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Table 13. General government deficit and debt

Table 13. General government deficit and debt

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OECD Economic Surveys: Japan



88



Figure 26.



Interest payments



Trillion yen



Per cent



18.0



6

Implied interest rate on public bonds

(right scale)



Interest payment



17.5



5



(left scale)



17.0



4



16.5



3



16.0



2



15.5



1



15.0



1991



1992



1993



1994



1995



1996



1997



1998



1999



2000



2001



2002



1



0



1. OECD estimate.

Source: Cabinet Office, National Accounts and OECD estimates.



than 700 trillion yen (Figure 26). The average interest rate on the public debt (total

interest payments divided by government debt) fell from 5.5 per cent in CY 1991

to 2.2 per cent in CY 2001. If the average interest rate and the composition of

government debt had remained at their 1991 levels, 23 trillion yen (4.6 per cent of

GDP) in additional interest payments would have been required in CY 2001.

Excess domestic savings help to finance budget deficits without causing

disturbances in financial markets. As discussed in Chapter I, the increase in

government net borrowing has been completely offset by the sharp decline in net

borrowing by the non-financial corporate sector, leaving the domestic economy as

a whole in a net saving position (Figure 10). At first glance, changes in the savinginvestment positions may suggest that the public sector has crowded out privatesector investment. However, the decline in the long-term interest rate, in real as

well as nominal terms, indicates that the causality is likely to run in the opposite

direction: a fall in investment in the private sector has accompanied an economic

slowdown, resulting in a higher government deficit due to lower tax revenue.

Moreover, the current problems in the financial sector have facilitated the

financing of public debt. Given the weakness of their capital base, financial institutions are hesitant to invest in risk assets or to expand their lending, thus favouring the purchase of government bonds.55 Consequently, during the past five years,

private banks increased their holdings of government bonds by 40 trillion yen



© OECD 2004



Achieving fiscal sustainability



89



(8 per cent of GDP), while they cut lending by 50 trillion yen. Moreover, given the

fragility of private financial institutions, public financial institutions’ share of

households’ assets continues to increase, helping to finance public debt. Households have around 240 trillion yen (48 per cent of GDP) in postal savings accounts.

This allows the Postal Savings System and the Trust Fund Bureau to hold a quarter

of the total stock of government bonds. In addition, under the current quantitative

easing scheme (see Chapter II), the Bank of Japan purchases some 14 trillion yen

of government bonds per year. Consequently, a third of the net lending of the

general government is virtually financed by the central bank, which currently

holds 15 per cent of total outstanding government bonds.

The current fiscal situation is not sustainable

The above arguments suggest that the current stability in public finance

has not been supported by strong fundamentals in the Japanese economy. On the

contrary, it reflects the fragility of the economy, as shown by the weakness in

private demand and the lack of risk-taking by households and the corporate

sector. Hence, the currently low level of long-term interest rates and the stability

in public finance do not guarantee fiscal sustainability because the current peculiar

economic situation itself is not sustainable. Strains in financing the budget deficit

may arise when a robust expansion is achieved and business investment

increases. Moreover, since necessary reforms tend to be postponed in the current

low interest-rate environment, the problem of fiscal sustainability could become

even more serious.

Indeed, the rapid accumulation of public debt raises serious concerns.

With a primary deficit of nearly 6 per cent of GDP and a nominal interest rate that

exceeds the growth rate of nominal GDP, debt dynamics work to drive up the debt

to GDP ratio very rapidly. A simple calculation suggest that the level of primary

surplus required to stabilise the debt to GDP ratio at 180 per cent would be

1¾ per cent of GDP, under the assumptions of nominal growth of 1 per cent and a

2 per cent interest rate.56 This implies that fiscal consolidation of nearly 8 per cent

of GDP is necessary just to stop the snowballing of public debt. However, such a

large-scale consolidation is difficult to implement in the current environment in

which the economy appears vulnerable to negative impacts from large cuts in

spending or increases in taxes. The experience in 1997 suggests caution in taking

radical steps toward fiscal consolidation.

The continuation of deflation and the decline in nominal income make it

difficult to reduce the government deficit through increased tax revenues. After

peaking in the early 1990s, total tax revenues fell by 7 trillion yen in the decade

to 2001, reducing its share of GDP from 20.5 to 17.5 per cent (Figure 27). In particular, revenues from income taxes on households and corporations declined by

16 trillion yen during the same period. Although a large part of the decline



© OECD 2004



OECD Economic Surveys: Japan



90



Figure 27. Tax revenue and GDP growth

Trillion yen



Per cent



100



8

Nominal GDP growth (right scale)

Tax revenue 1 (left scale)



95



6



90



4



85



2



80



0



75



1991



1992



1993



1994



1995



1996



1997



1998



1999



2000



2001



2002 2



-2



1. Excludes social security contributions.

2. OECD estimate for tax revenue.

Source: Cabinet Office, National Accounts and OECD estimates.



– around 10 trillion yen – can be explained by tax cuts,57 the weak economy and

deflation have also had a significant effect on revenue. Given the generous tax

allowances, a quarter of income earners do not pay any income tax at all and

almost 80 per cent of income tax payers fall in the lowest tax bracket of 10 per

cent. In addition, the proportion of firms paying corporate income tax has fallen

from more than 50 per cent in the early 1990s to 30 per cent at present. The relatively small role of indirect taxes amplifies the impact of declines in nominal

income on tax revenues. Consequently, the share of tax and non-tax revenue in

GDP has fallen from a peak of 34 per cent in the early 1990s to under 32 per cent

in 2001, one of the lowest in the OECD area.58

Population ageing also raises serious concerns about the sustainability of

public finances. The share of the population over the age of 65 is expected to rise

from 18.5 to 22.5 per cent in 2010, and to 35 per cent in 2050. Such rapid ageing of

the population is generating huge spending pressures. According to the government’s estimate, expenditures for social security, including pension, medical care

and other welfare programmes, are expected to increase from 82 trillion yen

(16 per cent of GDP) to 110 trillion yen in FY 2010 under the assumption of unchanged

policies (Figure 28).59 Moreover, under the existing social security system, the net

burden on generations born after 1980 could amount to 42 million yen per capita

for public services, which is three times higher than that on the generation born



© OECD 2004



Achieving fiscal sustainability



91



Figure 28. Projected social security spending

Trillion yen



Trillion yen



120



120

FY2002

FY2005

FY2010



100



100



80



80



60



60



40



40



20



20



0



0

Pensions



Medical



Welfare



Total



Source: Ministry of Finance.



between 1970 and 1979.60 This suggests the necessity of fundamental reform in the

social security system (see below).

Concerns about fiscal sustainability are amplified by uncertainty about

contingent liabilities. The planned reform of government special status corporations might increase the liabilities of the general government. Indeed, in 1998,

some 27 trillion yen (5 per cent of GDP) of debt held by the Japan Railway and the

National Forest Special Accounts was financed by the central government. The

recent plan for the reform of the public highway construction corporations may

require central and local government financing of the liabilities held by the

Honshu-Shikoku bridge authority. Moreover, according to published data,

129 government corporations, which are predominantly funded by the government, held some 532 trillion yen of gross liabilities (106 per cent of GDP) as of

FY 2001 and receive 8 trillion yen of subsidies and additional funds per year to

finance their operations. In this regard, the planned corporatisation or privatisation

may reveal that some government corporations face larger liabilities than

currently published.61

Contingent liabilities could also arise from the resolution of failed financial

institutions. The government Deposit Insurance Corporation has already provided

a significant amount of funds to protect depositors at failed banks. Between 1996

and March 2003, 18 trillion yen (3.6 per cent of GDP) of public funds were provided



© OECD 2004



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