Once the world's powerhouse, today Japan is the most indebted country in the world in comparison to the size of its economy. Public sector debt is at more than one quadrillion yen – that's around 246% of GDP. For comparison, Greece's debt to GDP ratio is 177%.
In a bid to jump start its economy following the so-called "lost decade" of the 1990s, the Bank of Japan (BoJ) pioneered the use of unconventional policies back in 2001 – referred to as financial repression.
It aggressively scaled up its quantitative easing programme in 2013 as part of its policy package 'Abenomics', which is aimed at smashing deflation and boosting the economy. But despite this, and earlier attempts to revitalise the economy, growth remains weak.
In fact, just a few weeks ago, US rating agency Standard & Poor's lowered Japan's sovereign debt rating. Its enormous national debt was the main reason – S&P doubts the government's ability to reverse the economic slowdown in the near future. An aging population and rising healthcare and pension costs are only going to add additional fiscal pressure in the future.
The cost of financial repression in Japan is very high. Household savings have been massively eroded by artificially low interest rates. Our new figures, published in the factsheet Japan's debt: How far is too far? reveal that Japanese households have lost around USD 900 billion – I repeat USD 900 billion! – in foregone interest rate income. To put that number into perspective: that's more than the value of Switzerland's GDP.
At the same time, Japanese insurers have experienced a hit of USD 230 billion to their yield income. As long-term investors, this results in less risk capital available to be put to work in the real economy.
If the BoJ keeps these actions up, the country will likely experience greater unemployment and low returns on most financial investments. These symptoms will not disappear until the debt overhang is addressed.
It's safe to say that Japan has a great challenge ahead, but it's not unique to Japan. Following the 2008 financial crisis central banks around the world dove into financial repression policies. Their economies, too, face similar consequences. (Read about it our publication, Financial repression: The unintended consequences).
Meanwhile, China is gradually shifting away from financial repression – see Chuan Lim's blog. The real mystery is: when will other central banks follow?