Japan's Debt, Now Twice the Size of Its Economy, Forces Hard Choices

New York Times

5 days ago

Japan, which has the highest government debt among leading economies, is finding it difficult to spend like it used to.
Debt-fueled public spending, enabled by low interest rates, has long been a way to address the country's problems. Struggling farmers and emptying countrysides received generous payments from the central government. Relief aid during the Covid-19 pandemic morphed into new outlays for defense and subsidies to help consumers weather inflation.
The spending continued even as more social security funding was needed for Japan's growing number of seniors. Government debt has ballooned to nearly $9 trillion — more than double the size of the economy.
Now, ahead of a heavily contested summer election, Japan's ruling party is facing pressure to add even more debt. Small businesses hurting from U.S. tariffs are calling for government aid, and households squeezed by rising prices are demanding a rollback in taxes.
But as the Bank of Japan moves away from the negative interest rates that for years made it easy for the government to borrow, the limits on spending are more stark.
Recently, the market for Japanese government bonds has reflected concern about the country's fiscal health. The yields on long-term bonds, an indication of investor confidence in the government's ability to pay back its debts, rose to record highs at one point last week. And weaker-than-expected demand for an auction of 40-year bonds on Wednesday kept investors on edge.
Japan's prime minister, Shigeru Ishiba, warned at a recent government meeting about the 'terror' of higher interest rates and even compared Japan's budget situation with that of Greece, which plunged into a debt crisis in 2009.
Most economists and officials agree that Japan is not headed for an imminent financial meltdown. A large majority of Japanese debt is held by the Bank of Japan and domestic financial institutions, meaning there is low risk of money being suddenly pulled out of the country. But doubts are increasing about how long the country can keep up its current spending path.
Generally, excessive debt can push economies into a perilous cycle. Bondholders grow increasingly apprehensive about a government's ability to pay its obligations which, in turn, drives up interest rates. Escalating rates then ripple through an economy, impeding a nation's capacity to borrow.
In Japan, 'yellow lights are flashing and at any moment any of them could turn red,' said Koji Yano, a former administrative vice minister at Japan's finance ministry. The risk of higher borrowing costs is real, he said, adding that he believes Japan's debt is at a 'significant risk' of being downgraded, as happened recently to the credit rating of the United States.
An election in Japan's upper house in July stands to test Mr. Ishiba's Liberal Democratic Party, which has kept a virtual lock on power in Japan for the past seven decades. The party's grip in more recent years, some analysts say, can be attributed in part to its ability to use spending to tamp down some of the populist opposition seen in other advanced democracies.
Possibilities for rupture have long existed. Aging populations are straining social security budgets, and the economies of rural areas are in decline. At the same time, pensions remain funded and subsidies flow from the national government to almost all of Japan's smaller municipalities to support local industries and help maintain roads and schools.
'There has long been this commitment to a uniform standard of service provision across the country, and taking on the costs associated with that,' said Tobias Harris, the founder of Japan Foresight, a political risk advisory firm. That kind of policy, he said, 'has helped diffuse discontent.'
More recently, Japan has started to experience, on a small scale, some populist tremors. Over the past three years, a resurgence of inflation, after decades of stagnation, has squeezed Japanese consumers, particularly the swath of nonregular workers whose wages lag behind those of permanent employees.
Unlike in some parts of Europe and North America, where populists tend to win with rural supporters, 'Japan's brand of populism is more of an urban phenomenon,' Mr. Harris said. Among some white-collar employees and nonregular workers, 'there is a feeling of revolt against portfolio spending when they're the ones generating tax surpluses and dealing with their own quality-of-life issues,' he said.
Recently, much of that public discontent has coalesced into anger directed toward those attempting to rein in Japan's deficits.
Over the past year, protesters have massed in front of the Finance Ministry's building in central Tokyo. The demonstrations, at times drawing around 1,000 people, are notable in a country mostly unaccustomed to large-scale displays of public dissatisfaction. Their placards demand the removal of national consumption taxes and the dismantling of the Finance Ministry, an institution long seen as the force within Japan trying to enact spending discipline.
Ahead of the election, several opposition parties have come forward with plans for how to roll back taxes that were raised in 2019 to chip away at Japan's deficits.
For years, the cost of servicing Japan's gargantuan debt has been kept manageable, in part thanks to the Bank of Japan's large-scale purchasing of Japanese government bonds. Since last year, however, Japan's central bank has dialed back its purchases, and weak private sector demand has led the yields on those long-term bonds to soar.
Mr. Ishiba has declared himself opposed to a consumption tax cut. But within his party, he faces opposition from a faction of fiscal expansionists who argue that government deficits are largely inconsequential for nations that can essentially finance themselves directly through their central banks.
Sanae Takaichi — a ruling party politician who narrowly lost to Mr. Ishiba when she contended for party leadership in September — urged that the Liberal Democratic Party offer its own tax cut proposal. She said Mr. Ishiba was essentially forfeiting the election by refusing to run on a cut in consumption taxes.
In the current environment, talk about rolling back taxes worries Mr. Yano, the former finance ministry official.
In 2021, Mr. Yano ignited controversy with a magazine article, which he wrote while still in office, that branded the Liberal Democratic Party's spending plans as 'disastrous,' likening Japan to a ship hurtling toward an iceberg. The public critique, unusual from a high-ranking official, drew the ire of party members, including Ms. Takaichi, who deemed his comments 'outrageous.'
With Japan's debt-to-G.D.P. ratio running above 200 percent for the past five years, creditors will reach a point where they say 'enough is enough,' Mr. Yano said. 'It's like a stew getting hot and then bubbling up. Interest rates will spike,' he said.
By comparison, federal debt in the United States is closer to 100 percent of G.D.P., and a tax-cutting bill making its way through Congress could push that up to around 130 percent, part of the reason for Moody's downgrade of the U.S. government credit rating this month.
Officials and economists less fiscally hawkish than Mr. Yano agree that Japan needs to pull back on spending. What they don't agree on is the timing.
Leif Eskesen, chief economist at the investment group CLSA, said that a 'Greece-like situation' remains highly unlikely for Japan in the near term. Economic uncertainty caused by U.S. tariffs also makes this an inopportune moment for Tokyo to push to significantly curtail government spending, he said.
However, looking further ahead, Japan's potential economic growth remains subdued, costs for pensions and health care will continue to climb, and rising interest rates will render the financing of its debt increasingly burdensome, Mr. Eskesen said. Japan, he said, 'is going to need to start actually delivering on promised fiscal consolidation.'