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WEEKLY ECONOMIC REVIEW

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The Japanese stock market continues its dramatic slide as fears of a downturn in economic activity intensify. Cons...
The Japanese stock market continues its dramatic slide as fears of a downturn in economic activity intensify. Consumer spending growth has been disappointing, and investors have taken fright following the government's announcement last month of a restrictive budget for fiscal 1997.

(Although investors have known that there would be a tightening since last Summer). Tightening comes from three main sources:

The ending of the FY94 income tax rebate. A rise in consumption tax from 3% to 5%. Cutbacks in public investment.

The proposed tax increases are equivalent to about 1.5% of GDP, and the consensus now expects GDP growth to be rather less than the government's 1.9% target for the fiscal year to March 1998.

In the event the Japanese consumer may prove surprisingly resilient to this fiscal tightening. However, this would not be evident in official economic data until well into the second quarter, and in the meantime Japanese policy makers will find it difficult to counter investor pessimism.

The health of the public sector remains a major dilemma for the government. If spending financed through the Fiscal Investment Loans Programme is included, the budget deficit is currently running at around 7% of GDP, while public sector debt continues to balloon.

The main risk for the government is that this year's fiscal tightening exacerbates this problem by weakening economic activity still further.

Currency depreciation is also proving a problem for the government. A competitive devaluation is one of the only economic tools now available to a government unable to reduce interest rates policy any further.

However, this policy runs the risk of raising tensions with the US if it causes Japan's trade surplus to widen, and is also likely to further detract foreign investment. Hence official attempts to talk up the yen earlier this week.

In the longer term economic growth should benefit from the building momentum towards financial deregulation in Japan. However, for the time-being the prospect of tougher competition in many sectors has added to the bleak outlook for the equity market.

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