Japan PM defeat casts cloud over fiscal,tax reform

TOKYO, July 30 (Reuters) The crushing defeat that Japanese Prime Minister Shinzo Abe's ruling camp suffered in yesterday's election could stall debate on fiscal and tax reforms needed to address the country's huge public debt, economists said.

The Democratic Party of Japan, the main opposition party that won the most seats in the upper house of parliament, opposes raising the 5 per cent consumption tax. The party is also seen as more open to new spending, such as programmes to provide child care and help struggling farmers.

''The grip on fiscal reforms may loosen,'' said Takuji Aida, chief economist at Barclays Capital Japan.

''The Democrats do not have control over the government yet, but their victory will likely raise the hurdle for an early implementation of a consumption tax hike,'' he added.

Abe's ruling bloc will not be ousted from government by the upper house defeat, since it has a huge majority in the more powerful lower chamber. But without control of the upper chamber, laws will be hard to enact, threatening legislative paralysis.

During the election campaign, Abe avoided direct reference to the need to increase the politically sensitive consumption tax, but he said debate on comprehensive tax reforms would start later this year.

While Abe's administration has said spending cuts will come before any tax hikes, a rise in the consumption tax has been seen as indispensable to financing growing social welfare costs in an ageing society.

Economists had expected that parliament would pass a bill to raise the tax in 2008 and implement it from April 2009, but they now say that may be postponed.

The government sought to play down any speculation of a delay in fiscal reform aimed at tackling the mountain of 773 trillion yen (6.5 trillion dollar) in outstanding public debt, standing near 148 per cent of gross domestic product -- the worst among the industrialised nations.

''The government and the ruling coalition have made a public pledge (to start tax reform talks this autumn), so we will do so whatever the circumstances,'' Chief Cabinet Secretary Yasuhisa Shiozaki told a news conference today.

Hideo Kumano, chief economist at Dai-ichi Life Research Institute, said he had thought the government could achieve its key fiscal consolidation target a few years earlier than planned, but that may no longer be possible.

The government aims to to move its primary balance -- revenue and spending excluding debt issuance and service -- into surplus by 2011/12.

''One lesson from this election may be that the government should avoid any policy that is unpopular,'' Kumano said of a consumption tax hike or cuts in social welfare spending.

''Tax revenues may be used for fresh fiscal spending rather than cutting debt,'' he added.

Abe, however, expressed his resolve to push reforms forward.

''The (election) result shows the road ahead is tough, but Japan can no longer survive without reforms,'' Abe told a news conference on Monday.

Some economists said Abe's defeat suggested that the public is not completely happy with stresses in the society, such as income disparity, caused by structural reforms promoted by Abe and former Prime Minister Junichiro Koizumi.

''This may be a turning point for 'Koizumi reforms', Kumano said. ''Abe needs to come up with a new idea.'' But expectations for Abe's reform agenda were never great.

''Investors may worry that the LDP's defeat means that the ongoing reform drive will take a back seat,'' said Takahide Kiuchi, chief economist at Nomura Securities.

''But they won't be greatly disappointed because expectations for Abe as reformer were not high in the first place, compared with his predecessor,'' he said.

REUTERS SW BD1328