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Thursday, 9 August, 2001, 16:53 GMT 17:53 UK
Japan's budget tussle hots up
Japanese workers take a break
Japanese unemployment is expected to rise further
By BBC News Online's Mary Hennock

Japan's government is due to publish its draft budget on Friday at a cabinet meeting which is being billed as a test of Prime Minister Junichiro Koizumi's reforms.

The budget is likely to be the first one in four years to set general expenditure below the previous year's level.

Guidance from the body drawing up the budget, the Council on Economic & Fiscal Policy (CEFP), suggests total expenditure will be about 48,000bn yen ($394bn; 276bn), a cut of 1,000bn yen on 2001.

The two key elements of the budget for the fiscal year from April 2002 to March 2003 will be a 10% cut in spending on public works and a cap on new government borrowing.

No more safety net

Both policies aim to curb spending on civic construction projects and other measures which Mr Koizumi's Liberal Democrat Party (LDP) has used to cushion failing Japanese companies from bankruptcy during 10 years of sluggish economic growth.

The budget approval process is taking place amid increasing signs of political friction in the cabinet as Mr Koizumi's decision to remove these safety nets is bound to bring job losses and hardship to core LDP supporters - particularly small and medium-sized firms and farmers.

I'm pretty certain he'll get what he wants on paper, and then the hard work starts

Noriko Hama, Mitsubishi Research International

Political infighting is visible in the battle between two slogans representing fundmentally different strategies, said Noriko Hama, chief economist at Mitsubishi Research International.

One is Mr Koizumi's election rallying cry of "gain through pain". The other slogan is "go for growth", and surfaces in the form of public advice to the prime minister by members of the LDP old guard such as defeated leadership contender Shizuka Kamei, said Mrs Hama.

Faction fighting

Inside the cabinet, trade minister Takeo Hiranuma spelled it out: "If small and medium-sized firms are carrying on normal operations and can make a profit, maybe it is one idea [for banks] not to dispose of bad loans to those firms for the time being."

But Mr Koizumi's popularity and the mandate he won in the July parliamentary elections means the opposition within his party remains muted.

"I'm pretty certain he'll get what he wants on paper, and then the hard work starts," Mrs Hama said.

"We've got six months of really complicated politics," agreed Kenneth Courtis, vice-chairman of Goldman Sachs Asia.

Budget outline

In the draft, the CEFP has proposed cutting 5,000bn yen from public works spending, 10% of the total.

Scores of government agencies are going to see their budgets slashed so they're going to have to focus for the first time on how they use their resources

Kenneth Courtis, Goldman Sachs Asia

About 4,000bn yen is likely to be redistributed towards Mr Koizumi's seven priority projects including education, housing, the renewal of industry and the revival of cities.

The result will be a net cut of 1,000bn yen.

In the process, government agencies must find 3,000bn yen of savings, mostly by shelving public works projects.

"Scores of government agencies are going to see their budgets slashed so they're going to have to focus for the first time on how they use their resources", said Dr Courtis.

Watch out for implementation

Not surprisingly, officials are as divided as politicians on the reforms, making implementation of the budget into a crucial battleground for the future.

They will also face pressure as a result of Mr Koizumi's pledge to cap new government borrowing by setting a limit of 30,000bn yen on new issues of Japanese government bonds (JGBs) in the 2002 fiscal year.

This is essential to remove the "Himalaya of debt crashing down on the economy", said Dr Courtis.

Government on-balance sheet debt has tripled in 10 years from 51% of gross national product (GNP), he said.

In addition, banks have provided small companies with loans worth 280% of Japan's GNP making a total debt load in excess of 400% of GNP.

For comparison, he points to Britain's debt at the end of World War II, which was a mere 254% of GNP.

To round off the problem, Japan will need to recapitalise the banks, which is likely to require $500bn-600bn.

Supplementary budget

It remains to be seen if there is the political will to implement the painful reforms needed to sort this situation out.

Even Mr Koizumi's seven priority projects have the potential to become a vehicle to preserve the public works projects the government has pledged to cut.

Furthermore, there is the prospect of a supplementary budget in spring 2002.

Finance minister Masajuro Shiokawa told a news conference on Tuesday that the government would increase spending if necessary.

"If there are clear signs of a drastic deterioration in the economy, we will consider extra spending," he said.

"The devil's in the detail and we face a hellish financial situation," Dr Courtis said.

See also:

30 Jul 01 | Business
Markets fall after Koizumi's victory
29 Jul 01 | Asia-Pacific
Japan's Koizumi secures victory
29 Jul 01 | Business
Can Koizumi save Japan?
16 Jul 01 | Business
Gloomy outlook for Japan
31 Jul 01 | Business
Japan's jobless at record high
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