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Fiscal policy: turning looser In FY17 Fiscal policy is undergoing an equally important shift. In August, the Cabinet approved an economic stimulus package totaling JPY28trn (roughly 5.5% of GDP). Though “real water” government spending is a comparatively modest JPY7.5trn (1.5% of GDP}, this is enough to put the fiscal impulse back in expansionary territory, after three years of tightening (Chart 10). The stimulus measures, which are centered on public investment and cash transfers to households, should boost CY2017 GDP by O.5ppt. Public construction orders are already rebounding as the government front-loaded public infrastructure spending (Chart 11). Meanwhile, the next stage of the consumption tax increase has been postponed until October 2019. Chart 10: After 3 years of tightening, fiscal policy to turn loose in FY17 2.5 2.0 1.5 1.0 0.5 0.0 0.5 -1.0 Contractionary Forecasts 5 Expansionary FY10 FY11 FY12 FY13 FY14 FY1Sf FY16f FYI7f m Fiscal impulse (change in cyclically-adjusted primary balance), % GDP Source: BofA Merrill Lynch Global Research, IMF, CAO To be clear, we are not talking about massive shifts in the fiscal stance here—the Ministry of Finance remains very much opposed to expanding the deficit and Prime Minister Abe has yet to abandon the government’s long-standing goal of balancing the primary balance by FY2020. However, there is a growing consensus among Japanese policymakers that premature fiscal tightening is counter-productive for reflation efforts, especially when monetary policy is stretched. Even Bo) Governor Kuroda, who initially underplayed the risks from 2014 fiscal tightening, has recently acknowledged that loose monetary and fiscal policies will have a “synergistic effect.” The upshot is that the risk of another policy error is low, in our view. If anything, we see upside risks from greater fiscal stimulus in the form of a third supplementary budget or relatively aggressive FY17 ordinary budget. We would not rule out further delays to the October 2019 consumption tax hike, either. Chart 11: Public investment is poised to pick up in the months ahead 30 20 10 0 -10 -20 2010 2011 2012 2013 2014 2015 2016 = Public construction orders received %YoY 3mma =—=Public construction orders completed %YoY 3mma Source: BofA Merrill Lynch Global Research, MITI Bankof America 4 Japan Economics Viewpoint | 18 November 2016 Merrill Lynch HOUSE_OVERSIGHT_014413