Japan: After Japan’s two years of misguided “stimulus” spending, it is good that Japan’s new economic and fiscal policy minister, Kaoru Yosano, is saying the right things about the country’s unsustainable debt levels. However, he must move fast. Spending cuts and tax increases can save Japan from a potential debt default, but only if Yosano can persuade Japan to take its bitter medicine.
Japan contines to spend beyond its means. This year's government outlay is likely to be just 0.1 per cent higher than the previous year, based on the budget presented on December 24 of ¥92.4 trillion ($1.1 trillion). Strip out interest payments, and spending will be marginally lower. Yet almost half of it will be funded with new debt. Government bond issuance is likely to be ¥44 trillion, 9 per cent of GDP.
Despite this profligacy, Japan’s public debt-to-GDP ratio actually stabilized in 2010. With economic growth recovering to around 5 per cent and inflation marginally positive, the ratio remained around 190 per cent. It could have been worse: the International Monetary Fund had forecasted it rising above 200 per cent.
The trouble is, Japan cannot rely on 5 per cent growth every year. With an aging and declining population, even 3 per cent annual growth would be an excellent performance in a normal year. Tax revenue tends to rise faster, perhaps at 5-6 per cent. But Japan would still need major tax increases and spending cuts to bring annual debt issuance down rapidly to the ¥30 trillion at which the debt-to-GDP ratio might stabilize.
Yosano at least recognizes the problem. He warned Japan was at a “critical point” where it risked a loss of investor confidence and a rise in debt costs. True, such dramatic language is not new; Naoto Kan warned last summer of a possible “Greek-style collapse”. Still, Yosano's words may bear more weight. As a former member of the opposition Liberal Democratic and Sunrise parties, he has a better chance of pushing tough measures through the Diet. Kan's proposal to double consumption tax last year lost the government its upper house majority.
Even if Yosano takes fast action, success is not guaranteed. A rise in taxes could stall Japan's growth, pushing the debt ratio up again. But if he does nothing, and Japan's economic growth stagnates or reverses, debts could reach 250 per cent of GDP within three years. At those levels, the prognosis would be grave indeed.