Japan’s stimulus package

Published: December 8 2009 09:35 Last updated: December 8 2009 15:05

Japan’s economy is on a war footing. For the first time since the end of the second world war, the government is issuing more new debt than it is taking in via tax revenues. That is only partly thanks to Tokyo’s latest stimulus programme, worth Y7,200bn ($81bn) or 1.5 per cent of gross domestic product. While this is designed to prevent a double-dip recession, even the government seems unclear where the extra money will come from.
With total debt heading towards 200 per cent of gross domestic product, Japan is already the world’s most indebted large economy. The danger it faces is of a “debt trap”.
With 10-year interest rates at, say, 1.5 per cent, Japan needs to run a primary budget surplus of 3 per cent of GDP merely to meet interest payments. Shrinking its debt mountain requires an even bigger surplus – or faster growth. At some point, the government will have to cut spending – just not now.
Such dynamics have made shorting Japanese government bonds a popular trade of late. Either the economy is shot, in which case Japan will have to issue more debt and yields will rise, or it is going to recover, in which case current low yields make little sense. (Although with deflation of 2 per cent, the real yield on Japanese bonds is rather high.)
Still, bond traders have frequently been caught out by the idiosyncrasies of the JGB market before.
For many years, high savings ensured a ready source of local buyers. But now, as the population ages, the savings rate has fallen to 2.2 per cent – below US levels.
Local banks could yet step into the breach. But they already hold some 44 per cent of outstanding bonds, equivalent to a sixth of total bank assets, Andrew Hunt Economics estimates, so their appetite for more paper may be limited.
Prospects for JGBs, and the investors that hold them, therefore appear bleak – which helps explain why three of the 24 banks on the Financial Stability Board’s recent systemic risk list are Japanese.

BACKGROUND NEWS
Japan’s cabinet on Tuesday agreed Y7,200bn ($81bn) in stimulus spending intended to shore up a fragile economic recovery.
After its election victory in August, the DPJ government has struggled to balance the need to find funds to finance its generous manifesto welfare promises, against concerns about the government’s huge debt burden and worries about the sustainability of Japan’s recovery.
About Y2,700bn in funding for the new package is expected to come from spending trimmed from a previous stimulus budget announced by the former government.
Japanese government bond sales for the current fiscal year are now expected to total more than Y53,000bn, far exceeding tax revenues of about Y37,000bn, Hirohisa Fujii, finance minister, said. However, he stood by plans to limit new bond issuance in the year from April 2010 to less than Y44,000bn.
“Japan’s fiscal situation is very serious,” Mr Fujii added.