Grim Outlook for Japan Economy: Barclays Economist

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It was exports which underpinned GDP growth at the time. So Koizumi was very lucky, since exports are purely dependent on external factors—other countries' ability to absorb exports.

So the relationship of Japanese exports to GDP growth was the flip-side of the debt explosion to GDP in the US?

That's right.

Japan's debt-to-GDP is already the highest in the developed world. How much can Japan spend in terms of fiscal stimulus to maintain GDP levels in the downturn?

The absolute level of debt is not the primary problem. The primary problem is the upward trend of the debt-to-GDP ratio: that the growth of debt is higher than the rate of GDP growth. This is a theoretical nightmare. It's unsustainable. The options are the following: declaring a debt default, or increasing the consumption tax. But new Prime Minister Aso has said he will not raise the consumption tax for two years. Considering the strong need for stable tax revenues to finance ever-increasing social security-related expenditure, we have to raise the consumption tax rate. If this is delayed, it may need to be even doubled to 10%. Until then, Japan will simply issue more government bonds.

Is Japan's sovereign rating under threat?

No, because of the large amount of financial assets held by Japanese households, namely ¥1,500 trillion ($15.7 trillion), which is three times as large as annual GDP. The government could tax those assets, for example, to repay the national debt should it really be on the verge of default. But we should note that these assets are the accumulation of the post-war era. Now that the savings rate is actually pretty low, mainly due to the aging of the population, it could be the case that the government debt grows faster than the household financial assets in the future. Then things become very hard to deal with.

Do you see any ray of light for the Japanese economy?

There is no source of cyclical recovery domestically. Japan needs the global economy to recover, which will buoy Japan's exports, even if the benefits probably won't extend to Japanese households. Now that the global economy is suffering, we need a fiscal policy, which must be efficient and effective. Otherwise it may simply raise interest rates, which will suppress future growth.