Kan Push to Pare World's Biggest Debt May Falter as Japan Slows

Japan’s economy may have expanded at the slowest pace in three quarters, adding to evidence the global recovery is faltering and undermining Prime Minister Naoto Kan’s efforts to reduce the world’s largest public debt.

Gross domestic product growth slowed to an annualized 2.3 percent in the three months ended June 30, from a 5 percent expansion in the first quarter, according to the median estimate of 19 economists surveyed by Bloomberg News. The report will be released on Aug. 16 at 8:50 a.m. in Tokyo.

Waning stimulus effects are sapping consumer spending, while slowing global expansion is cooling exports that may be threatened by an advance in the yen to a 15-year high against the dollar. Weakening growth may pressure the Bank of Japan to ease policy to spur the economy and end deflation, constraining the government’s efforts to pare debt.

“In the short term, Kan may need to shift the focus of his economic and fiscal policy to growth as the economy is losing steam,” said Takahide Kiuchi, chief economist at Nomura Securities Co. in Tokyo. “Given Japan’s worsening fiscal conditions, the government may find it difficult to have large additional stimulus spending and end up pressuring the BOJ to help boost the economy.”

Photographer: Koichi Kamoshida/Pool via Bloomberg

Naoto Kan, Japan's prime minister, attends a news conference at the prime minister's official residence in Tokyo. Close

Naoto Kan, Japan's prime minister, attends a news conference at the prime minister's... Read More

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Photographer: Koichi Kamoshida/Pool via Bloomberg

Naoto Kan, Japan's prime minister, attends a news conference at the prime minister's official residence in Tokyo.

Kan said on Aug. 3 that employment conditions remain severe and the global recovery outlook is uncertain, making it necessary to consider further stimulus measures. He has pledged to cap bond sales and spending for the next three years to prevent the country’s finances from collapsing.

Extend Incentives

Any spending package is unlikely to be large and may focus on reinforcing an employment safety net, such as an increase in subsidies for companies to keep workers, said Hiroshi Watanabe, a senior economist at the Daiwa Institute of Research in Tokyo. Another possibility is to extend incentives to purchase cars and electronics that are set to end this year, he said.

“The government needs to take some measures to ease any upheaval from the expiry of these incentives,” said Watanabe. “The boost from the government’s stimulus is rapidly losing steam.”

The BOJ introduced a fixed-rate lending facility last December after the yen touched a 14-year high of 84.83 against the dollar and stocks plunged. The program was doubled to 20 trillion yen ($234 billion) in March. The central bank has kept the benchmark interest rate at 0.1 percent since lowering it in December 2008.

Benchmark 10-year bond yields fell to a seven-year low yesterday, reducing the government’s borrowing costs at a time when public debt is approaching 200 percent of the economy. The rising yen is clouding the economic outlook by threatening exporters’ competitiveness and adding to deflationary pressure.

‘Excessive’ Moves

The currency’s advance prompted Finance Minister Yoshihiko Noda to say yesterday “excessive” moves can hurt growth, though he refrained from outlining steps to arrest this year’s 9 percent surge in the yen. He pledged to work with Bank of Japan Governor Masaaki Shirakawa, who said in a statement the bank is closely watching “substantial” movements in foreign-exchange and stock markets.

“If the Japanese economy is forced to create a production structure based on 85 yen to the dollar, that would be disastrous,” as the nation wouldn’t earn enough from exports to pay for commodities from overseas, Honda Motor Co. Chief Financial Officer Yoichi Hojo said on Aug. 5.

Already Concerned

Bank of Japan board members were already concerned last month about the effect a stronger yen and falling stock prices would have on the economy, according to minutes of a July 14-15 meeting released today in Tokyo.

Domestic demand probably contributed less to growth last quarter. Household outlays, which account for about 60 percent of the economy, will be unchanged after gaining 0.7 percent in the previous period, according to the median estimate of economists surveyed.

The likely slowdown in the second quarter contrasts with reports from Japan’s biggest companies that signaled a better earnings outlook, even as the yen surges. Toyota Motor Corp., Honda, Sony Corp. and Panasonic Corp. were among firms that raised profit forecasts over the past two weeks.

Companies plan to step up investment in plant and equipment based on the improved earnings. Business spending gained 0.9 percent in the second quarter, compared with a 0.6 percent increase in the first three months, the survey of economists showed.

Investment Appetite

“The appetite for new domestic investment has steadily revived among manufacturers, despite the continuing shift of production overseas, thanks to the improved profits and higher operating rates that have resulted from robust exports,” said Ryutaro Kono, an economist at BNP Paribas in Tokyo.

Finance Minister Noda said this month low long-term interest rates are good for the government.

Kan’s focus on fiscal discipline has irked members of his ruling Democratic Party of Japan, which lost an upper-house election in July after he said he will consider doubling the country’s sales tax to 10 percent. He faces a party leadership vote next month.

“Political backlash may compel Kan to prioritize boosting growth and overcoming deflation,” said Hiroaki Muto, a senior economist at Sumitomo Mitsui Asset Management Co. in Tokyo. “The DPJ could be leaning toward a public spending binge” to win over voters, he said.

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

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