Jesper Koll is Managing Director and Head of Japanese Equity Research at JPMorgan Securities Japan. He is convinced Japan will soon become a net debtor nation. Public alarm bells have been ringing since the Finance Ministry revealed Japan had accrued a 2.5 trillion Yen trade deficit in 2011, the first such deficits to arise since the oil crisis of 1980. Shortly thereafter the Ministry disclosed a 1.475 trillion Yen trade deficit for January along with a 437 billion Yen current account deficit. The current account deficit was the biggest monthly shortfall ever recorded. Moody’s Investors Service warned that a slide in the current account surplus due to falling exports could harm the creditworthiness of Japanese government bonds. So will the rating agencies downgrade JGBs? And if so, will the Yen derail as a safe haven currency? I asked J. Koll for his thoughts on the impact of a Japanese net current account deficit in this first part of a two part interview. (The second part will appear in the next edition of Beacon Reports.)
R. Solomon: If and when do you expect the rating agencies to react to Japan’s net deficit current account?
J. Koll: The current account per se has nothing to do with the rating of the country. There are plenty of countries that have current account deficits that have appreciating currencies but falling interest rates. The ratings agencies dynamics is determined by something completely different. It is the ability, willingness and credibility of the Japanese government to actually come up with a fiscal consolidation plan. So whether Japan enters into current account deficit tomorrow will not affect the rating agencies decisions. The rating agencies are looking very carefully at Mr. Noda’s ability to come up with a credible tax code. If he doesn’t, Japan will get downgraded.
R. Solomon: Does Noda have the capacity to raise taxes to offset the current account deficit?
J. Koll: No. You’ll see it unravel over the next three or four weeks for political reasons. Japan has been debating the tax code since 1978. They have been able to change the tax code exactly three times since then. The rational idea about what needs to get done is there, but the ability to make the decision politically is very difficult. If I were a credit rating agency, I’d be spooked. The scary thing is that that what needs to get done has been discussed for more than 30 years. But it doesn’t get done.
R. Solomon: What are the implications for the Yen-Dollar pair?
J. Koll: If you look around the world there are plenty of countries that have current account deficits where the currency is appreciating. The idea that “if there is a current account deficit, then therefore the Yen should depreciate”… this does not make any sense to me. To be specific, who is going to be the marginal buyer of Japanese debt? Everybody thinks it’s going to be America. That doesn’t make any sense. America is a debtor country, right? The marginal buyer is going to be the People’s Republic of China because the world’s largest creditor country is the People’s Republic of China. It is much more important to figure out what China does to its currency because right now it has a fixed exchange rate system with very little capital flows.
If you look where the marginal growth of exports has been coming from and is likely to continue to come from, the focus is not the stuff that our generation grew up with. Our generation was very focused on exports to the United States of America. It was about cars and car parts. Even as little as five or six years ago that was about a quarter to a third of the Japanese export market and the Japanese trade surplus. This has changed.
The fate of corporate Japan, and its trade and current account balance rests in the hands of Asia, and China in particular. That is where the marginal growth is going to be coming from. What I am saying is that the People’s Republic of China has just revised down their growth projections to 7 1/2%. More importantly, China is attempting this change in the growth model to one that is less dependent on capital formation and less dependent on imports. They want to manufacture for themselves. Whether its trains or machines that make machines used inside factories, they want to produce these things for themselves.
The threat to Japan’s exports that the doomsayers are forecasting is not just from the slowdown in the People’s Republic of China. The change in the growth mix, as China Inc. becomes more self-obsessed and ultimately more protectionist, poses in my view the biggest threat to Japan’s external account. New York and London don’t matter in relative terms. The future of Japan will be decided in the Asian time zone, not overnight by London and New York.
Jesper Koll, Managing Director and Head of Japanese Equity Research, JPMorgan Securities Japan Co. Ltd.