There are a few, special criteria a country needs to meet to become a member of the illustrious PIIGS – that collection of beleaguered Eurozone economies made up of Portugal, Ireland, Italy, Greece and Spain. Does Japan qualify for the honor?
High government debt? Check.
Low growth prospects? Check.
Desperate need for reform? Check.
Concern about the state of national finances? Check.
With all those points in favor, you might be asking: Why hasn’t Japan already become one of the PIIGS?
The fact is that Japan has been in a much more stable financial position than its level of debt would suggest. Government debt is heading towards 200% of GDP — the heaviest burden of any industrialized country – but that giant load hasn’t sparked as much concern in global markets as the debt of Greece, Portugal or Spain. That’s because the Japanese government generally finances its fiscal deficits through Japan’s own substantial pool of domestic savings. Thus Japan, unlike Greece, doesn’t have to depend on international markets to keep its government afloat. That has allowed Japan to dodge the growing jitters about rising sovereign debt that have seized markets in Europe. In fact, Japanese assets have even been seen as something of a safe haven amid the turmoil. Yields on Japanese government bonds (JGBs) have actually come down, an indication that they’re seen as less risky. Japan has thus been able to finance its deficits at very low cost, unlike most of the PIIGS.
But let’s not declare Japan PIIG-proof just yet. The question is: Can that happy situation persist? Julian Jessop, chief international economist at research firm Capital Economics, says no. Though the government recently announced a plan to balance the budget over the next decade, Jessop believes it won’t be enough to assuage those concerned about Japan’s fiscal position. Here is some of Jessop’s reasoning:
Demand for Japanese government bonds as a safe haven from the risk of sovereign debt defaults elsewhere has more than offset any concerns about the fiscal position in Japan itself. But this is likely to change soon as doubts grow about the new administration’s mid- to long-term plans…Even on the government’s plans, the ratio of debt to GDP…will continue to rise for another ten years… We suspect that something more concrete will be needed soon to protect Japan’s current rating (AA with S&P)… The current worldwide fears about sovereign credit mean that a further downgrade of Japan would be a much greater risk to JGBs – and to global markets generally – than those in the past.
Carl Weinberg of High Frequency Economics manages to get even gloomier. Japan’s public sector debt problem, he wrote in a recent report, “dwarfs those of all the PIIGS combined in every dimension.” Japan’s debt-to-GDP ratio could be stabilized only by a turnaround in its primary fiscal balance of 15% of GDP. What that means is that the government would have to cut budgetary spending or raise taxes to an amount equivalent of 15% of GDP. That’s huge, and bordering on impossible. Weinberg writes:
We presently have no plausible scenario in which the ratio of debt to GDP ever declines…We doubt that any government in Japan has the political moxie to introduce fiscal spending cuts or tax hikes on that order of magnitude…not one that plans to survive, anyway.
So that means Japan is…some kind of Super PIIG? Not everyone would agree with this negative view. Jim O’Neill, chief economist at Goldman Sachs, recently ended a visit to Japan with much more optimism about the economy’s future. Here’s what he wrote about his findings:
Many foreign investors (and perhaps, judging by their investment behavior, some domestic Japanese retail investors too) worry that the kind of crisis in many of the southern Mediterranean countries today will hit Japan at some point. If we look at the simple trend of Japan’s working population, its level of debt and its personal savings rate, it is hard to avoid sharing some of these concerns.
However, he also said:
Recent developments paint a less gloomy picture. First, the cyclical recovery of the economy is on a par with that in the US and Europe—and possibly even better. Second, following another change in the Prime Minister, the conditions for Japan to make progress on its taxation system and its fiscal challenges now appear to be in place.
Subsequent to my original post, Christian Carrillo, head of Asia fixed income strategy at Societe Generale, sent me an email outlining another important factor in Japan’s favor: Money keeps flowing into the country. That’s because it still runs current account surpluses and is a net creditor to the rest of the world. So as Japan’s public debt increases, the country’s assets are increasing at well. Yields on Japanese bonds are low, he writes, because “Japan as a whole is a very solvent, highly liquid country.” Here’s more from a report he published today:
Japan keeps getting richer: This highlights one of the key reasons behind our reluctance to accept the idea of an imminent fiscal collapse in Japan: on an aggregate basis, the country does not have a debt problem. Japan’s massive net financial surplus continued to increase in Q1 2010. According to BoJ flow of funds data, the surplus grew to ¥471tn (about $5.2tn at currentexchange rates), up ¥5.6tn from Q4 2009.
How would we fit a “J” into PIIGS anyway?