Understanding the Japanese Debt-ridden Economy

- OECD estimates that Japan's debt to GDP ratio is expected to rise to twice it's economy this year, significantly higher than Greece's 123 percent
- The Finance ministry estimates that Japan's public debt is expected to swell to 973.2 trillion yen by next year
- On 26 Jan 2010, S&P lowered it's outlook on Japan's debt to negative from stable and issued a warning that it was concerned with the large deficit and sluggish growth outlook of the Japanese economy, which currently ranks 2nd in the world economies.

Qn: Is Tokyo's fiscal foundations really shakier than those of Athens?

Optimists have insisted that it is wrong to focus on Japan's gross debt, since in net terms, the state only owes the equivalent of slightly over 100 percent of its GDP. This is because Japan is the holder of more than 100 trillion yen in foreign exchange reserves and also holds a large portion of it's own debt.

So in net debt terms, it puts Japan's debt burden in the same category as Italy, but its ability to attract local buyers (domestic savings and institutional investors)for its debt have been the key to the low JGB yields. Investors this week have snapped up an offering of 10-year Japanese government bonds carrying a coupon yield of 1.4 per cent.

However, institutional purchases by Japan Post Bank and Japan Post Insurance peaked at 29 per cent of market share in 2008 and have since been declining as they suffer from a structural decline in deposits and seek to diverisfy from holding JGBs.

Currently, the main buyers of JGBs are private Japanese banks and insurance companies. Banks are buying to meet new liquidity rules, because they lack alternatives in deflationary Japan and as they have excess deposits due to a lack of demand for corporate loans. Meanwhile insurers are buying JGBs to better match liabilities that they will have to mark to market from 2013.

In recent months, the government's ability to raise revenues have been called into question. Nanto Kan, the finance minister, and his colleagues are trying to draw up plans for fiscal sustainability to be implemented once economic growth strengthens, but their ability to reassure markets in the meantime will only mean more volatilty for the Yen till then.

Eric Tan, London

Greek options. Markets for the week ending 7-Feb-10

As the markets brace itself an escalating EU crisis, I wonder what options are available realistically to Greece..

1) Go-it-alone fiscal adjustment
This is the most probable approach that the Greek government will take to convince the markets and other European nations that it will be able to handle it's own domestic affairs, at least for the time being. It's a polite way of handling its problems but the feasibility is low. This will take a lot of support from the nation as it prepares to slash government budgets and halt pay increases for the government sector.
FEASIBILITY RATING: LOW

2) EU Bail-out
The main issue of an EU-led bail-out is the moral hazard attached. A modern Trojan Horse tale of how the Greek army invaded the city of Troy (in this case Germany and France) and opened the gates for Spanish, Irish and Italian armies could be written in the books of modern finance history. However, if the EU can agree on how the bail-out can be structured it could be feasible. I'm in favour of loan guarantees or short-term bridging loans, with strict conditions attached of course.
FEASIBILITY RATING: MEDIUM

3) Default or Debt restructuring
This could give temporary relief to Greece as it writes down its debt but will have a large cascading effect on other eurozone economies. We have already witnessed how Portugese CDS spreads have widened since the Greek crisis began and a default would make it costly for it's neighbours to raise debt.
FEASIBILITY RATING: LOW

4) Go NUCLEAR!
A full blown default and devaluation in Argentinean-style is what the markets fear most. Greece will have to leave the EU and this will have significant domino effect on the world economy as the Euro collaspes. The Greek GDP may fall as much as 10% and having most of it's debt denominated in Euros, it will be a long time until Greece recovers from its post-crisis trauma. However, markets have short memory and it may not be long before they start buying Greek debt again
FEASIBILITY RATING: VERY LOW

Eric Tan,
London