PM Abe's plan for $265 billion stimulus puts pressure on BOJ to ease

[July 27, 2016]  By Leika Kihara and Stanley White

TOKYO (Reuters) - Japan's prime minister unveiled a surprisingly large $265 billion stimulus package on Wednesday to reflate the world's third-largest economy, adding pressure on the central bank to match the measures with monetary stimulus later this week.

The earlier-than-expected announcement to boost the flagging economy sent Japanese and other Asian stock markets higher while it weighed on the safe-haven yen, but lacked crucial details on how much of the package would be direct government spending.

The size of the package, at more than 28 trillion yen ($265.30 billion), exceeds initial estimates of around 20 trillion yen and is nearly 6 percent the size of Japan's economy. It will consist of 13 trillion yen in "fiscal measures," which likely includes spending by national and local governments, as well as loan program.

"We need to take steps to support domestic demand and put the economy on a firmer recovery path," Shinzo Abe said in a speech in southern Japan on Wednesday. "I want to use various measures to increase our escape velocity from deflation."

The market expects the Bank of Japan to produce some fire power of its own at its rate review ending on Friday.

"The amount is so large that the stimulus package is bound to have a big economic impact. It is impossible to spend this much money in one extra budget, so this may take place over the next few years," said Hiroshi Miyazaki, senior economist at Mitsubishi UFJ Morgan Stanley Securities.

"The BOJ is likely to ease policy, including increasing government debt purchases, so you could say the BOJ can absorb the new debt. It also makes it easier to show that the BOJ and the government are working together."

Many BOJ policymakers prefer to hold off on easing as they expect the fiscal stimulus package to boost growth and brighten the prospects for hitting their 2 percent inflation target.

But yen moves and political considerations could be decisive factors for the BOJ policymakers agonizing over whether to expand stimulus or to save their dwindling policy resources for when the economy takes a turn for the worse.

Japan's Nikkei stock average <.N225> rose nearly 2 percent on the larger-than-expected stimulus package, while the yen slumped against the dollar.

NO LASTING IMPACT?

Abe ordered his government earlier this month to craft a stimulus plan to revive an economy dogged by weak consumption, despite three years of his "Abenomics" mix of hyper-easy monetary policy, big spending and structural reforms.

As part of the package, the government said it would raise the minimum wage by 3 percent this fiscal year to ramp up consumer spending.

Japan's Prime Minister Shinzo Abe makes a speech in Fukuoka, Japan, in this photo taken by Kyodo July 27, 2016. Mandatory credit Kyodo/via REUTERS

Sources told Reuters the package would have a headline figure of at least 20 trillion yen. Only about 9 trillion yen was to come from a combination of direct spending from both national and local governments and loan programs.

Such "fiscal spending" appeared to have increased to 13 trillion yen. But the rest is likely to come from state subsidies to private firms and lending from quasi-government entities, which does not involve direct government spending and thus may not give an immediate boost to growth, analysts say.

Abe's administration has also offered few hints on how it will finance the package, casting doubts on Japan's ability to fix its tattered finances.

Sources have signalled the package will be funded in state budgets spawning several years. The government is considering issuing construction bonds but remains cautious about resorting to large-scale debt issuance.

Japan's finance ministry denied a media report it was considering issuing 50-year government bonds for the first time to capitalize on ultra-low interest rates.

While Abe may have succeeded in giving stocks a temporary boost, some analysts have doubts the impact will last.

"Markets are used to this size of stimulus, so their reaction is neutral," said Kyohei Morita, chief Japan economist at Barclays Capital. "The effectiveness of the stimulus package itself is questionable."

($1 = 105.5400 yen)

(Additional reporting by Minami Funakoshi; Editing by Chris Gallagher, Eric Meijer and Jacqueline Wong)

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