Pimco’s Baz Says Japan In a Bind as Total Debt Tops 600% of GDP

(Bloomberg) -- There’s “very little” that Japan can do about its mounting debt pile, which presents a potential risk to growth, according to Pacific Investment Management Co.’s Jamil Baz.

With a government debt load that’s 2 1/2 times the size of annual gross domestic product and a total national borrowing burden that’s six times as large, “Japan is suffering from the excesses of the past” and the country “is in a bind right now,’’ the fund manager’s head of client analytics said in an interview in Sydney last week.

Japan’s economy is still struggling to gain traction even after policy makers hit it with repeated doses of budgetary stimulus and unprecedented monetary easing to drag the country out of its deflationary funk. The Bank of Japan’s adoption of negative interest rates has pushed down debt financing costs for now, but repeated delays to a planned sales tax increase, a new 28 trillion yen ($272 billion) fiscal boost from Prime Minister Shinzo Abe and the pressures of an aging population mean the borrowing pile is likely to keep on growing.

“In general, when you have these extremely high debt-to-GDP ratios, you have the choice between two things: you either default -- explicitly or via high inflation -- or you increase your savings to repay,” said Baz, who previously worked at Man GLG Partners and rejoined Pimco in February. “In both cases, there is obviously a substantial left tail risk to future growth.”

Japan is the Group of Seven nation that’s “closest to a situation of fiscal dominance,” Baz said, referring to a situation in which the country’s budgetary needs overwhelm more traditional objectives of monetary policy.

Baz, who has also taught at the University of Oxford, published a paper last month on seven potential outlier risks to the global economy. In it, he discussed the issue of Japan’s solvency and whether its problems might ultimately destabilize the nation and the global monetary system. He painted a tail-risk scenario in which there could be a backlash against negative yields on Japanese government bonds resulting in capital flight and a “melt-up” in the yen. That in turn could lead to either “fiscal dominance/hyperinflation” or a default by the government, he wrote.

While the probability of these outlier scenarios coming to pass in the next year is less than one-in-five in each case, the risks do increase over a longer horizon of 5-to-10 years, Baz said.

Nomura, Gross Skeptical

Japan’s fiscal position is “adverse” with its national debt to nominal GDP ratio in a “league of its own,” both by international and historical standards, Nomura Holdings Inc. analysts led by Yoshiyuki Suimon said in a note last week. The Japanese government needs to repair its finances to avert a fiscal crisis, they wrote.

Billionaire bond investor Bill Gross has said that the likely endgame is for the BOJ to forgive sovereign debt. Yukio Noguchi, a former Ministry of Finance official and best-selling author, said he believes the BOJ is already financing fiscal spending.

The economy has alternated between muted growth and outright contraction at various points, while a 17 percent strengthening of the yen this year is eating into corporate profits. Wage growth has been muted, companies and households are still hoarding cash, and progress on the so-called third arrow of Abenomics -- structural reforms -- remains slow.

Delaying an increase to the value-added tax -- currently scheduled for 2019 -- will exacerbate the debt problem, while pushing ahead with the hike that’s planned would make growth “even more mediocre, potentially negative,” Baz said.

To contact the reporters on this story: Narayanan Somasundaram in Sydney at nsomasundara@bloomberg.net, Benjamin Purvis in Sydney at bpurvis@bloomberg.net. To contact the editors responsible for this story: Garfield Reynolds at greynolds1@bloomberg.net, Andrew Monahan at amonahan@bloomberg.net, Tomoko Yamazaki

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