Japan's Debt Dependence At Some Point Will Push Up Long Rates

Japan's fiscal condition was already the worst among the major economies before the global recession hit. The Japanese government expects debt/GDP to reach 170% by 2009/2010, meaning the primary budget deficit could rise to 8.1% in FY2009/2010, up from only 3.9% in 2008/2009. The OECD however sees Japan's debt/GDP spiralling to 197% in 2010.

The Aso Administration has already been forced to abandon a pledge to achieve a primary fiscal balance by 2010. With the current recession, Japan's FY2010 budget will be the first in the postwar period where revenues from debt (JGB issuance) will exceed tax revenues. With general budge expenditures of around JPY90 trillion, tax revenues of around JPY40 trillion would imply a need to issue JPY50 trillion of new debt. FY09 planned issuance is already high at JPY44 trillion, but this is based on the government's forecast of minus 3.1% growth, whereas the OECD is forecasting minus growth in excess of 6%. In the OECD scenario, tax revenues could fall to the JPY30 trillion level, necessitating JGB issuance of more like JPY60 trillion rather than the JPY44 trillion already budgeted.

Long bond (10 year) bond yields already jumped temporarily to 1.5% in June on concern of oversupply of JGBs, but have since slipped back to the 1.3% range. If the above OECD scenario scenario for GDP growth is more accurate than the Japanese government's current 3.1% estimate, JGB yields are set to go noticeably higher as the Japanese government needs to issue extra debt--in other words, Japan could also see a buyer's strike by the bond vigilantes demanding higher yields. This of course would further hamper what is already seen as a very anemic recovery in 2010 ("recovery" with GDP growth of less than 1.0%).