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In fiscal jeopardy? An appraisal of the Japanese sovereign debt crisis


Lawrence Huynh

By

September 5th, 2020


Join Lawrence as he traverses through past and present to evaluate whether the Japanese sovereign debt level is truly a cause for concern, in light of the economic and political challenges that Japan and the world face today.


Nations around the world have undergone radically distinct societal and structural changes in recent times. Whilst a fortunate few may have bypassed the worst of circumstances, the cloud of uncertainty continues to linger above the figurative head of our global citizens and has rendered many governments averse to making careless decisions.

Amidst economic instability and geopolitical disarray, the terms ‘global debt crisis’ and ‘debt trap’ have been thrown around frequently. Many central governments around the world have adopted various monetary easing policies and instituted fiscal stimuli to counter the incessant ‘coronacoaster’ that has been disturbing socioeconomic peacetime. As such, countries all over the world are incurring heavier debts to cushion the economy forward.

However, is government debt actually a cause for concern, especially during challenging times like these? How has Japan, the highest net borrower in the world, fared for the longest time with its insurmountable debt situation and what is its outlook for the future? We’re going to try and answer these questions through both a historical and macroeconomic lens; to take a journey into the roots of the cause and realise the implications for the so-called debt crisis that presents itself to Japan and the rest of the world today.  

What is sovereign debt?

Sovereign debt is the central government debt issued by a country in the form of securities, such as bonds and treasury bills. Countries can finance domestic growth and development by issuing such debt securities to creditors and investors in debt markets. Additionally, they can borrow funds from banks, private institutions, individuals, and of course, from other countries.

Whilst sovereign debt is often considered risk-free, it is still possible for a country to face default risk , in which a country may fail to repay its debt obligations. The likelihood of such an event to occur is monitored and evaluated into a country’s creditworthiness,  in the form of a sovereign credit rating. This is no issue for developed, advanced countries. However, those that are less creditworthy may not have the capacity to commit to such debt issuance or borrowing programs. Thus, they may require the aid of international financial institutions like the World Bank or the International Monetary Fund. All countries have varying levels of debt; some are able to cope sustainably, while others have felt the consequences of taking on amounts that are simply excessive and unmanageable in the long run [1].  

A glimpse at Australia’s national debt

Historically, Australia has generally held one of the lowest debt-to-GDP ratios in the world. Despite the job subsidies, packages and safeguards put in place to counter the effects of the pandemic, the Australian net debt-to-GDP ratio (see the distinction between gross debt below) is likely to vault towards just roughly 36%, which is around $677.1 billion by the end of FY2021. [2]

Although earlier reports this year suggested that Australia’s debt is far from unprecedented [3], it will undoubtedly be a significant concern for future generations and complicates the options for a viable solution. Historically, after the Global Financial Crisis in 2008, it had taken 10 years for Australia to rebalance the large budget deficit it incurred. Furthermore, during World War II, Australia’s debt ratio rose from 40% to 120%, and it took 15 years to ease back down. Put into perspective, the current debt burden driven by the pandemic will likely take several decades to offset; a quandary for policy makers and central banks for years to come.

Sovereign debt in Japan

A question many are wondering is whether a country such as Japan, who has a dreadfully high amount of debt, should feel more apprehensive during this unparalleled downturn. Fitch Ratings projected that Japan’s gross debt-to-GDP ratio exacerbated by the pandemic will reach well above 240% into 2021 [4], which is not an unusual number for Japan, given that the country has in fact had the highest debt in the world for the last few decades.

On the surface, Japan’s debt situation simply seems to be a culmination of overly issued government bonds, bills and borrowing. However, macroanalysis tells a greater tale; whilst repercussive natural disasters certainly play a part in this, the Japanese asset price bubble burst in the 1990s was an important trigger. This major crash of real estate and stock market prices and accumulation of non-performing loans forced the nation to increase government stimulus spending, hike up sales-taxes, and incite aggressive policy to escape recession [5]. Inevitably, these rigorous manoeuvres left Japanese businesses riddled with bad debts and service payments, sending the country into a liquidity trap for the next decade and beyond (see the Lost Decade).

Notice that Japan’s debt began to taper off roughly after 2012. Why? It might be partially attributed to Abenomics, the macroeconomic policy package introduced in 2013 by the re-elected government of former Prime Minister Shinzō Abe. [6] In order to reduce debt levels, outsource manufacturing, fend off deflation and revitalise GDP growth, a three-arrow strategy was imposed:

  • aggressive monetary easing via asset purchasing programs and QE injections by the Bank of Japan,  
  • massive fiscal stimulus through government spending, and
  • structural reform to rejuvenate Japan’s competitiveness and aim for deregulation

Yet, the consequences of history have continued to exert negative forces on Japan, as the nation tries to grapple with both past and present during this pandemic. Prime Minister Abe declared his resignation on August 28th due to poor health, and many are left deliberating whether his policies ever worked in the first place. Indeed, when Abenomics first emerged, jobs were created, the economy grew modestly, the yen weakened, and the nation has been pulled out of economic slump through several crises since. However, the Bank of Japan has yet to achieve its 2% inflation target for a long time now. Furthermore, many have complained of the adverse effects that Abenomics has had on several other parts of the economy [5].

Now, the pandemic has proven to be an intensive setback for Japan’s fiscal disposition; real GDP fell at an annualised rate of 27.8% in the last quarter and ¥964 trillion worth of government bonds through debt structuring is expected to balloon at the end of March 2021 [7]. Overall, Abe’s government and attempts are worth commending. However, stagnation of growth, the incredulous debt  figure and economic chaos is left behind, and future leaders are going to have to deal with that for however long they are in position, and the country, unfortunately, may be beyond fiscal recovery.

But the situation isn’t as disastrous as you might think. Unless…

Though our little history lesson may have raised some alarms, the story hasn’t been fully told.

Recall that Japan has averaged around 240% gross debt-to-GDP for the last decade. Gross debt. If we deduct the pool of relevant financial assets, we can see how skewed the representation of debt can be [6]:

As of recent data, Japan’s net debt ratio is around 150% [8], and whilst that is undeniably a severe number, it is a far more accurate account of Japan’s fiscal health and comparison with other countries. What’s going on?

Well, consider the breakdown of Japan’s debt: around 88% is comprised solely of government bonds, and a combined 12% of financing bills and government borrowing [9]. Furthermore, 46.2% of bonds are held by the Bank of Japan, the central bank and subsidiary under the government, while the majority of the remains are in the palms of the citizens. As a result, the Japanese government has no obligation to repay money to itself through the central bank. Also, given that the majority of the residual is money deposited by Japanese citizens, Japan’s financial status is arguable far more overblown in media than required. Finally, Japan’s debt is purely denominated in its own currency, so a euro-driven default on debt such as what Greece experienced [10] cannot and should not happen in Japan.

“Each Japanese citizen owes an equivalent of ¥9 million” is a common report in the media. But it’s simply inaccurate. Japan merely cannot default for borrowing its own currency, and since Japan pays near-zero interest rates on borrowed funds [11], we should realistically be looking towards other nations in Europe or the Americas, such as Argentina, Ecuador and Lebanon, who have already defaulted on loans this year [12]. In any case, we cannot say that Japan is in ‘fiscal jeopardy’ purely based on a financial figure. Like any good investment into a business or asset, look past the figures and into the historical performance, the key events, the contextual evidence. In doing so, we can avoid misconstruing analyses and diverting our attention from nations with legitimately imminent economic disasters.

But, don’t relax just yet. Japan still owes over 150% of its GDP, and with the advent of the pandemic, the objective to end deflation, keep employment up, boost economic activity and protect the health system, is the challenge for several future generations of government. Will Abenomics carry on to achieve this? Or will a world-shattering economic policy pull off the incredible? It’s up to Japan and the world’s response to future shocks like the pandemic that will be the greatest determinant.

References

[1] Amadeo, K. (2019). Which Countries Have Too Much Debt?. The Balance. Retrieved from https://www.thebalance.com/sovereign-debt-definition-importance-and-rankings-3306353

[2] Australian Government. (2020). Economic and Fiscal Update July 2020 – Overview Fact Sheet (p. 4). Retrieved from https://budget.gov.au/2020-efu/downloads/fact_sheet_overview.pdf.

[3]Masters, J. (2020). EY. Retrieved from https://www.ey.com/en_au/covid-19/oceania-covid-19-response/is-australias-debt-level-unprecedented.

[4]Fitch Wire. (2020). Japan’s Coronavirus Response Increases Public Debt Challenge. Retrieved from https://www.fitchratings.com/research/sovereigns/japan-coronavirus-response-increases-public-debt-challenge-15-04-2020.

[5] Takeo, Y., & Curran. E. (2020). How the Shock Therapy of ‘Abenomics’ Worked in Japan. Bloomberg. Retrieved from https://www.bloomberg.com/news/articles/2020-08-28/how-the-shock-therapy-of-abenomics-worked-in-japan-quicktake.

[6] McBride, J., & Xu, B. (2018). Abenomics and the Japanese Economy. Council on Foreign Relations. Retrieved from https://www.cfr.org/backgrounder/abenomics-and-japanese-economy#chapter-title-0-4.

[7] The Japan Times. (2020). Japanese Economic Slump Threatens to Tarnish Abe’s Legacy. Retrieved from https://www.japantimes.co.jp/news/2020/08/18/business/japan-economic-slump-shinzo-abe/#.X0t9SMgzaUk.

[8] Quandl. (2020). Japan General Government Net Debt, % of GDP. Retrieved from https://www.quandl.com/data/ODA/JPN_GGXWDN_NGDP-Japan-General-Government-Net-Debt-of-GDP.

[9] Japan in Detail. (2019). Explain with charts why Japan’s HUGE national debt is not a problem at all. Retrieved from https://medium.com/@JapanDetail/explain-with-charts-why-japans-huge-national-debt-is-not-a-problem-at-all-5b1994293915.

[10] Amadeo, K. (2020). Greek Debt Crisis Explained. The Balance. Retrieved from https://www.thebalance.com/what-is-the-greece-debt-crisis-3305525.

[11] Sumner, S. (2019). Why is the public debt situation in Italy worse than in Japan?. The Library of Economics and Liberty. Retrieved from https://www.econlib.org/why-is-the-public-debt-situation-in-italy-worse-than-in-japan/.

[12] Goldman, D. (2020). Countries’ massive debt piles are turning into a disaster. CNN. Retrieved from https://edition.cnn.com/2020/05/17/investing/stocks-week-ahead/index.html.

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

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