By Yasuhiko Seki

TOKYO (MNI) – Japanese financial market players will pay more
attention to domestic political developments than other factors this
week as talk of a snap election raises hopes of a more market-friendly
government.

The ruling Democratic Party of Japan and the main opposition
parties — the Liberal Democratic Party and New Komeito — will hold a
meeting of their policy chiefs on Monday to discuss the establishment of
a national forum for social security reform, according to local media
reports.

The move forms part of key conditions for Prime Minister Yoshihiko
Noda to dissolve the lower house of parliament and hold a snap general
election, the Nikkei reported over the weekend.

“From the viewpoint of financial markets and the economy, the worst
case scenario for Japan will be that Noda stays in power,” said Mitsuru
Saito, chief economist at Tokai Tokyo Securities Co. “A government, led
by the LDP, will make a better administration than the one led by the
DPJ.”

Since the DPJ took power away from the LDP in 2009, the world has
gone through two major slumps, first triggered by the collapse of Lehman
brothers and then by the European sovereign debt crisis.

During this period, the Nikkei 225 Stock Average has lost more than
16% while the yen hit a historical high of Y75.32 against the dollar on
Oct. 30, 2011, striking a heavy blow to the Japanese economy.

Noda has repeatedly said he wants to win parliamentary approval of
a bill to allow issuance of deficit-financing bonds as well as
lower-house electoral reform bills to address disparities in voter
representation, before deciding on when to dissolve the lower house.

As part of a three-party agreement with the opposition parties,
Noda said in August that he would dissolve the lower house and call a
general election “as soon as possible.”

Later he said, “Once necessary conditions are fulfilled, I would
decide on my own.”

A recent survey by Nippon Television Network showed the support
rating for Noda has fallen to 20.8%, the lowest since he took office in
September 2011, raising chances for resign en masse or a diet
dissolution.

His predecessors Yukio Hatoyama and Naoto Kan stepped down after
their approval ratings fell to below the key 20%-mark.

While votes from middle-income earners led to a landslide lower
house election win by the DPJ in 2009, financial market players did not
like some DPJ policies that were taken as anti-market.

Noda, as well as his predecessor Naoto Kan, has put a higher
emphasis on rebuilding the nation’s finances through a sales hike over
shoring up the economy’s growth potential.

By contrast, the LDP’s Shinzo Abe, who has recently returned to the
top party post after giving up his premiership five years ago due to
poor heath, says he will try to boost the flagging economy before
tackling the debt issue.

“The best case scenario for Japanese financial markets would be to
have a lower house dissolution before the end of this year and to have
a market- and economy-friendly government, led by Abe,” said Masaru
Hamasaki, chief strategist at Toyota Asset Management Co.

“If this happens and is accompanied by a gradual weakening of the
yen, the Nikkei 225 Stock Average may rise toward 9,500,” he said.

FX strategists also seem to support an LDP-led government.

“There is emerging speculation that Abe would tackle a strong yen
more actively than the LDP-led government by putting pressure on the
Bank of Japan to do more (easing),” said Kengo Suzuki, FX strategist at
Mizuho Securities Co.

Abe recently said the BOJ should continue to ease monetary policy
until consumer inflation hits 3%. The year-on-year change in Japan’s
consumer prices is expected by economists to remain around zero for the
time being.

“Thus the emergence of an LDP-led government should add some
downward pressure on the yen, even though the yen is not likely to fall
notably, given the likelihood that interest rate differentials between
Japan and the U.S. would not widen sharply under the reelected Obama
administration,” Suzuki said.

President Obama beat Republican challenger Mitt Romney at last
week’s election, securing a second term. Romney has repeatedly said that
he would replace Federal Reserve Chairman Ben Bernanke. Bernanke’s term
ends in January 2014.

“Given the likelihood of the continuation of the current monetary
policy stance by the Fed and uncertainties about the impact of fiscal
cliff in the U.S., the yen will not depreciate beyond Y82 against the
dollar before the end of this year,” Mizuho’s Suzuki said.

JGB analysts also pay a close attention to the fate of the
debt-financing bill in the Diet, with the failure to approve such a bill
seen resulting in the suspension of government bond issuance from
December.

“The suspension of government bond issuance will initially help
improve supply and demand conditions in the JGB market, leading bond
yields to stay low,” Hamasaki said.

“But this will erode the confidence in Japan’s ability to finance
its huge budget spending and debt, thereby raising the risk for a spike
in bond yields in the future,” he said.

By the end of March 2012, the level of outstanding Japanese
government bonds will total Y709 trillion, 148% of projected gross
domestic product, while its outstanding long-term debt, including JGBs
and municipal bonds, is expected to total Y940 trillion, 196% of
projected GDP, according to an estimate by the Ministry of Finance.

As a result, Japan will be one of the most heavily indebted
industrialized nations, even dwarfing gross public debt held by Greece.

Aside from the market perspective, analysts also are watchful of
developments in Japan-China ties, which have deteriorated over the
long-standing territorial dispute that flared up again this year.

“If the person who let the deterioration in political and economic
relationships between Japan and China happen were to go, it might help
improve the battered relationships,” Kazumasa Yamaoka, chief
strategist at GCI Research Institute, said, referring to Noda.

As a result of growing anti-Japan protests in China, Toyota Motor
Corp, for instance, saw its vehicle sales nearly halved in China in
September and October, while other Japanese automakers also suffered
from steep sales declines in these months.

As the fallout from anti-Japan protests in China added to downside
risks to Japan, the nation’s economy contracted 0.9% in the third
quarter, or at an annualized rate of 3.5%, matching the median forecasts
in a MNI survey, official data showed Monday.

Japan’s economy marked the first contraction in three quarters,
adding to the view that the world’s third-largest economy is slipping
back into a recession.

tokyo@marketnews.com

[TOPICS: M$A$$$,M$J$$$,MGJ$$$]