The bond market has been shaken by the proposal of Japanese Prime Minister Sanae Takaichi to suspend sales tax on foods. This is because she does not have a clear plan for funding and may push fiscal policies in a more expansive direction.
Sales tax cut raises funding questions
Takaichi proposed a suspension of the sales taxes on food and drinks for two years. The measure is expected to cost around Y=5 trillion (US$31.6 billion) annually, according to Japan’s Finance Ministry.
This figure is just a little less than the total amount spent by Japan on education, culture, and science combined.
Analysts say that while Takaichi said the cut will be implemented without the issuance of additional government bonds to cover the deficit, it is still unclear how the shortfall will be financed.
In a Bloomberg article, Ataru Okumura said that it is highly uncertain whether the consumption-tax cut can be implemented with out relying on government bonds.
Analysts also doubt if the measure is truly temporary.
Many believe that restoring the tax will be difficult politically, as there is a general election in 2028.
The proposal was made on Monday, as Takaichi sought to bolster voter support before the lower-house elections scheduled for February 8, where inflation is expected be a major issue.
Bond market reacts strongly
Investor concerns are already reflected on the government bond markets.
The yield on Japan’s government bonds with a maturity of 40 years hit 4% Tuesday, the highest since the maturity was introduced to the market in 2007. This is the first time that a Japanese sovereign yield has reached this level in over three decades.
The yields across the curve increased sharply. The 10-year yield climbed above 2.3% and reached its highest level since 1999. The 20-year yield jumped to around 3.35%.
Takuya HOSHINO, chief economist of Dai-ichi Life Research Institute, said that markets are becoming more aware of fiscal expansion.
“They find it harder to purchase when they are worried about the possibility of an acceleration in fiscal policy expansion going forward.”
Masahiko loo, senior fixed-income strategist at State Street Investment Management said in a CNBC article that “Ultra long JGB yields have been pushed higher by not only the structural supply-demand deficit but also a new re-pricing term and risk premium, as markets absorb an expansionary fiscal stance, and persistent inflation.”
He said, “This has revived a classic Takaichi trade dynamic of stronger Nikkei and weaker JGBs, yen, and JGBs.”
Debate on fiscal room during elections
Takaichi supporters claim that Japan has more fiscal room than in the past because inflation has boosted nominal growth and reduced the debt-to GDP ratio.
Takaichi stated that her goal is to increase tax revenues without increasing tax rates by promoting the economic growth.
Okumura estimates that the inflation has already increased tax revenues, and that this boost is more than Y=2 billion per year.
Higher interest rates would increase government debt servicing costs by about Y=2 trillion. This would leave only a small net gain.
Okumura said that “new funding sources are needed, or else the majority of the funding would have to be reliant on new government bonds.”
Minoru Kiuchi, Japan’s Growth Strategy minister, sought to calm the markets on Tuesday by saying that the administration will keep fiscal discipline in mind.
He said: “We will continue to monitor market movements with a strong sense of urgency.” “We will continue to work hard to maintain the market’s trust.”
Opposition parties continue to push for looser policies.
The largest opposition group in Japan is calling for the permanent elimination of food sales tax. The Centrist Reform Alliance floated the idea of funding the reduction through a sovereign fund, but details are still unclear.
Investors are bracing themselves for more volatility as they assess whether Japan has entered a more aggressive fiscal phase. Takaichi is set to dissolve the parliament and run a campaign on economic policies.
This post Japan bond rates jump as Takaichi’s sales tax reduction plan raises fiscal concerns may be modified based on updates.
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