20130603 bh report: japanese government debt
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20130603 BH Report: Japanese Government DebtTRANSCRIPT
BH Report: Japanese Government Debt 2013/6/3
Context • How long have we been hearing the statement 'Japan is in deep trouble with so much debt?' ... entirely
too long ... – Politicians, journalists and economists are constantly making the argument on media – I distinctively remember hearing about the scenario of Japan going bankrupt in a matter of a few
years back in 1999 – I totally bought the argument at the time... but it didn't happen • The frustration I had was the fact that everyone has/had access to the same abundant data, and yet
each person comes up with different interpretation and story – I would hear both optimistic and pessimistic arguments, and I could not really tell which one to trust
• In preparation of writing this report, I looked across wide set of opinions of people who have tackled
the problem and delivered good insights- I put together what I believe to be the right set of analyses to answer key questions – Some of the sources I found to be interesting are listed at the end of the report
• In this report, I intend to answer following key questions
– Does Japanese government really have a lot of debt? if so, how did it get there? – Who is holding Japanese Government Bond (JGB)? – How likely is it for Japanese government to go bankrupt in the next 5 years? – What is Japanese government doing about this? Is it effective? – What does this all mean to people who have assets in Japan, or Japanese Yen?
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Summary of findings (1/3) Yes, a lot
– 1.1 quadrillion JPY worth of debt, ~85% of it is government bond – The ratio of debt to GDP is at ~240%, whereas the 'normal' rate for
developed countries is in ~80-100% range
It started in early 1990's post economic bubble Japanese government has been relaying on Japanese Government Bond (JGB) to bridge the gap between declining tax revenue and increasing spend
– Tax revenue peaked in 1990 and since then continued to decline: -2% CAGR through 2010
– Spend1: +1.5% CAGR for the same period
Direct owners: domestic financial institutions – Domestic financial institutions (Banks + Insurance Co's) account for
~66% of JGB balance – Foreign investors only account for ~10% of JGB balance... this is
incredibly low (UK ~30%, France ~35%, USA~45%) • This differentiates Japan from countries like Greece/ Argentina
who had financial crisis driven by FX
Indirect owners: Japanese citizens and companies – One can argue that it is Japanese citizens/companies who are the
ultimate owners (because 75% of banks/insurance co's liabilities come from retail + wholesale deposit)
Does Japanese Government really have a lot of debt? How did it get there? Who is holding Japanese Government Bond (JGB)?
1. Exclude special account 2
Summary of findings (2/3) Very low likelihood of going default in the next 5 years
– FX risk is non-issue as exposure to foreign investors is fairly low (i.e., not the same situation as Argentina/Greece in crisis)
– Enough room for Central banks to print money & buy JGBs – Banks/ insurance co's have enough asset to continue buying JGBs
(and they have enough incentives to support JGB market)
There is another potential 'disaster scenario' (serious inflation), but this is also unlikely to happen in next 5 years
– It would start with banks/Insurance Co's stop buying JGB, and then below sequence of events follow (order may move around) • Interest rates go up -> prices of outstanding JGBs drop ->
domestic FIs post huge loss -> Central Bank print lots of yen -> out-of-control inflation / yen loses all the credibility -> major imports (e.g., food/ oils) suffer
– Low probability in near term because of two main reasons: • 1. Even with 5% blended average rate hike – bank balance sheet
will only get damaged by ~6-7%1 (also it will be somewhat offset by stock market going up) which is manageable
• 2. Government/Central Bank would do anything they can to avoid it, incl. supplying banks with money, changing or adjusting guidelines/rules on ALM (Asset Liability Management) and accounting rules for evaluation loss
How likely is it for Japanese government to go 'bankrupt' in the next 5 years?
1. Assumed that the current JGB on banks balance sheets have average maturity of 5 years 3
Summary of findings (3/3) I don't have the answer (too complex of analysis needed... would require days) If you were to do it, you need to look at 3 different underlying drivers: (1) Government spend, (2) tax revenue driven by economic growth & tax rate, (3) bank balance sheet composition Either way – it is unlikely for this to happen in next 5 years seeing banks' BS
– Enough assets in other categories that can be shifted to JGB – Balance sheet still growing at ~15-30 trillion yen per year
Government , currently led by prime minister Abe in close collaboration with Central Bank, has been taking initiatives on monetary/fiscal policy known as 'Abenomics' which aims to achieve inflation target of 2% in 2 years
– (1) Quantitative easing: Central Bank to buy significant amount of JGBs -> keep rate down and facilitate lending/shift to stock market
– (2) Expansion of public Investment: Increase government spend E.g., earthquake relief, healthcare technology, regional investments
– (3) Economic growth: Evaluating ways to invest in private sector and drive economic growth (still in evaluation phase- the government planning to release more detailed views in June 2013)
This policy can either resolve the problem (i.e., increased tax revenue + modest inflation + gradual debt paydown) or it can completely mess up the economy (i.e., decreased tax revenue + hyper inflation + dramatic accumulation of debt driven by increased spend)
– Either scenario definitely takes more than 5 years to fully materialize – Which way it is headed will be evidently clear by mid year 2015,
seeing how consumption/tax revenue respond to sales tax hike
"When" will this happen (if ever)? What is Japanese government doing about this?
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Implications (assuming that you have some assets in Japan or JPY)
Recommendation 1: Avoid owning large amount of JPY in cash/ bank deposit– instead, own hard assets (e.g., real estate in prime locations, gold, etc.)
– Good hedge against 'disaster scenario' (e.g., hyper inflation), and reasonable hedge against 'optimistic scenario' (e.g., controlled inflation)
Recommendation 2: Watch out for key leading indicators/events to detect early signs of 'disaster scenario'... here are couple of key warning sings:
– 1. Not getting near the target inflation (2%) in '14 (e.g., if CPI growth remain below 0%)
– 2. GDP growth slows down more than expected in '14 (e.g., below 0%)
• Critical for the government to prove its commitment by clearly articulating and delivering growth strategy (most likely by the way of deregulating previously protected key industries)
– 3. Government deciding to postpone the sales tax hike seeing that 1. and 2. are not going well
– 4. Rate of new bank deposit slows down to below 10 trillion yen per year
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Appendix 1: Current state & history of Japanese Government Debt
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How much debt does Japan have?
1.1 Quadrillion JPY as of year end 2012 (that's roughly 11 trillion USD)
Roughly 85% of the debt is through Japanese Government Bond (JGB)
Source: Cabinet Office of Japan 7
How does it compare with other countries?
80
60
40
20
0
-20
250 200 150 100 50 0
Government debt as % of GDP ('12)
Greece
India
Russia
Brazil UK
France
Germany Japan
China
USA
% GDP growth ('12)
Source: IMF
It looks VERY alarming – but this itself is not an issue because most of debt is taken on by domestic investors (detail in later pages)
Each dot represents a country (173 countries plotted)
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How did it get there? (1)
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1,500
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Government debt (JPY Trillion)
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Government debt as % of GDP
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The trend is nothing new...
Source: IMF 9
How did it get there? (2)
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Japan
Government debt as % of GDP
USA
Regan Bush Clinton Bush Obama
Nakasone Takeshita
Kaifu
Miyazawa
Hosokawa/ Hata
Murayama
Abe
Obuchi/Mori Koizumi ...too many to note
Hashimoto
Source: IMF
... Japan started going down the path of heavy leverage beginning in early 1990's (post economic bubble)
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Why did/does Japan need so much debt? (especially since early 90's)
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100
75
50
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0
Government revenue (JPY Trillion)
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% of Government revenue
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Tax Debt Others
1. I will not go into much detail – but basically, there is another set of revenue/expense by the government that is not shown here that amounts to roughly 150 trillion JPY a year... it is a very unique and bizarre accounting scheme that Japan has... Source: Ministry of Finance Japan
Tax revenue hit the peak in 1990, but the spend continued to increase... Japan decided to rely heavily on debt
Note – above figures do not include special
account1
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Appendix 2: Views on Japanese Government Bond (JGB)
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Who is holding JGB?
66%
22%
9%100
0
20
60
80
40
% of Japanese Government Bond ownership
2012 Year End
4%
Domestict financial institutions excl. Central Bank
Domestic Government/ Municipalities/ Social Security/Central Bank
Foreign Investors
Domestic household & corporate
Source: Bank of Japan
90%+ of Government bond is held by domestic investors, large % of which is owned by domestic financial institutions • Foreign investors only account for
~10% of JGB balance... this is incredibly low (UK ~30%, France ~35%, USA~45%)
VERY limited dependency on foreign investors (much less bonds in foreign currency)
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How big is JGB on Japanese banks/ insurance co's balance sheet?
Assets
454 Other
360 JGB
624 Retail +
Wholesale lending
199 Cash/deposit
Liabilities
406 Other
1,230 Retail +
Wholesale deposit
(~800 from Japanese citizens +
~400 from compnanies)
1,637 1,637
Source: Bank of Japan
~22% of assets
Banks
Insurance Co's
Assets
214 JGB
Liabilities
429 Insurance +
Pension reserves 273 Other 100 Other
529 529
Japanese citizens
72 Other
429 Insurance + Pension
reserves
24 JGB 61 Mutual Fund
106 Equity
798 Deposit
56 Cash
Assets
1,547
supply
supply
Units: JPY Trillion
Japanese citizens' assets (e.g., deposit) is supplying the majority of banks/insurance co's balance sheet from which JGB is purchased/held (~22% of bank assets, ~41% of insurance co's assets)
~41% of assets
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Can banks continue to buy more?
10 11 11 11 11 12
50 48 44 44 43 40 39 40 42 40 39 38
58 9 10 12 18 18 19
21 22 23 22
35 38 37 35 34 31 32 31 27 27 26 28
11101010990
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% of total assets
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12
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39
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26
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41
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29
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45
37
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5
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Cash/deposit
Retail/wholesale lending
JGB
Other
2,000
1,500
1,000
500
0
Total assets / Total liabilities of banks (JPY Trillion)
20
12
20
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20
10
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0.4%
Retail+Wholesale deposit (1.0% CAGR)
Other (-1.1% CAGR)
Deposit growing at ~1% CAGR (15 years); ~15-30 trillion yen each year for the last 5 years
Share of JGB in the assets has increased, but it is still at ~22% range
Source: Bank of Japan
Yes – at least for next 5 years because (1) banks have enough assets in other categories that can be shifted to JGB (2) getting ~15-30 trillion yen worth of new deposits each year
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1.0
2.0
3.0
4.0
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6.0
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9.0
10.0
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1 year
10 years
How has JGB rate changed over time?
1. Since 1986 2. Plan is to extend average maturity of bonds purchased from 3 years today to 7 years Source: Ministry of Finance Japan
Japanese Government Bond interest rate
1
Monetary tightening/ economic bubble
burst in 1990
Long period of depression, stock market decline,
increased JGB issuance
"Zero interest-policy" in '98-'00,
'01-'06, '08-
April 4th 2013 - Central Bank declared large scale quantitative easing • Buy JGBs at annual pace of ~50
trillion yen • Buying JGBs with longer
maturity2
... naturally JPY dropped, stock market rose... interest rate surprisingly went up, but Central bank is determined to keep rates down in mid-term through continued purchasing (to encourage bank assets to flow into lending and/or stock market driving growth)
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Appendix 3: Interesting sources
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Interesting sources
Bank of Mitsubishi Tokyo UFJ report (April 2010) • http://www.bk.mufg.jp/report/ecorevi2010/review100428.pdf • Analysis on "how long JGB can continue to be owned primarily within Japan"
Chikirin's diary (March 2010) • http://d.hatena.ne.jp/Chikirin/searchdiary?of=7&word=%B9%F1%BA%C4 • A blog entry on "what Japan should do if banks stop buying JGBS" • It is half joking, half serious entry... the solutions suggested by Chikirin is pretty hilarious • Entries on other topics by the same blogger is also pretty good
Diamond interview with Kumagai (October 2012) • http://diamond.jp/articles/-/26187 • A good summary of views by an economist/analyst from DIR
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Disclaimer
This document is provided for general information only and nothing contained in the material constitutes a recommendation for the purchase or sale of any security. Although the statements of fact in this report are obtained from sources that I consider reliable, I do not guarantee their accuracy and any such information may be incomplete or condensed. Views are subject to change on the basis of additional or new research, new facts or developments.
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