A rising chorus of voices in Washington this week is warning about the danger of a sovereign debt crisis in Japan. "We may be at the edge of a cliff," a former senior Japanese finance ministry official told Emerging Markets, pointing to a possible sell-off of government debt.
Japanese banks are aware of the risks, the former official said, but members of the Japanese government are “too relaxed” about the situation. “It is getting worse and worse,” the official added.
Senior IMF officials have also expressed concern about Japan's fiscal position, and the very heavy exposure of Japanese banks to the Japanese Government Bond (JGB) market.
While Japanese banks’ exposure to the European sovereign crisis is limited, they “need to worry” about their Japanese government debt holdings, IMF deputy managing director Naoyuki Shinohara told Emerging Markets.
"They have to worry about the huge budget deficit in Japan, the huge government debt outstanding and the fact that a large part of government debt is held by banks."
With the IMF estimating that Japan’s debt to GDP ratio is currently tracking at around 220% of GDP, informed observers believe that a public debt crisis could be closer than many market players imagine.
“In the end I think the market will pick up on Japan's weak public finances. A crisis could be more a matter of when rather than whether,” former senior Japanese finance ministry official Shigemitsu Sugisaki said in a telephone interview from Tokyo.
“It is quite obvious that we [in Japan] need to take very drastic measures both on expenditure as well as in taxation,” Sugisaki, who is also a former deputy managing director of the IMF, added.
Carlo Cottarelli, director of the IMF’s fiscal affairs department, told Emerging Markets that the priority for Japan “is to have a medium-term plan that clarifies how the public debt to GDP ratio will be first, stabilised, and then reduced".
Concerns about JGBs are not shared unanimously, however. Mohamed El-Erian, CEO of Pimco, said that the threat of a near-term sell-off is small. “Japanese bonds benefit from a captive market, so unless the alternatives outside Japan look exciting, which they don't today, they will continue to be able to sustain a high debt stock.”
The unnamed former ministry official rejected suggestions that because a large proportion of Japanese debt is held domestically, that this will protect them from a potential sell-off.
"People say that 96% of JGBs are held by domestic holders and that Japanese investors have strong portfolios. But when the yen gets weaker they will move away from deposits in Japanese banks to foreign currency deposits and that is one way to start a panic,” the official added.