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Huge deficit bodes ill for yen, bonds, rates

by Tomoyuki Tachikawa

Kyodo

Japan’s goods trade deficit hit a record high in 2013, sparking fears that the country could fall into a constant current account deficit in the near future.

If expectations intensify that the current account balance will remain in the red for an extended period, long-term interest rates would jump and the value of the yen could dive, worsening the economic and fiscal situation down the road, experts warn.

Last year, Japan logged a record trade deficit of ¥11.47 trillion, up 65.3 percent from the previous year, the Finance Ministry said Monday in a preliminary report, underscoring that the world’s third-biggest economy is no longer an export powerhouse.

The trade deficit came as the depreciation of the yen and growing demand for fossil energy, including liquefied natural gas and crude oil, drove up import figures amid the suspension of nuclear power plants over the Fukushima crisis.

The current account balance will stay in the black as long as a surplus in the income account, which reflects how much Japan earns from its foreign investments, can offset trade and other deficits.

Recent data, however, suggest that the trade deficit is in danger of chronically exceeding the income surplus. In November, Japan registered a current account deficit of ¥592.8 billion, the largest since officials started compiling comparable data in 1985.

Fiscal and economic policy minister Akira Amari has expressed anxiety about the current account deficit, saying if the government leaves this issue unsettled, Japan “may become like the United States in depending on other countries for its financial funds.”

This is just what market participants are worried about, as the pace of export growth has been moderate due in part to a slowdown in emerging economies, while Japan’s needs for fossil energy are unlikely to wane for some time to come.

“Investors, in particular bond traders, have become skeptical about whether Japan can continue to cover its fiscal deficit with domestic assets alone,” a source said on condition of anonymity.

So far, around 95 percent of Japanese government bonds have been financed smoothly at home, as the Bank of Japan has pledged to buy massive government bonds in an attempt to keep long-term interest rates low to stimulate the economy.

“But if Japan’s current account balance deteriorates and investors start to expect the government would be compelled to sell its bonds to foreigners, they could try to let go of them with concern growing over the outlook for the sovereign bond market,” he said.

A selloff in government bonds would trigger a surge in Japan’s long-term interest rates. This would create a vicious cycle where expansion in the government’s interest payments on its bonds would hamper efforts to restore the government’s fiscal health, prompting more investors to sell JGBs and raising interest rates, analysts said.

Japan’s fiscal health is the worst among major developed economies, with public debt equivalent to more than 200 percent of gross domestic product. The central government debt topped a staggering ¥1 quadrillion for the first time ever last year.

“Japan turning into a country with a constant current account deficit would bring about a bad yen weakness, significantly hurting the economy,” said Masanobu Ishikawa, general manager of spot foreign exchange at Tokyo Forex & Ueda Harlow.

The yen would face downward pressure as long as importers sell the yen against foreign currencies to purchase goods and services from abroad at a faster pace than exporters exchange foreign currencies they earn overseas for yen, Ishikawa said.

“If traders expect Japan will keep posting current account deficits for a long period and become eager to sell the yen, the Japanese currency would plunge and Japan’s import costs would rise further, causing sharp inflation and dragging down the economy,” he said.

Some economists want Japan to boost the number of foreign visitors to improve the current account balance.

“For Japan that has been suffering from prolonged trade deficits, bolstering tourism would be an effective way to obtain foreign currencies,” said Takuya Hoshino, an economist at Dai-ichi Life Research Institute.

Ahead of the 2020 Tokyo Olympics, the government should “work to make Japan a tourism-oriented nation,” he said.

Prime Minister Shinzo Abe’s administration has said it aims to double the number of annual foreign visitors to 20 million by the Olympics, after the number topped 10 million last year for the first time ever.