Japan Growth Slows In Second Quarter, Adds To Sales Tax Uncertainty

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Japan's economy grew at a slower-than-expected rate in the second quarter, offering ammunition to those seeking to delay a scheduled sales tax increase even as government debt has risen past 1,000 trillion yen ($10.4 trillion).

A Japanese flag flutters in front of a shipping container area, at a port in Tokyo

Japan's economy grew at a slower-than-expected rate in the second quarter, offering ammunition to those seeking to delay a scheduled sales tax increase even as government debt has risen past 1,000 trillion yen ($10.4 trillion).

Capital expenditure unexpectedly fell for a sixth straight quarter, a sign that companies are yet to boost spending despite the feel-good mood generated by Prime Minister Shinzo Abe's reflationary policies over the first half of 2013.

The world's third-largest economy grew an annualized 2.6 percent in April-June, a third straight quarter of expansion but below both a forecast of 3.6 percent growth and a downwardly revised 3.8 percent rate in the first quarter.

"Private consumption came out stronger than expected but capital spending and inventory disappointed," said Takeshi Minami, chief economist at Norinchukin Research Institute.

"Growth above 2 percent is still considered high, so it wouldn't lead to a complete postponement of the sales tax hike. But the government could make tax hikes more incremental, without delaying the timing."

The Nikkei 225 share average fell to a six-week low on the weaker than expected data, with analysts saying confidence was hit by the combination of weak capital spending and the expected sales tax increase affecting consumption.

Abe was elected last December on a platform of aggressive fiscal and monetary stimulus to revive Japan's economy.

An immediate impact of 'Abenomics' was a sharp weakening of the yen, a surge in share prices and exceptionally strong personal consumption in early 2013, but there are questions over his commitment to the third leg - structural reform.

As part of efforts to curb its debt, which is about double the size of its GDP, Japan is due to raise its 5 percent sales tax rate to 8 percent next April and then to 10 percent in October 2015

Public debt exceeded 1 quadrillion yen -- or 1,000 trillion yen -- for the first time in June, Finance Ministry data shows, highlighting the need for higher taxes or other new revenue.

But the GDP data may weaken the case for the tax hike, and sources have said Abe is worried it may dampen spending and delay Japan's escape from 15 year of deflation.

"Growth is lower than I expected, so you cannot say that the conditions are appropriate to raise taxes as scheduled," Etsuro Honda, a professor at Shizuoka University and an influential adviser to Abe, told Reuters.

STRONG SPENDING, WEAK INVESTMENT

On a quarter-to-quarter basis, Japan's economy grew 0.6 percent in April-June, data released by the Cabinet Office showed on Monday. External demand added 0.2 percentage point to growth, while domestic demand contributed 0.5 point.

Private consumption rose 0.8 percent from the March quarter, more than a median market forecast of a 0.5 percent increase, on robust spending on food, travel and consumer electronics.

But capital expenditure slid 0.1 percent, much weaker than a median market forecast for a 0.7 percent increase and marking the sixth straight quarter of decline.

"The economy has been steadily rising since inauguration of the Abe administration last year," Abe told reporters.

"I'll continue to take all possible care about the economy. I'd like to focus on the economy, including implementation of further growth strategies in the autumn."

Government officials have said the preliminary GDP data and revised figures due on September 9 would be key factors in the tax debate, with a final decision possible by early October.

Critics of the planned two-stage tax hike are calling for a delay or at least a more moderate pace of increase.

Honda has repeatedly said he favors raising the sales tax by 1 percent per year and that he is worried about Japan's progress in escaping 15 years of mild deflation.

But Bank of Japan Governor Haruhiko Kuroda has said the tax hikes are needed and would not hurt the economy. Kuroda has also said Japan can raise taxes and still escape deflation.

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