Bank of Japan headquarters in Tokyo

With world stock markets volatile and the US economy teetering toward recession because of the sub-prime crisis, one of the many consequences of Japan’s divided Diet is that partisan politics has for the first time entered into the selection of a new Governor of the Bank of Japan.

Indeed, until last week there wasn’t even a process for Diet members to vet prospective governors. The national parliament simply approved whoever the government of the day chose. That situation changed suddenly after the July 2007 election left the national ruling coalition with only 37 of the 121 seats in the House of Councillors. Japan’s upper house is now controlled by the opposition Democratic Party of Japan (DPJ). Prime Minister Takeo Fukuda has been struggling with gridlock ever since.

Incumbent Governor Toshihiko Fukui’s five-year term expires March 19. Because of his investment in a fund tied to the Livedoor insider trading scandal that erupted in 2006, he is not being considered for reappointment. Fukui did not divest himself of the shares even after taking office, leaving him open to charges of conflict of interest.

The fear is that partisan infighting could leave the critical posts of governor and two deputy governors vacant, thus roiling the markets. The betting is that the government’s nominee will be appointed to replace Fukui, but that the opposition will make him sweat a little.

A 1998 revision of the Bank of Japan Law that was designed to strengthen the bank’s independence from the government required that the new governor and his two deputies be confirmed by both houses of parliament. And in this matter both houses are equal.

The normally more powerful House of Representatives cannot simply overrule the upper house with a super majority in the event of an impasse, as it did in January when the upper house defeated the bill to permit the Japanese navy to resume refueling Afghanistan coalition vessels in the Indian Ocean. If the government’s nominee is rejected by the upper house, the government would have to withdraw the nomination and submit a new name.

Under an agreement reached between the Liberal Democratic Party (LDP), its coalition partner and the opposition DPJ, the Rules and Administration Committees of each house will hold separate hearings much the same way as the US Congress holds hearings for the Governor of the Federal Reserve Board. Then the bodies will have a straight up or down vote.

But unlike Congress, these hearings will be closed to the press and public. A transcript of the hearings can be made public only after the nominee is confirmed and has taken his post.

Prime Minister Yasuo Fukuda is expected to formally nominate BOJ Deputy Governor Toshiro Muto to become the next governor sometime before the end of February. Almost everyone agrees that Muto is eminently qualified for the position. A former vice finance minister, he is said to be an expert in all aspects of fiscal, tax and monetary policy. He is also said to be close to Fukuda.

The only real objection to Muto comes from the fact that he served as the top civil servant in the finance ministry before becoming deputy governor. One of the major themes of “reform” in Japanese politics has been an effort to end the revolving door of senior bureaucrats moving seamlessly into government positions and vice versus.

In the past, the finance ministry and the BOJ bureaucracy have taken turns providing gubernatorial nominee, and Muto’s appointment would perpetuate this pattern. But with vacancies in the top three posts looming, it is probably too late to consider appointing some figure from the private sector. The DJP has not put forth its own candidate.

Opposition leader Ichiro Ozawa himself has stated that “Our policy is that bureaucrats should not parachute into other ministries and institutions.”

Some DPJ members actively oppose Muto’s appointment on these grounds. One is Yoshihito Sengoku, a former member of the socialist party who presumably has opposition to anything the LDP stands for in his blood. As he happens to chair the party subcommittee that vets appointment subject to Diet approval, he has the potential to clog things up, if he has a mind.

However, Ozawa has been firm in stating that the final decisions on the appointment of the bank governor will be held by the party leaders, and they seem inclined to vote for Muto once the hearing formalities have concluded.

The Democratic Party has, for the most part, pursued a policy of opposing most government initiatives using its majority in the upper house to defeat or delay government bills. The goal is to force the prime minister to dissolve parliament and call a general election.

This makes sense on certain measures such as the refueling bill or an extension of the gasoline tax, which are unpopular. But it is another matter to be seen as contributing to uncertainty in the global markets or, worse, for allowing these important central bank posts to fall vacant for any length of time. The party then would be held accountable for the disruption that might cause for the markets.

That would severely damage the party’s reputation at a time when it is on a roll. It might be the one thing that could revive Fukuda and his government’s flagging popularity (new polls show Fukuda’s approval ratings dropping from 45 percent in January to about 38 percent today).

Thus the betting is that the succession should proceed, though perhaps less smoothly than the government or the markets might have hoped. The democrats will acquiesce in the Muto appointment perhaps in return for having a stronger voice in selection of the two deputy governors

It is also fair to assume that Japan’s consumption tax will be raised sometime during the five year term of Fukui’s successor, and that he will have to deal with the government huge public debt. The next governor will also have to decide whether to raise or lower the bank’s benchmark interest rate, After years of zero rates, the bank raised the key, 2006, and to .5 percent last February. Undoubtedly, the Diet members will be keen to question Muto on these and other matters. But the public won’t know what he had to say about them until after he is confirmed and takes office. interest rate to .25 per cent in July