Japan's prime minister vowed on Friday to push ahead with tax reforms to curb bulging public debt, but an uncooperative opposition and divisions within his own party on policy make the chances of success slim.
Rating agency Standard and Poor's cut Japan's long-term debt rating on Thursday for the first time since 2002. The International Monetary Fund too had harsh words for Japan, saying it needed to act urgently to cut its deficit.
Prime Minister Naoto Kan has made tax and social security reform, including a future rise in the 5 percent sales tax, a priority given the rising costs of Japan's fast-aging society and a public debt that is the biggest among advanced nations.
The important thing is to maintain fiscal discipline and ensure market confidence in Japan's public finances, Kan, who took over in June as Japan's fifth premier since 2006, told parliament's upper house.
Kan needs help from opposition parties that control the upper house not only for broad reforms, but to enact bills to implement a record $1 trillion budget for the year from April, in which borrowing outstrips tax revenues for a second straight year.
But with his voter support sagging at around 30 percent, opposition parties have shown little inclination to compromise -- something S&P highlighted when explaining its reasons for the downgrade.
Kan's finance minister echoed his stance, saying the government must show its commitment to fiscal discipline. Deputy Chief Cabinet Secretary Hirohisa Fujii said the government would take S&P's criticism to heart.
The Japanese government must humbly take the rating by a leading world ratings agency and further deepen its awareness of the importance of restoring fiscal health, Fujii, a former finance minister, told a news conference.
DROPPING THE BALL?
Analysts had said the S&P downgrade could bolster Kan's campaign for fiscal reform.
But they said his initial response to the downgrade -- telling reporters he was not very familiar with the matter -- had only given the opposition more ammunition to attack.
In a sense, the S&P downgrade is evidence of tough criticism of the (ruling) Democratic Party of Japan (DPJ), so the opposition can argue that it is time for a change in government, said independent political analyst Atsuo Ito.
The head of the second-biggest opposition party, the New Komeito, told the upper house that doubts about Kan's leadership were increasing. A prime minister should understand how his words and actions could affect the people, markets and the international community, Natsuo Yamaguchi later told reporters.
Comments like 'I'm not familiar with it,' or 'I have no information on it,' themselves generate fresh concerns.
Kan defended his remark on Friday, telling parliament he had meant only that he had not heard about the ratings cut.
I have been fully aware of the importance of public finances and government bonds since I served as finance minister when the Greek debt crisis hit, Kan told parliament.
The Japanese government bond (JGB) market took the S&P move in its stride, reflecting the fact that domestic investors hold about 95 percent of the country's debt, in sharp contrast to troubled smaller European economies, much of whose debt is held by foreign investors.
JGBs are supported not just because the impact of the downgrade is small but also because of expectations that the downgrade could be a catalyst for fiscal reform. Japan's current fiscal position is clearly not sustainable, said a Japanese bank bond trader.
I think this has moved us a bit closer to a consumption tax hike.
Kan, whose Democrats swept to power in 2009 for the first time, has the immediate challenge of persuading opposition parties to help enact bills to implement the 2011/12 budget.
Opposition parties can block bills in the upper house, although the budget itself can be enacted after approval by the lower house, where the DPJ has a majority.
Some pundits have said Kan could be forced to resign or even call a snap election if the budget-related bills get stuck. Neither would necessarily resolve the political stalemate.
The opposition will decide its response based on the trends in public opinion, analyst Ito said. Mistrust in the government is increasing, so they won't compromise easily ... They will make big demands and see how the government reacts.
The main opposition Liberal Democratic Party (LDP) has demanded Kan's Democrats abandon costly campaign promises to put more cash in consumers' hands to boost growth, but Kan's critics inside his own party are opposed to such a change.