Consumption has been on rise in Japan and, despite tax-impacted Q2 GDP fall, economists remain confident about underlying prospects

Consumption has been on rise in Japan and, despite tax-impacted Q2 GDP fall, economists remain confident about underlying prospects

After decades of stagnation, Japan's economy appears to be stirring. This week, Japan reported a slump in its GDP in the second quarter of the year. However, a hike in sales tax hit consumption and economists believe Japan's recovery will resume in the back half of 2014, with the jobs market improving. However, demographic and cultural shifts could have significant implications on consumption for the food sector. Katy Askew reports.

The meteoric rise of Japan as an economic powerhouse in the post-war years made the nation one of the most attractive markets in Asia. Then came "the lost two decades" after the Japanese asset price bubble collapse in 1991 when the strong growth witnessed in the second half of the 20th century ended abruptly. These years were characterised by shrinking GDP, falling real wages, depressed spending and chronic deflation.

Japan's regulators are now grappling with the task of breathing fresh life into the economy. Since 2012, under Prime Minister Shinzo Abe and his Liberal Democratic Party, the Japanese government has implemented a series of economic policies based on the "three arrows" of fiscal stimulus, monetary easing and structural reforms.

A JPY10.3bn stimulus package designed to kick-start the economy has seen regulators expand public investment. The Bank of Japan acquiesced to a significant asset purchase programme and targeted a 2% annual inflation rate in two years through quantitative easing. Measures have been taken to correct the excessive appreciation of the yen and negative interest rates have been set.

Structural transformations have taken more time to implement but progress has been made.

In June, the Abe government unveiled the third arrow of structural reform. Measures included lowering the effective corporate tax rate to a range of 20-30%, diverting a larger portion of the Government Pension Investment Fund to equity investment, bringing more women into the workforce and reforming regulations in agriculture, employment and medical services.

The Abe administration moved to liberalise international trade in agricultural commodities as it looks to cut the hefty subsidiaries handed out to farmers.

In particular, regulators have targeted the Central Union of Agricultural Co-operatives (JA-Zenchu) as an obstacle to the growth of the nation's farm industry. However, JA-Zenchu is a powerful lobby group with close links to Japan's political elite. Proposed reform measures have taken something of a softly, softly approach as a result, calling on JA-Zenchu to "voluntarily transform itself into a new system" that allows local farm co-operatives to operate with greater autonomy and urges that efforts for voluntary reform be made within five years.

The jury is still out on whether Abe's three arrows will succeed.

One closely watched area is the inflation rate, which dipped to 1.3% in June - down from 1.4% in May. That prompted some concern the BoJ will struggle to meet its 2% target. Price increases for imports, triggered by the devaluation of the yen, have now filtered through the economy and are no longer supporting inflation.

However, consumer spending power is another area proving cause for concern.

In April, Tokyo followed through with the first of two planned consumption tax hikes, raising the rate from 5% to 8%. The second increase, scheduled for October 2015, would increase the rate to 10%.

The rise is necessary to boost tax revenue in order to support the elevated levels of government spending underpinning the fiscal stimulus and tame the country's massive national debt, which is currently twice the size of GDP.

Today, Japan reported a 6.8% annualised fall in its GDP in the second quarter - the biggest since 2011 when the economy was hit by the earthquake and tsunami that ravaged parts of the country.

In raising consumption taxes, the fear has been that consumer spending will be hit and growth retarded. When the consumption tax was increased from 3% to 5% in 1997, it tipped a recovering Japanese economy back into recession.

According to figures from the Cabinet Office, consumer spending increased to JPY322trn in the first quarter of 2014, from JPY315trn in the fourth quarter of 2013. Between 1994 and 2014 Japanese consumer spending averaged JPY286trn.

However, the impact of the consumer tax hike has been seen in recent months. Retail sales inched up 0.4% in June, slower than the 4.6% increase seen in May. And today's GDP figures provided a fuller picture of the impact of the tax hike.

However, economists had expected GDP to fall 7.1% and there is optimism among economists that the effect of the tax hike will fade.

A significant positive for growth is an improving jobs market - suggesting Japanese employers are growing in confidence and upping investment in their workforces.

Recent official data showed that Japan's unemployment rate edged up to 3.7% in June, down from the near 17-year low of 3.5% in May. But the ratio of job offers to job seekers sat at a 22-year high of 1.1, meaning there has been an increase in the number of job offers being issued and suggesting more people have started looking for work as the jobs market has improved.

Central to the rise in people seeking employment is a government-backed drive to grow female participation in the workforce. The number of working-age women employed rose by 1.7% on the year in June, according to the government figures, bringing female participation in the workforce to a high of 64%.

A traditionally male-centric corporate culture, long and inflexible working hours, insufficient childcare and nursing support and rigid immigration laws all stood as barriers to women entering and remaining in work.

As a result, according to the World Bank, Japan's female participation rate in the workforce is the second-lowest among the G7 advanced economies. When women have their first child, 70% of them stop working for a decade or more, compared with 30% of women in the US.

In a significant policy shift, the Abe government has called on Japanese businesses to increase the percentage of women in management positions to 30% by 2020 from the current level of 10%. It has also proposed a revision of the tax and social security system that will work in favour of women in paid employment.

According to a research report from Goldman Sachs, raising Japan's growth outlook could well be dependent on the country's ability to get more women into work. "If Japan could close its gender employment gap, we estimate Japan's workforce could expand by 8.2m and the level of Japan's GDP could increase by as much as 15%," the analysts note.

Increasing female employment would also enable Japan to offset one of the largest challenges it faces: its ageing population and declining birth rate, which means ITS working-age population is expected to fall by 40% by 2050. "Given Japan's acute demographic crisis, we believe the nation cannot afford to waste its most under-utilised asset," Goldman Sachs says.

A shrinking, ageing population where more women are economically active is likely to have some implications for food consumption in the country.

We can expect to see further demand growth for convenient products such as ready to eat, frozen and shelf stable foods. Functional foods with specified health benefits are also an area witnessing expanding sales. With over a fifth of Japanese consumers already over the age of 65, foods with positive nutrition messages strike an important chord. Inversely, demand for products such as baby food look set to fall.

Broadly, then, Japan's economy is showing signs of recovery, even after a challenging second quarter. Of course, how much the economy will rebound in the third quarter remains to be seen and the second planned increase to the consumption tax rate is one of the key reasons why the IMF expects Japan's growth trajectory to slow in 2015.

"One of the factors which is going to lead to lower growth we think is the increase in the consumption tax, which is going to come at the end of the year, showing the difficulty of taking measures to make debt sustainable while maintaining growth," IMF chief economist Olivier Blanchard says.

Pime Minister Abe may find himself in a position to cancel the planned tax hike.