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Wednesday, December 20, 2006

Japan: Fiscal Tightening Ahead

Koji Omi, Japan's finance minister, claimed yesterday that the gross domestic product deflator - an important measure of deflation - would turn positive in the year to March 2008 for the first time in a decade:

“The GDP deflator for the current fiscal year was minus 0.4 per cent, and that will become plus 0.2 per cent in fiscal 2007/08,” he said. “That shows the economy will become normal.”

Not everyone is completely convinced however:

Robert Feldman, economist at Morgan Stanley, said the disappearance of deflation as measured by the GDP deflator would be an important moment if it came true. However, he said that five years of economic growth were feeding through more slowly than expected into inflationary pressure.

This is just the point. As I have been arguing, consumer demand is proving to be much weaker than might have been expected, and this is raising doubts whether Japan can, finally, escape deflation.

Inflation has yet top break the 1% mark, and the yen is running still at historic lows against the euro, and is fairly weak against the dollar, both circumstances which are likely to be inflation positive.

At the same time Prime Minister Shinzo Abe seems determined to try to move forward to address the government debt situation, so that may well help explain the reluctance, commented on yesterday, of the BoJ to raise interest rates.

In fact the cuts they are looking at are no mere trifle:

Japan's government may eliminate its budget deficit earlier than the target date of 2011, Finance Minister Koji Omi said, confirming Prime Minister Shinzo Abe's commitment to cutting the world's largest public debt.

``If we just persist a little longer we may even be able to come in ahead of schedule,'' Omi said today in Tokyo after his ministry proposed reducing new bond sales by a record and curbing spending on public works in the year starting April 1.

The so-called primary deficit, the gap between revenue without new bond sales and annual spending excluding interest payment on debt, will decline to 4.4 trillion yen in fiscal 2007 from 11.2 trillion yen this year, improving for a fourth year. The government in July said it wants to eliminate the primary deficit by 2011 to stop the public debt from expanding.

So they would be aiming to make 7 trillion yen of savings in one fiscal year. Since this saving is only to come from a reduction in borrowing, and since interest rates are still only at 0.25% (and thus could not be claimed to have been excessively driven up by government borrowing), it is hard to see where the uptick in demand is going to come from to compensate for the cuts.

So it is hard to see the BoJ being especially vigorous with trying to raise rates, and it is hard to see where the inflationary pressure they are going to need to get themselves out of the mire of deflation is actually going to come from.

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