Japan's Economy Shrinks as Taxes Hit Home

Some analysts see the contraction reported yesterday as an aberration that won't stop recovery.

Japan's economy contracted at an annual rate of 11.2 percent in this year's second quarter, the government said yesterday.

Officials and analysts, however, saw the shrinkage as an unusual occurrence, linked to a tax rise that caused consumers to reduce purchases, and not a sign that Japan's economic recovery was in trouble.

The fall in real gross domestic product in the April-June quarter was a sharp turnaround from January-March, when GDP grew at a 6.6 percent annual rate.

This was the first quarterly contraction in a year and the sharpest drop since 1974, when Japan's economy was reeling from the first Middle East oil shock.

An April 1 increase in Japan's sales tax to 5 percent from 3 percent was the biggest factor weighing on the economy during the period, says Shimpei Nukaya, deputy director of the Economic Planning Agency, which released the data. The government also terminated $17 billion worth of special income-tax cuts, which had been in place for two years.

Mr. Nukaya says that despite the second-quarter figures, Japan's economic recovery continues and will gather momentum in the second half of the year.

"Although the recovery has slowed, the overall picture hasn't changed," he says.

But he concedes that the decline was larger than expected and that it will be difficult to achieve the official government GDP growth rate forecast of 1.9 percent for the fiscal year ending March 31, 1998.

Reflecting the tax increase, private consumption fell 5.7 percent from the previous quarter.

'THIS is a temporary development. It's extremely unlikely we'll see another 5.7 percent drop in personal consumption," says Andrew Shipley, an economist at Schroders Japan.

"I don't think the back of the recovery has been broken," he says.

A 4.6 percent rise in private consumption had been the main engine behind the first quarter's performance, as consumers rushed to buy goods before the tax increases.

Exports were a bright spot in the second quarter, growing 6.4 percent for the period, much faster than the 0.7 percent increase in the first quarter. Imports were down 2.0 percent.

Japan's current-account surplus came to 2.6 percent of GDP in the period.

A ratio of 2.5 percent is widely seen as an upper limit for containing trade friction with the United States, which has said Japan is trying to export its way out of recession while failing to ease barriers to foreign products.

"The ratio will definitely raise the issue of Japan's trade surplus" at the meeting of the Group of Seven industrial nations next week in Hong Kong, says Akiyoshi Takumori, senior economist at Sakura Securities. Japan's trade and current-account surpluses have risen four months in a row.