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Tuesday, Nov. 11, 2003

Deflation still Koizumi's bane

Prime minister set to soldier on with reform program

With the ruling coalition having won Sunday's House of Representatives election, albeit with a smaller majority, Prime Minister Junichiro Koizumi is expected to stick with his structural reform agenda.

But Koizumi has yet to devise effective measures to fight deflation, the biggest problem facing the world's second-largest economy.

Although the recent export-led recovery has been a godsend for the Liberal Democratic Party and its two junior coalition partners, voters are doubtful whether Koizumi will be able to realize the LDP's campaign pledge to achieve nominal economic growth of 2 percent or higher by the end of March 2007, given the nation's persistent price falls.

"That figure seems a bit high," said Naoko Nemoto, director of financial services ratings at Standard & Poor's. "The economy has begun recovering but deflation will continue for a few years," since Koizumi's policies -- particularly his drive to clean up the banking sector -- cause deflationary pressure.

Nemoto criticized the LDP for not spelling out specific measures aimed at achieving this target, which compares with the government's projection of 0.1 percent nominal growth in gross domestic product for fiscal 2003.

Nominal GDP fell 0.7 percent in fiscal 2002.

Financial markets also believe that the absence of substantial antideflation policies will make it difficult for Tokyo stock prices to climb above their current levels -- the Nikkei average is currently moving between 10,000 and 11,000 -- unless U.S. share prices rise sharply or the yen weakens significantly against the dollar.

Analysts say the Nikkei's current levels, well up from the 20-year low of 7,607.88 marked April 28, have been bolstered by pickups in the U.S. and in East Asian economies, as well as by aggressive corporate restructuring, rather than by rising personal consumption in Japan, a key factor in stemming deflation.

Koizumi, working with Financial Services Minister Heizo Takenaka, is expected to push forward his financial revitalization program in a bid to overcome the bad-loan problem by March 31, 2005, another pledge featured in the LDP election platform.

The program seeks to make banks conduct stricter loan assessments, set aside greater loan-loss reserves and strengthen their governance.

It also urges the managers of banks that have received public funds to step down if earnings fail to improve.

Analysts say that while the government is moving in the right direction in terms of transforming the financial sector, stronger measures are needed to prevent deflationary pressure from spreading throughout the economy.

They advocate, for example, greater use of the Industrial Revitalization Corp. of Japan, which helps indebted firms that are seen as being salvageable to rehabilitate.

The LDP's pledge to create 3 million jobs within two years apparently lacks specifics, although the party cites growing employment opportunities in the tourism, welfare and environmental sectors.

Koizumi's top reform initiatives -- privatization of certain postal services and of four road-related public corporations -- are also expected to have little impact on reversing price falls by stimulating domestic demand. The prime minister also faces the vital issue of reforming the nation's pension system amid a rapidly aging population.

Experts say that deregulation and tax cuts in certain areas are crucial to spurring the economy, especially as Koizumi has vowed not to pursue an expansionary fiscal policy in the form of public works spending.

The latter is a symbol of the pork-barrel agenda traditionally pursued by the LDP, which has governed Japan almost without interruption since World War II.

Yukari Sato, senior economist at J.P. Morgan Securities Asia Pte. Ltd., said the government should slash the effective corporate tax rate by 5 percent to 35 percent -- the average level for European states -- in order to avoid a further hollowing-out of Japanese industries and to lure more foreign direct investment into Japan.

The government could make up the tax revenue shortfall by having the Bank of Japan increase its outright purchases of long-term government bonds from the current 1.2 trillion yen a month, she said.

Sato also called for tax cuts related to capital investment, with capital spending expected to exceed exports in the spring as a leading force in terms of economic growth.

U.S. columnist Tom Plate urged Koizumi to take the lead in making the Japanese agricultural sector competitive via deregulation and severing the cozy ties between farmers and LDP lawmakers.

This is a vital issue if Japan is to play a greater role in moving forward stalled talks under the World Trade Organization and in formulating free-trade agreements with its Asian neighbors and with countries such as Mexico.

"Japan will miss the free-trade ocean liner if its powerful agricultural lobbies sink every proposed international agreement requiring agricultural tradeoffs," Plate, a professor at the University of California in Los Angeles, wrote recently.



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