Friday, June 25, 2004
Japan recovery threatened: S&P
David Pilling & Barney Jopson / Tokyo June 24, 2004
As Japan pulls out of deflation it faces risks from higher interest rates and rising public debt that could jeopardise its chances of a smooth recovery, the head of Asia-Pacific sovereign ratings at Standard and Poor's (S&P) said yesterday.
Takahira Ogawa, in an interview with the Financial Times, said he welcomed signs that deflation appeared to be in its last throes and that the economy was mounting a recovery thanks to structural as well as cyclical factors. However, he said there were dangers for the economy as it made the transition from deflation to inflation.
"Every step of improvement has a negative effect," he said. "This is a very difficult period to foresee, whether the future is brighter or gloomier."
In March, S&P upgraded its outlook on Japan's sovereign debt but kept its long-term sovereign rating at AA-, the worst of the Group of Seven countries.
Commenting on the recent sharp rise in long-term interest rates, Ogawa said, "There's a potential risk that if interest rates go up too fast before the macro- economic conditions become firmly in better shape it will have a negative effect on the economy."
In the past month, yields on 10-year government bonds have risen sharply, from 1.46 per cent to 1.84 per cent. This has prompted contrasting reactions from government ministers with some pointing out the dangers of volatility and others attributing rising yields solely to the economy's improved outlook.
Ogawa said a sustained rise would complicate the government's ability to meet its huge borrowing requirements. In a deflationary environment, he said, the central bank had a strong incentive to buy long-term government debt as a tool of monetary policy.
As deflation eased, however, the Bank of Japan (BoJ) would have less reason to buy government debt, issuance of which, including rollovers, was set to rise from ¥130,000 billion a year to more than ¥170,000 billion ($1,600 billion, ?1,300 billion, £860 billion) he said.
"When the BoJ changes monetary policy it will have no official reason to buy long-term government bonds but by that time the government will be desperate."
S&P will be watching for progress on closing the fiscal deficit, running at almost 8 per cent of gross domestic product annually. Gross debt is about 140 per cent of GDP, with nearly half of all government spending financed by borrowing.
Ogawa said Japan should move swiftly to close the fiscal gap as the economy improved, although he acknowledged the potential risk of choking off growth.
"This is a Catch 22," he said. "But when it comes to increasing tax, or cutting expenditure, Japan does not have the luxury to decide which to do first. It needs a combination."
He added, "Ideally, if Junichiro Koizumi (the prime minister) had more charisma or more guts, he should tell the nation, 'We can 't keep on going like this.' The size of the debt outstanding is snowballing and the cost the nation will have to bear will be greater."
Ogawa said that, paradoxically, as the economy improved the risk of bankruptcies would also rise. That was because companies that could service debts at near-zero interest rates might struggle as rates rose. "Higher rates create pluses and minuses," he said.