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Editorial: Depending on GDP growth to restore Japan's finances a dangerous illusion

The government recently included a target for restoring Japan's fiscal health in its draft Basic Policy on Economic and Fiscal Management and Structural Reform, based on the country's debt-to-GDP ratio.

That ratio now stands at just under 200 percent, the worst rate among the world's leading nations. The basic fiscal policy now states that this ratio is to be decreased steadily over time, which should lead to some contraction of the more than 1 quadrillion yen total debt now on the books of the central and local governments.

However, because the target has been set based on the debt-to-GDP ratio, reductions can be achieved even if spending goes up and the debt swells as long as Japan's GDP rises even faster. In other words, the policy could actually promote increased spending, though Japan simply does not have the leeway to get lax about government finances.

Until now, the government's yardstick for measuring improved fiscal health was Japan's primary balance, or the country's net borrowing excluding interest payments on government debt.

The primary balance figure tells us if tax revenues are sufficient to cover the government's policy-based outlays, such as for social security programs and public works. At the moment, Japan is running an annual deficit of about 20 trillion yen. The government says it is aiming to get back in the black by fiscal 2020, but this looks extremely difficult to achieve without deep spending cuts.

During his January policy address to the Diet, Prime Minister Shinzo Abe made no mention of getting Japan's primary balance out of the red, though this had featured in every one of his previous policy speeches. Meanwhile, Abe has always said that "improving government fiscal health is impossible without economic growth," evincing no enthusiasm for the pain that would accompany budget cuts.

However, the new debt-to-GDP-based goal in the government's basic economic and fiscal plan allows the Abe administration to highlight fiscal health improvement through economic growth even without returning Japan's finances to the black.

The basic plan in fact now includes both the primary balance target and the new debt-to-GDP ratio goal. However, the Cabinet Office has explained that the special importance of the latter has been made clear. Some Abe administration strategists are calling for shelving the attempt to eliminate the primary balance deficit, as well as for yet another postponement of the promised consumption tax hike. Shifting focus to the debt-to-GDP ratio, some observers say, can be seen as a strategic move in this direction.

Furthermore, if Japan's goal is to reduce the debt-to-GDP ratio, extravagant fiscal stimulus can be presented as the just and proper pursuit of economic revival.

Last year, Prime Minister Abe launched another round of large-scale economic stimulus policies, saying he would "rev up the 'Abenomics' engine." This year's basic economic plan also put forward proposals to make preschool free. The government's desire to boost spending is obvious.

Monetary easing by the Bank of Japan has taken the prime rate into negative territory. This is likely to prove quite handy for the prime minister's new debt-to-GDP goals. However, if fiscal stimulus fails to spark the kind of growth the Abe administration is hoping for, the government debt mountain will simply grow larger, and pull the debt-to-GDP ratio in the wrong direction.

The Abe administration has taken several swings at boosting Japan's economy, but tax revenue growth has stalled of late. Depending on economic expansion to nurse Japan's finances back to health is a dangerous proposition.

In the year 2025, Japan's baby boomers will all be 75 years old or more and social welfare costs are bound to expand, while there are no external signs that the country's fiscal position will get any better. Thus, instead of scrambling to restore ostensible fiscal health, spending cuts are necessary, and need to be tackled head-on.

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