Soaring debt, unsustainable government spending, slashed credit ratings. The problems that forced Europe to pledge a financial bailout for Greece sound all too familiar in Japan, one of the world’s biggest economies.
Japan’s budget, announced last week o kick off the fiscal year, promises to spend a record trillion dollars, and the government must issue a record ¥44.3-trillion of new bonds this year. The heavy spending and financing are raising worries in Japan about the country’s long-term fiscal health, amid concern that Japanese government bonds are turning into an asset bubble fuelling a public debt that is the highest among advanced economies.
Japan’s debt, mostly owed to creditors within the country, is more than 200 per cent of annual gross domestic product, compared with 113 per cent in Greece, 50 per cent in Spain, and 69 per cent in the United States, according to the New York-based ISI Group. “I’m actually envious of the Greek situation,” said Masaaki Kanno, chief economist at J.P. Morgan in Tokyo, and a former senior official of the Bank of Japan. “They have market pressure forcing them to take action sooner than later. In Japan, even if the government tries to cut spending, social security costs will likely grow ¥1-trillion every year. The government deficit is likely to grow forever, in a sense.”
“I think the debt is unsustainable, even if it’s stable at the moment,” said Richard Jerram, head of Asian economics for Macquarie Capital Securities, and a Japan specialist. “You just keep piling up more and more debt, and nothing changes to solve the problem. If you have persistent deflation for the next five to 10 years, the public finances are going to crash.”
Prime Minister Yukio Hatoyama has pledged to transfer funds from “concrete to households” by offering families $140 a month per child and free tuition at public high schools starting this month. He said the government will not release a fiscal discipline strategy until June. “When thinking about the long-term fiscal framework, vague discussions alone won’t do,” Mr. Hatoyama told reporters on Tuesday. “We need to show where we are heading two, three years ahead on fiscal reconstruction, possibly through some numerical form.”
Citing Mr. Hatoyama’s lack of clear strategy, Standard & Poor’s cut its outlook for Japan’s sovereign rating in January, and other agencies are reportedly threatening downgrades if Japan issues more debt. The Nikkei newspaper last week reported that the government may need to cancel spending plans or issue more bonds because it could face a shortage of ¥7-trillion ($75-billion) in funds over the next two years to pay for social programs.
Japan’s debt is “very serious,” even though most of it is held within the country, not overseas, and Japan continues to enjoy a current account surplus, said Haruhiko Kuroda, president of Asian Development Bank, based in Manila. “The Greek problem is largely an external debt problem. That does not mean that the Japanese debt situation is benign and can be left indefinitely,” Mr. Kuroda said. “Given the aging population and health care and pension costs which could continue to rise, Japan will have to deal with how to fund expenditure on social programs in coming decades. Solving it is absolutely necessary. It’s unsustainable domestically.”
Nouriel Roubini, who predicted the 2008 global economic crisis, is also sounding alarms. “The recent difficulties of Greece are part of the iceberg. Markets have already targeted Greece, Spain, Portugal, Great Britain, Ireland and Iceland. They could deal with other countries, including Japan and the United States,” Mr. Roubini wrote late last month in a French newspaper. “Aging populations, a serious problem in Europe and Japan, exacerbate the problem of budget deficits by increasing spending on social security and health. A low population growth also implies potentially weak economic growth, so a dynamic debt-to-GDP ratio raises doubts more seriously on the ability to repay debt,” he said.
Mr. Kanno at J.P. Morgan said deflation is leading to a rise in banks and individuals choosing what they wrongly assume are “risk-free assets” in Japan government bonds (JGBs), which yield more than bank deposits. While 94 per cent of debt is currently held by domestic investors, they won’t be able to finance the government indefinitely, as tax revenue flattens amid higher demands for welfare spending. “People forget about the credit crisis and the risk of JGBs,” Mr. Kanno said. “The JGB bubble will eventually burst some day. Japan’s fiscal problem is a flow problem. Will domestic investors finance the deficit forever?”
Within three to five years, the government deficit will exceed tax revenue, and debt servicing costs will likely rise, Mr. Kanno said. “Japanese journalists don’t want to tell the truth to the Japanese public. The current public pension system will not be sustained,” he said. “All the best policies are going to have short-term pain to get the best long-term results. Without taking these risks, Japan will fall into a trap from which we can’t find an exit.”