JAPAN'S CURRENT FISCAL STATUS, FY2003

JAPAN'S CURRENT FISCAL STATUS, FY2003

The Japanese fiscal balance has deteriorated significantly over the past 12 years (FY1991-2003), raising concerns about the need for comprehensive reform and the sustainability of the current system. While the current economic recovery may moderately improve tax revenues in FY2004, truly comprehensive reform has largely been postponed, with the result that the long-term prospects for national government finances remain problematic at best.

At their peak in FY1990, Japan's central government tax revenues reached ¥60.1trn, equal to 13.6% of nominal GDP. However, since then, such revenues have consistently contracted, due to protracted deflation attending the collapse of the "bubble" economy and tax break initiatives (both personal income tax and corporate tax) aimed at stimulating the economy. Thus, by FY2003, tax revenues declined to about ¥42trn, equal to 8.5% of nominal GDP.

As for expenditures, the increase has been caused by the mounting social security related expenditure (i.e., medical-related and pension-related expenses) owing to the graying of Japanese society, local tax transfers (an mandatory obligation of the central government to local governments), and the increasing debt servicing costs (mostly rising fixed-rate provisions.) Though the total amount of expenditures recorded its peak in FY2000, the general expenditures have declined for three consecutive years through the government's fiscal consolidation efforts.

The necessity to make up for revenue shortfall and increasing expenditures caused issuance of government bond. Bond issuance in FY1999 reached its record high of ¥37.5 trn. In spite of the recent effort to decrease the bond issuance, the bond issuance is still high and bond dependency hit a record high of 44.6% in the FY2003 budget.

According to the "OECD Economic Outlook" issued in December 2002, the gross debt in Japan has increased rapidly and will be 151.0% of GDP on a general government basis in CY2003, while the gross debt of other major advanced countries have continued to decrease (see chart below).

According to the estimate of the Japanese Government, the ratio of government gross debt to GDP (on a general government basis excluding social security) will be approximately 153.4% at the end of FY2002 (after revision) and approximately 163.3% at the end of FY2003.

Is the current Japanese fiscal status and outlook sustainable? The government of Prime Minister Koizumi is maintaining a moderate tightening fiscal policy stance, while enacting a series of measures designed to reform the pension system (i.e., raising annual premium rates) and cut the asset base of the Fiscal Loan Fund Special Account (i.e., control FILP bond issuance).

Talk of tax increases continue, but remain clouded by political posturing around the effectiveness and timing of any hike. Yet despite the erosion of Japan's household savings rate, Japan's private sector still appears to be fully capable of financing public deficits equating to more than 8% of nominal GDP thanks to the restructuring of debt in the corporate sector. Many Japanese companies continue to use their free cash flow to to pay down interest-bearing debt rather than pursue further investment activities or dividend increases. Consequently, net public sector savings as a percentage of GDP increased from 0.4% in FY1990 to 10.5% in FY2003.

To be sure, an upturn in the Japanese economy may improve tax revenues, but at the same time threatens the government's debt management with the onset of higher debt service costs via increased interest rates. Tax revenue would need to increase more than expenditure growth in order to stave off the worsening fiscal deficit.

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