Japan's 2019 budget deficit to worsen to 3.8% of GDP as consumption takes hit

Consumers will face higher taxes by October 2019.

Japan’s budget deficit is forecasted to reach 3.8% of gross domestic product (GDP) in 2019 compared to 3.7% in 2018 on the back of the government’s additional fiscal measures such as a planned consumption tax hike from 8% to 10%, according to report by Fitch Solutions.

The consumption tax hike scheduled for October 2019 is said to likely create economic distortions for Japan as consumers typically frontload their purchases prior to the hike before being affected by a loss in purchasing power thereafter, the report stated.

“Japanese prime minister Shinzo Abe announced in Q3 2018 that Japan will increase the value-added tax (VAT) to 10% from 8% in October 2019 in order to finance the rise in social security costs due to the ageing population and public works spending due to rising incidents of natural disasters,” Fitch Solutions highlighted in its report.

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The higher VAT is projected to weight on private consumption and economic growth as real income drops.

A supplementary budget worth US$17.63m (JPY2t) or 0.36% of GDP for FY19/20 was announced to balance the negative effects of the tax hike. As a result, consumers will get 5% rebates for some cashless payments at smaller businesses, whilst shopping vouchers will be issued for low income households.

“Combined with free pre-school policy and the exemption of the tax hike for food, we expect these measures to weaken the downside impact on consumers and retailers, preventing the economy from falling into recession,” Fitch Solutions said.

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Whilst Inflation is also expected to pick up, it is unlikely to spike up as various fiscal measures should cap upward price pressures. “We have also observed that global inflation trends in developed markets have been structurally lower in recent years partially caused by the urbanisation of the economy which may be one of the factors that has kept prices low in order for businesses to maintain their sales volumes,” Fitch Solutions highlighted.

Politically speaking, Japanese policymakers, especially Japan’s ruling Liberal Democratic Party (LDP), are expected to face increasing challenges going into 2019 against the backdrop of a slowing growth, tighter monetary policy and elevated risks.

“It is likely that the opposition parties will use the consumption tax as a main point of contention during the campaign,” the firm noted.

Overall, the target of achieving a budget surplus before 2025 somewhat falls in the background and may potentially be delayed as extra revenues are used for spending.