Financing Japan’s record stimulus

Little sign of debt crisis

In May, the Japanese government approved a second large-scale ¥117tn ($1.1n or 21% of Japan’s GDP) economic rescue package, matching the size of the first stimulus introduced in April. Prime Minister Shinzō Abe boasted that together, these represent the world’s largest pandemic response package. The measures, which include cash transfers and wage and rent subsidies, are welcome. But caution is needed, since they also contain non-budgetary items.

Around 40% of the second package will include expected coordinated lending by commercial banks. Another 30% will finance subsidised policy bank loans to businesses. This amount takes the form of government loans. As such, it is excluded from the government general account and thus from its budget deficit, even though Japanese government bonds will fund subsidised loans. The general account will record only the remaining 30% of the package as a deficit financing operation. This will be funded by a second supplementary budget, to be approved by Japan’s Diet before mid-June 2020.

The April package has similar accounting issues. The total amount included funds left over from the December 2019 economic stimulus package, as well as commercial banks’ potential lending activities (around 10% of GDP in total). Japan’s fiscal management system is complex with insufficient disclosure. This makes it difficult to grasp the full scale of budgetary measures to cope with the crisis. This often causes confusion, since the announced package is not consistent with the level of debt accumulation.

On a gross basis, the government plans to issue close to ¥253tn ($2.3tn) in government bonds and treasury bills in fiscal year 2020 (ending March 2021). This amount combines issues under all three budgetary plans. Excluding refinancing bonds, the net issuance of government bonds is reduced to almost ¥145tn (about 27% of GDP). This includes close to 4% of front-loaded bond issues from future fiscal years and is the largest net issuance in the post-world war II era.

Nonetheless, this is unlikely to cause severe strains in the Japanese bond market, for several reasons. First, the Bank of Japan has been purchasing a substantial amount of government bonds since 2013. As a result, it holds nearly half the government’s outstanding bonds. Japanese insurance firms, commercial banks, and pension funds own most of the rest. Insurance firms regularly need government bonds to mitigate an asset-liability maturity mismatch. Banks hold them to fill the gap between rising retail deposits and limited private sector demand for credit (and reserve balances with the BOJ). Government bonds dominate the debt securities market, given that the corporate bond market accounts for only 10% of GDP. Foreign investors own just 10% of these bonds. The BOJ’s massive holdings have created excess demand in the bond market, generating substantial downward pressures on government bond yields. This explains why the central bank has not been able to purchase many over the past months.

Second, yield curve control was adopted in September 2016 with a 10-year target of close to 0% with -0.1% interest on some of the excess reserves. The BOJ determines the size of its purchases by the difference between supply and demand from domestic financial institutions at around 0%. In the face of scarcity, maintaining low yields is not a difficult operation.

Third, the BOJ is likely to maintain monetary easing unless it abandons its ambitious 2% inflation target. The central bank’s core inflation rate (based on the consumer price index excluding fresh food) has been just 0.5% over the last seven years (excluding the direct impact of the consumption tax increase in 2014). The persistently low inflation suggests that a large fiscal stimulus through the BOJ’s massive holdings of government bonds is unlikely to generate a crowding-out effect or a sharp rise in yields. Japan’s rising debt is therefore sustainable for the time being.

Sayuri Shirai is Professor of Economics at Keio University and a former Policy Board Member at the Bank of Japan.

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