingly backfire.

The inflationary policies implemented by the Japanese government and the Bank of Japan (BoJ) are aimed at generating nominal GDP growth, and the surge in inflation allowed nominal GDP to stay roughly constant. However, wealth is increasingly being sacrificed in a bid to generate growth. In US dollar terms, the economy continues to contract, and is now no larger than it was in 1994.

Record Collapse In Final Domestic Sales
Japan - Real GDP Growth, % chg q-o-q Annualised

While the headline GDP figure is poor, the breakdown is even worse. Inventory accumulation added 3.3 percentage points (pp) to headline real GDP growth, which is likely to be taken back in the following quarters. Net exports contributed positively to growth, adding 3.2pp, although this was due to a collapse in imports, which posted a 22.3% q-o-q drop. Domestic final sales, which strips out inventory accumulation and net exports, contracted by 11.3%, more than the contractions seen in the aftermath of the 2011 tsunami and the 2009 Global Financial Crisis.

While we do expect to see some recovery in the data as the sales tax hangover recedes, we maintain our view that Japan's macroeconomic policy mix, together with the deteriorating demographic profile, is likely to result in sub-1% real GDP growth over the coming years. The sales tax is set to be hiked once again in October 2015, and if this goes ahead we would expect to see real GDP take another blow. However, Japan's dire fiscal position necessitates that tax hikes and spending cuts will have to be forthcoming, or the alternative of a sovereign default or hyperinflation would become real possibilities, with much more serious consequences for growth.

Despite The Poor Results, More Stimulus To Come

The fact that Japan's economy has stagnated under Abenomics, with real wages collapsing by record amounts ( see 'Inflationary Policies To Further Weaken Economy', August 1), is all the more ominous considering that real interest rates are deep in negative territory, essentially creating the conditions for growth to be front-loaded. When real rates ultimately turn positive (either through a decline in inflation or, more likely, a surge in bond yields), businesses are likely to face huge losses as projects they are undertaking suddenly become loss making. The longer real rates are held artificially negative, the larger will be the ultimate rise back into positive territory, and the worse the consequences will be for real GDP growth. However, this is unlikely to deter policymakers from doing more of the same, as the BoJ and the government remain convinced that increased money creation will generate real economic benefits. With this in mind, we maintain our forecast for real GDP growth to fall further in 2015 and 2016 to 0.8% and 0.7%, respectively, and note that risks are weighted to the downside.

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Related sectors of this article: Economy, Economic Activity
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