Japan — still in a desperate struggle to staunch further loss from the horrific earthquake, the aftershocks, the tsunami and the nuclear crisis, and to attend to relief efforts — will face a huge capital financing challenge when it begins to rebuild its infrastructure and economy.
Pension funds and other institutional investors worldwide can play a big role in helping Japan recover by helping supply the needed capital when the country begins the task.
Given its tight financial situation before the crisis, Japan will have to enlist the private sector to shoulder a major part of the capital financing burden.
The Japanese government appears to command great financial resources through its authority to tax and borrow, as well as its monetary policy powers. Still, it likely will encounter obstacles as it seeks to raise the tremendous amount of funding it will need for economic recovery. It already risks having its financing well run dry.
This current fiscal year is the third consecutive one where annual government bond financing provides more of its resources than tax revenue does, according to a report of the Ministry of Finance of Japan. In fact, tax revenue generally has declined since 1990, although there was a projected slight uptick this fiscal year before the disaster. Total outstanding Japanese government debt has risen steadily since 1965, and accounts for a rising share of GDP, now estimated at 138% for fiscal 2011.
Thus, the government has less room to maneuver to deal with the earthquake and tsunami disaster, and the nuclear crisis, because it is so burdened with debt. How will it finance the rebuilding of the cities and towns, highways, railroads, ports and airports, the power grid and the power stations?
Though interest rates on long-term government bonds have fallen steadily in Japan to 1.4%, annual interest payments are rising because the amount of outstanding debt has increased.
The huge amount of debt creates a perverse incentive for government to try to reduce its cost of debt by lowering interest rates, which might help private-sector borrowers but hurts private-sector savers. Such low interest rates hadn't sparked an economic revival prior to the earthquake. Overall, the Japanese government's policies have resulted in a slow-growth economy and a lackluster stock market.
Japan certainly has reached that “next” crisis, which will test its ability to draw down more internal and external financial resources. Therefore, institutional investors will have to carry more of the load, not just by buying government bonds, but by directly financing rebuilding.
But there will have to be a change in attitudes in governments about who should control infrastructure, not just in Japan, but also in the United States, which could supply much of the capital Japan will need.
President Barack Obama, in a speech last April, was dismissive of private-sector willingness to make investments in infrastructure and other public works. “No company is going to make investments for a public good. ... It's not profitable ... it's not a good investment,” according to a White House transcript.
Private investors should not only finance normal corporate and other commercial activity, but could also take on a large role in infrastructure, given the right incentives. In fact, infrastructure is a potential opportunity for private capital to provide innovative financing.
Pension funds, endowments, foundations and other institutional investors have been playing an increasing role in developing and operating infrastructure projects worldwide, displacing much of the activity that has been typically financed and developed through public ownership.
But the Japanese government, and others, will have to be willing to turn infrastructure into an income-generating asset instead of a cost, to free up capital for other governmental purposes.
Given the prospect of an appropriate return, investors can and will assume the risk and provide the capital, and governments should welcome and encourage such activity. Japan should quickly adopt tax and other policies to stimulate private investment directed at replacing the destroyed and damaged infrastructure.