Reasons for caution with Japan's unexpected GDP growth

Tokyo

JAPAN'S economy beat expectations with growth during the first quarter of the year, but a look under the hood shows that its engine is far from robust as policy makers brace for a sales tax hike in October.

Gross domestic product expanded an annualised 2.1 per cent, but the biggest driver was imports falling even faster than exports, which meant that net exports technically fuelled growth in the economy.

Declining imports is a sign of weakness in demand, so the GDP figure is somewhat misleading.

The economy's pillars of growth - exports, capital spending and private consumption - all declined during the quarter, with exports tumbling 2.4 per cent, the most since 2015. Picking up some of the slack were public spending and rising inventories, neither of which are signs of a strong economy.

Supporters of the tax hike are likely to point to the GDP figure to argue that the hike should go ahead, amid growing concern in Prime Minister Shinzo Abe's ruling party that it could derail the economy at a time of weakness.

Economy Minister Toshimitsu Motegi said on Monday that there is no change in the government's plan to raise the tax.

Another reason for caution is that the GDP figure is subject to large revisions. A 2015 study found that Japan's revisions to year-on-year growth figures were the second-largest among 18 OECD economies.

When Mr Abe decided in late 2014 to postpone the sales tax hike the first time, a preliminary GDP figure had shown the economy shrinking 1.6 per cent the previous quarter. The figure was later revised to growth of 0.3 per cent.

"The discussion about the tax hike delay might settle down," said Hiroyasu Ando, a senior economist at Sumitomo Mitsui Banking. "But when I look at the numbers closely, they are not strong. Household spending and capital investment are negative, which shows that internal demand during the quarter was sluggish. There are some worrisome factors."

While capital spending held up much better than expected during the first quarter, slowing global growth - especially in China, Japan's biggest market - and rising trade tensions have hit corporate sentiment.

"Fiscal stimulus already in the pipeline and last-minute purchases ahead of the sales-tax hike should support growth toward 2Q and 3Q. That said, the trajectory will hinge on how US protectionism and the yen's exchange rate affect Japan's exports," said Yuki Masujima, Bloomberg senior economist.

Japan's GDP is expected to grow in the second and third quarters, thanks partly to fiscal stimulus, before contracting in the fourth quarter after the sales tax hike takes effect. Economists expect private consumption - which fell 0.1 per cent in the first quarter - to pick up ahead of the tax increase. BLOOMBERG