Japan’s consumption drops sharply after sales tax increase

Japan's consumer spending and production fell more than expected in response to last month's sales tax increase, raising doubts over the pace of economic recovery and highlighting the need for reforms to sustain growth once the tax shock faded.

Though the International Monetary Fund expressed its confidence on Friday that the world's third-largest economy would pick up again in the second half of the year, it stressed the need for vigorous efforts to remove barriers and clear the way for rapid growth, after nearly two decades of stagnation and deflation.

The sales tax hike formed part of an effort that included monetary and fiscal stimulus aimed at stabilising the country's stretched finances.

The hike led to a sharp spending pull back which was expected, after an earlier rush of purchases, especially of high-ticket durable items.

However, while the first quarter performance of the company exceeded expectations, thanks to strong capital investment, the subsequent drop was steeper than what economists had forecast.

According to government data released on Friday, household spending was down 4.6 per cent in April from a year ago, which beat the median market forecast for a 3.2 percent drop, which came as the fastest annual decline since March 2011, when Japan was hit by a massive earthquake, a deadly tsunami and a nuclear disaster.

Meanwhile, the International Monetary Fund in its latest assessment of Japan's recovery, said Friday that Japan seemed to be weathering the sales tax increase and exports were expected to start picking up as overseas demand rebounded. According to IMF projections inflation would remain modest at 1.1 per cent in 2014.

However, the IMF cautioned that Japan needed deep, structural reforms to support growth.

According to the IMF, near-term risks to the outlook were balanced, but the sustainability of the recovery over the medium term was at risk.

According to economists wage increases were needed to ensure the strong consumer demand that would prompt companies to begin investing more for future growth.

Labour shortage in some sectors such as construction and trucking had led to higher prices and to a limited extent higher wages. However, so far overall incomes had failed to keep pace with the tax hike and price increases.