Japan's Economic Recovery May Offer Hatoyama Room to Rein in Biggest Debt

Japan’s government, aiming to avert a collapse of confidence in its 882.9 trillion yen ($9.6 trillion) debt, may get a boost from a report tomorrow likely to show growth accelerated in the first quarter.

Japan, the Group of Seven economy that shrank the most during the crisis, benefited from rising exports that spurred production and helped deliver the first gain in wages in 22 months. Gross domestic product rose at a 5.5 percent annual rate from January to March, according to the median of 21 estimates in a Bloomberg survey before tomorrow’s release.

“The government can put more emphasis on fiscal discipline” with a strong GDP number, said Minoru Nogimori, an economist in Tokyo at Nomura Securities Co., a unit of Japan’s largest brokerage. “Given the Greek sovereign problem, fiscal rehabilitation is becoming more crucial.”

Prime Minister Yukio Hatoyama’s administration aims to unveil a strategy next month to contain the world’s largest public debt after the collapse in Greek securities forced a European Union bailout of almost $1 trillion. The budget plan may leave the burden on Japan’s central bank to help sustain the recovery as deflation persists, according to Nogimori.

Tomorrow’s report may show that the GDP deflator, a gauge of prices across the economy, fell 3 percent in the first three months of 2010 from a year before.

Deflation Stretch

The measure has only risen twice in the past 47 quarters going back to 1998. BOJ policy makers as a result will keep the benchmark interest rate at 0.1 percent at a two-day meeting that starts tomorrow, according to the median estimate in a separate survey.

Deflation worsened in the aftermath of a collapse in global trade that led Japan to shrink 5.2 percent in 2009, the most in the postwar era and more than the U.S.’s 2.4 percent and the euro area’s 4.1 percent drop, International Monetary Fund figures show.

The rebound has been driven by a revival of foreign demand, especially in China, that has fueled profits at exporters from Toyota Motor Corp. to Toshiba Corp. and begun to spur wages and jobs. Unadjusted for price changes, nominal GDP for the world’s second-largest economy probably advanced 1.3 percent, the most in 10 years, a median projection shows.

IMF’s Assessment

The International Monetary Fund said Japan should “take advantage” of the recovery by narrowing the budget gap in the fiscal year starting April 1, 2011. The Washington-based lender, releasing its annual review of Japan’s economy today, said “the need for early and credible fiscal adjustment has become critical,” and recommended raising the 5 percent sales tax.

“It’s a good chance for the government to take action to improve the nation’s fiscal health and prevent a sudden rise in bond yields,” said Susumu Kato, chief economist at Credit Agricole CIB and CLSA in Tokyo.

Moody’s Investors Service Senior Vice President Thomas Byrne said in Tokyo today that the government’s fiscal plan due next month must be “decisive” in order for the outlook on the country’s Aa2 debt rating to stay “stable.”

Finance Minister Naoto Kan this month proposed extending a pledge to keep annual bond sales around 44 trillion yen by a year, through March 2012. He said that raising taxes could boost the economy if used wisely, adding to signs the government may consider increasing a levy on sales.

Four Recessions

A legacy of deflation, four recessions since 1990, and repeated fiscal stimulus packages is a gross debt level that exceeded twice the size of GDP last year, IMF calculations show. So far, that hasn’t caused a debt crisis given demand among Japan’s domestic investors, who hold more than 90 percent of government bonds.

Benchmark 10-year bond yields have remained below 1.4 percent for most of 2010, and were 1.28 percent in Tokyo morning trading, less than half the level of comparable-maturity U.S. Treasuries.

By contrast, Japanese shares have been hit by concern that the European crisis may crimp exports. The Nikkei 225 Stock Average slid 1.6 percent at the lunch break, taking the year’s losses to 4.4 percent. The yen has climbed 19 percent against the euro this year, threatening to make exports to the region more costly. It advanced 0.6 percent to 111.93 per euro at 11:41 a.m. in Tokyo.

China Risk

Japan’s recovery is more vulnerable to a slowdown in China than Europe, said Junko Nishioka, chief economist at RBS Securities Japan Ltd. in Tokyo. “Should China fail to control inflation, that will increase the chance for a bubble to burst and damage Japanese exports,” she said.

Only 12 percent of Japan’s shipments abroad went to the European Union in the year ended March 31, compared with 19 percent to China and 16 percent to the U.S., according to the Finance Ministry.

Japanese companies are counting on overseas demand to power earnings and spur capital spending.

Toshiba, the country’s biggest memory-chip maker, plans to spend about 2.4 trillion yen over three years, and the Tokyo- based company sees overseas sales climbing to about 63 percent from 55 percent. Toyota City-based Toyota forecasts profit will climb 48 percent this year, led by demand from abroad.

Rising wages have helped prompt an end to spending cuts by Japanese consumers, with retail sales advancing for three straight months through March on a monthly basis.

Faster growth would provide some relief for Hatoyama, whose public support has tumbled ahead of an upper-house election to be held in July. The fiscal situation has prompted his Democratic Party of Japan to consider paring promises such as the doubling of a childcare allowance.

The party is debating whether to endorse Kan’s bond-sales- limit pledge, as well as raise the country’s 5 percent sales tax after the next lower-house election, due by mid-2013.

To contact the reporters on this story: Keiko Ujikane in Tokyo at kujikane@bloomberg.net; Mayumi Otsuma in Tokyo at motsuma@bloomberg.net

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