Analysis: Japan's economic dilemma

By Shinya Ajima, Kyodo

Posted at Nov 13 2012 12:35 PM | Updated as of Nov 13 2012 11:20 PM

TOKYO - When the government released data Monday on Japan's negative third-quarter growth, it may have realized that its efforts to find a balance between stimulus and austerity are dead in the water.

The impasse, which complicates Prime Minister Yoshihiko Noda's drive toward a higher sales tax, key to solving Japan's serious fiscal problems, could again lead the government to easily depend on the Bank of Japan to boost the stagnant economy.

But a major difficulty facing the government is that the central bank no longer wants to serve as a handy tool toward that end.

"We want the BOJ to proceed with powerful monetary easing to beat deflation," Seiji Maehara, economic and fiscal policy minister, told reporters after the Cabinet Office data showed the Japanese economy shrank an annualized real 3.5 percent in the three months through September, adding to the evidence that it is in a recession.

A man walks past the Bank of Japan in Tokyo October 23, 2012. / REUTERS

Still, Maehara apparently tried to avoid adopting a posture threatening to the bank, saying, "The government must implement various policies as well, including fiscal (reform), deregulation and strengthening growth potential."

Maehara's mixed remarks reflected a rare joint statement released by the government and the BOJ last month, in which they outlined what they must do respectively to secure an exit from Japan's chronic deflation.

The central bank pledged to maintain ultraloose monetary policy until 1 percent annual inflation is in sight, while the government promised to seek structural reforms.

The October statement will help to protect BOJ Governor Masaaki Shirakawa, who has frequently found himself in the crosshairs of stimulus-minded lawmakers during parliamentary sessions, from excessive demand for monetary easing.

In a speech Monday, Shirakawa said he "strongly expects the government to vigorously promote measures for strengthening Japan's growth potential."

Nevertheless, with or without pressure on the BOJ, there is little prospect that the world's third-biggest economy will turn up immediately.

A number of analysts forecast that the economy will continue contracting in the fourth quarter of the year as they cannot expect a dramatic recovery in private consumption and business investment, while exports are likely to remain weak on the global economic downturn in the wake of the eurozone sovereign debt crisis.

"It is highly likely that the economy has already entered a recessionary phase," economists at Nomura Securities Co. wrote in a report. "Consequently, the timing of beating deflation may be delayed, and this would make the BOJ more inclined toward easing policy."

Some analysts suggest the bank cannot help bowing to pressure to help underpin growth when the government only has limited room for fresh fiscal stimulus due to worsening public finances.

The Japanese government has internationally pledged to achieve its self-imposed fiscal discipline goals in fiscal 2015 and 2020 and is currently expected to barely meet them.

Considering that Japan's improved fiscal discipline is a major premise of the planned consumption tax increases in fiscal 2014 and 2015, it seems difficult for the government to easily unleash stimulus to boost the economy.

But at the same time, the government has set different goals of achieving nominal 3 percent and real 2 percent growth before raising the controversial tax.

Although they are nonbinding, some lawmakers say the government cannot ignore the targets completely, and that attaining them without any stimulus would be rather challenging.

"There is a high possibility that the economic situation in the April-June period of 2013 would not warrant raising the consumption tax," said Hiromichi Shirakawa, chief economist at Credit Suisse Securities (Japan) Ltd.

In any case, the BOJ can hardly quit as the lender of last resort -- not only to the banking sector but, in this case, to the economy as a whole.

Given a looming general election, which must be held by next summer, Noda is apparently mindful of stabilizing the economy.

In October, he introduced a 420 billion yen (around $5.3 billion) stimulus package, using contingency funds and not issuing any new debt.

While the premier has said a full package of emergency measures will follow this month, analysts doubt whether they would be powerful enough to turn around the situation, pointing to uncertainty over how much the government could spend from its coffers.

Hideo Kumano, chief economist at the Dai-ichi Life Research Institute, said that after all the BOJ will again be pressed to lead the battle against deflation, although it eased monetary policy in September and October.

"It is inevitable a burden will be placed on the central bank at a time when fiscal firepower is very limited," Kumano said.