Heizo Takenaka: Japan must heed the warning signs over its massive debt

THE Greek fiscal crisis has sent shockwaves through markets around the world. But the problem of excessive government debt is not confined to the European Union.

Indeed, Japan's debt-to-GDP ratio is about 170 per cent – much higher than in Greece, at about 110 per cent. But Japan's government does not seem to think it needs to take the problem seriously.

Last year's general election brought regime change. Yukio Hatoyama's Democratic Party of Japan (DPJ) thrashed the Liberal Democratic Party, which had governed almost continuously for half a century. But Mr Hatoyama's government

is increasing spending to meet its grand electoral promises, including a huge amount for new grants to households and farmers. As a result, the ratio of tax revenue to total spending this fiscal year has fallen below 50 per cent for the first time in Japan's post-war history.

Despite the weakness of the fiscal position, the market for Japanese government bonds (JGBs) remains stable, for now. Japan had a similar experience in the 1990s, its so-called lost decade. At that time, the budget deficit soared after the property bubble burst, causing economic stagnation. But JGBs are mostly purchased by domestic organisations and households. In other words, the private sector's huge savings financed the government's deficit, so that capital flight never occurred in the way it has in Greece.

But this situation has deteriorated recently, for two reasons. First, the total volume of JGBs has become high relative to households' net monetary assets, which stand at roughly 1,100 trillion (8.5tn). But in just three years, total JGBs will exceed this total. This suggests taxpayer assets will no longer back government debt, at which point confidence in JGBs is likely to shatter.

Second, Japanese society is ageing. As a result, the household savings rate will decrease dramatically, making it increasingly difficult for the private sector to finance budget deficits. Moreover, an ageing population implies further pressure on fiscal expenditure, owing to higher pension and healthcare costs, which is expected to start around 2013.

Given these factors, the JGB market will face serious trouble in the years ahead. Japan's new government has started discussing tax hikes. But tax hikes alone will not close Japan's fiscal black hole.

The DPJ government must restore comprehensive economic management. Without a strategy for growth, an effort to reduce government spending, and a policy to stop deflation, a tax hike will not solve the problem.

In some countries, lower military expenditures and interest rates have helped to improve a weak fiscal position. But in the case of Japan, military spending is already low, as are interest rates. This suggests that fiscal rescue will be extremely difficult if and when trouble starts – and underscores the urgent need for real political leadership now.

• Former Japanese economics minister Heizo Takenaka is director of the Global Security Research Institute at Keio University, Tokyo.