A Collective Sigh of Relief - Deloitte

Global Economic Outlook 2nd Quarter 2012
JAPAN
30
Japan: New risk
factors
by Dr. Ira Kalish
Worrying about trade and debt
For some time, pundits have bemoaned the fact that
Japan’s sovereign debt is roughly 200 percent of GDP,
which is widely viewed as an unsustainable number that
puts Japan at risk of a financial crisis. However, other
observers remain unalarmed because Japan runs a current
account surplus. In other words, Japan saves so much
that the savings exceeds the funds needed to service
government debt and fund domestic investment. There is
still money left over to lend to or invest in the rest of the
world. Thus, Japan’s massive government debt should not
be viewed as a problem because of its formidable savings.
Yet, that is only true as long as Japan runs a current
account surplus.
That assumption is now being brought into question. In
January, Japan ran a trade deficit. The current account
balance is the trade balance plus net interest payments.
Those interest payments are so large that Japan still had
a current account surplus in January. Yet, the fact that
Japan ran a trade deficit raised eyebrows. If continued, it
could ultimately lead to a current account deficit. If that
were to happen, servicing the large sovereign debt could
be problematic. If markets perceived that to be so, they
could push up the yield on Japanese government bonds,
further exacerbating the problem of bringing the debt to a
sustainable level.
Why did Japan run a trade deficit? The main reason is that,
following the earthquake, most of Japan’s nuclear power
plants were idled. Thus, Japan had to import massive
quantities of oil and natural gas in order to generate
electricity, so the import bill rose. At the same time, a high
valued yen conspired with weak demand in Europe to
cause exports to falter. Moreover, rising oil prices could
worsen the situation. The good news is that there was a
trade surplus in February. Still, the stage is not yet set for a
sustained improvement in the trade balance.
Aggressive monetary policy
One of the problems for exporters has been the high
valued yen. However, in recent months, the yen has
declined somewhat, thereby boosting the competitiveness
of exports. This shift was mainly due to a change in
monetary policy. The Bank of Japan (BoJ) has implemented
two rounds of asset purchases (often known as quantitative
easing), the second of which was announced in
February and involved 10 trillion yen ($130 billion). The
effect of this was to boost liquidity, boost expectations of
inflation, and put downward pressure on the yen. Indeed,
the yen fell from roughly 77 yen per dollar to 83 yen
per dollar.
Now there is talk of another round of asset purchases.
There are two reasons for this. First, inflation remains close
to zero even though the BoJ set an explicit inflation target
of 1.0 percent. While the program of asset purchases
ended deflation and created a bit of inflation, it may not
be sufficient. Second, there is concern that the yen could
bounce back as long as the Japanese currency is seen as a
safe asset in a world of risk. Further financial market stress
in Europe or a stumbling of the U.S. economy could cause
the yen to shoot up.
Fiscal issues
Meanwhile, the Japanese government is determined
to put Japan on a sustainable fiscal path. Japan faces
several problems. First, the debt is already very large
and higher bond yields would make the situation worse.
Second, Japan’s economy has grown very slowly, thereby
generating modest revenue gains. Third, deflation meant
that incomes were declining or stagnant at best, thus
suppressing government revenue. Finally, the aging population
means that future spending on pensions and health
is likely to increase substantially. Many observers worry
that, without a plan to create fiscal probity, Japan could
face a serious crisis in the not-too-distant future.