By Leika Kihara and Takahiko Wada
TOKYO (Reuters) - Japan needs a faster "third arrow" growth strategy focussing on promoting a carbon-neutral society, including by creating a financial hub in Tokyo for Asian firms aiming to go green, said Hiroshi Nakaso, considered a front-runner to be the country's next central bank chief.
Massive monetary and fiscal stimulus deployed in 2013 as the first two "arrows" of then-premier Shinzo Abe's "Abenomics" policies reflated the economy. But the third, structural reform, barely took flight, failing to boost a potential growth rate stuck below 1%.
Steps to encourage capital spending on green projects would help lift Japan's potential growth rate and serve as an upgraded growth strategy, said Nakaso, a former deputy governor of the Bank of Japan (BOJ).
"Abenomics was the right prescription to revitalise Japan's economy. But there was too much burden laid upon the first two arrows," particularly on monetary policy, he told Reuters on Friday.
As a result, he said in an interview, short-term interest rates remain negative and the BOJ's balance sheet ballooned to 4.5 times the level before the launch of its huge asset-buying programme.
"The third arrow needed to fly faster and higher," Nakaso said.
"Steps to achieve carbon neutrality would be a breakthrough for Japan, which had struggled to raise potential growth," he said, adding the country's huge savings can be tapped to boost investment in green innovation.
An increase in Japan's potential growth would encourage firms to raise wages on prospects of stronger profits, and give households more purchasing power.
Nakaso is thought by insiders and BOJ watchers to be a strong candidate to succeed BOJ Governor Haruhiko Kuroda when his term ends next April. He is chairman of the Organization of Global Financial City Tokyo, a group of public and private entities working to raise Tokyo's profile as a financial hub.
"If the public becomes more accepting of higher prices, interest rates will come under upward pressure and allow the BOJ to normalise monetary policy," said Nakaso, who has close ties with officials of Prime Minister Fumio Kishida's administration.
Among efforts to fund green initiatives, he said, Japan must enhance Tokyo's presence as an Asian market hub for transition bonds, which are issued by high-emitting firms to transform their operations into greener businesses.
Many Asian firms remain reliant on fossil fuels and may struggle to suddenly go green. Japan can assist such firms by building a vibrant transition finance market, Nakaso said.
"Transition finance is important not just for Japanese firms but Asian companies that make up Japan's supply chain," he said.