Bond yields could soar if Noda’s tax hike plan stalls

Analysts warn of eurozone-style fiscal crisis unless opposition camp relents; polls show public conflicted

by Sachiko Sakamaki and Takashi Hirokawa

Bloomberg

Prime Minister Yoshihiko Noda says doubling the consumption tax is a necessary remedy to address soaring debt and social welfare costs, and while his opponents don’t disagree, they’re still not going to let him do it.

The Liberal Democratic Party has rejected repeated calls from Noda to negotiate on the proposal tax hike and instead demanded an election, as polls show 60 percent of voters oppose the levy and Noda’s popularity plunging. LDP lawmaker Ichita Yamamoto said raising the sales tax will be impossible under Noda’s watch.

Failure to reach a compromise threatens to deepen the country’s political stagnation and worsen an economy struggling to recover from last year’s natural and nuclear disasters. The impasse could also push up bond yields, preventing the government from financing a record debt burden with the world’s second-lowest borrowing costs.

“If Noda fails, it will have a very big impact on the market, former Bank of Japan Deputy Gov. Kazumasa Iwata said Wednesday.

Iwata said the possibility of an unusual shock in the bond market can’t be ruled out, citing two episodes when shifts in investor sentiment caused yields to spike: Yields on 10-year bonds more than tripled between October 1998 and February 1999, and again between June and September 2003.

The prospect of escalating borrowing needs has yet to be felt by domestic securities.

The government may have a revenue shortfall of ¥50.8 trillion in the fiscal year starting in April 2015 if there is no increase in the consumption tax, according to a Finance Ministry report obtained by Bloomberg News. This contrasts with Noda’s pledge to limit new bond sales to about ¥44 trillion a year through fiscal 2014.

Noda on Tuesday renewed his call for dialogue on the ruling Democratic Party of Japan’s plan to raise the sales tax to 8 percent in April 2014 and 10 percent in October 2015. A Cabinet Office report the same day said the government will probably miss its goal of balancing the budget by 2020 even if the tax hike plan clears the divided Diet, and officials have said further increases are likely.

A survey published in the Mainichi Shimbun on Jan. 23 said the proportion of the public opposed to the increase rose to 60 percent from 54 percent in December. Noda’s approval rating, meanwhile, fell to 32 percent from 38 percent, and is down 24 percentage points since he became the DPJ’s leader.

LDP chief Sadakazu Tanigaki has accused the DPJ of reneging on pledges to cut spending and overhaul the pension system, and is demanding that Noda call an election. LDP lawmakers say that while public discontent over the deadlock may also hurt their party, kicking the DPJ out of office takes precedence. The Mainichi Shimbun poll put support for the DPJ at 17 percent and for the LDP at 16 percent.

“Many people hate us, and this is serious,” the LDP’s Yamamoto said. “The point is there won’t be a breakthrough if the current situation continues.”

Lawmaker Takeshi Noda, who heads the LDP’s tax panel, said dissension among the ruling party’s ranks undercuts the government. Nine DPJ legislators opposed to raising the consumption tax have already quit to form their own party. “The ruling party is split in two,” said Noda. “It’s wrong to ask for opposition support before (Noda) unites his own party. The bill won’t clear the Lower House.”

But at the same time, the LDP’s own platform calls for raising the sales tax and Tanigaki, a former finance minister, in 2006 sought to raise the levy.

Opposition lawmakers have also criticized the prime minister’s inability to cut spending, pointing out that the DPJ has yet to come up with the ¥16.8 trillion reduction in “wasteful” outlays it pledged.

Social security expenses, which have more than doubled in the past two decades, will account for 52 percent of general spending in the fiscal year beginning April 1.

“The LDP also proposes raising the consumption tax to 10 percent, so the number is fine,” LDP member and former Credit Suisse First Boston economist Yukari Sato said in an interview. “But the government plan lacks specifics in cutting social security expenses. An election should be held to break through the current sense of frustration.”

Deputy Prime Minister Katsuya Okada, whom Noda appointed earlier this month to head the tax increase and reform drive, has repeatedly rejected the notion of going to the voters before the legislation is passed.

“Decisions have to be made,” Okada told Fuji Television on Sunday. “There’s no time for an election.” Then on Wednesday, Okada said that even a 10 percent sales tax “will be insufficient” to sustain the pension fund system in the world’s most rapidly aging society.

Political squabbling also may imperil Japan’s credit. Standard & Poor’s in November said it might be preparing to lower the country’s sovereign rating, given Noda’s lack of progress in tackling the mountain of public debt. S&P currently rates Japan AA, and since April has maintained a positive outlook.

Japan’s politicians “have to look around the world, especially at the European debt crisis,” said Masaaki Kanno, chief economist in Tokyo at JPMorgan Securities Japan Co. and a former Bank of Japan official. “We don’t have time to waste.”