— Government Bond Issuances Expected To Rise Sharply
— Government May Propose Tax Hike, Spending Cuts to Pay For
Reconstruction Bonds

By Yasuhiko Seki

TOKYO (MNI) – The government of Japanese Prime Minister Naoto Kan
has begun to draft legislation to reconstruct the nation’s northeastern
areas devastated by the March 11 earthquake and tsunami, but it is not
yet clear how the government will fund the plan.

Analysts suspect that the government will be forced to borrow
heavily from the market — at least initially — to finance the
reconstruction. But the government may propose a special tax hike and
painful spending cuts to pay for at least a portion of the
reconstruction bonds it must issue.

What is clear is that Kan and his government will face tough
choices in the next several weeks on how to proceed.

On Tuesday, the government’s main budget for fiscal 2011 was
enacted over the objection of the opposition. Just over 40% of the
record Y92.41 trillion plan will be funded through bond sales.

Under the Constitution, the annual budget was enacted within 30
days after the lower house’s initial approval on March 1, despite it
being voted down by the opposition-controlled upper house of parliament.

But unlike the main budget, other spending bills must be approved
by both chambers of the Diet.

In addition to overseeing the desperate effort to contain radiation
leaks from the quake-hit Fukushima Daiichi nuclear power plant, Kan is
faced with the thorny task of formulating the extra budget bills needed
for quake reconstruction — and discovering revenue sources to pay for
them.

“The government may need to compile a series of supplementary
budgets to address the negative shock stemming from the quake and such
spending is likely to be financed mostly by issuing new bonds, given
the tight fiscal positions,” said Takeshi Minami, chief economist at
Norinchukin Research Institute.

The government said last week that the massive damage inflicted on
Japan’s northeastern Pacific coast is estimated at up to Y25 trillion
($309 billion), making it the costliest natural disaster in the
country’s post-war history.

The official estimate, which was the first released after the
tsunami caused by the quake devastated fishing ports and farmlands, was
based on the assumption that 80% of existing buildings and factories in
the quake- and tsunami-hit zones of Iwate, Miyagi and Fukushima
prefectures in northern Japan were damaged.

The estimated damage would exceed the toll of around Y9.6 trillion
from the Great Hanshin Earthquake, which hit western Japanese port city
of Kobe on Jan. 17, 1995.

With the government having to increase spending at a time when
Japan is suffering from a snowballing fiscal deficit, Kan has shown a
more flexible stance toward altering the ruling Democratic Party of
Japan’s long-held spending policies.

Kan told a parliamentary committee on Tuesday that he will draw up
a supplementary budget by the end of April to secure necessary funds for
reconstruction work and that he would not rule out a tax hike.

The Liberal Democratic Party and other opposition parties have been
calling for scrapping the child allowance, the heart of the DPJ’s
manifesto, in exchange for their support for reconstruction spending
measures.

“I do not think there is a strong reason to give up the child
allowance entirely, since the government must push for expansionary
policies to help shore up the quake-hit economy,” said Takuji Okubo,
chief Japan Economist at Societe Generale Corporate & Investment
Banking.

“But if suspension of such measures could lure the opposition camp
over to the (government’s) side, it would speed up the process of the
enacting a supplementary budget,” he said.

With the existing budget unlikely to free up sufficient funds for
reconstruction, the government may consider an income tax surcharge of
around 10% over the next three to five years to redeem reconstruction
bonds issued by the government, the Nikkei reported Wednesday.

“If a tax hike is implemented at an appropriate time, it can shore
up pent-up demand and contribute to a recovery of the quake-hit
economy,” Okubo argued.

Japan’s government is also mulling the issuance more than Y10
trillion in emergency bonds to finance reconstruction works and it may
ask the Bank of Japan to directly underwrite the entire amount of
emergency bonds, the Sankei Shimbun reported last week.

But analysts argue that any move to monetize government debt could
jeopardize the nation’s long-term financial health. Bank of Japan
Governor Masaaki Shirakawa has repeatedly rejected the idea as
problematic.

“If the pace of decline in the national savings rate were to gain
momentum following the quake, it may not be too long before Japan has to
rely more on purchases by foreign investors for its debt financing,”
warned Izuru Kato, chief economist at Totan Research Institute.

“Therefore, Japan should avoid debt monetization by the Bank of
Japan in order to maintain confidence among overseas investors,” he
said.

Standard & Poor’s in January cut Japan’s sovereign debt rating to
AA-, the fourth-highest level, citing the DPJ’s lack of “coherent
strategy” in dealing with a debt approaching 200% of gross domestic
product.

Moody’s Investors Service lowered the outlook on Japan’s Aa2
sovereign debt rating to negative from stable in February, citing the
slow policy response by the government to the surging public sector
budget deficit.

By the end of March 2012, the level of outstanding Japanese
government bonds will total Y668 trillion, 138% of projected gross
domestic product, while its outstanding long-term debt, including JGBs
and municipal bonds, is expected to total Y891 trillion, 184% of
projected GDP, according to an estimate by the Ministry of Finance.

As a result, Japan will remain the most heavily indebted
industrialized nation, dwarfing gross public debt held by Greece. The
troubled African nation of Zimbabwe is the only country in the world
with a higher debt-to-GDP ratio than Japan.

As the government concentrates on quake reconstruction, Kan has put
plans to overhaul the nation’s social security system and tax structure
on the back-burner.

“It is of course the duty of the government to fix the damaged
infrastructure and get the Japanese economy back on a recovery path,”
said Akio Yoshino, chief economist at Amundi Asset Management, the
Japanese unit of France-based asset management company.

“But since it is evident that the current faulty tax and social
security system cannot be left unaddressed, the quake may give the
government a good opportunity to review the current budget structure and
freeze spending projects that it deems unnecessary and draw a road map
for a tax hike, in this order,” he said.

tokyo@marketnews.com
** Market News International Tokyo Newsroom: 81-3-5403-4835 **

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