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Japan after Abe

Suga says consumption tax hike inevitable, then backtracks

Abe's likely successor confirms 'no raise necessary for 10 years'

Chief Cabinet Secretary Yoshihide Suga speaks to reporters at the Liberal Democratic Party headquarters on Sept. 8.   © Reuters

TOKYO/NEW YORK -- Chief Cabinet Secretary Yoshihide Suga, who is leading the race to become Japan's next prime minister, suggested Thursday that the nation's consumption tax needs to be raised beyond the current 10% in the future, citing the rapidly aging population.

"When we think about the future, we have no choice but to raise the rate again, after carrying out thorough administrative reforms," Suga said in an appearance on TV Tokyo. "No matter how hard we try, Japan's population is going to shrink."

This is the first time Suga, a longtime lieutenant of Prime Minister Shinzo Abe, has referred to the possibility of a consumption tax hike since the ruling Liberal Democratic Party's leadership race kicked off. He has maintained Japan must first be on the track for recovery before it improves its balance sheet.

On Friday, Suga appeared to walk back the comment. "Prime Minister Shinzo Abe said Japan does not need to raise the consumption tax rate for the next 10 years," he said at a regular news conference. "I have the same idea."

Regarding the TV Tokyo interview, he said his answer was about "a future story."

Japan is in dire fiscal straits. Long-term national and regional debt now stand at 1.1 quadrillion yen ($10.4 trillion), or twice Japan's gross domestic product. The Bank of Japan is essentially making up for the shortfalls in the government budget through purchasing large amounts of government bonds.

Japan watchers, however, do not think suggesting another tax hike is a good idea, given the nation's economy has been battered by the coronavirus.

"It's something he shouldn't even talk about, because the expectation of the hike is going to dampen consumption and investment and further slow the economy," said Robert Dekle, professor of economics at the University of Southern California. "We are in the middle of pandemic and the future is so uncertain. No industrialized country and certainly no developing country is thinking about raising taxes right now, so even the suggestion is ill-timed."

Dekle said Abe's motivation to raise the tax last year for younger people, such as free education, was a good move.

"But Suga's saying, we are going to shore up, give it to the elderly. So that's not helpful. Where the money is earmarked -- that's what got the country in trouble fiscally earlier. You don't want to go back to that."

Abe raised the then 5% consumption tax rate to 8% in April 2014, and then to 10% in October 2019. Prior to the last hike, Abe said in July last year that a hike beyond 10% "will not be necessary for the next 10 years or so."

The market wants to know how the next leader plans to grow the Japanese economy, which will also help address the nation's towering debt.

"The economy was slowing pre-COVID and the consumption tax really made it slow some more. I guess they were expecting the Olympics to lift the economy in 2020 but now that's gone," Dekle said.

"The ideal is for Japan to be able to grow without relying on fiscal or monetary policy," said Katsutoshi Inadome at Mitsubishi UFJ Morgan Stanley Securities.

As the LDP leadership race, slated for Monday, draws closer, the candidates' approaches to monetary policy are also coming under scrutiny.

Suga has signaled he would stay the course on aggressive easing under Abe -- one of the three arrows of Abenomics.

"I would like to work with the BOJ like Prime Minister Abe did," he has said. But Suga has also hinted at the possibility of further easing, saying that he would "advance monetary policy if the situation requires it."

Although Article 3 of the Bank of Japan Act says its "autonomy regarding currency and monetary control shall be respected," Article 4 urges the central bank to "always maintain close contact with the government" to ensure its policies are compatible with the government's. The BOJ issued a joint statement with the Abe administration in 2013 declaring its commitment to bringing Japan out of deflation.

"The market reacted favorably to the idea that he would keep the same monetary policies," said Yuji Saito at Credit Agricole Corporate and Investment Bank.

But market players are wary of interest rates digging deeper into negative territory, since that would make it harder for already strained financial institutions in Japan to turn a profit. When the BOJ first introduced negative rates in 2016, investors dumped banking stocks and the yen strengthened against the dollar.

"There will be a negative response if rates go lower," Saito said.

"Further easing will fuel concerns that future pensioners will receive less cash, and lead individuals to save more," said Minori Uchida at MUFG Bank.

Both of Suga's opponents have raised alarms about further easing.

"Interest rates are already in negative territory, and we know how that is impacting regional financial institutions," LDP policy research chief and former Foreign Minister Fumio Kishida said. He argued that Japan should eventually normalize its monetary policy in cooperation with the international community.

Meanwhile, former Defense Minister Shigeru Ishiba said he was worried about the BOJ's outsize influence on the stock market through large-scale purchases of exchange-traded funds. "What does it mean for the health and sustainability of the stock market for the government to play such a big role?" he said.

"Many people believe the BOJ should gradually cut back on purchasing assets," said Shuichi Osaki at Bank of America Merrill Lynch. "But that would be difficult, since it goes against the goal to raise inflation to 2%."

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