Japan PM calls snap election, delays sales tax hike

Japanese Prime Minister Shinzo Abe called a snap election on Tuesday, and announced a delay in the second sales tax hike by 18 months after the country fell into recession.

The move comes after growth numbers on Monday showed the world's third-largest economy shrunk by an annualized 1.6 percent in the third quarter after a 7.3 percent contraction in the second quarter, shocking the markets.

"I have decided not to raise the consumption tax to 10 percent next October and I have decided to delay a consumption tax hike for 18 months," Abe said at a press conference.

Kazuhiro Nogi | AFP | Getty Images

Japan has suffered since the first consumption tax hike from 5 to 8 percent in April. Abe said the rise in the sales tax "acted as a heavy weight and offset a rise in consumption". A second consumption tax hike was set for October 2015 which would have seen a 2 percent increase to 10 percent.

Snap elections

Abe also said the lower house of parliament would be dissolved on November 21 and an election would be called in a move to strengthen his mandate for "Abenomics" - his set of economic policies.

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The Japanese Prime Minister admitted that it will be a "difficult election" but said he wanted the public to back his package of reforms.

"There are differing opinions on the structural reforms we have proposed and I have decided that I need to hear the voice of the Japanese public on whether or not we should go forward with these reforms," Abe said.

The Nikkei closed up 2.18 percent in anticipation of Abe's announcement, while the yen strengthened against the dollar hitting $116.49 by mid-morning following the news.

'Monumental task'

Analysts said the delay in a consumption tax increase would do little to foster economic growth.

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"The reality is that PM Abe faces a monumental task to try to engineer a sustainable upturn in Japanese economic growth. The Japanese economic outlook remains bleak, faced with the highest government debt to GDP (gross domestic product) ratio in the OECD, ageing demographics and a declining population," Rajiv Biswas, Asia-Pacific chief economist at IHS, told CNBC via email.

"While deferring the next sales tax hike will help to stabilize the economy, Japan faces a difficult fiscal outlook and will be unable to stabilize its government debt to GDP ratio without some further fiscal reforms."

'Clear the decks'

Abe's Liberal Democratic Party (LDP) holds over 60 percent of the seats in the lower house of the Japanese Parliament, but has faced public opposition to the consumption tax.

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The LDP is likely to come out on top in the next elections, according to analysts, since opposition parties remain divided - but his move remains a gamble.

"He will almost certainly win this election but hew question will be how many seats the LDP is likely to lose," John Swenson-Wright, head of the Asia progam at Chatham House, told CNBC by phone.

"On balance they will probably do okay in the election and get enough seat to stay in power and that will then clear the decks for Abe to move forward with economic issues as well as other policies."

- By CNBC's Arjun Kharpal