In a sharp turnaround from his predecessor, new Prime
Minister Naoto Kan has made fiscal reform a top priority ahead of a July 11
upper house election, vowing to consider doubling the 5 percent sales tax,
although not for at least two or three years.
"As shown by the Greek example, the market's view on
the size of outstanding public debt or sovereign risk has become very
severe," Kan said in a televised debate with other party leaders.
"If we could sustain the social welfare system forever
by issuing deficit financing bonds, there would be no need to bring up the
issue of the sales tax," he added. "But if left alone, our social
welfare system will collapse."
Credit ratings agency Moody's welcomed the plan as a step in
the right direction to fiscal health, but analysts said the long-mooted rise in
the consumption tax was vital for the targets to be met.
Indeed the Cabinet Office's projections showed that it would
not be able to bring the primary budget balance into the black within a decade,
as outlined in the fiscal plan, under the government's growth strategy, which
aims for an average 2 percent real growth by fiscal 2020/21.
Investors will be watching to see how the tax reform debate
progresses after the upper house election, which Kan's Democratic Party needs
to win to smooth policymaking.
Tuesday's plan did not factor in any tax hikes but said the
government should reach an early conclusion on overhauling the sales tax and
other taxes.
The fiscal program supported government bond prices, with
the benchmark 10-year futures prices edging near a two-year high hit earlier
this month.
"A hike in the consumption tax was politically taboo in
the past. Now it is becoming more realistic. That's one reason behind JGBs'
firmness," said Katsutoshi Inadome, a fixed-income strategist at
Mitsubishi UFJ Morgan Stanley Securities.
"That's not to say investors are convinced that fiscal
reform will succeed. They are watching whether the government can carry out the
reform," he added.
Ratings agencies have threatened to cut Japan's sovereign
debt rating unless it shows a credible plan to rein in its debt.
"The mention of tax is implicit recognition that
something along the lines of a tax hike would be necessary," said David
Cohen, director of Asian economic forecasting, at Action Economics in
Singapore.
Economists say the government needs to commit to raising the
sales tax to 15 percent or even 20 percent over the next 10 to 15 years to pay
for rising social welfare costs and a commitment to hike tax is needed to make
its fiscal plans look credible. But many also worry tax hikes could hurt
growth.
The plan lacked specific ideas of how to meet its long-term
aim of achieving budget balance targets and reducing its debt-to-GDP ratio —
now estimated at nearly twice the size of GDP, the worst in the developed
world.
Kan has put a debate on a consumption tax hike at the heart
of the Democratic Party's campaign for the upper house poll, which the party
needs to win to ensure smooth policymaking.
Coalition dynamics could complicate the push for fiscal
reform if the Democrats fall short of a majority in the upper house, which can
delay bills, although analysts say a future sales tax rise is inevitable.
"At the end of the day, most people realize that a rise
(in the sales tax) is a question of time. It has to be done at some time and
the question is the timing and what should be done first," said Koichi
Nakano, a Sophia University professor.
Japan's 5 percent consumption tax rate is among the lowest
in major economies. It compares with 17.5 percent in Britain, 19 percent in
Germany and Greece, 10 percent in South Korea as of January 2010. New York City
imposes a 8.875 percent sales tax, according to the Cabinet Office.
The government pledged to do its utmost to keep new debt
issuance in the year to next March at or below about the 44 trillion yen ($483
billion) that has been earmarked for this year, while aiming to steadily reduce
bond issuance thereafter.
The government still has a massive pool of bank deposits to
fund its deficits in the near term. But fears that this could change in the
long term as an aging population starts drawing on savings have led to a rise
in demand for protection against the risk of default in Japanese government
bonds in the credit default swaps market.
To ease such concerns, the plan calls for Japan to bring its
primary budget balance into the black within a decade — a goal it has not met
since the bursting of an asset bubble early in the 1990s. The primary budget
balance, which excludes revenue from bond sales and debt-servicing costs, is
estimated at 30.8 trillion yen, or 6.4 percent of GDP in the current fiscal
year.
From fiscal 2021/22 the government will aim to stably lower
the debt-to-GDP ratio.
