Japan: Budget busting

The Japanese cabinet is due on Wednesday to set ‘budget ceilings’, dealing with different ministries’ spending requests for next year.

Japan has the world’s largest public debt in absolute terms, estimated to reach 776 trillion yen (147% of GDP) in the fiscal year ending March 2009. In 2006 the government committed itself to reducing debt by bringing the primary balance (revenue minus spending, excluding debt sales and interest payments) into surplus by 2011. The debt problem is growing more urgent since high import prices increase the risk of inflation and so of eventual interest rate rises, which would suggest that servicing the debt more expensive. However, the government’s commitment to its debt targets is weakening.

Hopes that higher revenues from a stronger economy, along with spending cuts, would address the problem look optimistic. The Cabinet Office just revised down from 2.0% to 1.3% its growth forecast for the current fiscal year, and increased its budget deficit forecast accordingly. Meanwhile, the country’s ageing population means that cuts in defence and public works spending will be entirely offset by increased social spending next year – a problem that will worsen as more workers retire, leaving fewer taxpayers to fund government programmes. 

The case for reform is stark, but the implications are huge, undermining the government’s appetite for change. While there are some obvious initial steps (a politically-controversial increase in the 5% sales tax has long been suggested) Prime Minister Yasuo Fukuda has adopted a leisurely timetable for taking any, suggesting that it might be two or three years (in other words, after general elections) before taxes on consumption are adjusted. He might be looking back to a fight earlier in the year over road taxes, which not only failed to raise revenue, but led to a political fight, a halt in some fuel taxes and an actual reduction in government revenue. For all his talk of “drastic reform” this autumn, Fukuda might wish to preserve his political capital before an election, and especially while he faces wily opposition leader Ichiro Ozawa. The embarrassment of failing to act might be the lesser of two evils.

While the problem of paying the debt remains unsettled, attention has turned to managing it in the mean time. One proposal would be to securitise it, but this plan may fall victim to a troubled financial sector wary of exotic instruments following its losses on them last summer. The same financial turmoil poses a challenge to a creative debt repayment solution: the creation of a sovereign wealth fund, investing government pension savings and giving over the returns to debt payments. This, after all, would need to find appropriate returns, in an uncertain economic climate and given an inglorious history of Japanese pension funds’ investments abroad. As is clear from the country’s recent economic policy, a sense that something ought to be done is no guarantee of action.