Satyajit Das: Japan's coming debt crisis as an ageing population eyes retirement

Midweek View: Shinzo Abe's policies will provide a short-term lift in economic activity, but are unlikely to create a sustainable recovery

Satyajit Das
Wednesday 30 January 2013 00:21

Japan's Nikkei 225 stock average has risen sharply since late 2012, reflecting faith in the reflation strategy of second-time prime minister Shinzo Abe to increase growth through an additional $120bn (£76.2bn) of public spending and "create" 2 per cent inflation. It may be a triumph of hope over experience

In the post-war period, Japan enjoyed decades of strong, economic growth – around 9.5% per cent per annum between 1955 and 1970 and around 3.8 per cent per annum between 1971 and 1990. Since 1990, the country's growth has been sluggish, averaging around 0.8 per cent per annum. The Nikkei index fell from its peak of 38,957.44 at the end of 1989 to a low of 7,607.88 in 2003. It now trades around 8,000-12,000. Japanese real-estate prices are at the same levels as 1981. Short-term interest rates are around zero, under the Bank of Japan's (BoJ) policy. Japanese government 10-year bonds (JGBs) yield around 1 per cent per annum.

Since 1990, public finances have deteriorated significantly. Government spending to stimulate economic activity has outstripped tax revenues, resulting in a sharp increase in government debt Japan spends more than ¥200 (£1.40) for every ¥100 of tax revenue received. Japanese government gross debt is now around 240 per cent of gross domestic product (GDP). Net debt (which excludes debt held by the government itself for monetary, pension and other reasons) is about 135 per cent. Total gross debt (government, non-financial corporation and consumer) is more than 450 per cent of GDP.

As in previous, similar episodes, Mr Abe's policies will provide a short-term lift in economic activity, but are unlikely to create a sustainable recovery. It will compound the ongoing problem of large budget deficits and government debt levels.

Japan's large pool of savings, low interest rates and a large current-account surplus has allowed the build-up of this large government debt.

The country's global savings are estimated at around $19 trillion. In recent years, household savings were complemented by strong corporate savings, about 8 per cent of GDP. About 90 per cent of all Japanese government bonds are held domestically. Low interest rates make servicing the high levels of debt manageable.

But Japanese household savings rates have declined from between 15 per cent and 25 per cent in the 1980s and 1990s to under 3 per cent, reflecting decreasing income and the ageing population. As more Japanese retire, inflows into JGBs will decrease making domestic funding of the deficit more difficult. Insurance companies and pension funds are increasingly selling their holdings or reducing purchases to fund the increase in payouts to people eligible for retirement benefits.

Since 2007, the Japanese trade-account surplus has fallen sharply, turning into a deficit in 2012 due to an appreciating yen, slower global growth and higher cost of energy imports. But Japan's large portfolio of foreign assets ($4trn, including US treasury bonds of $1trn) will cushion the effects for a time. But even if net income from foreign assets stays constant, Japan's lcurrent account may move into deficit as soon as 2015.

As the drawdown to finance retirement accelerates, Japan will initially run down its overseas investments, losing its net foreign-asset position. Unless public finances improve, Japan will ultimately be forced to finance its budget deficit by borrowing overseas. Where the marginal buyers of JGBs are foreigners rather than domestic, Japanese investors, interest rates may rise, perhaps significantly.

Even at current, low interest rates, Japan spends around 25-30 per cent of its tax revenues on interest payments. At borrowing costs of 2.5-3.5 per cent per annum, two to three times current rates, Japan's interest payments will be an unsustainable proportion of tax receipts.

Given its large domestic savings and also the ability of the BoJ to further monetise its debt, the status quo can be maintained for a little longer. But eventually Japan's toxic combination of weak economic performance, large budget deficits, high and increasing levels of government debt, declining household savings and looming current-account deficits may prove unsustainable. Ultimately, Japan, the world's third-largest economy, may have no option other than a de facto domestic default to reduce its debt levels.

Satyajit Das is a former banker and author of 'Extreme Money' and 'Traders, Guns & Money'

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