As the Japanese labour market shows signs of improvement, managing debt to GDP remains a concern, says NAB.
In a recent Japan Economic Brief, NAB Group Economics said the unemployment rate's fall to 3.4 per cent in March was an encouraging improvement.
However, NAB Economics also indicated that labour earnings growth remains weak – real cash earnings contracted by 2.6 per cent over the year to March.
While some labour market indicators are improving, NAB Economics emphasised that Japan's high level of public debt – which sits at 246 per cent to GDP – represents a major challenge.
The Bank of Japan's (BOJ's) target 2 per cent inflation rate will have to be achieved if debt is to be made sustainable.
“Clearly, the large stock of public debt is one of the main challenges faced by Japan,” the report said.
Gross debt to GDP is expected to rise to 252 per cent by 2020, NAB Economics said.
“If the public debt stock continues to accelerate the situation could prove very challenging,” the report said.
"In fact, there are already concerns that the BOJ is being forced to monetise the debt.
“This is likely to manifest in persistent downward pressure on the Yen, an outflow of funds from Japan and higher rates from a steepening of the Yield curve," the report said.
“This would substantially raise government debt servicing costs, cause massive capital losses among Japanese banks and potentially trigger a recession."
Consumer spending is key to achieving the inflation rate, according to the report.
“This would be preferred to, for example, a stagflationary environment in which prices are rising due to supply shocks (e.g. higher commodity inputs), and real economic activity remains depressed,” the report stated.
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