Fri, 23 Feb 2001

Tackling debt not for the faint-hearted

By Ritsuko Ando

TOKYO (Reuters): Two things are certain in Japan: the day when the government must start tackling its huge debt is drawing ever nearer, and whoever takes on that daunting task is destined to make plenty of enemies.

The urgency of reducing the biggest public debt in the industrial world was underscored this week by Finance Minister Kiichi Miyazawa, who said Japan might well need to raise its consumption tax as part of a broader fiscal reform package.

With an election for the Upper House of parliament due in July, Miyazawa made it clear on Wednesday that such a move was not likely any time soon.

Yet whatever mix of tax increases and spending cuts is eventually chosen to improve the country's balance sheet, politicians will have to risk the wrath of a gamut of vested interests who have thrived on pork-barrel spending.

"It won't be easy," said Tomohiro Noda, senior economist at Industrial Bank of Japan (IBJ). "It might mean implementing unpopular changes."

One man not expected to lead the charge for change is the current prime minister, Yoshiro Mori. He is deeply unpopular and is expected to step down as early as next month.

After a decade of massive deficit-spending to prop up the economy, Japan forecasts that its fast-rising public debt as a proportion of gross domestic product will reach 128.5 percent by the end of the fiscal year starting on April 1.

The Organization for Economic Cooperation and Development calculates that the government needs to raise taxes or cut spending by the equivalent of 10 percent of gross domestic product in order to stabilize the debt at 150 percent of GDP.

With the unfunded pension liabilities of a rapidly ageing population making the outlook even gloomier, economists say people will keep saving instead of spending until they are assured the government will solve its debt problem.

But raising taxes now is not on the agenda given the still- fragile state of the economy after a decade of stagnation.

The last hike in sales tax in April 1997, which raised it to the current five percent from three percent, is still being blamed for pushing the economy into recession.

But economists said tax revenues would have to be raised in the long run and sales taxes may be a good place to start, since they were still low compared to western European levels.

Raising consumption tax, however, is likely to be opposed by the Liberal Democratic Party's (LDP) main coalition partner, the Buddhist-backed New Komeito, said Yunosuke Ikeda, an economist with Nomura Research Institute.

"Even if the next prime minister decides radical reforms are necessary, there will be little likelihood he'll go through with them unless the LDP dissolves its alliance with the New Komeito," Ikeda said.

One of Miyazawa's ideas is to cut other taxes in order to win public backing for a consumption tax increase.

Economists have suggested cutting income taxes, with some saying such a move is needed regardless of a rise in sales tax.

"People need to be encouraged to spend more," said IBJ's Noda. "Right now the government can't afford to do otherwise."

Like Miyazawa, Noda said now was not the time for fiscal belt- tightening. But he said the government should redirect spending away from the rural infrastructure projects with which the LDP has wooed farmers for decades.

"I think we still need fiscal stimulus," Noda said. "But there can be fewer dams and instead, for instance, more spending in the metropolitan area."

In what could be a straw in the political wind, the maverick governor of Nagano, which played host to the last Winter Olympics, vowed this week to block the use of taxpayers' money to build seven costly dams in his prefecture.

Another sign that change could be in the air is the growing determination of Hakuo Yanagisawa, the minister in charge of regulating the financial sector, to prod banks finally to rid themselves of the mountain of bad loans carried over from the asset-inflated bubble economy of the 1980s.

Steps in that direction would mean more bankruptcies and unemployment, but Nomura's Ikeda said such pain had to be endured for the long-term gain of the economy.

"For Japan to really grow on its own, it needs to come to some kind of closure on the bad-debt issue," he said.

Economics Minister Taro Aso, for one, thinks the Japanese are now ready to suffer.

"A few years ago I thought voters weren't really that ready for a big change, one that comes with pain. But now I think they are," he said on Tuesday. "I think the Japanese are expecting a leader from a new generation that thinks differently."