Multi-Asset Insights: The long-term outlook for the Japanese yen
This month we share our thoughts on a more structural view than usual: our long-term outlook for the Japanese economy and the read across to the yen, as deteriorating demographics and government indebtedness continue to plague the nation.
Age of innocence in decline
The country’s demographics are particularly concerning. The percentage of the nation’s population aged over 65 is projected to rise from 25% in 2010 to 40% by 2050.
2014 saw a record low number of babies born and the total fertility rate (the average number of children born to a woman in her lifetime) of just 1.4 is considerably below 2.1, the generally accepted rate required to maintain a steady population in developed markets, according to the World Bank.
These statistics point to an ageing, less economically-active population which is projected to decline from the current 127 million to 105 million by 2050.
The resulting decline in the labour force will likely weigh heavily on economic growth, while an increase in the number of those aged over 65 will add additional pressure to Japan’s poor fiscal position.
Counting the cost
Beyond Japan’s weak demographic position, the government’s debt burden, at 240% of GDP, is another significant headwind.
Almost 50% of the government’s revenues is currently being used to cover debt service costs alone which will become a considerable problem should Japanese government bond (JGB) yields rise from their current levels.
Japan’s post-war economic boom sharply turned into an asset price bubble which burst in the late 1980s. By the end of the 1980s, Tokyo commercial property prices had risen by a factor of 8 over just 20 years (source: Bloomberg).
Corporates had been buoyed by the rising asset prices and had increased their leverage accordingly.
However, once the bubble burst, corporates sold down assets to regain balance sheet stability, pushing prices lower and a downward spiral of asset prices began.
Servicing the debt
In an attempt to avoid a depression, the Japanese government began to aggressively loosen fiscal policy and raised government debt from 50% to 240% of GDP as a result.
History suggests that countries with such a high debt burden would normally struggle before reaching such a level but Japan has been held stable by a rich export market leading to a current account surplus, and domestic demand for JGBs.
Given that Japan is currently using more than 100% of tax revenues (Figure 1) to pay for debt servicing and social security payments, which are both forecast to rise, the country’s current fiscal path is clearly not sustainable over the long-term.
Japan’s internal funding source for JGB issuance also appears unsustainable given demographic trends.
Replacing this domestic demand with foreign investors may lead to higher yields and therefore higher debt service costs could cause Japan’s economic path to deteriorate further.