Japan faces a mammoth disaster relief and reconstruction effort after its worst-ever earthquake triggered a tsunami that devastated the country’s northeastern coast, killing thousands and spawned a severe nuclear crisis.
The government, which has been juggling relief work with a race to avert a catastrophic meltdown at a crippled nuclear plant, has yet to estimate the damage or say how much it may spend on reconstruction and where it will find the money.
Economists are certain the cost will exceed that of a 1995 quake in Kobe, estimated at USD 100 billion.
Another certainty is that Tokyo will have to ramp up borrowing to pay for its biggest rebuilding effort since the post-World War Two reconstruction.
The following are questions and answers about the fiscal strain of the relief and reconstruction effort and its possible market implications.
What are the early economic damage estimates?
Most private economists put the figure at up to USD 200 billion. Economy Minister Kaoru Yosano told Reuters in an interview last week the total direct and direct damage to the world’s third-largest economy could exceed USD 250 billion, the equivalent of 2% to 3% of gross domestic product.
Total costs could rise significantly because of need for heavy investments to deal with energy shortages following loss of nuclear-power capacity.
How much will the government have to spend?
A significant proportion of the cost will be borne by households and companies, though the government is likely to take a lion’s share, spending trillions of yen on relief efforts and reconstruction of the worst-hit areas.
Opposition and ruling party lawmakers are talking of extra budgets totalling between 5 and 10 trillion yen (USD 124 billion)on top of a regular 92 trillion yen budget. According to media reports, besides direct spending the government is planning to arrange low-interest lending and tax breaks for businesses hit by the disaster and capital injections for banks in the area.
Where will the money come from?
For now, the government is using 200 billion yen in emergency funds in the current budget to pay for rescue and relief efforts. Some Democratic Party lawmakers have suggested abandoning some of their spending plans in the next regular budget to mobilise up to 220 billion.
Still, most of the money will have to come in the form of additional budgets and probably will be borrowed, though there are other options. One, a special relief tax is a possibility, despite initial assurances from Finance Minister Yoshihiko Noda that no new taxes were planned to fund the effort. Secondly, at least in theory, Japan has an option of using some of its huge USD 1 trillion stockpile of foreign reserves to fund the reconstruction.
Can Japan borrow so much more?
Japan has so far been able to comfortably cover 95% of its borrowing needs at home at a negligible cost when compared with other high-debt nations. The yield on its benchmark 10-year bond is around 1.2% compared with more than 3% paid on German and US debt and more than 7% for Portugal.
The paradox is explained by a vast pool of domestic savings. Even after a big chunk gets invested abroad to make Japan the world’s leading creditor, what is left is more than enough to buy all government debt, which already exceeds the value of Japan’s USD 5 trillion annual economic output.
Moody’s ratings agency said on Monday risks to Japan’s economy, its debt, financial institutions and companies have increased over the past week. But its senior vice-president Tom Byrne said: “The Japanese government has the fiscal wherewithal and creditworthiness to deal with a disaster that could cost twice as much as the Kobe earthquake of 1995.”
Economists warn that in the long-run declining savings rate of a rapidly aging population will force Japan to increasingly rely on more fickle foreign investors for funding, but say such a tipping point is probably several years, if not decades, away.
Can Japan avoid a rise in borrowing costs?
A sharp spike in borrowing cost that could trigger a debt crisis similar to one engulfing the euro zone periphery seems a distant possibility now.
But some analysts say selling by nervous foreigners and Japanese financial institutions and households to meet higher quake-related cash needs could still push up bond yields enough to cause policymakers a headache.
So while merely ramping up sales of government bonds is the most straightforward scenario, the government may consider other options. One, suggested by one of Japanese newspapers but quickly dismissed by officials, would be to issue special disaster bonds and get the Bank of Japan to fully underwrite them.
Another option, and probably more palatable for the central bank, would be to increase government bond sales and at the same get the BOJ to increase its purchases of government debt in the market to prevent the extra supply from pushing up yields.
Yet another option could be an arrangement under which special reconstruction bonds would be taken up by public or semi-public financial institutions. A credit line from one of the international lenders, at least hypothetically, could also be a possibility.
Finally, some economists are floating an idea of a sovereign wealth fund dedicated to reconstruction and funded with part of foreign reserves. This, however, is the most far-fetched option as it would require significant changes to law to make it possible.
How soon can an emergency budget be passed?
A senior ruling party lawmaker Jun Azumi was quoted on Monday as saying large supplementary budgets were needed by June.
The government also needs opposition support to pass bills that accompany the regular 2011/2012 budget, including one that authorises the issue of new deficit-financing bonds.
Before the disaster, the opposition was blocking those bills to force the deeply unpopular Prime Minister Naoto Kan to call a snap election, but the crisis has raised chances that the impasse will end.