Insight - Japan deflation devil, election loss drove Abe's tax, poll moves

TOKYO (Reuters) - Japanese Prime Minister Shinzo Abe's twin decisions to delay an unpopular sales tax increase and call a snap election were not quite the bolt from the blue they first appeared.

Recent interviews with aides, politicians and officials reveal that the decisions, announced on Tuesday, resulted from months of deliberations based on two deeply held tenets: beating deflation must take priority and hesitating over elections would endanger Abe's hope of a long-term tenure.

With his ratings still around 50 percent in most surveys and the opposition weak, Abe judged that calling an election now would be safer than waiting until next year, politicians said.

Abe announced he would delay the tax increase by a year-and-a-half to April 2017 and dissolve the lower house of parliament on Friday for an election expected to be held on Dec. 14.

In 2015, Abe plans to push ahead with unpopular policies such as restarting nuclear reactors that went off-line after the 2011 Fukushima disaster and enacting laws to allow the military to fight abroad for the first time since World War Two.

That the tax and election moves came simultaneously resulted from the convergence of factors: a string of weak economic data, scandals in his cabinet, a shock monetary easing by the central bank and a diplomatic coup in the form of a summit with Chinese President Xi Jinping.

Abe was concerned from the start about the possible blow to the economy from a second rise in the sales tax to 10 percent from October 2015 after a hike to 8 percent from April, a two-step plan based on legislation passed with the backing of ruling and opposition parties before he took office in 2012.

"For sure, escaping deflation is his top priority," a senior administration official told Reuters, adding the danger to that goal was Abe's main gauge for deciding on the tax hike delay.

At the core of his "Abenomics" strategy is a belief that two decades of deflation have made Japanese consumers wary of spending on big ticket items and firms cautious about investing, and altering that mindset is vital to achieving growth.

Worries about that risk grew from the summer. Data released in early September showed the economy had shrunk by more than 7 percent in the April-June quarter after the first tax rise, the worst contraction since the 2009 global financial crisis.

As weeks passed, officials began to sense the rebound in the third quarter through September was less robust than hoped.

Finance Ministry bureaucrats, who had long argued the tax hike was vital to rein in debt, began to feel they were fighting a losing battle and to consider scenarios that included a delay.

HE WHO HESITATES LOSES

Even as the stream of gloomy economic data flowed, Abe was pondering when to call an election for parliament's lower house, whose four-year term does not expire until December 2016.

One option was to call a snap vote shortly after a Sept. 3 cabinet reshuffle that was intended to boost Abe's popularity.

That scenario became untenable, the administration official said, after two new cabinet members resigned over political funding scandals, denting Abe's support though not disastrously.

Weighing heavily on Abe's mind, however, was the bitter memory of how the last prime minister from his Liberal Democratic Party (LDP), Taro Aso, missed the best timing to call an election.

Aso, who took office in 2008 after his predecessor quit, was expected to call an early poll while his ratings were relatively high. Instead, he dithered, only to see his support dive. When Aso finally called an election in August 2009, the LDP lost power for three years.

"It's always better to go on the offensive when your administration is strong rather than be forced into an election," said a veteran LDP lawmaker.

A snap poll would have the added bonus of effectively silencing ruling coalition heavyweights who backed the tax hike.

PIECES FIT TOGETHER

On Oct. 22, Abe's close aide, Chief Cabinet Secretary Yoshihide Suga, made a comment that, in hindsight, suggested the deliberations on the tax hike and an election were merging.

The government, Suga said, would look at preliminary data for third quarter GDP in deciding on the tax increase.

While ambiguous, the remark suggested Abe might decide on the tax rise after seeing data due out on Nov. 17, while parliament was still in session and could thus be dissolved for a snap poll, rather than wait for later data in December.

In the event, the data was far worse than forecast, showing the economy slipped into recession in the third quarter.

As Abe neared a decision on an election, the Bank of Japan on Oct. 31 took a shock step many thought would make it easier to raise the tax, but instead appears to have done the reverse.

By announcing an expansion of its monetary stimulus programme that boosts its government bond purchases, the BOJ eased concerns about a bond market meltdown if the tax rise were delayed, and sparked a rally in Tokyo share prices.

On Nov. 7, what now looks like the final piece of the puzzle fell into place with a seemingly unrelated development.

Abe's top security adviser returned from Beijing to report that a long-sought meeting with China's Xi was likely in Beijing the next week. That added a dash of diplomatic success to the pitch Abe was now planning to take to the voters.

That evening, after separate meetings with his LDP No.2 and ruling coalition partner, Abe gave an interview to a private TV broadcaster where he flatly denied he was considering a snap election. Without prompting, however, he also said prime ministers always deny they are planning an election if asked.

Said veteran political analyst Minoru Morita: "He was sending a message: 'I'm going to call an election'."

(Additional reporting by Sumio Ito, Takaya Yamaguchi, Izumi Nakagawa, Yuko Yoshikawa, Leika Kihara and Tetsushi Kajimoto; Editing by Mike Collett-White and Dean Yates)

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