While it is amongst the world’s most advanced economies, Japan has the highest rated public debt to GDP at a staggering 253% (as of 2018), completely dwarfing Greece’s 177%. This debt mountain is the inevitable result of the monumental fiscal deficits that Japan has run since the 90s and it’s a debt that will probably never be “repaid.” At least not in the normal sense of the word.
Perhaps even more shockingly, Japan’s national debt currently sits at over one quadrillion yen (that’s 15 zeros). According to the International Monetary Fund, in order for Japan to pay down this substantial debt to 80% of GDP by 2030, it would need to reach a 5.6% of GDP surplus by next year (2020) and sustain that surplus for a decade.
Still, while one might reasonably assume that such a monumental debt should result in catastrophe, unlike Greece, Japan is still going strong. There have been over two decades of severe warnings, but the debt crisis that was always forecasted never arrived, despite these fears leading to policy misfires such as the 2014 rise in consumption tax that choked off economic recovery.
Logic dictates that there are only a handful of ways any country can pay off public debt - inflation, growth, repayment or default. With a shrinking and ageing population, growth is off the table and repayment is almost as large a hurdle given the government’s continued spending and the substantial budget surplus required over a number of years to pay off the debt. This leaves default or inflation.
Japan’s inflation target remains stunningly elusive, but it’s thought to be well below the central bank's 2% target. Default, meanwhile, makes no sense given that almost all of Japan’s debt is owned by the central bank and the domestic financial system. Instead, the country has a more plausible fifth option - live with the debt. With the economic stimulus achieved under Shinzo Abe (more on him later), it would appear that Japan’s debt (whilst still very high) is beginning to slowly stabilise, with low-interest rates meaning that the existing debt simply does not matter that much for fiscal sustainability.
So, whilst it seems to be perpetually living on the edge, after two decades of strife, Japan now boasts both low unemployment (around 2.5% as of July 2018) and low household debt (when compared to the US at least). Japan is continuing to survive and thrive in spite of its public debt problems, but it remains a fascinating case study. So, how did Japan’s debt get this way? What have the government been doing to help? And, more pertinently, what could the rest of the world learn from those actions (for better or for worse)?
The Programme for Financial Revival
The Japanese economy had reached a point of stagnation during the 1990s, which was caused in no small part by a build-up of bad loans which had a cumulatively negative effect on banks in the country. In order to reset the balance, the government proposed some radical policy changes.
The ambitious Programme for Financial Revival (PFR) was first announced in October of 2002 by the First Koizumi Cabinet as a means of reducing the huge amount of NPLs that had reached a peak in the 1990s after the collapse of the economic bubble. Whilst the primary goal of the programme was to solve the bass loan problem, it also strived to build a stronger and more stable economy by creating new frameworks for the financial system, corporate revitalisation and financial administration.
The programme worked around 40 key items that were rolled out over the next few years, all of which were based around those three new frameworks:-
Financial System - Adopting measures to help SMEs that would have had difficulty obtaining loans due to the number of bad loans in the country, including the establishment of a new public fund system.
Corporate Revitalisation - Creating a marketplace for loan claims and reestablishing the Resolution and Collection Corporation (RCC), which was founded in 1999.
Financial Administration - Implementing more strict asset assessments and improved governance.
As a result of the programme, inadequate assessment of assets and disclosure of information were tightened, bank management transparency was improved, NPL disposal was accelerated and the financial institutions’ supervisory and regulatory regime was significantly enhanced.
Despite its delayed introduction, it could be argued that it has been successful in stabilising the financial system and reducing NPLs, with the Financial Service Agency (which was created in 2000) reaching their target of halving the amount of bad debt by 2005; just three years after the PFR was introduced.
Some have suggested, however, that it was a case of “too little too late,” as the issue had been building for years before anything was actually done about it. Indeed, the bubble burst in 1992, but banks didn’t realise then just how toxic these loans were and it took more than a decade before action was taken. This is often referred to by economists as Japan’s “lost decade.”
In 2012, Shinzo Abe took power as Japan’s prime minister for the second time and brought with him lofty promises of smashing deflation and breaking the country out of the slump it had been settling into since the 90s. The boilerplate tactics of his so-called “Abenomics” were increased government spending, widespread reform and monetary easing.
Amounts owed don’t scale alongside deflation - as deflation increases, a debt burden becomes larger relative to its size. This means that deflation is very bad for debt and this is partly what led to Japan’s current predicament. Indeed, it was once speculated that, if things didn’t improve, the gross debt pile could have ballooned to a devastating 600% by 2060.
With the implementation of Abenomics, however, came slow inflation. Japan’s NPL ratio also managed to decrease from a record high of 8.4% in 2002 to a record low of 1.1% in 2018, decreasing from 2.4% in 2012 before Abe took office. So, it appears that whilst it has taken decades to get there, Japan is on a slow, but definitive upwards trajectory when it comes to tackling its NPL problem. However, the jury is still out on whether or not it will last.
The Big Banks
The PFR led to a dramatic reduction in bad loans and, as a result, in just two years, many of the leading Japanese banks merged or dissolved, to the extent that the 20 leading banks had become just 4 by 2004. Whilst these larger banks were able to cope (by merging and restructuring), the local banks didn’t have the resources to do this and still struggle to compete to this day. The big banks, however, have been keeping their earnings afloat with high-interest cash advances (or card loans) in recent years. Those loans are beginning to take a toll as irrecoverable debt begins to pile up, with bad debt tied to those advances climbing to 13% to 140 billion yen in 2017.
These advances are being issued at annual interest rates of between 2% and 14% with the money often able to be withdrawn directly with no questions asked. Lenders pay fees to guarantee companies will repay the loan if a borrower can’t. Cases of people borrowing more than they can afford in cash advances are growing across Japan. These cash advances have been criticised for leading to the excessive lending that has allowed borrowers to rack up debt from multiple borrowers. The lack of transparency here is truly astonishing.
The Japanese Bankers Association called for tighter screening in March 2017, and many banks have set voluntary financing limits in accordance with borrowers' annual incomes. This has prevented outstanding lending from growing for now, but bad debt is still piling up from past loans.
Hard learned lessons
So, how what could have been done differently, and what could the rest of their world (particularly the neighbouring Southeast Asian economy) learn from what Japan did right and what they did wrong? Japan is a prime example of what happens when you allow NPLs to mount. If a greater effort was made back in the 90s to take action on these bad loans, the problem could have been solved and the lion’s share of the damage circumvented.
Greater transparency is also something that other economies should be taking away from the Japanese debt situation. Indeed, Japan themselves have even advocated lenders and borrowers in emerging economies to disclose more debt in order to keep these nations from falling into the same debt trap they currently find themselves in. Because, whilst they might be strong enough to live with this debt, many emerging economies in Southeast Asia won’t be.
As the host of the G20 meeting for finance ministers and central bankers, Japan is urging lenders and borrowers to disclose the size, interest rates and conditions on loans to emerging countries and is also advocating responsible lending practices - like ensuring that borrowers have the ability to repay the loans in question.
This proves that Japan has, at least on paper, learned from its own mistakes over the past 20 years. But can the rest of the world do likewise? That remains to be seen.
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