Commentary: The Shadow Budget Haunting Japan
Sure, Japan has been on a debt binge for years. And yes, the numbers are scary. That's why Moody's Investors Service on Feb. 18 warned that it might take yet another notch off of Japan's once-sterling sovereign debt rating, now Aa1, as it did in 1998. Yet Japan still boasts $10 trillion in household savings, $260 billion in foreign exchange reserves, and a huge current account surplus. Given such wealth, why should Japan carry the same credit risk as Italy or Belgium? It seems almost absurd to ask.
Yet Japan deserves this wake-up call. Disregard the protests of disbelief from Tokyo officialdom: The rating agency is casting a needed, if unflattering, light for global investors on a world-class debt trap. Perhaps more important, even many inside Japan's top ministries are privately delighted that Moody's is blowing the whistle. Without outside pressure, Japan's reformers figure the government is unlikely to cut a huge new round of pork-barrel programs and inefficient corporate subsidies.AMMUNITION. The reformers are a diverse bunch. They include Liberal Democratic Party leaders such as Kato Koichi and a band of young fiscal conservatives within the Ministry of Finance. They want to throttle back public-works spending, push companies to cut capacity in sunset industries, and target government spending on building Japan's promising Internet economy. The reformers are already waging a behind-the-scenes battle with backers of Prime Minister Keizo Obuchi, who wants his next spending package to coincide with Japan's general election. The move by Moody's gives the reformers ammunition in the fight.
Supporters of government spending point out, correctly, that the risk of Japan defaulting on its government bonds today is next to nil. What's more, slamming on the fiscal brakes would be disastrous. A 1997 tax hike pushed Japan into recession.
But the reformers are fighting a long-term game. They want to raise awareness of the debt high enough to restrain future spending and finally prod Japan's ruling Liberal Democratic Party into cutting some of the pork-barrel stuff. Otherwise the debt could eventually suffocate the economy. Even after years of recession and faltering recovery, too many big companies get low-interest loans despite lousy business prospects, while state-linked lenders such as the Japan Development Bank keep bailing out troubled small and medium-sized companies that should probably restructure or fold.
The reformers inside and outside MOF are not just relying on outside pressure from Moody's to expose these financial follies. They plan to do some excavation of their own. Today, a massive shadow budget known as zaito funnels Japan's $2 trillion-plus postal savings deposits to all manner of questionable public works projects. Now a push is on to finally give the public a clear view of these off-book liabilities, many of them nonperforming loans.MASSIVE FLIGHT. The results could be far more shocking than any Moody's report. Indeed, if you throw in these off-book liabilities, plus future pension obligations in aging Japan, the country's true indebtedness could approach 250% of gross domestic product. That's far larger than current estimates, huge as they are. Barclays Capital credit analyst Hiroshi Kuribayashi thinks the debt burden could eventually trigger a massive capital flight by Japanese bond investors into Tokyo stocks and overseas markets, leaving the government helpless to fund its deficits. A public airing of zaito's obligations could bring that day of reckoning closer.
All of this presents Prime Minister Obuchi's ruling LDP with a horrible dilemma. The LDP is arguing it needs one more hit of public spending to tilt the economy into recovery. Yet if this doesn't work, the debt picture worsens, the country edges closer to another crisis, and the reformers have even more evidence to plead their case that the free-spending LDP is Japan's biggest problem. In this context, the fallout from Moody's warning will be felt for months to come.By Brian Bremner; Tokyo Bureau Chief Bremner Covers Japanese Finance and Politics.