Fitch: Japan's External Deficit Highlights Fiscal Risks

Thu Jan 16, 2014 1:00am EST

HONG KONG/SINGAPORE, January 16 (Fitch) The emergence of monthly current account deficits in Japan highlights the growing importance of fiscal adjustment for Japan's medium-term stability, says Fitch Ratings. This is because the external deficits indicate that the investment upturn, since the inception of Abenomics, has not been matched by any pick-up in savings, as the fiscal deficit remains high. An important reason for the erosion of Japan's current account has been the drop-off in domestic savings. These have fallen to 18.3% of GDP in 3Q13, down notably from an annual average of 24.8% in the decade up to mid-2008. This has been driven mainly by the deterioration in the savings position of the general government. In the absence of effective medium-term fiscal consolidation, the government's budget deficit would remain large and continue to constrain domestic savings. The IMF estimates Japan's cyclically adjusted budget deficit at 9.2% of GDP in 2013, greatly above the average 3.4% for advanced economies. The other key reason for the worsening deficit is that capital formation has reached 21% of GDP in 3Q13, up from a post-global financial crisis low of 19% though lower than the decadal average of 23.4% up until mid-2008. This pick-up in investment is in line with the thrust of Abenomics, and it could rise further. Our research highlights that Japan's investment cycle is closely related with global demand trends. A competitive currency coupled with improving global demand could thus raise investment even further. Failure to consolidate the structural fiscal deficit, coupled with a recovery in private-sector demand, would put pressure on Japan's trade balance and potentially on the yen. This could in turn force the Bank of Japan to opt for tighter domestic monetary conditions earlier than it otherwise would, to achieve the 2% inflation target it adopted in January 2013 and stabilise inflation expectations. This could have an adverse effect on the sovereign's own cost of funding. The sovereign credit profile continues to benefit from exceptional financing flexibility. The yield on 10-year Japanese government bonds averaged just 0.72% over 2013. Fiscal consolidation would also speed up the containment of Japan's exceptionally high public debt burden. Fitch projects general government debt at 245% of GDP by end-2014, up from 239% at end-2013, and expects the ratio to stabilise only in 2020. This is the key factor governing the Negative Outlook on Japan's 'A+' rating. Japan ran a JPY593bn (USD5.8bn) monthly deficit in November 2013 - its largest on record. Fitch emphasises that it does not read too much into one month's figures. The agency believes Japan's trade and current account balances are in the first stage of a "J-curve" effect arising from the yen's 19.9% depreciation since end-2012. This temporarily widens the trade deficit because imports become more expensive, but it takes time for spending patterns to adjust and shift export and import volumes. The seasonally adjusted current account deficit is much smaller, and the 12-month rolling sum of the current account remains in a small surplus. Nonetheless, the current account figures are of interest more because they highlight emerging structural economic trends rather than posing a risk factor in themselves. The external finances remain a key sovereign credit and rating strength for Japan. Fitch projects the current account surplus at 1% of GDP in 2014, buttressed by net income receipts on the country's vast external asset stockpile. Japan was a net external creditor to the tune of 247% of current external receipts at end-2013, much stronger than the median creditor position for the 'A' range of 34%. Andrew Colquhoun Senior Director, Sovereigns Tel: +852 2263 9938 Aninda Mitra Senior Director, Fitch Wire Tel: +65 6796 7232 Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings. Applicable Criteria andALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. 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