Japan eyes FX account to boost military outlay, delaying tax hikes

Japan's government is considering tapping surplus funds under a special account set aside for currency intervention to pay for an expected boost to defence spending, three government sources with direct knowledge of the matter said. The industrial world's most heavily indebted government is also expected to delay any tax hikes needed

to boost military outlay for at least a year, the sources said on condition of anonymity because the plan was not yet finalized.

"We have ruled out such options as tax hikes," one of the sources told Reuters. Instead, Japan would focus on streamlining expenditure and scraping together non-tax revenue such as surplus money from the foreign reserves special account and money left over from funds to help state-related firms cope with COVID, the sources said.

The government fears that tax hikes now would deal a blow to the positive momentum emerging in labour and management towards wage growth as they enter annual wage negotiations from early next year to March, the sources said.

Prime Minister Fumio Kishida told ministers on Monday to work on a plan to lift defence spending's share of gross domestic product to 2% within five years, from about 1% now, as Japan faces an increasingly assertive China and threats from North Korea. It would amount an annual defence outlay of roughly 11 trillion yen ($79.16 billion), which would make Japan the world's third-largest military power after the United States and China.

OPPOSITION Given Japan's dire public finances, the defence ministry and the fiscal hawks of the finance ministry have been at odds over how much the government should spend.

"A temporary boost to borrowing cannot be helped. Tapping the forex account would be well-timed given the marginal gain Japan has reaped from a weak yen," Koya Miyamae, an SMBC Nikko Securities analyst, said. "What's important is for Japan to present a credible plan on debt repayment through tax hikes and spending cuts. Without such efforts, Japan's debt would get out of hand."

The proposal highlighted the government's struggle to scrape together defence funding while dealing with the industrial world's heaviest debt burden - more than twice the size of Japan's economy. The Ministry of Finance has been wary of tapping the surplus funds, as they are used to repay past debt, while the reserves account, worth 158.2 trillion yen in terms of assets, is held for interventions in the foreign exchange market.

Opposition from within the ruling bloc against tax increases has also clouded the prospects for more defence spending, leaving more debt issuance and cuts in another spending as the two other leading options. Lawmakers at an LDP tax panel meeting on Monday suggested tax breaks including capital gains, a Nippon Individual Savings Account (NISA) tax-free investment scheme for corporate research and investment, start-up businesses, inheritance, and gifts.

Yoichi Miyazawa, head of the LDP tax commission, told reporters on Monday that he was ready to debate tax increases to fund more defence outlay, but such talk should wait until the government comes up with estimates on funding sources.