Japan set ambitious targets to rein in its debt today but admitted they would not be met even under its rosiest growth scenario, increasing the likelihood of politically contentious tax hikes to fill deep fiscal gaps.
In a sharp turnaround from his predecessor, new prime minister Naoto Kan has made fiscal reform a top priority ahead of an upper house election next month, vowing to consider doubling the 5 per cent sales tax, although not for at least two or three years.
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.
Investors will be watching to see how the tax reform debate progresses after the upper house election, which Mr Kan's Democratic Party needs to win to smooth policymaking.
Today'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 programme supported government bond prices, with the benchmark 10-year futures prices edging near a two-year high hit earlier this month.
Ratings agencies have threatened to cut Japan's sovereign debt rating unless it shows a credible plan to rein in its debt.
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.
Mr 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.
Japan's 5 per cent consumption tax rate is among the lowest in major economies. It compares with 17.5 per cent in Britain, 19 per cent in Germany and Greece, 10 per cent in South Korea as of January 2010. New York City imposes a 8.875 per cent 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 ageing 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 per cent of GDP in the current fiscal year.
From fiscal 2021/22 the government will aim to stably lower the debt-to-GDP ratio.
But the Cabinet Office estimated that neither the budget balance goals nor the debt-GDP ratio goals could be met under the government's growth strategy, which aims for an average 2 per cent real growth by fiscal 2020/21.
Reuters