Yes he Kan!
12 January 2010
Japanese economic policy news came thick and fast at the turn of the year. On the monetary front, on 1 December the Bank of Japan appeared to cave in to political pressure, holding an unscheduled policy meeting to agree a new fund-supplying facility. On the fiscal front, the Hatoyama government announced in early December its supplementary budget for the remainder of the present fiscal year, and, on Christmas Day, the draft budget for the forthcoming fiscal year (FY10). And to cap it all, early 2010 saw the resignation of Finance Minister Hirohisa Fujii and his replacement by Deputy Prime Minister Naoto Kan.
The prime reason for Fujii’s resignation was ostensibly medical – the septuagenarian was hospitalised at end-December complaining of exhaustion and high blood pressure. But the subtext was one of personality clashes and dysfunctional government. In particular, it was well known that Fujii failed to see eye to eye with Ichiro Ozawa, the Secretary General and kingmaker within the ruling DPJ, who seems to have untrammelled influence on policy from behind the scenes. Reportedly, Fujii privately told Hatoyama that he was unwilling to continue in his job if Ozawa maintained that influence. And the fact that Fujii was subsequently replaced by Kan – one of Ozawa’s closer acolytes – suggests that Fujii lost that argument. Whatever, it is clear that personal relationships rather than differences in policy were the key underlying factor behind for Fujii’s departure.
Nevertheless, for better or worse, new Finance Minister Kan offers scope for changes to economic policy. And early indications suggest that Kan is likely to be less conservative than his predecessor. Most obviously, Kan’s comments in favour of a weaker yen already contrast markedly with the ambiguity of his predecessor’s position with respect to exchange rate policy. However, as Kan has subsequently conceded, at the present level, there seems no case for active market intervention to weaken the yen. And, if our forecast of gradual yen depreciation through the coming months is right, nor will such a need arise soon. Therefore, instead of manipulating the yen, Kan’s first key challenge as Finance Minister ought to be fiscal policy, with the need to steward the passage through the Diet of the budget packages announced in December.
Most importantly from the perspective of the bond market, Fujii’s FY10 budget is designed to meet the government’s commitment to limit new JGB issuance in the coming fiscal year to ¥44.3trn, down from the record ¥53.4trn in FY09. To achieve this, spending is to be cut by more than some cabinet members – notably Financial Services Minister Shizuka Kamei – had argued for. Ahead of the announcement of the budget, Kan was highly critical of those calls for extra spending. And given his active role in the budget’s planning process, Kan should already have sufficient ownership of Fujii’s plans to provide confidence that there will not be immediate slippage from the ¥44.3trn issuance target. So while Kan may well in due course seek a supplementary stimulus package if the economy takes a turn for the worse in H110 – not least because the government has an eye on the Upper House elections scheduled for July – we expect Kan to ensure that public spending and JGB issuance will initially be capped in line with Fujii’s proposal.
Confirmation that new JGB issuance will be limited to little more than ¥44trn has earned the government some temporary breathing space from the ratings agencies. However, according to Fujii’s budget arithmetic, government bond debt as a share of GDP will rise 7 percentage points in FY10, maintaining the relentless upward drift in the debt stock. And so the future direction of Japan’s ratings will be highly dependent on the government’s medium-term plans, with negative actions possible if a credible consolidation programme for coming years is not articulated soon. So the onus is on Kan to define a plan to stabilise and then reduce the government debt stock over the medium term. In this respect, his comments over the past weekend that – contrary to the DPJ’s existing policy – a rise in the consumption tax might need to be placed on the agenda as soon as 2011 if insufficient spending savings can be found from elsewhere, suggest that Kan might be willing to think the unthinkable on tax policy. And given the extent to which the revenue base has eroded over recent years, the bond market should welcome his willingness to consider such a relatively simple and efficient source of additional tax receipts as soon as sustainable growth has returned.
Kan certainly has more than enough on his plate guarding Japan’s fiscal sustainability. However, he will also be keeping a close eye on the actions of the BoJ. Indeed, it was Kan who upped the political pressure on the BoJ last November by emphasising that the central bank had a responsibility to act to end deflation. And given the BoJ’s failure to deliver a definitive end to deflation over the past decade – and the likelihood that deflation will persist throughout 2010, 2011 and probably at least some of 2012 too – we can expect no let up in Kan’s determination for the BoJ to do more over coming months. Having chalked up one victory against the BoJ at the end of 2009, Kan will be looking for more in 2010, with an increase in the BoJ’s monthly JGB purchases from the present level of ¥1.8trn a key goal – a move which, conveniently for Kan, would also ease concerns about the market’s ability to absorb the current high level of JGB issuance.
Japan: Public spending, revenues and new government bond issuance*
* FY09 & FY10 reflect latest policy annoucements. Source: MoF.
Chris Scicluna, Head of Economics
Disclaimer:
This research report is produced by Daiwa Securities Capital Markets Co., Ltd and/or its affiliates and is distributed by Daiwa Capital Markets Europe Limited in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by The Financial Services Authority and is a member of the London Stock Exchange, Chi-X, Eurex and NYSE Liffe. Daiwa Capital Markets Europe Limited and its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.
This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FSA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.
Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-and-regulatory. Regulatory disclosures of investment banking relationships are available at http://www.daiwausa.com/.
For more details, please contact:
Chris Scicluna, Economic Research
Daiwa Capital Markets Europe Limited
5 King William Street, London, EC4N 7AX
+44 (0)20 7597 8326
For up to date Research analysis, see our blog site here.