TOKYO (Reuters) - Japan's government approved on Tuesday a $1.02 trillion draft budget for the next fiscal year that aims to nudge tax revenues above new bond sales for the first time in four years, but still relies on borrowing to cover 46.3 percent of its spending.
The first full-year draft budget compiled under Prime Minister Shinzo Abe, who led his Liberal Democratic Party back to power last month with promises of economic revival, marks symbolic improvement after years of deterioration.
With the 92.6 trillion yen ($1.02 trillion) in spending, the government effectively trimmed the size of its draft budget from the previous year for the first time in seven years, taking into account government funding for basic pension payouts.
Still, the budget size hovered around record levels, underlining the difficulty which Abe's government is facing in striking a balance between economic stimulus and fiscal reform.
Taken together with an 10.3 trillion yen extra stimulus plan signed off earlier this month and financed in more than half by new bond sales, it drives borrowing to new highs, pushing Japan's record high debt further into uncharted territory.
"We managed to make the annual budget slimmer than before," Finance Minister Taro Aso told reporters.
"Without the extra budget, the economy would fall into a severe situation in April-June," he added.
In fiscal year 2013/14 starting in April, the government plans to issue new bonds worth 42.8 trillion yen, below this year's 44.2 trillion yen initial target. But combined with the extra budget borrowing of 5.2 trillion, Abe's government will borrow 48 trillion yen, though technically the extra budget borrowing will be booked in the 2012/13 accounts.
Tax revenue is targeted to rise 750 billion yen to 43.1 trillion yen, mainly reflecting an expected pick-up in economic growth to 2.5 percent from 1.0 percent forecast for the current year.
Within the 92.6 trillion yen general-account budget, spending excluding debt servicing costs is estimated at about 70.3 trillion yen, slightly less than the 71 trillion yen earmarked in the regular budget for the current fiscal year.
The government is expected to submit the extra budget to parliament this week and the 2013/14 budget in late February.
The previous government led by the Democratic Party of Japan had set a 44 trillion yen ceiling on annual bond issuance and a 71 trillion yen cap on spending excluding debt servicing costs.
Rating agencies, institutions such as the International Monetary Fund and many economists have said that those limits were seriously insufficient, allowing Japan to rack up budget deficits of close to 10 percent of GDP, above those seen in some of the most indebted euro zone countries.
"We need to see whether the government can carry out its growth strategy to boost the economy, thus increase tax revenue, and also whether it can continue to cut expenditure," said Yasuo Yamamoto, senior economist at Mizuho Research Institute.
"I cannot deny a chance that the government will compile an extra budget again if the economy won't recover ... It may raise public work spending, which would require more bond issuance."
So far, however, vast domestic savings have allowed Japan to comfortably cover nearly all of its financing needs at home and at record low interest rates.
Abe's government has reaffirmed its predecessors' goal of bringing the primary budget, which excludes borrowing and debt service, into balance by 2020/21. This can only be achieved with substantial spending cuts and tax hikes.
"We must come up with something new to fix the primary balance by the middle of this year," Finance Minister Aso said. "It would not be convincing if only the economy picks up while we leave (fiscal reform) undone."
(Additional reporting by Kaori Kaneko; Editing by Tomasz Janowski and Kim Coghill)