Japan Economist Makes Rare Call to Tackle Debt

By Kosaku Narioka

It?s time for Japan to face up to its debts. While Western economists often make this point, when it comes from a Japanese economist, it?s news. That?s because many economists in Japan believe persistent domestic demand for government bonds means there?s no chance of a debt crisis anytime soon.

But Sayuri Kawamura, senior economist at the Japan Research Institute, disagrees. She says that with Japan?s debt mountain more than twice the size of its economy, it must either slash spending by more than half or raise an equivalent in extra tax revenue. The alternative is the potential loss of market confidence in Japan?s efforts to shore up its finances, she says.

Ms. Kawamura is one of only a few mainstream economists in Japan insisting on action now, spelling out the steps Prime Minister Shinzo Abe should take. The institute where she works is a subsidiary of Sumitomo Mitsui Financial Group, one of Japan?s biggest banks.

?It?s desirable to take advantage of the current solid political footing to discuss how to manage the fiscal situation,? said Ms. Kawamura, noting the resounding victory of the prime minister?s Liberal Democratic Party in Sunday?s election for the upper house of parliament. The win gives Mr. Abe?s coalition control of both chambers, making it easier to pass legislation, including unpopular measures to rein in the debt.

Specifically, Mr. Abe will have to cut government spending by ?50 trillion ($500 billion) by 2020 to bring the debt to sustainable levels in the future, Ms. Kawamura said. That amounts to more than half of Japan?s of ?93 trillion budget for the current fiscal year, or 10% of the entire economy. Alternatively, the prime minister could increase revenue by the same amount or get the same result through a combination of spending cuts and tax hikes.

Over the years, a slew of overseas hedge-fund managers have bought into the idea Japan is about to get slammed by its debt problems, betting against the Japanese government bond market. Over and over they have lost out as Japanese investors have consistently snapped up more than 90% of the debt.

However, Ms. Kawamura says this won?t last.

Her warning is timely. While the recent election result strengthens Mr. Abe?s control of the legislature, it comes ahead of a mid-term fiscal plan to be released in August. It will be the government?s first chance to demonstrate it is really serious about fiscal consolidation.

?Let?s face it. We need ?50 trillion,? Ms. Kawamura said. The figure may look large, but then about a half of Japan?s main budget this year was funded by debt issuance.

The hurdle for bringing the debt down to sustainable levels is very high without resorting to default or capital levy, she says. No major economy allowing free capital flows has ever had a debt of more than 200% of gross domestic product, Ms. Kawamura notes. This means there is no example of nations successfully bringing down such high debt levels by fiscal reforms. But that doesn?t mean it?s impossible, she adds.

Inflation expectations are another aspect of the problem. Over the years, despite fears about the ever-growing debt pile, falling bond yields have let the government refinance its debt at lower costs. But that may change as the government and central bank try to transform Japan?s deflationary mindset. Rising prices generally go hand in hand with rising interest rates.

Under current conditions it would be ?extremely risky? if interest rates start a rising trend, Ms. Kawamura said. She also cautions against complacency among those who say tax receipts will naturally increase as the economy grows. She says higher interest-rate payments on the gigantic debt pile?around ?1 quadrillion?are likely to offset any gains in tax revenues from an economic recovery.

Source: http://blogs.wsj.com/japanrealtime/2013/07/25/japan-economist-makes-rare-call-to-tackle-debt/?mod=WSJBlog

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