(Stories on Japan's economy [ID:nECONJP])
By Tetsushi Kajimoto and Shinichi Saoshiro
TOKYO, Nov 26 (Reuters) - Japan's government wants to keep its self-imposed cap on new bond sales in the 2011/2012 budget draft it plans to complete in December as Europe's debt crisis highlights the woes of heavily indebted nations.
The outlook for the budget process is clouded by Prime Minister Naoto Kan's struggle with a divided parliament and plunging popularity ratings.
Following are some questions and answers on Japan's budget process and its implications for markets:
WHEN WILL THE BUDGET BE READY?
Likely by the end of December. The Ministry of Finance usually prepares a draft late in December and sends it to a cabinet meeting for approval. The government sends budget bills to parliament in January so they can come into force by the start of fiscal year on April 1.
The preparations could get sidetracked if Kan were to fire his chief cabinet secretary who faces a non-binding but embarrassing censure motion by the opposition. Kan is, however, expected to keep his No. 2, which means that the opposition could use its control of the upper house of parliament to delay the budget's implementation.
CAN THE OPPOSITION STALL THE BUDGET'S IMPLEMENTATION?
Yes. The ruling Democratic Party of Japan (DPJ) can push the budget through parliament thanks to its majority in the more powerful lower house, and a rule that makes it become law after 30 days even if the upper house votes it down.
But in order to implement the budget the government needs so-called enabling bills, such as one on issuing deficit-financing bonds, which need to be approved by both houses of parliament.
That gives the opposition leverage to win concessions from the government or, in an extreme case, force an early election.
HOW CAN A POSSIBLE DEADLOCK BE RESOLVED?
The prime minister may allow for more spending in the budget in a concession to the opposition. Some analysts say Kan might be forced to step down or call a snap election for the lower house to break the deadlock even though no election is mandated until late 2013. This is, however, considered unlikely, given that an election would almost certainly cost the ruling party some of its seats.
HOW MARKETS MIGHT REACT?
A mere delay could unnerve investors and drive up bond yields temporarily. But none of the possible ways out of a potential deadlock would please investors either. More spending would be seen as backtracking on Kan's pledge to improve fiscal discipline. An early poll could be even more troubling. The main opposition Liberal Democratic Party (LDP) would have trouble winning a majority on its own, so a snap vote could lead to much horse-trading to form a new coalition or possibly even a realignment of party allegiances.
CAN THE GOVERNMENT KEEP TO ITS SPENDING, BORROWING LIMITS?
Maybe. The 2011/12 budget is the first to be compiled under the government's long-term fiscal plan announced in June and will be viewed as the first test of the government's ability to reign in public debt, which is about twice the size of the $5 trillion economy and the worst in the developed world.
The government has vowed to keep new bond issues at the current fiscal year's level of about 44 trillion yen ($526 billion) and general spending excluding debt-servicing costs at the current 71 trillion yen.
Some market players are sceptical if it can do that as the government is struggling to cover social welfare costs, including public pensions, and fund new schemes such as expanded child support.
Others say a recovery in corporate profits should boost tax revenues and help the government meet the targets.
Hidenori Suezawa, chief strategist at Nikko Cordial Securities, estimates tax revenues will rise 4.4 trillion yen to 41.8 trillion yen, and that the bond sales target can be met if the government manages to scrape together non-tax revenues worth 6.5 trillion yen while sticking to its spending plans.
DO MARKETS WORRY ABOUT NEW BOND ISSUANCE?
Not at the moment. That's different from last year when DPJ just came to power and investors doubted its ability to manage state finances. Now markets are less jittery because of expectations of higher tax revenues. Investors were also encouraged by the fact that the government put together this year's 4.4 trillion yen extra budget without issuing more bonds.
Even if new bond sales moderately exceed the target, investors say it would not affect much the direct sales of bonds to institutions via monthly auctions, which is of chief interest to bond investors.
Analysts say such issuance, which excludes the amount underwritten by the Bank of Japan or sold to retail investors, could be limited to a few trillion yen partly by raising the amount of JGBs for the BOJ to underwrite.
($1=83.58 Yen)