Debt Disaster Seen Unless VAT Rises to 20% by 2020: Japan CreditRocky Swift and Shigeki Nozawa
Japan must raise its sales tax to at least 20 percent by the time the Olympics come to Tokyo in 2020 to avert a “disaster” in its bond market, according to the head of a panel advising the world’s biggest pension fund.
The consumption levy, due to increase in April for the first time since 1997, will need to quadruple from current levels to handle Japan’s increasing welfare costs and rein in the nation’s debt, said Takatoshi Ito, who leads an investment panel for the 121 trillion yen ($1.23 trillion) Government Pension Investment Fund. He said funds like GPIF are at risk of being too dependent on Japanese government bonds, where 10-year yields of 0.675 percent are the lowest globally.
Prime Minister Shinzo Abe is expected to decide next month if Japan’s economy can weather an increase in the tax to 8 percent in April. Current rates of 5 percent are a fifth of the value-added taxes imposed in Nordic countries like Sweden, and need to be raised to prevent the implosion of a debt burden that’s more than double the size of Japan’s economy, Ito said.
“There is a narrow path to escape from the disaster,” Ito, the dean of Tokyo University’s Graduate School of Public Policy, said in an interview yesterday. “The good news is that there is a big fiscal space to increase taxes.”
Abe will announce his decision on Oct. 1 after the release of the Bank of Japan’s Tankan survey of business sentiment. He has pledged to defeat 15 years of deflation and spur growth in the world’s third-largest economy using the so-called three arrows of fiscal stimulus, monetary easing and a package of growth-oriented initiatives including deregulation.
The BOJ unveiled an unprecedented monetary stimulus program in April, saying it would double monthly JGB purchases to more than 7 trillion yen in pursuit of a 2 percent inflation target. The easing has kept a lid on bond yields as it helped Japan’s exporters by sending the yen to a 4 1/2-year low of 103.74 per dollar in May. It was at 98.75 as of 2:38 p.m. in Tokyo.
Even as Japan’s economy recovers from the effects of an earthquake and nuclear crisis in 2011, it hasn’t begun to chip away at its debt pile. Government obligations will grow to 245 percent of economic output this year, the highest ratio globally, according to International Monetary Fund estimates, compared with Greece’s 179 percent and 108 percent for the U.S.
Italy, whose debt is expected to expand to 131 percent of its gross domestic product in 2013, is slated to raise its value-added tax to 22 percent on Oct. 1.
While more than 90 percent of JGBs are held domestically, Japan’s declining population and expanding welfare expenses mean that the country will eventually lose the ability to fund its debts, Ito said. Without an increase in the tax rate toward 20 percent or higher by 2020, “my prediction is that a big disaster happens in 2023,” he said, citing projections for household wealth and government borrowing.
Sales tax increases are the way to reform Japan’s finances because they don’t affect growth as much as levies on household or corporate income and they don’t transfer costs onto future generations, according to Ito.
“It’s a clawback on the rich, retired Japanese persons,” he said.
Tokyo beat out Madrid and Istanbul to stage the 2020 games in a Sept. 7 decision by the International Olympic Committee, bringing the event back to Japan’s capital for the first time since 1964. The government sold its first bonds the following year to contend with a recession. By June this year the outstanding balance of debt grew to exceed one quadrillion yen, according to the Ministry of Finance.
“The Tokyo Olympic games started government bonds,” said Ito, 62, who has served stints in the Ministry of Finance and as a professor at Harvard University. “Let’s do the 2020 Olympic games as a turning point to reduce government bonds.”
An improvement in the economy because of the Olympics could hurt JGBs, Tomoya Masanao, the head of portfolio management for Japan at Pacific Investment Management Co., said in an interview in Tokyo yesterday.
“What is more important than the direct economic impact we can expect from infrastructure spending is the secondary effects from public confidence being restored,” said Masanao, whose company is the manager of the world’s biggest fixed-income fund. “If growth picks up and the economy becomes a little bit more inflationary, that would be negative for JGBs, but that hinges on whether the government can leverage the positive impact on economy.”
Yields on benchmark 10-year JGBs have swung from an all-time low of 0.315 percent to as high as 1 percent after the BOJ announced its unprecedented easing plan in April. The five-year average is 1.08 percent.
Japan will spend 22.2 trillion yen servicing its debt in the fiscal year begun in April, accounting for more than half of total tax revenue and occupying about 24 percent of the government’s budget, according to Finance Ministry estimates in January. In the U.S., total interest payments of $359 billion accounted for about 10.2 percent of budgetary outlays in the year that ended September, according to Treasury data.
Moody’s Investors Service said on Aug. 15 that “delaying or watering down” the sales tax plan would be “credit negative” because the government has yet to unveil significant steps to reduce its deficits.
A BOJ report in April examining potential losses at banks from rising bond yields found that if interest rates climb 1 percentage point across all maturities, Japan’s biggest lenders would incur 3.2 trillion yen of unrealized capital losses. A 3 percentage-point increase would lead to 8 trillion yen in capital losses, the central bank estimated.
Potential losses on JGBs pose a risk for pension funds like GPIF, Ito said. The fund, which is the world’s largest manager of retirement savings, posted its smallest gain in three quarters in the period ended in June because of record domestic bond losses.
GPIF announced in June a cut to its target holding for domestic bonds to 60 percent from 67 percent, while the proportion of foreign and local shares will rise to 12 percent each, from 9 percent and 11 percent respectively. Allocations will remain at the revised levels until at least March 2015, GPIF President Takahiro Mitani said.
Ito was named to a newly formed panel to advise on investments by GPIF and others government-related funds. The group will deliver its first report in November, and is discussing further diversification into stocks, overseas bonds and alternative assets such as real estate funds, he said.
“There will be a recommendation to change the portfolio,” Ito said. “There is a consensus that we should reduce the domestic bonds.”