Japan’s recovery may stretch its finances

April 1, 2011

An aging population that has begun to spend down its savings. A hobbled power grid. A drop in economic output that may be longer and deeper than first anticipated.

Although Japan is widely considered to have the financial wherewithal to bounce back from the calamity that struck three weeks ago, analysts are beginning to wonder if shifts in global production patterns and changes in Japanese society will make the country’s path to recovery more difficult.

Central to Japan’s ability to bounce back is the capacity of its government to borrow seemingly limitless amounts of money at cheap rates, a gravity-defying phenomenon that has remained constant for more than two decades despite the country’s world-leading levels of public debt. With more than $10 trillion in loans outstanding, an amount equivalent to more than 200 percent of the country’s annual economic output, the estimated $300 billion repair bill does not seem so large. The country also sits on a trillion-dollar stockpile of foreign reserves, and confidence in Japan remains so entrenched that interest rates since the disaster have not budged.

But the reasons behind Japan’s ability to borrow are unique to the country itself and won’t necessarily remain the case forever — a fact the International Monetary Fund noted in a paper last year warning that some of Japan’s built-in advantages are beginning to disappear.

The recent natural disaster and nuclear crisis, some analysts suggest, may hasten the change.

“I am not terribly optimistic about this,” Masaaki Kanno, a Japan analyst for J.P. Morgan Chase, said in a conference call last week. Though Kanno, like many others, sees the potential for a sharp rise in economic activity as Japan rebuilds, he said the outcome of the recent disasters could undercut some of Japan’s borrowing ability and lead to higher interest rates. It may also prompt global companies to diversify their sources of parts and materials away from Japan — a potentially difficult process, to be sure, but one likely to deepen the longer Japan’s industrial facilities are hobbled by the ongoing nuclear crisis and electricity shortages.

Economists see different forces at work, with the final outcome unclear. Marcus Noland, of the Peterson Institute for International Economics, said the country’s high productivity, capital investment and ability to innovate mean it is likely to retain its central role in global automotive, electronics, technology and other supply chains. Yet competition is only getting stiffer, and “there certainly are some Korean or Taiwanese firms that can . . . build up rapidly to fill in demand should production remain depressed,” said Michael Auslin, a resident scholar and Japan expert at the American Enterprise Institute.

One reason Japan has been able to borrow money at such low rates is its prodigious export economy, and the annual surpluses that generates. The flow of wealth into the country has been recycled by Japanese companies and banks into government bonds. If the annual surplus narrows because of a fall in exports or an expected rise in imports — and that was already happening before the earthquake and tsunami — it could erode Japan’s reputation as a safe-haven economy that can finance itself.

As it stands, the country relies very little on outside money, with only about 5 percent of its government debt held by foreigners. If that starts to change, so too could its ability to borrow cheaply. Economists sometimes speak of “cliff effects” in analyzing things such as a nation’s public debt, noting that a country’s level of borrowing often doesn’t matter until perceptions shift and a crisis is born.

“The patience of both the rating agencies and the bond markets is limited,” Capital Economics analyst Julian Jessop wrote in a paper this week outlining the Japanese government’s unenviable choice: finance reconstruction with tax increases or spending cuts while dealing a blow to other parts of the economy; pressure the Bank of Japan into buying government bonds and potentially deal a blow to its independence; or turn to outside markets and hope for the best.

Japan’s demographics may also pose limits. The country’s population has begun to contract, and the segment above age 65 is expanding. As of 2009, more than 22 percent of the country’s 127 million people were over 65, the largest percentage in the world, according to Japan’s statistics agency. The figure is expected to climb to 30 percent in less than a decade and continue growing, leaving fewer people of working age to support the expanding pool of retirees.

In one recent analysis, economists at IHS Global Insight, a consulting firm, projected that perhaps a quarter of the buildings and businesses destroyed by the earthquake and tsunami won’t be rebuilt — the rural homes of older Japanese who may move elsewhere, or marginal factories that find their markets gone when it comes time to reinvest.

That may lower the repair bill but also speaks to a narrowing economic horizon. Traditionally strong and risk-averse savers, Japanese families have been a stable source of money for government debt, according to the IMF, as they plow their money into local banks and pension funds that in turn buy safe, low-yielding “JGBs,” Japanese Government Bonds.

However, as they retire, Japanese families have begun to spend down. Japan’s savings rate, roughly 16 percent a generation ago, has been in steady decline and is now about 2 percent, much less even than the United States’.

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