Commentary / Japan

Japan's growing debt divergence

by Sayuri Shirai

Japanese households’ disposable income has been increasing since 2015. However, the scale of the increase has been moderate mainly because a rise in spousal income driven by greater female labor force participation has been partially offset by declining working hours as a result of the growing number of part-time jobs. Higher tax payments and social security contributions have also exerted downward pressure on disposable income, which today remains below the 2000 level.

Interestingly, Japanese households facing a budget surplus have increasingly allocated it to both debt repayment — net of new loans — and bank deposit accumulation, thereby raising the share of non-debt households from around 57 percent in the early 2000s to 63 percent currently. Aging has also contributed to the proliferation of non-debt households. The disappearance of savings-based insurance products in the current low interest rate environment has reduced households’ investment in insurance products, further accelerating debt repayment and adding to bank deposits.

By contrast, investment in securities has been limited. As a result, households appear to have become even more risk-averse over the past five years contrary to the Bank of Japan’s intention to promote risk-taking behavior with massive unconventional monetary easing since 2013.

Why are Japanese households so risk averse? Household debt generally helps to smooth consumption patterns throughout people’s lives as well as enrich material well-being by allowing the acquisition of houses, cars, and other durable items. It also contributes to skills development through higher education and occupational training. On the other hand, debt entails higher loan delinquency and default risks, especially in an aging society, which can arise from sudden job loss due to age-related illness, unexpectedly large health expenses and low wage growth projections.

Households may attempt to reduce their debt burden by selling off houses at elevated prices and repurchasing lower-priced houses. However, this option may no longer be feasible in Japan except in prime locations in major cities given swelling prices for new homes due to limited land and increased construction costs arising from a shortage of construction workers and imported construction materials. Non-recourse loans that enable defaulted borrowers to repay only up to the amount of foreclosing for collateralized properties are not widely available in Japan as a result of vacant home growth and higher borrowing costs relative to standard mortgages. This is why many Japanese households increasingly feel they cannot rest until all debt is fully repaid.

By contrast, Japan’s government reveals a very different pattern. Here, public debt continues to grow, already hitting ¥1.3 quadrillion or 245 percent of GDP — one of the highest public debt levels globally. Nevertheless, the need for fiscal consolidation has been hardly discussed in the Diet and in the public arena. Fiscal experts have repeatedly warned against unsustainably high public debt, but almost no one takes it seriously given that debt crises have not yet occurred. So what makes Japan’s public debt so different from private sector debt?

For starters, public debt such as government bonds are liquid and safe financial assets, with diverse maturities up to 40 years. As such, there is high demand among banks and insurance firms for public debt in the absence of alternative financial assets in Japan.

Second, Japan’s persistent current account surpluses and correspondingly substantial net external financial asset position have enabled Japanese borrowers to rely largely on domestic capital, thereby avoiding foreign debt crises.

Third, the Bank of Japan currently holds nearly half of all government bonds to achieve its 2 percent inflation target through unconventional monetary easing. The resultant lower yields have reduced the government’s interest payment. Moreover, efforts to stabilize the 10-year yield at around zero percent have postponed Japan’s debt sustainability problems further, with its nominal GDP growth rate consistently exceeding its nominal long-term interest rate.

It is important to consider, however, that Japan’s aging population and low economic growth potential of around 0.6 percent will deteriorate its fiscal deficit and reduce household savings, thereby making reliance on foreign capital inevitable in the long run. This may leave the BOJ with no choice but to end up providing permanent government support to avoid painful fiscal consolidation. Japan may be entering to a new norm.

Sayuri Shirai is a visiting scholar at the Asian Development Bank Institute and a former Bank of Japan Policy Board member.