Japan consumption tax hike to raise revenue to 2.5% of GDP

The two-fold increase of consumption tax to 10% reveals more than political risk.

According to Fitch, the controversy surrounding the increase in Japan's consumption tax highlights the political risk overhanging the country's fiscal consolidation strategy, Fitch Ratings says.

Here's more from Fitch:

The limited scope and leisurely pace of Japan's fiscal consolidation plans in the face of high and rising public debt ratios, and the political risk attached, were key drivers of our downgrade of Japan to 'A+' in May, and are still reflected in the Negative Outlook on the rating. A successful passage of the consumption tax bill was assumed at the time of the downgrade. Fitch estimates that doubling the consumption tax to 10% would raise additional revenue equivalent to about 2.5% of GDP.

The capacity of the Japanese political system to deliver fiscal consolidation remains a key component of our ratings analysis. The sovereign continues to enjoy exceptionally strong funding conditions, with yields on 10-year Japanese government bonds of around 0.8%.

Japan's Prime Minister, Yoshihiko Noda, said Thursday that there had been an agreement with opposition parties to pass the bill (allowing the consumption tax increase) in the upper house of parliament. In exchange, he said there would be an election "soon", but rejected demands from the main opposition party to commit to a specified date.

The fierce rivalries in Japanese politics have made it difficult for the political system to deliver policies that support fiscal sustainability, despite a broad consensus on the need for fiscal consolidation. If the controversy surrounding the consumption tax increase did lead to the fall of the government and fresh elections, the added political volatility would heighten our concerns on this point.

Furthermore, the enormous fiscal challenge that Japan faces as the most indebted Fitch-rated sovereign (gross government debt was about 225% of GDP at end-2011) means that additional policy measures are needed to stabilise its public finances. Without these, the risk that the Japanese sovereign's funding strength could be undermined would increase, and the rating could be downgraded further.