Japanese Prime Minister Shinzo Abe is set on Tuesday to sign off on a plan to curb the world’s heaviest debt burden.
To approach his balanced budget target by 2020, Abe has to cap spending growth, get economic expansion to a level Japan hasn’t seen since 1991, and stoke inflation that's near zero.
And consumers -- who pushed Japan into a recession after a hike in the sales tax last year -- will have to stomach another bump in the tax without complaint.
“The fiscal target that the Abe administration is aiming for is so tough that it has no choice but to assume the most optimistic economic scenario,” said Hidenori Suezawa, an analyst at SMBC Nikko Securities Inc. “There’s a risk that if just one thing goes wrong, the whole plan blow ups.”
As the charts below show, Abe can point to signs of improvement, but still has a hard road ahead.
The government shortfall is starting to narrow, as a pick up in economic growth boosts tax revenue that imploded with the global financial crisis.
Much credit for recent progress goes to the central bank, which on cue from the Abenomics reflation agenda, is pumping unprecedented monetary stimulus into the world’s third-biggest economy. A 24 percent drop in the yen since Governor Haruhiko Kuroda launched the stimulus program in April 2013 is helping drive record corporate profits -- a windfall for tax receipts.
With leeway to buy all new bonds issued by the government, the Bank of Japan is also pushing borrowing costs below the pace of nominal economic growth. If that’s sustained over the long term, the government could grow out of its debt, said Toru Suehiro, an economist at Mizuho Securities Co.
Japan has a mountain of obligations, a legacy of years of borrow-and-spend policies that failed to lift the economy out of a deflationary slump. By the International Monetary Fund’s estimate, public debt will increase to 247 percent of GDP next year.
Taking into account the government’s financial assets, the picture looks a bit better. Net debt as a proportion of GDP leveled off in 2012. “The rise in asset values due to Abenomics has helped the government’s net debt stabilize,” said Masaki Kuwahara, an economist at Nomura Holdings Inc. “It’s a favorable trend in terms of the government’s fiscal sustainability.”
The ultimate goal in Abe’s fiscal consolidation plan is to put Japan’s budget into surplus by the fiscal year starting in April 2020, excluding interest payments on debt. He’s set a mid-term target for this so-called primary balance to be cut to a deficit to 1 percent of GDP by fiscal 2018, from 3.3 percent this year.
Projections by the Cabinet Office in February showed Abe was likely to miss his mark. Even under a scenario where the economy achieves nominal growth of up to 3.9 percent, there would still be a primary balance deficit in fiscal 2020. Under a less optimistic trajectory, with growth as low as 1.3 percent, the shortfall will be 3 percent of GDP, according to the February projections.
Since then, the administration has signaled its intention to restrain spending growth. It will aim to limit the total rise in general expenditure to around 1.6 trillion yen ($13 billion) over the next three fiscal years, the same pace as the past three years.
That isn’t enough to eliminate the deficit, and the temptation to keep spending is high, according to Suezawa.
“The chances are high that social welfare spending will increase faster in coming years given the pace of aging,” said Suezawa.