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Japan's Obuchi Can't Coast Yet

TOKYO -- Celebrating his first year in office last Friday, Prime Minister Keizo Obuchi had a lot to be happy about. For the first quarter of the calendar year, Japan posted a stunning 7.9% annualized growth rate. The benchmark Nikkei Index has risen 29% since January. And bank shares, which represent the health of one of Japan's most troubled sectors, have seen even more impressive gains, up 37.5% this year.

On the political front, Obuchi has never been stronger. He's a shoo-in to win another term this September as president of the ruling Liberal Democratic Party (LDP). He's also on the verge of drawing yet another opposition party into his coalition government, a move that will give him full control of both houses of the Japanese parliament, the Diet.

In the court of public opinion, Obuchi's looking buff as well. A media poll released on Friday showed his cabinet with an impressive 57% public approval rating. Not bad for a man who entered office as one of the least popular incoming prime ministers in postwar Japan.

So everything is just peachy for the leader as he enters his second year in office, right? Not quite. The road ahead is mined with traps that could cripple his leadership and slow his drive to return Japan to sustainable growth.

For starters, Obuchi may be expanding his coalition to include the Komeito, Japan's second-largest opposition force, but it's not yet a done deal. Problem is, the LDP's current junior coalition partner, the Liberal Party, is worried it will be eclipsed by the larger Komeito, and is threatening to bolt.

Since an LDP-Komeito coalition alone would still control majorities in both houses of parliament, this isn't politically life-threatening for Obuchi. Nevertheless, an awful lot of LDP lawmakers worked hard to bring the Liberals on board. They'll have their knifes out for the prime minister if he lets the party leave.

An even bigger problem for Obuchi, however, is complacency. With the economy showing renewed signs of life, the sense of crisis that enveloped Nagata-cho, Japan's political district, when he first took office has largely evaporated.

During Obuchi's first eight months, he focused almost entirely on bailing out the country's foundering financial system and approving budgets stuffed full of public works spending to jolt the economy back to growth.

Since this spring, however, his administration has devoted an astonishing amount of energy to legislation that seems frivolous or inappropriately timed when considering the major economic problems at hand.

Earlier this month, the lower house approved legislation to give legal status to Japan's national flag and anthem. On Thursday, the Diet passed a bill to pave the way for parliamentary discussions to revise the nation's constitution. The ruling coalition is also moving to approve wire-tap legislation and a bill to assign national identity numbers to every Japanese citizen.

Granted, the coalition can walk and chew gum at the same time. But deliberations on these matters are drawing lawmaker attention away from important issues that impact the economy, such as settling how a new nursing care plan will be funded, pension reform, tax reform and a whole slew of competitiveness measures that Obuchi has promised to get passed this year.

To be sure, no one seriously doubts that lawmakers will be distracted from pumping up the economy with more fiscal outlays. Given the likelihood of a negative second-quarter GDP figure, Obuchi will almost certainly implement another 5 to 10 trillion yen supplementary budget this fall.

Continued lawmaker enthusiasm for structural reform, however, is another question. It's possible that Japan may finally be headed into a cyclical recovery. Just last Thursday, the government reported that industrial production jumped 3% in June, the largest month-on-month increase in two-and-a-half years. Yet if lawmakers are lulled into the belief that they've fixed things with their massive pork-barrel spending, there's a real danger they'll ease up on initiatives intended to generate painful economic restructuring.

This would not only jeopardize prospects for long-term growth. It would also scare off many of the foreign investors who have been funneling money into Japan's stock market this year partly on the belief the Obuchi administration is committed to genuine restructuring.

Japan apparently needs to feel an acute sense of crisis to achieve meaningful economic reform. Without it, the country's hidebound politicians, who depend on bloated industries for political support, have little incentive to seek real change. Ironically, the strengthening yen may be just the kind of pressure this country needs to keep the lawmakers focused on reform.

Since entering office 12 months ago, Obuchi has employed an effective three-pronged economic strategy. He's revved up the economy with huge spending packages. He's expanding the social safely net to ease the pain for the growing ranks of unemployed. (Unemployment hit a new historic high of 4.9% in June.) And, he's been taking steps to impose greater market discipline on certain areas of the economy, particularly the financial sector.

So while Obuchi deserves a warm pat on the back for his first year's accomplishments, he better not let success go to his head and forget the importance of the third prong of his economic strategy. Because if he does forget, Japan may get growth, but it won't be sustainable. And that could ultimately be the prime minister's undoing.

John F. Neuffer, a longtime observer of Japanese politics, is an analyst at Mitsui Marine Research Institute (MMR). He writes occasional commentary for TSC. Neuffer publishes an in-depth roundup of Japanese politics at his Web site, behindthescreen The views expressed above are those of Neuffer and not necessarily those of MMR. This column is exclusive to TheStreet.com.

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