Japan regulation: Taxing tactics

Japane se supermarket chain Seiyuexhibits a curious rallying cry to customers on its website: a muscle-bound manga character with burning eyes calls upon shoppers "not to give in to the consumer tax raise," while a banner message in Japanese cries out "Shop with courage!"

On April 1, the Japanese government increased the consumption tax from 5% to 8%, the first hike in 17 years. It will rise again, to 10%, in October next year. Seiyu is one of a number of retailers encouraging customers to buy in bulk ahead of the next stage in the tax hike - imploring them to stock up on a one-month supply of chocolate bars or three months' worth of instant noodles before shops start raising prices.

While in the short-term some companies are looking to make the best of the situation many anticipate a slowdown in spending.

Across the board, Japan's consumer-focused businesses are bracing themselves for the pinch and private equity portfolio companies operating in this sector are no exception. The logic goes that a drop in consumer spending will have a negative impact on balance sheets and consequently impact investor appetite in the sector. But is this necessarily the case?

"The tax is an inevitable measure as there is a need to reform the Japanese government's fiscal structure," says Satoru Arakawa, a partner with local mid-market buyout firm J-Star. "It is too early to say what the effect will be, we have to wait several months. If anything the impact so far has been that consumers have been on a shopping spree ahead of prices going up."

According to AVCJ Research, consumer-related companies have accounted for a fairly significant portion of private equity investment in Japan over the past few years.

Of the 2,404 PE and VC deals announced since the beginning of 2008, 562 have been in consumer-related sectors. Among buyouts alone, the consumer portion is much higher - accounting for one third (75) of the 230 buyouts to take place during the period.

Several of the largest transactions seen in Japan in recent years have focused on the sector, including: Bain Capital's acquisition of a 50% a stake in Jupiter Shopping Channel for JPY85 billion (just over a $1billion in June 2012); Permira's acquisition of a majority stake in sushi chain Akindo Sushiro for $1 billion; and, more recently, MBK Partners' JPY43 billion purchase of restaurant chain Komeda Coffee.

Fears that the tax will have an adverse impact on these consumers businesses, or could even derail the country's fragile economy recovery, are by no means unfounded. The consumption tax was first introduced at rate of 3% in 1989. The only previous increase - to 5% - was in 1997.

"If you look back to 1997 it was a very similar story to today," says Jonathan Stuart-Smith, Asia Pacific Leader with Ernst & Young's global tax network. "Back then the economy was starting to recover from a previous slump, but when the consumption tax increase came in, it was widely blamed for causing the slump into recession thereafter."

Recovery plans

However, it could equally be argued that the tax hike should be viewed in the context of economic reforms taking place in Japan.

It is part of the broader "Abenomics" policy package - Prime Minister Shinzo Abe's three-pronged strategy comprising monetary, fiscal and structural measures. Together they aim to tackle Japan's three economic problems of slow growth, deflation and a dependence on deficit spending. The hope is that the extra revenue generated by the consumer tax increase will help the government tackle its mountainous public debt, which currently stands at 240% of GDP.

"The consumer tax will probably lead to an increase in the nominal and real inflation rate, which would be supportive to the Bank of Japan's current policy," says Joji Takeuchi, CEO of Tokyo-based consultancy Brighttrust. "That is unless weaker demand pushes down pre-tax prices of goods and services in the next few months."

Even if the economy is able to absorb the impact of the hike, there is still a question mark over whether consumers and businesses could stomach that further scheduled increase to 10%. Ernst & Young's Stuart-Smith explains that currently there is a get-out clause: if the economy stutters the move can be deferred. Abe is due to make a decision at the end of this year.

"Next year will be problematic," reflects J-Star's Arakawa "We should check for real consumer spending recovery before accepting another tax increase."

A lot of the spending recovery will depend on the success of other policy objectives, chief among them a push to increase wages. According to Japan's Ministry of Health, Labor & Welfare, the average wage has dropped 15% over the past 15 years. In the 11 months through November 2013, it rose only 0.2%, while base wages fell for the 19th consecutive month last December. At the same time, real household income also fell 1.7% year-on-year in December.

"If people's expectation for stable growth is positive, then the additional 2% hike is less of a concern," says Tatsuo Kawasaki, co-founder of Unison Capital. "But if the government pushes for the hike without any tangible growth prospect or stability in the economic outlook then you can only wonder what might happen."

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• Topics
• North Asia
• Regulation
• Consumer
• Buyouts
• buyout
• Consumer
• Japan
• regulation
• tax
• J-Star
• Unison Capital