Talk about rude guests! They fly first class to your event, luxuriate in your splendid hotels and conference centers, pleasure in your unrivaled service, feast on your exquisite cuisine, and then dare to warn you that you are heading toward a financial catastrophe worse than the Greeks’. Also that your stolid, conservative bankers, rather than avoiding risk by channelling depositors’ savings into Japanese government bonds (JGBs), are setting themselves--and the country--up for massive losses when interest rates rise.
The IMF/World Bank annual meeting that ended in Tokyo on the 13th may have been unique in the extent of humiliation suffered by the host country, Japan. First it was the boycott by China’s Central Bank head, Zhou Xiaochuan, and Finance Minister, Xie Xuren (China sent the two institutions’ deputy heads) over the Japan-China territorial dispute. Then it was a seeming drumbeat of hectoring criticisms and condescending admonitions on the severity of Japan’s fiscal crisis and the “imperative” of actions to avoid disaster.
Of course one can hardly argue about how deep is the hole of dangerously high public debt and dangerously high deficits--ensuring more dangerously higher public debt--into which Japan has sunk. The IMF’s October 2012 Fiscal Monitor provided the statistics:
Start with government debt as a percentage of GDP. In 2012 the figure for gross debt is 236.6%, for 2013 the estimate is 245%. By comparison, the figures for the U.S. are 107.2% and 111.7%. For net government debt, it is 135.4% in 2012 and 144.7% in 2013 for Japan, and 83.8% and 87.7% for the U.S.
On to the government’s fiscal deficit--what will continue to stoke aggregate debt higher. As a percentage of GDP, the fiscal balance in the Japan for the years 2011, 2012, 2013 (estimate) is -9.8%, -10.0%, -9.1%. For the U.S. the deficit/GDP for the same years is -10.1%, -8.7%, -7.3%.
Japanese Minister of Finance Kojima Koriki did his best to put a hopeful spin on matters, pointing to the Noda government’s hard won legislation to raise the consumption (VAT) tax from 5% to 10% by 2015, as the primary step to achieve a positive “primary fiscal balance”--the net of revenues and non-interest expenditures--by FY 2020. But the IMF, having done the math, politely pointed out that 10% would not close the gap, that 15% or higher is needed.
The IMF warnings got even starker on the perilous trends--leading directly from the fiscal mess-- in Japan’s banking sector. IMF first deputy managing director David Lipton made the speech. Japanese bank holdings of JGBs now account for 25% of bank assets, five times the developed world average. On current trends--which are structural and unlikely to change much--the percentage could (will?) rise to 1/3 within five years.
Japan’s bankers, together with the Ministry of Finance, which issues the bonds, are not unaware of the dangers, if not of default (though this risk is increasing), then of massive portfolio value (and bank capital) losses at whatever time the Bank of Japan finds it necessary to abandon its zero interest rate policy and raise rates. The banks--and especially the three megabank groups--Mitsubishi UFJ Financial Group (NYS: MUFG), Sumitomo Mitsui Financial Group (NYSE:SMFG), and Mizuho Financial Group (NYSE: MFG)--continue to shorten average duration (price risk) in their ballooning JGB portfolios. Smaller regional banks are being less careful. The MOF is torn. It would prefer to issue longer dated bonds, to lock in low rates (the current 10 year JGB yields 0.76%). Issuing shorter bonds increases its refinancing price (interest expense) risks when rates rise.
Total Japanese government debt is JPY 940 trillion (US$ 12 trillion). Of this, some 9% is owned by foreigners, who will be quicker to dump holdings--sending market prices lower--at the first sign of higher rates.
The argument of Panglossian observers has always been that because almost all JGBs are held domestically, Japan is relatively insulated from the type of market turmoil and stresses we see now in Europe. This is wishful thinking for several reasons. The most fundamental is that within a few years existing and new issue government debt may absorb all private savings (corporate and household) in Japan, making foreign borrowing inevitable and creating a terrifying scenario of higher yields demanded by foreigners raising MOF interest costs while inflicting portfolio losses on JGB holders, and putting fiscal balance further (infinitely?) beyond reach, with (by then) predictably horrendous consequences.
The scale of the government debt problem is becomes depressingly clear in the IMF Fiscal Monitor data on “gross financing needs” for the years 2012 and 2013. Again, as a percentage of GDP, we have “maturing debt,” “budget deficit,” and “total financing.” For Japan, the figures, respectively, for 2012 are 49.3%, 10%, and 59.4% (i.e., the government needs to access the market for funds equivalent to 59.4% of GDP to keep running in this year only). The estimates for 2013 are 51.4%, 9.1%, and 60.4%. By comparison, for the U.S. for 2012, the figures are 17.6%, 8.7%, and 26.3%. For the U.K., deep into belt-tightening austerity, the 2012 figures are 6.9%, 8.2%, and 15.1%.
Thus did the IMF warn Japan of its terrifyingly dangerous fiscal course. Sadly, as yet, not enough has been done to avert disaster. "Whither Japan?" indeed.
