Japan's debt mountain: How is it sustainable?

by Etienne BALMER
The pile keeps growing

Already the global leader in accumulating debt, Japan is adding nearly $2 trillion to its mountain this fiscal year with record stimulus packages to cushion the impact of coronavirus.

With debt levels around two and a half times the size of its economy, Japan manages to keep government bond yields ultra low and investor confidence high that it can avoid default.

- How did we get here? -

Whichever way you look at it, Japan's debt is unfathomably large. According to the Bank of Japan (BoJ), at the end of 2019, it stood at 1,328,000,000,000,000 yen.

This is equivalent to around $12.2 trillion, just over half the total amount of US debt in absolute terms but by far the biggest pile when measured against the size of even Japan's mighty economy (around 240 percent of gross domestic product).

Japan's debt began to swell in the 1990s when its finance and real estate bubble burst to disastrous effect.

With stimulus packages and a rapidly ageing population that pushes up healthcare and social security costs, Japan's debt first breached the 100-percent-of-GDP mark at the end of the 1990s.

It hit 200 percent in 2010 and is now around 240 percent of GDP, according to the International Monetary Fund.

On Wednesday, Japan's parliament agreed anti-coronavirus measures worth 117 trillion yen -- which is likely to push the GDP ratio well above 250 percent.

- Isn't this a problem? -

To finance this debt, the Japanese government issues bonds known as JGBs.

These are snapped up in enormous volumes by the BoJ, the country's central bank that is officially independent but in practice closely co-ordinates economic policy with the government.

As part of anti-virus measures, the bank has removed its self-imposed ceiling on buying JGBs, giving itself unlimited purchasing firepower. It holds more than half of all JGBs.

These purchases support the price of the JGBs in the debt market and keep the yield on the bonds low (prices and yields move in opposite directions).

This means that in effect, the government is being financed by the central bank at an ultra-low (or even negative) interest rate, making it more sustainable.

"The ultra-low rate conditions created by very much accommodative monetary policy by BoJ can be one of the reasons" that Japan's mountain is less problematic than for other high-debt countries around the world, said Takashi Miwa, an economist at Nomura bank.

- Who else buys Japan's debt? -

Risk-averse private and institutional investors also have a healthy appetite for JGBs because they see them as a safe place to put their money, burned by a history of stock market bubbles.

"A large portion of wealth is held by seniors who lack financial literacy and prioritise stability rather than return," said Shigeto Nagai, from Oxford Economics.

"With limited investment and lending opportunities domestically, banks, insurance companies and pension funds still need the JGB to place their vast amount of excess savings," Nagai told AFP.

The bonds are denominated in yen, still seen as a safe haven in troubled economic times and the proportion held by foreign institutions is very low -- making Japan less vulnerable to external pressure.

In fact, 90 percent of the debt is held by Japanese investors.

Another thing that keeps market confidence high: Japan is the world's biggest creditor, holding more than $3 trillion in net assets in foreign currency reserves and direct investment abroad.

- How high can you go? -

The growing mountain of debt means that, even with ultra-low interest rates, the amount Japan's government pays for repayments is its second-largest budget line.

The only way to avoid adding to the pile is to reduce budget deficits by boosting taxes or cutting public spending -- but this threatens to throttle growth in Japan's already recession-hit economy.

One drastic step could be to write off the debt held by the BoJ -- a step that would be an "accounting trick" with "no consequence" on the real economy, said Frederic Burguiere, an economist specialising in Asia.

"But this does not take into account the moral dimension of economic mechanisms... if we allow states not to repay their debts, what becomes the rules for private investors and the state itself?" asked Burguiere.

The pile keeps growing