Japanese income tax cut sends surge through Asian markets

Spurred by accusations that Japan was doing too little, too late, to put its economic house in order, the government yesterday announced an unexpected $15.7bn cut in personal income taxes. Stephen Vines in Hong Kong examines whether the package will succeed in stimulating the economy.

The announcement, made by Ryutaro Hashimoto, the Prime Minister, created a surge of enthusiasm in Japan's financial markets which quickly spread to other markets throughout Asia.

"I have decided to carry out a special income tax cut as an emergency measure," said Mr Hashimoto, adding, "I think these steps will make the economic recovery trend stronger".

Japan has yielded to both local and international pressure to take measures which will stimulate domestic demand and put new life into the languishing economy. This has meant relaxing the Hashimoto government's commitment to tight monetary policy.

The previous day the government had launched a trial balloon, indicating that the tax cuts would be far lower but the response was dismal.

Investor response was rapid. The Nikkei 225 share index surged by more than 5 per cent but fell back to a 3.6 per cent rise by the time trading closed. The tax cut also gave an impetus to the Japanese yen, which closed at Y127 to the US dollar, a gain of almost 4 per cent. Traders believe that some of this rise can be explained by Japanese central bank intervention in the market.

Although investors have registered their backing for the loosening of the monetary reins, it is far from clear whether this move will provide the required economic stimulus. "The potential impact on the economy is fairly limited," said Goldman Sachs chief economist Tetsufumi Yamakawa. "It is unlikely to be spent for consumption. It is more likely to go for saving."

These doubts were largely cast aside in other Asian markets which are starved of positive news and will grab any that comes along.

The Malaysian, Philippines and Singaporean currencies were lifted from lows hit earlier in the week. Other Asian currencies, notably the new Taiwan dollar, made gains. It appears that central banks across the region took the signal from Tokyo as an opportunity to help along the timid upsurge of confidence by intervening in the foreign exchange markets to bolster their currencies.

The only weakness was seen in South Korea, where the won fell after a two-day rally. The Seoul stock market was also weaker as investors waited cautiously for the results of today's presidential election. All three candidates are theoretically committed to implementing the International Monetary Fund's tough demands for its rescue package. However, they have, to varying degrees, also made pledges on the economy which can only be fulfilled by defying the IMF.