Can Koizumi Tame This Tornado?

Wrestling with the shadow budget

Two months ago, Junichiro Koizumi stormed into office as a latter-day Hercules ready to perform heroic deeds to revive Japan's moribund economy. The new Prime Minister said one of his chief targets would be wasteful spending. That meant flushing trillions of yen out of a peculiar Japanese institution called the Zaito budget.

Zaito is the Japanese moniker for the Finance Ministry's Fiscal Investment & Loan Program. For years, this monster--a cross between a bank and a public works administration--has funneled money by the bucketful from the savings, insurance, and pension funds managed by the Post Office into loans that financed thousands of public works projects. Because they don't directly involve tax money, Zaito's loans, many of them to pork-barrel projects sponsored by local politicians, never appear in the central government budget. Finances at Zaito--including the record of repayments--are so murky that its spending plans are dubbed the shadow budget.

MONEY MOUNTAIN. Most of the 77 state corporations that manage these projects amount to employment programs for prospective Liberal Democratic Party voters and retired bureaucrats. Last year, Zaito reported it distributed $313 billion, increasing its portfolio of loans to $3.6 trillion. This money mountain is one reason Japan blows 7.8% of its gross domestic product on public investments--twice what other developed nations spend. Tellingly, officials running Zaito keep a low profile. They declined to be interviewed for this story.

Koizumi has proposed an array of laws that amount to a sweeping overhaul of Zaito programs. That could involve selling off such money-losing goliaths as the Japan Highway Public Corp., terminating the satellite operations of the National Space Development Agency, and slashing spending to 13 research and development agencies. He also wants to force state companies to borrow more on the private capital markets rather than depend on loans and guaranteed bonds issued by Zaito. Realizing that they won't be able to count on postal money, some 20 Zaito corporations are already planning to issue $8 billion in conventional bonds and asset-backed securities in the fiscal year ending next March.

Some think Koizumi should go further and eliminate Zaito altogether. But his goal to purge it and whack the bureaucracy down to size is far more radical than anything his predecessors have done. The reform of Zaito dovetails perfectly with a longtime obsession of Koizumi: privatizing the Post Office and its financial arm, which holds the bedrock of Japanese savings in deposits, insurance policies, and pension funds, $3 trillion all told. Putting that money out of lawmakers' reach is all the more important because Japan's population is aging so fast. With more pensioners and fewer active workers paying in, the postal pension system has a net outflow of funds for the first time in nearly 70 years. That was enough to jolt lawmakers into action under Koizumi's predecessor, Yoshiro Mori. To preserve capital for pension payouts, the postal savings and retirement funds were no longer required to lend to Zaito projects as of Apr. 1.

The Finance Ministry has long insisted that only 1% of Zaito loans are duds. But no one believes that. People suspect the worst: that many of Japan's public corporations would be insolvent if Zaito didn't keep giving them fresh loans.

PICK UP THE TAB. But until Koizumi, no Japanese Premier wanted to peer too hard into the Zaito murk. Since most of the loans are guaranteed by the government, pulling the plug would force lawmakers to move the debts onto the general budget. That would drive the national debt to as much as 200% of GDP, figures American Enterprise Institute Japan watcher David Asher, and would require higher taxes and more bonds to be issued. That would be admitting that Tokyo, after misusing taxpayers' savings, wants them to pick up the tab.

But now, Koi-zumi's priority is getting a handle on Zaito's problem loans. In that he has found a kindred soul, improbably enough, in a career bureaucrat, Masahiro Horie, the ombudsman at the Public Management Ministry. Horie, appointed in April, 2000, runs a team of more than 1,100 inspectors who look into pork-barrel projects. Past ombudsmen just made sure projects were legal but never delved into their viability. Horie proved a different animal. His office just completed a study that found that billions of dollars went to unneeded runways at small, rural airports, such as the one on the southern island of Shikoku, which can now accommodate Boeing 747 jumbo jets. Horie's group has also unearthed bid rigging at the Defense Agency and wasteful medical schools. His findings are making their way into parliamentary debate. That, insists Horie, is proof that Tokyo is serious about getting "rid of roads to nowhere."

Another sign Koizumi is serious: The government seems to be preparing taxpayers for the worst by leaking bad news about the biggest debt bombs Zaito has funded. A state-financed resort called Seagaia in southern Japan went bust with $3 billion in debts, leaving the local government, which backed its bonds, with the tab. U.S. investment fund Ripplewood Holdings LLC bought the resort for an undisclosed--but presumably fire-sale--price. Meanwhile, in May, the government conceded that the Honshu-Shikoku Bridge Authority, which manages six bridges and has $34.6 billion in liabilities, is in trouble. The $1.2 billion in annual interest it pays is almost twice its annual income. That information is now on the Authority's Web site, a promising sign in itself.

The process of weaning the Zaito companies from their postal savings predates Koizumi. But he has given it new vigor. Bonds issued by the Zaito companies this year will no longer come with government guarantees. Nudging these outfits to compete for capital in the conventional debt market should force them to streamline, the theory goes. Trouble is, warns Kunji Okue, a debt analyst at Dresdner Kleinwort Wasserstein, it would only take "one [state] corporation to default to scare investors off all similar bond issues." In other words, a run on Zaito paper would dry up life-support financing.

Koizumi's hardest labors lie ahead. Getting money-losing companies off state books means assuming at least some of their debt. The popular Koizumi has public support now for his muckraking. The test will come when the long-suffering Japanese get the bill.

By Ken Belson and Brian Bremner in Tokyo

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