Japan debates sustainable debt load as Takaichi eyes looser fiscal goal
Prime minister seeks to abandon single-year primary surplus target
Prime Minister Sanae Takaichi has called for strategic fiscal spending to achieve a strong economy. (Photo by Ken Suzuki)
TOKYO -- A heated debate is emerging within the government over whether Japan can rely on debt-financed spending as long as the economy logs high growth, as Prime Minister Sanae Takaichi looks to loosen the target for achieving a primary balance surplus.
"Nominal growth rates will recover thanks to productivity growth," Takaichi said at a meeting in Tokyo on Monday. "The debt-to-GDP ratio is declining," she added, calling for "strategic fiscal spending to achieve a strong economy."
In light of rising long-term interest rates, she touched on the need to pay close attention to interest rate trends and continue improving debt indicators, but did not mention achieving a primary balance surplus. In November, she said she looked to achieve a primary balance over several years, rather than in a single fiscal year.
Fiscally conservative members of Takaichi's Liberal Democratic Party are skeptical, asking how the government can achieve a primary balance surplus over multiple years if it gives up on achieving it in a single fiscal year.
Satoshi Honjo, a policy chief for the opposition Constitutional Democratic Party, assailed her plan as "very problematic."
Primary balance is an indicator of whether the government can finance its spending, such as on social security and public works, without relying on debt. When expenses exceed revenues, the primary balance is in deficit, increasing national and local government debt. Japan has had a primary balance deficit since fiscal 1992.
The goal of achieving a primary balance surplus was laid out by former Prime Minister Junichiro Koizumi in 2001 in his government's economic and fiscal policy guidelines.
The document emphasized the importance of "covering the costs of current government services with current tax revenues, without passing them on to future generations." It included the warning that "when interest rates exceed the growth rate, preventing the debt balance as a percentage of GDP from increasing requires not taking on new debt that will not go toward principal and interest payments."
This is the focal point of the current debate surrounding fiscal consolidation.
If the nominal growth rate is higher than interest rates, economic growth exceeds the pace of debt growth, bringing down the debt-to-GDP ratio -- a theory known in economics as the Domar condition. If interest rates exceed nominal growth rates, it is better to curb new bond issuance.
At a press conference in 2005, then-Minister of Economy, Trade and Industry Kaoru Yosano said, "a nominal growth rate higher than long-term interest rates should be considered a temporary bonus, and it is natural that long-term interest rates will be higher in the long term."
Then-Internal Affairs Minister Heizo Takenaka challenged this view. "I wonder if it's appropriate to assume that long-term rates are always higher" than nominal growth rates," Takenaka said at a Council on Economic and Fiscal Policy meeting.
His thinking was that if growth rates exceed interest rates, increased tax revenues would allow for bond issuance to be curbed. He made the comments amid a debate over whether tax increases were necessary to restore fiscal health.
The deadline for achieving a primary balance surplus was initially set in the early 2010s, a goal that was pushed back to fiscal 2020 during former Prime Minister Shinzo Abe's second term. The 2008 financial crisis and the 2011 earthquake and tsunami necessitated large-scale stimulus spending.
Low interest rates under the Bank of Japan's large-scale monetary easing continued under the Abenomics economic policy, creating a favorable environment for aggressive fiscal spending. A consumption tax hike was also postponed, and in 2018 the primary surplus target was put off again to fiscal 2025.
The basic economic and fiscal policy approved by the cabinet in June of this year under former Prime Minister Shigeru Ishiba aimed to achieve a primary surplus "as soon as possible between fiscal 2025 and fiscal 2026."
The economic environment has changed dramatically since the deflationary era. Unprecedented quantitative easing has ended, bringing back interest rates to Japan. Long-term interest rates are at their highest level in 17 and a half years.
While nominal growth rates are currently exceeding nominal interest rates due to inflation, some analysts see this as a temporary phenomenon. "Simulations suggest that interest rates will likely return to exceeding the growth rate after 2030," said Yohei Kobayashi, senior principal researcher at Mitsubishi UFJ Research & Consulting.
"If we're not looking at it on a single-year basis, we should solidify a framework for how much of a deficit we can tolerate in the medium-to-long term," Kobayashi said about the primary balance. "It's important to be careful about falling into a vicious cycle in which interest payments increase debt, which in turn raises interest rates."
Waseda University Professor Masazumi Wakatabe, a former BOJ deputy governor and private member of the Council on Economic and Fiscal Policy, is in favor of expansionary fiscal policy. As long as nominal growth rates exceed interest rates, "there is no need for a primary budget surplus target, and active fiscal spending is possible," he said.
Since Takaichi became LDP head in October, long-term interest rates have risen and the yen has weakened, a reflection of the risk of worsening finances.
At a lower house budget committee meeting on Nov. 10, Takaichi said she would issue instructions in January on setting a new primary balance target. Based on Cabinet Office fiscal estimates to be released in January, the government plans to clarify its plans further during parliamentary budget deliberations, and in its basic economic and fiscal policy to be decided before the summer.
The parliamentary session starting in January could see a contentious debate on economic growth and interest rates.
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