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Opinion

Japan sees sales tax increase as chance to boost cashless society

Rakuten and Line already big e-money players, but Tokyo wants broader adoption

A consumer scans QR code to pay at a octopus dumpling shop in Tokyo: it is too early to say whether the Japanese public will switch to e-money. (Photo by Arisa Moriyama)

When the Japanese government increases the sales tax from 8% to 10% on October 1, it will not just be an attempt to raise revenue and cut the country's deficit. It is also, the government thinks, a perfect opportunity to drive Japan toward becoming a cashless society.

At the moment, cash is king. Japanese people walk around with thick wallets sticking out of their back pockets or leave them on tables in coffee shops while waiting in line for a cup of latte. Counterfeiting of Japanese bank notes is extremely rare, the national mint says, and Japanese households hold more than half their assets in cash and deposits.

But the government wants greater adoption of cashless payments because it sees the development of modern financial tools as essential for Japan to embrace the fourth industrial revolution of artificial intelligence, robotics and more. There are also practical reasons such as being able to track the flow of money more efficiently.

It has laid the groundwork. In 2017, the Ministry of Economy, Trade and Industry published a fintech policy paper identifying three targets, including raising the cashless payments ratio from just over 18% in 2017 to 40% by 2027.

The impetus from METI, combined with the 2017 revision to the Banking Act supporting the deployment of "open banking," has prompted the development of electronic payment systems so that dozens of different systems now vie for space on Japanese users' smartphones.

The sales tax is the next stage. Given the risk of people curtailing their spending -- the last sales tax increase pushed the country into a recession -- METI has adopted, among its countermeasures, a nine-month long campaign to give consumers refunds, in the form of points, if they shop at one of half a million selected stores using one of the 40 approved electronic money payment systems.

Consumers can receive a refund of either 2% or 5%, depending on where they shop, to the e-money app they used for their purchases, thus in some cases benefiting more than the actual sales tax increase. This implicitly subsidizes the widespread adoption of cashless payments in Japan.

This is a huge boost for the e-payments industry, but determining the winners is unclear. On the one hand, the traditional financial services companies, already issuing credit cards, have been somewhat slow in experimenting with new forms of electronic payments.

In March 2019, Mizuho Financial Group launched J-Coin Pay, a QR-code based payment system, with 60 other financial institutions, although user adoption seems slow, and Mitsubishi UFJ Financial Group has been developing a blockchain based electronic currency for years, which it finally plans to release in the latter part of 2019.

On the other hand, technology companies such as Rakuten, Yahoo Japan and Messaging app operator Line have been very aggressive in promoting their e-money payment apps, which provide additional benefits such as loyalty points and discounts when used for transaction within their e-commerce sites.

The government's support of wider e-money adoption is a golden opportunity for technology companies' aspirations to capture a big slice of Japanese consumers' wallet. E-money is the ideal first point of contact for a company to establish a financial services relationship that can be leveraged over time into higher-margin financial products.

The likes of Rakuten and Yahoo Japan can much more easily pivot into broad financial services thanks to their wealth of data on spending habits and personal interests, their predisposition to new technologies such as AI and the government's support.

Clearly this pivot will require larger investments in financial services-specific infrastructure, such as compliance and reporting, but you can make a strong case that the technology companies, free from the banks' expensive legacy computer systems, will be able to gain market share, particularly among the most cost-conscious, younger and tech-savvy consumers.

Consumers can look forward to a superior, seamless experience when paying with e-money as well as being offered several benefits, such as additional loyalty points, discounts and customized offers. However, data privacy and potential hacks are a concern that the industry would need to address.

Japanese financial services companies can mitigate this threat in several ways and are not standing still, albeit their action is so far rather timid. First and foremost, Japanese banks must move ahead in their digitization efforts more aggressively. Secondly, banks must continue to collaborate with, and invest in, fintech startups to gain a better understanding of cutting-edge technologies.

Lastly, Japanese banks enjoy a very strong domestic reputation and customers' trust which, together with an aggressive pricing strategy, could be leveraged into differentiating their product offering and defending their market share.

Seven-Eleven Japan decided to shut down its 7Pay mobile payment service over widespread theft. (Photo by Keiichiro Sato)

Nevertheless, the frenzy of launching e-money payment systems has not been painless. 7Pay, the payment system backed by Seven & i Holdings, the parent company of ubiquitous convenience store chain Seven-Eleven Japan, suffered a major hack shortly after its launch in July 2019 and the company subsequently decided to shut down the service.

Mizuho discovered a hack into its J-Coin Pay's test system on August 27 affecting the data of thousands of users and participating stores.

It is still too early to say whether the Japanese public will truly switch to e-money and if the technology companies will be able to move into providing more financial services through their e-money apps. If it works, consumers can look forward to carrying around considerably thinner wallets in the near future.

Maurizio Raffone is CEO of Finetiq, a management consulting business focused on the fintech industry and active in Japan and Hong Kong.

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