What could the trade war do to Japan's economy?

Bank of Japan Governor Haruhiko Kuroda on Tuesday warned that escalating U.S.-China trade tensions could hurt business sentiment and inflict widespread damage on the economy.

Worries that the United States and China were digging in for a longer, costlier trade war weighed on markets, adding to headaches for policymakers in Tokyo fretting about the impact on Japan’s export-reliant economy.

“If trade tensions persist, they would have a widespread impact on global and Japanese economies via business sentiment and market developments,” Kuroda told parliament.

“We hope the United States and China engage in constructive discussions,” he said.

Other Japanese policymakers also voiced concern over damage from the trade war but maintained their view Japan’s economy was on a solid footing, signaling that Tokyo plans to proceed with a scheduled sales tax hike in October.

“We’re seeing some manufacturers delaying capital expenditure plans,” Finance Minister Taro Aso told parliament on Tuesday. “But corporate profits are high and the fundamentals supporting domestic demand remain solid.”

Chief Cabinet Secretary Yoshihide Suga said the government is already planning to take sufficient steps to mitigate the pain from the tax hike.

“We’ll do our utmost to respond to concerns over the impact” the tax hike could have on the economy, Suga told a briefing on Tuesday, suggesting that Tokyo will go ahead with it and deal with any damage to growth through additional spending.

Calls to postpone

Prime Minister Shinzo Abe has repeatedly said he would proceed with the twice-delayed tax increase to 10% from 8% in October. But some lawmakers have called for a postponement on concern it could tip Japan into recession.

Data on Monday showed Japan’s economic growth unexpectedly accelerated in January-March, though weakness in consumption and capital expenditure kept alive market speculation Abe could delay the tax hike.

Former BOJ Deputy Governor Kikuo Iwata, among architects of the premier’s “Abenomics” stimulus programs, said the gross domestic product (GDP) data looked “pretty bad.”

“Raising the sales tax when Japan has yet to pull out of deflation could cause recession,” Iwata told academics and lawmakers who met on Tuesday to discuss the potential impact of the tax increase.

Markets are focusing on the government’s monthly economic report for May, scheduled for release on Friday.

Sources have told Reuters the government is considering revising down its economic assessment. The key is whether the report will drop its view the economy is recovering, which some analysts say would be a sign the government sees growth as too weak to weather the hit from the higher levy.

A senior official of the Cabinet Office, which compiles the report, gave no hints on the assessment but said there were some weaknesses in exports and output.

“The impact of China’s (slowdown) is being felt among manufacturers,” Tomoko Hayashi, deputy director-general, told parliament. “But we don’t see domestic demand as under threat of a downturn.”