Q+A-Does Japan face a Greek-like debt crisis?

TOKYO, July 13 Tue Jul 13, 2010 6:33am EDT

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TOKYO, July 13 (Reuters) - Credit rating agencies are growing impatient with Japan's inability to tackle its ballooning public debt, a task just made more difficult by the ruling party's drubbing in upper house elections at the weekend.

The result means that Prime Minister Naoto Kan's ruling coalition lost its parliamentary majority so will need help from other parties to get bills, such as on tax reform, passed.

Greece's debt problems have highlighted the fiscal woes of Japan, but is the world's second-biggest economy really facing a Greece-like debt crisis?

HOW BAD IS JAPAN'S FISCAL POSITION?

By certain measures, Japan's debt load is worse than that of Greece.

Japan's outstanding long-term government debt is set to reach 862 trillion yen ($9.72 trillion) at the end of March 2011, or 181 percent of the country's gross domestic product, the Ministry of Finance says.

If short-term debt is added, Japan's liabilities will hit 197 percent of GDP this year and 204 percent in 2011, the highest among advanced economies and far worse than Greece's debt-to-GDP ratio of around 130 percent, OECD figures show.

Similarly, the IMF warned in May that Japan was growing more vulnerable to sovereign risk, estimating the country's gross debt-to-GDP ratio at 227 percent in 2010. <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

Graphic on Japan's fiscal woes; r.reuters.com/paw97f

Graphic on debt-to-GDP ratio r.reuters.com/neh98h

More stories on the Japanese economy, click [ID:nECONJP]

More stories on the Japanese politics, click [ID:nPOLJP] ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

WHY DOES JAPAN HAVE SO MUCH DEBT?

Tokyo's debt burden is a legacy of massive government spending in the 1990s to support the economy as it stagnated following the bursting of an asset bubble.

An ageing population has meant rising social welfare costs add considerably to government spending.

Some analysts say Japan's net debt provides a more accurate picture of the country's indebtedness. This measures gross debt minus government assets such as public pension fund reserves and foreign reserves.

On that basis, debt will reach around 105 percent of GDP in 2010, the highest among major economies, the OECD says.

Still, some analysts say Japan would not be much worse off by that measure than Belgium and Italy were in the 1990s, and both nations avoided a sovereign debt crisis.

WILL JAPAN DEFAULT ON ITS GOVERNMENT DEBT?

Unlikely. Japan has a massive pool of domestic deposits to draw upon to fund its debt issuance.

Japanese household assets total some 1,400 trillion yen ($15 trillion), some three times bigger than economic output and so providing a healthy pool of savings that can be funnelled into Japanese government bonds.

The government has almost no foreign currency-denominated debt obligations and more than 90 percent of Japanese government bonds (JGBs) are held by domestic investors.

Greece's profile is the opposite. About 70 percent of its sovereign debt is held by foreign investors.

Japan also has other avenues to raise funds. It is the world's largest creditor nation, with net external assets of 225.5 trillion yen.

Unlike Greece, it enjoys a steady flow of foreign earnings from a current account surplus.

The yen's status as a key international currency also helps Japan access external liquidity and markets, and the ratio of Japan's tax burden to national income is one of the lowest in the OECD, leaving it room to raise taxes.

SO WHAT MIGHT HAPPEN AND WHAT WILL THE TRIGGER POINTS BE?

Fears are growing that Japan's ageing population will start drawing on their savings, forcing the government to rely on foreign investors to fund its debt.

The most likely worst-case scenario is a sharp rise in long-term JGB yields. The Bank of Japan may be forced to step in to underwrite government issues.

Looking ahead, a trigger point would be if the government loses vital sources of funding its debt. One analyst said the country's current account could swing into deficit by 2016/17.

If that is combined with a significant loss of faith among Japanese in domestic investments, the government would lose its most important source of funding debt.

A significant erosion in the savings rate would force the government to pay more on its debt to entice foreign investors to risk their capital.

The savings rate, or savings divided by disposable income, is already falling as the population ages. It stands at about 3 percent, down from over 10 percent a decade ago.

But current yields on government bonds partly reflect the fact that markets see no immediate problems in the Japanese government securing ready buyers of its JGBs. Problems would occur several years in the future if the government fails to reduce its debt as more savings are used by an ageing population.

At around 1.120 percent on Tuesday, the 10-year JGB yield JP10YTN=JBTC is roughly one-third the level of comparable U.S. Treasury yields US10YT=RR, having been below 2 percent for more than a decade on deflation and near-zero short-term rates.

Greek yields on 10-year debt GR10YT=RR stand at more than 10 percent.

WHAT ARE THE GOVERNMENT'S LIKELY POLICY OPTIONS?

The most obvious option is to raise the sales tax. But it is unlikely to happen for a few years. [ID:nTOE66607O]

Having seen Greece's debt problems turn into a European crisis, Prime Minister Naoto Kan is determined to avoid a similar fate for Japan.

He wants to debate overhauling the tax system, including a possible doubling of the 5 percent sales tax. The government could raise some 2.5 trillion yen by raising the tax by 1 percentage point but Sunday's election means that achieving agreement in parliament will now be much more difficult.

Many voters are beginning to accept the idea of a sales tax hike to fund rising social security costs. But Sunday's election defeat suggested the DPJ did not convince voters of its vision to cure Japan's economic ills with the painful tax hike.

Since Japan's public debt is mostly yen-denominated, Japan has the ultimate option of printing money to prevent a debt default.

As a member of the European Union, Greece has lost control over its currency and monetary policy. Still, the size of Greece's economy meant a 110 billion rescue package was relatively easy to put together.

As noted by Kan, the consequences of a collapse in Japan's finances would be different. Under such a scenario, there might not be any country or agency like the IMF able to rescue Japan, he said.

(Editing by Neil Fullick)

($1=88.65 Yen)

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