CABINET APPROVES SLIGHTLY CONTRACTIONARY REGULAR

C O N F I D E N T I A L SECTION 01 OF 02 TOKYO 003526

SIPDIS

STATE EAP, EEB/IFD/OMA AND EEB/EPPD; TREASURY IA FOR
FOSTER, WINSHIP, DOHNER; USTR FOR AUSTR CUTLER AND DAUSTR
BEEMAN;

E.O. 12958: DECL: 12/29/2018
TAGS: ECON EFIN PGOV EAP JA
SUBJECT: CABINET APPROVES SLIGHTLY CONTRACTIONARY REGULAR
FY2009 BUDGET

REF: TOKYO 3417

TOKYO 00003526 001.2 OF 002


Classified By: Charge d'Affaires James Zumwalt; reasons 1.4 (b/d)


1. (SBU) Summary: Japan's Cabinet approved the central
government's draft regular FY2009 budget December 24,
clearing the way for its submission to the forthcoming
regular session of the Diet that begins January 5 and passage
before the end of FY2008 (March 31, 2009). Proposed outlays
of 33.5 trillion yen ($983 billion) represent an increase of
6.6 percent over the initial FY2008 budget. However,
demonstrating the Japanese government's growing use of
supplemental budgets, the proposed outlays are 0.4 percent or
0.4 trillion yen smaller than the revised FY2008 budget.
Revenues for FY2009 are projected to decline a sizable 13.9
percent from the initial FY2008 estimate, a refection of
Japan's worsening economic situation. The FY2009 budget
continues the GOJ's practice of appearing to tackle its
budget deficits while at the same time spending freely via
supplemental budgets to meet political considerations. End
Summary.

Overview of the General Account Expenditures
--------------


2. (SBU) Japan's latest revised budget for FY2009 (April
2009 - March 2010) projects total general account
expenditures at 17.4 percent of GDP, essentially unchanged
from 17.5 percent of GDP in the revised FY2008 budget. Most
FY2009 spending is non-discretionary, including mandatory
items such as social security spending (5.0 percent),
projected debt service costs (4.0 percent of GDP),and
revenue sharing with local governments (3.2 percent).
Discretionary spending, including public works (1.4 percent
of GDP),represents less than one third of total projected
outlays.

Major Spending Categories
--------------


3. (SBU) The FY2009 debt service costs, a major mandatory
spending item, are projected to total 20.2 trillion yen ($244
billion),up 0.4 percent from the initial FY2008 budget,
thanks to continued low government bond yields. Also, social
security spending is budgeted to increase 14.0 percent in
FY2009, reflecting a rise in government funding's share of
the basic national pension scheme from the current one-third
to one-half starting April 2009 (2.3 trillion yen, or $25
billion). Among discretionary items, FY2009 public works
spending is set to increase 5.0 percent to 7.1 trillion yen
($79 billion),in part as a stimulus measure to counter
rapidly deteriorating economic circumstances (ref). However,
spending on ODA has been cut 4.0 percent from the initial
FY2009 budget to 672 billion yen ($7.5 billion). This figure
represents the tenth consecutive annual decrease in ODA
funding. Additionally, a sizeable increase in reserves is
reflected in the creation of a new 1 trillion yen ($11.1
billion) special reserve fund for unexpected economic events.

Overview of General Account Receipts
--------------


4. (SBU) The Ministry of Finance (MOF) projects FY2009 tax
revenues at 46.1 trillion yen ($512 billion, or 9.0 percent
of GDP),a drop of 0.7 percent from the revised FY2008 level.
To cover this decline in tax revenues, MOF plans to issue
33.3 trillion yen ($367 billion) of new Japan Government
Bonds (JGB) in FY2009, the largest JGB issuance in five
years. As a non-tax receipt, MOF will also transfer
approximately 4.2 trillion yen ($46 billion) in funds from
the off-budget Fiscal Investment and Loan Program (FILP)
Special Account to the general account budget. (Note: often
termed "the second budget," the FILP finances government of
Japan affiliated institutions as well as local governments,
authorizes 15.9 trillion yen ($177 billion) for FY2009. End
note.)

FILP Overview

TOKYO 00003526 002.2 OF 002


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5. (SBU) In addition to the funds transfer to the general
account budget, the FY2009 FILP budget calls for total
outlays of 15.1 trillion yen ($168 billion or 3.1 percent of
GDP). This figure is up 14.4 percent from the initial FY2008
level, but down 3.6 percent from the revised level. FILP
lending to government-affiliated financial institutions and
public works implementing agencies is set to fall 2.1 percent
and 32.8 percent from the revised FY2008 levels,
respectively. In contrast, allocations to local governments
will grow 21.4 percent in FY2009. Issuance of FILP bonds
(12.0 trillion yen or $133 billion) and government guaranteed
bonds (3.8 trillion yen or $42.2 billion) are the primary
means for financing the FILP budget.

Fiscal Policy Shifts
--------------


6. (C) The Cabinet-approved FY2009 general account and FILP
outlays do not signal an aggressive new fiscal policy, but
suggest adoption of a moderately contractionary fiscal
posture from the current fiscal year. This development is
the result of the Aso administration's stated decision to
pursue both medium to long term fiscal consolidation and a
short term expansionary fiscal policy.


7. (C) Since FY2007, Japan has deployed a strategy of
promoting fiscal consolidation mainly through cuts in
government spending set by the medium term fiscal
consolidation plan. (Note: the Koizumi Cabinet adopted a
restrictive fiscal policy in July 2006 by setting specific
targets for annual spending cuts over the five year period
FY2007-2011 and calling for the GOJ to achieve "primary
fiscal balance" by FY2011. End note.) During the first
phase of compiling the FY2009 regular budget, the Cabinet
assumed restrictive guidelines for budget requests from
government ministries in July, as required by the medium term
fiscal consolidation plan. Under the guidelines, ministerial
budget spending requests, excluding social security, are
supposed to decline 0.2 percent from the initial FY2008
budget levels.


8. (C) Rapidly deteriorating economic conditions and the
need to appeal to voters in advance of Lower House elections
have led Prime Minister Aso to indicate repeatedly his top
priority is to get Japan's economy moving even at the expense
of increasing Japan's already large overall government
deficit (currently about 180% of Japan's GDP). The Aso
Cabinet, therefore, for the first time in seven years
compiled two distinct supplemental budgets for FY2008 to fund
measures committed under three separate economic stimulus
packages--11.5 trillion yen on August 29; 26.9 trillion yen
on October 30; and 43 trillion yen December 19, with 6
trillion yen of overlapping measures in the two most recent
packages)-- without suspending the medium term fiscal
consolidation plan. The two supplementals, plus the combined
general account and FILP outlays reached 20.7 percent of GDP
in FY2008, the highest level in four years.


9. (C) The long standing problem for Japan has been that
while the fiscal consolidation plan binds spending under
regular budget expenditures, it does not limit outlays under
supplemental budgets. The FY2009 budget continues the GOJ's
practice of appearing to tackle its budget deficits while at
the same time spending freely via supplemental budgets to
meet political considerations.
ZUMWALT