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Japan braces for first sales tax hike in 17 years

Japan's economy is showing signs of shaking off almost two decades of deflation and poor growth. Now it must brace for the first hike in the country's sales tax since 1997.

The consumption tax is set to rise to 8 percent from 5 percent on April 1 and Japan's consumers have been front-loading their spending ahead of the hike.

For instance Japan's domestic sales of new cars, trucks and buses increased 15 percent from a year earlier in February, rising for the sixth consecutive month.

This should provide a short-term boost for Japan, the second biggest economy in Asia after China and the third largest in the world, but economists say the real test will come later this year with the tax hike likely to take a toll on consumer spending.

(Read more: Japan's sales tax: What you need to know)

In short, Japan should avoid a recession but the going could get tough especially if employment growth and wage rises fail to give a significant boost to consumption.

"The rush in demand before the tax hike kicks in appears to be weaker than in 1997, so we are not expecting a recession but consumption will slow down and economic growth will be weaker," said HSBC Japan Economist Izumi Devalier.

"The pace of recovery in household spending will be contingent on wage and employment growth picking up," she added.

(Read more: A good start to the year for Japan's economy)

Izumi expects Japan's economic growth to slow to 1 percent in 2014 from around 1.5 percent last year.

A woman, center, leaves a store with her purchased red suitcase in the Ginza district of Tokyo, Japan.
Yuriko Nakao | Bloomberg | Getty Images
A woman, center, leaves a store with her purchased red suitcase in the Ginza district of Tokyo, Japan.

The decision to raise the sales tax, given the go ahead by Prime Minister Shinzo Abe last October, has proved controversial. Critics argue the move will derail Japan's economic recovery while those in favor of the hike say it is essential for bringing down a massive debt burden.

Japan has one of the highest debt levels in the developed world, with its public debt estimated at around 230 percent of its gross domestic product (GDP).

(Read more: Why wages in Japan are set to rise: Shinzo Abe)

Observers meanwhile note that the last time Japan lifted the sales tax in 1997 to 5 percent from 3 percent, the economy slipped into recession shortly afterwards.

Analysts say the comparison with 1997 is not necessarily a fair one.

"Apprehension was partly based on the fact that in 1997 the Japanese economy went into sharp recession not long after the tax was last raised," analysts at ANZ said in a note.

(Read more: Japan's energy debate rages on tsunami anniversary)

"However, blame cannot be apportioned to the increase in the consumption tax as a number of other events were happening at the time, including the Asian Financial Crisis and a domestic credit-crunch due to the poor state of bank's balance sheets."

— By CNBC.com's Dhara Ranasinghe; Follow her on Twitter @DharaCNBC

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