A debt piled highbalancing economic stimulus with reining in its unprecedented fiscal deficit will be no easy task for Japan.The country’s long-stagnating economy is back in the news—this time for the right reasons—with the economic revival policies of Shinzo Abe’s government, known as “Abenomics”, hailed in some quarters as a credible alternative to the austerity that has been implemented across much of Europe. Meanwhile, however, government borrowing has continued to grow, and, raising surprisingly few eyebrows, Japan’s public debt passed the quadrillion yen mark (more than US$10trn) at the end of June 2013, according to figures from the Ministry of Finance.

At the equivalent of 231% of Gross Domestic Product (GDP), Japan’s debt is already the highest in the world, and represents around US$165,000 for each member of the working-age population. Successive governments in Japan have been able to run up debt on this scale owing mainly to the willingness of domestic investors—banks, insurance companies, pension funds and individuals—to buy Japanese government bonds (JGBs), which pay near-zero interest rates. With the economy stuck mostly in deflation for the past two decades, this made some sense. However, one of the central policy pillars of the

new government, aided by a compliant Bank of Japan (BOJ, the central bank), is to achieve an inflation target of 2%. If that goal is achieved, then yields on government bonds should rise, too. Around one-half of all tax revenue is currently consumed by servicing the public debt; the remainder of the government’s budget is financed by fresh bond issuance. It would take only a rise of a few percentage points on JGBs to trigger a sovereign debt crisis by making it virtually impossible for the government to meet its debt-servicing obligations.

Over the years, however, a number of investors and traders have predicted, and staked their money on, a JGB crisis. In fact, betting against JGBs has resulted in such heavy losses to so many traders that the deal has been dubbed the “widow-maker”. Nevertheless, the International Monetary Fund (IMF) and credit-rating agencies have delivered repeated warnings to Japan over its gigantic debt stock.

Supporters of Abenomics point out that the economic growth these policies are beginning to trigger will lead to higher tax revenue, keeping the debt payments manageable. The government is also planning to double Japan’s relatively low consumption tax rate (currently 5%) in two stages by 2015, although there are concerns that this could derail the nascent economic recovery. A cut in corporate tax rates is being considered, too, with the hope that it would boost investment and economic activity—although critics of this approach say that it could lead to a further loss of vital revenue.

Japan’s giant pension funds are also

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At the equivalent of 231% of gdp, Japan’s debt is already the highest in the world, and represents around US$165,000 for each member of the working-age population.

JApAN

being encouraged by the government to rebalance their JGB-heavy portfolios into assets with better returns, such as equities and infrastructure investments in emerging markets. Although the BOJ could currently take up that slack with its massive asset-purchasse programme, some analysts suggest that the policy already amounts to monetising government debt, and is unsustainable.

Although almost no one believes that the country continuing on its previous course of a steady deflationary decline for a couple more decades was a viable option, Japan now has a precarious fiscal tightrope to walk.

Japan has often been referred to as a country of contradictions. Its unparalleled service and hospitality coupled with a certain cultural impenetrability; ancient serenity juxtaposed with hectic modernity; and the fact that it is among the safest societies on Earth but is also home to one of the world’s largest criminal organisations all showcase this dichotomy. In some ways Japan’s economy is no different—it is a contrast of successes and failures. The ruthless efficiency of its global corporations against the bloated structures of its domestic services sector, and the huge reserves of personal and corporate savings versus the country’s massive public debt, demonstrate why Japan has never been the easiest economy to make sense of.

The economy expanded by 1.9% last year, largely thanks to a rebound from 2011, when an earthquake and a subsequent tsunami devastated Japan and its economy. There was little indication, however, of an underlying recovery from the structural stagnation that has dogged the country for most of the time since its growth bubble burst at the beginning of the 1990s. The fears of global economic domination that characterised its image in the 1980s have long given way to Japan as a cautionary tale on how not to deal with a financial crisis. However, this year has seen other countries looking once again to Japan, this time to find out how it has triggered a stockmarket bull run and revived economic optimism under its new government. The Economist Intelligence Unit forecasts that Japan’s real GDP will grow by 1.7% in 2013.

Abenomics

The prime minister, Shinzo Abe, was returned to lead the country in December 2012 following a brief tenure that began in 2006 and ended 11 months later, when he stepped down owing to a combination of ill health, scandals and unpopularity. Although he is less than a year into his second stint, the contrast with his previous premiership could not be starker: public approval ratings have topped 70% and his administration’s policies for reinvigorating Japan’s economy have been dubbed “Abenomics” in his honour.

Abenomics is comprised of “three arrows”: doubling the monetary base in two years with an unlimited asset-purchase programme; ¥10.3trn (US$105bn) in fiscal stimulus; and structural reform.

A weaker yen was never officially one of the so-called three arrows, although it can be seen as an almost inevitable side-effect of the asset-purchase programme. Yen depreciation was something that Mr Abe’s government was able to begin triggering even before he took office: the announcement of the ultra-loose monetary policy he would implement after a virtually certain election victory alone was enough to send the currency tumbling on the foreign-exchange markets. Japan’s struggling exporters cheered and a stockmarket rally that would see the main Nikkei index rise as much as 80% began. When the Bank of Japan (the central bank) officially announced in early April 2013 that it would pump even more money than had been expected into the economy, the value of the yen fell further and the Nikkei climbed higher.

The ¥10.3trn fiscal stimulus package, made up largely of infrastructure repairs and reconstruction spending for the areas damaged by the 2011 natural disasters, was also well received when it was touted at the beginning of the year. However, in August the government announced a target of ¥8trn in spending cuts over the next two years, in an attempt to move towards a medium-term balancing of the primary budget.

Structural reform has so far proved somewhat elusive, although it is widely regarded as crucial to curing Japan of economic malaise. Mr Abe’s plan in this regard, unveiled in June, was short on details, and the measures that were announced were deemed less than inspiring, setting off a pullback in the stockmarket’s rapid rise.

Real reforms

Deregulation of the labour market, along with that of crucial sectors such as agriculture and energy, are necessary measures for a sustained revival of Japan’s economy.

JApANNO eASY ANSWeRS

MAcROecONOMic

OveRvieW2 0 1 2

Population: 126.1m

GDP: US$5.96trn

GDP per head: US$36,840

Consumer price inflation: 0.1%

Trade balance: US$64bn

Current-account balance: US$56bn

Foreign currency reserves: US$1.268trn

Total household assets: US$16trn

Recorded unemployment: 4%

Life expectancy at birth: 83 years

© The Economist Intelligence Unit Limited 2013

Real GDP growth(% change)

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

Source: Economist Intelligence Unit 2013

Japan World

However, Mr Abe’s Liberal Democratic Party (LDP), which has ruled Japan for most of the past 50 years—bar a brief three-year hiatus, which ended with the party’s election victory in December—has long and deep ties to special interest groups, including farmers and utility companies. The LDP has been struggling to unite its internal factions behind the US-led Trans-Pacific Partnership, a regional free-trade bloc opposed by much of rural Japan.

Parochial, conservative attitudes are also a major reason that Japan is yet to countenance significant levels of immigration, despite its shrinking workforce and population. The country’s greatest strength has always been its people (particularly its highly-skilled workforce), but there are fewer and fewer of them. A new point-based system implemented last year that was designed to attract skilled immigrant workers resulted in only 17 foreigners being accepted during its first 11 months. (The government has said that it will review the criteria.) Japan is already the oldest society in the world. And with a birth rate of only 8.39 per 1,000 people—ranking it 216th out of the 221 countries for which data are available—the burden on Japan’s dwindling number of workers will inevitably grow heavier, and economic expansion will be harder to come by.

Japan has been equally reluctant to use fully even one-half of the human resources it already has: women remain woefully underrepresented in almost every sector of the economy, with the exception of low-paid temporary and part-time work. If Japanese women (who still face unequal employment opportunities, despite them being enshrined into law) were able to participate economically to the same extent as their counterparts in northern Europe, this would add 8 percentage points to annual GDP, according to the IMF. The government is making the right noises on the issue, but it remains to be seen how hard it will be prepared to push.

Regional tensions

Although Japan’s economy has traditionally been less export-dependent than some might think—accounting for around 15% of GDP—the diminished prospects for domestic GDP growth will make overseas trade more crucial than ever.

China is Japan’s largest trading partner, while South Korea is its fourth-largest export market. However, it is with these two Asian neighbours that Japan suffers its most strained relations. Tensions have risen further recently as Mr Abe’s administration has talked of reforming the pacifist Article 9 of the constitution, in addition to increasing defence spending and having launched Japan’s biggest warship since the second world war.

Some observers have voiced concerns that following the success of the LDP in the upper house elections in July, Mr Abe may shift his focus from economic reform to promoting a more hawkish agenda, which could both slow the pace of reform and damage trade. If so, Abenomics could fail to live up to the hype and Japan could sink back into another lost decade.

Abenomics is comprised of “three arrows”: doubling the monetary base in two years with an unlimited asset-purchase programme; ¥10.3trn (US$105bn) in fiscal stimulus; and structural reform.

© The Economist Intelligence Unit Limited 2013

Inflation(% change)

Leading markets for exports(% of total exports)

Leading suppliers of imports(% of total imports)

2008 09 10 11 12 13 14 15 16 17

China

US

EU

South Korea

-2

-1

0

1

2

3

4

5

6

Source: Economist Intelligence Unit 2013

Source: Economist Intelligence Unit 2012

Source: Economist Intelligence Unit 2012

Japan World

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

0 5 10 15 20

18.1

17.6

10.2

7.7

China

EU

US

Australia

0 5 10 15 20 25

21.3

9.4

8.6

6.3

The information in this report is accurate as of August 2013.

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