DPJ Policy Implementation Could Inflate Japan's Fiscal Deficits; Compensating Measures Will Be Key

Tuesday 01 September 2009 07:23
Standard & Poor's Ratings Services said today that the change in government heralded by The Democratic Party of Japan's (DPJ) landslide victory in the nation's general election on Aug. 30, 2009, is unlikely to positively or negatively affect the sovereign ratings on Japan (AA/Stable/A-1+) in the short term. However, Standard & Poor's believes that there is potential risk that the implementation of some of the incoming government's policies could lead to future fiscal overruns or higher fiscal deficits.

In Sunday's election, the DPJ wrenched control from the Liberal Democratic Party (LDP), which had dominated Japanese politics since it was formed in 1955. The victory resolves the fragmentation of power between the Lower House of parliament, which was controlled by the LDP-led coalition, and the Upper House, which is controlled by DPJ-led opposition parties. Although the DPJ won 308 seats, more than half of the 480 seats contested, it is expected to form a coalition as in the Upper House, as it does not enjoy a majority and will likely seek the cooperation of other parties, such as the Social Democratic Party and the National New Party.

The new government is expected to make numerous policy changes. From a sovereign ratings perspective, however, its fiscal and economic policies will be most important. Generally speaking, the DPJ's policies place greater emphasis on distribution and welfare than those of the LDP. The DPJ has pledged to increase child benefits, make public high school education free, and abolish highway tolls; policies that are slated to take effect in fiscal 2010 (starting April 1, 2010). Before the election, the DPJ gave an overview of the financial resources needed to implement such policies without increasing the size of the fiscal deficit. If the DPJ-led government can achieve reforms in budget allocation and improve the efficiency of the use of public funds, it would be positive from a sovereign ratings point of view. However, we see a lack of detailed measures to reduce the cost of government and reallocate the budget to mitigate increasing fiscal pressure that would result from the above initiatives. As such, there is a potential risk that the implementation of the DPJ's plans could lead to fiscal overrun or higher fiscal deficits.

The DPJ leader, Yukio Hatoyama, has said that he will not increase the consumption tax in the next four years, a comment similar to that made by former Prime Minister Junichiro Koizumi when he was reelected in 2005. As a general election for the Upper House of parliament is expected next summer, in our opinion, the DPJ-led government's fiscal policies will likely focus to a greater extent on policies that generate immediate results and those that take time such as structural reforms, after that election. As such, although there is no immediate impact from the change in government, there is a potential negative impact, depending on the future implementations of DPJ-led government policies and the macroeconomic environment in the medium term.

For local and regional governments (LRGs), the DPJ has proposed integrating various transfers to local governments and reducing the involvement of various ministries. This would make LRGs in Japan more independent in implementing policies from the central government and there would be more room for LRGs to improve efficiency of the use of public funds. This could potentially be a positive factor for the ratings on some of the LRGs, depending on the level of commitment and feasibility for further fiscal consolidation. If this policy is implemented, it could enhance the power of LRGs for self governance and increase their fiscal independence. Other measures include creating new fiscal adjustments and support mechanisms for LRGs by the central government, although the effect on the credit ratings on LRGs remains unclear. On the other hand, the central government will be challenged in significantly revamping its allocation budgets to various ministries to realize such a policy change.

The new government is also likely to review and reorganize government related entities. For example, there is potential for change to the process or structure of the privatization of Development Bank of Japan (AA-/Stable/A-1+). As a part of the policy for the abolition of highway toll fees, Japan Expressway Holding and Debt Repayment Agency's (JEHDRA, AA/Stable/--) debt, which amounts to ?35 trillion, could be transferred back to the government. However, we see no significant impact on the risk of repayments of the debt as the current ratings on JEHDRA are equal to those on the sovereign.

A Japanese-language version of this media release is available on Standard & Poor's Research Online at www.researchonline.jp, or via CreditWire Japan on Bloomberg Professional at SPCJ . Standard & Poor's, a subsidiary of The McGraw-Hill Companies (NYSE:MHP), is the world's foremost provider of independent credit ratings, indices, risk evaluation, investment research, and data. With approximately 10,000 employees, including wholly owned affiliates, located in 23 countries and markets, Standard & Poor's is an essential part of the world's financial infrastructure and has played a leading role for more than 140 years in providing investors with the independent benchmarks they need to feel more confident about their investment and financial decisions. For more information, visit www.standardandpoors.com.

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