Tokyo's Debt Explosion Has Japan on Shaky Ground

Ten years of stimulus programs are driving Japan's national debt to unprecedented levels.
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TOKYO -- At one point or another, everyone in Japan talks about "The Big One." It usually refers to the next big earthquake, the one that could destroy the capital like the

Great Kanto earthquake that led to some 142,000 deaths. That was in 1923, and many reckon Tokyo is long overdue for a repeat.

But in the financial community, "The Big One" refers to something different: Japan's burgeoning gross national debt. The government has spent over $800 billion on economic stimulus packages over the past decade in an attempt to push Japanese growth out of the doldrums, and still it is doubtful whether the economic recovery is sustainable. With national debt expected to reach 130% of gross national product by the end of the year -- the worst among all

Group of Seven

nations -- many wonder if Japan's debt-trap is just an accident waiting to happen.

Figuring out how to solve Japan's debt problem is a tough nut, and so far Japanese politicians have refused to even try to crack it. But with parliamentary elections coming up in late June, officials will have to come up with some answers to the debt dilemma and try to find other ways to boost the economy without spending much more.

Whatever they decide will likely have a tremendous effect on the Tokyo stock market. If the spending stops, the boom in the information technology sector alone won't be able to support economic growth. If spending continues, rating agencies will downgrade Japan's sovereign debt, which will preclude some foreign investment firms from putting money to work in Tokyo.

"Someday the government will have to decide who will win and lose so that Japan can take care of its national debt," says Vincent Truglia, managing director and co-head of the sovereign risk unit at

Moody's Investors Service

. "Will the burden go on corporations or the young? How will Japan raise the money to pay down debt when tax revenues and consumer spending is declining?"

Unfortunately, Japanese politicians are in no mood to even start to consider who will shoulder the debt burden. Prime Minister

Yoshiro Mori

is definitely not going to hike the consumption tax to raise revenue, a move that cost former prime minister

Ryutaro Hashimoto

his job. And current

Liberal Democratic Party


Hiromu Nonaka


Shizuka Kamei

are two guys famous for urging former premier

Keizo Obuchi

to push through countless stimulus packages last year.

The top three politicians' love for spending disturbs Truglia, who says he had to look at pre-World War II data to analyze Japan's debt problem. "Prior to the 1970s, no country had built up so much debt without fighting a war," he says.

That's why Moody's put Japan's Aa1 sovereign debt rating on review for a possible downgrade in mid-February. Since a typical review period for Moody's lasts about four to five months, the market is talking up the possibility of a debt downgrade in May or June. Moody's last downgraded Japan's debt rating, from AAA status to Aa1, in November 1998.

"If Moody's downgrades Japan's rating, politicians will quickly dismiss it, as they did before, arguing that Japan still has a huge savings pool and current account surplus," says Shigenori Okazaki, political analyst at

Warburg Dillon Read

. "However, if the market gets nervous, politicians would find it more difficult to justify another stimulus package this fall."

The big question is when and if foreign investors, who poured a record 7.6 trillion yen into Japanese securities in fiscal 1999, will pull out of Japan as politics and policies get bungled. One key factor will be what rival

Standard & Poor's

does. Unlike Moody's and

Fitch IBCA

, S&P has yet to cut Japan's sovereign debt rating. The firm, which conservatively calculates Japan's debt to be nearing 65% of GDP by the end of 2000, says Japan's net foreign asset position of about $1.2 trillion and its export-oriented economy create enough external liquidity to ride out any fiscal and financial problems.

If S&P is right, then investors don't have much to worry about. However, the firm also says Japan needs to curtail the growth of debt and come up with a more proactive economic policy following elections. This suggests S&P won't cut Japan's debt rating until it sees what kind of new government is elected in late June. There is a good chance Mori will be ousted, but as long as Nonaka and Kamei still hold key positions within the LDP, government spending is likely to continue. That's why the market is already speculating that another stimulus package, worth 1 trillion yen, will arrive in the fall.

One only hopes Japan's top officials actually feel the tremors in the market, or else their debt dilemma will become more than a distant rumbling.