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Sat Takehiro [ProfiIe] Economy

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Japan ran up a trade deficit in 2011 for the first time in 31 years. The current account, which includes the
income account and other items, remained in the black, but its surplus shrank considerably. Sat Takehiro,
chief economist for Japan at Morgan Stanley MUFG Securities, examines whether further trade deficits will
push the current account into the red.
n 2011, Japan's trade balance registered a deficit for the first time in 31 years. This has sparked a
lively debate about the nation's ability to retain a surplus in its current account. Some market
participants argue that the surplus will dwindle and may turn into a deficit in just two or three years.
At Morgan Stanley MUFG Securities Co., Ltd. we do not subscribe to that view, however. t is
difficult to say precisely how long the current account will remain in the black, but in any case a
modest amount of red ink in the trade balance will not easily produce current account deficits in
Japan's case. This is because Japan is by far the world's largest holder of net foreign assetsin
excess of 250 trillion. These assets produce a steady inflow of dividends, interest payments, and
other such income gains, which are recorded in the income balance of the current account and can
offset deficits in the trade balance. With surpluses in the current account building up year after year,
net foreign assets are also accumulating through a positive feedback loop.
According to a rough estimate, the current account surpluses can be expected to last at least
another 10 or 20 years. One market implication of this is that, for the foreseeable future, the
government will be able to cover its budget deficits by relying solely on domestic funds. Long-term
interest rates should, accordingly, hold steady at a low level.
Factors Producing BIack Ink
A number of factors are working together to make it unlikely that the current account will fall into a
deficit. First, Japan's exports have remained buoyant; a fact that runs counter to the assumption that
exports would decline in the wake of shifting manufacturing oversees to respond to the yen's record
high exchange rate. This positive outcome is a result of the strength of Japan's capital goods and
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raw materials, and its proximity to Asian neighbors. Companies have indeed been steadily moving
an increasing share of their production overseas, but statistics show that Japanese exports
continued to expand during this same period (Figure 1).
A second factor, on the import side, is related to energy. t is true that there will be an increase in
imports of energy resources now that Japan's nuclear power stations are out of operation, and this
will negatively impact the country's current account. But the value of these additional imports, at
worst, will not exceed about 1% of Japan's gross domestic product. Energy imports alone are thus
unlikely to produce a large recurring deficit in the trade balance.
Third, in the income account, a large portion of the outflow from Japan consists of dividend
payments, which play a cushioning role because they can be reduced during a business downturn.
Structurally, they are a countercyclical factor, reducing the impact of swings in the business cycle.
n addition, the inflow into Japan from the more than 250 trillion in net foreign assets tend to
remain relatively stable despite changes in overseas interest rates. Given these circumstances,
Japan's income account has a strong tendency to stay in the black.
Fourth, the excess of savings in the private sector's saving-investment ratio is likely to last. There
has been a popular assumption that the graying of Japanese society will force families to tap into
their savings, but in fact the household saving rate has tended to increase or at least hold steady.
Corporate savings have also been sustained despite the deflationary conditions. Why has the
household saving rate not fallen even as Japan's population gets older? One possible answer may
be that senior citizens are continuing to build up savings even after retirement, reflecting their
serious concerns about the future.
ResiIience of Income Account SurpIuses
Among the foregoing factors, the black ink in the income account may be undermined by the recent
downward movement in overseas interest rates. The investment yield on foreign assets is currently
somewhat under 3%, but many economists expect future yields to fall due to the downtrend in long-
term interest rates. f we look, for instance, at the foreign securities in foreign exchange reserves,
which are part of net foreign assets, we find that many are longer-term securities; by maturity
composition, 56.6% are from one year to less than five years, 26.7% are for five years or more, and
only 17.7% are for under one year. We may take it for granted that many of them are investments in
US Treasuries. The five-year interest rate in the United States is currently in the vicinity of 1%. f we
use the simple assumption that when the securities mature they will be reinvested in instruments
with the same maturity period, we find that average investment returns will fall to the level of 1%
within five years from now.
t needs to be noted, though, that the black ink in the income account has proven to be fairly
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impervious to the downtrend in US long-term interest rates over the past 20 years or so (Figure 2).
The underlying cause of this can be summed up in two points.
First, among the items in the income account, the ratio of yields on securities have undergone a
long-term decline in their share of the total, while dividend receipts are now becoming more
prominent. Some of the dividends come from overseas stock investment, but others are a return on
profits from manufacturing subsidiaries established in other countries. With the shift of production
offshore, the manufacturing sector has seen its exports of finished products decline. At the same
time, however, these overseas profit dividends, which are closely attuned to trends in the global
economy, have increased. Thus while downward movement in overseas interest rates may
squeeze yields on overseas securities investment, the surplus in the income account is being
propped up by the growth of dividend receipts.
The second point is that Japan's net foreign assets have continued to swell even as overseas
interest rates have fallen. These additional assets have helped keep the income account in the
black at times when yields on securities come under pressure. The net foreign assets stood at
about 100 trillion 15 years ago but have since grown by 2.5 times, to the vicinity of 250 trillion
(Figure 3). As a result, even if yields on securities had been cut in half, overall investment returns
would still have increased as a result of the growth in net assets by 2.5 times. This shows that a
mechanism is in operation that prevents black ink in the current account from being easily
influenced by a decline in overseas interest rates.
Over the medium to long term we can naturally expect investment managers in the private and
public sectors to take steps to boost returns by diversifying their portfolios through investment in
Asian and other securities markets with considerable growth potential. n fact, the Ministry of
Finance recently announced that it would purchase a modest amount of Chinese government
bonds. While this is an example of portfolio diversification in the public sector, it is safe to assume
that the same thing is going on in many quarters of the private sector.
Domestic Funds Can Finance FiscaI Deficits
My conclusion, therefore, is that because of Japan's huge accumulation of net foreign assets, the
surpluses in the current account are structurally solid and will not easily turn into deficits. Measured
in dollars, these foreign assets have climbed to 3 trilliona level far above the assets held by
other countries (Figure 4). f movements in exchange rates are disregarded, a surplus in the current
account translates directly into a corresponding increase in net foreign assets. And the larger stock
of assets then produces more income gains in the current account.
As long as the current account stays in the black, the government should be able to finance its
fiscal deficits solely with domestic funds, relying on the private sector's excess of saving over
investment. A debt crisis, in other words, will not easily emerge. To be sure, a constant effort must
be made to bring public finance back into equilibrium, thereby lowering the risk of a fiscal crisis.
This is an issue the government leadership views quite seriously. But, unlike the debt crises of
southern Europe, there is little likelihood in Japan of debt-financing problems emerging for
macroeconomic reasons.
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Profile
Sat Takehiro
Chief economist at Morgan Stanley MUFG Securities Co., Ltd., and head of its nterest
Rate Strategy in Japan section. After graduating in 1985 from Kyoto University, where he
majored in economics, he began his career at Sumitomo Bank. n 1999 he joined Morgan
Stanley Securities, and has served in his present posts since 2010.
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(Originally written in Japanese on March 16, 2012.)
[2012.04.20]
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