Readers Question: After the insightful post on ‘Italian Economic Decline’, I was particularly captured by the % debt to GDP line graph of the different developed countries. The one thing that really caught my eye was Japan’s huge % debt to GDP and yet their government bond yields are consistently declining. Aren’t the markets worried that Japan may default on their debt someday or is the fact that they have a lender of last resort (no fear of liquidity problems) unlike Italy and their 0% interest rates shielding them from augmenting yields?
Source: Hoshi and Ito (2012).
It is true that Japanese public sector debt is over 229% of GDP, yet bond yields in Japan remain low. It seems the markets have no current concerns over Japanese repayment. Spain might feel aggrieved that they face rapidly rising bond yields – even though their public sector debt (70% of GDP in 2011) is considerably lower.
- Japan debt 229.1% of GDP on a gross basis, and 127.8% of GDP on a net basis
Why Can Japan Government Debt be So High at Low Interest rates?
- High levels of savings in Japan. Japan’s saving ratio has fallen in recent years (partly due to ageing population) but although it may sound a paradox, there are still high levels of domestic saving. Upto now, this large pool of savings have been used to buy Japanese government debt. (Japan Saving ratio)
- Liquidity Trap. Japan has been stuck in a partial liquidity trap for several years. Basically, interest rates are very low, but this has failed to stimulate prolonged economic growth. Inflation remains very close to zero, and the prospect of deflation has encouraged people to put their money into government securities rather than spend.
- Bank of Japan’s holdings of Government bonds. The Bank of Japan has supported government borrowing by buying large quantities of Japanese bonds. (B of J) holdings. “At the end of March, the BOJ held 9.7% of the nearly 1 quadrillion yen ($12.6 trillion) total of outstanding government debt. In addition, the central bank buys ¥21.6 trillion JGBs annually to provide liquidity for economic growth” (WSJ). The importance of this is also related to confidence. Markets have confidence that the Bank of Japan will intervene to buy bonds and prevent any liquidity shortages.
- 95% of debt is held domestically. The majority of Japanese government debt is held by domestic investors. They do not need to rely on foreign investors. Therefore, Japan does not have to fear a loss of confidence from other countries. In the case of Greece, Spain and Portugal – foreign investors have been worried about possibility of Euro exit. This would lead to significant devaluation and loss of savings. Therefore, most foreign investors have been demand higher interest rate yield in Spain.
The two main reasons are the Central Bank’s intervention and the high level of domestic savings. In the current economic climate, Japanese have been willing to buy sufficient bonds to finance debt. However, there is concerns that if the Japanese saving ratio continues to decline, this could be reversed.
Potential Problems of Japan’s Debt.
This deserves it’s own post. But, a few quick notes
- The cost of servicing Japanese debt is 23% of the federal budget (link) – even with interest rates of 1%. If interest rates were to increase, Japan would soon find itself in difficulty.
- Borrowing over 225% of GDP for a sustained period is unprecedented.
- Bank of Japan holding more long-term bonds makes it increasingly difficult to unwind it’s position should things change..
- Japan faces an aging population putting greater strain on social security spending. An ageing population will also lead to a fall in the savings ratio, meaning that domestic savings can’t mop up all the increase in government spending.