Japan faces challenges over debt
Japan is the most aged of the developed economies but others, both developed and emerging, are following the same path.
Aspects of what is happening in Japan are therefore relevant for other countries, just as changes in Japan may bring it more in line with others.
For decades, Japan has been moving gradually but inexorably towards a demographic – and therefore a fiscal – cliff. The size of companies’ and households’ savings were becoming ever harder to square with the huge indebtedness of the public sector. The initial increase in public sector debt followed the economic collapse of the 1990s and subsequent deleveraging in the private sector. The level of government debt, however, was not seen as an immediate problem, in spite of Japan’s deflationary backdrop, because the government was able to fund itself cheaply by issuing bonds into a market with unparalleled domestic support. The country enjoyed a comfortable trade surplus, allowing it to export capital. The picture today is less benign. The demographic profile will make it difficult for Japan’s corporate sector to produce enough growth to allow the public sector to reduce its level of indebtedness. Declining domestic savings are removing a support for the bond market.
Using last year’s tsunami as a turning point, things have changed and are moving more quickly. For instance, the change in energy policy in the aftermath of the Fukushima nuclear accident has had far-reaching consequences. Japan had been a leading proponent of nuclear power and an expert developer and manufacturer in related technologies. It has shut down its nuclear generators and now relies on imported fossil fuels. This has negative implications for its external account. The trade deficit on the nation’s current account that appeared in January could become a persistent feature. Japan may ultimately become an importer of capital. At the same time the earthquake-related construction boost has been positive and private-sector investment looks healthier than for some time.
Japan has historically been cash rich. Savings belonging to households and companies exceed the total borrowing of the public sector. However, as the population ages, household savings rates will fall. At the same time, businesses are no longer deleveraging and investing their savings into the Japanese government bond (JGB) market to the same extent. Foreign investors hold just 5 per cent of JGBs, while 45 per cent are in the hands of Japanese banks, which put as much resource into buying bonds as to funding commercial loans. If the private sector is done with deleveraging, that could change. Neither domestic banks nor pension funds are in a position to step up purchases of JGBs. Once the deficit exceeds the savings, the demand for, and supply of, JGBs will need to change.