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Oct 2 (Reuters) - (The following statement was released by the rating agency)
Japan’s consumption tax hike, announced yesterday, is in line with Fitch Ratings’ expectation, and does not by itself lead to a re-assessment of the Negative Outlook on the ‘A+’ sovereign rating.
The tax hike does signal a commitment to fiscal consolidation as a policy objective. For now, however, the process of budget deficit reduction remains slow and fragile amid unclear effects of accompanying structural reforms.
The tax increase, from 5% to 8% with effect from April 2014, is the first of a two-step process which is expected to reach 10% by 2015. This is also the centerpiece of the government’s long-term plan for halving its primary budget deficit by FY15 from the FY10 level, and stabilising its debt burden by FY20. Yet there will be only a limited short-term impact on the sovereign rating for two reasons.
One is that the pace of fiscal consolidation remains slow even in comparison with Japan’s fiscally challenged high-grade peers. In our base-case scenario, government debt stabilises at 250% of GDP (from 239%), but no earlier than 2020.
In comparison, France and the UK are likely to stabilise their debt burdens at lower levels, and much sooner - by 2014 and 2016, respectively (although the UK and France are more highly rated, at ‘AA+’).
Moreover, the near-term impact on the public finances is likely to be mitigated by some offsetting fiscal easing to smooth the effect on growth, although the details have yet to be determined.
Another reason is the lingering danger of fiscal slippage. This is due to two key risks. First, whether offsetting measures in this fiscal year will be reversed in a timely fashion so as not to erode the medium-term fiscal impact of the hike. A second risk would be non-implementation of the proposed extension of the sales tax to 10% by 2015.
The tax rise is in line with our base case, so there is not much in yesterday’s announcement to alter our Negative Outlook on Japan’s sovereign ratings.
Nonetheless, Fitch thinks Abenomics could result in the Outlook reverting to Stable. The central issue is to what extent structural reforms and supportive monetary policies can result in - and sustain - higher nominal and real GDP growth. In this respect, the following two evolving economic trends are particularly important:
First, whether wage growth accelerates and sets off a self-sustaining inflationary process; and, finally, whether tax incentives and other supply-side measures induce businesses to raise investment and ultimately boost the real GDP growth rate.
Recent data point to a pick-up in GDP, inflation and employment. Fitch has revised up its growth forecasts for Japan in 2013 and 2014 since the end of last year even while lowering the forecasts for the US, EU and emerging markets.
Moreover, monetary and credit conditions remain easy, and business confidence has also risen. However, sustained increases in core inflation, wages and business investment have yet to materialise.
The upshot is that yesterday’s consumption tax hike is a necessary but as-yet insufficient condition for a lasting improvement in Japan’s sovereign credit profile. Much depends on how inflation expectations, wage increases and corporate investment shape up. Constructive developments on these fronts could also help limit the medium-term risk of fiscal setbacks.