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People wait in line in front of a closed petrol station to get a number to be able to get fuel later in the day in the town of Tonoi on March 17, 2011, six days after a major earthquake and tsunami hit the northeastern coast of Japan. (NICHOLAS KAMM)
People wait in line in front of a closed petrol station to get a number to be able to get fuel later in the day in the town of Tonoi on March 17, 2011, six days after a major earthquake and tsunami hit the northeastern coast of Japan. (NICHOLAS KAMM)

Why Japan will avert a fiscal crash Add to ...

The government should do the same today, said Sebastian Mallaby, an economist with the Council on Foreign Relations in New York.

"It should be willing to act aggressively to increase the budget deficit in order to have the money to rebuild the damaged areas promptly," he wrote on CFR's website. "Now is not the time for being cautious or conservative. Now is the time for a bold response, and I've got every reason to think that they will do that," he added.

POLITICAL MESS

When the time comes to rein in the budget deficit, Japan already knows from years of experience what Greece and Ireland and other countries are just discovering: there is no secret recipe. It's "simply" a question of agreeing on a politically acceptable mix of tax increases and spending cuts.

The IMF and other agencies have zoomed in on Japan's low rate of consumption tax, 5 per cent, as the most promising candidate to raise the revenue needed to help stabilize the government's debt-to-GDP ratio. In its 2010 review of Japan, the Fund projected that by 2015 gross debt would reach 250 per cent, and net debt 154 per cent, unless there was a shift in policy.

The government could raise some ¥2.5-trillion for each 1-percentage-point rise in the consumption tax.

But a hamstrung political process has hobbled policy-making. Prime Minister Naoto Kan is the fifth man to hold the job since 2006, and his popularity ratings have been sinking like a stone, further reducing his chances of getting budget bills through a split parliament. Indeed, just hours before Friday's earthquake, Kan, accused of illegally receiving campaign funds, was rebuffing calls from an emboldened opposition for his resignation.

The tantalizing question now is whether the Sendai tragedy will change not only Japan's economic and fiscal outlook but also its politics.

"Kan needs to show his leadership to craft a big supplementary budget. This is the time to show his leadership by gathering ideas from the ruling and opposition parties very quickly," said Mr. Hamasaki, the Toyota Asset Management strategist.

POLITICAL GAME-CHANGER?

Pessimists suspect any political truce sealed in a moment of national solidarity will be short-lived once reconstruction is under way and the economy is recouping the output lost due to the disaster.

After all, the bursting of Japan's asset bubble in the early 1990s failed to jolt the political class into enacting the difficult structural reforms the economy needed. Japan's nominal GDP is stuck at the level it was at in 1992.

But Mr. Noland with the Peterson Institute for International Economics said that successful crisis management on Mr. Kan's part would go a long way toward reassuring voters still unsure whether his Democratic Party of Japan is a credible alternative to the Liberal Democratic Party. The LDP has governed Japan for most of the past 60 years. It lost power to the DPJ in 2009.

"Cementing a real two-party system could create 'more normal' politics and push Japan into becoming a truly modern, functioning democracy in the 21st century," Mr. Noland said.

"It would make governance more complicated, but it would bring issues such as the coddling of the agricultural sector, immigration reform and defence policies out into the open in a much more transparent, democratic way," he added.

The alternative is that Sendai turns out to be Japan's "Katrina" moment, Mr. Noland said, referring to the U.S. authorities' ineffectual initial response to the hurricane that ravaged New Orleans in 2005.

"If they do a bad job, then Japan's aging and risk-averse electorate could go flocking back to the LDP and essentially re-establish the status quo ante of the last 60 years," he said.

Seen in this light, the implications for Japan's economy and investment outlook are profound.

Like everyone, Jim O'Neill, chairman of Goldman Sachs Asset Management in London, is waiting to see how fast-changing events at the Fukushima plant play out. But he said the crisis could act as a catalyst in much the same way that the second oil price shock of the late 1970s prompted an all-out national effort by Japan to improve energy efficiency.

"My hunch is that this is so big it will galvanize change and force Japan's leaders to do more," he said in an e-mail.

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