Japan elections key to reform, market stability
By William Mallard
TOKYO (Reuters): A general election on Sunday will have profound implications for Japan's stalled economic reforms and would surely prompt short-term market turmoil if voters drive the present coalition government from power.
Regardless of what the unpredictable voters decide, many analysts say, the next government will likely stick to the present fiscal policy: just enough stimulus to keep government spending from falling below last year's levels.
That implies a modest supplementary budget later this year of about four trillion yen (US$37.8 billion), as Prime Minister Yoshiro Mori and other officials have begun to hint.
"For investors, the key conclusion at this point is that no party in Japan, and no potential combination of parties, supports a small-government, supply side-friendly fiscal policy," Morgan Stanley Dean Witter analysts wrote recently.
Newspaper polls on Tuesday buttressed the conventional wisdom that the ruling three-party coalition will stay in power. The surveys indicated Mori's Liberal Democratic Party may keep its outright majority in the 480-seat Lower House, while the coalition could keep the 254 seats needed to control all committees.
But the polls also showed some two voters in five have still not made up their minds how or whether to vote, meaning the result may still be up in the air.
"In other countries at other times, that level of undecided would lead you to believe that the party in power was about to get creamed," said U.S. investment adviser Richard Medley.
Polls show the Mori cabinet's popularity in the low double digits, near record lows for a premier facing a general election, because of comments he made that conjured up the emperor-centered ideology that led Japan to war more than a half-century ago.
Japanese voters do not directly elect their prime ministers, however, and polls show the LDP remaining the most popular party with support from about a quarter of the electorate.
Following are some key scenarios for the election and analysts' views of the impacts on policy and the markets.
The stay-the-course scenario:
The coalition slips from its two-thirds stranglehold on the Lower House but keeps the 269-seat majority needed to control all committees.
Voters largely shrug off Mori's remarks describing Japan as kami no kuni, or a "divine nation", allowing the LDP alone to maintain the 229 seats that leaders have decreed is the make-or- break line.
Mori keeps his job, the government doles out public works spending to keep the world's second-largest economy from sliding back into recession and to keep the LDP's construction and farm constituents happy.
The public is given no blueprint for how the government would eventually tackle the worst public debt in the industrial world, and deregulation stays in the deep freeze.
"That scenario would be continued death for reform," said adviser Richard Medley.
It is neutral for stock and bond markets, but if the LDP can keep its sole majority, the political stability would boost Tokyo stock prices, said analyst Ichiro Shikata at Sanwa Securities.
The chastened-coalition scenario:
The coalition of the LDP, the Buddhist-backed Komeito and the tiny Conservative Party take a beating but cling to a majority. The LDP falls below the 215 seats that Mori's men have targeted as they lower expectations for the embattled premier.
Mori's three-month try at running Japan is over, and a chastened LDP -- still the biggest party -- pushes forward a premier with better reformist credentials, such as Foreign Minister Yohei Kono or former LDP secretary-general Koichi Kato.
A result along these lines would still mean little change in overall economic policy and could in fact increase deficit spending for the time being, many politics-watchers say.
No single figure can impose his will on the party, and the LDP string-pullers stick to the pork-barrel politics that has kept them in power almost non-stop since 1955.
"More bridges and roads and airports," said Shigenori Okazaki, political analyst at UBS Warburg. Moreover, the populist Komeito would increase its influence and push policies such as a child- care package that would cost the government 1.2 trillion to 1.4 trillion yen.
That would be bad for bonds but could support shares if the market sees the election result as meaning more of the same.
The possibility of Kato as prime minister stirs feverish speculation. He has made no secret of his distaste for LDP bedfellow Komeito.
Most analysts think a Prime Minister Kato would get the top job only by toning down his budget-cutting rhetoric and making peace not only with Komeito but also with the LDP old guard.
He might be a tad less expansionary than the present government, said Lehman Brothers chief Asia economist Russell Jones, but he added: "I still don't think he'd be in a position to put in place a big fiscal U-turn."
The kick-the-rascals-out scenario:
Enraged voters flood polling booths and heave the coalition from power. Politics is in upheaval reminiscent of the early 1990s when the LDP was briefly dispatched to the political wilderness. If policies are delayed, fears of economic relapse emerge.
Stocks tumble and bonds surge, at least in the short term.
Several analysts said, however, this scenario could provide the best prospects in the medium term for real political change, leading to restarting reforms of bloated spending policies and vested-interest regulations.
The Democratic Party, Japan's largest opposition grouping, could be in the driver's seat, but to get a stable government it would need to convince Kato and a fat contingent of supporters to leave the LDP, or the Democrats would have to climb down from their vows not to join hands with the Communist Party, a sure beneficiary of the protest vote.
Although Kato and the Democrats have pilloried the government for its addiction to fiscal stimulus, no party is likely to risk tightening prematurely and choking off recovery -- a 1997 mistake that cost Ryutaro Hashimoto his job as prime minister and helped tip a recovering economy back into its worst postwar recession.