In the last two quarters, the economy of Japan has been recovering gradually from a shock induced by the tax hike that Shinzo Abe implemented in April 2014. The disturbance was intense, slashing annual growth rates by more than three percentage points, from 2.1 percent to a bottom of -1.4 percent. But shortly after the turbulence, quarter on quarter growth resumed, mainly driven by private consumption and exports, which registered two consecutive quarters of positive growth.

However, improvements did not take place smoothly throughout the Japanese economy. Investment growth, severely damaged in the same period, kept declining in the two quarters following the implementation of the measure. Overall, in the last quarter of 2014, GDP growth rose to -0.7 percent yearly (1.5 percent quarterly annualized), a considerable improvement taking into account the drawback that the increased taxation represented.

Other indicators suggest a moderately positive short-term outlook, with some uncertainties ahead. Hard indicators linked to consumption performed poorly in January, and pose a threat to the consumption and export-based recovery of Japan. Household expenditure annual growth, for instance, declined further in January (-2.9 percent), as well as retail sales (-2.0 percent). The bad performance of these indicators in the beginning of the year coincided with a timid pickup in unemployment — albeit at very low levels — of 0.2 percentage points, which may have had an impact in the gauges. Moreover, the fact that real wages have been in contraction for almost two years gives an idea of the underlying vulnerabilities of consumption in Japan as a source of growth, and suggests that weakness of the readings of the beginning of the year may not be temporary. Nonetheless, there are signs of blossoming in some sectors of the economy.

Industrial production has recovered from the harmful effects of taxation, from a reading of 95.0 to 102.6, although still lower than a year ago. The positive readings of the industrial sector are supported by the manufacturing PMI numbers, which remained above the 50 no-change threshold in January and February 2015, and with its output subcomponent registering high levels of growth. The depreciation of the yen is also sustaining Japanese industry by fostering external demand, as the gradual improvement of the current account balance and the growing contribution of net exports to GDP show.

Wrapping up, the fragility of the Japanese economy lies in its households, rather than in its corporate and industrial sectors. The Prime Minister Shinzo Abe already urged companies to increase employee compensation in order to address this fundamental threat to consumption, and avoid spillovers to the industrial sector. Additionally, the decision of Japan’s executive to postpone the second tax hike by 18 months, originally scheduled in October 2015, rules out another shock in the short term and postpones consolidation efforts, suggesting that government expenditure will not be a drag for the time being. The Economy Watchers Survey of Japan reflected the current vulnerability of households in the latest releases of January and February, however, it also signaled an improvement of conditions.

The delay of the tax hike, expectations of higher employee compensation and the affordability of fuel prices are likely to have a positive impact to the economy. If expectations materialize, and reforms beyond agriculture are implemented gradually and timely — mainly in the labor market, corporate governance and energy, in order to reanimate investment — the road that Japan has been following will keep leading to recovery in the quarters to come.

— Jordi Rof is economist at Asiya Investments.