The Urgency of Fiscal Reconstruction:
Before Strain Becomes Critical

Japanese government bond prices remain high

Japan’s public debt is approaching a level of 200% of GDP. This level stands out
among the world’s major nations. Looking at revenue and expenditure in terms of
flow, we find expenditure exceeding 90 trillion yen against tax revenue of around 40
trillion yen. This situation is somehow maintained by massive issues of government
bonds, but it is a fiscal situation that no one could consider sound or healthy.

Even more serious is the increasing burden on the nation’s finances represented by
its low birth rate and aging population. As social security costs balloon, fiscal
management will face a situation of increasing severity. We focus exclusively on the
debt generated by the past deficit, but the really serious issue is the predicted future
burgeoning of social security costs.

Despite the fact that the figures indicate a serious fiscal situation, prices of Japanese
government bonds are the highest they have ever been. For bonds, the higher the
price, the lower the yield. In the case of Japanese government bonds, the yield of
even long-term 10-year bonds is at the historically low level of around 1%. As debt
securities of a government with massive debts, the market underwrites Japanese
government bonds at extremely low rates of interest. The low yields on government
bonds have thus assisted the Japanese government in its fiscal management
(Figure 1).

However, the high price of Japanese government bonds increases concerns over
sovereign risk. The higher the price of underwritten bonds, and the greater the value
of the bonds held, the greater the losses which will be suffered by financial
institutions if prices decline. If the interest rates of government bonds increase, the
burden of interest payments when new issues are made and when bonds are
refunded will increase, making fiscal management more difficult for the government.
It seems inherently impossible for a state of ultra-low interest rates – the lowest in
history - to continue indefinitely........

Motoshige Itoh
President, National Institute for Research Advancement (NIRA) Professor, Graduate School of Economics,The University of Tokyo