What Japan must do to reduce its alarming government debt

It already exceeds 200% of GDP.

In a report, Moody's Investors Service says that generating economic growth is an essential element of a credible long-term fiscal adjustment policy, a necessary (but not sufficient) condition for reducing Japan's heavy level of government indebtedness.

And while spurring growth and ending deflation would support the sovereign's credit profile, a tipping point for creditworthiness would eventually loom if growth remains elusive and the government's debt and refinancing needs remain at very high levels.

Moody's conclusions were contained in a just-released article, entitled "Higher Growth Essential To Reduce Japan's Large Government Debt Burden." The article is part of a series of Moody's reports looking at the credit implications of Abenomics in Japan.

Moody's further notes that ending Japan's economic stagnation of two decades is contingent on stimulating private capital formation.

During the past two decades, the economy has only grown and the budget deficit only declined when global conditions were buoyant and companies responded by expanding capital expenditure, increasing workforces, raising wages, and paying more income taxes.

The lacklustre outlook for the global economy over the next two or three years exerts pressure on the government to devise a stronger domestic policy response to spur stronger and sustainable economic growth.

Achieving the revitalization strategy's objectives of annual average real GDP growth of 2% and nominal growth of 3% over the next decade would support the sovereign's credit profile, given that it would increase government revenues and improve key credit metrics.

Currency weakness, increased bank lending and higher productivity would also be conducive to growth, employment and company profitability, as well as increasing corporate, personal and consumption tax revenues.

Tax reform and containment of social security expenditure would further reduce the government's budget deficit and enhance its debt-servicing capacity.
In contrast, if the revitalization strategy does not generate sustainable growth, the government's stimulatory policies risk aggravating Japan's existing credit challenges.

Without an improvement in private capital investment, the government's willingness to expand its deficit and attempt to inflate the economy into a recovery will be of limited effect, instead merely adding to the government's already very high debt stock.

At some point, investors may demand a premium for funding Japan's growing debt. Such a development could threaten to undermine sovereign creditworthiness and erode confidence in the JGB market, potentially destabilizing the country's financial system.

Long-term government debt exceeds 200% of GDP and annual debt-refinancing needs are the highest among mature economies.