The flip side to Japan's brewing JPY12trn fiscal stimulus

Yen exchange rates will suffer.

DBS cited media reports as saying Japan’s new government will announce JPY 12trn fiscal stimulus by this Friday, covered in the supplementary budget for FY2012.

Equivalent to 2.5% of GDP, the size of this supplementary budget is not small. The increase in government spending should help to boost domestic demand (about
one half of the budget will be used on public works), pulling the economy out of recession.

Here's more from DBS:

On the flip side, however, the impact of fiscal expansion on the yen exchange rates would be negative.

The supplementary budget will add to Japan’s already-heavy fiscal burdens. We estimate that fiscal deficit for FY2012 will be boosted to 11-12% of GDP, same large as in 2011 (during the earthquake disaster) and 2009 (following the global financial crisis).

The public debt-to-GDP ratio, which has surged by 36ppt in 2009-2011 to reach a record high of 208%, is projected to rise further to approach 220% in FY2012.

The widening of fiscal deficit implies downward pressures on the current account balance – a measure of the saving investment gap in both the public and private sectors of the economy.

The expansion of fiscal policy and the ambiguity in the long-term fiscal consolidation plan also point to the risks of a downgrade of Japan’s sovereign credit ratings, and an erosion of foreign investors’ confidence on the JPY assets.

Moreover, the government’s fiscal policy expansion could require additional quantitative easing by the central bank to absorb the new bond issuance and stabilize the rise in bond market yields.

The Bank of Japan currently targets to buy JPY 44trn JGBs under its asset purchase program, which exactly matches the JPY 44trn government bond issuance plan in the initial budget for FY2012. Growing need for BOJ easing and worries about government debt monetization will also be negative for the yen.