Column : Land of the rising debt

On the face of it, there doesn?t seem to be much to cheer about in Japan from a political and financial viewpoint. The political system appears gridlocked, with a succession of uninspiring leaders coming and going with such rapidity that would make seem Pakistan?s cricket captain?s tenor long enough. Japan has the highest debt-to-GDP ratio among all developed countries. According to IMF data, Japan?s debt was 225% of GDP in 2010, and it is showing no sign of declining in 2011.

Naysayers for long have professed that Greece and Ireland were just the ?starters?. The ?main course? of Japan is yet to come. Japan has over a quarter of all sovereign debt outstanding worldwide. A Japan default would be more massive than that of Portugal, Italy, Greece and Spain combined together. And the aftershock of a default by the world?s third-largest economy would make Lehman default seem like a small blip on the default Richter scale. The prospect is as stomach-churning as a raw fish sushi to a vegetarian.

Yet a big difference between Japan and other countries with high debt levels is that Japan?s debt is primarily held domestically. Foreigners hold less than 5% of Japan?s government debt. So even if foreign investors became worried about a potential default, their impact on the bond market, and the currency, would be minimal. In a way, Japan?s debt is self-financed. The state is in deficit all right, but the cash-rich private sector saves enough to cover domestic needs and in addition, exports capital equivalent to around 3% of GDP every year. The result is a substantial savings in overseas assets. They run a large trade surplus, too. This is in stark contrast to a country like Greece or Ireland, whose debt has been externally financed, i.e., it is held by other countries.

In this respect, Japan resembles not Greece or Ireland, but another European economy?Belgium. Belgium has sported with a government debt-to-GDP ratio of more than 100% for the best part of two decades. At the same time, it has been in current account surplus year after year. Citizens of deficit countries such as Greece, Ireland and Portugal?or even the US and the UK?are in the reverse position. They must pay dividends and interest to foreigners, including Japanese and Belgians, who own their liabilities.

But surely such dizzying levels of government debt are unsustainable, or so the naysayers think. If so, nobody seems to have conveyed this to the investors of Japanese Government Bonds (JGB). The yield that investors seek for holding JGBs is much lower than any other developed country debt. For instance, the ten-year government bond yield for the US is 3.41%. The same for Germany is 3.19%. The UK?s bond yield is 3.69%. The bond yields for Greece are over 10%, a clear indication of its debt problems. In comparison, the yield on a ten-year JGB is a tiny 1.22%. It is the lowest for any major economy. The market very clearly believes that the risk of Japan defaulting is no more than that of the US, the UK or Germany. Perhaps it is even lower. So, while rating agencies may downgrade Japanese debt, JGB holders are hardly running for the exits.

But what about the constant churn of uninspiring leaders?won?t it have a bearing on the economy in the long run? Again, Belgium has ?been there, done that, got the T-shirt, had a hole in it and now uses it as a duster?. In 1978 and again in 2007, the country?s post-election stalemate meant no government could be formed for six months. There was no obvious damage?life went on, and the government?s financial health looked as good as ever. Perhaps Belgium?s acceptance that the country will remain on high fiscal deficit path is a more self-assuring attitude than that of Japanese leaders who seem to give too much credence to a rating agency?s verdict and press the panic button.

The reality is that in ageing countries like Japan and Belgium, the state spending is going to remain high. However, because these countries have a high savings rate, domestic private sector assets are able to fund public sector liabilities. They do not have to borrow from the external world. In fact, they are net lenders to the external world.

The Japanese leaders needn?t get too alarmed by the views of the rating agencies, which in any case haven?t had a terribly good track record recently. The risk with misguided fears of default is that they lead to policies, which, far from solving the government?s economic problems, make them a whole lot worse. Freaking out could start a self-fulfilling prophecy and in no way will help thwart Yosano?s ?dreadful dream?.

The author, formerly with JPMorgan Chase, is CEO, Quantum Phinance