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Abe's decision to delay sales tax hike aimed at averting further economic downturn

Prime Minister Shinzo Abe has decided to again delay a consumption tax hike set for next April in a bid to prevent the planned tax increase from causing consumer spending to drop and putting downward pressure on the overall economy.

Abe's decision comes at a time when the government is still fighting an uphill battle to ensure a favorable economic cycle and pull the economy out of chronic deflation. But some experts have started to point out that the effectiveness of so-called "Abenomics" -- economic stimulus policy measures pursued by Abe's government -- is reaching its limits. Therefore, Prime Minister Abe will be tested on whether he will be able to smooth out conditions for raising the consumption tax again in the future.

"I frankly think that it is certain that consumer spending is not increasing," said Finance Minister Taro Aso at a news conference after a Cabinet meeting on May 31. He was referring to the background in which Prime Minister Abe decided to postpone the planned consumption tax hike by 2 percentage points to 10 percent for 2 1/2 years. The Internal Affairs and Communications Ministry announced on the same day that inflation-adjusted consumer spending by households with at least two persons per family in April dropped 0.4 percent in real terms from a year earlier. Consumer spending has remained stagnant at the level seen before last-minute demand emerged ahead of the previous sales tax hike to 8 percent in April 2014. Prolonged sluggish consumer spending has become one of the biggest factors blocking the Japanese economy from pulling itself out of a standstill.

According to an estimate by the Bank of Japan (BOJ), when the consumption tax was raised to 8 percent from 5 percent in April 2014, last-minute demand pushed up gross domestic product (GDP) in real terms for fiscal 2013 by 0.8 of a point, while the tax increase would push down GDP in real terms for fiscal 2014 by 1.3 points due to the aftereffects of last-minute demand and the increased tax burden on households. If the consumption tax were to be raised in April 2017, last-minute demand would boost GDP by 0.4 of a point in fiscal 2016, while the tax increase would shrink GDP for fiscal 2017 by 0.6 of a point, according to the BOJ estimate. In that case, Japan's economy is forecast to grow at 0.1 percent in fiscal 2017, sharply down from an estimated 1.2 percent in fiscal 2016.

On the other hand, if the consumption tax hike is to be postponed until October 2019, many experts believe that the economy will continue to recover moderately. SMBC Nikko Securities Inc. predicts that the Japanese economy will grow at 0.7 percent in fiscal 2016 and 0.9 percent in fiscal 2017. It is predicting that the economy will keep expanding albeit slowly. Hiroshi Watanabe, senior economist at SMBC Nikko Securities, said, "There will be no aftereffects of last-minute demand as the tax increase has been postponed, so we can expect an economic recovery in line with an increase in income."

Nonetheless, although "Abenomics" helped businesses significantly improve their earnings by driving down the value of the yen and pushing up share prices through fiscal spending and large-scale monetary easing, a favorable economic cycle has not been achieved as income growth has remained sluggish. Abe's latest decision to postpone the consumption tax hike would avert temporary negative factors, but the effectiveness of the move itself in boosting consumption is limited. Mitsumaru Kumagai, chief economist at Daiwa Institute of Research, said, "Worries about future pensions and concerns about fiscal conditions are also factors behind sluggish consumption. The postponement of the consumption tax hike can support short-term consumption, but it will not be a fundamental solution."

While the government is to consider an economic package including measures to stimulate consumer spending, the BOJ is expected to try to prop up the economy by exploring the possibility of further easing monetary policy, among other steps. But the government will be tested on whether it will be in fact able to pull the economy out of deflation and boost the economy by using the time it buys through the postponement of the consumption tax hike.

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