Will Japan collapse under its public sector debts?

23rd May 2012

Yesterday saw this announced by the Fitch ratings agency.

Fitch Ratings has downgraded Japan’s Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) to ‘A+’ from ‘AA’ and ‘AA-’ respectively. The Outlooks on both IDRs are Negative.

So we see that the land of the rising sun has again come to the attention of the ratings agencies and they do not like what they see. There has been a slow but steady series of reviews,downgrades and negative outlooks for Japan over the past few years. If we look at her new Fitch rating we see that she joins Slovakia and Malta which I doubt will make the sake taste that good at Japan’s Ministry of Finance!

Disappointment for the media and headline writers

Downgrades by ratings agencies are often accompanied by journalists looking for falls in government bond prices and rises in yields to give a dramatic headline. A regular theme on here is that because ratings agencies are often tardy in their actions the move usually has already happened! Bond traders can be stupid but relying on them to be consistently stupid is usually unwise. And having checked Japan’s yields at the time of the announcement I can tell you that over the course of a day’s trading her ten-year government bond yield rose from 0.86% to 0.87%. Hardly a collapse!

And if we consider the absolute level of 0.87% we are reminded yet again of how cheaply Japan can issue its debt. If you would like a comparison then we have seen extraordinary rises in the price of German government debt in 2012 but even so it has a ten-year government bond yield of 1.44% or 0.57% higher than Japan’s.

Why did Fitch make this move?

Regular followers of my articles will not be surprised to see the level of public-sector debt at the top of the list.

Japan’s gross general government debt is projected to hit 239% of GDP by end-2012, by far the highest for any Fitch-rated sovereign. This debt ratio would also have risen 61pp since the global financial crisis. This compares with a median of 39pp for OECD economies and 8pp for ‘A’ range sovereigns.

At this point Japan is sounding rather like Greece, in fact worse than Greece in terms of indebtedness and profligacy. And she has no apparent urgency to do anything about it either.

Japan’s Fiscal Management Strategy envisages declines in the government debt/GDP ratio only from FY21

The planned rise in consumption tax from 5% to 10% is only planned to start in 2014 for example.

Disinflation and low economic growth are also themes

The economy has experienced recurring deflation (they mean disinflation) since 2001 and real GDP growth lags high-income peers. Nominal GDP of JPY468.6trn in 2011 was 0.2% lower than in 1991. Weak nominal GDP growth threatens to undermine fiscal solvency in the longer term.

I emphasised the middle sentence because I thought that it summed up the “lost decade” (now two decades…) as well as I have ever seen in one sentence. If you look at the final sentence you cannot help but look back and conclude that Japan’s fiscal solvency has been on a downward slope for the last twenty years. Also what country is not suffering from that last sentence right now? It is quicker to think of those that are not particularly in Europe!

Japan’s population is ageing

The population demographics for Japan are particularly poor and her population is expected to shrink over time with the outlier forecasts being for a population of only 50 million at the turn of the next century. Of course such forecasts are riddled with danger but there is a problem as Fitch discusses:

However, its demographic profile is a structural weakness. Working-age population has been in decline since the mid-1990s. The authorities estimate ageing is adding about 0.2% of GDP per year to the social security bill.

The other side of the ledger

Japan has a strong savings culture:

This funding strength is based on the deep pool of Japanese private sector savings, invested with strong “home bias”….

And even her public-sector has built up reserves:

its large pile of sovereign financial assets (worth about 80% of GDP on Fitch’s calculations),,,,,,,,,,,,,an official foreign reserves stockpile worth USD1.3trn at end-2011.

Whilst exporting has been strong there has been a weaker pattern more recently particularly since last year’s tsunami and today’s Bank of Japan meeting minutes are not reassuring on this front:

Exports have so far remained more or less flat.

In a country where the concept of “face” is very important this does not reassure me much. And the Bank of Japan was not entirely reassuring about its recent promises to deal with Japan’s continuing disinflation problem either as you can see.

On the price front, the year-on-year rate of change in the CPI (all items less fresh food) is around 0 percent.

The year-on-year rate of change in the CPI is expected to remain at around 0 percent for the time being.

A translation is needed here as we are used to central banks telling us there is no inflation. As so often things are different in Japan (topsy-turvy from our perspective) and the Bank of Japan usually over forecasts inflation! And considering the lack of economic growth over the last decade one may challenge this bit too:

The Bank continues to conduct policy in an appropriate manner

Continue reading…


More on Mindful Money

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Japan lends “free money” to the IMF whilst the UK’s inflation rise embarasses the Bank of England

Bank of Japan announces more QE

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