Japan Government Borrowing Set to Soar

Japanese public finances sit uncomfortably somewhere between a rock and a very hard place indeed. This is brought home again this week by the disclosure that the Council on Economic and Fiscal Policy in its final draft of the revised Structural Reform and Medium-Term Economic and Fiscal Prospectus, prepared by the Cabinet Office, estimates that bond issuance will climb to as much as 40.2 trillion yen in fiscal 2004. This will then be followed by an issuance of 41 trillion yen in fiscal 2005, 40.3 trillion yen in fiscal 2006 and 40.8 trillion yen in fiscal 2007.

The document, to be submitted to the council Monday before being sent to the Cabinet for approval, includes two fiscal policy scenarios: one in which state coverage of the national pension costs remains at its current one-third, and another in which the government burden is increased to 50 percent. In the latter scenario, the consumption tax is increased to 6 percent from 5 percent. Even then, the additional tax revenue would not reduce the national debt, as it would be used solely to slash the growing burden of the aging society on the social security system.Though the revised version stays faithful to the original pledge to erase red ink from the primary balance by the early 2010s, it projects a slowing down of the decrease in the budget deficit as a proportion of gross domestic product.
Source: Asahi Shimbun
LINK

It is this increase in the government tax support for the pension system from one third to one half which is provoking all the fuss about the projected rise in consumer tax which would be the knock-on effect (see Richard Katz artice HERE, since a new medium-term policy plan drawn up by the Cabinet Office includes fiscal projections that assume a consumption tax hike from 5 percent to 6 percent in October 2004. Obviously any such tax increases would make it even more difficult to escape the grip of deflation.

Some policy watchers are taking the estimates as a tacit acknowledgment by the government that a hike is inevitable. The calculations were included by Cabinet Office officials in a revised draft of the Structural Reform and Medium-Term Economic and Fiscal Prospects, considered an outline for the government's policy on midterm economic management.The document will be submitted Monday to the Council on Economic and Fiscal Policy, a key advisory panel headed by Prime Minister Junichiro Koizumi. It is expected to be approved at a Cabinet meeting this month.......... Some officials say the government has no choice except a hike if it ends up expanding state coverage of basic pensions from one-third to one-half, as planned under fiscal 2004 reforms.Observers say the projections reflect the prevailing mood in the government on a tax hike.
Source: Asahi Shimbun
LINK

Japan: Don't Sqeeze Me Too Tight

Japan economic specialist Richard Katz, writing in today's Financial Times, questions the advisability of turning the fiscal pressure screw in Japan. It's difficult to see how a country suffering deflation (or the imminent threat of it ) can benefit from further fiscal tightening. If in doubt ask the Germans.

It is not easy for a rich country to get itself into as much economic trouble as Japan has. In the postwar era, only Switzerland has stagnated as badly for as long. While the root cause is structural defects, policy blunders have repeatedly made a bad situation worse. They are at it again. Once more, the Ministry of Finance wants to raise taxes in a time of economic weakness. Last week, MoF officials and some business leaders discussed raising the 5 per cent consumption tax by 1 percentage point in 2004 and then another percentage point each year until it reaches 16 per cent. This comes on top of a permanent increase in government fees, equal to 0.5 per cent of gross domestic product, beginning in April that outweighs temporary tax cuts now being considered. In short, Tokyo exhorts consumers to spend more even as it takes away their means of doing so.

The last time Tokyo raised the consumption tax - from 3 per cent to 5 per cent, in 1997 - it triggered Japan's worst postwar recession to that point, caused the ruling Liberal Democratic party to lose the 1998 upper house elections and toppled the prime minister. Since then, GDP has grown a miserable 0.3 per cent a year and private domestic demand is still below the pre-tax peak. Why does the MoF propose to repeat the fiasco? The MoF argues that unless Japan begins closing its fiscal deficit - 7-8 per cent of GDP each year since 1998 - government debt will spiral out of control. Already, the debt-to-GDP ratio has soared from 80 per cent in 1995 to a projected 150 per cent this year. This trajectory, argues the MoF, will ultimately make mounting social security costs unpayable and could lead to financial calamity.The MoF reasoning is flawed. To be sure, Japan cannot keep expanding the debt-to-GDP ratio for ever. Nor can fiscal stimulus alone restore economic vibrancy. But the time is wrong for a contractionary fiscal stance - a cure worse than the disease.
Source: Financial Times
LINK

Katz is obviously right about the likely negative impact of an increased consumption tax in Japan. He is also right in pointing out that, thanks to ultra-low interest rates, government interest payments today add up to 2 per cent of GDP, compared with 3 per cent in the late 1980s. Whatsmore, for some years to come, the burden will continue to lessen since the average interest rate currently paid on outstanding bonds is 2.2 per cent, which is far above the 0.9 per cent rate on 10-year bonds in the secondary market. So as old high-interest bonds mature and are replaced with new low-interest ones, the average interest burden will continue to fall. Where Katz goes astray, in my opinion, is in not seeing the impact of this on debt dynamics. As government debt continues to rise the cost of eventually raising interest rates becomes horrendous. Thus there will be no incentive to work to produce inflation since the impact on interest rates will be likely to hit government financing so hard that the most probable effect would be to send Japan straight back into recession! At the same time doing nothing, and continuing to sit back and watch the deflation process at work (even if at a rate of only 1% or 2% per annum) will see the debt/GDP ratio moving steadily upwards until it finally becomes unsustainable, even if the cost of servicing the debt remains small. When will people finally wake up and realise that it is the demographic processes itself which lies behind all this, and that if Japan does nothing about its demographic problem (eg opening the doors to immigration) then there will continue to be be no end in sight.

Dollar Up, or Dollar Down

So which way is it this year for the greenback? A bevy of commentators (including the IMF and the OECD) regard the dollar as seriously overvalued. In principle I agree. The real problem is to identify a sound substitute. In this piece Morgan Stanley's Stephen Len argues for the dollar downside effect dominating. (Why is their global economic forum so full of talent, is this another example of a networking effect? Nine times out of ten I would certainly back the 'instinctual' economics of Roach's team over their aforementioned more heavyweight institutional rivals). What makes his argument interesting, and out of the pack, is that he justifies this by countering the weak yen view.

The topic of the month is the change of governor at the Bank of Japan (BOJ). There is a kind of will-he, won't-he debate over whether this will mean that the BOJ will go for that flavour of the month: inflation targeting (IT). What Len suggests, and I think this is a good argument, is that whoever is chosen the likelyhood of IT in the near term is extremely small. This is not only due to conservatism and lack of reform spirit at the BOJ, but because they seriously doubt it is credibly attainable on a sustained basis, hence their reluctance to jump for it. Many American commentators suggest that they are wrong (in fact too often they suggest they aren't even trying which is absurd) and that what they need to do is systematically (and in duly non-sterilised fashion) purchase government debt. Len is a Japan finance and in particular a Japan Government Bond (JGB) specialist and he strongly doubts this would work. The only clear strategy for provoking inflation he argues is by the BOJ purchasing foreign securities, and this they are still far from ready to do (again with reasons which could be argued). Maybe by the time they get round to doing it Bernanke will be leading the Fed into acquiring JGB's so they could do a straight swap. Bottom line: this year it's more probable that the dollars tendency to go down will dominate, but in currency markets sometimes anything can happen! Since I have long held that monetary factors only give part of the story for the thirtees depression, and that beggar-thy-neighbour devaluations and protectionism (especially in the case of labour mobility) also have their part to tell, I can only view all of this with growing concern. When will we get round to discussing the real problem, in the real economy? Meantime watch out Euroland, up you go.

The term of the current Governor of the Bank of Japan (BOJ) ends on March 19. From recent official statements, there is strong support within Koizumi�s government to replace Governor Hayami with someone who is sympathetic to the idea of inflation targeting (IT). If such a candidate is indeed appointed as the next BOJ Governor, the currency market�s initial knee-jerk reaction is likely to be a modest rise in USD/JPY -- modest because the market has already priced in a high probability of this outcome. (Conversely, if it turns out that the new Governor is not a strong supporter of IT, USD/JPY could fall!) However, whether USD/JPY rises further and stays high, against what I expect to be a broad downtrend in the USD this year, depends on a number of considerations. One key point in this note is that, for USD/JPY, the instrument that the BOJ uses to achieve an explicit inflation target is more important than whether there is an inflation target. Only if the BOJ decides to buy large quantities of foreign bonds would USD/JPY rise over the medium-term, in my view. In all other cases, I believe that any rise in USD/JPY will be temporary and psychological, and will eventually be overwhelmed by economic reality, which, in my view, justifies a lower USD/JPY.

The most compelling argument against the BOJ adopting an inflation target is that such a policy objective lacks credibility because it is simply not achievable under the current circumstances. Japan is suffering from "real deflation", not "monetary deflation". Money printing alone cannot get Japan out of this liquidity trap. Having been implicitly targeting an inflation rate of at least zero, the BOJ has already failed at achieving this target. Adding a time frame and making this target explicit would actually hurt the Bank�s credibility, in my view. Further, what if inflation does rise during this period? Should the BOJ tighten to keep inflation contained, given the likely continued weakness in the Japanese economy? Clearly, there are both theoretical and practical complications of adopting IT at this point.
Source: Morgan Stanley Global Economic Forum
LINK

Japan About to Try to Lower the Yen

Signals coming out of Japan, difficult as they are to read at times, seem to indicate that a change in exchange rate policy may be imminent. On Mondayprime minister Junichiro Koizumi added his voice to a growing body of evidence that his government, which regards the yen's rise as reflecting external weaknesses rather than any significant improvement in its own economy, would welcome a currency depreciation. He said the new governor of the Bank of Japan should support an aggressive anti-deflation policy. Mr Koizumi must choose a new BoJ governor by March. Since Japan has all but exhausted the possibilities of fiscal and monetary policy a substantial depreciation of the yen remains one of the few policy options open to the government.

A senior official warned on Monday that Japan would take decisive action against rapid fluctuations of the yen, reflecting growing concern that economic recovery is being stifled by a strengthening of the currency. The signal from Toshiro Muto, vice-finance minister, of possible intervention came on the same day that the Nikkei average notched up its longest losing streak in 11 years, with yen-sensitive exporters particularly heavy casualties. On Friday, the yen rose to a one-month high against the dollar at �120.3, and was hovering around �120.6 on Monday, prompting investors to unload shares of Japan's biggest exporters, including Sony and Canon. The Nikkei average lost 0.8 per cent to 8,450.94, its first nine-day losing streak since September 1991.
Source: Financial Times
LINK