Even so, there has been justifiable anxiety in Japan and elsewhere about the economic and fiscal implications of the recent events.
The Bank of Japan (BOJ) in January 2011 projected Japan’s real GDP growth rate at 1.6 per cent for fiscal 2011-12, and at 2.0 per cent the following year.
Most recent indications are that the 2011-12 growth will be significantly lower than 1.6 per cent, but still be positive; and growth will rebound in 2012-13. This is consistent with past experience in Japan. Indeed, manufacturing activity in the auto sector has already resumed.
The official projections are that the additional budget expenditure during financial year 2011-12 for the first phase of relief and rebuilding (primarily for relief) will be yen 4,000 billion (US$ 47 billion),equivalent to 0.8 per cent of GDP, larger than some earlier estimates.
The subsequent rounds will cost substantially more, estimated to be between 4 and 5 per cent of GDP spread out over several years. With appropriate policies, these expenditures could contribute to making quake-affected Northeast Japan more competitive than before.
The contingent liabilities on the state from the damage to the nuclear plant complex, from government guaranteed loans, and from other areas represent additional sources of fiscal risk for the Japanese economy.
Thus, recent events will lower Japan’s economic growth in the short term, and require additional fiscal spending for relief and reconstruction. How will this impact on fiscal and debt management in Japan?
Historical experience points generally to higher fiscal deficits and stock of public debt (in relation to GDP) frequently leading over time to higher real interest rates. Debt management and sustainability issues become acute when the real interest rate is persistently higher than real GDP growth.
Japan’s experience, however, has not been consistent with the standard historical experience since at least the early 1990s. A 2010 paper by Kiichi Tokuoka of the IMF suggests that during the 1990s the 10-year Japanese Government Bond (JGB) yields declined from 7 per cent to below 2 per cent, while net public debt increased from 20 per cent of GDP to 60 per cent of GDP. Since 2000, net public debt has further climbed to 90 per cent of GDP but the long term yields have not increased above 2 per cent. The global monetary ease, and BoJ’s accommodative policies have contributed to yields remaining low.
The public debt of Japan is reported on both a gross and net basis. The latter is defined as gross debt minus all the financial assets of the Central and Local governments, and of the Social Security funds. As these assets are substantial, net debt at 121 per cent of GDP in 2010 is significantly lower than the gross debt (227 per cent of GDP in 2010).
Several additional factors have contributed to relatively smooth financing of Japan’s fiscal deficits, and helped in debt management.
Japanese Government Bonds are denominated in yen and only around 6 per cent are held by foreign entities. Large and stable institutional investors (including the Japan Post Bank and the Government Pension Fund) own nearly half the public debt. In addition the Bank of Japan holds nearly one-tenth of the debt. Such ownership structure has contributes to greater flexibility in debt management.
Relatively large, though fluctuating, savings flows from the corporate sector have partly compensated for declining household savings as avenues for purchasing the JGBs. Finally, the declining role of the Fiscal Investment and Loan Program (FILP) to finance government capital expenditure has created fiscal space for other government debt. This has significantly cushioned the impact of continuing high fiscal deficits on the debt levels in recent years.
For these reasons some analysts contend that Japan’s main debt issue is one of managing liquidity and not one of solvency.
The external macroeconomic environment however has been altered by the 2008 global crisis. Many countries, in Euro zone and elsewhere, face substantially higher spreads on their sovereign debt, and sovereign debt default is no longer unthinkable.
Internally in Japan, the abilities and willingness of the traditional institutions, including the Japan Post Bank and the Pension Fund, and of households and corporations may not remain as strong as they earlier were in absorbing Japanese government debt.
Relatively benign environment for managing Japan’s fiscal deficits and public debt is not likely to be sustained in the future. Even before the recent natural disasters, Moody’s had assigned a rating of Aa2 (the third highest for sovereign debt) to Japan but lowered the rating outlook to negative from stable.
As the foreign share of the holdings of Japanese bonds increases, Japan’s high level of insulation from global investors will decline, and its debt costs may increase. Projected higher global inflation and tighter monetary policies globally may accentuate this increase.
If Japan is to continue to pursue fiscal and debt management policies without experiencing a crisis, it will need to begin implementing a credible fiscal consolidation plan in next couple of years.
Some estimates suggest that the required fiscal consolidation, spread out over several years, will need to approach nearly 10 per cent of GDP. This will involve roughly equal measure of tax increases, and expenditure reductions, particularly in pensions, health care, and other social expenditures.
Without much greater determination to address the rigidities of the current political and fiscal arrangements, such a large fiscal consolidation will not be feasible. The rest of the world, particularly Asia, has an important stake in Japan’s succeeding in regaining economic and fiscal vitality due to Japan’s deep integration with these economies, and its heightened dependence on them post triple disasters.
Mukul Asher is Professor at the Lee Kuan Yew School of Public Policy, National University of Singapore. An earlier version of this essay was published in DNA, a Mumbai-based newspaper on 14 April 2011.