Japan’s default risk has fallen the most among Group of Seven nations this year, so why are some of its leading economists more worried than ever?
The Bank of Japan’s unprecedented stimulus, which has scope to buy every new bond the government issues, is keeping yields artificially low even as sovereign notes head for their first annual loss since 2003, according to brokerages including Mizuho Securities Co. and SMBC Nikko Securities Inc. The Cabinet Office acknowledged last week it can’t see the government achieving its target of a primary budget surplus in five years, and the central bank has yet to outline how it plans to taper its asset-purchase program.
No sovereign debt has performed as poorly as Japan’s this month, and only Greece has done worse over the past five years. On a relative basis, at 232 percent of gross domestic product, Japan’s more than a quadrillion yen ($8.1 trillion) in debt makes Greece’s look enviably manageable.
“Credit-default swap are declining and bond yields are falling to the point where they no longer reflect a risk premium,” said Toru Suehiro, a Tokyo-based economist at Mizuho Securities. “It suggests the market is losing its ability to warn about the deterioration in Japan’s fiscal health.”
Japanese government bonds are headed for their first annual loss since 2003, declining 0.7 percent since the start of the year through June, according to Bank of America Merrill Lynch indexes.
Even so, JGB yields remain the lowest globally after Switzerland. The 10-year note yielded 0.415 percent late Thursday in Tokyo, after dropping to a record 0.195 percent in January.
Japan’s debt is unsustainable and could climb to around 290 percent of GDP by 2030, the International Monetary Fund said last week. The government should consider rules to curb spending instead of relying on optimistic economic assumptions, the IMF said.
The cost of living in Japan remained little more than zero in June while household spending dropped, challenging the central bank’s effort to spur inflation. Consumer prices excluding fresh food rose 0.1 percent from a year earlier, fractionally better than economists estimated.
Prime Minister Shinzo Abe’s fiscal goal assumes 2 percent real growth in the mid-to-long term, a forecast Fitch Ratings Ltd. calls “highly unlikely.” The company cut Japan’s debt grade in April to the same level as Israel and Malta.
Amid all that, Japan’s five-year sovereign CDS spread has narrowed 27 basis points in 2015 to 42 basis points, compared with a less than one basis point decline in the U.S. and about one in the U.K. and Germany. Spreads in those nations are 22 basis points or less.
In Greece, the gap is more than 2,000 basis points.
“The reason Japan’s CDS spread has remained low is because more than 90 percent of JGB investors are domestic, so even with a ratings cut, their home bias won’t change,” said Kazuhiko Ogata, a Tokyo-based economist at Credit Agricole SA. “Japan is the world’s biggest foreign creditor. It can continue to take the burden of its own debt, so it’s completely different to Greece.”
Even so, Ogata says the Cabinet Office’s projection signals how the path to restoring fiscal health remains “severe,” and that there needs to be a focus on reducing spending.
Japan’s Economy Minister Akira Amari has pointed to Greece as “proof that you can’t fix finances by just raising taxes and cutting spending.”
“There is no fiscal reform without economic revitalization,” he said this month. “Without continuing to steadily boost growth and increasing the size of the economic pie, just hiking taxes and cutting spending would leave us squirming.”
Fitch’s head of Asia-Pacific sovereign ratings, Andrew Colquhoun, said last week that “there’s probably a wider recognition that we are approaching the limits of what’s doable through the monetary policy route.” More than a third of economists surveyed by Bloomberg this month predict no additional easing, and 18 percent now foresee a tapering of stimulus next year.
“Liquidity is declining because of quantitative easing and that extends to CDS, so even if you see spreads narrowing, you can’t say that the debt is safe,” said Hidenori Suezawa, an analyst at SMBC Nikko Securities in Tokyo. “It simply means that the crisis has been delayed, and there will be risks when the BOJ eventually decides to exit stimulus.”