Realistic fiscal consolidation target needed

The Cabinet Office’s latest projection for the primary balance deficit in coming years makes the government’s efforts to put the nation on a path toward fiscal reconstruction appear even more difficult. After giving up on its earlier goal of achieving a primary balance surplus in 2020, the administration of Prime Minister Shinzo Abe is expected to come up with a new target for fiscal rehabilitation by around June. The administration must set a credible goal backed by feasible plans, instead of padding the goal with too rosy forecasts for economic growth. Further postponement of reaching the elusive goal risks making Japan’s commitment to fiscal consolidation less credible.

In its estimate released last week, the Cabinet Office said it now expects the national and local governments combined to achieve a surplus in the primary budget balance in fiscal 2027 at the earliest — two years later than in the previous forecast six months ago. The projected delay comes as no surprise, since Abe decided last fall to divert ¥1.7 trillion a year out of the additional revenue from the planned consumption tax hike in 2019 — initially set aside for paying back social security-related debts — on fresh spending for children’s education. That policy decision led Abe to officially abandon the goal of achieving the primary balance surplus by 2020 — a target that had already been deemed way off. The Cabinet Office last summer forecast the fiscal 2020 primary balance deficit at ¥8.2 trillion, while its latest projection puts the 2020 deficit at ¥10.8 trillion.

A primary budget surplus allows the government to fund its policy expenditures with basic revenue, such as tax income, without incurring new debt. Japan has posted primary balance deficits since the 1990s, and achieving a surplus is deemed a landmark in the government’s efforts toward fiscal reconstruction.

The Cabinet Office projection assumes that government expenditures — including social security expenses, which account for a third of the annual total — will continue to expand with the aging of the population and price increases. The government will use the latest estimate as a guide in setting the new target for a primary balance surplus, and the focus will be on the steps it can take to rein in the growing expenses and move up achieving the surplus from fiscal 2027.

The Abe administration has reiterated that there won’t be fiscal reconstruction without revitalization of the economy, putting the priority on tax revenue gains on economic growth to rebuild fiscal health. True, tax revenue has been rising under the five years of Abenomics (except in 2016). Still, improvement in the primary balance has not progressed as projected. An estimate compiled in August 2013 — after Abe returned to the government’s helm — projected that the primary balance deficit would shrink to ¥13.6 trillion in fiscal 2017 and that the ratio of outstanding government debt to GDP will start to decline after peaking in 2014. But the latest projection puts the deficit in fiscal 2017 at ¥18.5 trillion, and the debt-to-GDP ratio continues to rise.

As many private-sector economists reportedly point out, the problem with the Cabinet Office projection is that even the severe forecast is based on a scenario of a relatively high growth rate that Japan has not seen for years. The projection that a primary balance surplus will be achieved in fiscal 2027 assumes a “growth scenario” that the annual GDP growth will be around 2 percent in real terms and in the mid-3 percent range in nominal terms.

The growth forecast has been slightly reduced from the previous estimate, but the figure is still higher than the economy’s track record in recent years. On the other hand, deficit reduction will be further delayed under a “baseline” scenario assuming 1 percent-plus GDP growth in real terms and nominal growth in the upper half of the 1 percent range — which is closer to the economy’s current performance. Under that scenario, it is projected that the government will still face a primary balance deficit of ¥8.5 trillion in 2027.

Fiscal consolidation plans that count on overly optimistic growth scenarios may prove to be a pie in the sky. Efforts to streamline government expenditures might take a back seat if the plans rely too much on higher growth, possibly making the deficit reduction goal elusive once again. The government’s primary balance surplus goal has already been pushed back several times. The Abe administration should aim for a credible new target based on a more solid footing.