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The debt trap

Published: 30 Jan. 2011, 21:03

A downgrade in Japan’s sovereign debt rating should hardly be a surprise. Japan’s credit rating slipped three levels down to AA minus in 2002 from its 1975 peak of AAA as the economy tramped along in its “lost decade.” It recovered a notch to AA in 2009, but was set back again by its mounting fiscal deficit. The cut puts the economy’s rating on a par with those of China and Taiwan, even below that of crisis-ridden Spain.

Japan has long been plagued by fiscal problems as it struggled to revive its economy. Accumulated government debt hovers over 1,000 trillion yen ($12.2 trillion), more than 200 percent of the yearly gross domestic product. It is faced with a fiscal deficit unseen since World War II. The government has tried broad measures to solve the problem but to no avail. At last, it resorted to raising the consumption tax from 3 percent to 5 percent in 1997, after which the Hashimoto cabinet suffered an election defeat.

But Tokyo has few options. If Japan wants to maintain its social welfare system at the current level and improve its fiscal position at the same time, it needs to raise the sales tax to as high as 17 percent. The government, however, lacks strong leadership to push forward such a radical hike. Prime Minister Naoto Kan floated the idea when he took office, but has kept silent since his approval ratings fell.

But the situation is not as dire as it seems. The financial markets remained more or less calm because deficits from the government debt are still being serviced by foreign and domestic investors. Regardless of the fiscal side, Japan’s external balance sheet also remains strong thanks to robust corporate performances.

However, Tokyo did go on a debt-financed spending spree, while other government tried to grapple with their debts. The Liberal Democratic Party governments pursued costly infrastructure projects in hopes of spurring the economy, and the incumbent Democratic Party government also introduced various welfare benefits such as child-care allowances, free high school tuition and toll-free expressways. The profligacy will likely add a new debt of 54 trillion yen this year. The quickly aging society will also demand greater welfare costs with 7 million baby-boomers born between 1947 and 1949 expected to retire and claim pensions from next year.

Japan’s case is a lesson. Korea’s government debt is mounting fast and is expected to reach 1,000 trillion won by 2030. But politicians are wrangling over welfare increases when the country is aging, too. We will likely fall into the same pit if we don’t address our fiscal debt.