A Japanese central banker warned on Thursday that market turmoil from Europe's debt woes could hurt growth and urged the government to fix its tattered finances, as the ruling party raced to pick Japan's fifth premier in three years.
Japan's ruling Democratic Party will vote on Friday to pick a new leader after unpopular Yukio Hatoyama abruptly quit this week after just eight months in office to improve the party's chances in a July upper house election that the ruling bloc needs to win to avoid policy deadlock.
Investors worry that the political chaos could delay efforts to thrash out plans, due out this month, to cut a public debt already twice the size of Japan's GDP and to craft a strategy to engineer economic growth in an ageing society.
Finance Minister Naoto Kan, a fiscal conservative, is the front-runner to replace Hatoyama, although a relatively unknown lawmaker, Shinji Tarutoko, also said he would run.
Party powerbroker Ichiro Ozawa will play a key role in determining if the 63-year-old Kan, a former party leader with considerable clout, gets the job and what policies are adopted.
Strong exports to Asia and stimulus-driven consumption helped Japan's economy grow 1.2 percent in the first quarter of this year, outpacing U.S. and European growth.
But Bank of Japan board member Miyako Suda, the longest sitting member of the board, warned that fiscal problems in Europe would take a long time to fix, with the ensuing market turmoil and slowing euro-zone growth clouding Japan's economic outlook. That is the most pessimistic view from a BOJ policymaker to date.
"Stock and currency markets are very unstable, and as a result not only Europe but also Japan may see a negative impact on consumption and capital spending via a worsening of household and business sentiment," Suda told business leaders in Wakayama, western Japan.
TRUST IN THE GOVERNMENT
A government survey released on Thursday showed that while annual declines in corporate capital spending narrowed in the first quarter, the pace of improvement was slower than economists expected.
Suda also said she hoped whoever took over from Hatoyama, who quit on Wednesday just nine months after the Democrats swept to power in a historic election, would announce a medium- and long-term fiscal reform programme as scheduled in June.
"Regardless of who becomes the leader, I hope the government comes up with the plan," she said. "Otherwise, trust in the government's policy may be affected."
Kan, a former health minister once known for battling bureaucrats, has forged an image as a fiscal conservative and occasional central bank critic since assuming the finance post in January.
Him becoming premier could mean bolder steps would be taken to rein in the huge public debt.
But Ozawa's role in the leadership race could affect how aggressively Japan's new leader tackles a debt already twice the size of the economy, since Ozawa opposes pledging a hike in the 5 percent sales tax before the upper house poll.
"Whoever takes over, they cannot say they won't raise the sales tax, given the current national fiscal situation," Hajime Ishii, a party heavyweight close to Ozawa, told Reuters in an interview.
"But we must avoid a situation in which by raising the sales tax, we dampen consumption and the economy worsens greatly," he said, adding the party would not adopt a clear stance on the timing or scope of any rise before the upper house poll.
So far, only the 50-year-old Tarutoko, who heads the lower house environment committee, looks ready to challenge Kan.
Not much is known about his views on economic policy but while Tarutoko is a former Ozawa critic, Japanese media said he now had support from some in Ozawa's camp.
SHOT AT MAJORITY?
Whoever wins the upper house vote, the Democrats will run the government by virtue of their huge majority in parliament's powerful lower house. But they need to win control of the upper chamber to avoid parliamentary deadlock.
The DPJ's Ishii said the party and its small conservative ally, the People's New Party, now had a good shot at winning the upper house poll, enabling it to pass legislation smoothly.
"We may fall short of a stable majority but in the remaining 40 days … we want to make efforts to reach (that goal). It is possible," said Ishii, outgoing chairman of the Democrats' election campaign committee.
BOJ's Suda said the central bank will maintain very easy monetary policy in an effort to pull Japan out of deflation.
But she said central banks should not give markets the impression they could directly underwrite government debt, in a sign the BOJ was sticking to its reluctance to increase its outright government bond buying.
With the economy in relatively good shape and the BOJ having already taken several steps to try to beat deflation, a new government might not put pressure on the bank soon for further easing. But a new leader could quickly turn up the heat on the BOJ if the economy takes a turn for the worse.
The BOJ has kept interest rates at 0.1 percent, and eased monetary policy in December 2009 and again in March by setting up and later expanding a facility offering cheap funds to banks.
It also outlined last month a new loan programme aimed at encouraging banks to lend more to industries with growth potential.
