Japan PM Takaichi's reflationist aide calls for fiscal discipline

By Leika Kihara

TOKYO, Feb 5 (Reuters) - Japan must avoid ramping up fiscal spending in a way that fuels inflation and forces the central bank to raise interest rates rapidly, Toshihiro Nagahama, a government panel member known as an economic aide to premier Sanae Takaichi, said on Thursday.

The remark reflects the government's sensitivity to the risk of a renewed bond selloff, after Takaichi's pledge to suspend by two years a levy on food sales sent super-long Japanese government bond (JGB) yields to record highs last month.

Nagahama defended the administration's spending plans, saying the focus was on promoting investment in key areas such as artificial intelligence (AI) aimed at boosting Japan's growth potential and helping lower its debt-to-GDP ratio.

"The Takaichi administration is pursuing proactive fiscal policy accompanied by fiscal discipline, and won't do anything reckless that would destroy markets," said Nagahama, known to be one of the reflationist aides of the dovish premier.

Smooth communication with markets and the Bank of Japan is also crucial to avoid triggering a yen slide or sharp rises in long-term interest rates, he said in a research note.

"If fiscal policy is too expansionary, that would accelerate inflation and force the BOJ to raise interest rates rapidly," Nagahama said.

"It's therefore necessary to manage fiscal policy in a way that is neither too loose nor too tight, so that the BOJ can raise rates at a moderate pace and keep any shock to the economy at a minimum."

The government must also enhance transparency over its debt issuance plan, and prioritise dialogue with major buyers of JGBs such as megabanks and domestic life insurers, to avoid causing a bond selloff, Nagahama added.

Growing prospects that Takaichi's party will score a landslide victory in the election on Sunday, and secure a mandate for her expansionary fiscal policy, have kept bond investors on edge amid concern over Japan's worsening finances.

Some bond investors also warn the BOJ is behind the curve in dealing with the risk of too-high inflation. The central bank raised its short-term policy rate to 0.75% in December and has signalled its readiness to keep pushing up borrowing costs.

But real borrowing costs remain deeply negative with inflation exceeding the BOJ's 2% target for nearly four years.

Nagahama, who is chief economist at Dai-ichi Life Research Institute, now serves as a private-sector member of a key economic council that sets Japan's long-term fiscal blueprint.

Along with former BOJ Deputy Governor Masazumi Wakatabe who is also a member of the council, Nagahama is known to be among advocates of former Prime Minister Shinzo Abe's "Abenomics" stimulus, and in the past proposed that Takaichi deploy a huge spending package to prop up growth.