Japan is always considered as one of the most developed economies and maintain its high position in the world’s biggest economy ranking. Despite its achievements and contributions to the world economy, the economy of Japan is not as ideal as believed. Deflation, national debt and negative interest rates are the highlight elements related to the “Lost decade” that is thought to be long gone, but still remains a long-term disease to the economy.
A decrease in price level seems to be an ideal situation, however, it is not the case in Japan. The world’s third largest economy has been struggling to be officially free from deflation for the last 3 decades, even when its consumer price index has been inching higher for almost a year.
Figure 1: Japanese consumer price index (Cislo, 2017)
Despite being one of the largest economies in the world, Japan is also the most indebted country with substantial debt, roughly 233% of GDP on its shoulders. The number is remarkably higher than its runner-up, Greece, with 177%. However, the risk of default is lower as the majority of debts belong to its domestic creditors.
When the deflation takes places, the real value of debt is likely to increase as consumer spending power declines. Once consumer spending decreases, corporate revenue falls, which results in lower wage rate. This leads to lower tax revenue and less money for government to pay public debt. Or more simply, money becomes cheaper and debt becomes more expensive.
The deflationary spiral, therefore, makes Japanese national debts more problematic, especially with the country’s demographic problem. As the majority population of Japan are the elderly, it is getting harder for the country to pay off its accumulated debts. On the other hand, government spending on retirement which is getting larger also widens the current huge debts. Eventually, young generations carry the debt burden which they do not create.
With the current debt situation, there is doubt to where the Japanese economy will be in the future. There are four elements in the expenditure method to calculate GDP of a country: consumer spending (C), business investment (I), government spending (G) and the net export (Net Ex). Consumer spending in Japan is freezing due to the deflation effect. Once prices keep falling, consumer spending will firstly pick up and then drop as people anticipate a lower price in the future. In terms of business investment, foreign investors as well as domestic investors are definitely more interested in other markets rather than Japan. With a negative interest rate and negative government bond yield, Japan certainly loses its competitive advantage in attracting investment. Apart from that, being no longer a net exporter stops trading from contributing to the country’s GDP growth. The only hope to save the GDP growth of Japan is government spending which only worsens the current debt situation.
In order to fix the problem, firstly, the national debt, the Bank of Japan’s bond-buying program was implemented. Even though in the short-term, a part of the debt is paid off, interest expense accumulated in the long-term will not make the plan viable. Negative interest rates are believed to reduce the interest expense and encourage investment. However, it might incentivize banks to withdraw reserve deposits and not make the asset market more rational as expected.
Overall, despite the fact of being one of the largest economies in the world, Japan’s economy is not healthy as believed. Even though the government has come up with practices to meet its 2% inflation, the effectiveness of those plans still in doubt. The current decision of Japan’s government seems to help the economy in the short-term but is not a solution in the long-term for demographic and strong resistances against price hikes issues. Japan is likely to lose market confidence in the long term if it cannot assure the market that it can manage debt without relying on the BOJ.
This content has been written and published by KOSEC – Kodari Securities.
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