Japan: DPJ's First 100 Days (Part II)

New Democratic Party Leadership Puts FY2010 Budget Preparations on Hold

Unlike the US, where the Congress has the authority to formulate the national budget, the authority in Japan is the Prime Minister’s cabinet. Consequently, the DPJ has quickly put the FY2010 budget process on hold until they can get their Cabinet together and issue new budget instructions to the various ministries and the MOF.

The wheels of Japan’s national budget process begin to turn in June, a mere three months after the current fiscal year’s budget is ratified. The process begins with the Cabinet issuing guidelines for budget requests. The guidelines set out expenditure ceilings for major programs such as public works and social security for the next fiscal year. These ceilings are usually expressed in terms of absolute or percentage increases (decreases) from the previous fiscal year.

Submissions of budget requests by the various ministries are made at the end of August of each year, i.e., just as the DPJ was voted in power. In order for the budget to be passed by the Diet during the fiscal year (i.e., by March 31 the following year), it needs to be approved by the House of Representatives at least 30 days prior to the start of the new fiscal year. The Cabinet usually submits its formal budget proposal to the Diet in January to allow for sufficient deliberation. As a result, it takes five months or more to prepare the final draft government budget.

The Finance Ministry's Budget Bureau is responsible for incorporating the budget requests of the various ministries and agencies into a final budgetary framework. Budget requests are reviewed to calculate projected tax revenues versus expenditures. Adjustments to expenditure levels are worked out through negotiations with the ministries and agencies, after which the proposed budget is submitted to the Cabinet for decision.

This year, the DPJ will assume control of the government just the Ministry of Finance was receiving FY2010 final budget requests from the various ministries. In order for the DPJ to implement the spending and waste elimination promises outlined in their manifesto, they have to scrap what was already in progress under guidelines set by the Aso Administration.

As it stands today, the proposed budget for FY2010 was heading for a new historical high of JPY92.13 trillion. While the budget process is on hold, the MOF is unlikely to receive new expenditure guidelines from the DPJ cabinet until October, leaving only two months within calendar 2009 to go back to square one and re-prepare a preliminary budget draft. This in turn probably means that the FY2010 budget proposal won’t be forthcoming until early calendar 2010, which would be the first time this has happened since the 1993 Hosokawa Administration, or the last time that the LDP lost control of the budget process.

Where Will They Find the Money? Look in the Special Accounts

The DPJ wants to include JPY7.1 trillion of additional expenditures in the FY2010 budget. To fund this, they will be scrapping some LDP-proposed programs under the Aso Administration’s guidelines, including a dam project in Gumma prefecture and former PM Aso’s infamous “comic book palace”.

In addition, they will probably need to dip into the “hidden treasure” of funds sitting around in various special accounts, such as the fiscal investment and loan (FILP) and foreign exchange special account reserves, which ostensibly had reserves of some JPY1.3 and JPY1.8 trillion respectively in FY2009.

Another target is JPY4.3 trillion in government transfers to government-sponsored companies and organizations as well as municipalities and prefectural governments. Dogfights could erupt as the regional governments have already budgeted these transfers, while efforts to scrap already promised public works will also elicit screams of protest from local governments and government contractors.

Just looking at the proposed budget for FY2009, one would imagine that Japan has little leeway in its annual budget, as some 50.9% went to debt service (22.8%, or JPY20.24 trillion) and social security (28.0%, or JPY24.83 trillion) of a total JPY88.55 trillion of initial general account expenditures for FY2009.

On the other hand, the DPJ says they would like to wring JPY10 trillion of wasteful expenditures out of the national budget, and many believe they could wring out as much as JPY20 trillion. How is this possible?

Basically, there are four types of budgets in Japan, (1) the general account budget, (2) the special account budgets, (3) budgets for government-sponsored organizations and (4) the Fiscal Investment and Loan Program (FILP). As these special accounts (including the FILP) and government-sponsored entity budgets are only subject to monitoring and oversight by ministries and agencies, these are the real playground of the bureaucrats and historically, the LDP. Japan has no less than 31 special accounts that are subsidized by the general account.

As of FY2006, MOF-estimated net general account expenditures of JPY33.4 trillion paled in comparison to net special account expenditures of JPY225.3 trillion. Consequently there is plenty of room for rationalization of Japan’s government finances, as Japan to date has had no organization similar to the US Government Accountability Office.

The “hidden treasure” of unused reserves in all these special accounts has become a subject of debate and speculation as Japan’s public finances continue to rapidly deteriorate. As of FY05, the surpluses (assets minus liabilities) in these special accounts were estimated to be, (1) JPY26.73 trillion in the FILP, (2) JPY6.3 trillion in the foreign exchange special account, (3) JPY5.7 trillion in the forestry special account, (4) JPY2.6 trillion in the welfare insurance special account, and (5) JPY2.1 trillion in the airport facilities special account, for a total of JPY43.4 trillion, which equates to a cool 50% of Japan’s annual general account budget.

While there is room for debate regarding just how large these surpluses are now, it is also a fact that the special accounts responsible for these reserves are long overdue for massive rationalization.

In FY2006, the government used a total of JPY13.8 trillion of such reserves to retire government debt and return some JPY1.83 trillion to the general account in an effort to repair Japan’s government finances. The global financial crisis and synchronized, deep global recession however has put such plans on hold as the Aso Administration pumped over JPY15 trillion of fiscal stimulus into Japan’s economy—the remainder of which of course the DPJ will have to scramble to re-allocate before the FY2010 budget bus leaves the station.

However, like OMB director David Stockman during the Reagan Administration learned the hard way, potential budget savings on paper and what is actually politically achievable are two distinctly different kettles of fish. Stockman's proposed budget savings were reportedly sandbagged by his own Congressional Republicans, and similar structural reform efforts in Japan since at least 1993 (again with party majority support in the Diet) have basically met the same fate.

Either way, investors will be closely watching the DPJ's actions for hints about its ability to finance its new agenda without blowing up Japan's bond market. As for plays, International bond ETFs like BWX and BWZ hold anywhere from 13% to 23% of assets in JGBs (Japanese Government Bonds), which is quite a bit higher than the weight of Japanese stocks in most global portfolios, where the benchmark weight is more like 8%.

Disclosure: No positions

Comments

[ikkyu:]

Wow, awesome review of a complicated situation. Many thanks.
Cheers from Osaka,
john

Sep 01 09:19 AM