TOKYO Japan's incoming ruling coalition will review the country's mid-term fiscal plan and could scrap its annual spending cap to boost public expenditure to revive the economy, several government sources said on Wednesday.
Shinzo Abe's Liberal Democratic Party, returned to power in Sunday's election, is planning an extra budget as large as 10 trillion yen ($119 billion) early next year focused on public works to rebuild areas struck by the March 2011 tsunami and on disaster prevention infrastructure, LDP officials have said.
"The current mid-term fiscal framework may be reviewed in order to boost budget spending to beat deflation," a source familiar with the discussions said.
Economists say a combination of aggressive monetary easing and big spending may help pull the economy out of its fourth recession since 2000, but investors will want assurances that it will not lead to a lasting relapse in budget discipline.
"Japan is the only country in the world where we get both monetary expansion and lax fiscal discipline. This can't go on forever. The whole world is watching," said Arihiro Nagata, head of foreign bond trading at Sumitomo Mitsui Banking Corp.
The outgoing government of Prime Minister Yoshihiko Noda's Democratic Party set a goal of halving the deficit in Japan's primary budget that excludes debt servicing costs, in fiscal 2015 and bringing the primary budget to balance in 2020.
Noda, with the LDP's help, secured passage of a plan to double the sales tax from the current 5 percent to help achieve that and capped annual budget spending without debt-servicing costs at 71 trillion yen. It also kept a limit on new bond sales at 44 trillion yen.
Sources said those limits could be eliminated to give the new government more room to stimulate the economy. LDP No. 2 Shigeru Ishiba has already said the bond sales cap could be breached next year to help finance the extra budget.
Experts said a 10 trillion yen package would require new borrowing as only some 4 trillion yen could be scraped together from reserves and unused funds from this fiscal year.
However, the New Komeito party, the LDP's small coalition partner, said there was no need to abolish the mid-term budget plan and its targets originally proposed by the same parties while in power before the 2008-2009 global financial crisis.
"I don't think we need to scrap that," said the Komeito's policy chief, Keiichi Ishii, referring to the mid- to long-term target for restoring fiscal health.
CENTRAL BANK DECISIONS EXPECTED
Speaking a day before the Bank of Japan is expected to ease monetary policy for the fifth time this year after two days of meetings, Ishii also said the coalition deal would mention the need for the central bank to pursue monetary easing.
In its election platform, the LDP included the same deficit targets as those adopted by Noda's government, but did not say how it wanted to accomplish them without spending restraints.
Economists pointed out, however, that while the Democrats aimed for average nominal economic growth of 1.5 percent per year, the LDP set the target at 3 percent, which many investors see as unrealistic.
Abe's cabinet is due to be appointed on December 26 and is expected to lay out its budget policy shortly after that.
SMBC's Nagata said that despite market concerns that Japan could be slipping in its efforts to contain a public debt already exceeding twice the size of its economy, there was no immediate risk of a bond sell-off.
With more than 90 percent of government debt held by Japanese investors and given their strong domestic bias, short-term players' bets against government bonds have yet to pay off.
"It's still too early for that," he said, adding that the yield on 10-year Japanese government bonds - already near 7-week highs at 0.770 percent - could creep as high as 0.9 percent heading into the spring, but rather on progress in the U.S. "fiscal cliff" debate and a rise in U.S. Treasury yields, than reflationary steps in Japan.
($1 = 83.9850 Japanese yen)
(Editing by Tomasz Janowski and Ron Popeski)