Trouble ahead

Japan shuns fiscal cliff, won't escape growth funk

Japan has avoided fiscal harakiri. The decision by the country’s opposition parties to stop blocking the government’s deficit-spending plans is a big relief for an economy that shrank by an annualised 3.5 per cent in three months through September 30, and is likely to contract again in the current quarter.

Exports are stumbling amid weak global demand and a boycott of Japanese-made goods in China. Amidst this, government spending worth eight per cent of GDP was in jeopardy because of the parliamentary stalemate, according to Fitch.

As part of the deal to end the political deadlock, Prime Minister Yoshihiko Noda has agreed to call for elections, which may take place as early as next month.

If the conservative LDP wrests power from the ruling Democratic Party, newly elected LDP leader Shinzo Abe will be prime minister for a second time. Among the first things Abe did during his first stint as premier between September 2006 and September 2007 was to slash his own pay by 30 per cent and call for a reduction in public spending.

Fiscal belt-tightening was a bad idea back then, especially as the central bank had just prematurely ended its five-year-old quantitative easing programme.

With the Bank of Japan (BOJ) playing spoilsport even now, Abe will hopefully not repeat the mistake of preaching the austerity mantra at the wrong time. Consumer demand is already at risk as a result of the planned doubling of the sales tax that conservatives like Koji Omi, Abe’s finance minister in 2006, have for long advocated as a step toward fiscal rectitude.

To his credit, Abe recently urged the BOJ to be bolder and adopt a three per cent inflation target. That’s pragmatic. Japan badly needs to convince domestic savers that the yen balances in their bank accounts will be worth less tomorrow.

To give Japan’s struggling electronics exporters a chance, investors need to be persuaded to swap yen for dollars. Besides, a sudden bout of inflation could also reduce the government’s debt load, which will reach 237 per cent of GDP by the end of 2012, according to the International Monetary Fund. By contrast, untimely fiscal conservatism will just push Japan’s economy deeper into funk.