Japanese policymakers are starting to see fiscal stimulus as the most likely next step to spark economic growth given the central bank's dwindling monetary ammunition and uncertainty over the agenda of U.S. president-elect Donald Trump.
The market turbulence caused by Trump's victory has unnerved policymakers, and offers an opportunity for lawmakers favoring bigger fiscal spending to press their case, with another supplementary budget for this year a possible first step.
And the Bank of Japan's new monetary policy target of keeping the 10-year government bond yield near zero percent presents an opportunity to lock in long-term borrowing with virtually no interest cost to fund spending plans.
"Fiscal reform is important, but it's true uncertainties surrounding Japan's economy are increasing. That's why it's very important to come up with an effective fiscal policy," said Masahiko Shibayama, an adviser to Prime Minister Shinzo Abe.
"In general, having low interest rates helps fiscal policy."
Indeed, Abe may compile a small-size third supplementary budget for the current fiscal year that may include steps to buffer the economy from shocks, government officials say.
"More fiscal spending may be justified if the global economy stagnates" due to market volatility, one said on condition of anonymity.
Lawmakers are already pushing back on attempts by the finance ministry to rein in social welfare spending, which makes up a third of total government spending and rises each year due to a rapidly ageing population.
The dollar sank as low as 101.19 yen on Wednesday as Trump's victory boosted investors' appetite for the safe-haven yen. But since then the prospect of Trump's spending being inflationary has seen the dollar rebound to around four-month highs.
Government officials stress there is no plan right now to draft another big fiscal spending package or go down the route of "helicopter money" - a policy where the central bank directly finances government spending by underwriting bonds.
But Japan may not have much choice but to lean on fiscal policy if market turbulence persists and threatens a fragile recovery into next year. Trump's protectionist streak also makes it highly unlikely Tokyo will get Washington's consent to intervene in currency markets to stem any unwelcome yen rises, analysts say.
And with little to show for 3-1/2 years of massive monetary stimulus, fiscal policy may be better able to target support to areas of the economy directly affected by a tougher global trading climate.
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Abe has repeatedly said Japan is sticking to a pledge to balance the budget by 2020, which looks increasingly elusive after his decision to postpone a sales tax increase, and rein in the country's debt that is now twice the size of its economy.
But he also told his top economic panel last week the government "must be mindful of supporting the economy" even as it pursues fiscal reform, suggesting that his priority would be to bolster growth with additional spending.
Private-sector members of the panel - academics and business executives - called for fiscal policy to play a greater role in reviving the economy.
BOJ Governor Haruhiko Kuroda has also been calling for fiscal policy to reinforce the central bank's efforts, as he shifts from a view that monetary policy alone could banish deflation, and on Monday again called for the government to do its part.
"Synergy effects are produced when a government proactively carries out fiscal spending while a central bank provides accommodative financial conditions," he told business leaders in Nagoya, home base of Toyota Motor Corp (7203.T).
"We're likely to see such effects of the so-called policy mix going forward."
Already, Abe's administration is taking advantage of the central bank's new policy framework, which was deployed in September, by increasing issuance of 40-year bonds to fund private infrastructure projects.
Ultra-low interest rates also help cap the cost of funding Japan's huge debt pile, which makes up a quarter of the country's 96-trillion-yen budget.
The government has set aside 24.6 trillion yen ($230 billion) in debt servicing costs in the next fiscal year's budget, a four-year low, based on an assumed long-term interest rate of 1.6 percent, down 0.4 percentage point from the previous year.
The assumed rate may be cut further to around 1.4 percent thanks to ultra-low rates, government officials said, which may shave off nearly 1 trillion yen in debt-servicing costs.
Those savings could help Abe compile a supplementary budget or fill revenue short-falls that may arise by delaying spending cuts, analysts said.
And while the dollar's rebound and stock market rally may offer some relief to Japanese policymakers, some worry the respite will be shortlived.
"A weak yen, TPP ... all these things that were the basis of success for Abenomics risk being upended by a Trump presidency," said Yasuhide Yajima, chief economist at NLI Research Institute.
"Abe will probably compile a third supplementary budget. But what's next? I wonder how he could scrape out money to fund yet another big stimulus package next year." ($1=106.48 yen)
Reference: Leika Kihara