Japan Analysts Split on Fiscal Crisis Time as Tax Looms: Economy

Japan Analysts Split on Fiscal Crisis Timing as Tax Rise Looms
An employee holds a sign for a "okonomiyaki" restaurant at night in the Shibuya district of Tokyo, Japan. Photographer: Yuriko Nakao/Bloomberg

Economists are split over how long Japan’s government has to rein in the world’s biggest debt burden, a Bloomberg News survey shows, adding to a debate on whether the government should keep ratcheting up a sales tax.

Eleven of 34 analysts said the government has four years or less to put fiscal policy on a sustainable path and avoid a crisis, while seven said it has over 10 years. BNP Paribas SA and Credit Suisse Group AG were among five saying it’s too late to avert one. UBS AG says chances of a fiscal crisis are remote.

The lack of consensus offers an opening to opponents of a 2 percentage point increase in the sales tax, due next year after a 3-point jump next month. At stake is ensuring an improvement in Japan’s finances to assure demand for public debt remains once the central bank, the biggest buyer of the securities, achieves its inflation target and tapers stimulus.

“The government should demonstrate a clear road map for fiscal reconstruction before 2 percent inflation takes root,” said Yoshimasa Maruyama, chief economist at Itochu Corp. “If it doesn’t do that, investors might attack.”

A longer period would offer Prime Minister Shinzo Abe and his potential successors time to focus on strengthening economic growth before addressing a shortfall in social-security financing. Government debt currently exceeds twice the size of gross domestic product.

‘Extremely Meaningful’

The Topix index of stocks rebounded from a six-week low and was up 1 percent at the midday break. The yen was little changed at 101.77 per dollar.

Those who have expressed concern about the potential damage to a Japanese recovery from fiscal tightening have ranged from Nobel laureate Paul Krugman to Koichi Hamada, a retired Yale University professor who advises Abe on monetary policy. The government should freeze plans to raise the levy and instead cut the number of parliamentary representatives and bureaucrats, opposition Your Party says.

While BOJ Governor Haruhiko Kuroda repeatedly says it’s too early to discuss an exit strategy for the central bank’s easing, he has signaled an immediate need to address fiscal challenges.

Kuroda praised Abe for his October decision to raise the sales tax to 8 percent, saying it was “very meaningful,” and urged continued fiscal consolidation efforts.

Having warned Feb. 12 that doubts over sustainability of Japan’s finances would push up bond yields, Kuroda said in a March 13 interview with the Asahi newspaper that a corporate tax cut Abe plans would reduce revenue and should be considered within the overall tax framework.

Current Account

Japan’s debt will equal 242 percent of the economy by the end of 2014, according to International Monetary Fund. Just 8 percent of its bonds are held by overseas investors, reflecting a large pool of domestic savings.

A risk for the government in coming years is that cushion will erode as baby boomers start to retire in larger numbers from 2015 and draw down savings, said Hidenori Suezawa, a financial market and fiscal analyst at SMBC Nikko Securities Inc.

Japan’s current-account balance could swing into a sustained deficit between 2020 and 2025, boosting reliance on foreign creditors and the risk of a surge in yields, said Suezawa, who is a member of the government’s fiscal system council.

“I’m watching the current account balance carefully and am worried about it,” said Masahiro Fukuda, investment director at Fidelity Worldwide Investment in Tokyo, who said a deficit was possible in three to five years. “If a country has twin fiscal and current-account deficits, capital could be withdrawn really quickly.”

Fiscal Target

The finance ministry says even under its most optimistic scenario the government will miss a medium-term fiscal reform target outlined in August to achieve a surplus in the budget -- excluding interest payments -- by fiscal 2020.

The ministry forecasts a primary balance deficit of 6.6 trillion yen in 2020, or 1.1 percent of GDP, compared to 23.2 trillion yen 2013.

The BOJ is by far the largest single buyer of Japan’s government debt, accumulating 50 trillion yen a year, equal to 27 percent of planned total issuance for the fiscal year from April.

That support has helped suppress borrowing costs, with the benchmark 10-year government bond yielding 0.62 percent today -- the lowest in the world -- even with headline inflation of 1.4 percent in January.

“The bond market has been calm the past two years only because the BOJ has been buying,” said Takeshi Fujimaki, who once advised billionaire investor George Soros and holds a seat in Japan’s upper house of parliament.

BOJ Exit

The central bank is likely to reach its target of stable 2 percent inflation in 2016 or 2017, requiring a cut in stimulus to avoid fueling concerns it’s financing budget deficits, said Itochu’s Maruyama.

“The BOJ won’t be able to reduce its balance sheet in haste,” said Maruyama. “The point is how the central bank will contain interest rates in that situation.”

An exit of the BOJ’s unprecedented easing could cause the 10-year government bond yield to rise 1 to 2 percentage points over the following six months, according to 7 of 15 economists in a separate Bloomberg survey. Seven others predicted smaller increases.

Daiju Aoki, economist at UBS AG, said the likelihood of a fiscal crisis is remote, even if Japan’s debt were to reach 300 percent of GDP under a scenario of a weak economy that makes it hard to lift the sales tax and offset social security and bond expenses. It would take a long time for a rise in yields to lift interest expenses, while Japan has room to raise taxes, he said.

“Even if the current account deficit were to last longer than we expect and the foreign debt ownership ratio were to increase rapidly, we think the government’s and BOJ’s scope for policy action would hold down fiscal concerns and the risk of soaring interest rates triggered by panic selling,” Aoki wrote in a report.

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