Tue, 08 Feb 2000

Japan urged to defuse time bomb of state debt

By David Williams

TOKYO (AFP): Japan must start to defuse the time bomb of state debt which is growing at an alarming rate while the government focuses almost exclusively on economic growth, analysts say.

In the bond markets, for example, traders were flooded in supply and fretting over the outlook.

"I think people are basically worried about how much more there is to come," said Richard Jerram, chief economist at ING Barings.

"It is one thing to say, 'We have a whopping big deficit but we are determined to control it," Jerram said.

"But it is another thing to say, 'We have a whopping big deficit, full stop' -- and I think that is what they are doing."

The scale of the problem was mountainous.

Japanese government bond issues are expected to grow to 116,000 billion yen (US$1,100 billion) in the financial year to March 2004 -- up from 85,900 in the coming year, according to a finance ministry report.

"The market is already saturated with many bonds," said Mitsuhiro Kontani, a bond dealer at Fuji Bank Ltd.

Demand was being fueled for now by jittery investors looking for security, he said.

"But given the fact that the government will issue more bonds, the market is feeling weary and a sense of burden is increasing. The market will feel the pain slowly like a body blow."

Latest 10-year-bond yields of around 1.81 percent were likely to rise above 2.00 percent soon, Kontani said.

The government's money was filling financial injections aimed at finding the holy grail of private demand -- getting people and firms to open up their wallets.

In the mean time, much of the state cash was spent on construction projects criticized by some experts as wasteful.

Last week, the government submitted to parliament a record national budget worth 84.99 trillion yen for the fiscal year starting in April, further adding to the debt.

Matthew Poggi, economist at Lehman Brothers, said a recovery in consumption was likely to be tough.

"Growth in incomes has been negative. That is going to make it very difficult for consumption to recover," he said.

"The government is right in saying it needs to ensure a recovery first. But ideally if they could start putting together plans for fiscal consolidation now that would be good."

Finance Minister Kiichi Miyazawa said last week the limping economy was recovering and the next budget would be the last time it needed a crutch to keep moving.

But Jesper Koll, chief economist at Merrill Lynch, said the government would be forced to spend yet more.

"There is going to be another supplementary budget, there is no question about that," he said.

"Fiscal consolidation is a matter for the year 2003, and it is quite simple: you raise taxes and cut expenditure. But in the meantime it is not the problem."

Koll said Tokyo's creditors, the Japanese public, appeared quite comfortable with the debt levels considering the 10-year bond yields of less than two percent.

Prime Minister Keizo Obuchi told parliament in a key policy speech Jan. 28 that fiscal reform, or cutting the debt, was a concern that plagued his thoughts.

"However, unable at present to simultaneously pursue the objective of placing the economy back on the real path to recovery and the major challenge of addressing financial reorganization, I can think only of the idiom: 'He who runs after two hares will catch neither.'"

Jerram of ING Barings said the debt could hinder the economy over the next five-to-10 years but should not prevent growth altogether if managed properly by the authorities.

"To me, the real concern at the moment is that they do not seem to be in any hurry to address the fiscal problem," he told AFP.

"I think you are in a situation where you now have pretty clear economic improvement in which case the government needs to outline or at least to start to think about outlining a medium term fiscal reconstruction plan."

The economist urged gradual tightening over a period, not the "foolishness" of 1997 when the government was widely condemned for increasing taxes despite the threat of recession.

"It is necessary for three reasons -- one; to control the problem, two; to reassure the bonds market that they are paying attention and three; to reassure the Bank of Japan."

Investors generally would be happier if the Bank of Japan maintained its near-zero overnight market interest rate policy, he said. But this would likely require fiscal policy to pick up some of the slack.