Fitch: Public Debt to Remain High Under Japan Fiscal Plan

A multi-year fiscal plan approved by the Japanese cabinet on 30 June does not increase the likelihood of the country's high public debt ratios beginning to decline in a sustainable and substantive manner any time soon, says Fitch Ratings. The strategy focuses on enhancing growth through structural reforms as the guiding principle for fiscal consolidation. Many of the planned reforms are positive for enhancing productivity and encouraging investment, but Fitch believes that the government's expectations of their effect on growth are highly optimistic. 

The government's plan targets achieving a primary deficit of 1% of GDP by 2018 on the way to a balanced budget by 2020, through raising potential growth to above 2%. Notably, beyond previously announced plans to raise the consumption tax by two percentage points to 10% in April 2017, the government is relying almost wholly on economic growth to increase tax revenue. 

At the same time, the central government has not set a hard cap on general spending, though it aims to keep annual increases in general spending to JPY1.6trn through to the fiscal year to March 2018. The lack of a hard cap leaves room for fiscal slippage. The government's plans to control expenditure focus on improving efficiencies through technology, innovation, greater use of the private sector in the provision of public services and reforming incentives, which are broadly positive for long-term efficiency, but are not likely to curb expenditure growth materially over the medium term. 

The reliance on economic growth for fiscal consolidation comes with risks. The planned consumption tax hike in 2017 is likely to have a negative effect on household spending. If this is larger than expected by the government, it could undermine the fiscal plan's long-term growth assumptions. 

Furthermore, Japan's primary deficit has narrowed recently, due in part to a cyclical macroeconomic upswing. However, the IMF estimates that the Japanese economy is operating at near-potential. This suggests that the prospects for a further cyclical acceleration in economic growth are limited, and the economy will provide less support to narrowing the primary deficit in future. Judged from a cyclically adjusted basis, Japan's reduction in the primary deficit has been unremarkable relative to other advanced economies. 

Japan's Foreign- and Local-Currency Issuer Default Ratings were cut to 'A'/Stable from 'A+'/Rating Watch Negative on 27 April. Japan's main sovereign credit and rating weakness is the high and rising level of government debt.