December 23, 2016 6:40 am JST

Japan plans shaky step toward fiscal health in draft budget

Interest rate rise could obliterate spending cuts

TOKYO -- Japan's fiscal 2017 draft budget technically keeps the country on target in terms of limiting spending growth and lowering bond issuance, though any upswing in interest rates would open a gulf between this plan and reality.

The Cabinet Office on Thursday signed off on a draft that would limit growth in general expenditures, which cover the cost of social security and public works, to 530 billion yen ($4.51 billion) -- hitting the target set out in the government's fiscal consolidation plan for the second year running.

Yet Finance Minister Taro Aso was unusually reserved in his assessment, telling a news conference Thursday morning that the plan was "reasonably" balanced overall.

The draft envisions 57.7 trillion yen in fiscal 2017 tax revenue -- 1.2 trillion yen less than the figure used in longer-term estimates in light of a corporate tax shortfall. Japan's primary budget deficit is poised to deepen by 21.4 billion yen, arriving at 10.8 trillion yen. The Bank of Japan, meanwhile, is slated to hand around 300 billion yen to the government, over 200 billion yen less than the amount projected for the current fiscal year. Though efforts to curb rising social security costs have paid off to some extent, the prospect of running a primary surplus in fiscal 2020 as planned remains precarious.

A record-low projected interest burden of 1.1% on Japanese government bonds contributed the most to cost-trimming efforts. This rate is 0.5 point less than what was envisioned over the summer, when various government agencies were formulating budget requests, holding down anticipated expenditure by around 500 billion yen. Market interest rates are assumed to be zero, according to the Ministry of Finance.

The Bank of Japan's shift in September to a monetary easing framework based on interest rates -- specifically, a long-term rate target around zero -- is part of the reason for this change. The Ministry of Finance expects the central bank to take this target seriously, guiding rates downward if they creep too high by snapping up JGBs.

But global developments are testing the BOJ's resolve. U.S. long rates have climbed from 1.8% to around 2.5% since Donald Trump was elected president in November, dragging Japanese rates back above zero after a stint in negative territory. Naoya Oshikubo, a strategist at Barclays Securities Japan, reckons that, unless American rates approach 3%, Japan's long rates are unlikely to rise above 0.1% for any sustained period of time.

But higher rates are an undeniable risk nonetheless. If interest rates were to rise by 1 point, for instance, Japan would have to pay out 1 trillion yen more to bondholders each fiscal year. This growth in outlays has the potential to outstrip rises in social security spending, making it the largest threat to Japan's finances. According to the finance ministry, the country's long-bond balance will climb to 899 trillion yen by the end of fiscal 2017 -- an increase of 23 trillion yen on the year.

The BOJ "does not think it is acceptable for Japanese long rates to rise in response to increases overseas," Gov. Haruhiko Kuroda has said. Five years after Prime Minister Shinzo Abe debuted his signature Abenomics policies, fueled by ambitious monetary easing and deft fiscal spending, the central bank and national government are more tightly bound than ever.

(Nikkei)

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