SETTING NEW FISCAL CONSOLIDATION TARGETS

C O N F I D E N T I A L SECTION 01 OF 02 TOKYO 001400 SIPDIS TREASURY IA FOR DOHNER, WINSHIP, FOSTER, WEEKS STATE FOR EEB/OMA AND EAP/J PASS USTR FOR BEAMAN E.O. 12958: DECL: 06/18/2019 TAGS: ECON EFIN PGOV JA SUBJECT: SETTING NEW FISCAL CONSOLIDATION TARGETS TOKYO 00001400 001.2 OF 002 Classified By: CDA JAMES ZUMWALT FOR REASONS 1.4(B) AND (D) ¶1. (SBU) The Council on Economic and Fiscal Policy (CEFP) has released its draft basic policy framework for 2009. Known as the honebuto ("big-boned" or "robust"),the policy framework is meant to place this year's policy priorities in a medium-term context. The 2009 honebuto makes clear that the top priority is overcoming the current recession, but also sets new fiscal consolidation targets: stabilizing the gross debt-to-GDP ratio by the "mid-2010s" and reducing it by the "early 2020s." Other key priorities include strengthening Japan's social safety net and the identification of (and potential government support for) key industries expected to drive future growth. The Cabinet is scheduled to approve formally the honebuto June 23. ¶2. (U) (Note: The CEFP is a consultative body within the Cabinet Office. It is headed by the Prime Minister, and includes the Chief Cabinet Secretary, Minister for Economic and Fiscal Policy, Minister of Finance, Minister for Internal Affairs and Communications, Minister of the Economy, Trade, and Industry, and the Bank of Japan Governor. End note.) New Fiscal Consolidation Targets -------------- ¶3. (SBU) New Fiscal Consolidation Targets -- Since July 2006 under then-Prime Minister Koizumi, Japan has maintained two targets for fiscal consolidation: 1) achieving a primary surplus (i.e., a surplus net of interest payments on government debt) by FY11; and 2) the reduction of the gross debt-to-GDP ratio starting in the "mid-2010s." The primary surplus target has been criticized as technocratic and difficult for the public to understand. Further, the current economic downturn, with its associated decline in tax revenues and additional fiscal stimulus, has rendered both targets unachievable. ¶4. (U) The 2009 honebuto establishes two new targets for fiscal consolidation, each with its own interim benchmark: 1) Stabilize the Debt-to-GDP ratio by the mid-2010s. The interim benchmark is halving the primary deficit by FY13. (The primary deficit was about 5.7% in FY09 before the April 2009 stimulus package.) 2) Reduce the Debt-to-GDP ratio starting in the early 2020s. �00A;The interim benchmark is the achievement of a primary surplus by FY19. ¶5. (SBU) (Note: The Cabinet Office's definition of gross government debt includes only debt with an original maturity greater than one year, a definition most likely designed to avoid any noise associated with short-term debt issuance. For this reason, the Cabinet Office figure (163% at end-March 2009) is lower than the more inclusive OECD figure (173% at end-2008). Instrument-wise, the Cabinet Office definition includes Japanese government bonds (JGBs),local government bonds, and the borrowing of a special account to finance local governments. End note.) ¶6. (U) The honebuto does not detail any specific proposals for revenue increases or expenditure cuts. However, as reference material, Cabinet Office staff prepared extensive scenario analysis for fiscal consolidation for FY09-23. There are nine different scenarios combining three assumptions: 1) GDP growth; 2) increases in the consumption tax from the current 5%; and 3) whether the GOJ carries out JPY11.4 trillion or JPY14.3 trillion in aggregate scheduled spending cuts, as well as whether the government holds discretionary non-social security government expenditures at FY11 levels, or increases them with inflation (Note: The 2006 honebuto estimated that an adjustment of about JPY16.5 trillion would be needed to achieve a combined central and local government primary surplus by FY11. The plan specifically calls for JPY11.4 - JPY14.3 trillion in aggregate spending cuts in the FY07-11 period. Ttax increases and economic growth-driven rises in tax revenues would fund the remaining JPY 2.2 - JPY 5.1 trillion.) ¶7. (SBU) The Cabinet Office found only one of the nine combinations of assumptions could achieve the twin fiscal TOKYO 00001400 002.2 OF 002 consolidation targets -- raising the consumption tax by one percentage point annually from FY11 to reach 12% in FY17, combined with 1.5% average annual real GDP growth and large government spending cuts. (The Cabinet Office separately estimated potential growth at only 1.0%, but Japan does have a large output gap which would in theory allow a burst of non-inflationary higher growth.) If the consumption tax is raised only by a total of 5 percentage points to 10% in FY15, the Cabinet Office projects a combined primary surplus in FY21, two years later than the target. The Cabinet Office also projects that the debt-to-GDP ratio largely would stabilize by the early 2020s, but not significantly decline. As a rule of thumb, a one percentage point increase in Japan,s consumption tax is estimated to generate about JPY2.5 trillion (0.5% of GDP) in additional revenue annually. ¶8. (U) Briefing reporters on the honebuto, Finance Minister Yosano stressed the projections were no more than mechanical estimates and that the Aso Cabinet had not made any decision on a consumption tax increase. Strengthening Japan,s Social Safety Net -------------- ¶9. (U) The honebuto calls for building a "secure society" in three phases. In the first (FY09-11),the GOJ would improve access to social insurance programs for non-regular workers and introduce an earned income tax credit. In the second (FY11 to the mid-2010s),the government would review personal income and asset taxes to narrow income disparities, and improve childcare. In the final phase (mid-2010s to early 2020s),the GOJ would improve support services further for the elderly and boost the public nursing care program. Looking at Key Industries -- Industrial Policy Flashbacks? -------------- -------------- ¶10. (C) Finally, the honebuto asserts (not argues or demonstrates) that the following three fields will drive Japan,s economic growth: (1) environmental and energy-saving technology; (2) medical, healthcare, and nursing care services; and (3) animation and game software, information technology, and tourism (also meant to strengthen Japan's "soft power"). According to the plan, Japan will be able to create new competitive advantages and produce high-quality employment in these fields. (COMMENT: While the honebuto does not lay out concrete proposals, the identification of these industries may help lay the groundwork for future government assistance. END COMMENT.) ZUMWALT