The government’s record ¥97.45 trillion budget for fiscal 2017, adopted by the Abe administration last week, appears to reflect the shaky state of the nation’s economic revival. Growth in tax revenue, which Prime Minister Shinzo Abe has touted as the fruit of his Abenomics policies, stagnates as corporate profits remain at the mercy of the yen’s exchange rate fluctuations. While the issue of new government bonds will be barely kept below the previous year’s initial budget level thanks to anticipated pickup in tax revenue on the yen’s recent downturn and the low debt-servicing costs thanks to the Bank of Japan’s massive monetary easing operations, lax efforts to tame the ballooning expenditures continue to threaten the prospect of fiscal consolidation.
The government emphasizes that the budget achieves both resuscitation of the economy and fiscal rehabilitation in that the amount of new bond issuance will decline for the seventh year in a row while its tax income is expected to rise again. A closer look shows that the assessment stands on precarious grounds. Abe maintains that he has not given up on the government’s fiscal consolidation goals. But the administration should stop relying on rosy scenarios and talk straight.
The size of the general account budget hit a record high for the fifth year in a row since Abe returned to the helm of government in late 2012. The biggest factor is mushrooming social security expenses, which grow every year with the rapid aging of the nation’s population and now account for 30 percent of the government’s annual spending.
But while efforts are being made to tame the rise in social security expenses, the administration continues to increase defense spending and public works expenditures. The 1.4 percent rise in the defense budget, hitting a record ¥5.125 trillion in fiscal 2017 — the fifth consecutive annual gain — comes on top of ¥170 billion in additional defense spending set aside in the third extra budget for the current fiscal year.
In fiscal 2016, the government’s tax revenue is projected to fall ¥1.7 trillion short of the initial budget, as the yen’s upsurge on growing uncertainties over the world economy since the early part of the year ate into the profits of the nation’s major export-oriented firms, which had benefited heavily from the yen’s weakness under Abe’s watch.
As a result, the government had to make up for the shortfall by issuing ¥1.75 trillion in additional deficit-covering bonds in the middle of the term, for the first time since fiscal 2009 just after the Lehman shock of 2008. Coupled with additional public works spending through a series of supplementary budgets, the total amount of new bond issuance hit some ¥39 trillion.
Now, the government estimates tax revenue will rise nearly ¥2 trillion from the revised 2016 level to ¥57.7 trillion in fiscal 2017, based on forecasts of a recovery in corporate earnings thanks to the fallback in the yen exchange rate since November on market hopes for U.S. President-elect Donald Trump’s economic policies. But that might be too rosy a scenario, given uncertainties over the policies of Trump, who broached protectionist ideas on trade issues on his “America first” campaign. There is no guarantee that the yen’s downtrend following Trump’s victory will continue, while the forecast seems to underline the fact that after four years of Abenomics, a lot of its “fruits” depend on the yen’s exchange rate.
Based on that scenario, the government expects to issue ¥34.37 trillion in new bonds in the next fiscal year, down 0.2 percent from the initial fiscal 2016 budget. It will still rely on debt to pay for 35.3 percent of its expenditures. There remains no prospect for reducing the outstanding public debt, with the amount of national and local governments combined topping ¥1,000 trillion, as the administration keeps tapping the benefits of economic growth to pay for increased spending. The nation’s primary balance deficit — a condition in which the government is unable to pay for its expenditures except for debt-servicing costs without issuing new debt — will increase for the first time in five years, putting the government’s target of turning the primary balance into a surplus in 2020 further in doubt.
The government’s sense of urgency over fiscal rehabilitation and reducing the debt load seems to be receding at least in part due to the BOJ’s monetary easing and its negative interest rate policy, which has significantly pushed down the interest rates on government bonds. The debt-servicing costs of ¥23.5 trillion set aside for fiscal 2017, nearly a quarter of the general account expenditures, is based on a record-low assumed interest rate of 1.1 percent, which has also helped reduce the issuance of new bonds to make up for the revenue shortfall. But that assumption might be in question given that the U.S. plans to hike its policy interest rates next year — in addition to its hike this month — may put upward pressure on long-term rates in Japan, potentially pushing up its debt-servicing costs.
The government should avoid relying on stretched scenarios to cover its bloated expenses.
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