JAPAN´S GOVERNMENT BONDS: THIS TIME IT WON´T END WELL / THE ECONOMIST

A fiscal fable 

Japan’s government bonds: this time it won’t end well

Even as interest costs mount, politicians promise handouts

Pedestrians walk past an electronic board showing the Nikkei 225 index on the Tokyo Stock Exchange along a street in central Tokyo, Japan. / Photograph: Getty Images

FOR YEARS Japan was a reassuring example for governments. 

Even as its net public debt peaked at 162% of GDP in 2020, it suffered no budget crisis. 

Instead it enjoyed rock-bottom interest rates, including borrowing for 30 years at 0.1%. 

Now, though, Japan is going from comfort to cautionary tale.

Government-bond yields have risen steadily since 2022 and have surged this year. 

Interest payments gobble up a tenth of the central government’s budget. 

The central bank is paying out 0.4% of GDP in interest on the mountains of cash it created during years of monetary stimulus—costs that eventually land on taxpayers. 

Investors are starting to ask if Japan might be vulnerable to a fiscal crisis after all. 

They are watching especially closely because Japan’s bond market has lately acted as a bellwether for sovereign debt across the rich world.

The good news is that a crash is not imminent. 

Japanese bond yields have risen in part because inflation is up, meaning the government can still borrow over most horizons and repay less, in real terms, than it raises. 

High inflation has already helped shrink the net debt to around 135% of GDP. 

Even at Japan’s paltry rate of growth, only modest belt-tightening is needed to keep the ratio stable.

The bad news, though, is that politicians are going in the wrong direction. 

Ahead of an election to the upper house of parliament, which is due by the end of July, they are locked in a bidding war to shower voters with handouts.

Voters are eager to be bribed, since inflation has squeezed household incomes. 

Real wages are down by about 4% since 2019. 

And the price of rice, the politically sacred Japanese staple, has doubled since the start of 2024, as regulations and tariffs have stopped fresh sources of supply from responding to shortages caused by bad harvests.

The main opposition parties want to help stretched households by suspending the 8% consumption tax on food. 

Others want to halve or abolish the overall 10% rate of tax to help with the cost of living. 

The government is rightly resisting calls for tax cuts which, though supposedly temporary, could be hard to reverse. 

But the prime minister, Ishiba Shigeru, has yielded to temptation in other ways. 

He promises giveaways to households worth ¥20,000 ($139) per person, and twice that for children and low earners, at a cost of about 0.5% of GDP.

It is a worrying sign for an indebted country which, like most of the rich world, faces immense fiscal pressure. 

On plausible assumptions about future bond yields, the imf reckons that interest payments could double as a share of GDP by 2030. 

Moreover, Japan will need to boost its defence spending as America’s commitment to its allies frays. 

In the face of these pressures, politicians could have eased the cost of living with structural reforms—such as deregulating the rice market. 

Instead, they are reaching for handouts, fiscal consequences be damned.

Although politicians hope to help households, it is households that will suffer if Japan’s public finances become riskier. 

Any dove will tell you that only 12% of the country’s debt is held by foreigners, which makes a run on government bonds less likely. 

But local ownership is a double-edged sword. 

It means that any fiscal crisis would mostly hurt Japanese people, who would, in all likelihood, have to endure prolonged and destabilising inflation if public debt became unsustainable. 

Japanese households are particularly exposed to falls in the purchasing power of the yen. 

About half of their financial wealth is in bank deposits, compared with about a third in the EU and only 10% in America.

Debt, Japanese style

Japan could face more market pressure in the coming months. 

The central bank is reducing its purchases of government bonds, depriving the market of an important buyer. 

If inflation proves more persistent than expected, the Bank of Japan might have to raise interest rates faster and higher, worsening the fiscal picture. 

Donald Trump’s protectionism could dent the country’s economic growth. 

If Mr Ishiba loosens the purse-strings, a credit-rating downgrade is possible. 

Japan was once the ultimate demonstration of bond-market placidity. 

Now it is the first place to look for the start of trouble.