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Objections Swell Over Obuchi's Handling of Economy

Editor's Note: This will be John Neuffer's final column for TSC. On May 1, he will join the Office of the United States Trade Representative in Washington, D.C., as deputy assistant USTR for Japan. As a trade warrior for the U.S. government, he will no longer be commenting on the news, but making it. Neuffer's pithy and insightful biweekly columns from Tokyo on Japanese politics and their influence on the world's second-largest economy will be sorely missed. We wish him well as he endeavors to crack open markets in Japan for U.S. companies doing business there. -- AKM

TOKYO -- Big spending is turning into a big problem for Japanese Prime Minister Keizo Obuchi. Earlier this year, powerful rivals in the ruling Liberal Democratic Party, or LDP, began blasting Obuchi for his heavy reliance on expansionary fiscal policies to put the economy back on its feet and his inattention to Japan's ballooning public debt, soon to reach 130% of GDP.

Indeed, that growing deficit is back in the news. Last Thursday, Moody's Investors Service announced that it's considering another downgrade of Japanese government debt, citing concerns over the nation's growing budget deficit. In November 1998, the ratings agency clipped Japan's pristine AAA rating.

Overseas ratings agencies aren't the only ones attacking Obuchi's fiscal policies. Last week, Tokyo Gov. Shintaro Ishihara submitted a controversial proposal to his city assembly to impose a 3% tax on gross profits of about 30 of Tokyo's largest banks for five years starting April 1. Facing a 700 billion yen funding shortfall for fiscal 2001, Ishihara's message to the Obuchi administration was brutally simple: You guys may not have the guts to deal with the national debt, but I'm not waiting around to watch my city drop into a fiscal abyss.

Claiming the local bank tax threatens to undermine Japan's fragile economy, the LDP, the Ministry of Finance and the banking industry have thrown up stiff opposition to Ishihara. Nevertheless, the tax is almost sure to pass before the end of this fiscal year on March 31. Tokyo taxpayers overwhelmingly support the measure and all the key parties in the metropolitan assembly have signed onto the scheme.

Not surprisingly, the new tax has helped to accelerate the fall in Japanese bank shares that began three months ago. Since Ishihara's Feb. 7 tax-hike announcement, the TOPIX bank index has plunged roughly 12%. Bank of Tokyo-Mitsubishi (MBK), the country's largest bank, has fallen 9%.

What's really troubling for Obuchi and the banks is that other municipalities may follow suit. Already the LDP members in the Osaka assembly have said they intend to introduce a similar levy on large banks operating in that city, which is also awash in red ink.

In a thinly veiled attempt to prevent further insubordination from local governments around Japan, the LDP's tax council leaked to the press last week that it's considering a new nationwide tax on all firms, not just banks, starting from April 2001. But only if the economy recovers.

Ishihara's revolt is not the only recent affront to Obuchi's spendthrift ways. The Japanese public is growing increasingly concerned about Japan's public debt. The Nihon Keizai Shimbun, Japan's biggest business daily, published a public-opinion survey last Tuesday showing that nearly 70% of Japanese feel fiscal spending should be curtailed to avoid future tax hikes. This despite the fact that 63% of the respondents in that survey don't think the economy is headed for recovery anytime soon!

Attacks on Obuchi's big spending are the last thing he needs right now. The prime minister is getting beaten up in parliament over allegations that one of his aides improperly obtained stocks in NTT DoCoMo (owned in part by telephone giant Nippon Telegraph and Telephone (NTT)) that made him fabulously wealthy. Obuchi's popularity is on the wane. And he must hold a lower-house election before Oct. 20.

Nevertheless, Obuchi's not about the stop pumping up the economy with taxpayer money anytime soon. This economy, which is poised to tip back into a technical recession next month, couldn't survive a sudden pullback in spending right now. Furthermore, the prime minister knows that it would be political suicide to restrict the flow of the public spigot because thousands of small firms that support the LDP, particularly in the construction industry, would immediately go bust. That's not a pre-election scenario he could tolerate.

So the 85 trillion-yen budget for fiscal 2000 -- easily the biggest spending package in Japanese history -- will win passage in the parliament as is by the end of March.

But the longer-term prospects for Obuchi's expansionary polices are anything but certain.

Given the recent groundswell of support for fiscal restraint in Japan, watch for him before the election to start taking up the virtues of fiscal consolidation in an attempt to neutralize fiscal hawks in the LDP who want his job. This suggests the markets should begin to price in a decidedly modest supplementary budget this fall.

Of course, if the economy comes on strong later this year, Obuchi will be able to reverse course on fiscal policy more easily, presuming he survives the election. But even if the economy continues to sputter, with the budget deficit only getting worse and with the Japanese people becoming genuinely alarmed about the country's fiscal future, the prime minister may still be forced to start reining in the debt. And what would that mean? The government would have to resort to its last line of defense -- printing money like there's no tomorrow to re-inflate this economy and compel consumers to bolster their spending on the expectation that prices are going up.

When Obuchi came to office in July 1998, the Japanese economy was in a tailspin and beefy spending packages were the order of the day. But those crisis days have passed. Fiscal consolidation is politically in play again. If Obuchi fails to respond to this, he might be looking for a new job after the next election.
John F. Neuffer, a longtime observer of Japanese politics, is an analyst at Mitsui Kaijyo Research Institute (MKR). He writes biweekly commentary for TSC and publishes an in-depth roundup of Japanese politics on his Website, behindthescreen.com . The views expressed above are those of Neuffer and not necessarily those of MKR. This column is exclusive to TheStreet.com.

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