Analysis: Japan debt stays lukewarm as Europe boils over

Δημοσίευση 11 Δεκεμβρίου 2011, 14:52 / Ανανεώθηκε 27 Ιουνίου 2013, 14:55
Analysis: Japan debt stays lukewarm as Europe boils over
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Europe's debt crisis has brought Japan's own debt pile into a spotlight that ironically buys Tokyo more time to fix its finances by making alternatives to Japanese bonds look even less appealing.
Europe's debt crisis has brought Japan's own debt pile into a spotlight that ironically buys Tokyo more time to fix its finances by making alternatives to Japanese bonds look even less appealing.
A closer look at Japan's debt and savings dynamics, market conditions and its tax and welfare reform plans suggests a funding crunch of a kind that now looms over southern Europe is still several years away.
Income and corporate tax hikes agreed to last month should cover most of the nearly $244 billion to be spent on rebuilding from the March earthquake, tsunami and nuclear disaster and prevent it from piling on a debt mountain double the size of Japan's annual economic output.
The plan to double the 5 percent sales tax that the ruling party may formally endorse by the end of the year should stabilize funding of the social security system which eats up a third of the budget. A proposal to peg pension payouts to Japan's steadily falling prices can even reverse a steady rise in welfare costs.
"Japan needs to do something to contain welfare spending, and that's why a sliding scale for pension payouts is important," said Yasuo Yamamoto, senior economist at Mizuho Research Institute.
"It's also very important to raise the sales tax. But Japan isn't like Europe. We can fund our debt domestically and we don't have to bail out anyone else."
Yet Prime Minister Yoshihiko Noda and his government can ill-afford to be complacent.
None of the steps taken or proposed so far are sufficient to stop debt from growing -- Japan's main scenario has the debt to GDP ratio rising for at least another 12 years and stabilizing only a decade from now under most optimistic assumptions.
Instead, they merely help maintain a fine balance between Japan's huge borrowing needs and its vast pool of domestic savings.
Those savings have allowed Tokyo to cover 95 percent of its needs at home and explain how it can borrow for 10 years at about 1 percent while nations with similar debt metrics but reliant on foreign borrowing struggle with funding at rates many times higher.
The International Monetary Fund estimates that Japan's gross debt will reach 250 percent of GDP in 2015. By comparison, the IMF forecasts Greece's gross debt in 2015 at 165 percent, Italy's at 116 percent and Spain's at 76 percent.
Many economists point out a better measure is net debt, which factors out funds owed by public institutions to each other. Using this measure, Japan is still high, at 131 percent this year, and the number is expected to rise.
Japan's fiscal consolidation plans also look timid in comparison with crisis-ridden European nations. Its budget deficit of around 8 percent of GDP for the current fiscal year is expected to improve to 7.4 percent in 2015 compared with 2.8 percent forecast for 2015 for Greece, 1.1 percent for Italy and 4.1 percent for Spain, according to the IMF.
Yet many economists say Japan should have little trouble selling new bonds for the next five to six years when debt is expected to start exceeding household and corporate savings.
And even as rating agencies and institutions such as the IMF and the OECD have recently flagged Japan's well-known challenges, the events of the past year -- the March disaster, the escalation of the euro debt crisis and the government's tax plans -- have not markedly changed that perspective.
Noda himself, keen on building political consensus around fiscal reforms, keeps on reminding that low borrowing costs must not be taken for granted and that a sharp spike in yields similar to one experienced by Italy would get Japan in trouble.
According to the IMF, Japan's interest payments would double to 4 percent of GDP if yields rose 100 basis points and a rise by 200 basis points would mean that even aggressive tax hikes and spending cuts would fail to stabilize the debt-GDP ratio.
Such warnings and a poor German government debt auction last week pushed Japan's 10-year bond yields to a four-month high of 1.09 percent.
But since then, yields have fallen back to a two-week low of 1.015 percent and market strategists struggle to imagine where else Japanese funds could go. In fact they note the Japanese bonds' safe-haven appeal for foreign investors rattled by the euro zone's fight for its very existence.
"Safe haven flows into JGBs from overseas could pick up," said Katsutoshi Inadome, fixed income strategist at Mitsubishi UFJ Morgan Stanley Securities.
"There's really not much else that Japanese banks could buy. Life insurers also don't have much choice because they have to offset their liabilities."
In addition, as the IMF itself pointed out, Japanese banks and life insurers, which account for nearly two thirds of the JGB market, are quite resilient, and would not have to increase capital or liquidate assets even if yields spiked by 400 basis points.
Under one still hypothetical scenario, a weak yen could serve as a catalyst for investment outflows abroad, said Atsushi Mizuno, a former Bank of Japan board member.
"The end game for JGBs could be when the yen weakens and JGB yields rise simultaneously," said Mizuno, currently vice-chairman of Credit Suisse's Asia-Pacific fixed income business.
"But that's not something that will happen next year."