It’s no secret that Japan is haunted by a snowballing amount of public debt that is about twice the size of the country’s gross domestic product.
But the worsening fiscal health has only been aggravated in the past year thanks to the coronavirus pandemic, which has forced the government to finance enormous outlays for an array of measures.
This fiscal year alone, the issuance of new Japanese government bonds (JGBs) will be about ¥112 trillion — the highest ever and more than double the previous record of ¥52 trillion seen in fiscal 2009, when the global financial crisis hit the country.
Experts say that increased spending due to the emergency is unavoidable but that Japan will need to start seriously discussing how it will be dealing with its debt once the pandemic eases — otherwise, it may face severe ramifications.
They also said the Bank of Japan’s exit strategy from its ultraeasy monetary policy will be a grueling issue, with the central bank’s ballooning balance sheet likely to pose a risk to the country’s fiscal sustainability somewhere down the line depending on the market’s situation.
“I must say that Japan is now on the rockier path for fiscal reconstruction,” said Takero Doi, a professor at Keio University and an expert in finance.
Public debt stood at ¥1.12 quadrillion — 198% of GDP — at the end of fiscal 2019 and will exceed ¥1.2 quadrillion during this fiscal year.
Experts agree that the priority is to assuage the economic impact of the coronavirus, supporting those in need, but what’s dangerous is that despite the sharply rising COVID-19-related costs, the government and ruling parties are not drafting specific schemes to pay back the debt.
For instance, the European Union is considering introducing new taxes, such as a digital tax, to repay the cost of its coronavirus relief package.
“Japan is not even having a discussion. I think people’s sense of crisis regarding healthy fiscal management has been really paralyzed,” Doi said.
In contrast, Japan had planned how to finance the cost of the economic damage caused by the Great East Japan Earthquake that hit the Tohoku region in March 2011. The government devised a two-year special corporate tax, while individuals need to pay extra income tax until 2037, securing about ¥10 trillion.
But this time, the spending spree over the coronavirus measures is somehow not raising a red flag. After introducing the first and second relief packages, both worth ¥117 trillion, the Cabinet approved the third extra budget to finance a ¥73.6 trillion stimulus package earlier this month.
A Finance Ministry official said no specific plans to repay the increased debt has been decided.
Because of superlow interest rates, “some people are probably misunderstanding that the government can just keep issuing bonds,” said Doi.
The government has maintained its target to turn the primary budget balance into a surplus by fiscal 2025, but its simulation disclosed in July shows that the goal would be unachievable even if the country’s economy were to grow steadily. A primary budget surplus means the government can fully cover its expenditures excluding debt-servicing costs with its own tax revenues.
Doi stressed the importance of at least starting discussions on fiscal reconstruction to avoid some “hard landing” scenarios in the future where the county might have to implement steep tax hikes or drastic cuts on government spending. High inflation could also occur.
Those in support of strong fiscal spending often claim that most JGBs are purchased by domestic banks and institutional investors, so the risk of an interest-rate spike is limited. They also say that, since the total amount of households’ financial assets exceeds the country’s debt, Japan can still keep issuing JGBs. According to the Bank of Japan, total household financial assets stood at ¥1.9 quadrillion.
The idea of promoting government spending, known as modern monetary theory (MMT), has been gaining traction recently. Simply put, it claims that governments that can print their own currencies are able to plow money into economic measures without worrying about debt, as long as inflation does not occur.
Some point out that Japan has been in practice engaging in MMT, as the BOJ has been purchasing a gargantuan amount of JGBs to effectively finance the government’s spending.
Following the 2008 global financial crisis, central banks in other countries have also rolled out asset purchase programs similar to the BOJ.
Yet experts say that the BOJ’s purchasing of JGBs is far more reckless than moves by its counterparts.
As of September, the BOJ was the largest JGB holder in the country with ¥542 trillion, which accounts for 45.1％ of the total outstanding JGBs. The BOJ’s total assets as of September were about ¥690 trillion, exceeding the country’s GDP.
Although other central banks have boosted asset purchases since the COVID-19 crisis, “they are nowhere near what Japan has been doing,” said Sayuri Kawamura, chief economist at the Japan Research Institute.
Japan’s ultraloose monetary policy started after former Prime Minister Shinzo Abe launched his administration in 2012 with the mission of ending the country’s chronic deflation.
In April 2013, BOJ Gov. Haruhiko Kuroda, who took the helm in March of that year, surprised the markets with his announcement that the central bank would keep buying government bonds, increasing the amount by as much as ¥50 trillion each year. Kuroda would later bolster the policy in 2014 by raising the annual goal to ¥80 trillion.
In September 2016, Kuroda introduced a new policy called “yield curve control” in which the BOJ buys bonds to varying degrees with the goal of keeping the 10-year JGB at close to 0%, an apparent attempt to ease concerns among some market watchers over possible volatile interest rates for long-term JGBs.
For now, interest rates are still at historically low levels, and the country has seen no sign of inflation, with the BOJ struggling to achieve its 2% goal.
Kawamura points out that the BOJ’s ultraloose monetary policy has posed a serious risk to Japan’s fiscal management.
Once the pandemic is stamped out and the economy returns to normal, central banks in other nations may raise interest rates, but the BOJ’s hands would be tied due to its enormous amount of JGBs.
The BOJ purchased those JGBs at ultralow interest rates, so if it proceeds with rate hikes, the cost of interest for the cash that private banks deposit at the BOJ would be higher than the BOJ’s profit. Also, a spike in interest rates would significantly increase the cost of the central government financing its budget.
Kawamura said the BOJ’s ballooning assets are vulnerable to changes in the market, which could leave the central bank with excess debt.
“People need to recognize what risks the BOJ is taking and what would happen if the situation continues,” said Kawamura.
“Some major development in the financial situation could put the BOJ in insolvency. If that happens, the loss would have to be covered by tax payers’ money.”
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