<p>Simon Kuznets, a Nobel Prize-winning economist, once remarked that there are four types of countries – advanced economies, emerging markets, Argentina and Japan. Japan, which has over the years and despite a series of policy efforts, remained plagued with price deflation and feeble growth. But a new worry that it is now struggling with is the massive debt burden of its government. With rising interest rates this may become unsustainable.</p><p>A little over two decades ago, Japan’s public debt was at a troubling 110% of GDP; now the figure stands at an agonising 260%. For the past ten years, the implications of this mounting debt have been stifled by extremely low bond yields, which basically meant its treasury paid less interest to subscribers than it did several decades ago. But all that has now begun to change. The cost of borrowing is more pricey, as bond deals have soared in effect from zero to about 0.7%. Now with inflation perking up, the Bank of Japan is being compelled to abandon its pledge of capping 10-year bond yields at under 1%. As higher rates persist, the economic growth that investment policies are expected to foster will fail. Currently, in Japan, 8% of its budget services interest payments. It seems logical that when bond deals increase to say 1.5%, as they may, Japan’s government will have less money to spend in areas such as defence as it intends to. Prime Minister Fumio Kishida, in the wake of global geopolitical tensions, an aggressive China and a combative Russia, announced the doubling of defence expenditure over the next 3 years.</p><p>More recently, the government has implemented tax cuts worth 1% of GDP with a view to urging investment and consumption. As treasury bonds come in for refinancing over the coming 3-4 years, the burden on the treasury will only increase. Adding to the pain, Japan is fraught with a declining population, and 10 years from now its labour force would shrink, putting further pressure on pension liabilities. With strictly controlled immigration policies, Japan will sadly lose its stature as one of the world’s large economies. All of this is bound to have geopolitical ramifications, especially on investment, trade and security. Its ability to stand up to China, now the rising Asian superpower, will consistently weaken, and so may its influence within the Asian region.</p><p>Global economies move in cycles, with periods of crests and troughs. The phenomenon of cheap money, which lasted for over a decade and was the main reason for high rates of growth, has now come to an end. In the coming few years, we will witness higher rates of inflation, higher interest rates and lower growth. Countries that need to undertake bold reforms in order to foster national productivity can do so less painfully in good times. When the tide turns, these structural alterations become so much harder to politically swallow. When government debt surpasses 90% of GDP, there is some evidence to suggest, the potential for economic growth begins to fall. Like in the decade of the 1990s, Japan now runs the risk of stagnation. Its nascent growth, many analysts believe, will begin to temper. Clearly, clouds are now forming over the Japanese sun.</p><p>Leverage and high volumes of debt only work if they are accompanied by significant productivity gains. Unfortunately, that has not been the case with Japan or for that matter with most countries that over-extend themselves for short term gains. Borrowings must come with painful reforms in the labour markets and efficient infrastructure. That is the simple lesson for countries.</p>
<p>Simon Kuznets, a Nobel Prize-winning economist, once remarked that there are four types of countries – advanced economies, emerging markets, Argentina and Japan. Japan, which has over the years and despite a series of policy efforts, remained plagued with price deflation and feeble growth. But a new worry that it is now struggling with is the massive debt burden of its government. With rising interest rates this may become unsustainable.</p><p>A little over two decades ago, Japan’s public debt was at a troubling 110% of GDP; now the figure stands at an agonising 260%. For the past ten years, the implications of this mounting debt have been stifled by extremely low bond yields, which basically meant its treasury paid less interest to subscribers than it did several decades ago. But all that has now begun to change. The cost of borrowing is more pricey, as bond deals have soared in effect from zero to about 0.7%. Now with inflation perking up, the Bank of Japan is being compelled to abandon its pledge of capping 10-year bond yields at under 1%. As higher rates persist, the economic growth that investment policies are expected to foster will fail. Currently, in Japan, 8% of its budget services interest payments. It seems logical that when bond deals increase to say 1.5%, as they may, Japan’s government will have less money to spend in areas such as defence as it intends to. Prime Minister Fumio Kishida, in the wake of global geopolitical tensions, an aggressive China and a combative Russia, announced the doubling of defence expenditure over the next 3 years.</p><p>More recently, the government has implemented tax cuts worth 1% of GDP with a view to urging investment and consumption. As treasury bonds come in for refinancing over the coming 3-4 years, the burden on the treasury will only increase. Adding to the pain, Japan is fraught with a declining population, and 10 years from now its labour force would shrink, putting further pressure on pension liabilities. With strictly controlled immigration policies, Japan will sadly lose its stature as one of the world’s large economies. All of this is bound to have geopolitical ramifications, especially on investment, trade and security. Its ability to stand up to China, now the rising Asian superpower, will consistently weaken, and so may its influence within the Asian region.</p><p>Global economies move in cycles, with periods of crests and troughs. The phenomenon of cheap money, which lasted for over a decade and was the main reason for high rates of growth, has now come to an end. In the coming few years, we will witness higher rates of inflation, higher interest rates and lower growth. Countries that need to undertake bold reforms in order to foster national productivity can do so less painfully in good times. When the tide turns, these structural alterations become so much harder to politically swallow. When government debt surpasses 90% of GDP, there is some evidence to suggest, the potential for economic growth begins to fall. Like in the decade of the 1990s, Japan now runs the risk of stagnation. Its nascent growth, many analysts believe, will begin to temper. Clearly, clouds are now forming over the Japanese sun.</p><p>Leverage and high volumes of debt only work if they are accompanied by significant productivity gains. Unfortunately, that has not been the case with Japan or for that matter with most countries that over-extend themselves for short term gains. Borrowings must come with painful reforms in the labour markets and efficient infrastructure. That is the simple lesson for countries.</p>
