'Relative safety' of Japan may evaporate when other countries put houses in order

Europe the real test for economy



Some people may be wondering why, despite the devastating earthquake and tsunami in March, the yen has been rising against the dollar, the euro and other major currencies, indicating investor confidence in the country’s economy, at least so far.

Many analysts respond to the question with just two words, “relative safety,” which means shorter-term prospects for economic conditions in Japan are better than those for the United States, where unemployment remains high, and Europe, which is watching the sovereign debt crisis develop into a banking crisis.

But skepticism is rapidly spreading among Japanese experts as to whether the trend will last, with some warning that the real challenges for Japan, including a weakening yen or a surge in long-term borrowing costs for the government, may suddenly arise once Europe overcomes its current problems.

Finance ministers and central bank governors from the Group of 20 leading economies gathered in Paris until Saturday and raised pressure on eurozone countries to make further efforts to contain the debt crisis in Greece and some other countries that adopted the unified currency.

At the two-day meeting, which laid the groundwork for the G-20 summit next month in Cannes, France, Japan repeatedly said it would offer additional support to the eurozone when it proves necessary.

Finance Minister Jun Azumi admitted that Tokyo has to draw lessons from Europe’s experience.

“We must learn that if national debt cannot be trusted in a stable manner, then it would have an incredibly negative impact on the world economic order,” Azumi told reporters after the G-20 meeting.

He warned that Japan may be forced to tread the same path as Europe with investors losing confidence in its debt if the government fails to restore its fiscal health, the worst among the major developed countries.

Azumi and Bank of Japan Gov. Masaaki Shirakawa, who also attended the meeting, have shared the view that the current low and relatively stable long-term interest rates in the country can easily be pushed up if investors stop buying Japanese government bonds, the bulk of which are owned by Japanese.

Experts echo their view.

“The tide may suddenly change,” said Hiroshi Watanabe, president of the Japan Bank for International Cooperation. “It may occur in the near future, possibly next year,” the former vice finance minister for international affairs said.

Watanabe, who used to be Japan’s chief currency diplomat, stressed that the yen’s sharp appreciation could be easily reversed once market participants calm down from watching the developments in Europe.

The welfare system of Japan is very similar to that of Italy, he said, referring to the country widely seen, along with Greece and Spain, as another source of concern for Europe. The government must show a blueprint for social security reforms before market participants recognize that “there is another troubled country far east in Asia.”

The government is planning to submit a bill to the Diet next year to double the sales tax rate in stages to 10 percent over the next few years in an attempt to cover the swelling welfare costs being caused by its rapidly aging population.

It also aims to raise some other taxes and use the proceeds to finance reconstruction work in the aftermath of the March 11 disasters, as Prime Minister Yoshihiko Noda has pressed for fiscal discipline, refusing to issue any new debt without first securing funds for repayment.

Osamu Takashima, chief FX strategist at Citibank Japan Ltd., sees no logical thinking in expecting many speculators to start selling Japanese government bonds en masse after they fed on the sovereign debt crisis in Europe.

“As long as a crisis unfolds in Europe, it will not come to Japan,” Takashima says, but still warns that Japan could become speculators’ next target.

It means that “if Europe heads off the crisis, then it is no surprise that Japan suddenly finds itself in a crisis.”

He believes the “tide” in the foreign-exchange market could change in mid-2013 at the earliest, when the yen is likely to start continuously depreciating against the dollar on possible interest hikes by the U.S. Federal Reserve to nip inflation in the bud.

Given the European debt crisis, the Japanese government purchased in January and June a total of around 20 percent of the European rescue bonds to support Ireland and Portugal, and it has not ruled out the option of buying additional rescue bonds, this time for Greece.

Masamichi Adachi, senior economist at JPMorgan Securities Japan Co., says the government should be more careful and strategic about offering aid to Europe as “this is certainly the last chance for Japan to help others.”

“There is no doubt that Japan will be the next to suffer from crisis after Europe,” Adachi said, underscoring the urgent need for the government to consider how Japan can remain an important player at international meetings like the G-20, even after it becomes a country to receive aid rather than giving it.