FOCUS: Abe to confront economic challenges immediately

TOKYO, Dec. 16 -- (Kyodo) _ Shinzo Abe and his Liberal Democratic Party, decisive winners in Sunday's general election, will need to confront immediate challenges if they are to reenergize Japan's economy as promised, giving them little time to bask in the glow of victory.

The world's third-biggest economy is widely seen as having fallen into a recession on the global economic downturn and weak domestic demand as a result of diminished effects from government spending on reconstruction following the March 2011 earthquake and tsunami.

Abe, who is certain to become the next prime minister given the dominance of the party in the powerful House of Representatives, has said the LDP-led government will boost budget spending on public works projects to create employment and underpin growth while urging the Bank of Japan to more aggressively ease monetary policy.

"The economy is in a very difficult situation," he told reporters Sunday. "With deflation, the rising yen...it is not easy to handle."

But more budget spending is highly likely to pinch the nation's public finances, which have been already plagued by a pile of debt, and making the BOJ cooperate in the efforts could prove tricky, as there is a counterargument against his position for more government intervention in the central bank's operations.

The LDP and its ally, the New Komeito party, have said they will implement public works projects worth up to 200 trillion yen ($2.4 trillion) over the next decade, focusing on stronger infrastructure and other measures to prevent natural disasters.

Abe has staked his political reputation on beating chronic deflation, which has mired the economy for so long. By unveiling the stimulus plan, he underscores that economic growth supersedes fiscal discipline, even suggesting the planned sales tax hikes in 2014 and 2015, touted as key to improving Japan's fiscal health, could be shelved depending on economic situation.

For the BOJ, which has frequently found itself in the crosshairs of stimulus-minded lawmakers, the election result will likely trouble it in attempting to shield itself from such hard-liners' calls for more monetary easing. The bank has already lowered interest rates to near zero while providing ample liquidity to the banking system by purchasing government bonds and other assets from commercial lenders.

Abe has said he wants to conclude a policy accord with the BOJ that would press the central bank to take bold steps until it reaches an annual inflation rate of 2 percent -- double the bank's current price stability goal of 1 percent.

With more monetary easing expected, the yen has weakened against the U.S. dollar and other major currencies, a development that in turn triggered an advance in Tokyo stocks, with exporters taking heart and the benchmark Nikkei index hitting an eight-month high.

The flourishing markets may prove short-lived, however, if investors find Abe struggling to match his words with deeds.

"Without concrete action, hopes in the market can easily turn to disappointment," said Yasuhiro Sato, president of Mizuho Financial Group Inc., who heads the Japanese Bankers Association.

Reactions to Abe's policy pledges are mixed. Many welcome his resolve to fight deflation but there are also many who doubt the effectiveness of having the BOJ seek 2 percent inflation, given that Japanese consumer prices have fallen or remained almost flat for recent years.

Some warn that pursuing the target could backfire by triggering sharp increases in food and energy costs, hurting the average household.

In any case, Abe taking office is hardly enough to bring Japan's economy out of the woods. The LDP said it would achieve nominal growth of 3 percent or higher without clarifying deadlines. This compares with the contraction of 1.4 percent in fiscal 2011, which ended in March, and growth of 1.3 percent in fiscal 2010.

The party is also planning to create a large extra budget for fiscal 2012 as the first step to turn the stagnant economy around.

Akira Amari, LDP policy chief and former industry minister, says the supplementary budget will focus on making Japanese firms more internationally competitive and "never be sufficient at 4 trillion or 5 trillion yen." Natsuo Yamaguchi, head of Komeito, says it could be around 10 trillion yen.

But how to finance the budget remains unclear. The LDP says it can only secure less than 3 trillion yen by immediately streamlining the current government's spending such as livelihood subsidies and personnel costs for public servants.

With Abe showing a tough stance against the BOJ, such a lack of financing resources would intensify the market view that the new government cannot help turning to the bank for funds.

But it is exactly the last thing BOJ Governor Masaaki Shirakawa could accept as he, just like other central bankers in the world, is reluctant to directly finance the government, an act banned in principle under a Japanese law because of fears it could trigger uncontrollable inflation.

During the election campaign, Abe indicated he looked to force the BOJ to purchase bonds directly from the government -- not from the market as usual -- to help finance public works projects. But he later rejected the idea of direct financing and said it is the BOJ who decides on bond purchases amid widespread criticism that he is breaching the bank's legally secured independence.

Despite Abe backtracking, analysts say greater pressure from the government on the BOJ to support state finances will be inevitable.

Whether direct or indirect, "it is monetization in that a central bank clears the mess" of the government, Ryutaro Kono, chief economist at BNP Paribas Securities (Japan) Ltd., said in his report.