Fukuda may up spending to win rural, elderly votes

by Kyoko Shimodoi and Jason Clenfield

Bloomberg

By KYOKO SHIMODOI and JASON CLENFIELD Prime Minister Yasuo Fukuda, under pressure to increase government spending before the next election, may scuttle plans to balance the budget and cut the world’s largest public debt.

Some members of Fukuda’s Liberal Democratic Party, reeling from the worst election setback since 1993, are pushing plans to channel more money to rural and elderly voters. Fukuda, who took office last month, is facing calls for an early ballot after the opposition won control of the Upper House in July.

“They’ve made a lot of promises, but they haven’t said how they are going to pay for it,” said Kirby Daley, a strategist at Societe Generale SA’s Fimat unit in Hong Kong. “The outlook for Japan doesn’t look good, politically, fiscally or for economic growth.”

To finance pork-barrel projects, the government would need to borrow, adding to interest payments that will already cost ¥21 trillion this year, about the same as Hong Kong’s gross domestic product. Japan’s debt represents about 150 percent of GDP.

Selling more debt would put pressure on bond yields to rise, increase corporate financing costs, reduce company profits and damp equity prices, according to Robert Feldman, Morgan Stanley’s chief economist in Tokyo.

The day Fukuda got the job, the LDP agreed with its coalition partner, New Komeito, to come up with policies that support rural residents and the elderly. These voters complained they’d suffered from spending cuts introduced by Junichiro Koizumi, who became prime minister in 2001 and served for five years with a heavy reform agenda.

In July 2006, Koizumi, 65, set a target of balancing the budget by 2011 to stop the expansion of public debt. At the time, the government said that would be achieved through spending cuts and revenue increases, such as a higher sales tax.

“We genuinely regret we rushed to reform and didn’t provide enough safety nets for people left behind,” the LDP-New Komeito agreement reads. The plan calls for rural “revitalization.”

The coalition also agreed to freeze an increase in health-care charges to the elderly, which the Finance Ministry estimates will cost the government at least ¥90 billion.

“A fiscal monster is starting to rear its ugly head in Japan,” said Feldman. “Political competition has started a race to spend, and to rescind even scheduled revenue measures.”

While the LDP-New Komeito policy document may indicate a wavering in efforts to balance the budget, Cabinet ministers have stressed that is not the case and spending cuts will continue.

Finance Minister Fukushiro Nukaga, Economy and Fiscal Policy Minister Hiroko Ota and Fukuda himself pledged not to sway from the goal of balancing the budget introduced by Koizumi.

“This is election season,” said Morgan Stanley’s Feldman. “It’s difficult to believe they’ll stick to the Koizumi plan of cutting spending, regardless of what they say.”

The LDP has only been out of power once in 55 years, for 10 months after Prime Minister Kiichi Miyazawa had to step down in August 1993 following the implosion of the 1980s asset bubble and the collapse of the stock and property markets.

After regaining power, the LDP kept up spending on roads, bridges and railways in an attempt to kick-start economic growth. Japan’s public debt grew from ¥334.1 trillion in 1996 to ¥836.5 trillion now, more than the entire output of the Asia-Pacific’s next 16 largest economies, including China.

Faced with the possibility of being ousted again, some LDP officials are pushing for an end to spending cutbacks. The party’s land-and-transportation panel is seeking to discontinue planned spending cuts of 3 percent.

Japan should delay attempts to eliminate the deficit beyond 2011, said Kazuo Kitagawa, secretary general of New Komeito, according to the Nikkei daily on Sept. 19.

Ministries and agencies are asking for a combined ¥88.9 trillion in spending for the next fiscal year, 3.8 percent more than a ceiling set by the government.

To finance the spending plans, the government would probably need to “increase government debt, but at the same time they’re saying: ‘No, we’re committed to restoring the fiscal balance by 2011,’ ” said Masaaki Kanno, chief economist at JPMorgan Securities Japan Co. “What’s the magic? Fukuda has to show us the magic.”