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東京大学公共政策大学院 | GraSPP / Graduate School of Public Policy | The university of Tokyo

Who’s trapped, debtor or creditor?

International politics can mislead our understanding of finances through geopolitically ill-motivated narratives. Geopolitical motives may sound plausible initially but turn out to be a false alarm or groundless. Economic rationale matters for the debtor and the creditor. Global public and private debt ended at 247 percent of the world’s GDP in 2021. Who will eventually be trapped with the debt burden? The answer varies depending on if or when the policymakers take precautionary or remedial action to avoid overburdening current and future generations. Three recent cases of sovereign debt in developing and advanced nations in Asia shed light on this question.

Growing debt on a global scale

Global public and private debt ended at 247 percent of the world’s GDP in 2021. Although down by 10 percentage points from 2020, the size remains almost 20 percent above pre-pandemic levels.

Debt involves two actors, the debtor and the creditor. Those who sign a debt contract to share future net gains are exposed to risks and uncertainties. Suppose future gains from borrowed and invested money appear unattainable unexpectedly or, even worse, fall short of the debt amount. In that case, both actors must agree on sharing the loss. In principle, the debtor must pay the debt principal and interest. But if the debtor cannot pay, the creditor may decide to give up some of its claims.

In the renegotiation, relative bargaining power matters, and either side or both may look debt trapped. Who’s trapped, debtor or creditor? The recent sovereign debt incidents in developing and advanced nations suggest answers to this question. Knowing who is eventually trapped helps us consider a precautionary or remedial action before it becomes too late.

A ‘debt trap’ for a debtor also implies a ‘debt trap’ for a creditor

Laos is currently struggling with heavy debt mainly due to mega infrastructure projects such as the Laos-China railway. Debt stock was projected to increase to over 100 percent of GDP in 2022, and about half is owed to China. Scheduled debt payments of around US$1.3 billion annually until 2026 are below foreign exchange reserves of US$1.1 billion as of September 2022. These will require continued debt service deferral and liquidity provision by China.

However, the claim of Laos being debt-trapped by Beijing’s geopolitical motives is a myth. As a matter of fact, heavily indebted infrastructure projects can affect the fate of debtors and creditors unless they contribute to economic growth and generate sustainable economic and social returns. A ‘debt trap’ for a debtor may imply a ‘debt trap’ for a creditor with non-performing assets. Generally, not only the debtor but also the creditor may go bankrupt if the value of its assets falls short of its liabilities. The government balance sheet gives a comprehensive picture of what the government owns and owes. However, unlike corporations, the sovereign state is not liquidated nor dissolved, instead subject to debt restructuring when it goes bankrupt.

Policymakers’ unwise decisions result in loss sharing among various stakeholders

The debt crisis in Sri Lanka exposed by its default in May 2022 was described as ‘caused almost entirely by unwise policy decisions made by the Rajapaksa administration.’ Sri Lanka’s sovereign debt reached 103 percent of its GDP in 2021. The two-fifths are owed to diverse external creditors, exposing the debtor to complex coordination challenges.

The government reached a staff-level agreement with the IMF in September 2022 on a four-year program supported by a US$2.9 billion financing arrangement. The IMF’s financing precondition was debt restructuring with the country’s diverse creditors and a good faith effort to negotiate with private creditors, most notably international bondholders in the market. Burden sharing among creditors is required in line with a ‘comparability of treatment’ principle. A tug-of-war between official bilateral creditors, such as China, India, and Japan, with respective geoeconomic interests is underway. This will be followed by another between official creditors and profit-motivated private investors. Policymakers’ politically motivated, unwise decisions over the years have resulted in loss sharing between many ordinary Sri Lankans, foreign tax-payers, and wealthy investors.

A shadow of fiscal dominance and a vicious cycle of increasing debt burden

Japan faced a gross debt of 262 percent of its GDP at the end of 2021, nearly doubling since 2000. The Japanese government’s balance sheet shows a negative net worth of 655 trillion yen (US$5.0 trillion)—liabilities exceeding assets—at the end of March 2021. This negative gap might be interpreted conceivably as an invisible asset covered by the tax collection authority.
The people’s ability to pay taxes depends on their income levels and wealth. Japan’s nominal gross national income (GNI) was 576 trillion yen (US$4.4 trillion) in 2021, down from 580 trillion yen in 2019. National wealth was 3,859 trillion yen (US$29.7 trillion) at the end of 2021, over the level at the end of 2000 by a meager 10 percent. In the end, repetitive rhetoric of growth strategies accompanied by politically driven extravagant spending, and its floundering gross national income have dispelled aspirations of economic revitalization. Furthermore, Japan’s shrinking and aging population is depressing growth prospects. The IMF points out the government’s tendency to present optimistic prospects and recommends ‘adopting more realistic projections.’

Who then has been filling the funding gap? The Bank of Japan (BOJ) held 545 trillion yen (US$4.2 trillion) or 45 percent of Japanese government debt securities, constituting 80 percent of the BOJ’s assets at the end of September 2022. The bank’s liabilities were 681 trillion yen, including 493 trillion yen of current deposits, which are liabilities owed to depositors through financial intermediaries. The debt landscape has changed dramatically, with the BOJ’s balance sheet tripling and its holding ratio of the government debt reaching almost half the total, up from 11 percent in 2012.

BOJ’s prolonged purchase of Japanese Government Bonds (JGBs) since 2013 has allowed the affordability illusion of government borrowing to persist and created distorted bond market conditions. One economist stated ‘the BOJ is effectively the only willing purchaser in the market for JGBs.’ The BOJ continues price-supporting operations for JGBs under the ‘yield curve control’ policy to drive down long-term bond yields. In January 2023, the BOJ decided to maintain its policy to purchase JGBs without setting an upper limit to allow ten-year JGB yields to remain at around zero percent. The purchase hit a monthly record of 24 trillion yen. The government and the BOJ are trapped in a vicious cycle of excessive debt burden, under the shadow of fiscal dominance by the central bank capping interest rates to reduce the costs of servicing government debt.

Economics tells us that Japan cannot maintain low-interest rates, a stable yen and free capital flows simultaneously, known as ‘the impossible trinity.’ The yen, staying around 130 per US dollar, lost value since the beginning of global monetary tightening trends and is 42 percent cheaper than its highest value of 76 yen per dollar in January 2012. A weaker yen implies the products and services offered by the Japanese labor force are at bargain prices. At the same time, households face import-induced price hikes. Core consumer prices rose by 4.2 percent in January 2023 compared to the year before, the highest since 1981. A rise in interest rates will soon become inevitable despite the BOJ’s insistence on easing monetary policy.
Since the BOJ’s holding is backed by liabilities owed to depositors through financial intermediaries, the BOJ is not the lender of last resort to the government. Instead, it owes a debt to households and the non-financial corporate sector. Other than the BOJ, institutional and overseas investors held 37 and 14 percent of Japanese government securities, respectively, at the end of September 2022. Such creditors do not tolerate the real value of their assets dropping due to inflation and ask for higher interest rates to compensate for the lost value.

Three insights into sovereign debt

Three insights into sovereign debt can be gleaned from these cases. First, sovereign debt can be sustained only by growing the economy, which enlarges a shared pie between debtor and creditor.

Second, political motives cannot survive market forces over the long term. Politically motivated narratives negate a sense of urgency, prolong the affordability illusion, and postpone needed actions.  A country’s bargaining power is submissive to market forces, which do not wait forever and penalize unwise policy decisions. How long can Japan escape the ‘moron risk premium’ before its central bank is depleted, in contrast to the UK?

Finally, geopolitical motives surrender to economic rationale. International politics may first mislead us through ill-motivated narratives, such as the debt trap diplomacy claim and a campaign for enhanced defense capabilities against security threats. However, economic rationale matters for the stakeholders, including the debtor and the creditor. When nations get caught in spiraling debt, future generations end up paying the price. Who eventually can be trapped with the debt burden? The answer varies depending on if or when the policymakers take rational precautionary or remedial action to avoid overburdening the current and future generations. We are responsible for the future of our children and theirs.


This blog post is the original version of the article titled “Creditors, politicians and ‘morons’: who’s really caught in the government debt trap?” published on February 27, 2023, as part of the Special Report “Governments in the Red” by 360info. 360info is an independent nonprofit public information service with headquarters in Melbourne hosted at Monash University, Australia’s largest and most globally connected university with campuses worldwide.

西沢 利郎

Toshiro Nishizawa

Toshiro Nishizawa is a Professor at the Graduate School of Public Policy, the University of Tokyo since July 2013 after serving at the Japan Bank for International Cooperation (JBIC). Early in his career, he spent years working at Japan’s EXIM Bank, the Ministry of Foreign Affairs, the IMF, and the World Bank. He has been actively engaged in policy dialogue and research activities with his interests in Asian economies, financing for development, Public-Private Partnerships (PPPs), and sovereign debt. He has been a senior visiting fellow at the Policy Research Institute (PRI) of the Ministry of Finance (MOF). Japan International Cooperation Agency (JICA) invited him as the lead researcher under Joint Policy Research and Dialogue Program for Fiscal Stabilization in Lao PDR (2018-2020). He received “Foreign Minister’s Commendations for FY2022” for his contribution to deepening the cooperative relationship between Japan and Laos. He holds a BA in Latin American studies from the Tokyo University of Foreign Studies (1982), a BA in economics from the University of Tokyo (1984), and an MSc in economics from the University of Wisconsin-Madison (1988).