By Junko Fujita
TOKYO (Reuters) - Hidden beneath its streets, Japan's aging sewer pipes spotlight a challenge that has held back reforms Prime Minister Shinzo Abe is pushing to revitalise the world's third-biggest economy.
Overhauling the country's infrastructure - roads, tunnels, ports and sewage plants, many of them built after 1970s when the construction boom started - is a looming burden on the government, whose deficit has already swollen to more than twice its GDP.
Abe's solution is to sell public assets to companies or allow firms to manage them, which he argues would also help reduce the bulging deficit and generate economic momentum and jobs.
Success here would be a boon to stalled structural reforms, which along with monetary and fiscal stimulus, make up his three-pronged approach, or the so-called "three arrows", to reenergize long-moribund activity.
So far, Japan has sold the right to operate Kansai International Airport, serving Osaka, and Sendai International Airport in northern Japan. Cashing in on a tourism boom, the government is planning to privatise more regional airports.
Now authorities aim to open markets for the water systems to private investors. But the plans are not getting much traction. Cities don't trust businesses to take over something as vital as water supplies.
Nara, Japan's ancient capital, last year rejected a proposal to let a business operate its water works jointly with the city.
“What we are afraid of the most, if the service is privatised, is that the new entity may stop proper water supply in some areas to seek efficiencies," said Kentaro Shirakawa, a member of Nara's city assembly.
So far, only Hamamatsu, a town in south central Japan, has picked a group of companies led by France's Veolia <VIE.PA> as a winning bidder to operate its sewage system - but not the hard part, overhauling the pipes.
The obstacles highlight the difficulties Abe faces in carrying out deeper reforms he says Japan needs to put the economy on a sustainable footing as its population declines.
He envisions a 21 trillion yen ($190 billion) market of public-private partnerships (PPPs) by 2022 where businesses operate government-owned assets.
So far, that market has reached 9.1 trillion yen, with the Kansai airport accounting for 5 trillion of that.
Abe's government is urging cities to privatize their water works as replacement costs rise and their populations decline.
Assembly members and local officials in some cities believe that privatizing will lighten the fiscal burden on their own dwindling resources.
By 2035, about 28 percent of sewer pipes - or 130,000 kilometers - will reach their 50-year lifespan. Replacement costs for pipes, pumps and other equipment are seen ballooning 66 percent to 1 trillion yen ($9.1 billion) over 20 years from 2013.
Lawmakers in many cities, however, are concerned about whether private companies could provide services in the event of an earthquake, and what would happen if they went bankrupt. Opponents also argue privatization may result in job losses for the contractors that cities rely on now.
Cities have little incentive to privatize their water systems because they know they can fall back on the central government to bail them out if they run into a crisis, said Hideaki Tanaka, professor at Meiji University’s graduate school of governance studies.
For now, smaller cities and towns are waiting to see if such moves are successful in bigger cities. But most want to keep the status quo - even if they are in the red.
In Nara, for instance, the water operations were already running a 200 million yen deficit each year.
"They will probably leave the pipelines until they explode,” Tanaka said.
(Reporting by Junko Fujita; Editing by Malcolm Foster & Shri Navaratnam)