Monday, March 21, 2011

Japan's Borrowing

Given the loss of human life in Japan after the devastating earthquake, economic problems seem to pale in comparison. However, as the countries faces upto the devastation, it will face many challenges, including the level of government borrowing.

Even before the crisis, Japan's staggering level of national debt 225% of GDP, seemed to defy normal economic rationale. In Europe, countries with less than 100% of GDP have panicked the markets into fears of default. Japan by contrast has had a robust bond market, with a seemingly large supply of investors willing to lend the Japanese government money at low interest rates.

The reason Japan has been able to borrow so much is:
  • Willingness of Japanese individuals to buy bonds at low rates.
  • Liquidity trap. Despite low interest rates, the economy is still sluggish.This has helped keep government bond yields low as people prefer buying bonds to consuming.
  • Strength of Japanese Yen. Japan has huge reserves of oversees assets. A seeming paradox of the crisis was an appreciation in the Yen, as investors moved money back to Japan. The Japanese national debt doesn't require foreign investors to keep buying bonds (which is a bigger issue in European debt markets)
The threat of a depressed economy could lead the Bank of Japan to monetize part of the debt. Often monetising the debt (buying bonds by increasing the money supply) would lead to fears over inflation. But, Japan has persistently experienced either deflation or inflation below target.
In this situation, the Bank can buy debt, at least in the short / medium term. THe most recent report suggests consumer prices fell 0.3% in the year to Feb 2011.

However, despite many factors helping large borrowing, it is uncertain at what point, markets will increasingly become concerned at the levels of borrowing. The debt interest payments combined with low growth, and an ageing population could make it very difficult to get borrowing levels under control.

As far as I know, Japan's levels of borrowing has few, if any precedents. But, if Japan gets into difficulties, it could have knock on effects for other bond markets. In the past, Japan have been big players in buying foreign bonds (in US and EU) A mounting Japan debt issue could lead to much lower demand for foreign bonds which will not be good news for European countries like Ireland.

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