(Reuters) -Japan's Liberal Democratic Party ruling coalition may lose its majority in the upper house in an election on Sunday, which could heighten calls for the government to boost spending and cut tax.
Here is a guide on how the election outcome could affect Japan's fiscal and monetary policy:
LOOMING POLITICAL UNCERTAINTY
Recent media polls show the LDP coalition could lose its majority, heightening the risk of political instability when the country is struggling to strike a trade deal with the U.S., and stoking fears of an increase in debt. Japan's debt burden is the highest in the developed world at about 250% of GDP.
Prime Minister Shigeru Ishiba is regarded as a fiscal hawk, but concern over possible increased spending by parties to ensure political support on Tuesday pushed up bond yields to multi-decade highs. Yields may rise further if the chance of big spending or a sales tax cut increases.
WOULD JAPAN HAVE A NEW PRIME MINISTER?
If the election loss is small, Ishiba could remain prime minister and seek opposition parties' cooperation to pass bills through parliament. Faced with a big defeat, Ishiba could step down and his party will hold a leadership race to choose a successor. Depending on the extent of loss, there is a slim chance a new premier could be chosen from an opposition party.
WOULD JAPAN SEE BIGGER SPENDING?
Regardless of the election outcome, Japan will increase spending as Ishiba has pledged to offer cash payouts to households to ease the cost of living. The estimated 3.5 trillion yen ($23.6 billion) in payouts will be funded by tax revenues.
But spending may balloon if the LDP coalition suffers a big loss, as it would heighten calls from within the party and opposition forces to take bolder steps to cushion rising living costs.
Some analysts expect Japan to compile an extra budget around autumn this year to fund spending of at least 10 trillion yen, which will likely require additional debt issuance.
HOW LIKELY IS A CUT TO JAPAN'S SALES TAX RATE?
Japan's sales tax rate is set at 10%, except for food items at 8%. Ishiba has shunned opposition calls to slash the sales tax, which funds social welfare costs for a rapidly ageing population. An election defeat could force Ishiba to cut sales tax, which would leave a huge hole in Japan's finances.
Excluding proceeds from debt issuance, the sales tax is Japan's biggest source of revenue. In fiscal 2025, it collected 25 trillion yen, or 21.6% of total budget. Analysts say halving the tax rate would cut revenues by over 10 trillion yen.
A sales tax cut will require passing legislation through parliament, so will not take place until April at the earliest.
WHAT WOULD BE JAPAN'S WORST-CASE SCENARIO?
A worst-case scenario is a credit rating downgrade on Japan's sovereign debt, which could trigger a triple selling of bonds, yen and Japanese stocks - and boost the cost of dollar funding for Japanese banks.
Moody's Ratings has said an increase in tax cut pressure could be negative for Japan's rating depending on the size and duration of the cut. It rates Japan A1, the fifth-highest level.
HOW WOULD THE ELECTION OUTCOME AFFECT BOJ POLICY?
The ruling coalition has given a quite nod to gradual interest rate hikes, as has the biggest opposition Constitutional Democratic Party of Japan. If the clout of other smaller opposition parties increases, the BOJ could come under pressure to go slow in rate hikes.
But the BOJ's long-term rate hike path is unlikely to be affected unless Ishiba is replaced by vocal advocates of bold monetary easing like Sanae Takaichi, who Ishiba narrowly defeated in a LDP leadership race last year.
($1 = 148.1800 yen)
(Reporting by Leika Kihara; Editing by Michael PerrEditing by Michael Perry)
